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Insurance Law News - October 2014

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Auto Insurer Cannot Exclude Coverage for Insured's Liability to Non-Relative Resident of Household

An auto insurer could not validly exclude coverage for an insured's liability for bodily injury suffered by a non-relative resident of the insured's household. (Mercury Casualty Co. v. Chu (2014) 229 Cal.App.4th 1432)

Facts

Mercury Casualty Company issued an auto policy to Hung Chu, who had a roommate named Tu Pham. While Chu was driving his car with Pham riding as a passenger, Chu caused an accident in which Pham was injured.

Pham subsequently filed a personal injury action against Chu, who sought defense and indemnity from Mercury. The Mercury auto policy excluded coverage for bodily injury suffered by an "insured," and defined an "insured" so as to include Chu as named insured as well as any "resident … who inhabits the same dwelling as the named insured." Mercury agreed to defend Chu against Pham's lawsuit. However, Mercury reserved its right to assert that it had no duty to indemnify Chu on the ground that Pham was a "resident" of the same dwelling as Chu, and hence Pham was an "insured" under Chu's policy. Eventually, Pham obtained a $330,000 judgment against Chu in the personal injury action.

Mercury filed a declaratory relief action seeking a determination that it had no duty to indemnify Chu for any liability to Pham in the underlying personal injury action. The trial court ruled that the Mercury policy excluded coverage for Chu's liability to Pham and entered judgment for Mercury. Pham appealed.

Holding

The California Court of Appeal reversed, and held that in these circumstances the exclusion in Mercury's auto policy was not enforceable.

The appellate court acknowledged that California Insurance Code section 11580.1(c)(5) allows an auto insurer to exclude coverage for bodily injury to an "insured." However, the appellate court held that for purposes of the statutorily-authorized exclusion, there are limits as to how an insurer can define the term "insured." The appellate court observed that historically, the exclusion was intended to bar coverage when an insured is sued by a relative residing in the same household. That is because in that situation there is a high potential for collusion between family members. Here, by contrast, Mercury's exclusion purported to bar coverage when the insured was sued by a non-relative residing in the same household. According to the appellate court, in this latter situation there is not the same potential for collusion, and thus the exclusion should not apply.

In short, the court held that Mercury's non-relative resident exclusion was "an overbroad expansion" of the statutorily-allowed exclusion and "contrary to public policy." As such, the exclusion did not bar coverage for Chu's liability to Pham.

Comment

In Farmers Insurance Exchange v. Cocking (1981) 29 Cal.3d 383, the California Supreme Court upheld a traditional "resident relative" exclusion, explaining that the public policy behind the exclusion was to prevent the insurer from being subjected to "suspect inter-family legal actions which may not be truly adversary and over which the insurer has little or no control."

However, in this case, the appellate court concluded that the broader "resident" exclusion which was at issue did not further the goal of avoiding collusive lawsuits. Indeed, the appellate court noted that cohabitation in the same residence is often temporary and can involve complete strangers. Thus, there was no basis to assume that in this situation insurers face the same risk of fraudulent lawsuits.

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Loss Payee Who Owns First and Second Loans and Forecloses on Second by Making "Full Credit Bid" Cannot Recover from Insurer for Property Damage

A loss payee who owns both a first loan and a second loan, and who forecloses on the second loan by making a "full credit bid," cannot recover from an insurer for property damage that occurred before the foreclosure sale. (Najah v. Scottsdale Ins. Co. (2014) 2014 WL 4827882)

Facts

Orange Crest Realty Corporation (Orange Crest) purchased commercial land that was improved with a building. Orange Crest financed part of the purchase price with a first loan from the Lantzman Family Trust (Lantzman Trust), and financed the remainder with a second loan from Jamshid Najah and Mark Akhavain, the sellers. The first loan was secured by a first trust deed, and the second loan was secured by a second trust deed. (Under California law, a "trust deed" arrangement is essentially the same as a "mortgage" arrangement.)

