Howard bases his claim for punitive damages on two grounds. To avoid the chilling effect of punitive damage suits and to allow insurers to dispute their liability in good faith, the insured must present clear and convincing evidence of the insurer's bad acts. Additionally, Indiana courts have allowed punitive damages when an insurer investigating a claim that it reasonably believes was fabricated by the insured prejudices the insured's ability to prove his innocence by delaying and misrepresenting the true nature of the investigation. 599, 349 N.E.2d 173 (1976) (insurer refused to pay or negotiate the insurance policy proceeds until the insured procured a release from an associate on an unrelated claim, a service to which the insurer was not entitled). 308, 323 N.E.2d 270 (1975) (insurer asserted a defense after a limitations period had expired knowing, as a matter of law, that the defense was no longer available) Vernon Fire & Casualty Ins. The insured may recover punitive damages if he is able to demonstrate that the insurer was acting in bad faith in denying the claims specifically, 'bad faith means knowledge by that it had no legitimate reason for denying 's claim, but nevertheless refused it.' Id.

the public interest is served by the deterrent effect of the punitive damages award.' Id. As an exception however, Indiana courts will allow the imposition of punitive damages, 'where the breach also includes conduct (1) which independently establishes the elements of a common law tort such as fraud or (2) where elements of fraud, malice, gross negligence or oppression mingle in the controversy.

The general rule in Indiana is that punitive damages are not recoverable in contract actions. Additionally, Howard sought punitive damages under both policies contending that Continental, 'willfully, wantonly, maliciously, oppressively, and in bad faith, refused, without legal cause, to meet its contractual obligations' under the insurance policies. Howard counterclaimed for the proceeds of the insurance policy covering the factory ('factory policy') and for the value of a truck destroyed in the fire, also insured by Continental under a separate automobile business policy ('automobile policy').

Continental initiated a declaratory judgment action in the United States District Court for the Northern District of Indiana to determine its liability under the policy. After investigating the cause of the fire, the insurer, Continental Casualty Company ('Continental') concluded that the fire had been set by an arsonist, and that the circumstances surrounding the fire indicated that the owner, Howard, was the arsonist, and that the business' financial condition had deteriorated during the past three to four years. * This litigation, in federal court under our diversity jurisdiction, arose out of the destruction by fire of the defendant's roof-truss factory in LaFayette, Indiana in January of 1981.

Roger bennett lafayette