Gribaldo, Jacobs, Jones & Associates v. Agrippina Versicherunges A. G.

MOSK, J.

I dissent.

Plaintiffs are soil engineers and are also engaged in testing construction materials. Underwriters are three foreign insurers who issued a policy to plaintiffs, effective April 13, 1964, insuring them against “any claim or claims for breach of professional duty which may be made” against them “arising from any negligent act, error or omission” committed by them or their employees for which they would be legally liable. It was provided that Underwriters would not be liable for any claim unless the amount exceeded the $2,500 deductible. The policy was procured through the offices of a surplus line broker, Appleton & Cox of California.

The only references in the policy relating to the defense of actions are contained in three paragraphs under the heading “Conditions.” They provide as follows:

“1. The total liability of the Underwriters hereunder in respect of all claims made against the Assured in any one policy year . . . together with the costs and expenses incurred in the defence of any claim shall not exceed the sum stated in the Schedule.

“2. The Assured shall not admit liability for or settle any claim or incur any costs or expenses in connection therewith without the written consent of the Underwriters, who shall be entitled at any time to take over and conduct in the name of the Assured the defence of any claim.

“Nevertheless, the Assured shall not be required to contest any legal proceedings unless a Lawyer (to be mutually agreed upon by the Assured and the Underwriters) shall advise that such proceedings should be contested.

“3. The Underwriters shall not settle any claim without the consent of the Assured. If, however, the Assured shall refuse to consent to any settlement recommended by Underwriters and shall elect to contest or continue any legal proceedings in connection with such claim, then the Underwriters’ liability for the claim shall not exceed the amount for which the claim could have been so settled, together with the costs and expenses incurred with their consent up to the date of such refusal, provided always that Under *453 writers’ total liability under this Insurance shall not exceed the sum specified in the Schedule.”

A substantial number of actions was filed against plaintiffs alleging breach of their professional duties and asserting damages in excess of $2,500. The dispute as to Underwriters’ liability for defending these actions arose shortly after the policy was issued. Plaintiffs, with the express consent of Underwriters, utilized their own attorney to defend the suits. They filed this action in declaratory relief and prayed for judgment in the amount of their defense costs. Plaintiffs prevailed in some of the actions filed against them, and lost in some, and others were still pending at the time of this trial.

In order to comprehend the problem involved we must discriminate between Underwriters’ duty to defend a third party action filed against plaintiffs and the duty to reimburse plaintiffs for their defense costs. As to the latter, the trial court found that the reference in subdivision 3 of Civil Code section 2778 to an insurer’s duty to pay “the costs of defense against . . . claims” applied only to those defense costs which plaintiffs had paid in satisfying judgments (or settlements) which exceeded $2,500. Thus, it concluded that if plaintiffs prevailed in a suit brought against them by a third party or if they were ultimately required to pay less than $2,500 Underwriters was not compelled to reimburse them for defense costs even if the prayer of the complaint sought more than $2,500.

Subdivision 4 of Civil Code section 277.8 relates to the duty to defend actions on request of the insured “in respect to the matters embraced by the indemnity.” The trial court determined that Underwriters had no obligation to defend under this subdivision and that plaintiffs made no request of Underwriters to undertake a defense of the claims but voluntarily undertook the defense. In its opinion the court stated that the duty to defend under subdivision 4 would arise only if the obligation to reimburse for a claim paid exceeded the deductible. The Underwriters could stand by, stated the court, and assume the risk that the loss to plaintiffs might exceed the deductible amount, in which event Underwriters would become liable for the excess loss and the costs of defense.

I turn to the applicability of subdivision 4 of Civil Code section 2778 to the policy involved here. At the threshold there is the problem as to whether the subdivision is to be employed in interpreting the policy since, by the terms of the section, it is to be applied only in the event a contrary intention does not appear in the policy itself. Any doubt as to whether there is an obligation to defend must be resolved in the insured’s favor (Fireman’s Fund Ins. Co. v. Chasson (1962) 207 Cal.App.2d 801, 805 [ 24 Cal.Rptr. 726 ]), *454 all ambiguities in a policy must be resolved against the insurer, and any exceptions to the performance of the basic underlying obligation in the policy must be so stated as to clearly apprise the insured of its effect (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 269 [ 54 Cal.Rptr. 104 , 419 P.2d 168 ]). In order to avoid importing the duty to defend imposed by subdivision 4 into the policy we must therefore find clear, unambiguous language in the policy stating that Underwriters has no duty to defend claims made against plaintiffs by third parties.

