California Court of Appeal: An Insured’s Refusal to Pay Amounts Due Under a Contract Is Not a “Wrongful Act”
On May 22, 2012, in Health Net, Inc. v. RLI Insurance Co., et al., B224884, the California Court of Appeal, in a published opinion authored by Justice Walter Croskey, held that the “vast bulk” of amounts that Health Net, Inc. (Health Net) paid to defend and settle an ERISA class action (Wachtel) were not covered by Health Net’s professional liability policies, to the extent plaintiffs sought (1) unpaid benefits; (2) injunctive relief; (3) civil penalties; (4) damages arising out of claims subject to the willful act and other policy exclusions; and (5) attorney’s fees arising out of any of the above.
In Wachtel, subscribers to employer health insurance plans administered by Health Net alleged that Health Net and/or its subsidiaries systematically underpaid health care benefits by using a flawed database to calculate usual, customary and reasonable charges. After the district court issued a “blistering” opinion condemning Health Net’s discovery abuses and finding that Health Net had “knowingly and willfully used outdated data,” Health Net settled Wachtel by establishing a $215 million settlement fund (out of which the plaintiffs’ counsel received a $70 million fee award) and agreeing to business practices changes.
In the coverage action, Health Net sued its primary and three excess professional liability insurers (each with policy limits of $25 million) to obtain coverage for the settlement and for $60 million Health Net allegedly incurred defending against Wachtel. The trial court found no coverage for Wachtel because of the policies’ dishonesty exclusion.
The Court of Appeal then ruled that claims for unpaid benefits do not seek “Damages . . . resulting from any Claim or Claims . . . for any Wrongful Act” under the policies’ insuring agreement, as Health Net was already contractually obligated to pay those benefits, independent of any Wrongful Act. The Court of Appeal relied heavily on the reasoning of August Entertainment, Inc. v. Philadelphia Indemnity Ins. Co., 146 Cal. App. 4th 565 (2007), to support its finding that “[a]n insured’s alleged or actual refusal to make a payment under a contract does not give rise to a loss caused by a wrongful act.” According to the Court of Appeal, the fact that there was no contract exclusion or “benefits due” exclusion in the policies was irrelevant. The Court of Appeal further found it irrelevant that the Wachtel plaintiffs alleged “breach of fiduciary duty,” because the nature of the damage was for failure to pay contractual benefits.
The Court of Appeal further rejected Health Net’s argument that the Wachtel plaintiffs’ claim for attorney’s fees was a separate claim for “Damages,” finding that such fees are covered only to the extent that they arise out of covered Wrongful Acts: “coverage cannot be bootstrapped based solely on a claim for attorney’s fees.”
Finally, the Court of Appeal ruled that the dishonesty exclusion barred coverage for certain aspects of Wachtel, and also ruled that defense costs attributable to years of discovery abuses were not “reasonable and necessary.” The Court of Appeal remanded the case to the trial court to determine whether and to what extent there would be any coverage at all for Wachtel, in particular finding it “quite unlikely” that coverage would reach into the excess layers.
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