Fraud Exclusion, California Insurance Code Section 533 Preclude Coverage for Arbitration Award

A California federal court, applying California law, has held that an employment liability policy does not provide coverage for a judgment against the insured following an arbitrator’s finding of fraud. Primary Color Sys. Corp. v. Hiscox Ins. Co., 2023 WL 2347386 (C.D. Cal. Feb. 1, 2023).

The insured employer sought coverage for a claim brought by a former employee. The employee alleged that the company promised him an equity stake in the company but later refused to pay and instituted arbitration. The employer tendered the claim under its EPL policy. The policy excluded claims “arising out of, based upon or attributable to the committing of any . . . deliberate fraudulent act if any final adjudication establishes that such . . . deliberate fraudulent act was committed.” The insurer agreed to defend under a reservation of rights. The arbitrator found that the company engaged in fraud because it never intended to honor its promise of equity. After the employee confirmed the arbitration award in his favor, the insurer denied coverage for the judgment.

In the ensuing coverage litigation, the court sided with the insurer. First, the insurer cited California Insurance Code Section 533. The court agreed that Section 533 “prohibits indemnification for intentionally harmful conduct such as fraud.” Second, the insurer cited the fraud exclusion in its policy. The court agreed that the judgment implicated the exclusion because the arbitrator found that the insured induced its former employee to stay with fraudulent intent.

The court also dismissed the insured’s claim for breach of the implied covenant of good faith and fair dealing. It also rejected the insured’s request for leave to amend the complaint, finding that such efforts would be futile.