Property & Casualty Insurance Archives - Page 2 of 4

We do not normally focus on dissents in our blogging but we made an exception here with a published Per Curiam opinion from the Ninth Circuit Court of Appeals, Guam Industrial Services, Inc. v. Zurich American Insurance Co., 2015 DJDAR 5948 (9th Cir. June 1, 2015). This insurance coverage case arose out of the sinking of a dry dock, loaded with barrels of oil, during a typhoon on Guam. The issues pertain to whether either of two insurance policies covered costs of damage to the dock and the associated cleanup which was accomplished before any of the oil leaked out of the containers into the Pacific Ocean. Guam Industrial Services, Inc. (“Guam Industrial”) owned the dry dock. At the time of the sinking, one of its insurance policies, an Ocean Marine Policy, covered liability for property damage caused by pollutants, issued by Zurich American Insurance Company (“Zurich”). After the dock sank, Guam Industrial filed a claim under each policy. Zurich denied the claim, and Guam Industrial brought suit. The district court granted summary judgment for the insurers, finding that the first policy was voidable because Guam Industrial had failed to maintain the warranty on the dock, and that the coverage under the second policy was never triggered because no pollutants were released. Guam Industrial appealed the decision and the Ninth Circuit affirmed.

The court found no ambiguity in the terms of the policy, and under the ordinary meaning of the relevant endorsement, Zurich would have to provide coverage of Guam Industrial’s damages if either oil or pollutants were discharged into the water. However, the court determined that although the barrels or containers were discharged, the oil was not. The parties agreed that the oil remained sealed inside its containers at all relevant times. Thus, the majority found that under the ordinary meaning of applicable endorsement, Zurich’s coverage was not triggered by a “discharge, dispersal, release, or escape” of oil. Furthermore, it ruled that sealed containers did not qualify as “pollutants” under the plain meaning of the Policy, which limited the term “pollutants’ to chemicals and other hazardous substances.

Judge Alex Kozinski dissented. His incendiary comments on Zurich’s actions are particularly notable:

If you slap a silk suit on a monkey, you still won’t want to take it to the prom. And if you pour crude oil into a barrel, you still won’t want it in your hot tub.

Zurich’s Ocean Marine Policy covers claims “arising out of the discharge, dispersal, release, or escape of . . . oil . . . or pollutants into . . . any watercourse or body of water.” Guam Industrial paid for this coverage and Zurich happily accepted the premiums. (Insurance companies seldom have trouble with this part of the bargain.) What risk was Zurich paid to assume? The risk that something nasty would get into the water and Guam Industrial would be under a legal obligation to clean it up. That’s just what happened here: Some very nasty stuff—barrels containing over 100,000 gallons of industrial oil—plunged into the harbor when the dry dock sank. To no one’s surprise, the Coast Guard immediately issued Guam Industrial a clean-up notice. This wasn’t an invitation to the prom; it was a clean-up-or-else-we’ll-do-it-ourselves-and-make-you-pay-through-the-nose notice . . . .

Like the majority, I start with the dictionary definitions of “discharge,” “dispersal,” “release” and “escape” to ascertain their ordinary meaning. A “discharge” is a “release from confinement, custody, or care.” Merriam-Webster’s Collegiate Dictionary 356 (11th ed. 2003). A “dispersal” is the act of “spread[ing] or distribut[ing] from a fixed or constant source.” Id. at 361. A “release” is the act of “set[ting] free from restraint [or] confinement,” id. at 1051, and an “escape” is “flight from confinement,” id. at 425. The majority concludes that “barrels or containers were discharged, dispersed, and released” from the dry dock. Op. at 11. It then follows that the contents of those barrels were likewise “discharged, dispersed, and released” from the dry dock.

Let’s say you place your cell phone in your backpack while hiking, and the backpack falls into a crevice and can’t be recovered. You’d certainly be right in claiming that you lost your cell phone, even though the phone is still inside your backpack. What matters is that the backpack and its contents are no longer in your control. If the phone was insured against loss, no insurance company (except maybe Zurich) would claim that the phone isn’t lost because it’s still inside your backpack.

