News - April 2006

• Insurer Can Rescind Based on Material Misrepresentation in Application
• Under Claims-Made Policy, Claim is “First Brought” Insured Where Receives Demand Letter
• Insured Cannot File One Suit for Contract Damages and Another Suit for Bad Faith Damages
• Subrogation: Insurer Need Not Prove “How or Why” Sewage Backed Up from City Main if Evidence Eliminates Other Causes

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Insurer Can Rescind Based on Material Misrepresentation in Application

The California Court of Appeal has held that a D&O insurer properly rescinded a policy based on the insured’s material misrepresentation in the application.  (TIG Insurance Company of Michigan v. Homestore, Inc. (2006) 137 Cal.App.4th 749)

Facts

Homestore, Inc. (Homestore) submitted an application to TIG Insurance Company of Michigan (TIG) for a directors and officers liability policy.  As part of the application process, TIG required that Homestore submit a financial statement.  After TIG issued the policy, Homestore’s chief financial officer admitted that, on the date he signed the insurance application, he knew the financial statement contained material misrepresentations about Homestore’s true financial condition.

TIG’s policy stated “this Policy in its entirety shall be void and of no effect whatsoever if such [material] misrepresentations were known to be untrue on the inception date of the Policy by one or more of the individuals who signed the Application.”  TIG sued to rescind the policy, and sought summary judgment based on the chief financial officer’s admission, and based on an underwriters’ declaration that TIG would not have issued the policy had it known the true facts. 

In response, Homestore argued that the TIG policy provision was ambiguous as to whether the rescission applied to officers and directors who did not sign the application and were not aware of the misrepresentations.  Homestore also argued that the policy provision was unenforceable because it violated public policy and was not “conspicuous, plain and clear.”

Holding

The Court of Appeal ruled TIG policy provision was consistent with the Insurance Code, which provides insurers the right to rescind coverage based on material misrepresentations in the insurance application.  Further, Insurance Code section 650 provides that rescission applies to all insureds unless the policy provides otherwise.  The provision was “conspicuous, plain and clear” because it was easily located on a page with double-spacing and used words readily understandable by the average layperson.  Under the circumstances, TIG was entitled to rescind the policy.  

Comment

A material concealment or misrepresentation on an application—even if unintentional—entitles an insurer to rescind.  The insurer may either file an action for rescission or raise the misrepresentation as a defense to coverage.  Further, rescission can be based on policy provisions or statute. (See Insurance Code sections 330-361, 650.) 

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Under Claims-Made Policy, Claim is "First Brought" Insured Where Receives Demand Letter

The California Court of Appeal has held that, under a claims-made policy, a claim is “first brought” at the place the insured receives a third party’s demand letter. (National Cas. Co. v. Sovereign Gen. Ins. Svcs. (2006) 40 Cal.Rptr.3d 591)      

Facts

National Casualty Company (National) issued a liability policy to Sovereign General Insurance Services, Inc. (Sovereign), a surplus lines broker.  The policy provided coverage for wrongful acts committed anywhere in the world provided that the claim was first brought in the United States, and so long as the claim was first made during the policy period. The policy defined a “claim” as a demand or assertion of a legal right seeking damages, and included any arbitration proceeding to which any insured was required to submit.

Under agreements with Certain Underwriters at Lloyd’s, London (Lloyd’s), Sovereign issued certificates of insurance and processed claims.  Sovereign’s agreements with Lloyd’s required that all matters “arising under, out of or in connection with” the agreements had to be arbitrated in London in accordance with the laws of England.

In a letter addressed to Sovereign’s offices in California, Lloyd’s asserted that it had suffered losses as a result of Sovereign’s breach of the agreements and that Lloyd’s intended to recover all losses arising out of Sovereign’s actions. Lloyd’s then demanded $5 million to settle its claims, and also demanded arbitration.  Sovereign tendered the claims to National.

National agreed to defend Sovereign, but reserved its rights to assert that Lloyd’s claims were brought outside the territorial limits of National’s policy.   National then brought a declaratory relief action, contending that the coverage for a “claim … first brought in the United States” meant that a claimant had to initiate a legal proceeding in the United States.  Essentially, National asserted that Lloyd’s claim was “brought” when Lloyd’s initiated an arbitration proceeding in London and that, therefore, the claim fell outside the territorial limit of National’s policy.

Holding

The Court of Appeal rejected National’s interpretation of the policy, finding it was not reasonable to interpret the phrase “claim first brought” as a limitation to a particular territory given the fact that the policy purported to cover wrongful acts committed anywhere in the world.  The Court also found the phrase “claim first brought” to be ambiguous because the policy defined a “claim” to include not only a lawsuit, but also a mere demand for damages.  Therefore, the Court concluded, Lloyd’s “brought” the claim when Lloyd’s mailed the demand letter to Sovereign’s offices in California.