I find no such language here, and the majority point to none. The policy does not in express terms provide either that Underwriters need not defend third party actions brought against plaintiffs or that plaintiffs are required to defend such actions.

Paragraph 1 under “Conditions” in the policy, quoted above, provides merely that Underwriters’ total liability, together with defense costs, should not exceed a stated sum.

Paragraph 2 provides that plaintiffs shall not admit liability for or settle any claim or incur costs or expenses in connection therewith without the written consent of Underwriters, who shall be entitled at any time to take over and conduct the defense in the name of plaintiffs.

This provision gives Underwriters the power to refuse to consent to a settlement or an admission of liability by plaintiffs and, if plaintiffs attempt to pursue such a course, i.e., if they do not wish to oppose the claim, Underwriters may take over and conduct the defense in plaintiffs’ name. For example, if plaintiffs believe that it would damage their business reputation to proceed to trial on a complaint filed by a third party, they might wish to admit liability or settle but they are prohibited from doing so without Underwriters’ consent. Contrary to Underwriters’ contention, the fact that the provision states that it has the right to take over the defense in this situation is not inconsistent with its duty to conduct the defense where no desire of plaintiffs for settlement or admission of liability is in issue.

The next sentence of paragraph 2 states that nevertheless plaintiffs “shall not be required to contest any legal proceedings unless a Lawyer (to be mutually agreed upon by the Assured and the Underwriters) shall advise that such proceedings should be contested.”

The trial court found that this provision required plaintiffs to defend claims when the lawyer so advised. While the provision conceivably can be interpreted in this manner, it is not the only rational construction of the language.

*455 Plaintiffs maintain that this sentence refers to a decision-making mechanism to be used in the event they wish to settle a claim and Underwriters contrarily insists they should “be required to contest” the claim. That is, should such a dispute arise between plaintiffs and Underwriters, the provision states that it is to be resolved by a lawyer mutually agreed upon between the parties. This construction of the sentence is plausible for several reasons. It provides some measure of protection to plaintiffs by the intervention of a neutral party whenever it would be to their interests to settle or admit liability. Moreover, the sentence is preceded by the word “nevertheless,” which indicates that it is concerned with another aspect of the matter set forth in the prior sentence, i.e., admitting liability or settling claims. It must also be noted that paragraph 1 and the first sentence of paragraph 2 refer to the “defence” of claims where Underwriters intended this meaning. There is no reason to suppose that the same word would not have been employed in the second sentence of paragraph 2 (instead of the word “contest”) if this is what Underwriters had intended.

The third paragraph refers to a situation the reverse of that covered by the second, i.e., a circumstance in which Underwriters desires to settle a claim but plaintiffs do not. It prohibits Underwriters from settling any claim without the consent of plaintiffs but provides that if plaintiffs refuse to consent to any settlement and elect to contest or continue any legal proceedings, then Underwriters’ liability should be limited to the amount for which the claim could have been settled, together with costs up to the date of plaintiffs’ refusal.

I do not intend to imply that no other meaning of these provisions is possible. Certainly contrary interpretations may be urged with rationality. Where the majority opinion falters, however, is in failing to recognize that nowhere is Underwriters’ duty to defend, imposed by statute, negated by clear, unambiguous language in the policy.

