GETTING MONEY PAID BACK: HOW PUBLIC ENTITIES CAN RECOVER INDEMNITY DOLLARS

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1 League of California Cities Annual Conference September 17, 2004 Michael E. Molland Morgan, Lewis & Bockius LLP San Francisco, CA GETTING MONEY PAID BACK: HOW PUBLIC ENTITIES CAN RECOVER INDEMNITY DOLLARS

2 Cities are often left holding the bag to pay for problems that should have been paid for by others. This article discusses how cities, and other public entities, can use insurance assets to pay for these problems, or leverage their special standing under state statutes to force those that cause the problems to pay for them. This article canvasses three areas of recovery: first, the insurance assets of public entities themselves; second, the insurance assets of the problem makers; and finally, key California statues that allow public entities special standing to either sue for recovery or penalties based upon the damages others have caused. A. Your Insurance The first place to look to solve a financial problem is your own insurance policies. Even if a city is self insured to some limit, or participates in a pooling arrangement for some of its coverages, its existing insurance resources are probably an underutilized asset. Insurance is a commodity whose only product is money. You pay the money in premiums; the insurance company invests it for its own accounts, and only pays the money back if there is an event or claim covered under your policy, and then only if you ask for it. The insurance company has no duty to determine whether any of your problems are covered by its policy unless you tell them that one is. This means that whether your insurance asset works for you is up to you. Statistics are often cited are that for every dollar that is deposited with an insurance company, insurance companies only pay back, on average, about 65 cents. That s not much of a rate of return. One reason it is so low is that many insureds simply don t ask for the money they should receive. Bockius LLP -2-

3 Public entities and their employees are subject to a host of liability claims, many of which are potentially covered by its insurance policies, or the pooling arrangements which substitute for these policies. In addition, public entities are exposed to other types of losses that may be insured, such as losses involving damage to real and personal property from hazards such as fire and environmental hazards, among others. Moreover, if individuals responsible for dealing with liability claims and other losses are not fully aware of the nature and scope of coverage available to the entity, or requirements that must be fulfilled in order to perfect an insurance claim, the investment and asset made in acquiring insurance coverage can be squandered. We have seen many situations where policyholders have been faced with claims that would have been covered by their insurance, but the opportunity to obtain recovery under their policies was lost because the individuals involved in handling the matters were either not aware of the existence of the coverage, or they were not aware of what was required to submit a valid claim. In other situations, policyholders assumed that they had coverage for a particular situation, but when they pulled out their policies after what they thought was a covered event had occurred, they realized that they did not have the insurance coverage they bargained for. Millions of dollars can be left on the table if the insured does not fully understand its existing insurance asset. The time to learn about your insurance coverage, whether it offers adequate protection to the entity and its employees and management personnel, and the requirements that must be met in order to make a valid claim, is before a claim needs to be made, rather than afterward when it may be too late to do anything. We recommend that you conduct a thorough review and analysis of your insurance program by those who are familiar with policy language and your financial problems. Some policies have strict deadlines by which claims must be submitted, and others might require that specific information be submitted to the insurance company, in a certain way, Bockius LLP -3-

4 in order for a claim to be properly made. You should know how any coverage problems can be corrected on a going forward basis and where the gaps are in your coverage, so they can be filled. We recommend you pay close attention to the following: 1. Coverage of third-party claims now pending against the city under specific insurance policies or pooling arrangements. by its insurers. 2. Reimbursements for money already spent by the city that should rightfully be paid 3. Special opportunities posed by the city s excess insurance situation. These often come into play for self-insured entities. 4. Across-the-board denials for certain coverage or recurring claims that suggest an aggressive response to insurers. 5. The extent of the city s first party coverage. Even for entities which self-insure for third party claims, or participate in pooling arrangements, first party coverage is usually available. As an example of the potential of your insurance asset in action, let s further examine your insurance for third party liability claims. If you give notice of such a claim an insurer must defend it if any claim is potentially covered by the policy. The standard of potential for coverage is favorable for the insured. After you give notice of a claim, insurers usually have an incentive to accept your defense in most cases because they suffer the following risks: (1) they can lose control of the defense, since the insured may be justified under California law in settling whatever terms it deems proper unless the insurer defends; (2) insurer loses the right to object to the amount of any such settlement and is bound by that amount and later coverage proceedings if the claim is determined to have been covered; (3) in that event the insurer may also have to pay for the defense of non-covered claims; (4) if liable the insurer must reimburse the insured for Bockius LLP -4-