* * *

No rational dry dock owner would buy a policy that covers government-ordered pollution clean-up if containment vessels filled with toxic waste break apart upon sinking but not if they remain intact. It’s absurd. Zurich’s denial of coverage is the type of slimy conduct that gives insurance companies a bad name. This opinion should serve as fair warning to those who would throw away good money doing business with Zurich.

Judge Kozinski will not be taking Zurich to the prom any time soon.

When a covered property is damaged, the insured may face a quintessential Catch-22—the insured cannot afford to proceed with costly repairs or replacement without insurance money, but until the repairs or replacements are finished, the insured cannot recover under the replacement cost provision of the liability policy. A recent court decision held a policyholder must actually repair or replace the damage in order to claim replacement cost value, but may recover a “conditional judgment” for replacement cost benefits and satisfy the condition after trial. Stephens & Stephens XII, LLC v. Fireman’s Fund Insurance Co., 2014 Cal. App. LEXIS 1073, 2014 WL 6679263 (Cal. App. 1st Dist. Nov. 24, 2014) (“Stephens”). Stephens fashions a pragmatic approach whereby insurers can condition payment on actual replacement, while policyholders preserve their rights to benefits after proving coverage.

The case involved a vacant, industrial warehouse owned by Stephens & Stephens XII, LLC (“Stephens XII”), which was covered under a commercial property insurance policy issued by Fireman’s Fund Insurance Co. (“Fireman’s Fund”). The insurance policy initially covered liability, and subsequently, Stephens XII added property damage coverage. The updated policy covered loss from property damage, including rent, and provided two different measures for reimbursement of covered damages: Stephens XII either could recover the replacement cost, or full cost of repairing the damage, so long as the repairs were actually made promptly or as soon as reasonably possible, or the actual cash value, or depreciated value of the damaged property.

Three days after the property damage coverage became effective, Stephens XII discovered large scale vandalism and theft by burglars who stripped all the electrical and conductive materials on the covered property, causing an estimated $1 million in repairs. Stephens XII filed a claim, but Fireman’s Fund delayed resolution of the claim, asserting that given the extensive scope of the vandalism, the damage must have occurred before the policy effective date. Stephens brought suit against Fireman’s Fund for breach of contract and breach of the implied covenant of good faith and fair dealing. Five years later, and one month before the trial, Fireman’s Fund denied coverage. As of the trial date, Stephens XII had yet to repair the damage. Regardless, in a special verdict, the jury awarded Stephens XII the “Replacement Cost,” plus over $2 million in lost “Business Income” for breach of contract, but denied damages for repair and lost profits and awarded $436,896 in “lost rents” as bad faith damages and awarding no damages for loss of rental value.

The trial court granted a judgment notwithstanding the verdict (“JNOV”), holding the terms of policy did not require Fireman’s Fund to pay replacement cost until the property damage was actually repaired or replaced, and such repairs had not been made. Replacement cost insurance, which typically places the insured in a better position than before the loss, creates a moral hazard that the insured will intentionally destroy property and recover under the policy. Therefore, replacement coverage typically requires as a condition to recovery that the insured actually repair or replace the damaged property before the insurer will pay the replacement cost. Generally, policies provide that the actual repair or replacement must occur as soon as possible.

The court noted that often, a policyholder with replacement cost coverage could claim an immediate payment based on the actual cash value to use as seed money to start the repairs. Here, claims discussions were in vain, with Stephens XII taking no steps to make repairs, and Fireman’s Fund never accepting coverage. Stephens XII did not ever seek the actual cost value to use as “seed money” to begin repairs and instead sought the replacement cost value with making any repairs, and sought its lost income. Because Stephens XII did not seek actual cost value and did not repair the damage, the trial court ruled that neither award was warranted. Next, the court rejected the jury award for lost business income. The policy contained a provision under which Fireman’s Fund agreed to pay for “actual loss of Business Income and Rental Value” sustained “due to the necessary suspension of operations during the period of restoration.” The court explained Stephens XII did not sustain losses because potential income lost from a failed property sale did not constitute “business income,” and Stephens XII did not suffer business losses as it did not conduct business at the property, as required by the policy.

