La Jolla Beach & Tennis Club, Inc. v. Industrial Indemnity Co.

Opinion

This case presents a convergence of two distinct but related areas of law: insurance and workers’ compensation. In particular, we determine whether a workers’ compensation insurer has a duty to defend a former employee’s civil suit alleging wrongful termination in violation of public policy. We conclude that no reasonable construction of the workers’ compensation insurance contract provides coverage for such a suit, and hence there is no duty to defend. We therefore reverse the Court of Appeal.

The Court of Appeal rejected Industrial’s argument that Saleh’s choice of a civil forum precluded coverage or defense under the workers’ compensation policy. It stated that the policy language did not expressly exclude defense of civil actions. “Moreover, it is well established that while the superior court does not have jurisdiction to grant relief for injuries suffered within the course and scope of employment, it does have, concurrently with the Workers’ Compensation Appeals Board (WCAB), the jurisdiction to determine jurisdiction. [Citation.] ‘Thus, if there is a final determination as to the matter of coverage (i.e., of jurisdiction) in either the [WCAB] or the superior court proceedings, such determination will be res judicata in subsequent proceedings before the other tribunal between the same parties or those privy to them.’ [Citation.] [¶] In our view the undisputed jurisdiction of the civil courts to determine the existence of WCAB jurisdiction lends considerable support to the conclusion . . . that insured employers ‘could reasonably expect an appropriate defense to any claim based on injuries potentially covered by the policy . . . regardless of whether the plaintiff’s choice of forum was appropriate.’ ”

Applying these principles, the Court of Appeal concluded that “Insofar as Saleh alleged he suffered emotional distress upon his termination, his claim” was potentially “within the scope of the workers’ compensation act. . . . Thus it had the potential for coming within the coverage provisions of part 1 of the Industrial policy,” and this potential gave “rise to a duty to defend.”

The court noted, however, that Saleh alleged “discriminatory termination” had caused his emotional distress. “Because liability on discrimination claims falls outside the scope of our workers’ compensation law, it also falls outside the scope of a workers’ compensation insurance policy.” Nonetheless, the court concluded Saleh’s claims might still fall within part 1 of the policy. It reasoned, “If La Jolla was able to establish it had not terminated Saleh because of his Palestinian ancestry and that his termination did not otherwise violate public policy, Saleh would still have a remedy under the workers’ compensation law for the emotional distress he suffered upon his termination.” “Given this potential, La Jolla was entitled to a defense under part 1 of the policy.” Industrial’s petition for rehearing was denied.

In California, every employer except the state is required to “secure the payment of compensation.” (Lab. Code, § 3700.) This mandate is satisfied by either purchasing workers’ compensation insurance, or self-insuring. (Ibid.) “The terms of workers’ compensation policies issued in California are strictly governed by statute, and each policy is conclusively presumed to contain all the provisions required by law.” (1 Cal. Liability Insurance Practice: Claims and Litigation (Cont.Ed.Bar 1994) § 1.28, pp. 1-21 to 1-22; Ins. Code, § 11650.)

The statutes carefully distinguish between “compensation” and “damages.” “ ‘Compensation’ means compensation under Division 4 [the Workers’ Compensation and Insurance section of the Labor Code] and includes every benefit or payment conferred by Division 4 upon an injured employee, including vocational rehabilitation, or in the event of his death, upon his dependents, without regard to negligence.” (Lab. Code, § 3207; Ins. Code, § 11630 [“As used in this chapter [Chapter 2—Workers’ Compensation Policies], the term ‘compensation’ means the benefits insured by workers’ compensation insurance.”].) “ ‘Damages’ means the recovery allowed in an action at law as contrasted with compensation.” (Lab. Code, § 3209.)

Workers’ compensation policies generally contain two types of coverage: The first is workers’ compensation insurance (part 1 in the policy at issue in this case), “under which the insurer agrees to pay all workers’ compensation arid other benefits that the employer must legally provide to covered employees who are occupationally injured or disabled.” (1 Cal. Liability Insurance Practice: Claims and Litigation, supra, § 1.28, p. 1-22.) The second, which is optional, is employers’ liability insurance (part 2 in the policy at issue in this case). (Producers Dairy Delivery Co. v. Sentry Ins. Co. (1986) 41 Cal.3d 903 , 914 [ 226 Cal.Rptr. 558 , 718 P.2d 920 ].) This insurance “protects employers against lawsuits by employees who are injured in the course of employment, but whose injuries are not compensable under the workers’ compensation laws.” (1 Cal. Liability Insurance Practice, supra, § 1.28, p. 1-22.) This coverage “also indemnifies employers against civil suits brought by employees.” (Ibid.)