5 defense costs even if it is later determined there is no actual coverage for indemnity as long as there was a potential for coverage; and finally (5) if the insurer s failure to defend reaches the implied duty of good faith and fair dealing, the insurer may be liable for punitive damages. Moreover, an insurer has a duty to defend the entire action or lawsuit against you if any claim is potentially covered. The insurer must mount and fund a defense for the entire action, even including those claims for which there is no potential coverage. An insurer may properly refuse the defense only where undisputed facts conclusively show there is no potential for coverage. Remember, however, the insurer has no duty to do anything though until there is a tender of the claim by the insured. The insured has other advantages if it is forced to sue its insurer to obtain coverage, either for third party, first party, or excess coverages. Attorney fees reasonably incurred by insured to force payment of benefits due under insurance policy are generally recoverable as damages in a bad faith action against an insurer. See Brandt v. Superior Court 37 Cal 3rd 813 (1985). The rationale under Brandt is that when attorney fees are incurred it is a type of economic loss caused by the insurer s tortious refusal to pay the amounts due under the policy. Tortious conduct causes an economic loss which will be compensated in tort. Essentially this means that the insurer s tort has made necessary for the insured to hire a lawyer. Brandt was recently affirmed by the California Supreme Court in Cassem v. Allstate SI 09711, 2004 Cal. Lexis 6832 (July 29, 2004); see also State Pacific Indemnity Company 63 Cal. App. 4th 1535 (1998). Many public entities, of course, participate in pooling arrangements with other public entities, for workers compensation and other liability insurance coverage against some or all third party claims. In these instances, the public entities act both as insureds and insurers. The key concern in these arrangements is for the covered entities to identify the existing coverage available and supplement, if necessary, with supplementary insurance. Bockius LLP -5-

6 B. The Insurance Policies of Others If you are sure you do not have insurance either because you are self-insured or participating in a pool which does not provide coverage for the financial problem at hand, the city or public entity should seek reimbursement by the third party who caused it. The best place to look is at the insurance held by that third party. This third party itself may not have much money, or it may be bankrupt or insolvent or departed from a corporate existence, but that doesn t mean it doesn t have insurance designed to pay for the problem you, as a deep pockets defendant, now confront. Look for the insurance company that stands behind the absent or insolvent defendant. Their pockets will be deeper than yours. A party may discover the existence and contents of another party s liability insurance policy, including the identity of the carrier and the nature and limits of the coverage. If the insurance company pays the claim on behalf of the liable third party, no problem. But what if it does not? The problem then is that, generally, only the insured may sue its insurer for failure to defend or indemnify against a third party claim. That means that an uninsured innocent, but solvent, bystander, like a city, lacks standing to sue another s insurer directly, because the city did not contract directly with the insurer and is not the beneficiary of its policy with its insured. However, there are key exceptions. The third party insured may assign to you its claim against the insurance company if the insurer does not defend or indemnify the insured. The assignments are often made as part of a direct settlement to the injured party in exchange for a covenant not to execute on the insured s personal assets. Further, if you become a judgment creditor of the insured, you acquire standing to seek payment under its insurance policy. If an insurer refuses to defend its third party insured, the insured may assign his or her claims against the insurer to the injured party in exchange for a covenant not to execute, as long as there is no collusion in doing so. In the assigned bad faith action the insurer will have the Bockius LLP -6-

