updated 4/7/2008 8:15:41 PM ET 2008-04-08T00:15:41

A federal appeals court on Monday threw out a $1 million punitive damage award to a Mississippi couple who sued the nation's largest insurance company over Hurricane Katrina damage.

The 5th U.S. Circuit Court of Appeals in New Orleans also ordered a new trial for the lawsuit that Norman and Genevieve Broussard filed against State Farm Fire and Casualty Co. after the August 2005 hurricane.

A jury in Gulfport, Miss. awarded $2.5 million in punitive damages to the Broussards in January 2007. U.S. District Judge L.T. Senter Jr. later reduced that amount to $1 million.

But a three-judge panel from the 5th Circuit vacated the entire award, saying Senter shouldn't have allowed jurors to consider punitive damages in the case.

The appeals court also ruled that Senter erred when he took part of the case out of jurors' hands and held State Farm liable for $223,292 in wind damage to the Broussards' Biloxi home.

The 5th Circuit said a "rational jury" could have sided with State Farm and concluded that Katrina's water destroyed the home. State Farm and other insurance companies say their homeowner policies cover damage from a hurricane's wind but not its water.

Senter concluded State Farm acted in a "grossly negligent way" by denying the Broussards' claim. The judge also said the company denied policyholders' Katrina claims based on a new "wind-water" protocol that is "at odds with other express terms of the insurance contract."

However, the 5th Circuit said State Farm had an "arguable basis" for denying the couple's claim based on observations made by one of the company's adjusters.

"Even after extensive investigations by both parties, the question of whether the Broussards' property was first destroyed by wind or water remains an extremely close one," the judges wrote in their 18-page ruling.

Hundreds of policyholders in Mississippi have sued their insurer for denying their claim. The Broussards' case was the first to be tried before a federal jury in Mississippi.

State Farm spokesman Phil Supple said the ruling confirms the company's belief that Senter should have allowed jurors to distinguish between damage from wind and water to the Broussards' home.

"It has also been our belief there was no basis for punitive damages, and the appellate court agreed," Supple added.

William Walker, a lawyer for the Broussards, said he was disappointed but not surprised by the court's ruling.

"If we retry the case, we fully anticipate that we will be able to get a jury verdict in our favor for the entire policy limits," he said.

Walker also hailed a portion of Monday's ruling as a victory for policyholders: The 5th Circuit rejected State Farm's claim that the Broussards had the burden of segregating covered damages, such as wind, from non-covered damages, like flood water.

"It will help every other person who has to sue an insurance company in Mississippi," Walker said of that finding.

The 5th Circuit also found that Senter didn't abuse his discretion by holding the trial on the coast. State Farm, citing possible bias among potential jurors in southern Mississippi, had asked him to move the trial to the northern part of the state.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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