“[Employers’ liability insurance is traditionally written in conjunction with workers’ compensation policies, and is intended to serve as a ‘gap-filler,’ providing protection to the employer in those situations where the

2. Principles Governing Interpretation of Insurance Policies

“While insurance contracts have special features, they are still contracts to which the ordinary rules of contractual interpretation apply.” (Bank of the West v. Superior Court (1992) 2 Cal.4th 1254 , 1264 [ 10 Cal.Rptr.2d 538 , 833 P.2d 545 ]; see AIU Ins. Co. v. Superior Court (1990) 51 Cal.3d 807 , 821-822 [ 274 Cal.Rptr. 820 , 799 P.2d 1253 ].) “The fundamental goal of contractual interpretation is to give effect to the mutual intention of the parties. (Civ. Code, § 1636.)” (Bank of the West v. Superior Court, supra, 2 Cal.4th at p. 1264.) “Such intent is to be inferred, if possible, solely from the written provisions of the contract.” (AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d at p. 822.) “If contractual language is clear and explicit, it governs. (Civ. Code, § 1638.)” (Bank of the West v. Superior Court, supra, 2 Cal.4th at p. 1264.) Moreover, if the policy’s terms are “ ‘used by the parties in a technical sense or a special meaning is given to them by usage,’ ” this use or meaning “controls judicial interpretation.” (AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d at p. 822.)

“ ‘An insurance policy provision is ambiguous when it is capable of two or more constructions, both of which are reasonable.’ ” (Bay Cities Paving & Grading, Inc. v. Lawyers’ Mutual Ins. Co. (1993) 5 Cal.4th 854 , 867 [ 21 Cal.Rptr.2d 691 , 855 P.2d 1263 ], italics omitted; Producers Dairy Delivery Co. v. Sentry Ins. Co., supra, 41 Cal.3d at p. 912.) “Courts will not adopt a strained or absurd interpretation in order to create an ambiguity where none exists.” (Reserve Ins. Co. v. Pisciotta (1982) 30 Cal.3d 800 , 807 [ 180 Cal.Rptr. 628 , 640 P.2d 764 ].) “ ‘[Ljanguage in a contract must be construed in the context of that instrument as a whole, and in the circumstances of that case, and cannot be found to be ambiguous in the abstract.’ ” (Bank of the West v. Superior Court, supra, 2 Cal.4th at p. 1265, italics omitted; New York Life Ins. Co. v. Hollender (1951) 38 Cal.2d 73 , 81 [ 237 P.2d 510 ] [In construing insurance contracts, “the entire contract is to be construed together for the purpose of giving force and effect to each clause.”].) If an asserted ambiguity is not eliminated by the language and context of the policy, courts then invoke the principle that ambiguities are generally construed against the party who caused the uncertainty to exist (i.e., the insurer) in order to protect the insured’s reasonable expectation of coverage. (Bay

3. Insurer’s Duty to Defend

Nearly 30 years ago, in the landmark decision of Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263 [ 54 Cal.Rptr. 104 , 419 P.2d 168 ], we held that an insurance carrier has a duty to defend when the policy is ambiguous and the insured would reasonably expect coverage based on the “nature and kind of risk covered by the policy.” (Id. at pp. 273-275.) In the alternative, we concluded that such a duty arises when the underlying suit “potentially seeks damages within the coverage of the policy.” (Id. at p. 275, italics in original; Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287 , 299 [ 24 Cal.Rptr.2d 467 , 861 P.2d 1153 ].)