7 burden of proof on the question of fraud or collusion. For the effect of a covenant not to execute, see Consolidated American Insurance v. Mike Soper 942 F. 2d 1421, Fritz v. Farmers Insurance Group 230 Cal. App. 2d 788; see also Pruyn 36 Cal. App. 4th 500. C. Civil Penalties Under California Statutes If no indemnity can be found from an insurance policy, either yours or theirs, you should consider the possibility of an action to recover damages or restitution based on the special standing or penalties divisions under certain state statutes. Public entities have particular standing to do so in California under business competition, environmental, and civil rights statutes. Here are the ones you should consider. 1. The Unfair Competition Law California s toughest pro-consumer law is the Unfair Competition Law ( UCL ), codified in the Business & Professions Code section et seq., which broadly applies to civil cases of all types. The California Attorney General and consumer fraud units of district attorneys offices bring many civil cases under the UCL, and section claims appear in most consumer class actions in California. Section is appealing because it broadly defines forbidden business practices and has less stringent standards with regard to standing and classwide relief. Furthermore, since much of the law is unsettled, the UCL allows wide latitude for creative lawyering. Potentially hundreds of law enforcement officials have standing to bring actions in the name of the People of California under section The following can bring UCL claims as public prosecutors: the California Attorney General; any of the fifty-eight California county district attorneys; any city attorney from one of the five California cities with populations over 750,000; and county counsel, with the consent of the district attorney, where there has been a Bockius LLP -7-

8 violation of a county ordinance; and city prosecutors, with the consent of the district attorney, in any city with a full-time city prosecutor. Bus. & Prof. Code Each can bring an action upon their own complaint or upon the complaint of any board, officer, person, corporation or association or by any person acting for the interests of itself, its members or the general public. Id. A public prosecutor can bring an action under section even if a statutory scheme exists that vests authority in some other agency or entity to bring such suits. See People v. McKale, 25 Cal. 3d 626 (1979). Furthermore, the People of California have standing to sue under the UCL on a parens patriae basis on behalf of the victim class, and such standing exists even if the victims lack standing. See People v. James, 122 Cal. App. 3d 28 (1981). It is important to note, however, that Article III of the United States Constitution limits the power of a law enforcement official to sue in federal court, making state court the preferred forum for such claims. Most importantly, the UCL provides civil penalties in cases brought by public law enforcement officials that are not available to private litigants. A person found in violation of the UCL shall be liable for a civil penalty not to exceed two thousand five hundred dollars ($2,500) for each violation. Bus. & Prof. Code 17206(a). (emphasis added.) The UCL suggests six discretionary factors for courts to consider in assessing the amount of a civil penalty: [T]he nature and seriousness of the misconduct, the number of violations, the persistence of the misconduct, the length of time over which the misconduct occurred, the willfulness of the defendant s misconduct, and the defendant s assets, liabilities, and net worth. Bockius LLP -8-

9 Bus. & Prof. Code 17206(b). Thus, the UCL is an attractive consumer protection vehicle because it offers the enticement of civil penalties that can go directly to public entities. Upon a successful UCL action, distribution of recovered funds depends on who brought the case. If the Attorney General brought the case, one-half of the penalty collected goes to the treasurer of the county in which the judgment was entered, and the other half goes to the State General Fund. If a district attorney or county counsel brought the action, the entire civil penalty goes to the treasurer of the county in which judgment was entered. For actions brought by city attorneys or city prosecutors, one-half of the penalty goes to the treasurer of the city where judgment was entered and the other half goes to the treasurer of the county where judgment was entered. Where a city attorney for a city and county brings an action, the entire civil penalty shall be paid to the treasurer of the city and county in which the judgment was entered. Bus. & Prof. Code 17206(c). There are some important rules to note regarding civil penalties under the UCL. First, the Sixth Amendment right to jury trial does not apply to section actions because the penalties are civil, not criminal. Second, because the UCL provides civil penalties, any recovery is not subject to the guidelines for punitive damages set forth by the Supreme Court in BMW v. Gore and later cases which will probably operate to significantly reduce punitive damages in California in the future. Third, once a court finds a violation of section in a case brought in the name of the People of California, it is error for the court to not impose a civil penalty. Restitution under the UCL, however, is discretionary. See Cortez v. Purolator Air Filtration Products, Inc., 23 Cal. 4th 163, 180 (2000). Fourth, the People do not have to prove that any of the victims of the practice actually relied on or suffered actual damages as a result of defendant s conduct to recover civil penalties. See People v. Toomey, 157 Cal. App. 3d 1 (1984). Bockius LLP -9-

