Where an insured contends an insurer fraudulently induced the insured into entering into a settlement agreement, the insured cannot affirm the agreement, keep the money and sue for damages but, instead, must seek to rescind the settlement agreement in accordance with California’s rescission statutes. ( Village Northridge Homeowners Association v. State Farm Fire and Casualty Company (2010) 50 Cal.4th 913)
Facts
An earthquake caused damage to property that Village Northridge Homeowners Association (Village Northridge) owned. Village Northridge made a claim to its insurer, State Farm Fire and Casualty Company (State Farm).
State Farm represented that the policy limit for earthquake damage was $4,979,900, with a 10 percent deductible. State Farm made several payments, totaling about $2,068,000, to Village Northridge for the earthquake loss.
Later, Village Northridge located documents indicating the limits were different than State Farm had represented. In addition, Village Northridge discovered additional allegedly caused by the earthquake. State Farm re-inspected the property and concluded that some of the additional damage was earthquake-related, while other damage was not. State Farm paid Village Northridge about $7,466 for the additional damage.
Still later, although they continued to dispute the policy limits and the amount of money owed, Village Northridge and State Farm negotiated a written settlement agreement by which State Farm paid an additional $1.5 million. Pursuant to the settlement, Village Northridge released State Farm from all known or unknown claims related in any way to Village Northridge’s earthquake claim. More specifically, Village Northridge specifically agreed to “refrain and forbear from commencing, instituting, or prosecuting any lawsuit, action, or any other proceeding against [State Farm] based on, arising out of, or in connection with any claims, actions, causes of action, charges, demands, contracts, covenants, liabilities, obligations, expenses . . . and damages that are released and discharged.”
After entering into the settlement agreement and accepting the $1.5 million settlement payment, Village Northridge sued State Farm. In its complaint, Village Northridge alleged that State Farm had misrepresented that the policy limit for earthquake damage was only $4,979,900, and that the actual limit was much higher. Village Northridge also alleged that the $1.5 million additional settlement State Farm paid was grossly deficient and represented only a partial payment for the actual damage. In addition, Village Northridge alleged that it had signed the settlement agreement “under compulsion” in order “secure partial benefits owed.”
Significantly, Village Northridge insisted throughout the litigation that it did not seek to rescind the settlement agreement and that it did not intend to refund the $1.5 million that State Farm had paid. Instead, Village Northridge asserted that it wanted affirm the release and to sue for additional damages.
The trial court ruled in favor of State Farm, and concluded that Village Northridge “could not affirm the settlement agreement and simultaneously assert claims that were explicitly released in it.” The case went to the Court of Appeal and, eventually, to the California Supreme Court.
Holding
The Supreme Court ruled in favor of State Farm, and concluded that Village Northridge could not affirm the settlement agreement and simultaneously assert claims that were explicitly released in the settlement agreement. The Court noted that California statutes and California case law specify the rules under which a party can seek to set aside a settlement agreement.
Village Northridge alleged State Farm committed fraud in the inducement in the settlement process by misrepresenting policy limits. Generally, when one party contends he entered into a contract because he was induced to do so by fraud, that party must rescind the agreement.
Civil Code section 1691 requires the party seeking rescission to give notice to the other party “as to whom he rescinds,” and to restore all consideration or “everything of value which he has received” under the contract. A related statute, Civil Code section 1693, provides that a party who files an action for rescission “shall not be denied relief because of a delay in restoring or in tendering restoration of such benefits before judgment unless such delay has been substantially prejudicial to the other party; but the court may make a tender of restoration a condition of its judgment.”
Although California has rejected the “affirm and sue” principle adopted by several states, Civil Code section 1693 permits a plaintiff who is unable to restore the consideration received through a settlement agreement to delay the restoration of consideration until final judgment consistent with equitable principles, including that the defendant not be substantially prejudiced by the delay. Had Village Northridge sued for rescission of its release under the statutory scheme governing rescission, it might have had the opportunity to delay restoration of the consideration it received in settling the property damage matter. Again, however, Village Park never attempted to rescind the settlement agreement.
Comment
To allow an insured to settle with an insurer and sign a release, keep the money, and then sue the insurer for alleged fraud without rescinding the release under California’s statutory scheme would violate the terms of the bargain and frustrate its purpose. It would also likely inhibit insurance companies’ practice of using a release to settle disputed claims. The Legislature has created a fair and equitable remedy to address the alleged fraud problem: rescission of the release, followed by suit. When restoration is impossible because the settlement monies have been spent, the financially constrained parties can turn to Civil Code section 1693 to delay restoration until judgment, unless the defendants can show substantial prejudice.