On appeal, the Court of Appeal reversed, holding that Stephens XII was entitled to a conditional judgment awarding the replacement value, so long as the repairs were actually made. The court first confirmed that the trial court properly interpreted the contract as stating Stephens XII could claim either replacement cost, only if it actually repaired the damage, or actual cost value, which it did not claim. Further, there was no dispute that Stephens XII did not actually repair the damage, and therefore it was not entitled to replacement cost under the policy. The only issue to resolve was whether Stephens XII was excused from repairs based on Fireman’s Fund’s actions.

Stephens XII successfully argued its failure to repair was prevented by Fireman’s Fund’s failure to accept coverage. The court upheld the jury finding that there was significant evidence of Fireman’s Fund’s refusal to cover the loss which made it difficult for Stephens XII to repair the property. The court held that an insurer’s failure to pay a claim excused the procedural requirements (i.e., time restrictions), but not the insured’s underlying obligations (to repair the building) under the policy. However, the insured was entitled to a conditional judgment for replacement costs conditioned on the insured’s completion of repairs promptly after judgment. The Court of Appeal explained:

If coverage is ultimately resolved in favor of the insured, the insured should remain eligible to receive replacement cost, but only so long as the insured complies with other applicable policy terms, such as a repair requirement. In other words, a coverage dispute should not give the insured a benefit under the policy it never had in the absence of the dispute—such as the right to receive the replacement cost without actually repairing the damage.

The court rejected Stephens XII’s arguments that Fireman’s Fund waived, and was estopped from asserting, its right to demand compliance with the repair provision because it failed to communicate this demand in its correspondence. The court noted that California courts adhere to the general rule that waiver requires an insurer intentionally relinquish its right to deny coverage, and a failure to raise one basis for a denial in a denial letter may not reflect an intention to waive that reason. Here, Stephens XII did not provide sufficient evidence that Fireman’s Fund intended to waive the repair requirement.

Finally, the court upheld the jury’s verdict of $436,896 in “lost rents.”

Stephens identified a problematic issue in recovering replacement cost under a property damage policy and fashioned a rarely used judicial remedy by permitting a conditional judgment of award of replacement/repair costs. This solution seems appropriate and allows an insured to establish its right to coverage under a policy where the insurer denied coverage by requiring insurers to pay the replacement value once repairs are made.

The April 21, 2014 edition of the Los Angeles Daily Journal featured Robert McKennon’s article entitled: “New Liability for claim adjusters the right move.” In it, Mr. McKennon discusses a new case which exposes insurance adjustors to negligent misrepresentation and intentional infliction of emotional distress claims by policyholders. The article is posted below with the permission of the Daily Journal.

New liability for claims adjusters the right move

After filing an insurance claim, it is not uncommon for an insured to receive unfair treatment from the claims adjuster assigned by the insurer. For example, a claims adjuster may misrepresent the value of a claim or misstate policy coverage. An insured can, of course, bring claims for breach of contract and insurance bad faith against the insurer for such improper actions; however, it is well-established that under California law, insureds cannot sue the claims adjuster for breach of contract or insurance bad faith. See Sanchez v. Lindsey Morden Claims Services Inc., 72 Cal. App. 4th 249 (1999).

But can an insured sue a claims adjuster for negligent misrepresentation or intentional infliction of emotional distress? The state Court of Appeals, in Bock v. Hansen, 2014 DJDAR 4280 (Apr. 2, 2014), held that they can. Bock is the first case to extend liability for certain claims handling actions to adjusters.

