Section 533 of the California Insurance Code provides that an insurer is not liable for loss caused by an insured’s willful act. The applicability and impact of Section 533 are frequently litigated issues in insurance coverage cases to which California law applies. The following guest post surveys the recent significant case law involving Section 533. The article’s authors are Marisa DeMartini, Vice President, Management Claims Liability Manager, Ascot Insurance Company, James Talbert, Associate, Bailey Cavalieri LLC and Elan Kandel, Member, Bailey Cavalieri LLC. I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the author’s article.
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Introduction
In recent years, and particularly in 2023, there has been a proliferation of coverage litigation involving California Insurance Code § 533, including in the context of management and professional liability coverage. Accordingly, as 2024 gets underway, we take this opportunity to discuss several decisions from the past twelve months, which deal with important issues, both novel and perennial, related to Section 533’s scope.
As a threshold matter, for those less familiar with Section 533, a brief overview may be useful. The text of the statute reads:
An insurer is not liable for a loss caused by the wilful [sic] act of the insured; but he is not exonerated by the negligence of the insured, or of the insured’s agents or others.
Courts acknowledge that the Section 533 embodies a public policy to prevent encouragement of willful torts. In other words, it is a codification of the jurisprudential maxim that no man shall profit from his own wrong.[i] For purposes of Section 533’s proscription, “willful” conduct means more than a conscious or reckless disregard of the rights of others; rather, it is an action “done with a preconceived design to inflict injury.”[ii] It is treated as an “implied exclusionary clause,” which must be read into all insurance policies governed by California law.[iii] For purposes of Section 533’s proscription, “willful” conduct means more than a conscious or reckless disregard of the rights of others. Rather, courts have generally limited Section 533 to: (1) acts done with subjective intent to inflict injury,[iv] (2) acts that are inherently or necessarily harmful whether or not the actor subjectively intended harm, or (3) acts performed with knowledge that damage is highly probably or substantially certain to result.[v]
Client and Employee Poaching Claims
A common claim noticed under private company D&O policies and one that often raises the question of Section 533’s applicability involves an insured’s liability for poaching clients or employees from a competitor. Most recently, in United Talent Agency, LLC v. Markel Am. Ins. Co., a California federal district court analyzed whether coverage was implicated for the underlying poaching claim in which Creative Artists Agency (“CAA”), accused United Talent Agency (“UTA”) and two of its individual agents of unlawfully poaching several clients of CAA. The underlying suit was settled in January 2019. Thereafter, UTA initiated coverage litigation against its management liability carrier, claiming that the insurer wrongly denied coverage for sums incurred by UTA to defend and settle the poaching claim.
The federal district court granted the insurer’s motion for summary judgment on grounds that Section 533 precluded coverage for the underlying settlement. Notably, the court observed that Section 533’s applicability is not conditioned on a final adjudication in the underlying lawsuit, provided the legal theories asserted in the underlying action necessarily depend on a showing of “willful” misconduct within the meaning of Section 533.
The court proceeded to evaluate the causes of action asserted in CAA’s complaint to determine whether each was “necessarily willful” for purposes of Section 533. It found that five of the eight counts—namely, CAA’s causes of action for (1) intentional interference with contractual relations, (2) inducing breach of contract, (3) intentional interference with prospective economic advantage, (4) conspiracy to breach fiduciary duty and conspiracy to breach duty of loyalty, and (5) aiding and abetting breach of fiduciary duty and aiding and abetting breach of duty of loyalty—included willful conduct as an element, such that CAA could only prevail by establishing that UTA engaged in willful acts for which coverage is excluded by Section 533. Thus, “[b]ecause liability for each of these causes of action necessarily requires proof of willful conduct, coverage is barred by section 533.”[vi]
As for the three remaining causes of action—(6) breach of fiduciary duty, (7) breach of the duty of loyalty, and (8) violation of Section 17200 of California’s Business and Professions Code—the court acknowledged that “[l]iability . . . could conceivably be sustained ‘based on alleged conduct that has a lower degree of culpability’ that what would be required to establish ‘willful’ conduct under section 533.”[vii] Nevertheless, the court rejected the UTA’s argument that these three causes of action, which are not categorically willful, prevented the insurer from relying on Section 533 as a complete defense to coverage. The court reasoned that the gravamen of the underlying complaint concerned uncovered intentional malfeasance, such that “[t]o the extent CAA could have succeeded on these causes of action by proving non-willful conduct, any such conduct would have been ‘so closely related to [the] intentional misconduct as to constitute the same course of conduct for purposes of Insurance Code section 533.’”[viii]