The trial court indicated in its memorandum opinion that subdivision 4 of the statute applies only if the obligation to reimburse for a claim paid exceeded the deductible sum. That is, that Underwriters would discharge its obligation under the subdivision by paying plaintiffs their defense costs if a judgment or settlement against plaintiffs exceeded that amount and was paid by them. This conclusion is incorrect. Subdivision 4 imposes upon Underwriters a duty to defend an action brought against plaintiffs in respect to matters embraced by the indemnity. The provision must mean at the very least that whenever a third party brings an action against plaintiffs within *456 the policy coverage and the prayer is for more than $2,500, Underwriters must provide a defense against the third party’s demand. 1

The duty to defend, as opposed to the duty to reimburse for the costs of defense, can arise only prior to the final determination of the action. As was said in Gray v. Zurich Insurance Co., supra, 65 Cal.2d 263, 271-272 , “[T]he nature of the obligation to defend is itself necessarily uncertain. Although insurers have often insisted that the duty arises only if the insurer is bound to indemnify the insured, this very contention creates a dilemma. No one can determine whether the third party suit does or does not fall within the indemnification coverage of the policy until that suit is resolved. . . . The carrier’s obligation to indemnify inevitably will not be defined until the adjudication of the very action which it should have defended.” (Fn. omitted.) Both Gray and Fireman’s Fund Ins. Co. v. Chasson, supra, 207 Cal.App.2d 801, 804-805 , make it clear that the obligation to defend is broader than the duty to indemnify and that the duty to defend exists if the complaint shows a potential liability within the policy coverage.

It seems evident that the defense requirement set forth in subdivision 4 necessarily must be discharged prior to final judgment. Thus, the statement in the subdivision that the duty to defend exists “in respect to the matters embraced by the indemnity” must be interpreted to mean at least that the duty arises whenever a complaint alleges a cause of action for damages the indemnitor would be compelled to pay if the third party prevails in the suit against the indemnitee. 2

*457 Underwriters attempts to distinguish Gray , pointing out that there the requirement of a defense was contained within the four corners of the policy whereas no such provision exists in the policy involved here. It seems obvious without elaboration that there is no substantive difference between defense duties specified by policy provision and those imposed by statute. (See Interinsurance Exchange v. Ohio Cas. Ins. Co. (1962) 58 Cal.2d 142 , 148 [ 23 Cal.Rptr. 592 , 373 P.2d 640 ].)

Subdivision 4 also provides that the insurer must defend an action or proceeding on request of the insured. The trial court found that plaintiffs did not request that Underwriters undertake the defense of these actions and that plaintiffs voluntarily undertook this burden. However, Underwriters was notified of every action brought by third parties against plaintiffs and appropriate claim forms were filed with Underwriters.

An insurance adjuster employed by Underwriters testified that he acted on its behalf in attempting to work out problems with plaintiffs in connection with providing a defense against third party claims. He stated further that there had been a dispute on this subject from the inception and that he was aware of plaintiffs’ interpretation of the policy. In order to avoid a multiplicity of lawsuits whenever a third party filed an action against plaintiffs in excess of $2,500, as Underwriters’ agent he recommended that plaintiffs’ attorney be employed to defend the actions.

This evidence shows that Underwriters, with notice of third party claims in excess of $2,500, and with knowledge of plaintiffs’ interpretation of the policy provisions, employed plaintiffs’ own attorney to defend the actions. Moreover, as we shall see, Underwriters knew, even before the issuance of the policy, that plaintiffs’ attorney would be employed at Underwriters’ expense to defend actions in which a third party sought more than $2,500 in damages. Since Underwriters chose to discharge its duty to defend by employing plaintiffs’ attorney for this purpose it must be held to have waived the statutory, and in this circumstance the meaningless, requirement that plaintiffs make a demand for a defense.

My interpretation of the defense duties of Underwriters is indicated not only by the legal construction discussed above but also by pragmatic aspects of the parties’ relationship. If the policy were to be construed as requiring plaintiffs to defend all actions filed against them by third parties they would have little incentive to seek a defense verdict in many cases. In all superior court actions which were brought by third parties the prayer is for more than $2,500 and in many instances plaintiffs’ eventual liability is less than that sum. Attorney’s fees and costs exceed $2,500 in a substantial number *458 of the actions filed by these third parties. If plaintiffs lose these cases their liability will be limited to $2,500 but if they win they could be liable for attorney’s fees far exceeding that amount.

