California Appeals Court Rules that Insurer Not Entitled to Rescind Policy Based on Material Misrepresentation Due to Ambiguity of Application Questions

In Duarte v. Pacific Specialty Insurance Company, a California appeals court found that an insurer was not entitled to rescind an insurance policy due to material misrepresentation and/or concealment of material facts as a matter of law. The court held that the insurer could not prove that the insured had made misrepresentations when he applied for the policy because the application questions at issue were ambiguous.

Victor Duarte bought a tenant-occupied rental property in 2001. Sometime thereafter, the daughter of the tenant moved into the rental property with her father, and continued to reside there after her father’s death in 2010. In February 2012, Duarte served the daughter with an eviction notice. The daughter did not leave the rental property and Duarte did not take any further action to remove her.

In April 2012, Duarte electronically submitted an application for a landlord insurance policy with defendant Pacific. Pacific issued a policy to Duarte covering the rental property the same day.

In June 2012, the tenant/daughter filed a lawsuit against Duarte for habitability defects at the rental property which allegedly existed since 2009. The lawsuit alleged that Duarte had been notified of these defects, and sought various damages arising from the defects. In August 2012, Duarte tendered defense of the lawsuit to Pacific which denied coverage and any duty to defend. Duarte then sued Pacific for breach of contract and other claims on the grounds that Pacific not only failed to defend the tenant lawsuit but also wrongfully cancelled his policy. In responding to the lawsuit, Pacific asserted a right to rescind the policy due to material misrepresentations on the application.

In cross-motions for summary judgment/adjudication, Pacific argued that it was entitled to rescind the policy because Duarte made material misrepresentations when he answered “no” to two questions on the application: (1) whether he knew of any disputes concerning the property; and (2) whether there were any businesses conducted on the property. In support of its position, Pacific submitted records regarding a March 2012 complaint filed by the tenant/daughter against Duarte with a public agency. Pacific also submitted a transcript of Duarte’s deposition in which he testified about his understanding about the complaint filed against him by the tenant/daughter. The trial court granted Pacific’s motion and denied Duarte’s motion. Duarte appealed, and the appeals court reversed.

The court held that Pacific did not meet its initial burden of proving that Duarte made misrepresentations on the insurance application. The court noted that the first application question at issue – “Has damage remained unrepaired from previous claim and/or pending claims, and/or known or potential (a) defects, (b) claim disputes, (c) property disputes, and/or (d) lawsuit?” – had “garbled syntax” and was “utterly ambiguous.” The court found that the evidence submitted by Pacific showed that Duarte knew of claims and/or disputes concerning the property. However, the court rejected Pacific’s position that the question required the answer, “yes” if there was unrepaired damage, any open or pending claims, potential defect, property disputes, or potential lawsuits. Given the question’s ambiguity, the court found that Duarte properly answered, “no” because he reasonably interpreted the question to ask whether the property had unrepaired damage associated in some way with previous or pending claims, defects, claims disputes, property disputes or potential lawsuits.

With regard to the second application question – “Is there any type of business conducted on the premises?” – the court noted that Pacific submitted evidence that showed that Duarte knew the tenant and tenant/daughter occasionally sold motorcycle parts from the rental property. Nonetheless, the court held that Duarte properly answered, “no,” because he reasonably interpreted the question as referring to “regular and ongoing business activity,” of which there was none to his knowledge.

California Appeals Court Rules that “Escape” “Other Insurance” Clause Contained in Coverage Portion of Primary CGL Policy Not Enforceable in Equitable Contribution Action

In Certain Underwriters at Lloyds, London v. Arch Specialty Insurance Co., a California appeals court held that an “other insurance” clause in a primary commercial general liability policy would not, as a matter of public policy, allow the insurer to avoid having to share defense costs.

Certain Underwriters at Lloyds, London (“Underwriters”) and Arch Specialty Insurance Company (“Arch”) were both primary insurers of Framecon, Inc. over successive policy years. Framecon was sued by a real estate developer for framing and carpentry work it performed on residential homes in three separate homeowner actions. Framecon tendered the claims to both Underwriters and Arch. Underwriters agreed to defend Framecon, while Arch denied any defense obligation based on the “other insurance” language contained in the insuring agreement and in the conditions section of its policy.

