Truck Insurance Exchange v. Superior Court (51 Cal. App. 4th 985, 1996)

Opinion

HASTINGS, J.

This writ proceeding presents a question whether confirmation of an arbitration award pursuant to Civil Code section 2860 is inconsistent with a prior reservation of rights issued by an insurance carrier. We conclude that it is not, and grant a peremptory writ of mandate ordering the trial court to set aside the original order granting summary adjudication in favor of real parties in interest.

Statement of Facts

On July 24, 1991, real parties in interest, Andrew Cherng, Peggy Cherng, Panda Management Company, Inc., Panda Express, Inc., and Galleria II Panda Express, Inc. (collectively referred to as real parties), were served with a complaint filed in the Los Angeles County Superior Court by Jack Yu and Fung Nien Chow (the Yu action). The complaint alleged that Yu and Chow were business partners with the Cherngs in the various Panda entities.

Petitioner, Truck Insurance Exchange, had issued a number of insurance policies to real parties and they requested that petitioner provide defense and indemnity with regard to the Yu action. Petitioner agreed to provide a defense under a reservation of rights which included the “right to seek reimbursement of any sums spent in defense or settlement of the [Yu action] should it be determined that the Truck policies do not apply to the [Yu action].” In addition, petitioner advised real parties that if they believed a conflict of interest existed by reason of the reservation of rights they could invoke the provisions of Civil Code section 2860 (hereafter section 2860) and request independent counsel.

Real parties requested independent counsel and were afforded a defense by counsel of their choice, resulting in a judgment in their favor entered on March 26, 1993.

On July 14, 1992, petitioner initiated a declaratory relief action against real parties, seeking a declaration that it owed no duty to defend them in connection with the Yu action and that it was entitled to reimbursement for moneys spent in defense of the suit. Real parties cross-complained against petitioner alleging causes of action for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief.

A dispute arose over the amount and nature of fees to be paid by petitioner to independent counsel, and petitioner filed a motion to compel arbitration pursuant to section 2860, subdivision (c). Petitioner contended arbitration would conclude all issues in connection with the cross-complaint filed by real parties, which petitioner characterized as basically seeking relief for attorneys fees pursuant to section 2860. Real parties filed opposition to the motion and disagreed with petitioner’s characterization of their cross-action. They advised the court they had filed a first amended cross-complaint that expanded their theories beyond attorneys fees to include breach of the covenant of good faith and fair dealing, fraud, and negligent misrepresentation. However, they stated they were “agreeable to arbitration of its ‘attorney’s fees’ dispute with [petitioner] as the scope of Section 2860(c) permits.”

At the hearing on the motion, the scope of the arbitration was discussed and counsel for each side urged that the arbitration should be limited to attorneys fees and not include issues of bad faith, coverage, or other legal issues raised by the pleadings in the action. The court ultimately ruled: “I’m going to compel arbitration of the portions of the cross-complaint that fall under Civil Code 2860(c). The allegation re: denial of coverage shall not be included. [H . . . [H Should I say the allegations re: denial of coverage and/or bad faith fflj . . . ffl] And/or fraud [U . . . [f| or negligent misrepresentation. ”

Arbitration was conducted, and on August 20, 1993, the arbitrator issued an award as follows: “[Real parties are] entitled to be reimbursed $456,260.50 for attorney’s fees, $96,734.50 for paralegal charges and $134,264.47 for costs incurred to outside third parties for a total of $687,259.47 less the sum of $352,248.07 previously paid by [petitioner] to [real parties] resulting in a net award in favor of [real parties] against [petitioner] of $335,011.40.”

Petitioner sought confirmation of the award pursuant to the contractual arbitration provisions of Code of Civil Procedure section 1280 et seq. Real parties objected to confirmation pursuant to the contractual arbitration statutes because they were concerned that petitioner would attempt to use the resulting judgment to assert res judicata against the remaining portions of their first amended cross-complaint. However, they did agree that an interlocutory judgment relating to the issues raised in the arbitration would be appropriate. The court ordered counsel for real parties to prepare and submit an interlocutory judgment.

The interlocutory judgment was entered on October 28,1994. The following is recited in the judgment: “On November 9, 1992, this court granted [petitioner’s] motion and ordered arbitration of the ‘portions’ of the cross-complaint of [real parties] that fall under Civil Code Section 2860(c), specifically excluding from arbitration allegations re: denial of coverage and/or bad faith and/or fraud and/or negligent misrepresentation.” It then ordered real parties to recover from petitioner the sum ordered by the arbitrator and concluded with the following language: “This is an Interlocutory Judgment. This court retains jurisdiction to make further orders necessary to complete determination of the proceedings.” On the same date the interlocutory judgment was entered, checks for the amount awarded were tendered in satisfaction of it.