10 Public officials bringing UCL claims benefit from access to special investigative tools available to them in addition to the civil discovery procedures of ordinary civil litigants. For instance, California prosecutors have brought civil actions under section based, in part, on investigations that relied on tape recordings obtained through eavesdropping and wiretapping. This powerful privilege is a result of an exception in the California Penal Code, section 633, for government investigations, which does not exist in federal law. Prosecutors conducting section investigations can also take advantage of the administrative subpoena, which does not depend on the formal filing of a complaint. Therefore, a district attorney conducting an investigation under the UCL can issue a subpoena without first filing an accusation. See Brovelli v. Superior Court, 56 Cal. 2d 524 (1961). The Evidence Code provides a qualified privilege where public prosecutors do not have to produce investigatory files. Ev. Code 1040(a). Finally, prosecutors can grant witnesses immunity from prosecution for testifying in UCL claims. See Matter of Myra Critchlow, 11 Cal.2d 751 (1938). However, a public entity considering a action should consider the right (or lack of it) to recover attorney fees under the statute. One of the disadvantages to public entity enforcement claims under UCL is that there is no automatic right to attorney fees. Although private plaintiffs pursuing UCL claims are eligible for attorney fees under doctrines such as common fund and substantial benefit, no such parallel exists for law enforcement actions. Further, while attorney fees can be awarded to the party who prevails as a private attorney general under CCP , governmental agencies often are restricted in collecting such fees. Bockius LLP -10-

11 For example, except in suits enforcing important rights against other governmental entities, governmental entities are ineligible for fee awards under CCP The Cartwright Act The Cartwright Act makes a trust, defined as a combination of capital, skill, or acts by two or more persons, firms, partnerships, corporations or associations of persons to restrict trade, limit production, increase or fix prices, or prevent competition. Bus. & Prof. Code 16702, 16720, In interpreting the Cartwright Act, California courts look to the federal Sherman Act. Standing under the Cartwright Act is similar to that under the UCL. The Attorney General can bring an action on behalf of the state or any of its political subdivisions or public agencies, and a district attorney can prosecute any action on behalf of any county or city or public agency or political subdivision located within the county. Bus. & Prof. Code 16750(c),(g). The penalties for Cartwright Act violations have a much higher cap than penalties under the UCL. Any person violating the Cartwright Act is found to be in a conspiracy against trade; if the violator is a corporation, the fine should be no greater than $1,000,000, and if the violator is an individual, the person can be fined no more than $250,000. An individual can also receive up to three years imprisonment, or a combination of a fine and jail time. Bus. & Prof. Code 16755(a)(1),(2). However, if the violator either derives pecuniary gain or causes pecuniary loss to another, the violator can be fined up to the amount of the gross gain multiplied by two or 1 An overview of CCP for those interested is found in McDermott and Rothschild, The Supreme Court of California, : the private attorney general rule on public interest litigation in California, 66 Cal. L. Rep. 138 (1978). See also California Attorney Fee Award, Richard Pearl, 2nd edition, November 2002, page 85 et seq. Bockius LLP -11-

12 an amount equal to the amount of the gross loss multiplied by two, whichever is applicable. Bus. & Prof. Code 16755(a)(3). Courts can also grant prohibitory and mandatory injunctions as may be reasonably necessary to restore and preserve fair competition in the trade or commerce affected by the violation. Bus. & Prof. Code Allocation of any fines or civil penalties received under the Cartwright Act depends on who initiated and prosecuted the action. If the Attorney General brought the action, the entire amount is deposited into the State Treasury, and if a district attorney brought the action, the entire amount goes to the treasurer of the county where the prosecution occurred. If the Attorney General and one or more district attorneys brought the action, the funds are divided between the State Treasurer and county treasurers in a proportion agreed upon by the agencies jointly prosecuting such case and as approved by the court. Bus. & Prof. Code 16755(c). Like the UCL, there is a mandatory duty to impose a penalty for each violation of the Cartwright Act. See The People v. National Association of Realtors, 155 Cal. App. 3d 578 (1984). Furthermore, in a situation involving numerous victims of the same or similar unfair practices, it does not suffice to assess one civil penalty. In National Association of Realtors, the court stated that multiple violations occurred, and therefore multiple penalties should be assessed, where multiple persons are affected by separate acts although pursuant to a single scheme. Id. at 586. There, the Court of Appeal remanded the case and the $20,000 civil penalty, ordering the trial court to recalculate the penalty by considering the number of persons directly affected by each act of unfair competition and the extent of public injury the defendant s acts caused. 3. The Unruh Civil Rights Act Bockius LLP -12-

