SoftEx, Inc.v. American International Group, Inc.

Filed 7/17/07 SoftEx, Inc.v. American International Group, Inc. CA2/7

NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS

California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

SECOND APPELLATE DISTRICT

DIVISION SEVEN

APPEAL from a judgment of the Superior Court of Los Angeles County. William F. Fahey, Judge. Affirmed.

John T. Blanchard for Plaintiffs and Appellants

Barger & Wolen, Gail E. Cohen and Andrew S. Williams for Defendants and Respondents.

Plaintiffs SoftEx and John Zabasky sued American International Group and its subsidiary Granite State Insurance Company for damages arising out of Granites termination of SoftExs workers compensation insurance policy. The trial court sustained a demurrer to Zabaskys cause of action for intentional infliction of emotional distress and granted defendants motion for summary judgment on SoftExs causes of action for breach of contract and interference with economic advantage. Plaintiffs appeal from the judgment. We affirm.

FACTS AND PROCEEDINGS BELOW

The material facts are undisputed.

At the time of the events leading to this lawsuit SoftEx was a Professional Employer Organization which means it acted as the employer of another businesss employees in all ways except assigning and supervising work. Its duties included paying salaries, providing medical benefits, paying payroll taxes and providing workers compensation benefits. This last duty required SoftEx to acquire a workers compensation insurance policy.

SoftEx retained an insurance broker, Payne & Company, as its agent to obtain a workers compensation policy. Payne obtained a policy from Granite State Insurance Company (Granite), a subsidiary of American International Group, Inc. (AIG).

In obtaining the policy, Payne misrepresented to Granite the nature of the work performed by SoftExs ersatz employees. Payne claimed all the employees worked as computer programmers. In fact, 45-50 percent of the employees were domestic workers who cleaned houses for the Molly Maid Company. This misrepresentation had a significant effect on the cost of the policy. Granites premium rate for a computer programmer was 66 cents per 100 dollars of payroll. Granites premium rate for domestic workers, if it issued a policy at all, would have been 40 dollars per 100 dollars of payroll, 60 times higher than the rate for computer programmers.

Granite learned about the undisclosed Molly Maid workers approximately four months after it issued the policy. On September 22, 2003 it sent a notice to SoftEx stating it was cancelling the workers compensation policy effective October 25, 2003. The notice stated: The reason for cancellation is underwriting reason: material misrepresentation.

In addition to canceling the policy, Granite referred SoftExs owner, John Zabasky, to the California Insurance Commissioner and the district attorney for possible fraud prosecution.

SoftEx and Zabasky responded to Granites notice of cancellation and fraud referral with this lawsuit against Granite, AIG, Payne and other insurance brokers involved in obtaining the policy.[1] SoftExs suit against Granite and AIG (whom we will refer to jointly as Granite) alleged wrongful termination of the workers compensation policy, bad faith, intentional interference with existing contracts and with prospective business advantage. Zabaskys suit alleged intentional infliction of emotional distress.

Granite demurred to Zabaskys cause of action for intentional infliction of emotional distress on the grounds he lacked standing to complain he suffered emotional distress from the termination of an insurance policy issued to a corporation and its referrals for possible fraud prosecution were absolutely privileged under Civil Code section 47. The trial court sustained the demurrer without leave to amend.

Granite answered SoftExs complaint and alleged as affirmative defenses SoftEx and its agents made material misrepresentations about, and concealed the nature of, SoftExs business and that these misrepresentations entitled Granite to rescind the policy.

In addition, Granite brought a cross-complaint against SoftEx seeking judicial rescission of the workers compensation policy and other relief on the grounds of misrepresentation and concealment.

Granite moved for summary judgment on SoftExs complaint and on its cross-complaint for rescission. The trial court found there was no dispute over the fact SoftExs application for workers compensation insurance contained false information. It further found this misrepresentation or concealment of facts was material because it was undisputed Granite, had it known these facts, would have charged SoftEx a premium 60 times greater based upon the higher risk of injury to janitorial employees as opposed to computer programmers. Accordingly, the court granted Granites motion for summary judgment.

