Generally, in order to sue for insurance bad faith there necessarily must be an insurance policy at issue that establishes a concept known as “privity of contract” between an insured and an insurer.  This means that an insured under an insurance policy typically may sue for bad faith if the insured is entitled to benefits under a policy and if those benefits are wrongfully withheld or payment was wrongfully delayed.  This includes the contracting parties (persons named as insureds) as well as others entitled to benefits as “additional insureds” or as express beneficiaries under the policy.  In insurance parlance, this means that the “named insured” and any “additional insureds” may sue.  For example, an auto liability insurance policy covering a vehicle may extend coverage to permissive users as additional insureds.

In addition, an insurance bad faith claim can be assigned.  In the context of a third party claim, it is possible to assign a bad faith claim under certain circumstances.  This is most typically done in connection with a failure by an insurer to defend and indemnify an insured for third party liability.  However, because purely personal tort claims are not assignable, the insured's claims for emotional distress damages and punitive damages are not assignable. Essex Ins. Co. v. Five Star Dye House, Inc., 38 Cal. 4th 1252, 1263 (2006).  An assignment allows the third-party to obtain more than the policy limits from the insurer.  Without the assignment, a third-party can only sue the insurer for the amount of the judgment as third party beneficiary of those liability policies.  Ins. Code § 11580(a).

The same “privity of contract” requirement applies in determining who may be sued.  Generally, only the insurer(s) on the risk as the party to the contract can be sued.  This includes “primary,” “excess” and “umbrella” insurers.  Moreover, it is possible to sue an insurer's alter ego or joint-venturer, typically a parent company.  It is also possible under certain circumstances to sue a “managing general agent” who is appointed by the insurer to manage all or part of its insurance business.  An insurance agent can be sued for professional negligence, but not for insurance bad faith.  See Kurtz, Richards, Wilson & Co. v. Insurance Communicators Marketing Corp., 12 Cal. App. 4th 1249, 1257 (1992) (“At a minimum, an insurance agent has a duty to use reasonable care, diligence, and judgment in procuring the insurance requested by its client.  An agent may assume additional duties by an agreement or by holding himself or herself out as having specific expertise.”); Williams v. Hilb, Rogal & Hobbs Ins. Services of Calif., Inc., 177 Cal. App. 4th 624, 635–636 (2009) (holding that a special duty will arise when an agent holds himself out as having specific expertise.)

Insurance bad faith claims can be potent weapons for insureds or beneficiaries who have been mistreated by insurance companies in the handling of their insurance claims.  Knowing who can sue and be sued is therefore important to understand if you are considering an insurance bad faith lawsuit.

In an unpublished opinion, the Court of Appeal considered the trial court’s ruling on both of the post-verdict motions.  First, after reviewing the available record, the Court determined that the verdict in Bosetti’s favor was supported by substantial evidence, including specifically that her depression caused the disabling physical symptom of an increase in her fibromyalgia pain.  Based on these facts, the Court reversed the trial court’s ruling on the motion for judgment notwithstanding the verdict.  In reaching this conclusion, the Court of Appeal affirmed its earlier ruling that a limitation on coverage for “mental, nervous or emotional disorders of any type” does not apply if the insured‘s disability was caused, in any part, by her physical symptoms.

However, with respect to U.S. Life’s motion for a new trial, the Court of Appeal explained that the trial judge is afforded great deference and “an order granting a new trial `must be sustained on appeal unless the opposing party demonstrates that no reasonable finder of fact could have found for the movant on [the trial court's] theory,’” Applying this standard, the appellate court affirmed the order granting a new trial after finding that there was also substantial evidence that would have supported a verdict in U.S. Life’s favor. 

While the case was remanded to the trial court for a second trial, the Court of Appeal did not overturn its 2009 ruling, and thus Bosetti I and its position regarding mental disabilities with physical symptoms should still be considered good law.

The Huffington Post, in a very interesting article entitled, “Insurance Claim Delays Deliver Massive Profits To Industry By Shorting Customers” reports that since the mid-1990s, “a new profit-hungry model, combined with weak regulation, has upended that ancient social contract” between insurers and claimants. 

The change started, according to the article, when consulting giant McKinsey & Company sold Allstate and other leading insurance companies on a “new system to boost the bottom line.”  The article states that rather than adjusting claims the traditional way, which gave claims managers wide latitude to serve customers, insurers embraced a computer-driven method that produced purposefully low offers to claimants.

The article explains that this strategy “put profits above all” and insurers like Allstate have certainly gained: Allstate made $4.6 billion in profits in 2007, double its earnings in the 1990s.  The stunning increase, the article quotes Russ Roberts as stating, came through "driving down loss values to an average of 30 percent below the actual market cost" -- that is, paying dramatically less on claims.  Roberts told the Huffington Post that, by his estimate, the companies that take in 70 percent of total insurance profits in the United States “now abuse their obligations to their policyholders.”

According to NAIC data[https://eapps.naic.org/documents/cis_aggregate_complaints_by_reason_codes.pdf], claim delays have long been the most frequent cause of policyholder complaints.  As of Nov. 28, 2011, the NAIC had received 11,053 delay-related complaints this year alone, comprising almost a quarter of the year's total complaints.  This data only reflects confirmed complaints -- the ones that the state insurance commission has investigated -- so the actual number of delayed claims is likely much higher.

This article is interesting reading for all consumers who buy insurance. 

The recent decision of the District Court, Southern District of California in Barbour v. UNUM Life Ins. Co., 2011 U.S. Dist. LEXIS 91060 (S.D. Cal. 2011),  is a primary example of how an insurer’s misuse of in-house experts and its reliance on the “genuine dispute doctrine” can result in potential bad faith liability, as well as punitive damages.

Barbour involved a disability policy issued by UNUM through a school district and covering the Principal of a school in the district.  The Group Salary Protection Insurance Policy (“Policy”) at issue provided Accident and Sickness Disability Benefits for one year in the event of total disability, and after one year, the Policy provided monthly long term disability income benefits for as long as the claimant remains totally disabled or otherwise qualifies for benefits, up to age 65.  The Policy defined “Total Disability” during the first two years as the inability “to perform the material duties of your own occupation.”  After two years, the Policy defined “Total Disability” as the inability “to engage in any gainful occupation for which you are reasonably qualified by training, education or experience.”  In February 2003, the insured submitted a claim for disability benefits based on abdominal pain that restricted her from driving, walking/standing and sitting for extended period, and UNUM began paying benefits.  Over the course of several years, the insured suffered multiple further injuries relating to her initial injury, which required multiple surgeries, and which rendered her totally disabled.  The insured submitted regular medical reports and updates, and UNUM continued to pay disability benefits. 

In December 2007, UNUM hired an investigator to conduct surveillance on the insured to confirm the claimed disabilities.  The investigator observed a “female subject believed to be the insured” who was moving without the physical limitations represented to UNUM by the insured and her doctors.  The investigator’s report and video raised suspicion within UNUM regarding the insured’s disability, and resulted in UNUM conducting further surveillance.  UNUM investigators made a field visit in October 2008, and again conducted surveillance in January 2009.  In February 2009, UNUM’s in-house doctor/consultant reviewed the file and prepared a report which concluded that the insured’s claimed disability was inconsistent with her findings.  Then, in March 2009, UNUM’s “Designated Medical Officer” reviewed the file and determined that there were three occupations that the insured was capable of performing, notwithstanding her disability.  UNUM thereafter revoked the insured’s disability benefits effective March 31, 2009, and advised her that she had the right to file a civil action under the section 502(a) ERISA statute.  Unsurprisingly, the insured hired an attorney.

The insured’s attorney sent a letter to UNUM advising that UNUM’s determination that the claim was governed by ERISA was erroneous.  The attorney also provided a letter from the insured’s doctor stating that the person observed during surveillance in December 2007 was not the insured.  UNUM was also provided a functional capacity evaluation by the insured’s physical therapist that concluded that the insured’s “physical limitations presented a barrier to work.”  This information was reviewed by UNUM’s in-house medical experts.  On October 6, 2009, UNUM sent a letter agreeing with the insured’s position as to ERISA, but stating that the new medical information did not change UNUM’s decision to deny benefits.

