The California Court of Appeal has held that where an insurer misrepresents the policy limits to induce an insured into settling a disputed insurance claim, the insured may keep the money paid and sue for fraud. ( Village Northridge Homeowners Association v. State Farm Fire and Casualty Company (2007) 69 Cal.Rptr.3d 551)
Facts
Village Northridge Homeowners Association (“HOA”) made a claim to its insurer, State Farm Fire and Casualty Company (“State Farm”) for earthquake damage. State Farm initially paid the HOA over $2 million, and ultimately entered into a settlement agreement by which State Farm paid an additional $1.5 million in exchange for an unconditional release of all claims.
Two years later, after it had spent the $1.5 million on earthquake repairs, the HOA sued State Farm for breach of contract and bad faith, claiming that State Farm had fraudulently induced the HOA into executing the release. The HOA also claimed that State Farm had misrepresented the policy limits of its policy to be $4.9 million when they were in fact $11.9 million. Finally, the HOA claimed that the court had inherent power to set aside a fraudulently-procured release and that State Farm’s $1.5 million payment was a grossly deficient partial payment toward the HOA’s earthquake loss.
State Farm demurred, contending that under California Supreme Court precedent, Garcia v. California Truck Co. (1920) 183 Cal. 767 and Taylor v. Hopper (1929) 207 Cal.102, the HOA could either (1) rescind the settlement agreement and return the $1.5 million State Farm paid or (2) affirm the settlement agreement and sue for fraud. However, State Farm argued, the HOA could not affirm the settlement, keep State Farm’s settlement payment, and still pursue a claim against State Farm that it had expressly released. The trial court sustained State Farm’s demurrer without leave to amend and the HOA appealed.
Holding
The California Court of Appeal reversed. It determined that Garcia and Taylor —which essentially provide that a release can be set aside only through rescission and the restoration of the consideration paid—apply solely in the context of personal injury cases. Here, however, the Court of Appeal reasoned that State Farm did not dispute the existence of its contractual obligation to pay for some damage, but merely disputed the extent of the damage. Therefore, a jury could determine what damages an insured incurred in entering into a fraudulently-induced settlement of a disputed insurance claim.
Moreover, the court also noted that prohibiting an insured from affirming a fraudulently-induced release and suing for fraud damages would leave the insured with no practical remedy in such cases, as it is unlikely that the insured actually would be able to return the consideration paid.
However, the Court also expressly limited its ruling solely to the facts of the case, stating that if an insurer fraudulently induced an insured to settle a claim by a misrepresentation of policy limits , the insured could elect to keep the money paid and then sue for fraud rather than on the released claim.
Comment
The Court of Appeal’s ruling is simply an application of the general principle that a party induced to execute a contract by fraud has the option of rescinding it or affirming it and recovering damages for fraud.