United States: Southern Insurance Company v. Workers' Compensation Appeals Board

In Southern Insurance Company v. Workers' Compensation Appeals Board, 11 Cal.App.5th 961 (May 10, 2017), the Court of Appeal of California, Second Appellate District ruled that an insurer may rescind a workers' compensation insurance policy, and is not barred from doing so by California Insurance Code section 650. The Court annulled the workers' compensation appeals board's ("appeals board") decision that the policy could not be rescinded, and remanded with instructions to determine whether the insurer was entitled to, and did, rescind the policy.

In 2008, EJ Distribution Corporation ("EJ") applied for workers' compensation insurance, indicating in its application that EJ's routes are under 50 miles and EJ's employees do not travel out of state. In addition, EJ's agent prepared an online application, which listed the business as "local hauling," indicated the employees do not travel out of state, and indicated the radius of travel is not greater than 200 miles. Southern Insurance Company ("Southern") issued a workers' compensation policy to EJ, effective January 1, 2009.

An EJ employee injured his back while in Tennessee for EJ on April 6, 2009. He filed a workers' compensation claim on May 13, 2009. By letter dated June 12, 2009, Southern informed EJ it was rescinding the policy based on material misrepresentation, or concealment of material facts in the application, specifically with respect to the information regarding its employees' travels. In the letter, Southern also claimed it would not have issued the policy had it known the true facts. Southern returned the premiums paid to EJ.

Pursuant to Labor Code section 5275(a)(1), the parties submitted to mandatory arbitration. An underwriter at Southern testified Southern would not have issued the policy had it known EJ's employees traveled outside 200 miles or out of state, even though there was no such restriction in the policy language itself. A special investigator for Southern also testified, claiming: EJ's employees had traveled beyond the 200-mile radius in the past; prior to 2009, EJ had engaged in out-of-state operations in Utah and Tennessee; there were notes of conversations between prior investigators and EJ that confirmed EJ engaged in out-of-state operations before the policy incepted (however, the investigator did not have firsthand knowledge of these operations at the time EJ submitted its application); and, at the time EJ submitted its application, he "did not uncover anything specified [ . . . ] as to EJ's operations."

The arbitrator found: There was "no retroactive rescission" of the policy; [the employee's] claim for his April 6, 2009 injury was covered by the policy; and the policy was prospectively cancelled under Insurance Code section 676.8, subdivision (b)(5) as of June 15, 2009, and not before. [ . . . ]

The arbitrator gave three reasons for his ruling that there was "no retroactive rescission" of the policy.

First, the arbitrator found that the "only remedy" for Southern upon discovering misrepresentation of out-of-state operations was cancellation of the policy pursuant to subdivision (b)(5) of section 676.8. The arbitrator ruled that there "is nothing in Insurance Code Section [676.8] that permits a workers' compensation insurer to retroactively rescind a policy that has been incepted from day one." The arbitrator found that Southern did not comply with section 676.8 "when it unilaterally retroactively rescinded the policy to the inception date of the policy."

Second, the arbitrator ruled that there is "no mechanism in place in California for a workers' compensation insurer to unilaterally retroactively rescind a policy especially if a claim is pending under that policy." Not entirely excluding rescission of a workers' compensation policy, the arbitrator explained the insurer cannot "retroactively rescind a workers' compensation policy without authorization from a judge in Superior Court, a workers' compensation judge, or a WCAB arbitrator."

Third, the arbitrator was concerned over leaving the injured employee without coverage by what the arbitrator termed a "unilateral, retroactive" rescission of the policy by the insurer.

Southern petitioned for reconsideration, which the arbitrator recommended be denied.

As an initial matter, Southern challenged the appeals board's subject matter jurisdiction. While conceding that insurance coverage is within the appeals board's jurisdiction, Southern claimed there was no subject matter jurisdiction over a contract dispute between an insurer and insured. The Court rejected this argument: "while Southern is free to litigate contractual disputes with its insured in a court of law, if Southern disputes workers' compensation insurance coverage because it claims there is no contract, it must submit to the jurisdiction of the appeals board on the issue of coverage even if that entails a ruling on whether the insurance contract is (or was) in effect."

The Court then turned to the statutory framework governing workers' compensation insurance:

Section 676.8 is contained in chapter 11, part 1, division 1 of the Insurance Code. Chapter 11 is entitled Cancellation and Failure to Renew Certain Property Insurance. Section 676.8 is specifically limited to workers' compensation insurance and it addresses only the cancellation of a policy. It does not even inferentially address rescission.

Chapter 9 of part 1, division 1 of the Insurance Code is entitled Rescission. Chapter 9 has only two sections, one of which (§ 650) applies to this case. Section 650 provides that "[w]henever a right to rescind a contract of insurance is given to the insurer by any provision of this part such right may be exercised at any time previous to the commencement of an action on the contract. The rescission shall apply to all insureds under the contract, including additional insureds, unless the contract provides otherwise."

Section 650 applies to workers' compensation insurance policies. Addressing section 650, as we must, in its context and within the overall statutory scheme [citation] we find that there are three reasons for this.

First, there is nothing in chapter 9 or in section 650 specifically that provides that section 650 does not apply to workers' compensation insurance policies. By contrast, subdivision (a) of section 675 specifically exempts workers' compensation insurance from the provisions of chapter 11, which deals with the cancellation of certain insurance policies.