UNUM filed a motion for summary judgment to dismiss the insured’s claims for breach of the implied covenant of good faith and fair dealing (bad faith), intentional infliction of emotional distress and punitive damages.  To defeat the bad faith claim, UNUM relied on the “genuine dispute doctrine.”  In rendering its ruling, the court noted that the overarching issue in a bad faith claim is whether the insurer’s claims-handling conduct was reasonable.  Amadeo v. Principal Mut. Life Ins. Co., 290 F.3d 1152, 1161 (9th Cir. 2002).  The court then explained the applicability of the genuine dispute doctrine:

"The genuine issue rule in the context of bad faith claims allows a district court to grant summary judgment when it is undisputed or indisputable that the basis for the insurer's denial of benefits was reasonable--for example, where even under the plaintiff's version of the facts there is a genuine issue as to the insurer's liability under California law. In such a case, because a bad faith claim can succeed only if the insurer's conduct was unreasonable, the insurer is entitled to judgment as a matter of law." Amadeo, 290 F.3d at 1161-62 (citation omitted). "On the other hand, an insurer is not entitled to judgment as a matter of law where, viewing the facts in the light most favorable to the plaintiff, a jury could conclude that the insurer acted unreasonably." Id. at 1162 (citation omitted)(emphasis added).

The court held that a reasonable jury could conclude that UNUM acted unreasonably when it was informed that the evidence UNUM relied upon to deny the insured’s claim was wrong (i.e., the surveillance was of someone other than the insured).  The court further determined that there was no evidence that UNUM’s experts evaluated the evidence with an eye towards favoring the insured and in a manner which would indicate that she was indeed disabled as she and her doctors asserted.  The court relied upon the facts as viewed “in the light most favorable to Plaintiff” to determine that a jury could conclude that UNUM acted unreasonably, and thus in bad faith when it denied the insured’s claim.  The court therefore denied UNUM’s motion for summary judgment.

The court also discussed UNUM’s initial erroneous determination that the claim was governed by ERISA, and held that it created evidence of insurer bias, which could also indicate and support a claim for bad faith. Hangarter v. Provident Life & Acc. Ins. Co., 373 F.3d 998, 1010 (9th Cir. 2004) (citing Chateau Chamberay Homeowners Ass'n v. Associated Int'l Ins. Co., 90 Cal. App. 4th 335, 348 (2001)). 

The court placed a premium on UNUM’s apparent failure to reasonably and thoroughly investigate the insured’s claim.  In particular, the court found that UNUM’s failure to seek an independent medical examination of the insured supported her claim that UNUM acted unreasonably.  In so finding, the court discussed a line of cases which suggest that an insurer’s sole reliance on its own in-house experts, and its failure to obtain an independent medical examination, is clear evidence that an insurer has acted unreasonably. 

Based on these findings, the court held that the insured’s claims for intentional infliction of emotional distress and for punitive damages were equally as viable based on UNUM’s potentially unreasonable conduct in evaluating the insured’s claim.

With this decision, the court made it very clear that an insurer cannot escape liability for bad faith by relying on its own in-house experts and ignoring evidence presented by an insured which, when viewed in favor of the insured, would indicate coverage should be afforded.  An insurer cannot create a “genuine dispute” as to coverage on which it can deny an insured’s claim simply by relying on its own in-house experts.  An insurer who does so, does so at its own peril, and opens itself up to claims for bad faith and punitive damages.

In 2006 the Villa Los Alamos Homeowners Association (HOA) contracted to have spray-applied acoustical (“popcorn”) ceiling texture in common area ceilings and stairways scraped and removed.  During the removal, asbestos fibers were released into the air, common areas, individual units and public areas outside the building.  The Bay Area Air Quality Management District (District) cited the contractor and ordered the HOA to clean up the asbestos fibers.  The HOA submitted a first party claim to State Farm, its insurance carrier, for approximately $650,000 in cleanup costs.  The HOA also sued the contractor.  The contractor then cross-complained against the HOA and its management company.  The HOA tendered its defense to State Farm.

A pollution exclusion in the first party coverage section of the policy excluded coverage for any loss caused by the “presence, release, discharge or dispersal of pollutants,” while the exclusion pertinent to third party claims removes coverage for injuries arising out of “discharge, seepage, migration, dispersal, spill, release or escape of pollutants.”  State Farm denied coverage for both the first party and third party claims, citing the pollution exclusion and faulty workmanship exclusions in the policy. 

The HOA sued State Farm for breach of contract, bad faith and declaratory relief.  The trial court granted summary adjudication in favor of State Farm on the first party claims based on the pollution exclusion.  The HOA dismissed its third party claims, and appealed.

Discussion

In MacKinnon v. Truck Ins. Exchange, 31 Cal. 4th 635 (2003), the California Supreme Court found that the standard pollution exclusion clause in a comprehensive general liability policy was intended to exclude coverage for injuries resulting from events commonly regarded as “environmental pollution.”  The Court rejected a broader, literal interpretation of the clause that would foreclose coverage for any and all injuries arising from harmful substances.  So, the Court held that it was unlikely that a reasonable policyholder would think that the activity in question there—namely, the ordinary but negligent spraying of pesticides around an apartment building in order to kill yellow jackets—was an act of pollution.  

The HOA argued that MacKinnon applied here, and that the pollution exclusion in the State Farm policy did not cover a single, negligent, localized asbestos release.  After reviewing MacKinnon and its progeny, the Villa Los Alamos court agreed that the general principles announced in MacKinnon concerning the pollution exclusion also pertain in the context of a coverage dispute over first party property insurance claims based on analogous pollution exclusion—despite the well-recognized analytical differences between first party property and third party liability policies.  But the Villa Los Alamos court otherwise rejected the HOA’s application of MacKinnon to the facts at hand. 

Reading the State Farm pollution exclusion in accord with MacKinnon as pertaining to environmental pollution, the Villa Los Alamos court asked this question:  Did the accidental release and airborne dissemination of asbestos fibers in this case amount to what is commonly regarded as “environmental” pollution?  The court concluded that asbestos is a pollutant as a matter of law, and that it was “released” into the air and areas around the popcorn ceiling texture during the contractor’s scraping and removal.  Emphasizing factual differences between a homeowner being able to buy and apply pesticides in a residential setting, and the removal of asbestos containing building materials being highly regulated by a myriad county, state and federal laws, the court rejected the HOA’s analogy of the asbestos removal to a single, ordinary act of negligence.  In short, the Villa Los Alamos court concluded that the ordinary layperson would understand the release of asbestos fibers under these circumstances to be “environmental pollution.”  Citing American Casualty Co. of Reading, PA. v. Miller, 159 Cal. App. 4th 501, 515-516 (2008), the court explained that

the key point under a MacKinnon analysis is whether the act in question is commonly thought of as environmental pollution. Thus, even if the accident consisted of a one-time negligent release of methylene chloride [as in Miller], the pollution exclusion would preclude coverage because permitting the chemical to be released into a public sewer was an act of environmental pollution. (Ibid.) Miller is persuasive. To establish bright-line rules as to what constitutes “environmental pollution” makes no sense: A one-time event can be a polluting event if it creates “‘impurity, something objectionable and unwanted.’” (MacKinnon, supra, 31 Cal. 4th at p. 654.) To reiterate: The release of asbestos from a product into the air people breathe constitutes a health hazard for which no level of exposure is safe. The work here apparently occurred over several days and resulted in the sufficient release of asbestos fibers into the air to contaminate the building complex and the adjacent outside areas, constituting environmental pollution.

