Calif. Insurance Rulings GCs Should Watch Out For

California appellate courts tackled a diverse array of insurance issues in 2007 that included health care post-claim underwriting, directors and officers (D&O) liability, employee dishonesty and the scope of the attorney-client privilege in the context of insurance. The decisions in these cases will have a direct influence on business processes for companies across many industries, and California general counsel should be aware of how these rulings may affect their companies.

• Health care. In suits that could have an impact on health insurance claims brought by employees, two recent court of appeal decisions held that “post-claim underwriting” by insurers was a prohibited practice. In Ticconi v. Blue Shield of California Life & Health Ins. Co., 157 Cal.App.4th 707, the 2nd District Court of Appeal held that post-claim underwriting of disability insurance policies is prohibited by Insurance Code �10384. The court allowed a case to proceed where it was alleged that the unlawful conduct was post-claims underwriting in which the insurer rescinded disability insurance policies based on alleged misrepresentations in the applications. The applications were incorporated by reference in, but neither endorsed on nor attached to, the insureds’ policies, in violation of Insurance Code �10113 and �10381.5.

  Also, the 4th District, in Hailey v. California Physicians’ Service, 158 Cal.App.4th 452, concluded that Health & Safety Code �1389.3 precludes a health services plan from rescinding a health insurance policy for a material misrepresentation or omission unless the plan can demonstrate that the misrepresentation or omission was willful or that the plan had made reasonable efforts to ensure that the subscriber’s application was accurate and complete as part of the pre-contract underwriting process. The court found that an insurer cannot engage in post-claim underwriting and, given the likelihood of inadvertent error in the application process, required an accurate risk assessment by the health insurance plan, which requires a reasonable check on the information the insurer uses to evaluate the risk at the time of the application.

• D&O liability. California courts in 2007 also interpreted D&O insurance policies. In August Entertainment Inc. v. Philadelphia Indem. Ins. Co., 146 Cal.App.4th 565, a corporate officer had entered into a contract without stating that he was acting on behalf of the corporation. The corporation subsequently disputed liability under the contract and the other contracting party brought suit against the corporation and the officer seeking to recover the contract price. The 2nd District found that there was no coverage under the D&O policy because the policy was not meant to cover the corporation’s contractual debt or the officer’s liability for breaching a contract. The breach of the asserted contractual obligation did not give rise to a loss caused by a “wrongful act” as that term is used in the D&O policy. Rather, the corporation was simply being required to pay an amount it voluntarily contracted to pay. According to the appellate court, to hold the insurer liable for the contract price would be tantamount to making it a business partner of the corporation and the officer, which was not the mutual intention of the insurer and the insured under the policy.
• Commercial wrongful eviction. The 2nd District also looked at whether “wrongful eviction” coverage would provide coverage in a breach of a commercial lease situation. In Golden Eagle Ins. Corp. v. Cen-Fed Ltd., 148 Cal.App.4th 976, Washington Mutual Bank sued its landlord, Cen-Fed, for breach of lease on commercial premises. The court found that “wrongful eviction” coverage only applies to claims brought by “persons” and not by “organizations.” According to the court, when an insurance policy distinguishes between natural persons and organizations, the distinct meaning of those terms must be honored. In a similar case, Stonelight Tile Inc. v. California Insurance Guarantee Assn., 150 Cal.App.4th 19, the insured’s recycling facility caused dust to fly around the surrounding neighborhood. It was alleged that this led a neighboring tile company to go out of business. In this case, the 6th District found that there was no coverage for “wrongful injury or eviction” because that coverage only applied to claims by natural persons.
• Employee dishonesty policy. Employee dishonesty — and who should pay for it — was an issue in Simon Marketing v. Gulf Ins. Co., 149 Cal.App.4th 616. In this case, the insured’s director of security organized a network of accomplices and co-conspirators to funnel high-value winning game tickets to specified individuals. The director of security stole game pieces with a total redemption value of about $21 million and received kickbacks from game winners. He was ultimately sentenced to prison. In general, the employee dishonesty policy covered losses to property caused by theft or forgery committed by the insured’s employees. The 2nd District found that the policies provided coverage only for direct losses caused by the employee theft and did not cover the insured’s vicarious liability for the tortious acts of its employee.
• Third-party beneficiaries. The appellate court also refused to extend insurance coverage beyond the named insureds even though the party seeking coverage claimed to be a third-party beneficiary under the policy. In Infinet Marketing Services Inc. v. American Motorists Ins. Co., 150 Cal.App.4th 168, the 4th District concluded that a party claiming to be a third-party beneficiary must show that the policy was procured expressly for its behalf or that it is a member of the class of persons for whose benefit the policy was procured.
• Insurance contract choice of law. In Frontier Oil Corp. v. RLI Ins. Co., 153 Cal.App.4th 1436, the 2nd District discussed choice-of-law rules applicable to the interpretation of insurance policies. Relying on California Civil Code section 1646, the court found that a contract is to be interpreted according to the law and usage of the place it is to be performed if the contract “indicates a place of performance” and according to the law and usage of the place it was made if the contract “does not indicate a place of performance.” The court found that a contract indicates a place of performance within the meaning of the statute if the contract expressly specifies a place of performance or if the intended place of performance can be gleaned from the nature of the contract and its surrounding circumstances.
• Attorney-client privilege. Attorney-client privilege also came before the court of appeal in 2007. The case of Zurich American Ins. Co. v. Superior Court (Watts Industries, Inc.), 155 Cal.App.4th 1485, revolved around a dispute between an insurer and its insured regarding the scope of the attorney-client privilege relating to reserve and reinsurance documents. The 2nd District found that the first relevant inquiry was whether a document sought for production contained a discussion of legal advice or strategy of counsel. Under Zurich, a document is privileged if it is determined that the document reflects legal advice or opinions. But the court must then determine whether the corporation waived the privilege by distributing the advice within the corporation beyond a “need to know” basis.