In addition to finding that the insurer had no indemnification obligation, the court also found that the insurer had no duty to advance defense expenses.[ix] In reaching this conclusion, the court acknowledged other California authorities found Section 533 applicable only to indemnity coverage, and inapplicable to an insurer’s duty to defend.[x] However, the United Talent court distinguished those cases on grounds that UTA’s management liability policy “is not a ‘duty to defend’ policy,” but rather imposed a “duty to ‘advance covered Claim Expenses.’” According to the court, the “duty to ‘advance covered Claim Expenses’ is . . . a duty to provide indemnification” for purposes of Section 533, and therefore fell within the scope of Section 533’s proscription against indemnifying an insured for willful acts.[xi]
Employment Liability Claims
It is well settled that Section 533 bars indemnification of an insured’s direct liability Section 12940(h) of California’s Government Code, which prohibits employers from retaliating against employees for engaging in protected activity under California’s Fair Employment and Housing Act (“FEHA”). However, an employer can also be held vicariously liable under Section 12940(h), and Section 533 does not generally bar coverage for an insured’s vicarious liability. In County of Sacramento v. Everest National Insurance Co., the Ninth Circuit rejected the policyholder’s argument that the potential for vicarious liability under Section 12940 was sufficient to shield a judgment from Section 533’s preclusion.
Specifically, the policyholder challenged its insurer’s denial of indemnity coverage for a damages award stemming from FEHA violations. The policyholder argued that its liability under FEHA was vicarious and therefore that the judgment against it did not establish “willful” conduct of purpose of Section 533. The district court rejected this argument, and the Ninth Circuit affirmed. As a threshold matter, the Ninth Circuit recognized that an insurer’s duty to indemnify “is determined by the actual basis of liability imposed on the insured,” rather than potential alternative theories of liability that were never actually presented to the factfinder. Next, the court observed that the jury in the underlying lawsuit was never instructed on vicarious liability, and its verdict form gave no indication that the County’s liability was vicarious, rather than direct. Accordingly, the court rejected the County’s position that the potential for vicarious liability under FEHA rendered Section 533 inapplicable to the damages award in the underlying FEHA lawsuit.[xii]
In addition to finding that Section 533 precludes indemnification for direct liability for retaliation in violation of FEHA, California courts have found that Section 533 applies to wrongful termination and other employment-related theories of liability that “[n]ecessarily implicate willful and intentional conduct on the part of the insured.”[xiii] However, California courts have acknowledged that in analyzing the applicability of Section 533, it is important not to “paint with too wide a brush” in the employment practices liability context.[xiv] In particular, California courts generally find in favor of coverage for sexual harassment and wrongful termination claims where “[n]either precedent nor logic dictates that an employer who wrongfully terminates an employee cannot also be liable for other intentional torts or for torts of negligence against the victim which are apart from, and not integral to, the wrongful termination.”[xv]
Malicious Prosecution
In Aspen Specialty Ins. Co. v. Miller Barondess, LLP, the Ninth Circuit Court of Appeals, in an unpublished decision, held that the district court erred in concluding that Section 533 did not preclude indemnification for sums paid by an insured law firm to settle a malicious prosecution claim. Finding that a cause of action for malicious prosecution categorically required proof of a willful act for purposes of Section 533, the Ninth Circuit held that Section 533 barred coverage for the pre-trial settlement of such claim.[xvi] The Ninth Circuit’s decision in Aspen aligns with other California cases in which courts have “examine[d] the allegations of the underlying complaint, not whether there has been an adjudication of the allegations, in determining whether § 533 bars coverage.”[xvii]
Additionally, the Ninth Circuit rejected the policyholder’s argument the underlying lawsuit fell within Section 533’s carveout for negligence and vicarious liability. Specifically, the court noted that, even though the underlying lawsuit sought to hold the insured law firm vicariously liable for the actions of its partners, the malicious prosecution action was not based on an innocent party’s vicarious liability for the wrongdoing of another. Rather, the complaint alleged that the insureds themselves, not an agent or third party, engaged in the acts of malicious prosecution.[xviii]
Aspen demonstrates that Section 533 requires an examination of each insured defendant’s role in bringing about the “willful acts” at issue in a lawsuit. Attention should be paid to the entity defendant’s liability, which may be treated as vicarious or direct depending on whether the alleged misconduct was authorized, ratified, and/or perpetrated by one or more principles versus lower-level employees.