Orange Crest ultimately defaulted on the first loan, and the Lantzman Trust commenced foreclosure proceedings. In order to protect their interest, Najah and Akhavain purchased the first loan for $1.749 million (the full amount Orange Crest owed to the Lantzman Trust) and obtained an assignment of the first trust deed held by the Lantzman Trust. As a result, Najah and Akhavain owned both the first and second loans.

Later, Najah and Akhavain discovered that Ronald Shade (Orange Crest's principal) had caused extensive damage to the building, and had stolen various building components. After discovering the damage and theft, Najah and Akhavain instituted foreclosure proceedings on the second trust deed. At the foreclosure sale, Najah and Akhavain re-acquired the property by bidding $2.878 million, which was the full amount of the unpaid debt on the second promissory note, including interest, fees, and the costs of foreclosure. (As will be explained, this is known as a "full credit bid.")

Najah and Akhavain then submitted a claim to Scottsdale Insurance Company (Scottsdale), which had issued a policy on which Orange Crest was named as the insured and on which Najah and Akhavain were named as loss payees pursuant to a "standard" lender's loss payable endorsement. Scottsdale denied coverage for numerous reasons, and Najah and Akhavain filed suit for breach of contract and bad faith.

At trial, the court found in favor of Scottsdale. Among other things, the court ruled that because Najah and Akhavain had made a "full credit bid" when Najah and Akhavain foreclosed on the second loan, this eliminated their right to recover on the policy. Najah and Akhavain appealed.

Holding

On appeal, Najah and Akhavain did not dispute that their full credit bid at the foreclosure sale on the second trust deed extinguished that debt. However, they contended they should still be able to recover from Scottsdale because, before the foreclosure sale, they held two trust deeds that secured two separate debts, and after the foreclosure sale, they still held the first loan. More specifically, they contended that, even though they had made a full credit bid, a recovery from Scottsdale would not provide them with an unfair windfall, as they had invested a total of $4.627 million to acquire the property – the $1.749 million they paid to the Lantzman Trust for the first loan and the $2.878 million they bid at the foreclosure sale when they foreclosed on the second loan. Thus, Najah and Akhavain argued that all liens held by a single loss payee should be aggregated to determine whether a full credit bid extinguished a loss payee's right to recover from an insurer.

The Court of Appeal rejected all of these arguments, and held that when Najah and Akhavain made a full credit bid at the foreclosure sale regarding the second loan, that bid established that, at the time of the foreclosure sale, the property was equivalent to the value of the total debt they held. Therefore, their full credit bid barred any claim against Scottsdale for damage that occurred before the foreclosure sale.

Comment

Generally, when a lender forces a foreclosure sale, anyone – including the lender – can bid at the sale. At the foreclosure sale, the lender has "credit" that is equal to the sum of the unpaid principal, accrued interest, late charges and costs of sale. Because it would be a pointless exercise for a lender to tender cash or a check to itself to satisfy the unpaid debt, the courts recognize that the lender can use some or all of this "credit" to bid at the foreclosure sale.

If the property sustains damage before the sale and the lender then acquires title at the sale, the lender often will make a claim against any property insurance policy on which the lender was named as a loss payee. However, in many instances, the "credit bid" rules will limit or even altogether eliminate the lender's recovery against the policy. (Track Mortgage Group, Inc. v. Crusader Insurance Company (2002) 98 Cal.App.4th 857.)

A loss payee's recovery for damage that occurred before the sale is limited to the difference between the amount of the debt and the amount of the lender's credit bid at the foreclosure sale. Two examples illustrate application of the credit bid rules.

Suppose the full amount of the debt is $100,000 and the lender acquires title at the foreclosure sale by making a credit bid of $50,000. (This generally is known as a "partial credit bid," because the lender used only part of its "credit" to acquire title.) However, after acquiring title, the lender discovers that, prior to the foreclosure sale, the property sustained damage of $75,000 caused by a peril covered by the policy on which the lender is named as the loss payee. Although the property has damage of $75,000, the carrier is obligated to pay the lender only $50,000 (i.e., the difference between the debt of $100,000 and the lender's partial credit bid of $50,000).

