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.

Denial of Summary Judgment Does Not Automatically Establish Duty To Defend

In McMillin Companies, LLC v. American Safety Indemnity Company, a California appeals court found a trial court erred in finding the denial of an insurer’s motion for summary judgment on the duty to defend meant the insurer’s duty to defend was established as a matter of law.

McMillin Companies, LLC was the general contractor for a series of residential construction projects in Temecula, California.  After the projects were completed, McMillin was named in a construction defect lawsuit that arose out of the projects.  McMillin tendered its defense to the insurers of allegedly implicated subcontractors, including American Safety Indemnity Company (“ASIC”), contending it was an additional insured.  None of the insurers accepted McMillin’s tender.

McMillin sued ASIC and other insurers for breach of contract and bad faith based on their alleged failure to defend.  After numerous settlements, ASIC was left as the sole remaining defendant.  ASIC submitted a motion for summary judgment, arguing, inter alia, that it did not owe any duty to defend because its policy only covered  liability arising out of its named insured’s “ongoing operations” which had ceased prior to the occurrences alleged in the litigation.  This motion was denied on the basis ASIC had not met its initial burden of proof to show no triable issue of material fact.

At trial, McMillin moved in limine to exclude argument disputing ASIC’s duty to defend, and ASIC moved in limine to preclude McMillin from arguing the amounts it had received from the other insurers in settlement were not offsets to McMillin’s alleged damages against ASIC.  The trial court granted McMillin’s motion, finding the prior denial of ASIC’s motion for summary judgment demonstrated the existence of a disputed issue of material fact which necessitated a finding of a duty to defend.  The trial court also granted, without explanation, ASIC’s motion as to the settlement offsets.

The California court of appeal reversed, holding the trial court erred in granting the motions in limine.  Disagreeing with the trial court’s conclusion, the appeals court reasoned that the denial of an insurer’s motion for summary judgment because it failed to meet its initial burden of proof was not the same as denying the motion based on an unresolved factual dispute.  The appeals court also concluded McMillin’s settlements with the other insurers were not potential offsets to damages but rather would only affect McMillin’s right to recover any damages awarded at trial.

California Supreme Court Overrules Prior Appellate Decision on Coverage for Product Disparagement

In Hartford Casualty Insurance Co. v. Swift Distribution, Inc., the California Supreme Court clarified the law on coverage for commercial disparagement, expressly overruling an earlier intermediate appellate decision that had significantly broadened coverage for the tort.  The Supreme Court held a claim of disparagement must contain a false or misleading statement that specifically refers to and clearly derogates a competitor’s product or business.

Hartford issued a CGL policy to a company doing business as Ultimate Support Systems.  Ultimate sold a product called the Ulti-Cart, a multi-use cart marketed for the loading and transport of musicians’ equipment.  A competitor who made a similar transport cart called the Multi-Cart sued Ultimate for patent and trademark infringement, false designation or origin, and damage to business, reputation and goodwill.

Hartford denied any duty to defend or indemnify Ultimate on the ground the claims were outside the personal and advertising injury insuring agreement.  Ultimate contended the allegations raised a claim for covered disparagement. An earlier appellate decision, Travelers Property Casualty Co. of America v. Charlotte Russe Holding, Inc. (2012) INS BLOG_charlotte russe207 Cal.App.4th 969, had found a claim for covered disparagement potentially existed because an insured’s reduction in the price of a product could implicitly constitute disparagement of that product.  Hartford brought a declaratory relief action in which the trial court granted summary judgment for Hartford, which was affirmed by the Court of Appeal and Supreme Court.

The Supreme Court found Ultimate’s advertisements contained no disparagement of Multi-Cart’s products.  It held that, while the similarity between the Ulti-Cart and the Multi-Cart could cause consumer confusion and might support a claim of patent or trademark infringement, it did not, by itself, support a claim of disparagement because there was no express assertion or clear implication of the inferiority of the Multi-Cart.

The Supreme Court also held that phrases and words used in Ultimate’s advertising, such as “patent-pending,” “innovative,” “unique,” “superior” and “unparalleled,” did not support a claim for disparagement as these phrases and words were not specific enough and were more akin to “mere puffing,” which could not support tort liability.

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