Koken v. Precision Framing

Filed 3/28/07 Koken v. Precision Framing CA3

NOT TO BE PUBLISHED

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

THIRD APPELLATE DISTRICT

(Placer)

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Villanova Insurance Company provided workers compensation insurance to defendant and cross-complainant Precision Framing, Inc. from October 1999 to October 2001. Villanova was later placed into involuntary liquidation in California and Pennsylvania. Plaintiff and cross-defendant M. Diane Koken, in her capacity as the insurance commissioner of Pennsylvania and liquidator of Villanova, filed a lawsuit to recover $150,190 from Precision in unpaid workers compensation insurance premiums. Precision alleged as an affirmative defense a setoff for the entire amount, which it explained at trial was based on Villanovas unclean hands that caused Precisions insurance costs to another insurance company to increase. The jury awarded Koken $18,190, and the trial court entered a judgment of $19,360.80 in her favor.^[1] Koken contends the judgment must be reversed because there was no right to a setoff, there was insufficient evidence Villanova had unclean hands, and the jury instruction on unclean hands was incorrect. We agree with Koken and reverse the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

In June 2004, Koken filed an amended complaint against Precision for $150,190 in unpaid workers compensation insurance premiums.

In August 2004, Precision answered with a general denial and alleged the affirmative defense of setoff. According to Precisions pleading, Villanova failed to report the loss experience of Precision Framing to the California Workers Compensation Rating Bureau for the period October 2000 to October 2001, and [a]s a result Precision had to pay approximately $550,000 in increased workers compensation premiums to date that would not otherwise have been charged had the loss experience been properly reported.

On the same day Precision filed the general denial, it filed a cross-complaint for declaratory relief based on identical facts as the answers affirmative defense.

In March 2005, Koken and Villanova filed a motion to dismiss Precisions cross-complaint because there was a stay of litigation against Villanova as it was in liquidation proceedings. The court denied the motion and instead stayed Precisions cross-complaint.

The case went to trial in May 2005. At trial, the parties stipulated Villanova had provided Precision with a workers compensation insurance policy from October 1, 2000, to October 1, 2001, at a cost of approximately $440,000. Precision paid that amount. After an audit was done on that policy, the bill increased by approximately $235,000. Precision paid approximately $85,000 of the increased bill, leaving an outstanding balance of $151,900.^[2]

The dispute at trial was whether Precision owed Villanova the outstanding balance of $151,900, given Precisions claim that the behavior of Villanova cause[d Precision] to spend more money on other policies.

To help resolve this dispute, Villanova called its vice president James Bracken. Bracken explained that Villanova was an insurance company based in Philadelphia that sold workers compensation insurance in California to Precision from October 1999 to October 2001. In April 2002, Villanova went into rehabilitation. In November 2002, California placed Villanova into involuntary liquidation. At that point, the California Insurance Guarantee Association (the association) started taking over payment of Villanovas claims to California employees injured on the job with the $130 million Villanova had deposited with the California Department of Insurance. Villanova therefore turned over its claim files to the association. From November 2002 onward, Villanova did not receive information from the association on what activity [the association] had, what type of claim payments [it] w[as] making, [and] what type of reverse charges [it] w[as] making.

As a provider of workers compensation insurance, Villanova was obligated to report payroll data and loss data incurred under its policies to the California Workers Compensation Insurance Rating Bureau (the bureau). The bureau collects this data from many other insurance carriers and selects suggested rates for individual worker classifications. These suggested rates and classifications must be filed with and approved by the California Department of Insurance. Each insurance carrier can file with the state to accept the bureaus rates or to modify those rates based on actuarial data submitted by the insurance carrier to the state.

Insurance carriers are also obligated to regularly report the loss activity for the business theyre writing in the state. When the insureds account reaches a certain size, it can develop an experience rating factor as a way of having an impact on [its] own rate. The insured may receive a higher rate if its experience is worse than expected, or it may receive a lower rate if the experience is better than expected. The bureau takes the data from the past three years from the insurance carriers, uses a formula to compute the losses for the insured against the expected losses for the insured based on the insureds worker classifications, and generates an experience modification.

In June 2001, Villanova submitted its first unit statistical report regarding Precision detailing losses relating to Precisions 1999 to 2000 policy. This data was accepted by the state, but it was not used by the bureau in calculating Precisions experience modification because the most recent year for a policy term is always omitted from the calculation. In June 2002, Villanova submitted its second report detailing losses relating to the 1999 to 2000 policy, which was accepted by the state and used in calculating Precisions experience modification. In June 2003, Villanova submitted its third report detailing losses relating to the 1999 to 2000 policy. This data was not used by the state because Villanova could not verify the legitimacy of the claims information, as Villanova had experienced a lapse of almost seven to eight months of receiving claims data from [the association]. Bracken was not aware of any way that Villanova could have gotten the [s]tate . . . to accept this data.