SoftEx and Zabasky filed a timely notice of appeal from the subsequent judgment.

DISCUSSION

Under the Insurance Code, [n]eglect to communicate that which a party knows, and ought to communicate, is concealment which, whether intentional or unintentional, entitles the injured party to rescind insurance.[2] The Code also provides, If a representation is false in a material point, whether affirmative or promissory, the injured party is entitled to rescind the contract from the time the representation becomes false.[3]

The undisputed facts show SoftEx or its agent, Payne, neglected to communicate that which a party knows and ought to communicate and made a representation . . . false in a material point when it concealed in the application process the true nature of the work performed by approximately half of SoftExs employees and instead represented they were all computer programmers. Such conduct on the part of SoftEx or

Payne furnished Granite with affirmative defenses to SoftExs cause of action for wrongful cancellation of the policy and to the causes of action for intentional interference with existing contracts and prospective economic advantage because all three causes of action are premised on the theory SoftEx had a valid, enforceable insurance policy with Granite.[4]

SoftEx, however, attempts to convince us Granite is stuck with the policy it issued even though it issued the policy based on SoftExs admitted concealment and misrepresentation of facts. We briefly summarize SoftExs arguments and explain why they lack merit.

SoftEx argues Granite failed to show the facts SoftEx concealed or misrepresented were material to the issuance of the policy. We disagree.

For purposes of rescission, [m]ateriality is to be determined . . . solely by the probable and reasonable influence of the facts upon the party to whom the communication is due, or in making his inquiries.[5]

The undisputed evidence showed Granites premium rate for a computer programmer was $0.66 per $100 of payroll. Granites premium rate for domestic workers, on the other hand, would have been $40 per $100 of payroll. Clearly SoftExs claim all its workers were computer programmers influenced the amount of the premium Granite charged for the policy; it is untenable to argue otherwise.

The fact Granite had the right to audit SoftExs payroll and submit a bill for a supplemental premium does not mean SoftExs concealment and misrepresentation were not material. Under the statutes cited above Granite is entitled to determine what risks it is willing to accept before it accepts them.[6] It is not required to accept undisclosed risks and the risk the insured may be unable to pay the supplemental premium once the undisclosed risks are disclosed.

SoftEx maintains it is too late for Granite to rescind the policy because section 650 states: Whenever a right to rescind a contract of insurance is given to the insurer by any provision of this part [including sections 330, 331 and 359] such right may be exercised at any time previous to the commencement of an action on the contract[.] (Italics added.) Granite did not exercise its right to rescind before SoftEx brought this action on the contract for wrongful cancellation. Rather, it raised the right of rescission as an affirmative defense to the action and in a cross-complaint. Therefore, SoftEx argues, Granite is procedurally barred from rescinding the policy.

Other courts have considered this argument and rejected it. Those courts have recognized section 650 is an anachronism left over from the days when there was a distinction between the jurisdiction of courts of law and courts of equity. Those days having long passed, section 650 has little significance in todays legal system. It lingers on only to prohibit an insurer from filing a separate suit for rescission against its insured after the insured files an action on the contract against the insurer. Section 650 does not prevent the insurer from raising the grounds for rescission as affirmative defenses to the insureds action[7] nor does it prevent the insurer from bringing a cross-complaint against the insured for rescission.[8]

The opinion in Resure, Inc. v. Superior Court gave a succinct history of section 650 and explained its present significance:

Section 650 of the Insurance Code was enacted as part of the Civil Code by the 20th session of the Legislature in 1874. [Citation.] In 1935, it was transferred to the newly established Insurance Code where it has remained, unchanged in all pertinent respects. [Footnote and citation omitted.]

When Insurance Code section 650 was enacted, the distinction between an action on the contract at law and an action for equitable rescission was of great significance because of the artificial separation between law and equity. Equity would not assume jurisdiction when the plaintiff had a clear remedy at law. [Citation] It followed that once an action to enforce a contract was commenced at law, the party holding a right to rescind was expected to raise that as a defense rather than bring a new action in equity. [Citation.]