13 The California Civil Rights statutes, embodied in the Unruh Act, Civil Code 51 et seq., give county and city attorneys standing to seek broad remedies for civil rights violations. Generally, under the Unruh Act, in any action brought by the Attorney General, a district attorney or city attorney, attorney fees are awarded as determined by court. Under Civil Code 52 any business which denies, aids, or incites a denial of civil rights is liable for each and every offense for the actual damages in any amount that may be determined by a jury up to a maximum of three times the amount of actual damage, plus attorney fees. Under Civil Code 52(b) any person who denies the right or conspires in that denial is liable for each and every offense for the actual damages suffered by any person denied that right and an amount to be determined by a jury for exemplary damages. Under Civil Code 52(c), whenever there is reasonable cause to believe that any person or group of persons is engaged in conduct or resistance to the full enjoyment of any rights described in this section and that conduct is of the nature that is intended to deny the full exercise of those rights, any Attorney General, district attorney, or city attorney, or any person aggrieved by the conduct, may file a civil action. Under Civil Code 52(d) if any action has been commenced that seeks relief from the denial of equal protection, any district attorney or city attorney may intervene. Finally, under Civil Code 52.1, if a person interferes or attempts to interfere with exercise or enjoyment of any individual rights secured by the Constitution or laws of the United States or California, the Attorney General or any district attorney or city attorney may bring a civil action for injunctive relief. 4. Environmental Statutes Certain state environmental statues in California s Fish and Game Code also provide for special standing for public entities to seek penalties for environmental damage. The principal statutes are as follows in the Fish and Game Code. Bockius LLP -13-

14 A chapter of the Fish and Game Code, entitled Fish and Wildlife Protection and Conservation, is devoted to the preservation of the fish and wildlife resources of this state, a purpose deemed to be of utmost public importance. Fish & G. Code 1600 et seq. Violators of this chapter can be fined up to $25,000 for each violation, and courts are to consider all relevant circumstances in assessing penalties, including the nature, circumstance, event, and gravity of violation. Fish & G. Code 1615(c). All penalties collected under this chapter are distributed as follows: fifty percent of the penalties go to the county treasurer of the county in which the action was prosecuted. The funds are to be deposited in the county fish and wildlife propagation fund established in the Fish and Game Code. Fish & G. Code 1615(f)(1). The other fifty percent of the penalties goes to the Fish and Game Preservation Fund, and these funds can pay legal costs or for any other law enforcement purpose consistent with Section 9 of Article XVI of the California Constitution. Fish & G. Code 1615(f)(2). Public prosecutors also can bring an action for the disposal of certain substances and materials, including petroleum, acid, and sawdust. Fish & G. Code 5650(a). Although the statute offers an affirmative defense, it is not available in cases brought by public prosecutors. Fish & G. Code 5650(f). Violators of this section have to pay civil penalties of up to $25,000 for each violation. Fish & G. Code (a). Penalties assessed under this section are to be apportioned as follows: fifty percent to the county treasurer of the county in which the action was prosecuted, and fifty percent to the Fish and Game Preservation Fund, which can be used to Bockius LLP -14-

15 cover legal costs and any other law enforcement purpose consistent with the California Constitution. Fish & G. Code (h)(2). 2 2 There are a number of other environmental statutes that concern certain narrowly defined problems, which are not further discussed here. An example is Food and Agriculture Code 5341(b), which allows district or county attorneys to bring actions against persons operating motor vehicles that enter the state with agriculture shipments for failing to obtain proper inspection certificates. Violators are subject to civil penalties of up to $1,000 per violation. Food & Ag. Code (b). The civil penalty shall be awarded to the agency which brings the enforcement action for use by that agency in enforcing the provisions of the code. Food & Ag. Code (e). Bockius LLP -15-