The underlying claims against Framecon were eventually settled with both Underwriters and Arch agreeing to indemnify Framecon for damages on a “time on the risk” basis. Underwriters then sued Arch for declaratory relief and equitable contribution for defense costs incurred in the underlying litigation. In cross-motions for summary judgment, Arch argued that its “other insurance” provisions relieved it of any duty to defend. The trial court found in favor of Arch, and relied on a prior California case which held that the placement of the “other insurance” clause in the insuring agreement of the policy, as opposed to in the conditions section, makes it an enforceable exception from coverage for defense costs rather than a disfavored “escape” clause.

On appeal, the Court of Appeal noted that the original purpose of “other insurance” clauses was to prevent multiple recovery by insureds in cases of overlapping policies providing coverage for the same loss, but that public policy disfavored “escape” clauses. The court explained that “escape” clauses are so named because they permit an insurer to make a seemingly ironclad guarantee of coverage, only to withdraw that coverage – and thus “escape” liability – in the presence of other insurance. The Court of Appeal rejected Arch’s argument that its “other insurance” clause was enforceable because it was located in both the insuring agreement and in the conditions section of the policy, and found that the “modern trend” is to distrust “escape” “other insurance” clauses that attempt to shift the burden away from a primary insurer. The court also stated that reliance on location of the “other insurance” clause in the coverage section as determinative “would tend to encourage insurers to jockey for best position in choosing where to locate ‘other insurance’ language, needlessly complicating the drafting of policies, inducing wasteful litigation among insurers, and delaying settlements – all ultimately to the detriment of the insurance-buying public.”

The Court of Appeal concluded that Underwriters was entitled to receive equitable contribution from Arch as the “other insurance” clause contained in Arch policy was not enforceable based on public policy considerations.

California Appeals Court Rules that Defending Insurer Is Not Bound by Stipulated Judgment to Which It Did Not Consent

In 21st Century Insurance Company v. Superior Court (Tapia), a California appeals court held that an insurance company that is defending its insured cannot be bound by a stipulated judgment entered into by its insured without a trial and judgment after verdict.

The insured, Cy Tapia, was a teenager living with his aunt and grandmother. Tapia was driving with Cory Driscoll in a vehicle owned by Tapia’s grandfather when he was involved in an accident that left Driscoll severely injured. Tapia had $100,000 in liability coverage under an automobile insurance policy issued by defendant 21st Century Insurance Company.

Driscoll and his mother sued Tapia. 21st Century agreed to provide a defense to this suit. Plaintiffs rejected 21st Century’s settlement offer of the $100,000 policy limit as they believed that Tapia might be covered under 21st Century policies issued to Tapia’s aunt and grandmother, each providing $25,000 in coverage.

21st Century offered $150,000 to settle the case against Tapia which plaintiffs declined as they demanded $3 million for Driscoll and $1.15 million for his mother. 21st Century warned Tapia that it would not agree to be bound if Tapia accepted the offer. Tapia ignored this warning, agreed to the entry of a stipulated judgment and assigned any rights he had against 21st Century. Plaintiffs filed a bad faith action against 21st Century, and 21st Century moved for summary judgment which was denied. This denial was reversed on appeal.

The Court of Appeal cited Hamilton v. Maryland Casualty Co. (2002) 27 Cal.4th 718, 730 for the rule that “a defending insurer cannot be bound be a settlement made without its participation and without any actual commitment on its insured’s part to pay the judgment.” The crucial element in the Hamilton ruling was the lack of a judgment rendered after an adversarial trial given the potential for collusion. The Court stated that if the situation involved an insurer that refused to defend, then the insured was free to enter into a stipulated judgment at any time.

