The California Supreme Court has declared that insurers can be liable for unfair competition suits if a policyholder can allege violations of other state statutes or common law.

The decision resolves a split among the state’s appellate courts, which struggled to deal with a 1988 decision from the state’s highest court holding that a private cause of action for commission of the various unfair practices listed in the state’s Insurance Code was not created by the Unfair Insurance Practices Act (Moradi-Shalal v. Fireman’s Fund Ins. Companies, 46 Cal. 3d 287).

Clarifying its holding, the Court affirmed that a policyholder cannot simply bring a suit alleging a violation of the state’s unfair competition law (UCL) against an insurer. However, first-party UCL actions based on grounds independent of the UIPA – even where the insurer’s conduct also allegedly violated the insurance law – are allowed.

Plaintiffs may not use the UCL to “plead around” the UIPA, but that fact “does not immunize insurers from UCL liability for conduct that violates other laws in addition to the UIPA,” the court wrote.

The issue arose when Yanting Zhang sought coverage for fire damage to her commercial property from California Capital Insurance under a comprehensive general liability policy. When coverage was declined, Zhang filed suit alleging breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of the UCL. In her UCL claim, Zhang claimed California Capital had “engaged in unfair, deceptive, untrue, and/or misleading advertising” by promising to provide timely coverage in the event of a compensable loss when it had no intention of paying the true value of its insureds’ covered claims.

A trial court initially dismissed the suit, relying on Moradi-Shalal, but was reversed on appeal.

Reviewing Moradi-Shalal and its progeny, the Court said the decision left intact administrative remedies as well as traditional common law theories of private recovery against insurers.

Noting the split among appellate courts when applying the decision, the Court clarified the law in the state. “The legislature did not intend the UIPA to operate as a shield against any civil liability,” the Court wrote. “The UIPA does not immunize insurers from UCL liability that violates other laws in addition to the UIPA.”

Fear of opening the floodgates to litigation against insurers was unfounded, the Court added, because the remedies provided by the UCL are limited to injunctive relief and restitution. In addition, the passage of Proposition 64 requires plaintiffs bringing a UCL action to show economic injury caused by unfair competition, further limiting potential plaintiffs.

Turning to Zhang’s case, the Court said her UCL claim was premised on allegations of false advertising. According to her complaint, California Capital misleadingly advertised that it would timely pay the true value of her covered claims, but the insurer’s treatment demonstrated it had no intent of honoring this promise. Alternatively, California Capital contended that Zhang’s UCL claim was really an allegation of improper claims handling, and the accompanying claims of unfair competition and false advertising were merely window dressing in an effort to plead around Moradi-Shalal.

“[B]ad faith insurance practices may qualify as any of the three statutory forms of unfair competition,” the Court said. “They are unlawful; the insurer’s obligation to act fairly and in good faith to meet its contractual responsibilities is imposed by the common law, as well as by statute. They are unfair to the insured; unfairness lies at the heart of a bad faith cause of action. They may also qualify as fraudulent business practices. Under the UCL, it is necessary only to show that the plaintiff was likely to be deceived, and suffered economic injury as a result of the deception.”

Zhang’s complaint met the standard, the Court said. “Moradi-Shalal imposed a formidable barrier, but not an insurmountable one.”

The Court also dismissed California Capital’s concerns about the next steps in the case. Noting that it was not troubled at the pleading stage about how Zhang might go about proving her claims, the Court did not credit the insurer’s arguments about potential relief in the suit (how would an injunction be formulated and enforced? the insurer wondered) as well as concerns about how “unmanageable” it would be to examine its claims handling practices in thousands of cases.

“When the legislature enacted the UIPA, it contemplated only administrative enforcement by the Insurance Commissioner,” the Court concluded. “Private UIPA actions are absolutely barred; a litigant may not rely on the proscriptions of [the unfair practices listed in the Insurance Code] as the basis for a UCL claim. However, when insurers engage in conduct that violates both the UIPA and obligations imposed by other statutes or the common law, a UCL sanction may lie. The legislature did not intend the UIPA to operate as a shield against any civil liability.”

To read the decision in Zhang v. Superior Court of San Bernardino County, click here.

Why it matters: The Court has made clear that Moradi-Shalal does not bar first-party UCL claims based on claims handling practices that also constitute violations of the UIPA, as long as they are not exclusively based upon UIPA violations. Thus, the Zhang decision could have a substantial impact in California, allowing policyholders another option when litigating against an insurer. While the impact of the decision might be limited because damages on UCL claims are not allowed, the Zhang decision provides insureds with significant reasons to add a UCL cause of action to a breach of contract and bad faith case.