Real parties filed their second amended cross-complaint on November 17, 1994. It included eight separate causes of action: two for breach of contract, two for breach of the implied covenant of good faith and fair dealing, and one each for fraud, negligent misrepresentation, civil conspiracy, and declaratory relief. Pertinent to our discussion, the first cause of action alleges breach of contract against petitioner for failure to timely and adequately defend real parties and asserts that not all of the costs incurred by real parties in defense of the Yu action were included in the arbitration award.

True to the prediction of real parties, petitioner filed a demurrer and asserted that many, but not all, of the claims contained within the second amended complaint were subsumed by the arbitration award: “[Real parties] now attempt[] to state causes of action for breach of contract, breach of an implied covenant of good faith and fair dealing (‘bad faith’), fraud, negligent misrepresentation, and conspiracy based upon matters previously arbitrated and upon which an Interlocutory Judgment has been entered. These causes of action are barred by the doctrine of res judicata. [Real parties’] allegations in the Second Amended Cross-Complaint regarding [petitioner’s] payment of defense fees have merged into the arbitration award and are barred by the Interlocutory Judgment. The doctrine of res judicata therefore precludes those claims.” (Italics added.) Petitioner also challenged other claims within the cross-complaint on other grounds. The trial court sustained the demurrer to the first cause of action without leave to amend on the basis that the issues alleged therein were covered by the arbitration; it denied the remaining demurrers. Real parties filed a third amended cross-complaint deleting the breach of contract cause of action against petitioner.

On April 26, 1996, real parties filed a motion for summary adjudication requesting that the court adjudicate that petitioner had a duty to defend and provide independent counsel to real parties in the Yu action. Relying upon Handy v. First Interstate Bank (1993) 13 Cal.App.4th 917 [16 Cal.Rptr.2d 770] and Truck Ins. Exchange v. Dynamic Concepts, Inc. (1992) 9 Cal.App.4th 1147 [11 Cal.Rptr.2d 873], real parties argued that, by participating in the arbitration without obtaining a prior judicial determination of the duties to defend and to provide independent counsel, petitioner conceded the issues. Therefore, they concluded, the arbitration award was res judicata on both issues and the only remaining issue to be decided was the extent of tort damages to be awarded to real parties.

Petitioner opposed the motion, urging that real parties’ position was flawed because it would result in forfeiture of a carrier’s reservation of rights by invoking arbitration to resolve attorneys fee issues while the carrier provided a defense to the insured. They urged that real parties “misread Dynamic Concepts and Handy for the proposition that there is an express or implied adjudication of a duty to defend and the existence of a conflict of interest by virtue of an insurer voluntarily availing itself [of] arbitration to resolve a fee dispute.”

Real parties filed a reply to petitioner’s opposition wherein they conceded “that the prerequisite issues to the Civil Code § 2860(c) arbitration were not actually litigated or decided by [the arbitrator].” Real parties also argued that their motion “does not ultimately rest on a finding of implied waiver, as a matter of law, and certainly not express waiver through [petitioner’s] prior counsel in this litigation. . . .”

On July 1, 1996, the trial court issued a minute order granting real parties’ summary adjudication motion. On the issue of the effect of the arbitration, the court stated as follows: “Court finds that a Civil Code Section 2860(c) arbitration is improper in absence of either a court determination that there is a duty to defend and a conflict of interest or a stipulation or unconditional agreement between the parties. Despite the impropriety [petitioner] petitioned to compel arbitration and then petitioned to confirm the award. A Civil Code Section 2860(c) arbitration assumes the existence of a duty to defend and a conflict. The order confirming the arbitration award and entering judgment is res judicata with respect to all issues which were litigated or assumed by the judgment.” (Italics added.)

The court also made the following finding: “Even if the arbitration was not res judicata, [petitioner] would be estopped from denying that it owed a duty to defend and that there was a conflict of interest because, to [real parties’] detriment, [petitioner] asserted res judicata in a demurrer which successfully extinguished [real parties’] breach of contract claim. [Petitioner] cannot continue to litigate whether it owed a duty to defend (and possibly prevail and entitle itself to reimbursement) after denying [real parties] the opportunity to prove contract damages.”

No notice of the trial court’s ruling was given. The parties stipulated to extend time for petitioner to seek writ relief from the July 1, 1996, order through July 31, 1996, and the trial court granted the extension.

On July 31, petitioner filed the instant petition for writ of mandate or in the alternative for writ of prohibition, challenging the July 1 ruling. We issued an alternative writ, and real parties filed opposition.

Discussion

An insurance carrier owes a duty to defend its insured whenever a suit against the insured “potentially seeks damages within the coverage of the policy.” (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 275 [54 Cal.Rptr. 104, 419 P.2d 168].) The duty to defend continues until the insurer can conclusively eliminate, through undisputed facts, any potential for coverage under the policy. (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 301 [24 Cal.Rptr.2d 467, 861 P.2d 1153].)

If there is a question whether the duty to defend exists, the carrier has three choices it can pursue. First, the carrier may accept defense of the lawsuit without raising any objection to coverage. By doing so, the insurer waives its right to contest coverage at a later date. (Miller v. Elite Ins. Co. (1980) 100 Cal.App.3d 739, 755 [161 Cal.Rptr. 322].)

