California Statute Prohibits Insurer from Defending a Unfair Competition and False Advertising Law
California enacted a statute, Insurance Code § 533.5(b) to prevent insurers from providing a defense or indemnity to a party sued by the state for Unfair Competition or False Advertising. Adir International challenged the statute in the Ninth Circuit Court of Appeal after California’s Attorney General sued Adir International, LLC for violating state consumer protection laws.
Adir’s insurer, after initially agreeing to provide coverage, Starr Indemnity, refused to continue to pay for Adir’s defense pursuant to California Insurance Code § 533.5(b), which forbids insurer coverage in certain consumer protection cases brought by the state. In ADIR International, LLC, DBA Curacao, FKA La Curacao, a Delaware Limited Liability Company; Ron Azarkman, an individual v. Starr Indemnity And Liability Company, a Texas Corporation, No. 19-56320, United States Court Of Appeals For The Ninth Circuit (April 15, 2021) the Ninth Circuit resolved the dispute after the District Court agreed with Starr.
California’s Attorney General sued Adir International for violating state consumer protection laws. To defend itself, Adir asked its insurance carrier to pay its legal fees. The insurer agreed, but the Attorney General warned that California Insurance Code § 533.5(b) forbids it from providing coverage in certain consumer protection cases brought by the state. The insurer reversed itself and said it would no longer pay for Adir’s legal defense. Adir challenged the law’s constitutionality, arguing that the state unfairly stripped it of insurance defense coverage based on unproven allegations in the complaint.
Adir operates a retail chain called Curacao with stores in California, Nevada, and Arizona. In 2017, the California Attorney General sued Adir and its Chief Executive Officer, Ron Azarkman, for unfair and misleading business tactics that allegedly exploit Curacao’s mainly low-income, Spanish-speaking customer base. The complaint alleged violations of California’s Unfair Competition Law (UCL) and False Advertising Law (FAL), and sought restitution, civil penalties, costs of suit, and other equitable relief. Relevant for this appeal, the complaint sought injunctive relief permanently enjoining Adir from making any false or misleading statements in violation of the FAL and engaging in unfair competition in violation of the UCL.
Meanwhile, Adir had bought an insurance policy from Starr Indemnity. The policy provided that Starr would defend and indemnify Adir and its executives for losses arising from certain claims alleging wrongful acts. When the California Attorney General sued, Starr agreed to defend the action under a reservation of rights.
This all halted in March 2019 when Starr received a written warning from the California Attorney General’s Office. In the letter, the Attorney General’s Office explained that Starr violated California Insurance Code § 533.5. (Adir also apparently received a copy of the same letter.) Section 533.5 provides that “Any provision in a policy of insurance which is in violation of subdivision (a) or (b) is contrary to public policy and void.” [Cal. Ins. Code § 533.5.] A few weeks after receiving the letter from the Attorney General’s Office, Starr informed Adir that it would “stop making any payments for defense costs” and reserved “its rights to seek reimbursement of all amounts paid to date.”
On appeal, Adir challenged both the indemnification and the defense provisions of California Insurance Code § 533.5.
As Adir points out, California has stacked the deck against defendants facing these lawsuits filed by the state: Although the Attorney General has yet to prove any of the allegations in his lawsuit, he has invoked the power of the state to deny insurance coverage that Adir paid for to defend itself.
The Ninth Circuit has held that there is “no constitutional right to counsel in a civil case.” United States v. 30.64 Acres of Land, More or Less, Situated in Klickitat Cty., Washington, 795 F.2d 796, 801 (9th Cir. 1986).
The Due Process Clause, like its forebear in the Magna Carta, was intended to secure the individual from the arbitrary exercise of the powers of government. And as a practical matter, that means due process bars the government from actively preventing a party from obtaining counsel or communicating with his or her lawyer in civil cases.
The limited right to retain counsel does not include the indirect right to fund and retain counsel through an insurance policy.
Although Adir complains that California Insurance Code § 533.5(b) is unfair, the statute does not actively prevent Adir from obtaining counsel or communicating with its lawyers.
California’s law only makes it harder, though not necessarily impossible, for a civil litigant to retain the counsel of their choice. Adir has not alleged that the government actively thwarted it from obtaining counsel, or that the law precluded it from communicating with counsel. Indeed, Adir appears to have obtained an able and competent counsel — without the use of insurance proceeds — for this appeal. The Ninth Circuit concluded that Insurance Code § 533.5(b) does not impinge on a due process right to retain counsel.
The text of the Starr policy defines “claim” to encompass a “written demand for monetary, non-monetary, or injunctive relief.” But “claim” is not the same thing as “coverage.” The word “Loss” is in turn defined to include “damages” but to exclude “any amounts paid or incurred in complying with a judgment or settlement for non-monetary or injunctive relief, but solely as respects the Company.”
In any event, given (1) the premise in California law that the duty to defend is always broader than the duty to indemnify and (2) because there is no duty to defend any criminal or civil proceeding under the UCL or FAL (including this action), there would be no reason to suggest a duty to indemnify in this action under subsection (a) of the statute.
When the law requires a wrongdoer to disgorge money or property acquired through a violation of the law, to permit the wrongdoer to transfer the cost of disgorgement to an insurer would eliminate the incentive for obeying the law. Otherwise, the wrongdoer would retain the proceeds of his illegal acts, merely shifting his loss to an insurer. The plain meaning of the statutory text of California Insurance Code § 533.5(b) forecloses defense coverage for any claim in an UCL or FAL action in which the state seeks monetary relief. Here, the state seeks (among other things) monetary relief against Adir under the UCL and FAL. The statute thus bars defense coverage for Adir.
The text of the insurance policy explicitly provides for a right to reimbursement of defense costs.
The Ninth Circuit affirmed the district court’s ruling that Starr is entitled to a reimbursement of defense costs.
Cal. Ins. Code § 533.5(b) did not facially violate the due process right of insurance holders to fund and retain the counsel of their choice in the civil context. The panel also rejected Adir’s statutory argument that section 533.5 applied to actions involving only monetary relief. The panel further held that under the plain text of the statute, it applied to actions that seek injunctive relief along with monetary relief.
California Insurance Code § 533.5(b) — which nullifies an insurance company’s duty to defend — does not facially violate a party’s due process right to retain counsel. In civil cases, courts have recognized a denial of due process only if the government actively thwarts a party from obtaining a lawyer or prevents it from communicating with counsel. Adir has made no such allegation. While it cannot tap into its insurance coverage, Adir has managed to obtain and communicate with counsel. Under the plain text of the statute, it applies to actions that seek injunctive relief along with monetary relief.
Insurance is a contract of indemnity that provides defense or indemnity for contingent or unknown events. It is also subject to state statutes that control the use of insurance to the public. In this case § 533.5 prohibited Starr from providing a defense or indemnity to Curacao and was entitled to a return of the money it spent under a reservation of right to defend Curacao until it withdrew its defense after it was warned by the state of California that its action was in violation of the statute. In essence, the state effectively rewrote the terms, conditions and provisions of the policy and added an exclusion to defense and indemnity that was not in the contract of insurance.
© 2021 – Barry Zalma
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost
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