The California Court of Appeal has held that an insured’s misrepresentations on an application for insurance allowed a liability insurer to rescind the policy and obtain reimbursement of defense/settlement costs the insurer had paid on behalf of the insured prior to the rescission. ( LA Sound USA, Inc. v. St. Paul Fire & Marine Insurance Company (2007) WL 3358373)
Facts
LA Sound USA, Inc. (LA Sound) and its directors, Ancle Hsu and David Ji, entered into a written joint venture agreement with Hollywood Sound, Inc. (Hollywood Sound) to produce, market and sell audio equipment. The joint venturers used another entity, LSY Trading Development, Inc. (LSY), to begin consolidating their businesses.
Several months after the joint venture was formed, an LA Sound employee contacted an insurance broker about renewing an expiring policy issued by St. Paul Fire & Marine Insurance Company (St. Paul). Based on information supplied by LA Sound, the broker completed the application and submitted it to St. Paul. The application asked “Has applicant been active in or is currently active in joint ventures?” and “Is there a labor interchange with any other business or subsidiaries?” Both questions were answered “No.” Based on the information in the application, St. Paul issued a $1 million general liability policy covering LA Sound as named insured and its directors and officers as additional insureds.
Sometime later, disputes arose amongst the joint venturers. As a result, Hollywood Sound sued LA Sound, Hsu, Ji and LSY for trademark infringement. LA Sound, Hsu, Ji and LSY tendered defense of the trademark infringement action to St. Paul. St. Paul agreed to provide a defense under reservation of rights to LA Sound, Hsu and Ji, but denied coverage as to LSY. Thereafter, St. Paul paid a portion of the defense costs incurred by LA Sound, Hsu and Ji.
Eventually, the trademark infringement action was partially settled. Pursuant to the partial settlement, St. Paul paid $1 million on behalf of LA Sound, Hsu and Ji to Hollywood Sound, and Hollywood Sound dismissed its claims against LA Sound and its claims against Hsu and Ji in their capacities as officers and directors of LA Sound. However, Hollywood Sound did not dismiss its claims against Hsu and Ji in their individual capacities, and did not dismiss its claims against LSY. After further litigation, Hsu, Ji and LSY paid an additional $2.85 million to Hollywood Sound to settle Hollywood Sound’s remaining claims.
Following conclusion of the underlying trademark infringement action, LA Sound, Hsu, Ji and LSY filed a bad faith action against St. Paul, seeking to recover defense costs St. Paul had not paid in the underlying action as well as the $2.85 million which Hsu, Ji and LSY had paid to settle the remaining claims of Hollywood Sound. St. Paul cross-complained, alleging that LA Sound had made misrepresentations on the application, and that as a result St. Paul was entitled to rescind the policy and obtain reimbursement of the defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji.
The trial court ruled that LA Sound had made material misrepresentations on the application justifying rescission of the policy, and that St. Paul was thus entitled to recover all of the defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji in the underlying action. The trial court further held that LA Sound, Hsu and Ji were jointly and severally liable for the entire amount of reimbursement. LA Sound, Hsu, Ji and LSY appealed.
Holding
The Court of Appeal affirmed the finding that LA Sound had made material misrepresentations on the application, and that St. Paul was thus entitled to rescind the policy. The appellate court emphasized that the application specifically asked whether LA Sound was involved in joint ventures, that LA Sound had misrepresented its involvement in a joint venture, and that LA Sound had then demanded that St. Paul defend LA Sound against trademark claims related to the joint venture. LA Sounds’ misrepresentations, whether intentional or unintentional, were sufficient to give St. Paul a right to rescind. Further, because St. Paul had a right to rescind the policy, St. Paul was entitled to reimbursement of all defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji.
However, the Court of Appeal reversed the finding that LA Sound, Hsu and Ji were jointly and severally liable for the entire amount of reimbursement. According to the appellate court, although St. Paul was entitled to recover the policy benefits it conferred on LA Sound, Hsu and Ji, St. Paul still had to establish the amount of benefits conferred separately on each insured. In other words, St. Paul bore the burden of allocating its defense and indemnity costs separately amongst LA Sound, Hsu and Ji. The appellate court thus remanded the case to the trial court to make findings as to the amount owed by LA Sound, Hsu and Ji as restitution of the benefits received by each under the rescinded policy.
Comment
An insured’s material misrepresentations on an application—whether intentional or unintentional—will give the insurer the right to rescind the policy and to obtain reimbursement of all policy benefits the insurer paid on behalf of the insured prior to the rescission. However, as this case makes clear, where the insurer has paid policy benefits on behalf of more than one insured, the insurer must prove what portion of the benefits are allocable to each insured, and the insurer can only recover from each insured the benefits allocable to that particular insured.