False Claims Act Liability
In view of the renewed focus by federal and state authorities on False Claims Act enforcement, we expect to continue to see an uptick in such claims in 2024. To date, those California courts that have examined whether Section 533 precludes coverage for false claims liability have found that it does not.
Most recently, in Practice Fusion, Inc. v. Hiscox Insurance Company Inc., et al., Great American Insurance Company denied coverage pursuant to Section 533 for a suit premised on the False Claims Act on grounds that basis that such claim was “due to plaintiff’s wrongful acts.”[xix] The trial court rejected the insurer’s arguments finding that the two essential elements of an FCA violation are (1) the falsity of the claim and (2) the defendant’s knowledge of the claim’s falsity.”[xx] The court noted that the term “knowingly,” as used in the FCA, includes “reckless disregard,” which fell short of the standard for “willful” misconduct under Section 533. The court further observed that the FCA explicitly states that liability is not dependent on “proof of specific intent to defraud.” Thus, because the government could have prevailed on the basis of recklessness, Section 533 was inapplicable. In reaching this determination, the court also relied on Section 533 case law involving federal securities violations in which such wrongful acts could be predicated on a recklessness standard.[xxi]
The Practice Fusion court then rejected the insurer’s alternative argument that the policyholder’s alleged FCA violations are “inherently and necessarily harmful,” and therefore should be treated as categorically willful for purposes of Section 533, regardless of the insured’s subjective intent. While the court acknowledged the cases finding that certain conduct is so intrinsically harmful that it is always considered “willful” for purposes of Section 533, it distinguished those cases on grounds that they generally involve “violent or other criminal acts.” Notably, in reaching its decision, the California state court relied heavily on other California case law that reached the same conclusion regarding Section 533’s application in the context of an FCA violation.[xxii]
Conclusion
Given that Section 533 is an implied exclusion found in every insurance policy issued to a California policyholder, that cannot be contracted around, it is evident that questions of Section 533’s applicability to the myriad types of claims that permeate the management and professional liability insurance space will be a coverage issue for years to come.
The opinions expressed in this article are solely those of the authors and not those of Bailey Cavalieri LLC or Ascot Insurance Company or any of its parent companies or affiliates. In addition, nothing in this article is meant to influence, convey or imply a coverage position by any insurance carrier on any past, current or future claim. The information in this article should not be interpreted to imply that all exposures, hazards or loss potentials on any subject or issue were identified or considered. This article also does not constitute or provide legal advice.
[i] Am. States Ins. Co. v. Borbor, 826 F.2d 888, 894 (9th Cir. 1987).
[ii] See Seneca Ins. Co. v. Cybernet Entertainment, LLC, 2017 U.S. Dist. LEXIS 194441, * 19 (N.D. Cal. Nov. 27, 2017); Mulkins v. Allstate Ins. Co., 2000 U.S. App. LEXIS 8202, * 6 (9th Cir. Apr. 21, 2000) (“California courts have indicated that Section 533 precludes coverage for ‘inherently harmful’ actions. Section 533, however, does not preclude coverage for acts that are negligent or reckless even though such acts are often ‘wilful’ as the term is commonly used.”); Office Depot, Inc. v. AIG Specialty Ins. Co., 772 Fed. Appx. 745, 746 (9th Cir. 2018) (holding that Section 533 did not bar coverage for a statutory claim because that claim required proof of only “reckless” conduct and did not require “proof of specific intent to defraud”)
[iii] See, e.g., Downey Venture v. LMI Ins. Co., 66 Cal. App. 4th 478, 78 Cal. Rptr. 2d 142, 154 (Cal. Ct. App. 1998). In this article, we focus on California decisions because the bulk of jurisprudence regarding Section 533 comes from California courts. This is not surprising because Section 533 is a California statute,and is an implied exclusion in every policy issued to a California policyholder. . However, it should be noted that the forum state for coverage litigation is not dispositive of Section 533’s applicability for coverage litigation involving Section 533 outside of California. Instead, a choice-of-law analysis will be required to confirm Section 533’s applicability such coverage dispute.