Michael and Lorie Bock purchased a homeowner’s policy from Travelers Property and Casualty Insurance Co., which covered physical loss to their home and the cost of debris removal. After a tree limb collapsed onto the Bocks’ home and caused substantial property damage, the Bocks reported the incident to Travelers, which assigned Hansen, a claims adjuster to handle the claim. The Bocks allege that the adjuster spent no more than 15 minutes at the scene, altered the scene to downplay the severity of the damage, and falsely informed the Bocks they were not covered for debris removal.

Subsequently, the Bocks discovered and reported additional damage to their chimney. Travelers sent Hansen again, despite the Bocks’ protests. Hansen again told the Bocks their policy did not cover “cleanup,” and the Bocks, relying on this representation, began cleaning the debris themselves. Later that day, Travelers sent Vertex Construction Services, a company without a valid contractor’s license, which assessed the damage and issued a false report understating the extent of the damage. Based on Vertex and the adjuster’s estimates, Travelers issued a check in an amount barely enough to cover the costs of tree removal, let alone to cover the damage caused, and denied coverage for the chimney damage. The Bocks submitted additional information, including a licensed contractor’s review and response to the Vertex report, for a reconsideration of their claim, but Travelers never responded.

Subsequently, the Bocks filed a complaint against Travelers, the adjuster and Vertex for, among other claims, breach of contract, bad faith, negligent misrepresentation and intentional infliction of emotional distress. The trial court sustained demurrers to these actions without leave to amend. The Bocks appealed.

The Court of Appeal reversed and upheld the negligent misrepresentation claim and granted the Bocks leave to amend their IIED claim. The court noted that insurers were in a “special relationship” with insureds, “akin to a fiduciary relationship,” and therefore owed insureds a duty to perform their responsibilities in good faith. Because Travelers was in a special relationship with the Bocks, Hansen, its employee, owed certain legal duties to the Bocks as well.

Courts focus on two circumstances in finding negligent representation liability: (1) where providing false information poses a risk of, and results in, physical harm to a person or property and (2) where the information is conveyed in a commercial setting for a business purpose. Here, the court found both circumstances applied — Mrs. Bock was physically harmed while cleaning up broken glass around the tree limb, and Hansen misrepresented Travelers’ scope of coverage for a business purpose.

The court also explained an agent or employee is always liable for his or her own torts, even when acting within the scope of his or her agency or employment: “Hansen also argues that he cannot be liable as an agent because he was acting in the course and scope of his employment. The complete answer is found in the terse statement of the rule in Witkin: ‘An agent or employee is always liable for his or her own torts, whether the principal is liable or not, and in spite of the fact that the agent acts in accordance with the principal’s directions. Similarly, an agent who commits an independent tort, such as fraud, remains liable despite the fact that the principal, by ratification, also becomes liable.’” (Emphasis added).

The court distinguished cases involving an insurance agent rather than a claims adjuster, and dismissed the argument that reliance on any misrepresentation was unjustified because the policy itself stated otherwise. Indeed, California courts do not allow a duty-to-read-the-insurance-policy defense when agents make representations to insureds about policy coverage. The court explained that insurance policies are complicated legal contracts and “[a]bsent some notice or warning, an insured should be able to rely on an agent’s representations of coverage without independently verifying the accuracy of those representations by examining the relevant policy provisions.”

Additionally, the court rejected the argument that the Bocks were on notice as to coverage since the Bocks began cleaning up prior to receiving an estimate based on Hansen’s misrepresentation, and sustained damages despite the minimal amount paid by Travelers.

Finally, the court ruled that insureds may assert IIED claims against claims adjusters, but found that the Bocks did not adequately plead the claim. The Bocks alleged that Hansen engaged in outrageous conduct by, among other things, ignoring evidence of coverage, altering the accident scene to deny coverage, creating a false report regarding damage to the Bocks’ property, and denying the claim for chimney repair when Hansen knew it was the Bocks’ primary source of heat. Ultimately, the court was not persuaded that these allegations constituted extreme and outrageous conduct as a matter of law. However, because the Bocks identified a litany of other allegations they could assert in an amended complaint that constituted outrageous conduct and caused them severe emotional distress, the court permitted the Bocks to amend their claim to support an IIED claim.

