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INSURANCE NOTES

Upon Properly Rescinding A Policy, The Insurer Has The "Extremely Difficult" Burden To Prove The Amount Each Insured Must Reimburse

01.14.2008
In LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co. 156 Cal.App.4th 1259 (2007), the Court of Appeal reaffirmed an insurer's right to rescind an insurance policy for material misrepresentations in the application for insurance. However, the Court placed on the insurer the difficult burden of showing which defense and indemnity costs should be reimbursed by each insured.

LA Sound and Hollywood Sound formed a joint venture to sell audio products. When LA Sound applied to renew its liability policy with St. Paul Insurance Company, its application indicated "No" to a question asking whether LA Sound was "active" in "joint ventures." The policy insured LA Sound's "directors and executive officers . . . only for the conduct of their duties as [LA Sound's] directors or executive officers."

Later, Hollywood Sound sued LA Sound and its principals for trademark nfringement. St. Paul negotiated and paid a settlement on behalf of LA Sound and its principals in their capacities as directors and officers, leaving pending the suit against the principals for their conduct outside their duties as LA Sound directors and officers.

LA Sound and the principals sued St. Paul for not paying all of their defense costs. In turn, St. Paul sought rescission of the policy for material misrepresentations in the insurance application. The Court agreed with St. Paul, noting the insurance application specifically asked about LA Sound's involvement in joint ventures and the suit against LA Sound arose out of LA Sound’s undisclosed joint venture. A St. Paul underwriter testified that the existence of joint ventures affected a policy’s premium and posed “increased risk” to St. Paul, two factors considered in evaluating the materiality of a misrepresentation in an insurance application.

LA Sound asserted that the misrepresentation was not intentional and that its rights were not affected under the policy provision that “unintentional errors or omissions won’t affect your rights.” The Court stated the provision applied only to statements made after the policy had been issued, not statements made to procure the policy. No fraudulent intent by the insured was required to rescind the policy.

Although the Court agreed that the policy was properly rescinded and that St. Paul was entitled to reimbursement of all sums it had paid for defense and settlement (as though the policy had never been issued), the Court held that the insureds were not jointly and severally liable for the total sum. The Court reasoned that it would be “inequitable to require a party insured under a rescinded policy to reimburse the insurer the policy benefits it received and also all policy benefits that every other insured party received.” [Emphasis in original.] Adopting the allocation burden imposed by Buss v. Superior Court, 16 Cal.4th 35 (1997), in “mixed” actions involving covered and non-covered claims, the LA Sound Court required the insurer to present a “detailed analysis” of which insured benefited from a certain discovery or motion practice and of the liability of each insured.

The Court remanded the case to the trial court to allow St. Paul to attempt the “extremely difficult,” “if ever feasible” task of proving allocation of the defense and indemnity costs among the insureds. The task will also be costly. As a result, insurers will have less incentive to seek reimbursement following rescission.

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