Combs was sued for racial discrimination in his management of an apartment complex. State Farm defended him, while reserving its rights. After entering a default against Combs for his refusal to produce documents in discovery, the trial court found that Combs' conduct constituted "racial animus" and imposed compensatory and punitive damages. The attorneys' fees for trial and appeal, also imposed against Combs, amounted to some $650,000.
In his suit against State Farm, Combs did not pursue indemnification for the compensatory and punitive damages, apparently acknowledging that coverage for such liability was barred by California Insurance Code § 533. Section 533 prohibits an insurer from indemnifying a "loss caused by the wilful act of the insured . . . ."
Combs did assert that the supplementary payments provision of his policy entitled him to be reimbursed for the attorneys' fees taxed against him as costs. Combs argued that he was entitled to a defense under the State Farm policy and that payment of costs taxed against him is a function of the defense obligation, not the indemnity obligation.
The Court of Appeal acknowledged that Section 533 does not necessarily preclude the defense of a suit in which an insured is found liable for willful misconduct. The Court nevertheless concluded that, merely because the obligation to pay the attorneys' fees arises from the insurer's defense obligation under the supplementary payments provision, does not mean that Section 533 permits the insurer to indemnify the insured for such costs. The Court noted that:
Attorney fee awards may not normally be considered as "damages" in that they do not compensate claimants for the injury for which they brought suit [citations], nor may they ordinarily be awarded for the purpose of punishing the defendant [citations]. Nonetheless, the term "loss" is not limited to damages. While providing a legal defense pursuant to the terms of an insurance policy does not constitute indemnification for a loss [citation], providing a defense is hardly the same as indemnifying the insured for the other party's costs and attorney fees that the insured becomes obligated to pay only as a result of being found liable for the underlying misconduct.
As the Court further explained:
Like the duty to indemnify, the obligation to pay costs taxed to the insured "arises only after liability is established." [Citation.] . . . Permitting the wrongdoer to insure against this consequence would, no less than permitting the wrongdoer to be indemnified for the damages he or she must pay as a result of willful misconduct, undercut the public policy behind section 533 and permit the offender to avoid what may be a significant consequence of the wrongdoing.
The Court concluded that "despite its contractual agreement to pay these costs, Section 533 prohibits State Farm from doing so."