a. Reasonable Expectations of the Insured

In Gray, the insurer had refused to defend its insured in a civil action alleging assault on the ground that its policy excluded coverage for bodily injury “ ‘caused intentionally by or at the direction of the insured.’ ” (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at pp. 266, 267, 272-273.) In delineating our first basis for concluding there was a duty to defend, i.e., if the language is ambiguous, the reasonable expectations of the insured control, we invoked the familiar contract principle that the parties could have clarified “the performance of the duty to defend ... by the language of the policy.” (Id. at p. 272.) We found no such specificity in that case. Rather, the comprehensive personal liability policy at issue made “two wide promises: ‘[1.] To pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage, and [2.] the company shall defend any suit against the insured alleging such bodily injury or property damage and seeking damages which are payable under the terms of this endorsement, even if any of the allegations of the suit are groundless, false, or fraudulent.’ ” (Ibid.) We concluded that “clearly these promises, without further clarification, would lead the insured reasonably to expect the insurer to defend him against suits seeking damages for bodily injury, whatever the alleged cause of the injury, whether intentional or inadvertent.” (Ibid.) We further concluded that the language and placement of the exclusionary clause precluding coverage for damage caused “ ‘intentionally by or at the direction of the insured’ ” failed to meaningfully inform the reasonable expectations of the insured. (Id. at p. 273.)

b. Potential for Damages Within the Coverage of the Policy

Alternatively in Gray, we held that there was also a duty to defend whenever the underlying action potentially sought damages covered by the indemnity provisions of the policy. (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at pp. 275, 277; Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 299.) Thus, while the underlying complaint in Gray originally alleged bodily injury as a result of intentional conduct, it conceivably could have been amended to allege merely negligent conduct. (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 277.) For this reason in part, we concluded that the “complaint clearly presented the possibility that [the underlying plaintiff] might obtain damages that were covered by the indemnity provisions of the policy.” (Id. at p. 277.)

We recognized, however, that “the insurer need not defend if the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage.” (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 276, fn. 15; Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 300.) For example, in Jaffe v. Cranford Ins. Co. (1985) 168 Cal.App.3d 930 [ 214 Cal.Rptr. 567 ], a psychiatrist was prosecuted for Medi-Cal fraud and theft. (Id. at p. 932.) He tendered his criminal defense to Cranford, his medical malpractice insurer. (Ibid.) Cranford refused to defend him. (Ibid.) The Court of Appeal upheld the judgment of dismissal of Jaffe’s subsequent complaint. (Id. at pp. 933, 936.) It observed

The court reasoned, “the outcome of Jaffe’s criminal case could not result in damages payable under the policy since neither imprisonment nor a fine constitutes ‘damages’ for insurance purposes.” (Jaffe v. Cranford Ins. Co., supra, 168 Cal.App.3d at p. 934.) Moreover, the policy excluded damages arising from criminal charges. (Ibid.) Thus, “there is no conceivable set of facts under which Cranford could be liable for the result in the criminal case.” (Ibid.; see Perzik v. St. Paul Fire & Marine Ins. Co. (1991) 228 Cal.App.3d 1273 , 1275-1278 [ 279 Cal.Rptr. 498 ] [professional liability policy which provided protection against professional liability clauses and promised to defend any suit for damages did not give rise to duty to defend grand jury proceedings and subsequent criminal action]; State Farm Fire & Cas. Co. v. Superior Court (1987) 191 Cal.App.3d 74 , 76, 77 [ 236 Cal.Rptr. 216 ] [Homeowners policy promising to pay “ ‘damages for which the insured is legally liable’ ” did “not cover any liability which might arise from the alleged criminal action(Italics in original.)].)

Likewise, in United Pacific Ins. Co. v. Hall (1988) 199 Cal.App.3d 551 [ 245 Cal.Rptr. 99 ], an elementary school sustained serious fire damage. (Id. at p. 553.) Juvenile proceedings were instituted against the Halls’ son pursuant to Welfare and Institutions Code section 602. It was ultimately determined that the minor was not responsible for the fire. (199 Cal.App.3d at p. 553) While this proceeding was pending, the school district filed a civil action for damages against the Halls. The Halls tendered defense to their homeowners’ insurance company, United Pacific. The policy obligated United Pacific to defend an action for damages against the insured. (Id. at p. 556.) United Pacific paid for counsel to defend the civil suit, but not for his services rendered in the juvenile proceeding. (Id. at p. 554.) United Pacific then commenced a declaratory relief action to obtain a determination of its obligation to pay counsel for the juvenile proceeding. (Ibid.)

