Insurance Law and Professional Liability Alert: D&O Insurer Required to Defend Insureds Against Federal Criminal Charges

In Mt. Hawley Insurance Company v. Lopez (California Court of Appeal, 2nd District – No. B234082 – May 1, 2013), a federal grand jury had indicted a physician (Dr. Richard Lopez), charging him with criminal conspiracy, false statements and concealment and falsification of records. Dr. Lopez was then the medical director of the St. Vincent’s Medical Center Comprehensive Liver Disease Center and allegedly conspired with another physician and other hospital staff to transplant a liver designated for a particular patient on the transplant waiting list to another patient, farther down the list. Dr. Lopez then allegedly lied about the “switch,” sought to cover up the maneuvering and created false pathology reports and altered medical records in furtherance of the scheme. The first patient later died.

Daughters of Charity Health Systems, which owns St. Vincent’s, had purchased a “Not For Profit Organization and Executive Liability Policy” from Mt. Hawley in which the insurer agreed to “pay on behalf of the Insureds, Loss which the Insureds are legally obligated to Pay as a result of Claims . . . against the Insured for Wrongful Acts.” The policy contained a customary provision to the effect that Mt. Hawley had the duty to defend covered claims “even if any of the allegations are groundless, false or fraudulent.” An endorsement defined “Claims” to include “a formal civil, criminal, administrative or regulatory investigation against any Insured.” The definition of “Insured” included employees of St. Vincent’s like Dr. Lopez.

When Dr. Lopez tendered his defense in the federal criminal prosecution to St. Vincent’s insurer, Mt. Hawley promptly declined to defend or to indemnify him and commenced a declaratory relief suit in the Los Angeles County Superior Court. Its primary argument was that California Insurance Code section 533.5(b) precluded it from defending or indemnifying Dr. Lopez in the federal criminal proceeding. Section 533.5(b) provides: “No policy of insurance shall provide, or be construed to provide, any duty to defend [defined in sub-section (c) as ‘the insurer’s right or obligation to investigate, contest, defend, control the defense of, compromise, settle, negotiate the compromise or settlement of, or indemnify for the cost of any aspect of defending any claim] any claim in any criminal action or proceeding or in any action or proceeding brought [under the California unfair competition and false advertising laws – commonly referred to as the “UCL” and “FAL”].” (Emphasis added.) Dr. Lopez filed a cross-complaint for breach of contract and bad faith. After a series of challenges to the parties’ initial pleadings in which Dr. Lopez argued unsuccessfully that the statute did not apply, Mt. Hawley filed a motion for summary judgment premised on its interpretation of Section 533.5(b) to the effect that it precluded any defense of any criminal proceedings. The trial court agreed and found the statute unambiguously precluded Mt. Hawley from defending Dr. Lopez, ruled in its favor and entered judgment in its favor.

On appeal, the court found that the trial court had erred in granting Mt. Hawley’s motion. No California court had previously addressed whether Section 533.5(b) precluded an insurer from providing a defense in all criminal actions, including federal criminal proceedings. The only prior case addressing the issue was a 1997 decision by the United States Court of Appeals for the Ninth Circuit, Bodell v. Walbrook Insurance Co. (9th Cir. 1997) 119 F.3d 1411, which held that Section 533.5(b) applies to criminal actions brought by California State and local prosecutors, but did not apply to federal criminal prosecutions. A dissenting judge in Bodell (and the trial judge) had concluded that the statute applied to any criminal action, including federal proceedings.

The appellate court agreed with the Ninth Circuit and rejected Mt. Hawley’s contention that the statute unambiguously precluded any insurance contract from providing for the defense of “any criminal action or proceeding.” The court found Section 533.5 was susceptible of two other reasonable interpretations: (1) that the statue applies to criminal actions only when brought by California State and local prosecutors under the UCL or FAL; or (2) that it applies to any claim, in either a criminal or UCL/FAL proceeding, seeking recovery of a fine, penalty or restitution sought by the enumerated California prosecutors. Concluding it could not find the statute clear and unambiguous, the court then engaged in a lengthy review of the legislative history, the circumstances surrounding the statute’s enactment, and applicable maxims of construction of the statutory language; the court’s examination included the original legislative history of Section 533.5 when enacted in 1988 as well as subsequent amendments leading to the present version quoted above. The court reversed the summary judgment in Mt. Hawley’s favor and returned the case to the trial court for further proceedings.

The Mt. Hawley case is the first California decision to expressly conclude that insurers cannot use Insurance Code section 533.5(b) to avoid providing defense and indemnification for federal criminal proceedings to insureds under applicable policies, typically D&O and executive liability forms. It can also be read as clarifying that Section 533.5(b) is limited to actions involving the UCL and FAL laws, brought by State and local prosecutors in California. And its lengthy consideration of principles of statutory construction and legislative history could be useful to practitioners in other similar situations.

This document is intended to provide you with general information about professional liability law related developments. The contents of this document are not intended to provide specific legal advice. This communication may be considered advertising in some jurisdictions.