Federal Court Holds California Insurance Code Bars Duty to Defend Against False Claims Act Violations

Life, Annuity, and Retirement Solutions   |   Property & Casualty Insurance   |   January 24, 2017
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The Central District of California held that Section 533 of the Insurance Code eliminated any potential for coverage for suit under the state False Claims Act.

On January 4, the U.S. District Court for the Central District of California held that California’s Insurance Code precluded AIG Specialty Insurance Company from reimbursing $15 million in defense expenses incurred by Office Depot in defending a False Claims Act suit.

In Office Depot, Inc. v. AIG Specialty Insurance Company, Case No. 15-02416-SVW-LPRx (C.D. Cal. Jan. 4, 2017), the court analyzed whether AIG had a duty to defend Office Depot against a qui tam lawsuit alleging that the company overcharged public entities in violation of the California False Claims Act. Office Depot settled the suit in 2014 for $77.5 million and sued AIG in 2015, claiming that AIG was obligated to reimburse Office Depot for the settlement and its defense costs. Office Depot also asserted bad faith.

Before addressing the duty to defend claim, the court dismissed Office Depot’s indemnity claim with prejudice. The court based its dismissal on Section 533 of the California Insurance Code, which states that “an insurer is not liable for a loss caused by the willful act of the insured.” Office Depot argued that Section 533 did not apply because a party may be liable under the CFCA for “reckless” misrepresentations and Section 533 does not bar the indemnification of reckless conduct. The court disagreed and held that a CFCA claim requires “the intent to induce reliance”—i.e. an intent that the government pays the claim—and thus was more akin to negligent misrepresentation than purely reckless conduct, where the result is not intended by the act.

Upon the parties’ competing motions for summary judgment, the court held there was also no duty to defend. First, the court found that Section 533 precluded any potential indemnity coverage for a claim under the CFCA. “Though specific intent of fraud is not required, any person who ‘burie[s] his head in the sand and fail[s] to make simple inquires which would alert him that false claims are being submitted’, certainly expects the harm to occur. This is intentionally harmful conduct.” Further, the court held that Office Depot had no reasonable expectation of a defense for CFCA claims that could not be indemnified under Section 533. While Office Depot relied on the general coverage grant to establish its “reasonable expectation,” the court noted there was no specific promise to defend CFCA claims or willful conduct. “General liability clauses,” the court held, “are not enough.”

Accordingly, the court held that Section 533 relieved AIG of any obligation to reimburse the approximately $15 million in defense costs incurred by Office Depot. The court’s Order did not reach AIG’s arguments under the policy’s insuring agreement and exclusions, which AIG asserted independently barred coverage.

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