Lesson Learned

There is no “bright-line” rule for when an ordinary layperson will consider a “release” of harmful substances in or around a residential structure to be “environmental pollution” rather than an “ordinary act of negligence.”  One can imagine the Villa Los Alamos court just as easily analogizing the release of asbestos fibers from asbestos-containing building materials in a residential building to be an “ordinary act of negligence” on par with pesticide contamination a la MacKinnon rather than “environmental pollution” a la Miller.  The clever insurance coverage attorney will start framing and controlling the analogy early on.

The most common causes of action against insurers in the non-ERISA context are breach of contract and bad faith. 

The breach of contract claim allows an insured to recover policy benefits owed under the insurance policy plus applicable interest from the date the benefits were due (or at the rate of 10% on delayed disability payments in California).  The benefits due will depend on the type of policy at issue.  They may be a specific amount (e.g., death benefits) or may depend upon a proof of loss (e.g., value of property damaged or destroyed).

There are three primary categories of damages recoverable in these types of actions:

1. Contract Damages – In first-party cases, the measure of contract damages is the benefits due under the policy.  In third-party cases, the measure is the amount expended or liability incurred by the insured up to the policy limits.  Consequential damages are also recoverable where appropriate, and are defined as those damages the parties should have foreseen as likely to result from a breach when they entered into the contract.  Thus, an insured may recover damages that were within the parties’ reasonable expectation at the time of contracting. 
2. Tortious (Extracontractual) Compensatory Damages – In bad faith actions, an insured may recover extracontractual compensatory damages based on an insurer’s tortious conduct.  This includes all damages caused by the insurer’s tortious conduct, including both economic loss and non-economic harm (e.g., emotional distress).  This will often include attorney’s fees reasonably incurred to compel payment of benefits due under an insurance policy (called Brandt fees).
3. Punitive Damages – In an action against an insurer where, in addition to bad faith or other tortious conduct, there is clear and convincing evidence of oppression, fraud or malice on the part of the insurer, the insured may recover punitive damages.  Punitive damages will be awarded to punish an insurer for tortious conduct giving rise to an action not based on the terms of the insurance contract (e.g., fraud).

In addition to breach of contract and bad faith, other claims available to insureds are fraudulent and negligent misrepresentation, intentional and negligent infliction of emotional distress, invasion of privacy, and intentional interference with economic advantage.  Each of these causes of action may allow for recovery of alternative and additional damages, including punitive damages.

For additional information on this and other insurance matters you can visit the FAQ section of our website:  www.mslawllp.com.  

If you need to consult with an attorney about a possible insurance bad faith or ERISA matter, please contact our office. 

When an insurance company denies a claim, that denial decision might not only be incorrect under the terms of the insurance policy, but also might be in “bad faith.”  As a matter of law, every insurance contract contains a covenant of good faith and fair dealing.  If this covenant is violated, the insurance company is said to have acted in “bad faith.”  A tortious breach of this implied covenant involves something beyond breach of the specific contractual duties or mistaken judgment.  To establish a bad faith claim in first party cases (such as those involving life insurance, health insurance, disability insurance, property and casualty insurance, auto liability insurance, and homeowner’s insurance), it must be shown that an insurer’s delay or withholding of benefits under the policy was unreasonable or without proper cause.  

When an insurance company acts in bad faith (that is, when an insurance company violates the covenant of good faith and fair dealing), the policyholder or insured can sue the insurance company for both breach of contract and the tort claim of bad faith.  In addition to contract damages, damages available under a tort claim for bad faith can include foreseeable financial losses, emotional distress, and attorney’s fees incurred by the insured to force the insurance company to pay the policy benefits (Brandt fees). If the insurance company acted with malice, oppression or fraud, the insured may also recover punitive damages.  Punitive damages are meant to punish the insurer, and are not available in a breach of contract lawsuit. 

When determining whether or not an insurer acted in bad faith, a court will use the “reasonable” standard.  This means the court will evaluate the actions of the insurers and determine if they were reasonable under the circumstances.  If the insurer did not act reasonably, then the insurer has acted in bad faith in dealing with the insured.    

Some examples of bad faith are:

• interpreting the language of the policy in an unreasonable manner;
• unreasonably failing to reimburse the insured for the entire amount of the loss;
• unreasonably failing to settle the lawsuit;
• unreasonable refusal to defend a lawsuit;
• unreasonable delay in paying benefits; and
• unreasonable delay in investigating the claim or improper valuation of the claim.

If an insurer does not act reasonably in complying with the terms of the insurance policy, then they have breached the covenant of good faith and fair dealing (a.k.a. bad faith) and will be held accountable by the court.  For additional information on this and other insurance matters you can visit the FAQ section of our website:  www.mslawllp.com.  

If you need to consult with an attorney about a possible insurance bad faith or ERISA matter, please contact our office. 

In Minich Allstate issues a homeowner’s insurance policy to Kelly and Debbie Minich.  A fire destroys the Minichs’ home.  The policy requires Allstate to pay the Minichs the "actual cash value" of their home up to the $129,840 policy limit.  An extended policy limits endorsement requires Allstate to pay up to 150% of the policy limit in excess of the actual cash value if the Minichs actually repair or replace the home. 

Allstate pays the $129,840 policy limit, less the $250 deductible, within 2 weeks of the fire.  Allstate refuses to pay the $64,920 extended limit until the Minichs demonstrate to Allstate 15 months after the fire that they in fact are rebuilding the home.

Allstate files a motion for summary judgment and argues that it timely paid the Minichs the full "policy limit" under §2051(b)(1), and that the additional $64,920 represents an amount above the policy limit.  Allstate maintains that it is not required to pay the additional $64,920 unless and until the Minichs rebuild their home.  

The Minichs oppose Allstate's motion and argue that §2051 and §2051.5 require that an insurer pay the "policy limit or the fair market value of the structure, whichever is less" (§2051(b)(1)), without regard to whether the insured repairs the structure. The Minichs maintain that the "policy limit" of their policy includes the $64,920 provided for in the extended limits endorsement. 

The trial court grants Allstate's motion, and enters judgment in its favor. The Minichs appeal.

The appellate court concludes that the Minichs’ interpretation of the policy is flawed, and that neither the statutes nor the policy require Allstate to pay the extended limits under the endorsement without regard to repair or replacement.  The appellate court interprets the endorsement to refer to an amount in excess of the policy limit, and not to extend or increase the policy limit.

The appellate court also notes that public policy supports its interpretation; otherwise the homeowner would be “bettered” by receiving replacement cost benefits above the actual cash value of the home without ever having to actually replace the home—a benefit not bargained for in the insurance contract.  And a benefit that the California legislature could easily have mandated in the statutes, if it had so intended.

Since the appellate court determined that Allstate timely paid the Minichs all benefits owed under the policy, it also affirmed summary judgment and dismissal of the Minichs’ bad faith claims.  The Minich decision reaffirms that a homeowner must actually start repairs of its damaged home in order to collect policy benefits under an extended repair or replacement cost limits endorsement over and above the actual cash value of the loss.

The Facts

Gaylord owns and operates a livestock operation, raising his own cattle and raising cattle for others.  In June 2008 some of the cattle die suddenly.  By September and October 2008 cattle begin dying at an alarming rate.  Gaylord suspects feed poisoning.  Autopsies and feed testing confirm that the cattle are dying from liver failure caused by toxic plants in the alfalfa feed.  There is no known cure, so Gaylord gets permission from the Department of Agriculture to sell the cattle off for early slaughter—but at a financial loss for Gaylord and the other cattle owners. 

Nationwide issued a farm-owners insurance policy to Gaylord in March 2008.  One part insures against physical loss to covered property (first-party); one part insures against third-party liability claims.  Gaylord says he moved his farm-owners insurance from Fireman’s Fund to Nationwide because his long-trusted insurance agent told him that Nationwide had better coverage, including coverage for cattle loss from poisoned feed.  But Gaylord’s agent says he told Gaylord that a “custom feeding of livestock” endorsement was necessary to cover cattle loss from poisoned feed, and that Gaylord declined it because it was too expensive.

