Insurer Has a Duty to Defend Lawsuits Potentially Seeking Damages Not Flowing From a Contractual Obligation

The California Court of Appeal has held that an errors and omissions insurer had a duty to defend lawsuits seeking amounts owed under contract because the lawsuits potentially sought non-contractual damages for breach of fiduciary duty and non-disclosure.  Health Net, Inc. v. Am. Int’l Spec. Ins. Co., 2016 Cal. App. Lexis 7296 (Cal. Ct. App. Oct. 6, 2016).

The insured, a managed care company, was sued in three consolidated class actions for violating the Employee Retirement Income Security Act (ERISA) by failing to pay the usual, customary, and reasonable charge for services by out-of-network medical providers to subscribers and beneficiaries of the insured’s health plans.  The insured sought coverage from its primary and excess errors and omissions insurers for the defense and indemnification of the consolidated class actions.  In a previous appeal, the court held that no coverage was available under the policies for the insured’s alleged failure to pay promised benefits under its health plans because amounts owed under contract are not covered damages.  However, the appellate court remanded for the trial court to determine whether the plaintiffs sought relief other than amounts owed under contract.  On remand, the trial court determined that the plaintiffs did not seek non-contractual damages.  It also held that no coverage was available for one of the class actions based on the willful acts exclusion and Section 533 of the California Insurance Code and that the insured failed to state a claim against the excess insurers because the primary policy had not exhausted its policy limits.  The insured appealed.

The appellate court held that the primary carrier had a duty to defend the underlying claims because plaintiffs potentially sought relief other than amounts owed under their health plans.  First, the court determined that Section 502(a)(3) of ERISA, which provides for “appropriate equitable relief” for breaches of fiduciary duties and non-disclosures, did not preclude the award of damages other than amounts owed under a covered health plan.  Second, the court held that the plaintiffs in the underlying actions potentially sought damages other than amounts under their health plans.  Although not specifically alleged in the complaints, the court concluded that plaintiffs made allegations regarding fiduciary violations and non-disclosures to plan participants for which damages outside of amounts owed under health plans could have been awarded.

The appellate court also held that the trial court erred by ruling that the primary policy’s willful acts exclusion and Section 533 of the California Insurance Code barred coverage for one class action.  The exclusion barred coverage for claims “arising out of any Wrongful Act committed with the knowledge that it was a Wrongful Act.”  Section 533 provides that an insurer is “not liable for a loss caused by a willful act of the insured.”  The court rejected the insurers’ argument that a finding by the court in the underlying action that the insured knowingly and willfully used outdated data to determine its reimbursement rates triggered these exclusions.  The court reasoned that the underlying action did not completely arise from knowingly willful conduct because the plaintiffs alleged other conduct that did not arise out of the use of outdated data.  The court further held that coverage for an alleged violation of the Racketeer Influenced and Corrupt Organizations Act was not precluded because the alleged predicate act could be proven by reckless rather than intentionally wrongful conduct.

The appellate court affirmed the trial court’s dismissal of the insured’s breach of contract cause of action against the excess insurers.  The excess policies were not triggered until exhaustion of the primary policy’s limits “solely as a result of actual payment of claims or losses thereunder.”  The court held that the primary insurer’s exhaustion of its policy limits was a condition precedent to coverage under the excess policies, so the excess insurers had not failed to meet any contractual obligations owed to the insured.


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