[iv] See Seneca Ins. Co. v. Cybernet Entertainment, LLC, 2017 U.S. Dist. LEXIS 194441, * 19 (N.D. Cal. Nov. 27, 2017); Mulkins v. Allstate Ins. Co., 2000 U.S. App. LEXIS 8202, * 6 (9th Cir. Apr. 21, 2000) (“California courts have indicated that Section 533 precludes coverage for ‘inherently harmful’ actions. Section 533, however, does not preclude coverage for acts that are negligent or reckless even though such acts are often ‘wilful’ as the term is commonly used.”); Office Depot, Inc. v. AIG Specialty Ins. Co., 772 Fed. Appx. 745, 746 (9th Cir. 2018) (holding that Section 533 did not bar coverage for a statutory claim because that claim required proof of only “reckless” conduct and did not require “proof of specific intent to defraud”).
[v] Wonderful Co. LLC v. Starr Indem. & Liab. Co., 2023 U.S. Dist. LEXIS 207158, *7-8 (Oct. 31, 2023), quoting Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal. App. 4th 715, 740-41 (Cal. Ct. App. 1993)).
[vi] Id. at *19-20.
[vii] Id. at *20.
[viii] Id. at *22, (quoting State Farm Gen. Ins. Co. v. Mintarsih, 175 Cal. App. 4th 274, 289, 95 Cal. Rptr. 3d 845 (2009)).
[ix] Id. at *26 (“MAIC has shown that pursuant to section 533 it had no duty to advance any defense costs related to the CAA lawsuit.”).
[x] See, e.g., B & E Convalescent Center v. State Compensation Ins. Fund, 8 Cal. App. 4th 78, 93, 9 Cal. Rptr. 2d 894 (1992) (“Section 533 precludes only indemnification of willful conduct and not the defense of an action in which such conduct is alleged.’”).
[xi] Id. at *14.
[xii] Id. at *3-4.
[xiii] See, e.g., Markel Am. Ins. Co. v. G.L. Anderson Ins. Servs., 715 F. Supp. 2d 1068, 1077 (E.D. Cal. 2010) (finding that, for purposes of Section 533, any liability imposed on the policyholder in connection with a former employee’s suit for retaliation based on past complaints of sexual harassment would “necessarily involve willful and intentional misconduct”) (quoting B & E Convalescent Ctr. v. State Compensation Ins. Fund, 8 Cal. App. 4th 78, 95, 98, 9 Cal. Rptr. 2d 894 (1992));
[xiv] Uhrich v. State Farm Fire & Cas. Co., 109 Cal. App. 4th 598, 614, 135 Cal. Rptr. 2d 131 (2003).
[xv] Lesser v. State Farm Fire & Cas. Co., No. CV-95-4154, 1996 U.S. Dist. LEXIS 22919, 1996 WL 339854, at *8 (C.D. Cal. June 14, 1996).
[xvi]Id. at *4.
[xvii] Id. at *2.
[xviii] Id. at *5.
[xix] No. CGC-20-58816 (Cal. Super. Dec. 19, 2023).
[xx] United States ex rel. Schutte v. Supervalu Inc. (2023) 598 U.S. 739, 747.
[xxi] See Raychem Corp. v. Federal Ins. Co. 853 F.Supp. 1170(N.D. Cal. 1994) (holding that because “the Ninth Circuit, along with ten other circuits, has held that recklessness may satisfy the element of scienter in a civil action for damages under § 10(b) and Rule 10b-5,” the court found that “Section 533 would not per se bar insurance coverage for alleged violations of §10(b) and Rule 10b-5, which require only a showing of recklessness to fulfill the scienter requirement.”).
[xxii] See Office Depot, Inc. v. AIG Specialty Ins. Co. (9th Cir. 2018) 722 Fed. Appx. 745 (finding that California False Claims Act claims “do not necessarily involvethe ‘willful’ conduct required for preclusion under Section 533.”); see also JP Morgan Chase Bank, NA. v., Superior Court (2022) 85 Cal.App.5th 477, 492-493 [observing that the definition of “knowingly” in the FCA is the same as in the California FCA and does not incorporate an additional requirement of willfulness.).