A third-party sues Gaylord in September 2009 for the loss of its cattle in Gaylord’s care.  Gaylord tenders his defense to Nationwide in October 2009.  Nationwide seeks the advice of coverage counsel, and denies the tender in January 2010.  Gaylord sues Nationwide in March 2010 for breach of contract, bad faith and declaratory relief on both his first-party and third-party claims.  Nationwide moves for summary judgment.

FRCP 56(c) Summary Judgment Standards

All too often attorneys moving for summary judgment cut and paste points and authorities from older cases, parroting the standards for summary judgment under FRCP 56(c) in archaic and stilted prose.  Judge  Ishii articulates the standards in clean, non-legalese prose.  Cut and paste this.  Not that.

Insurance Contract Interpretation

Ditto.  Cut and paste this.  Not that

The One-Year Contractual Limitations Clause Bars Gaylord’s First-Party Claim

The policy has a one-year limitations clause giving the insured one year to file suit for the denial of a first-party claim.  The period commences when damage becomes sufficiently “appreciable” to put the insured on notice to make a claim.  The district court concludes that Gaylord knew by October 2, 2008, when Gaylord first reported the cattle deaths to Nationwide, that his loss was “appreciable,” and that Nationwide’s October 3, 2009, denial is “unequivocal.” 

The district court also finds that Nationwide’s (standard) offer in its denial letter to consider any new or different information that the insured might furnish does not render the denial equivocal, and does not continue the tolling.  Accordingly, the limitations period was tolled for one day, and Garylord had until October 3, 2009, to timely file suit on his first-party claim.  The district court grants summary judgment on Gaylord’s first-party claim because Gaylord waited until March 2010 to file suit.

The Conflicting Agent and Insured Declarations Create a Genuine Dispute over Third-Party Coverage

The district court assumes for purposes of the motion that a contractual liability exclusion and a custom feeding exclusion in the policy encompass the third-party liability claims against Gaylord. But livestock operations endorsement (LOE) modifying the liability coverage provides that “In consideration of the premium charged for this endorsement, the liability coverage of this policy applies to your livestock.”  Gaylord and Nationwide each offer conflicting interpretations of the LOE, each of which the district court finds to be reasonable—hence ambiguous.  Standard rules of insurance contract interpretation would resolve the ambiguity in favor of Gaylord.  But… 

Gaylord says the agent told him that poisoned cattle were covered.  The agent says he told Gaylord that a more expensive endorsement was necessary, and Gaylord declined to pay for it.  The district court concludes that the trier of fact will have to resolve this conflicting extrinsic evidence in order for the district court to interpret the policy.  If Gaylord is believed, he wins.  If the agent is believed, Gaylord loses. So, the district court denies Nationwide’s motion for summary judgment on Gaylord’s third-party liability claim.

A “Genuine Dispute” over Coverage Defeats Bad Faith

When an insurer’s denial of a claim is unreasonable or without proper cause, the insured may be able to recover tort damages.  The district court point out, however, that "bad faith" implies conscious unfair dealing, and mere negligence or mistaken judgment is insufficient. Nieto v. Blue Shield of Cal. Life & Health Ins. Co., 181 Cal.App.4th 60, 86 (2010); Chateau Chamberay Homeowners Assn. v. Associated Internat. Ins. Co., 90 Cal.App.4th 335, 345(2001). When there is a "genuine issue" or "genuine dispute" as to the "insurer's liability under the policy for the claim asserted by the insured, there can be no bad faith liability imposed on the insurer for advancing its side of that dispute." McCoy v. Progressive W. Ins. Co., 171 Cal.App.4th 785, 793 (2009).

The Ninth Circuit apples the genuine dispute doctrine to duty to defend disputes. See Lunsford v. American Guar. & Liab. Ins. Co., 18 F.3d 653, 654, 656 (9th Cir. 1994).  In Lunsford the insurer refused to defend a counterclaim against the insured for abuse of process. The Ninth Circuit found the insurance policy ambiguous and resolved the ambiguity in favor of the insureds, thus mandating that the insurer cover the defense costs. Despite finding a breach of the duty to defend, the Ninth Circuit held, "Because [the insurer] investigated the insureds' claim and based its refusal to defend on that information and a reasonable construction of the policy, [the insurer] did not act in bad faith, and we conclude that [the insurer] was entitled to summary judgment on the implied covenant of good faith and fair dealing claim." Id. at 656. 

After reciting California insurance bad faith standards in a way that presages the insured is going to come up short, the district court quickly dispatches Gaylord’s first-party bad faith claim based on the contractual limitations period.   The district court then concludes that there is no material dispute that Nationwide conducted a reasonable investigation into the third-party claim, sought the advice of outside coverage counsel, and that its interpretation of the contractual liability and custom feeding exclusions under the facts and circumstances is not unreasonable.  So, the district court also grants summary judgment on Gaylord’s third-party bad faith claim, including the punitive damages claim.

The take-away—beside some great cut-and-paste points and authorities—is that policyholder attorneys need to be mindful when analyzing limitations periods that the insured may need to file suit early to protect a first-party claim, even when the third-party claim may not be ripe.

Kawakita purchased her health insurance policy through Blue Shield’s alleged agent, Steven Stendal, and claimed that Stendal was responsible for any misstatements on her application.  Blue Shield rescinded Kawakita’s policy in August 2006, and she filed her lawsuit in July 2009, asserting causes of action for breach of contract, tortious breach on the implied covenant of good faith and fair dealing and declaratory relief.

Blue Shield filed a motion for summary adjudication, arguing that the bad faith claim was barred by the two-year statute of limitations imposed by California Code of Civil Procedure Section 339 and Love v. Fire Insurance Exchange, 221 Cal. App. 3d 1136, 1144 n.4 (1990).  The trial court rejected Blue Shield’s motion, and with Blue Shield of California Life & Health Insurance Company v. Superior Court (Kawakita), No. B225632, Blue Shield sought a peremptory writ of mandate directing the trial court to reverse its order.  While the California Court of Appeal did not agree with the trial court’s reasoning, it did agree with the result and allowed Kawakita to proceed with her bad faith cause of action.

Based on this provision, with its broad application to “any other matter arising out of the Plan,” the Court of Appeal ruled that Kawakita’s bad faith claim needed to be filed no later than three years after the coverage was first denied; which it was.  With this ruling, Kawakita’s attempt to impose bad faith liability of Blue Shield’s decision to rescind her coverage case can proceed.

Noting a paucity of recent California Supreme Court precedent on whether strict or merely substantial compliance with an insurance warranty is required to invoke coverage, the Ninth Circuit Court of Appeals recently held that California law requires strict compliance with a pilot warranty in an aviation insurance policy as a condition precedent to coverage.  Trishan Air, Inc. v. Federal Insurance Company, __ F.3d __ 2011 WL 540532 (9th Cir. 2011).  The Ninth Circuit affirmed the Central District of California’s summary judgment dismissal of the insured’s breach of contract and bad faith claims.

Trishan Air, Inc. (Trishan) owned a fleet of corporate jets.  It purchased an aviation insurance policy from Federal Insurance Company (Federal). The policy included a pilot warranty endorsement that required a two-pilot crew for each aircraft and that

such pilot(s) must have successfully completed a ground and flight recurrent/initial training course for the make and model operated within the past 18 months. Any such course must incorporate the use of a motion-based simulator specifically designed for the insured make and model/make and model series.

In June 2007 Trishan’s 13-passenger Dassault Falcon 900 ran off the main runway at the Santa Barbara Municipal Airport in an aborted high-speed takeoff.  The impact snapped the front landing gear, and the Falcon 900 skidded to rest in the dirt 600 feet away.  Thankfully, no fatalities.  At the time of the accident the co-pilot had never attended any formal training course or flight simulator course for the particular jet involved.  