The rule that equitable rescission would not be permitted where there was an adequate remedy at law, taken together with the rule that an applicant's fraud could be raised as a defense to an action on the policy, clarifies what is meant by Insurance Code section 650s limitation on the right of an insurer to rescind the policy to the time

previous to the commencement of an action on the contract. The Legislature intended that the insurer be precluded from rescinding once the insured had proceeded with an action to enforce the insurance contract at law. [Citation] The point was merely to guarantee that resort to equity was not needlessly made where the insurer had ample opportunity to raise the same issues in defense of the action on the policy. . . . California law affords that opportunity to insurers where the insured fires the first shot.[9]

As this analysis shows, section 650 does not affect the insurers remedy of rescission but only the procedural means for obtaining it.

Section 676.8 describes the exclusive circumstances under which an insurer may cancel a policy of workers compensation insurance. Subdivision (b) of the section states in relevant part: After a policy is in effect, no notice of cancellation shall be effective unless it . . . is based upon an occurrence, afterthe effective date of the policy, of one or more of the following: . . . (5) Material misrepresentation by the policyholder or its agent.

It is undisputed SoftExs concealment and misrepresentation of facts occurred before the effective date of the policy. Therefore, under section 676.8, Granite could not use the concealment and misrepresentation as grounds for cancelling the policy. SoftEx argues Granites attempt to cancel the policy in violation of section 676.8 constituted an anticipatory breach of the insurance contract thereby terminating the contractual relation between the parties.[10]

Up to this point SoftExs analysis of the attempted cancellation appears correct. The purported cancellation was unlawful under section 676.8 and Granites announcement it would no longer perform its duty under the contract to provide SoftEx with workers compensation insurance could reasonably be treated as an anticipatory breach.

SoftEx goes wrong, however, when it contends if Granites anticipatory breach terminated the contractual relationship between the parties then by the time Granite sought to rescind the policy through its answer to the complaint and its cross-complaint there was no policy to rescind.

An anticipatory breach operates prospectively giving the injured party the right to seek damages immediately rather than waiting until the time of performance arrives.[11] If the anticipatory breach is a repudiation of the contract, the repudiation extinguishes all the executory obligations of the contract which may be owed to the breaching party but it does not extinguish the contract itself.[12] Thus there still existed a contract subject to rescission.

Furthermore, even if there was no contract to rescind, it is clearly established the same grounds which would support rescission, e.g., concealment and misrepresentation, serve as affirmative defenses to an action for breach of contract.[13]

SoftEx maintains it is entitled to tort damages for business losses it suffered as a result of Granites wrongful cancellation of its workers compensation policy even if

Granite rightfully could have rescinded the policy.[14] We reject this argument.

As explained in Imperial Casualty & Indemnity Co. v. Sogomonian, a rescission effectively renders the policy totally unenforceable from the outset so that there never was any coverage[.][15] In other words, Granites rescission extinguished the policy ab initio, as though it had never existed and, consequently, SoftEx never was insured under the policy.[16]

SoftEx cannot sue for damages for the wrongful loss of something it never had.

Zabasky asserts a cause of action against Granite for intentional infliction of emotional distress. The complaint alleges Granite vigorously sought to have plaintiff Zabasky criminally prosecuted and attempted to have plaintiff Zabasky convicted of crimes he did not commit. . . . As a direct and proximate result of defendants above-outlined misconduct plaintiff Zabasky was criminally charged and temporarily incarcerated, resulting in severe emotional distress.

The trial court sustained Granites demurrer to this cause of action without leave to amend based on the absolute privilege under Civil Code section 47, subdivision (b) to report a crime even if the report is made with malice.