Even if Underwriters exercises its right under the policy to assume the defense of a claim it might be psychologically difficult for plaintiffs to cooperate fully when a verdict for them would cost them more than an adverse judgment. In one case costs of defense have already mounted to $9,500. Underwriters has assumed the defense, and plaintiffs’ liability if the suit is won will be several times over its liability if it is lost.

Underwriters concedes the foregoing possibilities, but insists it will assume the risk. It suggests the danger is obviated by the policy provision that the insurance is void if plaintiffs prefer any claim knowing it to be false or fraudulent. Moreover, it asserts the risk of noncooperation exists theoretically in every policy since whenever a party is fully insured he has no pecuniary interest in defending the suit but the problem rarely arises because an insured is generally sufficiently interested in the outcome of the suit to cooperate with the insurer.

While the foregoing contention may have merit, the undeniable fact is that if the policy is interpreted as Underwriters maintains it should be, plaintiffs would advance their pecuniary interest in many cases by failing to cooperate if Underwriters conducts the defense and by losing the suit if plaintiffs themselves were defending. We do not suggest that a policy may not provide for such consequences, but these practicalities have a bearing upon the reasonable interpretation to be given the terms of the contract. A policy should not be interpreted to compel a party to “indulge in financial masochism.” (See Critz v. Farmers Ins. Group (1964) 230 Cal.App.2d 788, 801 [ 41 Cal.Rptr. 401 , 12 A.L.R.3d 1142 ].)

The trial court’s interpretation of the policy was incorrect for other reasons than those set forth above. The court concluded that the policy was not ambiguous, but nevertheless during the trial it admitted evidence regarding the negotiations which led up to the purchase of the policy by plaintiffs, subject to a motion to strike. This evidence consisted largely of conversations between plaintiffs’ attorney and Ralph Jackson, an employee of Appleton, the broker through which the policy was purchased. There was also documentary evidence of communications between plaintiffs’ attorney and Appleton as well as between Appleton and a London broker who placed the insurance with Underwriters. Underwriters moved to strike this evidence on the grounds that it violated the parol evidence rule, that it was immaterial, and that no proper foundation was laid because Appleton was *459 not an agent of Underwriters and representations by Appleton’s employees could not bind Underwriters.

The trial court found that the policy was not ambiguous and that Appleton was not the agent of Underwriters. However, it did not rule on the motion to strike because, according to its memorandum opinion, it found that nothing in the evidence offered by plaintiffs showed an intent of the parties contrary to that expressed in the policy as interpreted by the court.

I assume for the purpose of discussing this aspect of the case that the trial court was correct in concluding that Jackson was not an agent of Underwriters and I shall not consider the testimony regarding his representations to plaintiffs’ attorney. However, the court was not correct in its determination that the policy was unambiguous, as is evident from my prior discussion. In any event, it was required to admit the extrinsic evidence under the rule set forth in the majority opinion in Pacific Gas & E. Co. v. G. W. Thomas Drayage etc. Co. (1968) 69 Cal.2d 33 [ 69 Cal.Rptr. 561 , 442 P.2d 641 ], decided after judgment was rendered by the trial court.

If we confine our consideration of the extrinsic evidence to communications between Appleton and Underwriters, the conclusion is compelled that Underwriters knew that plaintiffs’ understanding of the policy prior to its purchase was that Underwriters would pay all legal costs if a third party’s claim exceeded $2,500. Plaintiffs’ attorney was concerned about who would bear the cost of defending actions under the policy and he contacted Jackson, who made certain representations to him on the subject. Jackson in turn dealt through a London broker who arranged Underwriters’ acceptance of the risk and who was the only person involved in the negotiations with the ability to make direct contact with Underwriters. Prior to the purchase of the policy, Jackson wrote the London broker as follows: “A question arose ... on the subject of defense costs, and we have indicated that the deductible would not apply to such costs. . . . The point also arose regarding the use by the assured of their own attorney. We have indicated that in cases where the claim was under the deductible that, subject to underwriters being put on notice, the use of such attorneys (who are apparently well versed in this type of business) would be in order, but at the assured’s cost. If, however, the claim was in excess of the deductible, then underwriters would probably approve the continued use of such attorneys subject to the supervision by an attorney of their own chosing [sic], the total legal cost to be borne by underwriters. We shall be obliged if you will . . . verify our understanding regarding defense.” 3