In June 2002, Villanova submitted to the bureau its first unit statistical report for Precisions 2000 to 2001 policy. The data was not used in calculating the experience modification because it was the most recent year of the policy term. In June 2003, Villanova submitted its second report for the 2000 to 2001 policy. It was not accepted or used because of Villanovas liquidation status and Villanovas inability to verify the accuracy of the data.

At some point,^[3]Villanova finally received a report from the association showing the associations activity on Villanovas claims since it took over the claims in November 2002. The association did not report this data to the state because it did not have a duty to do so. Villanova also did not have a duty to report the data because by the time the data had been generated, the bureau had modified its rules and procedures so that experience data from companies in liquidation would not be used to determine experience modifications. Because of this rule change, two years of Precisions loss and payroll data that would have been used for its 2003 experience modification were not included. Villanova ended up submitting some unit statistical reports to the bureau after the order of liquidation, but the bureau stated the data was not going to be used, so Villanova stopped sending further reports.

William Peterson is the sole shareholder of Precision. Peterson agreed that both the audit of Precisions payroll that increased the premiums due to Villanova and the calculations arising from that audit were properly performed. Precision did not pay the remaining amount it owed because Peterson was told by a couple [of insurance] brokers that his company would be adversely affected by Villanovas no longer reporting the loss runs to the State. In Petersons mind, Villanova not reporting the information and the state not accepting the data were the same thing.

Ronald Wood is an insurance broker with over 40 years experience who testified as Precisions expert. In Woods opinion, Villanova improperly made [its] filings with [the bureau], and the filings were not accepted, which increased Precisions experience rating modification by 11 points, which resulted in an additional cost of $162,000 on its 2003 policy. This was money Precision had to pay to another insurance company. In support of his position, Wood reviewed a bulletin from the bureau dated May 23, 2003. The bulletin stated that Villanova had informed the bureau that the unit statistical data being submitted is either incomplete or inaccurate. The bulletin continued that [i]n view of this information and the [bureaus] concern regarding the accuracy of the data that has been submitted, the [bureau] has suspended, until further notice, the promulgation and issuance of experience ratings based upon unit statistical data submitted by [Villanova] after May 22, 2003. [] The [bureau] is working with representatives of . . . Villanova to determine whether complete and accurate unit statistical data will be forthcoming at a later date. When more information is available, [bureau] members will be notified accordingly.

Based on this evidence, Precision argued to the jury that the core of its case was that Villanova ran [its] company so [in]competently that the State of Pennsylvania closed [it] down and as a consequence Villanova did not report the data correctly, [t]he rating end[ed] up being higher for a year and as a result, Precision had to pay[] more money. It further argued there was no dispute that if [Villanova] had been run properly, [Precision] would have owed [Villanova] money; and [P]recision would have paid it. . . . The idea of unclean hands is did [Villanova] do something that [it is] responsible for that makes [its] request a little unseemly.

The jury returned a verdict of $18,190 in favor of Koken. The court entered judgment in Kokens favor for $19,360.80, from which Koken filed a timely notice of appeal.

DISCUSSION

Koken contends there was no legal basis for a setoff, the instruction on unclean hands was prejudicially deficient, and in any event, the doctrine of unclean hands was inapplicable because Villanova never engaged in morally reprehensible conduct. Precision understands this last argument to be a challenge to the sufficiency of evidence to support the jurys implied finding that Villanova had unclean hands. We agree with Precision that one of Kokens arguments is directed at the sufficiency of evidence of unclean hands, but we agree with Koken the evidence does not support the affirmative defense of setoff or unclean hands.

We begin our discussion with a summary of how the issue of unclean hands was presented below to unravel the procedural and substantive morass that resulted from Precisions confusion about the affirmative defense of unclean hands and its relation to the affirmative defense of setoff, concluding in the end that Precisions attempt to defeat Kokens recovery on either basis fails as a matter of law.

I

Factual And Procedural Background Relating To Precisions Affirmative Defenses Of Setoff And Unclean Hands

In its answer to the complaint, Precision introduced the idea that Villanovas failure to report experience modification data to the bureau caused Precision monetary harm and thus, it alleged the affirmative defense of setoff. At trial, Precisions expert witness Ronald Wood testified that Villanovas improper filings with the bureau ended up costing Precision an additional $162,000 in workers compensation insurance policy premiums for 2003 that it had to pay to another insurance company.

