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June 2013

California Insurance Code Section 533.5(b) Does Not Apply to Criminal Actions Brought By Federal Prosecutors

In Mt. Hawley Insurance Co. v. Lopez, the California Court of Appeal for the Second District, following the 9th Circuit’s 1997 ruling in Bodell v. Walbrook Ins. Co., held that California Insurance Code Section 533.5(b) does not proscribe insurers from agreeing to provide an insured a defense in a criminal action brought by federal prosecutors.

Section 533.5(b) says, “No policy of insurance shall provide, or be construed to provide, any duty to defend . . . any claim in any criminal action or proceeding or in any action or proceeding brought pursuant to [California’s unfair competition law under Business and Professions Code Section 17200 and 17500] in which the recovery of a fine, penalty or restitution is sought by the Attorney General, any district attorney, any city prosecutor, or any county counsel, notwithstanding whether the exclusion or exception regarding the duty to defend this type of claim is expressly stated in the policy.”

According to the May 1 opinion, Mt. Hawley issued Daughters of Charity Health Systems, Inc., a not-for-profit organization, an executive liability policy wherein Mt. Hawley agreed, inter alia, to defend the insured against certain claims, which an endorsement defined to include “a criminal proceeding against any Insured commenced by return of an indictment” or a “formal civil, criminal, administrative or regulatory investigation against the Insured.” Dr. Richard Lopez was covered as an insured under the policy.

Lopez was indicted by the U.S. Attorney’s Office for criminal conspiracy, false statements and concealment, and falsification of records. The indictment averred that he had wrongfully moved a patient to the top of a liver transplant list and that the patient who was originally on top of the list died as a result. The indictment also alleged Lopez falsified records to cover up his malfeasance. Lopez tendered the defense of the criminal charge to Mt. Hawley and Mt. Hawley denied the tender contending there was no coverage under the policy for criminal charges pursuant to Section 533.5(b). Mt. Hawley then filed a declaratory relief action seeking a declaration that it had no duty to defend or indemnify Lopez. The trial court granted Mt. Hawley’s motion for summary judgment and Lopez appealed.

The dispute was one of statutory interpretation. Lopez asserted that Section 533.5(b) only proscribed coverage for criminal actions brought by “the Attorney General, any district attorney, any city prosecutor, or any county counsel.” Since federal prosecutors were not expressly enumerated in this list, Lopez argued that coverage was afforded. Mt. Hawley claimed that Section 533.5(b) barred defense coverage for all criminal prosecutions and for actions brought under California’s unfair competition laws by the four enumerated law enforcement entities. In other words, the four enumerated law enforcement entities only related to actions or proceedings brought pursuant to California’s unfair competition law and did not limit the application of the section to criminal prosecutions.

The court found that both parties’ interpretations of Section 533.5(b) were reasonable and turned to the canons of statutory interpretation to ascertain the legislature’s intent. The court noted that the original 1988 enactment of Section 533.5(b) provided that “no policy of insurance shall provide . . . any duty to defend . . . any claim in any civil or criminal action or proceeding in which the recovery of a fine, penalty, or restitution is sought by the Attorney General, any district attorney, or any city prosecutor.” The court found that clearly the enumerated law enforcement entities in the 1988 enactment qualified both “civil” and “criminal” actions. The subsequent enactments of Section 533.5(b) and the legislative history indicated that the statute was enacted to prevent insurance companies from absolving their insureds of personal responsibility for violating unfair competition laws and from prolonging and complicating the enumerated law enforcement entities’ efforts to enforce California unfair competition laws. Telling was the absence of any mention of federal prosecutions in the legislative history. Indeed, federal prosecutors are not authorized to enforce California’s unfair competition laws. Accordingly, the court concluded that the Legislature intended that Section 533.5(b) was only to apply to criminal or civil actions under California’s unfair competition laws brought by the enumerated law enforcement entities.

The court recognized that, grammatically, Mt. Hawley’s construction was reasonable, but that grammar was merely a tool used by courts to interpret statutes and that the Legislature’s intent controls, which clearly did not comport with Mt. Hawley’s interpretation. The court found that the “legislative history is bursting with manifestations of intent to bar indemnity and defense [of unfair competition] actions brought by state and local agencies, and devoid of any indications that the bar would apply to criminal actions brought by federal agencies.”

Section 533.5(b) proscribed insurance coverage for an unfair competition action seeking the recovery of “fines.” Since fines are only recoverable in criminal actions, the court opined, employing the rule of statutory interpretation providing courts should avoid constructions rendering any word a surplusage, that the statute clearly only applied to criminal actions brought by the enumerated law enforcement agencies.

Finally, the court stated that the defense coverage for criminal prosecution was specifically bargained for as it was an express term in the policy. The court reiterated the importance of the presumption of innocence and that, in the absence of a statutory prohibition, individuals should be able to marshal any resources available to defend themselves in criminal prosecutions, including insurance coverage. That California Insurance Code Section 533 proscribed insurance coverage for indemnification of willful criminal acts was of no moment since the issue was the duty to defend a federal prosecution, not the duty to indemnify fines related to a federal conviction.

To read the opinion in Mt. Hawley Insurance Co. v. Lopez (May 1, 2013) 13 C.D.O.S. 4387, click here

This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority in California state courts.

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David L. Jones