Fremont Comp. Ins. Co. v. Superior Court[17] is directly on point. In Fremont a doctor sued a workers compensation insurer for intentional infliction of emotional distress and other torts alleging the insurer acted in bad faith in reporting him to the district attorney and the Department of Insurance for workers compensation fraud. The insurer demurred to the cause of action for intentional infliction of emotional distress on the ground it had an absolute privilege under Civil Code section 47, subdivision (b) to report a crime even if it did so in bad faith.[18] The trial court overruled the demurrer on the ground the insurer was limited to the qualified immunity provided by section 1877.5 to insurers who report workers compensation fraud in good faith. The Court of Appeal granted the insurers petition for a writ of mandate and commanded the trial court to sustain the demurrer. The court held in enacting section 1877.5 the Legislature did not intend to leave insurers with less protection in reporting workers compensation fraud than they previously had under Civil Code section 47.[19] To support this conclusion the court cited the second sentence of the statute which states: Nothing in this chapter is intended to, nor does in any way or manner, abrogate or lessen the existing common law or statutory privileges and immunities of an insurer[.] The court further held the absolute reporting privilege under Civil Code section 47 extended to reports to a local district attorney and the fraud bureau of the Department of Insurance.[20]

We concur in the reasoning of the Fremont decision and therefore affirm the demurrer to Zabaskys cause of action for intentional infliction of emotional distress.

DISPOSITION

The judgment is affirmed. Respondents are awarded their costs on appeal.

NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS

JOHNSON, J.

We concur:

PERLUSS, P. J.

ZELON, J.

Publication courtesy of San Diego free legal advice.

Analysis and review provided by Santee Property line Lawyers.

[1] Payne and the other brokers were not parties to the proceedings subject to this appeal.

[2] Insurance Code sections 330, 331. All section references are to the Insurance Code unless otherwise stated.

[3] Section 359.

[4] For purposes of summary judgment, [a] defendant or cross-defendant has met his or her burden of showing that a cause of action has no merit if that party has shown . . . that there is a complete defense to that action. (Code Civ. Proc., 437c, subd. (p)(2).)

[5] Section 334.

[6]Williamson & Vollmer Engineering, Inc. v. Sequoia Ins. Co. (1976) 64 Cal.App.3d 261, 273.

[7] See Resure, Inc. v. Superior Court (1996) 42 Cal.App.4th 156, 166; Atmel Corp. v. St. Paul Fire & Marine Ins. Co. (N.D. Cal. 2006) 416 F.Supp.2d 802, 805-807.

[8] Civil Code section 1692 states in relevant part: When a contract has been rescinded in whole or in part, any party to the contract may seek relief based upon such rescission by . . . (b) asserting such rescission by way of defense or cross-complaint.

[9]Resure, Inc. v. Superior Court, supra, 42 Cal.App.4th at pages 163, 165.

[10]Taylor v. Johnston (1975) 15 Cal.3d 130, 137.

[11]Taylor v. Johnston, supra, 15 Cal.3d at page 137.

[12] Civil Code section 1700 states: The intentional destruction, cancellation, or material alteration of a written contract, by a party entitled to any benefit under it . . . extinguishes all the executory obligations of the contract in his favor . . . .

[13]Resure, Inc. v. Superior Court, supra, 42 Cal.App.4th at page 161; Maggini v. West Coast Life Ins. Co. (1934) 136 Cal.App. 472, 477; Atmel Corp. v. St. Paul Fire & Marine Ins. Co., supra, 416 F.Supp.2d at page 805.

[14] See discussion at pages 6-8, above.

[15]Imperial Casualty & Indemnity Co. v. Sogomonian (1988) 198 Cal.App.3d 169, 182.

[16]Imperial Casualty & Indemnity Co. v. Sogomonian, supra, 198 Cal.App.3d at page 184.

[17]Fremont Comp. Ins. Co. v. Superior Court (1996) 44 Cal.App.4th 867.

[18] Civil Code section 47, subdivision (b) affords a privilege for a publication made [i]n any (1) legislative proceeding, (2) judicial proceeding, (3) in any other official proceeding authorized by law . . . .

[19]Fremont Comp. Ins. Co. v. Superior Court, supra, 44 Cal.App.4th at pages 872-875.

[20]Fremont Comp. Ins. Co. v. Superior Court, supra, 44 Cal.App.4th at pages 875-877.