*460 The reply from the London broker was a cablegram stating, “Please refer to policy conditions one and two.” Jackson thereafter wrote agents of plaintiffs, “You will recollect that the main question to be resolved is that pertaining to defense, and your attention is drawn to conditions 1, 2 and 3 of the insuring agreement, which will be found to be self-explanatory. ”

Jackson testified that when he used the term “claim” in the letter quoted he meant the claim by plaintiffs against Underwriters after plaintiffs had satisfied a judgment in an action brought by a third party and not a claim in an action brought by a third party against plaintiffs. However, the letter is not reasonably susceptible of such construction. There would be no need for the continued use of an attorney subject to the supervision of another attorney to collect from Underwriters a sum which plaintiffs had already paid out pursuant to a judgment or a settlement.

Thus, Underwriters knew that plaintiffs had some question regarding defense costs prior to the issuance of the policy and knew that Appleton had represented to plaintiffs that they could use their own attorneys to defend third party claims at Underwriters’ cost in the event the prayer was over $2,500. Yet, when asked for a verification of this understanding it merely referred plaintiffs to provisions of the policy which did not clarify the issue. Underwriters must, of course, be charged with knowledge of its statutory duty to defend absent a clear policy provision to the contrary. It is elementary that if Underwriters knew that in purchasing the policy plaintiffs understood a defense would be provided for third party claims over $2,500, in the absence of an unequivocal correction of that understanding plaintiffs’ interpretation of the policy must prevail. (See 3 Corbin on Contracts (1960) § 537, p. 45.)

I am convinced that under the circumstances of this case plaintiffs should have been awarded damages. However, I have no disagreement with the majority on the disposition of the two claims involving Hersey Testing & Control, Inc.

I would return the matter to the trial court for the purpose of computing damages sustained by plaintiffs in accordance with the views expressed in *461 this opinion, since it may be that some of the third party claims which were pending at the time of the judgment have now been finally resolved.

The judgment should be reversed.

Peters, J., and Tobriner, J., concurred.

I do not mean to imply that the duty to defend is limited to a situation in which the complaint alleges a cause of action relating to a risk within the policy. In Gray v. Zurich Insurance Co., supra, 65 Cal.2d 263 , we held that even where the complaint alleged a risk outside the carrier’s liability to indemnify the insured, the carrier would be compelled to defend the action if potential liability was created by the suit. Thus, the insurer was required, in determining potential liability, to take cognizance of facts outside the complaint which would raise the possibility that it would be liable under the policy. Here we have a stronger case than Gray—i.e., the complaint alleges coverage within the policy but the carrier nevertheless argues that it has no duty to defend.

In connection with the holding in Gray that there may exist a duty to defend even if the complaint alleges a risk outside the policy coverage, we stated that the third party should not be permitted to act as the arbiter of the policy’s coverage by confining the insurer’s duty to defend to the face of the complaint. ( 65 Cal.2d at p. 276 .) Underwriters, relying upon this statement, contends that if we require an insurer to defend whenever the complaint shows on its face a liability within the policy coverage, we would be rendering the third party complainant the arbiter of the insured’s rights under the policy, contrary to the statement in Gray . If we were to accept this argument the duty to defend imposed upon an insurer would be rendered virtually meaningless. Clearly, Gray held that the insurer must defend in all cases in which the complaint upon its face alleges a risk within the policy but it extended the duty even further in a situation involving knowledge by the insurer of a potential risk from information dehors the policy.

It should be noted that Jackson used the phrase “. . . subject to Underwriters being put on notice . . .” and not the statutory term in subdivision 4, “. . . on *460 request of the person indemnified . . . .” The evidence is uncontradicted, as discussed above, that Underwriters was notified of every action brought by third parties.