Bock is a well-reasoned, policyholder-friendly decision that expands liability to claims adjusters, such that adjusters may be liable for negligent misrepresentation and IIED. Based on the holding, there is no reason to believe that intentional misrepresentation claims cannot also be asserted in the proper circumstances. Claims adjusters are often the face of the insurer. They are expected to know the policy terms and coverages and to apply them in good faith to a given set of facts to determine coverage. When claims adjusters misrepresent policy terms or assert facts that they know, or should know, are false and when they know or believe that the insureds will rely on them to their detriment, it is not unreasonable to hold them accountable. It will be up to policyholders’ attorneys to determine if suing adjusters adds any value to their case. In most cases it will not, but it may in some situations, be just the right remedy and it may even mean the difference between litigating in state court vs. federal court as naming a local claims adjuster could act to defeat diversity jurisdiction in federal court.

Commercial property owners may recover lost rental income from their insurer if they are unable to rent out damaged property, absent clear policy exclusions. The California Court of Appeal recently held the owner of commercial property has a reasonable expectation of coverage for loss of rent, even if the property was not leased out at the time the damage occurred. Ventura Kester, LLC v. Folksamerica Reinsurance Company, 2013 DJDAR 12253 (September 11, 2013). The court explained that if insurers want to limit loss of rent coverage to leases in force at the time of the damages occur, such limitations must be plainly stated in the policy. Ventura is significant because it limits insurers’ abilities to take advantage of ambiguous policy language as a means to deny coverage.

The case involved a commercial building owner, Ventura Kester, LLC (“Ventura”), whose property and casualty insurance policy covered up to $2.76 million for structures and $552,000 for loss of rents resulting from damage to the covered structure. The insurance company, Folksamerica Reinsurance Company (“Folksamerica”), agreed to cover “net loss of rental income” and “rents accrued but rendered uncollectible by reason of a covered loss.” At the time the policy was issued, the commercial building was leased to a tenant. The tenant later vacated, and Ventura sought prospective tenants, including OfficeMax, Equinox Fitness Club and Crunch fitness club. However, before Ventura could execute a lease agreement, thieves broke into the building and stole copper wire and pipes. Adjusters discovered additional vandalism and estimated the total cost of repair to be $1 million. In addition, a construction company estimated the repairs would take up to one year.

Based on these assessments, Folksamerica provided Ventura with two checks for $383,989.90 and $128,973.71 to repair the damage. However, Ventura could not begin repairs until the claim was paid in full. Folksamerica paid Ventura $414,460.42 for property damage claims, but denied Ventura’s claim for loss of rents because no lease was in effect at the time of loss.

Following the denial, Ventura filed an action against Folksamerica for breach of contract and breach of the covenant of good faith and fair dealing. Ventura claimed Folksamerica’s failure to pay the entire claim caused a total loss of rent in the amount of $3.8 million. Folksamerica filed a motion for summary judgment, claiming Ventura could not establish it lost rent due to the property damage. Ventura opposed the motion, arguing that the policy did not require an executed lease, and also that whether the lost rent was due to property damages was a triable issue of fact. The trial court granted summary judgment for Folksamerica, stating the policy language did not provide coverage for lost rent when a building was vacant.

Ventura appealed the summary judgment, arguing the policy covers lost rents due to property damage, regardless of whether there was a tenant. Folksamerica again asserted that Ventura was required to have a tenant in place to recover lost rent under the policy. The California Court of Appeal reversed lower court, and awarded Ventura its costs on appeal, stating that:

If the insurer had wanted to limit the recovery or calculate the rents based on existing tenants at the time of the building damage, it clearly could have written the policy to provide that.