Alternatively, suppose the full amount of the debt is $100,000 and the lender acquires title at the foreclosure sale by making a credit bid of $100,000. (This generally is known as a "full credit bid," because the lender used the full amount of its "credit" to acquire title.) However, after acquiring title, the lender discovers that, prior to the foreclosure sale, the property sustained damage of $75,000 caused by a peril covered by the policy on which the lender is named as the loss payee. Although the property has damage of $75,000, the carrier is obligated to pay the lender nothing (i.e., the difference between the debt of $100,000 and the lender's full credit bid of $100,000).

In order to determine the possible effect of California's credit bid rules, it is first necessary to determine whether the damage occurred before or after the foreclosure sale. Importantly, the credit bid rules apply only to damage that occurred before the sale.

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General Liability Insurer Has No Duty to Defend Massage Company's Employee Against Suit Alleging Employee's Sexual Assault of Client

A commercial general liability insurer had no duty to defend a massage company's employee against a suit alleging that the employee sexually assaulted a client during a massage. (Baek v. Continental Casualty Co. (2014) 2014 WL 4966020)

Facts

Jamie Weinberg filed a lawsuit against Luis Baek and Baek's employer, Heaven Massage and Wellness Center (HMWC). In her complaint, Weinberg alleged that Baek was an HMWC massage therapist, and that during a massage Baek sexually assaulted Weinberg by touching, rubbing and fondling Weinberg's breasts, buttocks and genitals. Weinberg asserted causes of action against Baek and HMWC for sexual harassment, sexual battery, assault, battery, false imprisonment, intentional infliction of emotional distress, and negligence.

Baek claimed that he was either an employee of or partner in HMWC, and that he therefore qualified as an insured under HMWC's general liability policy issued by Continental Casualty Company. However, Continental declined to defend Baek, asserting that Baek's alleged tortious conduct was not within the scope of Baek's employment.

Baek subsequently filed an action for breach of contract and bad faith against Continental, alleging that Continental had wrongfully failed to defend Baek in the underlying tort action filed by Weinberg. The trial court ruled in favor of Continental. Baek appealed.

Holding

The California Court of Appeal affirmed, holding that Continental had no duty to defend Baek against Weinberg's lawsuit.

The appellate court noted that the Continental policy covered HMWC's employees "for acts within the scope of their employment" and "while performing duties related to the conduct of [HMWC's] business." However, according to the appellate court, Baek's alleged sexual assault of Weinberg could not have been an "act within the scope of [Baek's] employment" and could not have occurred "while performing duties related to the conduct of [HMWC's] business." Although Baek's alleged sexual assault occurred at the workplace and during the work day, it was unrelated to Baek's duties for HMWC. Thus, even if Baek was an employee of HMWC, Baek could not qualify as an additional insured under these provisions of HMWC's policy though Continental.

The appellate court also noted that the Continental policy covered HMWC's partners "with respect to the conduct of [HMWC's] business." However, the appellate court concluded that Baek's alleged sexual assault of Weinberg was not an act undertaken "with respect to the conduct of HMWC's business." Baek's conduct was not done at HMWC's request or for its benefit, but rather was simply the product of Baek's lust. Thus, even assuming Baek was a partner in HMWC, Baek was not an insured in these circumstances.

In short, because Baek's alleged acts of sexual battery could not properly be characterized as relating to the conduct of HMWC's business or within the scope of Baek's employment, Baek was not an additional insured under the Continental policy. Thus, Continental has no duty to defend Baek in the underlying action.

Comment

The appellate court found that while Baek's employment with HMWC may have provided Baek with the opportunity to be alone with Weinberg, Baek's alleged sexual assault on Weinberg was a purely personal act and was committed for reasons unrelated to work. Therefore, Baek was not an insured under HMWC's policy through Continental.

 

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