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The Court of Appeal affirmed a trial court's order rescinding a policy based on the insured's material misrepresentations on the insurance application. Although the court also found the insurer was entitled to reimbursement of the defense and settlement costs it paid on a claim, the court erred in awarding judgment jointly and severally against all insureds because the insurer failed to present evidence of the amount by which each of its insureds benefited from these payments.
Plaintiffs Ancle Hsu and David Ji were the officers, directors, and sole shareholders of LA Sound, an audio equipment company. In January 2001, LA Sound and Hollywood Sound, Inc. (Hollywood Sound), entered into a written agreement to engage in a joint venture.
Six months after the joint venture was formed, LA Sound, through its broker, renewed a St. Paul insurance policy providing coverage for advertising injury. LA Sound provided information for the application in two telephone calls with its broker. The application asked, "HAS APPLICANT BEEN ACTIVE IN OR IS CURRENTLY ACTIVE IN JOINT VENTURES?" and "IS THERE A LABOR INTERCHANGE WITH ANY OTHER BUSINESS OR SUBSIDIARIES?" Boxes were checked indicating the answer to each question was, "NO." The insureds did not sign the application.
In October 2001, Hollywood Sound asserted claims including unfair competition and trademark infringement against LA Sound, Hsu and Ji. St. Paul agreed to defend LA Sound, Hse and Ji for certain claims under a reservation of rights. St. Paul ultimately paid the $1 million policy limit to settle the claims against LA Sound, as well as Hsu and Ji in their capacities as officers and directors. However, the claims against Hsu and Ji as individuals were not included in the settlement. Hsu and Ji eventually paid a portion of $ 2.85 million to settle these remaining claims.
Plaintiffs then sued St. Paul for bad faith breach of the duties to defend and indemnify. They sought to recover the $2.85 million and the defense costs St. Paul did not pay. St. Paul answered, asserting the affirmative defense of misrepresentation, and filed a cross-complaint for rescission due to misrepresentation. St. Paul also sought reimbursement of the defense and settlement costs it did pay.
The court ruled St. Paul was entitled to rescind the policy based on the misrepresentations and was entitled to reimbursement of amounts it incurred in defending and settling the claims. When a policyholder conceals or misrepresents a material fact on an insurance application, the insurer is entitled to rescind the policy. "Each party to a contract of insurance shall communicate to the other, in good faith, all facts within his knowledge which are or which he believes to be material to the contract." (Ins. Code, § 332.) Concealment, which is the "[n]eglect to communicate that which a party knows, and ought to communicate" (§ 330), "entitles the injured party to rescind insurance." (§ 331.) Similarly, "[i]f a representation is false in a material point … the injured party is entitled to rescind the contract from the time the representation becomes false." (§ 359.)
The misrepresentations in this case were "material." St. Paul demanded answers to specific questions in the application, which is in itself usually sufficient to establish materiality as a matter of law. In addition, a senior underwriter testified the undisclosed joint venture was material to the risk.
The court concluded Insurance Code section 650 did not prevent St. Paul from rescinding. This provision only bars an insurer from filing a "separate" suit for rescission once a policyholder has filed an action to enforce the policy. Established law clearly affords the insurer the right to avoid coverage by way of cross-claims and affirmative defenses when the insured files an action on the contract before the insurer can file its action for rescission.
The court also concluded the insured's broker was acting as its agent, not St. Paul's, and therefore the insureds were responsible for the misrepresentations. An insurance broker by definition represents policyholders, not insurers. (§§ 33, 1623.) As a matter of law, if an application was prepared by an insurance broker, the application's contents are the insured's responsibility. It did not matter that the insureds had not signed the application.
The insureds' contention that the misrepresentations were unintentional was irrelevant. "Concealment, whether intentional or unintentional, entitles the injured party to rescind insurance." (§ 331.)
Finally, St. Paul did not waive its right to rescind by accepting the defense. An insurer does not waive its right to rescind a policy if it was unaware of the falsity of the insured's misrepresentations. St. Paul was entitled to rely on the misstatements in the application when it accepted the defense. St. Paul's reservation of rights also prevented a waiver.
Although St. Paul was entitled to rescind, Hsu and Ji were not jointly liable with LA Sound for the entire reimbursement amount because St. Paul failed to establish the amount of benefits conferred separately on each insured. Under Buss v. Superior Court (1997) 16 Cal.4th 35 (Buss), an insurer may obtain reimbursement only for defense costs that can be allocated solely to the claims that are not even potentially covered, which the insurer must establish by a preponderance of the evidence. In the rescission context, an insurer seeking reimbursement bears the burden of showing which costs can be allocated to the defense or indemnity of each particular insured. Because St. Paul did not prove any such allocation, the court remanded for a new trial limited to the issue of the amount owed as restitution by the three insureds.
This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted buy the California Supreme Court. These events would render the opinion unavailable for use as legal authority.
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