In its decision, the Court of Appeal noted that policy was ambiguous, and a reasonable policyholder would expect to recover lost rents due to property damages. The court further explained that if an insurer wanted to limit loss of rents to periods when the property was leased, and exclude periods where the property was vacant, the insurer should have expressly stated that in the policy. The court cited Whitney Estate Co. v. Northern Assurance Co. of London, 155 Cal. 521, 522 (1909), which permitted contracting parties to stipulate a reasonable method for computing loss of rents due to damaged and vacated property. In Whitney, the insurance policy calculated coverage based on covered “actual loss of rent.” Calculations of actual loss was limited to the period when the damage occurred until repairs made the building was “tenable,” and profits from rentals in place at the time of damage. The court also recognized the validity of vacancy provisions, and noted such provisions were absent in the present policy. Therefore, Folksamerica could not rely on MDW Enters. V. CNA Ins. Co., 4 A. D. 3d 388 (N.Y. App. Div. 2004), where an insurer’s policy clearly excluded coverage when the building had been vacant for over sixty days before the occurrence. The Court of Appeal noted that Folksamerica’s policy did not specify such express limitations or methods of calculating loss. Finding that the policy language failed to clearly limit coverage, the court applied a reasonable interpretation of the policy and rejected the limitation.

The Court of Appeal also determined that whether Ventura could establish actual loss of rents was a triable issue of fact. On one hand, Folksamerica presented evidence that Ventura’s potential tenants declined to rent the building due to reasons other than property damage. In contrast, Ventura presented evidence of a long-term lease in place prior to the damage, a list of prospective tenants, and OfficeMax’s decline to rent was due in part to the delay in resolving the insurance claim. A trier of fact could have determined that but for the property damages, Ventura would have secured a tenant. Therefore, the court determined summary judgment was inappropriately granted.

Ventura is an important decision because it prevented insurers from denying coverage absent clearly stated exclusions. Although the court recognized the validity of exclusionary provisions and calculations limiting recovery, the court refused to apply Folkamerica’s broad reading of its policy. The court’s decision adheres to established contact law principles by construing ambiguous language against the drafting party, or insurer.

In a recent ruling, the California Court of Appeal held that an insurer’s general reservation of rights to deny coverage of damages outside its policy does not create a conflict of interest with the insured, such that the insured in entitled to Cumis counsel. The decision in Federal Insurance Co. v. MBL, Inc. __ Cal. App. 4th __, 2013 Cal. App. LEXIS 679, 2013 WL 4506149 (August 26, 2013) follows California precedent denying insureds the right to select independent counsel at the insurer’s expense absent an actual conflict of interest.

The case arose out of United States v. Lyon, an action by the Federal government against Halford’s Cleaners, for soil and groundwater contamination. Halford’s, a dry cleaning facility, filed third party actions against the suppliers of dry-cleaning products, including defendant MBL, Inc. (“MBL”). MBL’s insurers retained counsel for MBL, but asserted a general reservation of rights to deny coverage for damages occurring beyond the policy period and in excess of the policy amount. However, the reservation of rights did not address any specific policy exclusions. MBL alleged that their insurers’ reservation of rights created a conflict of interest such that MBL was entitled to choose an independent counsel (known as Cumis counsel) at the expense of the insurer. The trial court granted summary judgment in favor of the insurers, finding there was no actual conflict of interest. On appeal, MBL contended the trial court erred in finding the insurers were entitled to declaratory relief.

The Court of Appeals affirmed, analyzing and rejecting each of MBL’s arguments that a conflict of interest existed requiring Cumis counsel. The Court explained that:

Without an express reservation of a right under the policy, there can be no conflict of interest based on the application of that exclusion or policy term during the pendency of the action. (Emphasis added.)

First, the court rejected MBL’s contention that a general reservation of rights creates a conflict of interest, stating at most, they create a theoretical, potential conflict of interest, which is not sufficient to trigger the right to Cumis counsel. Next, MBL argued the policy exclusions create a conflict because the appointed counsel would have an interest in establishing policy exclusions, such as when the damages occurred. The Court rejected this argument, holding that MBL and the insurers’ interests were aligned because it is in the interest of both parties’ interest to avoiding liability, and defense counsel could not control the issue of when such damages occurred. Furthermore, no conflict exists because insurer’s retained counsel has no control over whether exclusions apply.

