California Court Affirms Insurer's Right To Rescission And Explains Burden Of Proof On Reimbursement Claim
A California appellate court provided further guidance to insurers on satisfactory grounds for rescission of an insurance policy and the burden on the insurer to obtain reimbursement of defense costs and settlement amounts paid on an insureds’ behalf. The court’s decision provides further delineation of the difficult burden imposed on insurers in obtaining reimbursement from an insured (even when the insured is able to pay).
In LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co., __ Cal.App.4th __ [2007 Cal.App. LEXIS 1853], the California Court of Appeal for the Fourth Appellate District (which includes Orange County) ruled that: (1) the failure to advise the insurance company that the insureds were involved in a joint venture was a material misrepresentation supporting rescission of the policy ab initio; and (2) the insurance company was entitled to reimbursement of all amounts paid to defend and settle the claim against its insureds; but (3) the insurer had the burden of showing by a preponderance of the evidence how much each of three insureds should reimburse and had failed to do this, so the case was remanded for this determination.
The insureds were LA Sound, an audio equipment company, and its two officers and directors. At the time of renewing their insurance policy with St. Paul, the insureds (through their broker) answered an application indicating they were not involved in any joint ventures or in a labor interchange with any other business or subsidiary. In fact, the insureds had been involved for six months in a joint venture with Hollywood Sound to produce, market and sell audio and speaker products. The joint venture was a new corporation by the name of LSY Trading Development, Inc.
The joint venture stalled and Hollywood Sound sued the insureds and LSY for unfair competition (trademark infringement).
St. Paul agreed to defend LA Sound and its officers/directors, but only in their capacity as such, under a full reservation of rights. St. Paul specifically disclaimed any obligation to defend LSY and its (same) officers and directors. St. Paul agreed to pay the portion of the defense costs being incurred by LA Sound. St. Paul reserved the right to get the money back. Thereafter, St. Paul settled the claim against LA Sound and its officers/directors, and the case proceeded against LSY and its (same) officers/directors until resolved.
Following conclusion of that lawsuit, LA Sound sued St. Paul for breach of contract and bad faith and St. Paul counterclaimed for rescission and reimbursement of amounts paid on LA Sound’s behalf. Trial resulted in a decision for St. Paul in all respects. The appellate court on review agreed there were grounds for rescission of the policy. Misrepresentations had been made to St. Paul about whether there was a joint venture or labor agreement. The omitted information was material to St. Paul’s assessment of the risk, underwriting, and determination of the premium to charge.
The appellate court also found St. Paul was entitled under Buss v. Sup. Ct. [16 Cal.4th 35 (1997)] to be reimbursed for defense costs and the settlement paid on LA Sound’s behalf. However, the appellate court found St. Paul had not met its burden of showing by a preponderance of the evidence an allocation as between LA Sound and its two officers/directors. It was not fair, according to the court, to allocate all amounts to the insureds jointly and severally as there was no showing each faced the same liability and received the same benefit from the payments. As the court explained:
"[I]n the absence of proof, we decline to assume that every dollar St. Paul spent on the underlying action benefited all three insureds. Whether this is true depends on a detailed analysis of how the defense costs were spent – did any discovery or motion practice benefit one insured alone, or did all litigation costs benefit all insureds equally? It also depends on a detailed analysis of how the indemnity costs were spent – did the insureds face the same amount of liability , and was the liability settled on identical terms?" *15.
Under Buss the burden was on the insurer to prove the right to reimbursement and allocation, which the court found appropriate since the insurers were in the "best position to monitor the underlying litigation, track expenses, and allocate policy benefits among insureds.” Id.
Thus, the case was remanded for further determination on the proper allocation of restitution based upon the “respective benefits received by each” of the insureds under the rescinded policy.