Before closing arguments and jury instructions, Villanova told the court it was trying to figure out . . . the basis for [Precisions] setoff claim. Precision stated it was not negligence and not breach of contract and referred to the jury instruction it had proffered on unclean hands.^[4] Villanova objected to the instruction because it fail[ed] to set out a cause of action which would form a basis for determining that Villanova has caused any harm to Precision Framing. Precision responded that its instruction included a reference to a case that describes the doctrine of unclean hands. Villanova continued objecting that Precision was not being required to put forth any grounds for making a finding that Villanova has caused any harm to [Precision]. We dont have any cause of action thats being required to be proven. Precision responded that [h]arm is all that equity . . . requires. The court overruled Villanovas objections.

Villanova persisted that the basis for Precisions instruction seemed to be its allegation that Villanova failed to report data and that Precisions proposed instruction did not explain[] how the jury is supposed to get to a finding that [Villanova] did something wrong. Precision responded that [t]he simple answer to that was unclean hands. Villanova suggested it could prepare an additional instruction on unclean hands, but the court refused the offer.

The court then instructed the jury consistent with Precisions proposed instruction on unclean hands as follows: This is it. Here it is. Precision Framing can be credited with a setoff in this case against the 150-some thousand sought by the Pennsylvania insurance commissioner and Villanova. If you find Precision can be credited, if you find that Villanova caused Precision Framing harm, the extent of the setoff, if any, is to be determined by you.

The day after the jury was instructed, Villanova proposed its own instruction on unclean hands.^[5] The court rejected the instruction because the jury had already been instructed on the law. Villanova persisted that Precisions answer did not list any legal basis for the setoff; only the day before did Villanova learn that Precisions theory was unclean hands; Villanova would have prepared an instruction earlier if it had known Precisions legal theory; the jury was deliberating without a standard in front of [it]; and the jury was entitled to know that the standard for unclean hands was unconscionable conduct. Precision responded that its proposed instruction (that the court read to the jury) was based on the setoff statute and on case law relating to unclean hands and that it would be confusing and unfair to further instruct the jury on unclean hands, as the jury had already begun deliberations. The court sustained Precisions objection to Villanovas proposed instruction because the jury has already deliberated part of one day.

II

As A Matter Of Law, Precision Could Not

Rely On The Affirmative Defense Of Setoff

Setoff is an equitable doctrine that allows a defendant to set off an amount owed to a plaintiff so that the defendant will owe only the balance remaining. (Harrison v. Adams (1942) 20 Cal.2d 646, 648.) A setoff can be pled as an affirmative defense in an answer (Space Properties, Inc. v. Tool Research Co. (1962) 203 Cal.App.2d 819, 827) and is limited to the amount of the plaintiffs claim (Construction Protective Services, Inc. v. TIG Specialty Ins. Co. (2002) 29 Cal.4th 189, 198). A setoff, however, must rest on a claim enforceable in its own right. (R. M. Sherman Co. v. W. R. Thomason, Inc. (1987) 191 Cal.App.3d 559, 563.)

Here, Precisions setoff was based on the additional money it had to pay in increased workers compensation insurance premiums to another insurance company because of Villanovas failure to report the loss experience data from October 2000 to October 2001. However, the setoff was not enforceable in its own right because Precision never filed a claim in Pennsylvania against Villanova for the additional money and was therefore barred from establishing the obligation in this case.

In the July 2003 order of liquidation, the Pennsylvania trial court prohibited the filing of any action against Villanova after the effective date of the liquidation. There was no evidence Precision pursued the claim underlying the alleged setoff at any time in the Pennsylvania court. Thus, as a matter of law, Precision had not established the legal basis by which it could pursue a setoff against Villanova in this case.

Precision contends Koken forfeited her argument that a setoff was not permissible because in the trial court Villanova conceded there is a right to setoff. Precisions reading of the record is too narrow. The entire statement of Villanovas counsel was as follows: I object to [Precisions proposed instruction on unclean hands] because it fails to set out a cause of action which would form a basis for determining that Villanova has caused any harm to Precision Framing. [Precisions counsel] relies simply on the statute that says there is a right to setoff, and I dont disagree with that. We understand this to be an objection to the proposed jury instruction and not an acquiescence that a setoff was permissible in this case. In any event, the application of the doctrine of setoff is one that we examine as a matter of law. (Granberry v. Islay Investments (1995) 9 Cal.4th 738, 744, 751.)