Finally, that Court found that, although MBL and select third party plaintiffs in Lyons shared the same insurance company, there was no per se conflict of interest because the insurer’s interest ultimately remained in indemnifying their insureds against judgment. The court noted the insurers retained different law firms for these plaintiffs, assigned different claims adjusters and ensured the adjusters did not have access to each other’s files.

The trial court granted declaratory relief for the insurers stating that absent a conflict, insurers were not obligated to provide independent counsel. Furthermore, MBL’s refusal to accept appointed counsel relieved the insurers of their contractual obligation to defend MBL.

Ultimately, the California Court of Appeal agreed that MBL failed to establish a significant and actual conflict of interest, and their insurers’ were therefore not obligated to retain independent counsel. A general reservation of rights is not enough to create a conflict of interest; instead, the parties’ interests must be analyzed to determine whether the interests can be reconciled. The ruling therefore affirms the San Gabriel Valley Water Co., 82 Cal. App. 4th 1230 (2000) decision that insured parties are not entitled to Cumis counsel absent a showing of an actual conflict of interest with the insurer.

A recent California Court of Appeals decision sought to clarify the application of California Insurance Code Section 533.5(b) concerning the statute’s preclusion of an insurer’s duty to defend its insured in criminal actions. In Mt. Hawley Insurance Co. v. Richard Lopez, Jr.,__Cal.App.4th___, 2013 Cal. App. LEXIS 346 (May 1, 2013) the Court of Appeals held that Section 533.5 (b) is not applicable to criminal actions brought by federal prosecuting authorities, and thus is limited to precluding the insurer’s duty to defend its insured in state criminal actions brought by the Attorney General, any district attorney, any city prosecutor, or any county counsel. The Court importantly held that the insurer’s Motion for Adjudication of the insured’s bad faith claim should be denied given the insurer’s potentially unreasonable actions even though the insurer gave a reasonable interpretation to an insurance code section.

In Mt. Hawley, the Court of Appeals addressed the appeal of a summary judgment motion and a demurrer concerning the extent of Section 533.5 (b)’s preclusion of the duty to defend. This case arose out of an indictment of the insured by the United States Attorney for the Central District of California for allegedly committing a criminal conspiracy, making false statements, concealing fraudulent actions, and falsifying records. The charges were brought based upon the insured’s alleged participation in a conspiracy to falsify records to move a patient up the transplant waiting list, which consequently resulted in the death of another patient. The Policy at issue stated that the insurer, “shall have the right and duty to defend any Claim covered by this Policy, even if any of the allegations are groundless, false or fraudulent.” The definition of clam in the policy’s endorsement included a criminal proceeding against any insured commenced by an indictment. However, the Insurer rejected the insured’s tender a defense based upon its belief that Section 533.5 (b) precluded the duty to defend in all criminal matters.

The Court of Appeals reversed the District Court’s grant of summary judgment. The court first noted that Bodell v. Wallbrook Insurance Co., 119 F.3d 1411 (9th Cir. 1997) held that Section 533.5 (b) applies to criminal actions brought by the four listed state and local agencies, but does not apply to criminal actions brought by federal prosecutors. However, in the Bodell decision, the Ninth Circuit did not engage in the three-step analysis for statutory interpretation required under California law, and did not specifically address whether or not Section 533.5 (b) precluded an insurer from providing a defense in all criminal actions, including federal criminal actions. Thus, the Court of Appeals analyzed the statute to determine: 1) whether the plain language of the statute is susceptible to only one reasonable interpretation; 2) the purpose behind the statute; and 3) whether, “reason, practicality, and common sense to the language at hand,” mandated a conclusion that the statute required that the insurer defend and indemnify the insured.

