The United States District Court for the Central District of California has held that California Insurance Code Section 533.5 precludes a duty to defend any claim brought by the California Attorney General under the Unfair Competition Law or False Advertising Law for the recovery of a fine, penalty, or restitution.  Adir Int’l, LLC v. Starr Indem. & Liab. Co., 2019 WL 4462613 (C.D. Cal. Sept. 10, 2019).

The California Attorney General filed a complaint against a retail company, asserting claims under California’s Unfair Competition Law (UCL) and False Advertising Law (FAL) and seeking permanent injunctions, restitution, and civil penalties.  The retail company provided notice of the complaint to its D&O insurer.  The insurer initially denied coverage, but then later withdrew its denial and agreed to provide a defense subject to a full reservation of rights.

Over a year later, the Attorney General’s Office advised the insurer that California Insurance Code Section 533.5 prohibited coverage for the retail company in the underlying action.  Specifically, Section 533.5 states that an insurance policy shall not provide, or be construed to provide:  (a) any coverage or indemnity for the payment of any fine, penalty, or restitution in any action or proceeding brought pursuant to the UCL or FAL by the Attorney General, or (b) any duty to defend any claim in any proceeding brought pursuant to the UCL or FAL in which the recovery of a fine, penalty, or restitution is sought by the Attorney General.  The insurer notified the retail company that, based on Section 533.5, it would stop paying defense costs and would continue to reserve all rights to seek reimbursement for amounts paid.  The retail company argued, in relevant part, that Section 533.5 did not apply because the Attorney General sought injunctive relief in the underlying action in addition to “a fine, penalty, or restitution.”

In the ensuing coverage litigation, the court agreed with the insurer, finding that Section 533.5 unambiguously establishes that there is no duty to defend in any case in which a fine, penalty, or restitution is sought under the UCL or FAL.  The court also held that the insurer was entitled to reimbursement of defense costs.  The court rejected the retail company’s estoppel arguments, holding that the retail company did not reasonably rely on the insurer’s tender of defense costs, given (1) the express language of Section 533.5 precluding coverage for the underlying action, (2) the policy’s explicit right to reimbursement for uncovered loss, and (3) the insurer’s previous denial that expressed its doubts concerning coverage.