Trishan submitted a claim for the loss to Federal.  Federal denied coverage based on a breach of the pilot warranty.  Trishan filed suit for breach of contract, breach of the duty of good faith and fair dealing, reformation and declaratory judgment.  Federal moved for summary judgment.  Trishan introduced fact and expert evidence that the co-pilot substantially complied with the pilot warranty, and that substantial compliance satisfied the warranty.  Causation was not an issue because Trishan and Federal stipulated that Federal was not required to demonstrate a causal connection between the accident and any breach of the pilot warranty.

The district court granted Federal’s motion for summary judgment on the grounds that California law requires strict compliance with the pilot warranty.  Trishan appealed.

Citing turn-of-the-century California Supreme Court precedent, and more recent appellate precedent, the Ninth Circuit rejected Trishan’s arguments.  It concluded that the pilot warranty was in the nature of a condition precedent to coverage, requiring strict compliance, rather than a mere condition of coverage as to which substantial compliance might suffice.

Trishan's argument is premised on the warranty being a mere condition of the insurance policy, thus requiring only substantial compliance. This argument ignores the dichotomy between conditions relating to basic coverage, such as notice provisions, and conditions, like the pilot warranty, that are ‘an element of the fundamental risk insured.’ [citation]. ‘There are well-established differences between insuring clauses, exclusions, and conditions that should not be amalgamated into one binary question: coverage yes or no under an ‘if ... then’ analysis. [citation].

Contrary to such variations in insurance provisions, Trishan seeks universal application of the substantial compliance doctrine untethered from the type of warranty at issue. However, strict compliance with pilot warranties serves as a necessary corollary of aviation insurance policies. ‘Federal courts uniformly enforce [pilot warranties] ... and for good reason. Pilot qualifications and experience are obviously factors bearing directly on the risk the insurer is underwriting.’ [citation].

The pilot warranty is like a condition precedent because it expressly establishes the events or conditions that must occur before coverage can take effect.  The Ninth Circuit noted that the practical effect of adopting Trishan’s substantial compliance standard would be to substitute the underwriter’s clear underwriting parameters with the insured’s subjective assessment.  It would introduce too much uncertainty into ascertaining the risk that the underwriter agreed to assume, and would essentially re-write the insurance policy—which California courts are prohibited from doing.

The Ninth Circuit went further.  It noted that even if substantial compliance would suffice, the co-pilot’s lack of formal coursework and simulator training for the Falcon 900 did not even substantially comply with the pilot warranty. 

Trishan elides the fact that it did not comply with the pilot warranty's training requirements for co-pilots in any fashion. Instead, Trishan asserts that the pilot's alternative training served as a substitute for the simulator training. However, a complete failure to comply is not analogous to minor deficiencies. [citation]. Thus, Trishan's complete failure to comply with the pilot warranty precludes coverage even under the substantial compliance doctrine. [citation]. 

Finally, noting the long established rule in California that there is no bad faith where there is no coverage, the Ninth Circuit also affirmed the district court’s dismissal of Trishan’s bad faith claim.  The Ninth Circuit added that since Federal’s denial of coverage based on Trishan’s failure to strictly comply with the pilot warranty was reasonable, the “genuine dispute” doctrine also insulated Federal from any bad faith liability. 

The take-away for insureds:  review your insurance program carefully for warranty endorsements in your policies.  Strict compliance may be required.

Karen and Terry Lee ("Lees") purchased property in Solano County in 1990.  The purchased property was covered by a policy issued by Fidelity National Title Insurance Co. ("Fidelity").  Fidelity's preliminary report of the purchased property identified two parcel numbers, APN 09 and APN 22.  Although Fidelity’s policy did not incorporate parcel APN 09 and APN 22, it did have attached to it a map indicating parcels APN 09 and APN 22.  It was not until 2006 when the Lees were selling their property did they discover they only in fact owned one parcel and not the two parcels as they originally thought they had purchased. 

That reasonable expectation informs interpretation of the policy’s coverage.  As our Supreme Court stated in White v. Western Title Ins. Co. (1985) 40 Cal.3d 870, 881 (White), “ ’In determining what benefits or duties an insurer owes his insured pursuant to a contract of title insurance, the court may not look to the words of the policy alone, but must also consider the reasonable expectations of the public and the insured as to the type of service which the insurance entity holds itself out as ready to offer.  [Citation.]  Stated in another fashion, the provisions of the policy must be construed so as to give the insured the protection which he reasonably had a right to expect….  [Italics in original.]  [Citation.]’  The White court rejected the insurer’s argument that the plaintiffs in that case could not be deemed to have relied upon the title policies in question when they purchased their lands because the policies “were issued only when the sale was consummated.”

* * *

While an “ordinary reading” of the legal description of the land insured in Havstad precluded any reasonable expectation of coverage in that case, the same cannot be said here.  “[T]he words in an insurance policy are to be interpreted according to the plain meaning which a layman, not an attorney or insurance expert, would ordinarily attach to the words’ ”[Citation omitted] and laypersons like plaintiffs would have no way of knowing from the surveyor’s metes and bounds description of the land in their title policy whether APN 22 was covered.  In the context of the coverage issue in this case, the legal description was ambiguous.  (See Croskey et al., Cal. Practice Guide:  Insurance Litigation, supra, [¶] 4:300, p. 4-43 [“an ambiguity may arise where a policy uses terms beyond the working vocabulary of a person of ordinary intelligence”].)  Further ambiguity was created by the attachment of the assessor’s parcel map that, on the one hand, was said to be excluded from the policy, but on the other hand had an arrow pointing to APN 22 as a parcel in the policy.

The court found that the Lees had an objectively reasonable expectation of coverage because they purchased both parcels of land in 1990 given the circumstances surrounding the issuance of the title insurance policy.  Therefore, the court concluded that Fidelity's denial of coverage was erroneous.

Chicago Title sued both PSIC and McGraw, the parent company of PSIC, for breach of insurance contract, bad faith, and declaratory relief .  In a special verdict, the jury found:

1)     The EOI was not legally cancelled before the Mustain’s fire loss on 11/11/2005

2)     AMZ had actual or ostensible authority to prepare and issue the EOI on behalf of PSIC and McGraw

3)     PSIC and McGraw breached their obligation of good faith and fair dealing by failing to pay insurance proceeds to the Mustain’s under the EOI

4)     PSIC and McGraw breached their obligation of good faith and fair dealing by failing to properly investigate the Mustain’s fire loss; and

5)     PSIC and McGraw’s wrongful actions caused Chicago Title to bring the lawsuit against AMZ. 

On appeal the Appellate Court affirmed, ruling in favor of Chicago Title.  The central issue in this case was whether EOI issued by AMZ was an enforceable binder of homeowner’s insurance extending coverage from PSIC for a fire loss incurred by the Mustains.  The EOI was an effective binder for which the loss of the house came within coverage.  The court explained:

The trial court correctly instructed the jury.  The existence and content of the EOI were undisputed.  “Whether undisputed facts establish the existence of a binder is a question of law.”  (Adams, supra, 107 Cal.App.4th at p. 451.) 

The EOI on its face constituted a binder as a matter of law.  It included all of the required elements for a binder under Insurance Code section 382.5, subdivision (a):  The EOI identified the insurer (PSIC), the insureds (the Mustains), the (purported) agent executing the EOI (AMZ), the effective date of coverage, the binder number, and the address of the insured property.  The EOI states, “[t]his is evidence that insurance as identified below has been issued, is in force, and conveys all the rights and privileges afforded under the policy.”  Under “Coverage,” the EOI states, “See Supplemental Information Page(s),” which lists the coverages provided with the amounts of insurance and the deductible for each.  The EOI recites the total annual premium as $776, and included with the EOI was an invoice to Chicago Title in that amount.