Precision further contends in a one-sentence argument that Pennsylvania law is irrelevant to Appellant liquidators collection action in California because, by statute, California law controls. (Insurance Code 1064.10.) This contention is followed up by another one-sentence argument that California does permit a set off, both by statute and case law, citing inter alia Code of Civil Procedure section 431.70. Code of Civil Procedure section 431.70, which explains the doctrine of setoff, does not create a substantive right to raise a setoff but, rather, delineates the procedures to be followed when a setoff is appropriate. (Granberry v. Islay Investments, supra, 9 Cal.4th at p. 744.) As we have already explained, a setoff was not appropriate here because Precision never established the legal basis by which it could pursue a setoff against Villanova in this case given its failure to file a claim in Pennsylvania.

Our analysis, however, does not end here because at trial, Precision argued it was entitled to a setoff based on the doctrine of unclean hands. Although setoff and unclean hands are distinct affirmative defenses, Precision and the trial court believed the setoff could be based on Villanovas unclean hands. We therefore turn to the distinct affirmative defense of unclean hands and examine its applicability to the facts here.

III

There Was Insufficient Evidence To Support

The Jurys Implied Finding Of Unclean Hands

The doctrine of unclean hands applies to deny a plaintiff recovery when the plaintiff has violated conscience, good faith or other equitable principle in his prior conduct. (Lynn v. Duckel (1956) 46 Cal.2d 845, 850.) The doctrine does not apply when the improper conduct [is] not necessarily connected with the transaction particularly involved. (Watson v. Poore (1941) 18 Cal.2d 302, 313.) In other words, The actions of the party alleged to have soiled hands must relate directly to the transaction concerning which the complaint is made; i.e., it must pertain to the very subject matter involved and affect the equitable relations between the litigants. (Pond v. Insurance Co. of North America (1984) 151 Cal.App.3d 280, 290.) Whether the doctrine of unclean hands applies is a question of fact. (Kendall-Jackson Winery, Ltd. v. Superior Court (1999) 76 Cal.App.4th 970, 978.) We will not disturb that finding on appeal if it is supported by substantial evidence. (Golden West Baseball Co. v. City of Anaheim (1994) 25 Cal.App.4th 11, 42-43.)

Here, viewing the evidence in the light most favorable to the verdict, we find no substantial evidence to support the jurys implied finding that Villanova had unclean hands. The evidence showed that Villanova was forced into liquidation in November 2002 by California and at some later date by the Pennsylvania Insurance Department based on the insurance departments belief that Villanovas financial position was such that [Villanova] would not be able to meet [its] obligations. Villanovas vice president explained that

although Villanova had substantial assets in the form of receivables from re-insurers[,] . . . from [its] managing general agents and . . . from policyholders that almost matched [its] liability, it did not have cash.

When Villanova was placed into liquidation in California, the association took over paying Villanovas claims using $130 million Villanova had deposited with the California Department of Insurance. Villanova therefore turned over its claim files to the association. From November 2002 onward, Villanova did not receive information from the association on what activity [the association] had, what type of claim payments [it] w[as] making, [and] what type of reserve changes [it] w[as] making. While Villanova in June 2002 and June 2003 had submitted to the bureau reports regarding Precisions workers compensation insurance policies on which Precisions experience modification could be based, the 2003 reports were not used by the bureau because Villanova could not verify the legitimacy of the claims information, as it had experienced a lapse of almost seven to eight months of receiving claims data from [the association]. The bureaus refusal to use any of the 2003 reports was confirmed in a bureau bulletin which stated that Villanova had informed the bureau that the data Villanova was submitting was incomplete or inaccurate and therefore, the bureau was suspending the promulgation and issuance of experience ratings based on this data. Villanovas failure to provide this data resulted in an increase in Precisions experience modification by 11 points, which cost Precision an additional $162,000 on its 2003 policy.

We conclude that Villanovas involuntary liquidation based on lack of cash, its failure to provide accurate or complete data to the bureau after it was in liquidation proceedings and not receiving data on claims the association was now paying on behalf of Villanova, and its failure to later provide this data when it had no obligation to do so do not rise anywhere near the level of a violation of conscience, good faith or other equitable principle necessary to support a finding of unclean hands. (Lynn v. Duckel, supra, 46 Cal.2d at p. 850.) There was, for example, no evidence that Villanova deliberately or in bad faith underfunded its company to ensure it could not remain viable, that it deliberately or in bad faith provided inaccurate or incomplete data to the bureau or that it otherwise acted improperly or unethically in its handling of its own company or Precisions data which led to an increase in Precisions experience modification.