Second, the carrier may simply refuse to furnish a defense, but under this option the carrier may place itself in a position of risk: it loses control over defense of the action (Drinnon v. Oliver (1972) 24 Cal.App.3d 571, 580 [101 Cal.Rptr. 120], overruled on other grounds in Johnson & Johnson v. Superior Court (1985) 38 Cal.3d 243, 254-255 [211 Cal.Rptr. 517, 695 P.2d 1058]); the insurer may be bound by any issues litigated in the underlying action (Hogan v. Midland National Ins. Co. (1970) 3 Cal.3d 553, 566 [91 Cal.Rptr. 153, 476 P.2d 825]); and the carrier may be sued for breach of contract and breach of the covenant of good faith and fair dealing, resulting in contractual and noncontractual damages being awarded against it (Campbell v. Superior Court (1996) 44 Cal.App.4th 1308, 1319 [52 Cal.Rptr.2d 385]; Aero-Crete, Inc. v. Superior Court (1993) 21 Cal.App.4th 203, 212 [25 Cal.Rptr.2d 804]; State Farm Mut. Auto. Ins. Co. v. Allstate Ins. Co. (1970) 9 Cal.App.3d 508, 527-528 [88 Cal.Rptr. 246]).

Third, the insurer may defend the action under a reservation of rights: “In any event, if the insurer adequately reserves its right to assert the noncoverage defense later, it will not be bound by the judgment. If the injured party prevails, that party or the insured will assert his claim against the insurer. At this time the insurer can raise the noncoverage defense previously reserved. In this manner the interests of insured and insurer in defending against the injured party’s primary suit will be identical. . . .” (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 279, fin. omitted.) If the reservation of rights agreement contains a reimbursement clause, the carrier retains its right to seek reimbursement for payments expended if noncoverage is ultimately proven. (Johansen v. California State Auto. Assn. Inter-Ins. Bureau (1975) 15 Cal.3d 9, 19 [123 Cal.Rptr. 288, 538 P.2d 744]; Maryland Casualty Co. v. Imperial Contracting Co. (1989) 212 Cal.App.3d 712, 720-722 [260 Cal.Rptr. 797].) While the underlying action is pending, the carrier can file an action for declaratory relief and attempt to obtain a declaration that no duty to defend or indemnify exists. Such a determination would allow it to withdraw from the defense without subjecting the carrier to a claim of breach of contract or bad faith. (Harford Accident & Indemnity Co. v. Superior Court (1994) 23 Cal.App.4th 1774, 1778 [29 Cal.Rptr.2d 32].)

If the reservation of rights creates a conflict of interest between the insurer and the insured, the insured has the right to demand independent counsel. (San Diego Federal Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 364 [208 Cal.Rptr. 494, 50 A.L.R.4th 913]; § 2860, subd. (a).) A conflict exists when “the outcome of [the] coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim. . . .” (§ 2860, subd. (b).) This usually arises where the issue creating the conflict is one which must be decided in the underlying action. (Golden Eagle Ins. Co. v. Foremost Ins. Co. (1993) 20 Cal.App.4th 1372, 1395-1396 [25 Cal.Rptr.2d 242].) Also, if the issue which creates a conflict must be resolved in the underlying action, any declaratory relief action relating to coverage should be stayed pending resolution of the underlying action. (Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 301.)

When independent counsel is required, “[t]he insurer’s obligation to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended. This subdivision does not invalidate other different or additional policy provisions pertaining to attorney’s fees or providing for methods of settlement of disputes concerning those fees. Any dispute concerning attorney’s fees not resolved by these methods shall be resolved by final and binding arbitration by a single neutral arbitrator selected by the parties to the dispute.” (§ 2860, subd. (c).)

The exact issue we are presented with is the timing of a judicial determination of the duties to defend and provide independent counsel in connection with a declaratory relief action where the carrier is providing a defense under a reservation of rights and has acceded to the insured’s request for independent counsel. The issue is not directly presented in the cases relied upon by real parties.

An important fact distinguishes Truck Ins. Exchange v. Dynamic Concepts, Inc., supra, 9 Cal.App.4th 1147, from the instant case. In that case, Truck Insurance Exchange agreed to provide a defense to its insured under a reservation of rights but the insured and Truck disagreed over whether independent counsel was required and Truck refused to accede to the request. Dynamic filed a complaint for bad faith insurance practices and declaratory relief. Truck responded with a petition to compel arbitration. The trial court denied the petition and the Court of Appeal affirmed. “Civil Code section 2860, the Cumis statute, deals with various aspects of an insured’s selection of independent counsel where a conflict of interest has arisen between an insurer and its insured concerning the duty of the former to defend and indemnify the latter in litigation prosecuted by third parties. Where insurer and insured unconditionally agree independent counsel is warranted and where independent counsel is actually retained, subdivision (c) provides a simple remedy for resolving disputes concerning the fees to be paid to that individual or firm: arbitration. [