But the Appellate Court also found that despite the lack of notice of appointment with the Department of Insurance, AMZ’s acted as PSIC’s agent based on actual and ostensible agent theories.  The issuance of the EOI by AMZ was not out the ordinary course of business between AMZ and PSIC, and PSIC had never complained about AMZ issuing the EOI prior to the receipt of the insurance premiums.  The court explained its ruling that the lack of a notice of appointment was not controlling:

While the lack of a notice of appointment might subject AMZ to fines or a disciplinary proceeding, AMZ’s actions in issuing the EOI as a binder could bind PSIC if the facts otherwise support an agency relationship.  “[Insurance Code section 1704, subdivision (a)] may simply impose further requirements on the conduct of an insurance agent, rather than establishing additional criteria for the creation of an agency relationship.  In other words, it may be unlawful for an entity to act as an agent of the insurer without complying with section 1704[, subdivision ](a), but that entity would still constitute an insurance agent for the present purposes.”  (Oakland-Alameda County Coliseum, Inc. v. National Union Fire Ins. Co. (N.D.Cal. 2007) 480 F.Supp.2d 1182, 1196.)  We agree with this reasoning.

The Appellate Court also found that PSIC and McGraw acted in bad faith because they did no investigation into the Mustains’ claim, as there was evidence that an employee with PSIC concluded “the EOI issued to the Mustain’s escrow was legally inconsequential and not even worth forwarding to the PSIC claims department.”  The court found that PSIC did not investigate whether its policy of authorizing AMZ to cancel a binder by stamping “void” on the EOI was lawful.  The court also stated that “[t]he evidence supported the inference too that PSIC’s policies and practices for issuing EOI’s were created in bad faith to allow PSIC to try to evade liability precisely in the circumstances presented by this case.” 

In first party cases, where payment is sought for the insured’s direct losses, an insurer may raise a reasonable dispute over coverage without being guilty of bad faith.  But it has never been held that an insurer in a third party case may rely on a genuine dispute over coverage to refuse settlement.  Instead, it is a long-standing rule that “the only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim’s injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer.

Id. (internal citations omitted). Essentially, American’s dispute over coverage could not justify its failure to refuse settlement and should not affect its evaluation of whether a settlement offer is a reasonable one.  American had a duty to the insured to evaluate and participate in the settlement negations despite the potential coverage issues.  In addition, the court noted that a genuine dispute exists only where the insurer’s position is maintained in good faith and on reasonable grounds.  Here, the court found that American distorted Howard’s deposition testimony by equating his memory of specific acts of molestation into an admission that no molestation occurred during the policy period.  This, the court decided, was unreasonable and evidence of bad faith. 

The key takeaway in this case is the narrowing of the genuine dispute doctrine.  The court’s opinion essentially limits the doctrine’s use as a defense in bad faith failure-to-settle cases and reinforces the principle that the mere hint of potential coverage invokes the duty to defend. 

In an important vindication of a California policyholder’s right to a jury trial to enforce an insurer’s duty to defend, the California Fourth Appellate District recently held that a liability insurer that fails to promptly acknowledge its insured’s right to independent counsel and begin funding that defense forfeits its rights to binding arbitration under Civil Code section 2860.  Intergulf Development, LLC. v. Superior Court (Interstate Fire & Casualty Company), __ Cal.App.4^th __, 2010 WL 1052745 (March 24, 2010).  In Intergrulf, the court ruled that the insured may proceed first to a jury trial, and, if successful, recover contract and tort damages against the insurer.

Under California law, a liability insurer must defend its insured if the underlying complaint alleges the insured’s liability for damages potentially covered under the policy or if the complaint might be amended to give rise to a liability that would be covered under the policy.”  Montrose Chem. Corp. v. Superior Court, 6 Cal. 4th 287, 299 (1993).  The duty to defend arises at the time the insured tenders defense of the third party lawsuit to the insurer.  Imposition of an immediate duty to defend is necessary to afford the insured what it is entitled to: the full protection of a defense on its behalf. Montrose Chem. Corp., supra, 6 Cal. 4th at 295; Buss v. Superior Court (Transamerica Ins. Co.), 16 Cal. 4^th 35, 49 (1997) (“To defend meaningfully, the insurer must defend immediately”); 10 Cal. Code Regs., section 2695.7(b).  On occasion, an insurer will delay its decision to defend outright, defend under a reservation of rights, or deny coverage altogether while it “investigates” coverage, leaving the insured to its own devices.

An unreasonable delay in paying policy benefits or paying less than the amount due is an actionable withholding of benefits which may constitute a breach of contract, as well as bad faith, giving rise to tort damages. Wilson v. 21st Century Ins. Co., 42 Cal. 4th 713, 720, 723 (2007);  Major v. Western Home Ins. Co., 169 Cal. App. 4th 1197, 1209 (2009).  The general measure of damages for breach of the duty to defend consists of the insured’s cost of defense in the underlying action, including attorney fees.  Major v. Western Home Ins. Co., 130 Cal. App. 4th 1078, 1088-1089 (2005).  Breach of the duty to defend also results in the insurer’s forfeiture of the right to control defense of the action or settlement, including the ability to take advantage of the protections and limitations set forth in Civil Code section 2860.  Fuller-Austin Insulation Co. v. Highlands Ins. Co., 135 Cal. App. 4th 958, 984 (2006); Atmel Corp. v. St. Paul Fire & Marine Ins. Co., 426 F.Supp. 2d 1039, 1047 (N.D. Cal. 2005).

An Insurer’s Right to Invoke Civil Code Section 2860 Fee Arbitration

Under Civil Code section 2860, when a liability insurer reserves its rights to contest coverage for a third party’s suit against its insured, and defense counsel could manipulate the suit in a way that could impair the insured’s coverage, section 2860 requires the insurer to pay for independent counsel to defend the suit.  For example, defense counsel may be in a position to hire expert witnesses with particular perspectives, and guide their testimony on issues such as when damage occurred or whether particular damage was expected or intended—steering claims in or out of coverage.  Notably, section 2860(c) limits the hourly rates that the insurer must pay independent counsel, and requires the insured to submit any fee dispute to binding arbitration.

An Insurer’s Unreasonable Delay Forfeits its Right to Invoke Civil Code Section 2860

In Intergulf, Intergulf developed a condominium project in San Diego, California. Intergulf was an additional insured on policies issued to one of its subcontractors by Interstate Fire & Casualty Company, a division of Fireman’s Fund Insurance Company.  The policies provided that Interstate had the right and duty to defend any lawsuit seeking damages because of property damage.  While Interstate’s policies were in effect, the homeowners association sued Intergulf for alleged construction defects.   

Intergulf promptly tendered its defense to Interstate.  Two weeks later, Interstate responded, not with an acknowledgment of its defense obligation, but by requesting information and reserving all of its rights.  Interstate wrote that, if it determined it had a duty to participate in Intergulf’s defense, it would impose “litigation handling guidelines,” and it would typically not pay hourly rates of more than $ 150 for partners, $135 for associates, and $ 75 for paralegals.  Intergulf defended with its own counsel—Luce, Forward, Hamilton & Scripps, LLP—billing at a blended rate of $250 per hour.

Seven months later, Interstate finally informed Intergulf that Interstate recognized a “potential” for a defense obligation, but did not actually acknowledge either a duty to defend or coverage.  Interstate offered to “participate” in the defense of Intergulf through the firm of Wood, Smith Henning & Berman.  Intergulf objected that Interstate’s reservation of rights created a conflict of interest for the Wood Smith firm, and demanded the appointment of its own independent counsel under section 2860.   

Intergulf then asked Interstate to reimburse its out-of-pocket defense fees and costs.  No response.  About a month later, Intergulf asked again.  No response.  Approximately one year after it had tendered its defense, Intergulf had neither a commitment to defend with conflict-free counsel nor any reimbursement for outstanding defense fees and costs from Interstate.  Intergulf then sued Interstate for breach of the duty to defend, bad faith, and declaratory relief.  Two months after Intergulf filed suit, Interstate made a first payment of approximately $ 140,000; nine months later, Interstate made a second payment of approximately $ 98,000.