What then, is the evidence Precision presents to support its position that the jurys implied finding of unclean hands was supported by substantial evidence? Surprisingly, it is nothing. Precisions entire factual argument supporting the jurys verdict is as follows: Closing arguments summarized the evidence upon which the jury would find that Villanova acted despicably, viz., it ran its company into liquidation, it wrote

incomplete or inaccurate loss reports knowing the financial harm that would result to its insured, it did not work with the [bureau] to rectify the rejected reports, it did not appeal the rejection or advise/assist [Precision] to do so, and it did not tell [Precision] of the [bureau]s rejection.

Closing argument is not evidence and, in fact, many of Precisions assertions are not supported by the record. For example, there was no evidence Villanova ran its company into liquidation, or that it wrote the loss reports knowing they would result in financial harm to Precision. Furthermore, although Villanova did receive a report from the association showing the associations activity on Villanovas claims since the association took over Villanovas claims in November 2002, Villanova was exempt from reporting this data as the bureau had told Villanova that it would not be using any data from companies in liquidation to develop experience modifications. Moreover, Villanova actually had submitted some unit statistical reports to the bureau after the order of liquidation, but the bureau told Villanova the data was not going to be used, so Villanova stopped sending further reports.

It is no surprise, however, the jury came to the conclusion Villanova had unclean hands based on the trial courts patently inadequate instruction. The court instructed the jury that Precision could be credited with a setoff if it found Villanova caused Precision Framing harm. This instruction

contained no guidance whatsoever that for the doctrine of unclean hands to apply, Villanova must have violated conscience, good faith or other equitable principle in [its] prior conduct (Lynn v. Duckel, supra, 46 Cal.2d at p. 850) or that the conduct on which a finding of unclean hands could be made must relate directly to the transaction that formed the basis for Villanovas complaint (Pond v. Insurance Co. of North America, supra, 151 Cal.App.3d at p. 290). The defective instruction was reinforced by Precisions closing argument that stated the doctrine applied if Villanova did something that [it is] responsible for that makes [its] request a little unseemly. We, however, need not undertake a prejudice analysis on the courts defective instruction because of our conclusion that there was no substantial evidence of unclean hands.

Given this conclusion, the jurys verdict of $18,190 cannot stand. As Precision offered no affirmative defense other than unclean hands on which it was entitled to setoff Villanovas claim for unpaid workers compensation insurance, and it stipulated that the outstanding balance on Villanovas claim was $151,900, Villanova is entitled to that amount, up to the extent requested in the complaint (which was $150,190 plus interest).

DISPOSITION

The judgment is reversed, and the matter is remanded for the trial court to enter a new and different judgment consistent with this opinion. Koken is awarded costs on appeal. (Cal. Rules of Court, rule 8.276(a).)

ROBIE , J.

We concur:

SCOTLAND, P.J.

HULL, J.

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^[1] We will refer to plaintiff interchangeably as Koken or Villanova.

^[2] A company such as Precision pays an expected premium at the beginning of the policy term. The actual premium is calculated at the end of the policy term based on audits of the payrolls of the insured company. If the payrolls are higher than expected, the insurance company charges an additional premium. If the payrolls are less than expected, the insurance company returns a portion of the paid premium to the insured company.

^[3] The record does not state when Villanova received this information.

^[4] Precisions proposed instruction reads as follows: Precision Framing, Inc. can be credited with a set off in this case against the $151,900 sought by Pennsylvania Insurance Commissioner Koken and Villanova Insurance Company if you find that Villanova Insurance Company caused Precision Framing, Inc. harm. The extent of the set off, if any, is to be determined by you. (Code of Civil Procedure section 431.70; Fi[bre]board Paper Products [Corp.] v. East Bay [Union of Machinists] (1964) 227 Cal.App.2d 675, 728.)

^[5] Villanovas proposed instruction reads as follows: Defendant Precision Framing, Inc. has argued that Villanova Insurance Company and M. Diane Koken should not be awarded its premium due based on the Doctrine of Clean Hands. [] Any unconscionable conduct that relates to the transaction in issue may give rise to the defense of unclean hands and bar relief. [] The doctrine does not apply in the absence of any such unconscionable conduct. The rule does not pertain, for instance, to a plaintiff who had no intention of defrauding or otherwise disadvantaging the defendant. [] 30 Cal Jur 3d, Equity, Sections 26 and 27, Doctrine of Clean Hands, pgs. 514 to 520.