The California Court of Appeals recently upheld a trial court judgment rendering a policy void ab initio and awarding the insurer reimbursement of amounts it incurred in defending and settling the underlying litigation. LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co., Nos. G036691, G036794 (Cal.App. Ct. November 14, 2007).

In the underlying case, the insured and its principal officers were sued for breach of a joint venture agreement. The insured tendered its defense to its liability carrier, who agreed to defend under a reservation of rights, but only consented to pay a proportional share of the defense costs as certain claims against the insured's officers were not covered under the policy. Ultimately, the insurer agreed to pay a partial settlement of $1 million on behalf of the insured and its officers, but the officers paid an additional $2.85 million to settle the remaining uninsured claims.

Thereafter, the insured filed an insurance coverage action against its insurer seeking to recover the remaining $2.85 million. The insurer filed a cross-complaint alleging that the policy should be rescinded because the insured misrepresented the existence of the joint venture agreement in the policy application. Following trial, the court found in favor of the insurer on its misrepresentation and concealment claims, ruling that the policy was void ab initio and that the insurer was "entitled to reimbursement of amounts it incurred in defending and settling the [underlying litigation]. . . ."

On appeal, the insured argued, among other things, that the insurer was precluded from rescinding the policy because: (i) it failed to provide written notice of rescission as required under California law; and (ii) it waived its right to rescind when it agreed to defend and ultimately fund the settlement in the underlying litigation. The Court of Appeals ruled that the cross-complaint filed by the insurer satisfied its responsibility to provide written notification of rescission. The court further ruled that the insurer did not waive its right to rescind the policy because it was entitled to rely on the representations made in the application in providing a defense in the underlying litigation. The court noted that an insurer does not waive its right to rescind a policy on the ground of false representations if it was unaware of the falsity of those representations.

With respect to amounts incurred by the insurer in defending and settling the underlying litigation, the Court of Appeals overturned the trial court's ruling that the insured and its officers were jointly and severally liable for reimbursing the entire amount. The Court of Appeals instead found that liability for reimbursement was subject to allocation based on the benefit conferred upon each insured, with the burden of proof on the issue resting on the insurer.

A full copy of the court's opinion is available here.