(b) No policy of insurance shall provide, or be construed to provide, any duty to defend, as defined in subdivision (c), any claim in any criminal action or proceeding or in any action or proceeding brought pursuant to Chapter 5 (commencing with Section 17200) of Part 2 of, or Chapter 1 (commencing with Section 17500) of Part 3 of, Division 7 of the Business and Professions Code in which the recovery of a fine, penalty, or restitution is sought by the Attorney General, any district attorney, any city prosecutor, or any county counsel, notwithstanding whether the exclusion or exception regarding the duty to defend this type of claim is expressly stated in the policy.

The Court of Appeals found that Section 533.5 (b) was susceptible to three different interpretations as to the preclusion of the insurer’s duty to defend in criminal actions, and determined that the statute was therefore ambiguous and necessitated an interpretative analysis of the statute’s legislative history. Upon review of the legislative history of Section 533.5 (b) the Court of Appeals found the statute had been intended to address a very specific problem the State Attorney General was experiencing in litigating Unfair Competition Actions (Cal. Bus. & Prof. Code § 17200) and False Advertising Actions (Cal. Bus. & Prof. Code § 17500). The State Attorney General’s Office found itself filing actions against a business or an individual, only to proceed into litigation of the matter against a defense tendered by an insurance company, while the individual/business whose conduct violated the provision(s) was not being held directly accountable. Therefore, the purpose of Section 533.5 (b) was to facilitate consumer protection activities, while alleviating the burden being placed on the local prosecutorial resources from the pro-longed litigation battles with insurance defense teams.

The Court of Appeals found the application of reason, practicality, and common sense unnecessary, but proceeded through the final step to provide further support of its holding that Section 533.5 (b) did not apply to criminal actions brought by federal prosecutors. The Court of Appeals found unpersuasive the insurer’s argument that there was a strong public policy of barring insurance coverage to discourage certain types of behavior, and remarked that the public policy concerns applied to indemnification of an insured rather than the defense of an insured. The Court Appeals rejected the insurer’s argument that the Court’s interpretation of Section 533.5 (b) would create a potential conflict with California Insurance Code section 533.5, subdivision (a), explaining that the latter dealt with indemnification of fines, penalty or restitution of in a criminal action or proceeding rather than a duty to defend. Nor did the Court of Appeals find any merit in the insurer’s argument that its interpretation of Section 533.5 (b) would conflict with statutes in the Corporations Code and Government Code. Instead, the Court of Appeals found that its interpretation brought harmony to the code section, and assisted in practically applying the intent the Legislature had when drafting Section 533.5 (b).

Through this in-depth analysis, the Court of Appeals recognized that the California Legislature never intended for Section 533.5 (b) to apply to criminal actions other than those brought by the state and local agencies enumerated in the statute. However, the insurer argued that even if it were incorrect in its interpretation of the statute, it should still be entitled to summary adjudication of the insured’s bad faith claim because a general dispute exists from the insurer’s reasonable interpretation of the statute. As discussed above, the Court of Appeals agreed that the insurer’s interpretation of the statute had been reasonable, but the Court of Appeals stated that it was doubtful that the “general dispute doctrine” applied to third party disputes such as the present matter. Instead, the Court of Appeals found that the reasonableness of the insurer’s conduct in denying the defense of the insured was a question of fact that precluded summary judgment, especially since the insurer had agreed to defend the hospital where the insured was employed for the same criminal investigation, while refusing to defend the insured, who was covered under the policy as an employee of the hospital.

Moreover, the Court of Appeals additionally found that the insurer may have acted in bad faith by denying coverage based on a medical incident exclusion that, according to the insured, was not part of the policy. The Court of Appeals noted that the “insurer’s continued reliance on endorsement insureds claim they never received was ‘indicia of bad faith’ and one for the jury to decide.” Tomaselli v. Transamerica Ins. Co., 25 Cal.App.4th 126 (1994). Therefore, a triable issue of fact existed as to whether the insurer acted in bad faith by denying coverage based on an exclusion that cannot be found in the Policy and the trial court’s ruling for summary judgment was reversed.

“Slimy Conduct That Gives Insurance Companies a Bad Name:” Some Quotes from Judge Alex Kozinski

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