United States: California's First District Holding Closes Loophole For Evading Removal Jurisdiction In Insurance Coverage Declaratory Relief Actions

California law has long held that the parent and controlling shareholder of an insured corporation has no standing to sue for breach of contract or bad faith under an insurance policy issued to the corporation. In a published decision that recently became final on June 27, 2016, Division Two of the California Court of Appeal for the First District held that the parent and controlling shareholder of an insured corporation also lacks standing to seek purely declaratory relief as to the insured corporation's coverage. See D. Cummins Corp. v. Untied States Fid. and Guar. Co., 246 Cal. App. 4th 1484 (Cal. App. 1st Dist. 2016).

The Court of Appeal concluded that a parent company and controlling shareholder that is not an insured under the insured corporation's insurance contracts is not a "person interested under a written instrument" for purposes of California's declaratory relief statute, Code of Civil Procedure section 1060.

The parent company in the case was a limited liability company (LLC) and sole shareholder of an insured corporation facing asbestos litigation. The LLC and the insured corporation had different citizenship such that joining the LLC as a co-plaintiff defeated diversity jurisdiction with respect to one of the defendant insurance companies named in the declaratory relief action. The defendant insurance company removed the case to federal court and opposed the LLC's and insured corporation's motion to remand on the grounds that the LLC, which had been formed only days before filing the declaratory relief action (id. at 1487 n. 2), was fraudulently joined as a co-plaintiff because it lacked standing to sue for declaratory relief under the insured corporation's alleged insurance policies.1

As the Court of Appeal noted, the district court remanded the case to state court because it appeared to it that "[w]hether the owner of an insured corporation qualifies as an interested person under Section 1060 appears to be an unresolved question of California state law" and that "[w]ith no California authority interpreting the 'interested person' standard in this context, the court must conclude that whether the shareholder of an insured corporation has standing to sue the corporation's insurer for declaratory relief under Section 1060 is not a well-settled matter of California law." 246 Cal. App. 4th at 1488 n. 5. Thus, by joining as a co-plaintiff in the declaratory relief action, the LLC successfully thwarted removal of the action to federal court.

When the case was back in state court, the defendant insurers demurred to the LLC's cause of action for declaratory relief on the ground that it was not an additional insured under the alleged insurance policies or otherwise in privity with the insurer and thus lacked standing. Id. at 1488. The trial court agreed and sustained the demurrer without leave to amend.

The Court of Appeal affirmed, rejecting the LLC's argument that it had a "practical interest in the proper interpretation of [the insured corporation's] insurance policies given its relationship to, and its central role in the pursuit of those insurance assets." (Id. at 1490.) "While [the LLC] may, as it says, have a 'practical interest' in the success of [insured corporation's] litigation with the insurers by virtue of its relationship with the corporation, it has not shown how that indirect interest—no matter how enthusiastic it may be [citation omitted]—translates into 'a legally cognizable theory of declaratory relief.'" (Id.) It further stated that it is only the insured itself that has "a direct interest in the interpretation of the policies in question" for purposes of Section 1060. (Id.)

The Court of Appeal observed that the principles stated in California cases holding that a corporation's shareholders generally do not have standing to sue the corporation's insurer for breach of contract or bad faith principles were relevant to this declaratory relief action. Id. at 1491-1492 (citations omitted).  It also took judicial notice that litigation of the case had continued without the LLC and that its participation in the declaratory relief action thus was not necessary "to prevent a grave injustice." Id. at 1492 (internal quotation marks and citation omitted).

In short, this decision closes a loophole that previously could have been used to evade removal jurisdiction in insurance coverage declaratory relief actions by forming a holding company of non-diverse citizenship with a contemplated defendant insurer and joining the holding company as a co-plaintiff with the insured corporation.

Footnote

1 By analogy to case law addressing fraudulent joinder of defendants, a co-plaintiff is fraudulently joined if its failure to state a cause of action against the defendant is "obvious according to the well-settled rules of the state." United Computer Sys., Inc. v. AT&T Corp., 298 F.3d 756, 761 (9th Cir. 2002). A fraudulently joined party's "presence in the lawsuit is ignored for purposes of determining diversity . . . ." Morris v. Princess Cruises, Inc., 236 F.3d 1061, 1067 (9th Cir. 2001).

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