Second, chapter 9 and section 650 do not single out workers' compensation insurance for special treatment. Section 676.8, on the other hand, specifically governs the cancellation of such policies. This is indicative of the intent that the general provisions regarding rescission set forth in section 650 should govern workers' compensation insurance policies.

Third, there is no provision anywhere in the pertinent statutes that can be construed to preclude the rescission of workers' compensation insurance policies.

The Uninsured Employers Benefits Trust Fund ("UEBTF"), joined as a defendant due to the possibility that EJ was uninsured as a result of the rescission then dismissed by the arbitrator, argued "that a workers' compensation insurance policy cannot be rescinded." The Court rejected this claim: "The premise of this argument [ . . . ] is in error since rescission is provided for in chapter 9, not chapter 3, and section 675 makes no mention of chapter 9." The Court also rejected UEBTF's argument against rescission, relying on Section 676.8, by noting that section "deals with cancellation only and is in a chapter that governs cancellation, not rescission." 

The Court also found that California law does permit rescission as an affirmative defense after suit is brought: "[S]ection 650 is an echo of the past reality that an equitable suit for rescission could not be brought in the face of a pending action at law. [S]ection 650 does not affect the current state of the law, which is that rescission can always be asserted as a defense to the action on the contract." The Court further rejected UEBTF's argument that the policy could not be rescinded after the employee filed his claim, determining that "filing a workers' compensation claim is not the equivalent of an action on the contract." The Court also dismissed the arbitrator's apparent "unfavorabl[e] impress[ion]" of the rescission as unilateral, noting that "[a] party effecting a rescission necessarily does so unilaterally."

The Court detailed the difference between effectuating a rescission (accomplished by giving notice and restoring, or offering to restore, all consideration received, pursuant to California Civil Code section 1691), and seeking legal or equitable relief based on the rescission, e.g. by filing a declaratory relief action.

The thought that performing the acts set forth in Civil Code section 1691 effectively discharged Southern's obligations under the contract is incorrect. A judgment finding that Southern's rescission was effective following an action filed to enforce the rescission under Civil Code section 1692, on the other hand, would be the discharge that Southern seeks. The same finding could be entered if Southern asserts rescission as a defense to the workers' compensation claim. Of course, such a finding would not be entered until the facts were tried and determined in the workers' compensation hearing. It should be unnecessary to point out that there must be grounds for the rescission, fraud being one of them (Civ. Code, § 1689, subd. (b)(1)), and that Southern cannot unilaterally decide, with binding effect on all the world, whether any of the grounds set forth in Civil Code section 1689 apply to this case. The point is that it is possible, as section 1692 itself recognizes, that notwithstanding Southern's assertion that it rescinded the contract, the rescission was not effective.

The Court considered the appeals board's concern that "rescission should not be used for the improper purpose of obtaining impermissible modifications to a workers' compensation insurance policy." "The answer to the appeals board's concern is that if rescission is asserted as a defense to the claim in a workers' compensation proceeding, the appeals board itself can ensure that the rescission is not used as a subterfuge to evade the laws governing workers' compensation insurance." The Court also addressed concern about damage to an injured worker: "The answer here is that the insurer cannot be certain that the rescission will be enforced and that the insurer is therefore well advised to avoid drastic decisions about coverage until the validity of the rescission has been adjudged."

Referring to the arbitrator's finding "that Southern's attempted rescission was legally ineffective," the Court "assume[d] the arbitrator gave little consideration to the facts with which Southern sought to justify its rescission of the policy or to the facts that pointed to a contrary conclusion."

Though in the report on the petition for reconsideration the arbitrator addressed some of the facts pertinent to rescission, this analysis of the facts did not inform the decision that was made, that as a matter of law, Southern could not rescind the policy. It appears that contrary evidence, that Southern did effectively, and prospectively, cancel the policy as of June 15, 2009, based on EJ's misrepresentation, was given little attention.

The gist of the factual views set forth in the report on the petition for reconsideration was that there was no evidence that, as of the time that EJ entered into the policy, EJ was engaged in transportation out of state and beyond 200 miles.

There was, however, evidence from which it can be reasonably inferred that EJ knew when it entered into the policy that representations as to the nature of its transportation business were false. Southern's special investigator testified that a prior investigator confirmed that EJ engaged in out-of-state operations prior to the inception of the policy on January 1, 2009. Although Southern's special investigator did not have personal knowledge of EJ's operations at the time EJ completed its insurance application, there were business records referenced by the investigator that tended to show that EJ conducted out-of-state operations possibly during the insurance application process.

Regardless, the report on the petition for reconsideration stated that "[t]here is no doubt that at some point the employer in this case concealed the fact that its employee truck drivers drive out of the State of California." It was for this reason that the conclusion was reached that the policy was cancelled prospectively as of June 15, 2009. Although the appeals board contends that there were no material misrepresentations in this case, this is at odds with the arbitrator's view.

Given there were misrepresentations, the issue yet to be decided is whether EJ concealed material facts from Southern when it negotiated and entered into the policy. There is also no decision of record on whether the misrepresentation was material since the insurer must prove that the insured concealed or misrepresented a material fact on the insurance application. [Citation.] "Materiality is to be determined not by the event, but solely by the probable and reasonable influence of the facts upon the party to whom the communication is due, in forming his estimate of the disadvantages of the proposed contract, or in making his inquiries." [Citation.]

The conclusion is unavoidable that the issue whether Southern's rescission was legally effective remains factually open and unresolved.

The Court annulled the appeals board's decision affirming the arbitrator's award, and remanded to the appeals board for further proceedings. 

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