The Ninth Circuit Court of Appeals has held that California Insurance Code section 533 does not necessarily preclude coverage for claims arising from an insured’s alleged breach of fiduciary duties. ( Unified Western Grocers, Inc. v. Twin City Fire Ins. Co. (9th Cir. 2006) 457 F.3d 1106)
Facts
In 1990 Unified Western Grocers, Inc. (Unified) acquired Hawaiian Grocery Stores (HGS) for $2.3 million, and over the next several years Unified invested a total of $7 million in HGS. By 1996, Unified decided to sell HGS, and Unified appointed six of its own corporate officers, including Daniel Bane, to act as officers and/or directors of HGS. These appointed officers and directors then approved a leveraged buy-out transaction to sell all of the common shares of HGS sale from Unified to RHL, Inc. for $2.4 million.
To fund the transaction, Unified obtained a $4.5 million line of credit which was secured by HGS’s assets. Unified’s appointed directors, acting as HGS’s board, also approved a secured promissory note from HGS to Unified for $5.3 million, which converted Unified’s investment into HGS into secured debt. All of the officers and directors Unified appointed to HGS’s board, except Bane, resigned after HGS was sold.
HGS then filed for bankruptcy, and the bankruptcy trustee representing HGS’s bankruptcy estate sued Unified and all of the officers and directors it had appointed to run HGS, including Bane. The bankruptcy trustee asserted claims for breach of fiduciary duty, aiding and abetting and civil conspiracy, alleging that Unified, the officers and directors it appointed to run HGS, and RHL had all conspired to drain assets from HGS while misleading creditors as to HGS’s credit-worthiness and concealing damaging information. The trustee sought $13.5 million in damages and further alleged that around $8.5 million was transferred from HGS to Unified after it was sold to RHL.
Twin City Insurance Company had issued a directors and officers’ liability policy to Unified, which also insured all of the officers and directors Unified had appointed to run HGS. The officers and directors filed a declaratory relief action seeking a declaratory judgment that Twin City was obligated to pay defense costs and reimburse them for the losses resulting from the bankruptcy trustee’s lawsuit.
The United States District Court granted summary judgment for Twin City, ruling that coverage was barred by California Insurance Code section 533, which states that an insurer is not liable for losses caused by the insured’s “willful act.” The District Court also held that because the bankruptcy trustee’s complaint only sought “restitution,” Twin City had no duty to indemnify because California law precludes indemnification and reimbursement of claims that seek restitution of an ill gotten gain.
Holding
The Ninth Circuit Court of Appeals reversed. The Court of Appeals concluded that although the bankruptcy trustee’s conspiracy claim contained allegations of willful conduct, the bankruptcy trustee’s breach of fiduciary duty claim did not depend on a knowing, intentional or purposeful act, and could have occurred without any intent or expectation to cause harm. Nor were the allegations of breach of fiduciary duty inseparably intertwined with the allegations of willful conduct. Therefore, section 533 did not necessarily bar coverage for the bankruptcy trustee’s claims.
The Ninth Circuit further held that although the bankruptcy trustee sought the return of all monies improperly funneled to Unified, only $8.5 million of the $13.5 million in damages was alleged to have been transferred to Unified. Therefore, at least some of the monies sought by the trustee constituted “damages,” rather than “restitution” and, thus, there was a genuine issue of material fact as to whether all of the damages sought by the bankruptcy trustee constituted restitution.
Comment
In analyzing the applicability of section 533, insurers should carefully review the allegations of the complaint and other available facts to determine if liability under the causes of action alleged could be established without evidence of willful or intentional conduct. If liability can be established without evidence of willful or intentional conduct, then section 533 may not apply to defeat coverage.