California Corner: California’s Bar on Coverage for Willful Acts under Insurance Code Section 533—Don’t Assume It Applies

David A. Thomas and Linda Kornfeld

Like a number of states, California prohibits insurers from indemnifying policyholders for liability based on intentional conduct that was committed with the intent to cause harm, although it does not bar a defense against such claims. California’s public policy is codified in Insurance Code Section 533, which provides: “An insurer is not liable for a loss caused by the wilful act of the insured; but he is not exonerated by the negligence of the insured, or of the insured’s agents or others.”

A significant body of law has elucidated the rules for application of Section 533. Reckless or grossly negligent conduct generally does not trigger application of the statute.[1] Nor, with very limited exceptions, does the mere fact that a policyholder intended the act that caused the harm bring the conduct within Section 533.[2] Instead, the policyholder must have intentionally performed a liability-producing act for the express purpose of causing harm or with knowledge that harm was highly probable or substantially certain to result.[3] Fraud and malicious prosecution are common examples.[4] Section 533, however, does not bar coverage for intentionally harmful acts based solely on vicarious liability.[5]

Despite the specificity of these rules, discerning whether an allegedly wrongful act is “willful” under the statute can be challenging at times. But, as a recent case illustrates, the standard generally continues to require both an intent to perform the liability-producing act and an intent to cause, or an expectation of causing, harm. In Office Depot Inc. v. AIG Specialty Insurance Co., 722 Fed. Appx. 745 (9th Cir. May 21, 2018), the Ninth Circuit considered whether California Insurance Code Section 533 necessarily barred coverage in a lawsuit asserting state-law qui tam claims. In the underlying action, the plaintiff filed suit on behalf of more than 1,000 California state and local government entities alleging violations of the California False Claims Act (“CFCA”).[6] The suit alleged that Office Depot “knowingly presented and caused to be presented . . . false and fraudulent claims, and knowingly failed to disclose material facts, in order to obtain payment and approval from” California public entities. Nineteen entities filed intervention complaints, including direct claims against Office Depot for common law fraud and breach of contract. The parties ultimately settled the case for $68.5 million.

AIG denied coverage for defense and indemnity under the “Multimedia Module” of two liability policies. Office Depot filed suit for breach of contract and other relief. AIG filed a motion to dismiss, contending that Insurance Code Section 533 barred coverage for indemnity for the CFCA claims. AIG observed that to state a claim under Section 12651(a)(l) of the Government Code, the whistleblower must establish that the defendant “knowingly present[ed] or cause[d] to be presented a false or fraudulent claim for payment or approval.” Office Depot responded that the scienter required for a CFCA claim includes not only the “willful” conduct precluded by Section 533, but also insurable reckless conduct. The requirement under the CFCA that claims be “knowingly” presented, it noted, includes claims submitted with “[r]eckless disregard for the truth or falsity of the information” where “specific intent to defraud is not required.”

The district court granted AIG’s motion.[7] Invoking California authorities applying Section 533 in what the district court deemed an analogous context, the court concluded that although recklessness can give rise to liability under the CFCA, that standard applies to only one element of the claim: the truth or falsity of a misrepresentation. According to the court, liability under the CFCA further requires an intent to induce reliance on the misrepresentation. Because this intent is required, Section 533 applied and barred coverage for the plaintiffs’ CFCA claims.

The Ninth Circuit reversed. The court found dispositive the fact that liability under the CFCA requires only recklessness regarding the truth or falsity of the information in the claim and does not require proof of specific intent to defraud. That, in the Ninth Circuit’s view, meant that CFCA claims do not necessarily involve the “willful” conduct required for preclusion under Insurance Code Section 533. The court stated summarily that it was “unpersuaded” by the district court’s reasoning that CFCA claims also require an intent to induce reliance.

The lesson for California policyholders confronting denials of coverage based on Section 533 is that as long as liability can be based on conduct that is reckless or of a lower standard of culpability, they should be prepared to push back firmly against the insurer’s position. That liability on a claim may also require a specific intent to cause harm or otherwise engage in wrongful conduct may not be enough to implicate Section 533. Relatedly, where an insurer has not denied coverage but has reserved rights on a claim based on Section 533, the policyholder should take care not to characterize the potential underlying liability as necessitating intentionally harmful conduct when such culpability is not required. Should the lawsuit settle, the policyholder should be mindful not to permit inclusion of any recitals in the settlement agreement explicitly or implicitly accepting culpability based on an intent to cause harm (including accepting such allegations in the complaint). And, where the policy at issue provides a duty to defend, the insurer has reserved rights based on Section 533, the policyholder’s liability could be based on either an intent to cause harm or a lower level of culpability, and defense counsel could potentially shape the development of evidence bearing on the degree of culpability giving rise to liability, the policyholder may be entitled to retain independent (or “Cumis”) counsel pursuant to California Civil Code Section 2860.[8] In all events, the policyholder should recognize that the standard for application of Section 533 is stringent, and any attempt by the insurer to invoke it should not be lightly accepted.

[1] California Amplifier, Inc. v. RLI Ins. Co., 94 Cal. App. 4th 102, 112 (2001).

[2] California Shoppers, Inc. v. Royal Globe Ins. Co., 175 Cal. App. 3d 1 (1985).

[3] Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal. App. 4th 715 (1993).

[4] E.g., Community Nat’l Bank v. Fidelity & Deposit Co. of Md., 563 F.2d 1319 (9th Cir. 1977) (fraud); Downey Venture v. LMI Ins. Co., 66 Cal. App. 4th 478 (1998) (malicious prosecution).

[5] Arenson v. National Auto. & Cas. Ins. Co., 45 Cal. 2d 81 (1955) (in bank); Dart Indus., Inc. v. Liberty Mut. Ins. Co., 484 F.2d 1295 (9th Cir. 1973).

[6] Cal. Gov’t Code § 12650 et seq.

[7] Office Depot Inc. v. AIG Specialty Ins. Co., No. 2:1-cv-02416-SVW-JPR, 2016 WL 6871283 (C.D. Cal. May 21, 2018).

[8] See Long v. Century Indem. Co., 163 Cal. App. 4th 1460 (2008).