Five weeks before the scheduled trial, Interstate filed a petition to compel arbitration of what it characterized as a section 2860 fee dispute.  Intergulf responded that the case was about the contract and tort damages that Interstate owed for breaching its duty to defend—not about a fee dispute.  It argued that because the questions of Interstate’s duty to defend, conflict of interest, and bad faith had not been resolved, Interstate did not satisfy the prerequisites for arbitration under section 2860(c).  The trial court, however, granted Interstate’s petition to compel arbitration and continued the trial, pending completion of  arbitration.

Intergulf challenged the trial court’s ruling by filing a petition for writ of mandate.  The appellate court summarily denied the petition. The Supreme Court granted Intergulf’s petition for review and transferred the matter back to the appellate court with directions to vacate the order denying mandate and issue an order to show cause why the relief sought should not be granted.

The appellate court agreed with Intergulf that the gravamen of the complaint was bad faith and breach of contract, not a dispute over the amount Interstate should pay independent counsel under section 2860(c).  By filing the action for breach of contract, bad faith, and declaratory relief, Intergulf gave Interstate notice that it was treating Interstate’s failure to acknowledge Intergulf’s right to independent counsel and delay in paying policy benefits as a total breach of the duty to defend.  Intergulf  at *2-3, citing  Coughlin v. Blair, 41 Cal. 2d 587, 599 (1953) (filing suit gave defendant notice that plaintiff viewed its failure to perform as a total breach of contract); and Sackett v. Spindler, 248 Cal. App. 2d 220, 229-230 (1967)(seller could treat persistent delay in payment for stock as total breach of the purchase agreement).

Intergulf’s entitlement to damages for breach of contract and bad faith turned on (i) whether Interstate owed Intergulf a duty to defend in the first instance; and (ii) whether Interstate breached that duty by failing to defend Intergulf “immediately” and “entirely” on tender of the defense.  Intergulf  at *3, citing  Buss v. Superior Court, supra, 16 Cal. 4th at 49; and Montrose Chemical Corp., supra, 6 Cal. 4th at 295.  Neither of these questions had been resolved at the time the court granted Interstate’s petition to compel binding arbitration of the purported fee dispute pursuant to section 2860(c). 

As the appellate court noted, ordering fee arbitration under section 2860 under these circumstances puts the cart before the horse. If Intergulf proves that Interstate breached the duty to defend or committed bad faith by failing to acknowledge Intergulf’s right to independent counsel or failing to immediately and fully fund its defense, Interstate forfeits its right to limit defense fees and costs under section 2860(c) fee arbitration.  Instead, a jury could award contract and tort damages in the trial court.  Intergulf at *4.  The appellate court issued a peremptory writ of mandate directing the trial court to vacate its order granting Interstate’s petition to compel arbitration under section 2860(c), and to enter an order denying the petition to compel arbitration.

Sound Public Policy

The appellate court’s decision is based on sound public policy.  If an insurer could delay a full and immediate defense for its insured, and then run for cover under section 2860’s rate limits and binding arbitration, it would have an incentive to fabricate a Cumis conflict, comforted by the knowledge that the attorney fee element of its insured’s damages would be limited by Cumis rates, claim management protocols, and binding arbitration, instead of being tried to a jury.  The insured’s right to have a jury determine breach and damages is fundamental to enforcing the insurer’s duty to provide a full and immediate defense.

Superior Dispatch (“Superior”) was a trucking company who obtained a Cargo Coverage insurance policy from the Insurance Corporation of New York (“Inscorp”).  The policy issued to Superior contained a contractual statute of limitations period stating, “No suit or action or proceeding for the recovery of any claim under this policy shall be sustainable in any court of law or equity unless the same be commenced within twelve (12) months next after discovery by the Insured of the occurrence which gives rise to the claim."

In July of 2003, Superior was hired to transport a dump truck on the back of a flat rack trailer.  En route to its destination, the cab of the dump truck struck an overpass and was severally damaged.  On July 17, 2003, Superior submitted a claim to Inscorp for the damaged dump truck.  Inscorp denied the claim in a letter dated November 5, 2003.  The denial letter did not notify Superior of the policy’s one-year contractual limitations period.  In January 2004, Superior retained legal counsel who challenged the denial in a several letters to Inscorp.  However, Inscorp affirmed the company’s decision to deny the claim arguing that there was no coverage under the policy.  Once again, Inscorp’s letter did not notify Superior of the one-year contractual limitations period.  When counsel for Superior finally filed a complaint on May 20, 2005, Inscorp filed a motion for summary judgment arguing that the contractual limitations period barred the complaint.  The trial court agreed and entered a judgment in favor of Inscorp.

Although the trial court’s summary judgment was overturned, all was not lost for Inscorp.  The appellate court ultimately held that Superior made a material misrepresentation on its insurance application by failing to disclose that Superior transported motor vehicles.  This misrepresentation, the court held, rendered the policy invalid and established a complete defense to the breach of contract and implied covenant claims.

This case should serve as an additional reminder that an insurer has a duty to notify the insured of a contractual limitations provision, regardless of whether or not the insured has retained legal counsel.  Whenever a policy contains a contractual limitation provision, the insurer should provide notice of the provision in nearly all communications with the insured.

Blue Shield offers several health insurance plans to individuals.  As part of the determination whether to issue coverage, Blue Shield provides an application to an individual seeking coverage that requests detailed information of past and current health problems, treating physicians, prescribed medications and recommended treatment.  Using proprietary written guidelines, Blue Shield engages in the underwriting process by evaluated the responses provided by each applicant to determine eligibility for health insurance and, if so, at what premium rate.  Julie Nieto applied for one of these policies but failed to disclose information about her back and hip condition and treatment on a health insurance application she submitted to Blue Shield.  Blue Shield issued her a policy based upon her representations.

After issuing the policy, Blue Shield’s underwriting investigation unit opened a file on Nieto after it received a referral from the medical management department indicating that she had received a diagnosis of necrosis of the hip and was scheduled for hip replacement surgery.  As part of the investigation Blue Shield sought and obtained her medical and pharmacy records.  At that point, Blue Shield learned that immediately preceding her application appellant had received extensive treatment for back and hip pain and had been prescribed multiple medications.  Blue Shield proffered evidence that if it had been aware of the undisclosed information it either would have declined to issue the policy or, at a minimum, would not have issued the policy until receiving additional information from appellant.

The Second Appellate District affirmed, holding that as a matter of law, Blue Shield was entitled to rescind coverage if the undisputed evidence showed that Nieto committed fraud by making material misrepresentations or omissions concerning her medical history or condition to Blue Shield before it issued the policy.  Turning to the evidence submitted in connection with the motion, the court affirmed the trial court’s finding “that the undisputed facts establish each element of fraud and deceit under California law, with respect to [Nieto's] misrepresentations when applying for coverage with Blue Shield Life.”

The court found that undisputed evidence established that Nieto made material misrepresentations and omissions on the application regarding her medical condition and treatment finding that she responded negatively to the inquiries in the “Medical History” portion of the application, when in fact she had suffered from chronic back problems throughout 2005 and previously.  Moreover, she represented that her last doctor’s visit had occurred three years earlier, when in fact she had seen and received significant treatment her doctor, and she had seen him at least 17 times between February and May 2005, including the day she signed the application.  She further represented that she had not taken or been directed to take any prescription medications when in fact she had filled at least 10 prescriptions for four different medications and had received two steroid injections as well as an oral steroid.

The court found that the undisputed evidence further established that Nieto’s misrepresentations and omissions were material.  In support of summary judgment, Blue Shield offered a declaration that it would not have approved Nieto for coverage had it known about her medical history.  According to Blue Shield’s underwriting guidelines, the medical conditions reflected in Nieto’s medical and pharmacy records, if disclosed on her application, would have rendered her ineligible for enrollment in any Blue Shield product.