Comment

This case illustrates that, once a California appellate court determines that a policy term is ambiguous, the court will use the parties’ “objective reasonable expectations” to resolve the ambiguity (usually in favor of the insured).

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Insured Cannot File One Suit for Contract Damages and Another Suit for Bad Faith Damages

The California Court of Appeal has held that an insured seeking recovery for breach of contract and bad faith cannot file separate suits against the insurer, and must assert all theories of recovery in a single action.  (Lincoln Property Company, N.C., Inc. v. The Travelers Indemnity Company (2006) 137 Cal.App.4th 905)

Facts

Lincoln Property Company, N.C., Inc. (Lincoln) hired a contractor to paint some buildings.  The painting contract required the contractor to carry general liability insurance and to name Lincoln as an additional insured on the policy.

The contractor obtained a comprehensive general liability policy from The Travelers Indemnity Company (Travelers).  The policy included a “Blanket Additional Insured” endorsement that added as an insured “any person or organization . . . whom you have agreed in a written contract, executed prior to loss, to name as additional insured.”

While the work was underway, a painter employed by the contractor fell from the roof of a building.  The worker sued Lincoln, and Lincoln tendered defense of the action to both the contractor and Travelers.  However, Travelers did not respond to Lincoln’s tender.  Therefore, Lincoln hired an attorney and paid for its own defense costs for several months.  Later, another insurer began providing Lincoln with a defense. 

In the personal injury case, Lincoln filed a cross-complaint for breach of contract against the painting contractor and Travelers.  Eventually, Travelers agreed to participate in Lincoln’s defense under a reservation of rights.

While Lincoln’s cross-complaint for breach of contract was still pending against Travelers, Lincoln filed a separate bad faith suit in which Lincoln alleged that Travelers had acted unreasonably by not timely responding to Lincoln’s request for defense and indemnity.

Travelers settled the personal injury case and obtained a general release in favor of Lincoln.  In addition, Travelers reimbursed Lincoln for the attorney fees and costs Lincoln had incurred after Lincoln’s tender.  Thereafter, the trial court entered summary judgment on Lincoln’s cross-complaint for breach of contract, ruling that Travelers and the other insurer had satisfied any potential contractual obligations to defend and indemnify Lincoln.

Next, the trial court in Lincoln’s separate action for bad faith ruled that the suit was barred because Lincoln had “split” a cause of action. 

Holding

The Court of Appeal agreed, holding that Lincoln’s cross-complaint against Travelers for breach of contract and Lincoln’s separate complaint against Travelers for bad faith both arose out of an alleged violation of the same “primary right.”  The Court held that, Travelers’ alleged breach of contract and its alleged bad faith conduct both involved a violation of the same primary right and, therefore, both involved only one cause of action.

Comment

California courts adhere to the “primary right” theory, which provides that a “cause of action” is comprised of a primary right of the plaintiff, a corresponding primary duty of the defendant, and a wrongful act by the defendant constituting a breach of that duty.  The most important characteristic of a primary right is that it is indivisible, i.e., the violation of a single primary right gives rise to only a single cause of action.  A plaintiff seeking recovery for violation of a primary right may utilize multiple theories (e.g., breach of contract and breach of the implied covenant of good faith), but where all theories of recovery arise from the same primary right, the plaintiff cannot “split” the cause of action, and must assert all theories of recovery in one case. 

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Subrogation: Insurer Need Not Prove "How or Why" Sewage Backed Up from City Main if Evidence Eliminates Other Causes

(California State Automobile Association Inter-Insurance Bureau v. City of Palo Alto 2006 WL 903684)

A sewer line located on residential property became blocked with tree roots, causing raw sewage to back up inside a house.  The homeowners’ insurer paid for the damage.  During repairs, the homeowners replaced the entire lateral sewer line that extended from their house to the city sewer main. 

Immediately after repairs were completed, sewage again backed up inside the house.  Investigation revealed the lateral sewer line the homeowners had just replaced was in “perfect” condition, but that the city’s main sewer line had an insufficient downward slope and was partially blocked with roots.  The homeowners’ insurer again paid to repair the damage to the house, but then filed a subrogation action against the city to recover the sums the insurer paid in connection with the second sewage backup.

After a bench trial, the judge ruled in favor of the city.  The judge reasoned that, although the insurer had proved the blockage occurred in the city’s main, the insurer had not specifically proved “how or why” the blockage occurred.

The Court of Appeal reversed, and held the insurer was entitled to recover on the evidence presented.  One of the theories on which the insurer had proceeded was “inverse condemnation.”  Under this theory, the insurer was entitled to recovery if the insurer could establish the city’s sewer main was a “substantial factor” in causing the damage and if the insurer also could eliminate the probability that other forces alone had caused the damage.  The Court of Appeal ruled that the insurer had met this burden and did not need to show specifically “how or why” the blockage occurred. 

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