As Matter of First Impression, Court Holds Class Action Failed to State a Claim Against Insurer because California Law Permits Insurers to Demand Reimbursement of Insurance Benefits Following Insured’s Recovery of Damages from Tortfeasor
Plaintiff filed a class action in California state court against Allstate Insurance alleging that its demand for reimbursement of benefits paid under the insurance policy violated various state and common laws. Allstate Ins. Co. v. Superior Court, 151 Cal.App.4th 1512, 1518 (Cal.App. 2007). Defense attorneys demurred, arguing that Allstate’s reimbursement demand, made pursuant to the terms of the insurance policy, was allowed by California law and so the class action complaint failed to state a claim, id., at 1519-20. The trial court overruled the demurrer, permitting the class action to proceed, id. The California Court of Appeal granted Allstate’s petition for writ of mandate and reversed.
Following an accident, plaintiff tendered a claim to Allstate under the first-party, no-fault medical payments insurance coverage section (“med-pay”) of his automobile policy, and Allstate paid him $4203.36. Allstate, at 1518. Plaintiff then sued the responsible party, recovering $11,000 but incurring $5926.84 in attorney fees and costs, id. Allstate did not participate in the litigation, but demanded reimbursement of the policy benefits paid pursuant to the “subrogation rights” provision which provides, “When we pay, your rights of recovery from anyone else become ours up to the amount we have paid. You must protect these rights and help us enforce them.” Id. Plaintiff reimbursed Allstate $1,696.13; “Allstate agreed to the reduction based on the common-fund rule that an insurer is required to deduct from its reimbursement a pro rata portion of the insured’s attorney fees and costs incurred to recover covered losses against a third party tortfeasor when the insurer had knowledge of, but did not participate in, the litigation.” Id., at 1519 (citing Lee v. State Farm Mut. Auto. Ins. Co., 57 Cal.App.3d 458, 465-66 (Cal.App. 1976)).
Plaintiff’s class action complaint alleged violations of California’s unfair competition law, and common law claims for conversion, unjust enrichment and declaratory relief; the legal theory underlying each claim was that plaintiff was not “made whole” by the $11,000 settlement because of the attorney fees and costs he incurred to recover it. Allstate, at 1519. In other words, because the $5900 he spent to recover the $11,000 exceeded the $4200 policy benefits paid by Allstate, plaintiff should not have been required to reimburse any sums to Allstate because he had not been “made whole.” Id. Defense attorneys demurred to the class action complaint on the ground that “under California law, the made-whole doctrine does not include a consideration of attorney fees and costs in determining whether an insured was made whole.” Id. The trial court disagreed, holding that insurers are not entitled to reimbursement if the amounts paid by the insured to recover in tort exceed the amounts paid by the insurer under the policy. Id., at 1520. The Court of Appeal reversed.
The appellate court concisely summarized the issue and its holding at pages 1517 and 1518 as follows:
An insurer that pays benefits to its insured under a first party policy is generally entitled to reimbursement from funds paid by the third party wrongdoer for the covered losses. One exception to this rule is the common law “made-whole” doctrine, which provides that an insurer is not entitled to these funds unless the insured has been made whole by the recovery from the tortfeasor and any other source. Whether an insured has been made whole is determined by comparing the insured’s total damages resulting from the third party’s tortious conduct with the total amount the insured recovered in compensation for those damages. The narrow issue presented in this writ proceeding is whether, in calculating the made-whole amount under no-fault medical payments insurance coverage, the insured’s total recovery amount must be reduced by the insured’s attorney fees and costs incurred to obtain the compensation from the third party tortfeasor. We conclude that under California law these expenses are not deducted when calculating the total recovery received by the insured.
The appellate court stated that the issue before it – viz., “the proper calculation of the insured’s recovery under the made-whole rule” – was one of first impression in California. Allstate, at 1524-25. After discussing in some detail the general rules regarding subrogation, the “made whole” doctrine and its application, see Allstate, at 1521-27, the appellate court reasoned (1) the made-whole rule arises from tort law, and under the American rule attorney fees “are not included in determining the plaintiff’s total losses,” id., at 1527-28 (citation omitted), and so the insured is “made whole” without regard to considering attorney fees and costs incurred in prosecuting his or her action, id., at 1528 (citation omitted); (2) accepting the insured’s argument would impermissibly “‘shift the burden of his attorney fees from the plaintiff in a personal injury action to the first party carrier,’” id. (citation omitted), which would be inconsistent with California law obligating insurers to pay for an insured’s attorney fees “only under certain circumstances,” id., at 1528-29 (citation omitted); (3) the insured is not entitled to recover attorney fees “directly from the tortfeasor,” and so should not be allowed to recover them from the insurer, id., at 1529 (citation omitted); and (4) the “made whole” rule does not permit courts to rewrite the insurance contract and “provide the insured with a benefit for which he did not pay and require the insurer to pay for a risk it did not assume,” id.
The Court of Appeal recognized that a California federal court had “considered the identical legal issue presented here and reached an opposite conclusion,” id., at 1529 (citing Chong v. State Farm Mut. Auto. Ins. Co. (S.D.Cal.2006) 428 F.Supp.2d 1136), but it concluded that Chong had been wrongly decided, see id., at 1530. Accordingly, it granted Allstate’s petition and directed the trial court to dismiss the class action. Id., at 1533.
NOTE: The appellate court’s decision was split: one judge dissented, stating he “agree[d] with the strong majority of jurisdictions in the United States to have considered the issue that attorney fees and costs must be deducted from the total recovery in determining if the insured is made whole,” Allstate, at 1533 (citations omitted), and that he believed Chong had been decided correctly, id., at 1533-34.