The court also rejected Nieto’s assertion that even if the undisputed evidence established that she misrepresented and omitted material information on her application, Blue Shield was precluded from rescinding the policy because it neither attached nor endorsed the application to the policy.  Nieto relied on Ticconi v. Blue Shield of California Life & Health Insurance Company, 160 Cal. App. 4th 528 (2008).

In Ticconi, the insured alleged that Blue Shield issued his policy without either attaching or endorsing a copy of his application and that therefore he was not bound by any representation made in the application.  He further alleged Blue Shield had rescinded multiple policies that did not have the applications attached to or endorsed on the policies and that such rescission violated sections 10113 and 10381.5 and was an unfair business practice.  Id. at pp. 535–536.  Determining that the insured had stated a claim suitable for class certification, the court summarized the pertinent statutes, stating that “section 10113 prohibits incorporating applications into a disability insurance policy by reference unless they are endorsed upon or attached to the policies when issued.  [Citation.]  If a copy of an application for a policy is not attached to or endorsed on the policy when the policy is issued, then the insured is not bound by statements made in that application.  [Citation.]“  Id. at p. 540.

Turning to legislative history, the court observed that section 10381.5 “was designed to ‘repeat[ ] a provision of section 10113 . . .’ [citation]” and separately established that when a copy of the application is neither attached to nor endorsed on the policy the insured is not bound by any statement made in the application.  Id. at p. 540.)  Further, citing Telford v. New York Life Ins. Co., 9 Cal. 2d 103 (1937), the court determined that “[a]nother consequence of violating sections 10113 and 10381.5 is that the insurer may not invoke the defense of misrepresentations in or omissions from the unattached and unendorsed application.”  Id. at p. 541.  Thus, it concluded that the insured’s claim that Blue Shield “fail[ed] to attach applications to or endorse them on disability policies when issued and later engage[ed] in post-claims underwriting by holding insureds to statements in those unattached and unendorsed applications as grounds for voiding or rescinding the policies” alleged unlawful conduct that could serve as a predicate unlawful business practice in violation of Business and Professions Code section 17200.

The court explained that, though not cited by the Ticconi court, Metzinger v. Manhattan Life Ins. Co., 71 Cal. 2d 423 (1969) that section 10113 does not apply to a situation where an insurer seeks to rescind a policy because of fraudulent misrepresentations made by the insured.  It further explained that in Blue Shield did not seek to incorporate any document into the policy by reference.  Rather, it sought to demonstrate that, in accordance with sections 331 and 359, it was entitled to rescind the policy.

The appellate court also agreed with the trial court that the undisputed evidence failed to establish that Blue Shield was precluded from rescinding the policy because it engaged in postclaims underwriting in violation of section 10384.  That statute prohibits an “insurer issuing or providing any policy of disability insurance covering hospital, medical, or surgical expenses” from engaging in postclaims underwriting, defined as “the rescinding, canceling, or limiting of a policy or certificate due to the insurer’s failure to complete medical underwriting and resolve all reasonable questions arising from written information submitted on or with an application before issuing the policy or certificate.”  Id. The trial court ruled:  “Blue Shield Life did not engage in postclaims underwriting for at least two reasons:  (1) the undisputed facts establish that Blue Shield Life properly completed its underwriting and resolved all reasonable questions arising from the written information submitted on or with respect to [Nieto's] application; and (2) even if one were to assume that Blue Shield Life had some obligation to contact the providers listed in the application, [Nieto] did not even list the providers who had treated her for the conditions that led to the rescission.  Thus, the rescission was not ‘due to’ (i.e., the result of) any claimed underwriting deficiency.”

The court rejected Nieto’s reliance on Hailey v. California Physicians’ Service, 158 Cal. App. 4th 452, (2007).  Hailey involved an interpretation of Health and Safety Code section 1389.3, which applies exclusively to health care service plans licensed and regulated by the Department of Managed Health Care.  The statute is phrased similarly to section 10384, but does not apply upon a showing of willful misrepresentation.  See Health & Saf. Code § 1389.3.  In Hailey, the insured completed a Blue Shield application, mistakenly believing the application sought information only about her—not her husband and son for whom she also sought coverage; she also incorrectly underestimated her husband’s weight.  After Blue Shield extended coverage to the insured and her family, the insured’s husband was admitted to the hospital for stomach problems and later became completely disabled as the result of an automobile accident.  Following the first hospitalization, a Blue Shield investigation revealed that the insured had misrepresented and omitted material information concerning her husband’s medical condition.  Blue Shield rescinded the policy.  The trial court granted summary judgment in favor of Blue Shield on the insured’s complaint for breach of contract and breach of the implied covenant of good faith and fair dealing and on Blue Shield’s declaratory relief cross-complaint.

The Hailey court reversed, concluding that there were triable issues of fact as to whether Blue Shield engaged in postclaims underwriting and whether the insured willfully misrepresented her husband’s medical condition.  It explained that Blue Shield was operating as a health care service plan subject to the Knox-Keene Health Care Service Plan Act of 1975 (Knox-Keene Act, Health & Saf. Code, § 1340 et seq.), which was designed “to ‘ensure the best possible health care for the public at the lowest possible cost by transferring the financial risk of health care from patients to providers.’  See § 1342, subd. (d).)”  Consistent with that goal, the Legislature enacted Health and Safety Code section 1389.3 to prevent providers from shifting the financial risk of health care back to patients.  Hailey, supra, at p. 463.  Given these particular policy considerations, the Court determined that “to effectuate section 1389.3’s purpose, and in light of the equitable nature of rescission, we interpret ‘medical underwriting’ to require a plan to make reasonable efforts to ensure a potential subscriber’s application is accurate and complete.”  Id. at p. 469.  The Court rejected Blue Shield’s argument that it could rely on the truthfulness of an applicant’s responses as part of its medical underwriting process, explaining that while such a position was consistent with section 331—permitting an insurer to rescind a policy for concealment—the Knox-Keene Act does not have a counterpart to Insurance Code section 331.”  Id. at p. 470.  The court held that “given this qualification, we construe the Hailey court’s medical underwriting requirements to be limited to health care service plans subject to the Knox-Keene Act.”

The court went on to hold that Blue Shield did not commit bad faith.

It will be interesting to see if the California Supreme Court weighs in on this issue and resolves the conflicting holdings in this case and Ticconi.

On appeal, the court explained that Moradi-Shalal did not stand for the proposition that insurers who violate the Unfair Insurance Practices Act can never be liable in tort to the injured party.  Instead, the court noted that “the courts retain jurisdiction to impose civil damages or other remedies against insurers in appropriate common law actions, based on such traditional theories as fraud, infliction of emotional distress and (as to the insured) either breach of contract or breach of the implied covenant of good faith and fair dealing.”  Moradi-Shalal, at 304-305.

This was departure from Textron Financial Corp. v. National Union Fire Ins. Co., 118 Cal.App.4th 1061 (2004), which was previously interpreted to bar UCL "unlawful" prong claims against insurers based on conduct prohibited by section 790.03.  Instead, the court held that “if a plaintiff relies on conduct that violates the Unfair Insurance Practices Act but is not otherwise prohibited, Moradi-Shalal requires that a civil action under the UCL be considered barred.”  Where, however, as in Zhang, a plaintiff alleges unlawful, misleading and untrue conduct that is expressly within the parameters of the UCL, the suit may proceed on that claim.

In response to those who make the “end run” argument, the Zhang court observed in a footnote that, as established in State Farm v. Superior Court, 45 Cal. App. 4th 1093 (1994), a UCL plaintiff is not entitled to seek compensatory and punitive damages, only restitution and injunction.  Accordingly, “if a plaintiff expressly alleges conduct that was prohibited by the UCL, then there is no reason to apply Moradi-Shalal to prohibit the cause of action.”

As a result, the Court of Appeal found that the trial court erred in sustaining the demurrer and issues an order overruling the lower court’s decision.