Insurer Entitled to Reimbursement for Defense Costs Prohibited by Statute

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In October 2017, the California Attorney General (AG) filed a complaint against Adir, doing business as department store chain Curacao, and its CEO under the state’s Unfair Competition Law (UCL) and False Advertising Law (FAL).[1]

Adir presented a claim based on the AG’s action under a directors and officers liability policy issued by Starr Indemnity and Liability Company. Starr initially denied coverage, but after receiving a letter from Adir, Starr agreed to provide a defense, subject to a reservation of rights. Starr later received a letter from the California AG advising that California Insurance Code Section 533.5 prohibited coverage for the underlying action because the AG sought fines, penalties, or restitution pursuant to the UCL or the FAL. Starr subsequently withdrew its defense.

Adir and its CEO then filed suit against Starr, arguing that Starr’s policy provided coverage notwithstanding Section 533.5 because the AG sought injunctive relief in addition to fines and penalties, and because the AG’s action alleged liability based on other laws in addition to the UCL and the FAL. Starr filed a counterclaim seeking reimbursement of the defense costs it paid before withdrawing its defense. Both sides moved for summary judgment.

The court denied the motions filed by Adir and its CEO. Section 533.5 plainly applied to actions that included claims for fines, penalties, or restitution pursuant to the UCL or the FAL, even if the action also involved other claims. Moreover, allowing Starr to defend the claim for an injunction would undermine the legislative goals of Section 533.5. On the other hand, the court granted Starr’s motion seeking reimbursement of defense costs. Because of Section 533.5, the court held that there was no potential for coverage because the claims did “not even possibly embrace any triggering harm.” Adir argued that Starr was not entitled to reimbursement because its reservation of rights letter did not specifically reserve the right to seek reimbursement, nor did it mention Section 533.5. However, the court held that the policy itself provided that Adir would reimburse Starr “[i]n the event and to the extent that [Adir] shall not be entitled to payment of [] Loss”. Thus, Adir was required to repay all amounts Starr had paid for Adir’s defense.

The Adir decision represents a happy outcome for an insurer that found itself in a difficult situation. Starr was required to thread the needle between avoiding bad faith allegations for failing to defend and complying with the California Insurance Code’s prohibition on coverage for allegations of unfair competition and false advertising. Fortunately, the court’s willingness to interpret Section 533.5 broadly allowed Starr to recoup the costs of defending Adir until the basis for withdrawing coverage was clear.

[1] Adir International, LLC et al. v. Starr Indemnity and Liability Company, et al., No. 2:19-cv-04352-R-PLA (C.D. Cal. Sept. 10, 2019)