The Court of Appeal rejected plaintiffs’ arguments that 21st Century breached its duty to defend because it did not acknowledge coverage or a duty to defend under the policies issued to Tapia’s aunt and grandmother.  The Court also found that the undisputed evidence demonstrated that 21st Century did not have a duty to defend Tapia under either of the policies issued to his aunt or grandmother.

Insurer Not Obligated to Defend Underlying Action Seeking Only Injunctive Relief Even Though Amendment Added Damage Claim

California has long recognized a liability insurer has no duty to defend lawsuits that seek nonmonetary relief such as injunctive relief actions.  The trickier aspect is what happens if a damage claim is later sought? Does that mean the insurer had a duty to defend from the outset because a damage claim could be stated? The California Court of Appeal, Fourth Appellate District, says no.

In San Miguel Community Association, et al. v. State Farm General Insurance Co. (2013) 220 Cal.App.4th 798, the underlying action against the insured initially sought only injunctive relief.  State Farm agreed to defend after the underlying plaintiffs amended their complaint to seek “damages.”  The insured argued State Farm had a duty to defend from the outset because the original complaint implied a claim for “damages.”  The trial court said no and the Court of Appeal affirmed adopting the simple test that, whether the underlying plaintiffs had sustained “damages” prior to the plaintiffs’ amendment was irrelevant because the earlier complaint did not seek recovery of “damages.”

The underlying lawsuit against the insured, San Miguel, involved a dispute over enforcement of parking restrictions in a condominium community.  The underlying plaintiffs began complaining at board meetings that San Miguel was not enforcing the restrictions.  They initially claimed distress, adverse effect on property values, and nominal out-of-pocket costs (such as for copying).  San Miguel demanded mediation.

The underlying plaintiffs subsequently filed suit against San Miguel for injunctive relief.  Neither the original nor the first amended complaint sought “damages” (although the plaintiffs requested punitive damages).  State Farm denied coverage with respect to both complaints.  The court allowed the plaintiffs to file a second amended complaint in which the underlying plaintiffs alleged – for the first time – that they sustained actual monetary “damages.”  State Farm initially denied coverage for the second amended complaint but, after speaking with the underlying plaintiffs’ counsel, agreed to provide San Miguel with a defense.

Coverage litigation followed.  San Miguel alleged State Farm breached the insurance contract and the covenant of good faith and fair dealing in declining to pay for the defense of the underlying claim prior to the second amended complaint.  San Miguel also contended that State Farm misrepresented its conversations with the underlying plaintiffs’ counsel in an effort to avoid coverage.  State Farm successfully moved for summary judgment, and San Miguel appealed.

On appeal, San Miguel did not dispute that State Farm’s policy required a claim for covered “damages” to trigger a duty to defend.  But, despite the lack of an explicit claim for “damages,” San Miguel argued the earlier allegations gave rise to the implication of “damages,” which triggered a defense obligation.  The Court of Appeal disagreed, noting that an insurer cannot deny a defense merely because the allegations against the insured are not phrased in the precise language of the policy.  However, this rule against strictly construing the underlying allegations does not mean the insurer must infer that other allegations exist where they are clearly not pleaded.

On Oct. 1, 2013, the Court of Appeal found the specific allegations in the earlier versions of the complaint were inconsistent with an implication that the underlying plaintiffs sought to recover money “damages.”  The court also rejected San Miguel’s argument that the request for punitive damages implied a claim for consequential “damages.”  Even assuming the punitive damages claim was flawed (due to the absence of a “damages” claim), the court observed that there would be no need for demurrers if courts and other parties were required to infer the existence of missing allegations.  The testimony of the underlying plaintiffs’ counsel also was consistent with State Farm’s view that San Miguel did not seek recovery of “damages” until its second amended complaint.

As to the allegation that State Farm fabricated a conversation with counsel for the underlying plaintiffs, the court found no evidence of misrepresentation or any reason State Farm would have reached a different conclusion about coverage had it handled the investigation differently.  Finally, the court rejected San Miguel’s bad-faith claim based on the contention that State Farm manufactured evidence.  Absent any right to recover additional benefits under the policy, San Miguel had no viable claim of bad faith.

Click here for the opinion.