The Court of Appeal upheld summary judgment in United Pacific’s favor. (United Pacific Ins. Co. v. Hall, supra, 199 Cal.App.3d at pp. 554, 557.) The court concluded that “Where the language of an insurance policy plainly obligates an insurer to defend an action for damages against the insured, the insurer has no obligation to defend an insured in criminal or administrative proceedings where damages are not sought.” (Id. at p. 556, italics deleted.) “The obligation to defend, which is co-extensive with coverage under the

Finally in Hackethal v. National Casualty Co. (1987) 189 Cal.App.3d 1102 [ 234 Cal.Rptr. 853 ], the issue was whether “an insurance policy which promises to reimburse an insured physician for his expense and loss of earned income ‘for each day the insured is required to attend the trial of a civil suit for damages against the insured alleged to have been caused by malpractice’ provide[s] such coverage for a hearing before the Board of Medical Quality Assurance” which the insured was required to attend. (Id. at pp. 1104-1105, italics in original.) The Board of Medical Quality Assurance accusation charged the physician with gross negligence, incompetence in the practice of medicine, and acts of moral turpitude, dishonesty, and corruption. (Id. at p. 1108.) The Court of Appeal reversed the judgment against the insurer, concluding that such a hearing was not a “ ‘trial of a civil suit for damages against the insured.’ ” (Id. at p. 1110; see also id. at pp. 1105, 1112; cf. Bank of the West v. Superior Court, supra, 2 Cal.4th at pp. 1258, 1265-1266 [comprehensive general liability insurance policy that applied to “damages” the insured must pay for injury arising out of “unfair competition” occurring in the course of the insured’s “advertising activities” did not cover claims for advertising injury that arose under the Unfair Business Practices Act since damages are not available under this statutory scheme].)

B. Application of Principles to Industrial’s Policy

1. Reasonable Expectations of the Insured

La Jolla asserts that it reasonably expected that its workers’ compensation insurer would defend it from a superior court action filed by an employee alleging claims potentially compensable under the Workers’ Compensation Act. As noted earlier, part 1 of the policy in this case provides in pertinent part, “We will pay promptly when due the benefits required of you by the workers compensation law. . . . We have the right and duty to defend at our expense any claim, proceeding or suit against you for benefits payable by this insurance. We have the right to investigate and settle these claims, proceedings or suits. [¶] We have no duty to defend a claim, proceeding or suit that is not covered by this insurance.”

In Gray, we held that an insurance carrier has a duty to defend when the policy is ambiguous and the insured would reasonably expect such coverage based on the “nature and kind of risk covered by the policy.” (Gray v. Zurich

Moreover, “ ‘language in a contract must be construed in the context of that instrument as a whole, and in the circumstances of that case, and cannot be found to be ambiguous in the abstract.’ ” (Bank of the West v. Superior Court, supra, 2 Cal.4th at p. 1265, italics omitted.) Here, the “instrument as a whole” contained two parts, the workers’ compensation insurance and the employers’ liability insurance. The employer’s liability policy afforded coverage for “all sums you legally must pay as damages because of bodily injury to your employees,” and promised to defend “any claim, proceeding or suit against you for damages payable by this insurance.” It excluded “damages arising out of the discharge of, coercion of, or discrimination against any employee in violation of law,” and “any obligation imposed by a workers compensation . . . law.”

As noted above, employer’s liability policies operate as “gap-fillers,” providing “protection to the employer in those situations where the employee has a right to bring a tort action despite the provisions of the workers’ compensation statute or the employee is not subject to the workers’ compensation law.” (Producers Dairy Delivery Co. v. Sentry Ins. Co., supra, 41 Cal.3d at p. 916.) “Generally, these two kinds of coverage are mutually exclusive.” (Ibid.) Thus, if any part of the policy would provide La Jolla with defense and indemnification of Saleh’s action, it is, absent any applicable exclusions, the employer’s liability, not the workers’ compensation portion. Construing the workers’ compensation portion to also include the duty to defend any claim asserted by an employee, including civil suits for damages, renders the employer’s liability section superfluous. We do not believe this result is what the parties reasonably intended or expected.

La Jolla asserts, however, that an expectation of coverage under part 1 is “justified where the policy clearly and broadly provides that a workers’ compensation insurer . . . will defend any claim or suit.” However, the policy in this case does not require Industrial to defend La Jolla in any proceeding. Rather, by its express language, the policy requires Industrial to

La Jolla also asserts that “It is vitally important to assure the seamless insurance protection that California businesses expect through their subscription to, and substantial premium payment for, Comprehensive General Liability . . . and workers’ compensation insurance policies.” There is, however, no evidence that La Jolla expected “seamless insurance protection” when it purchased the workers’ compensation portion of its policy. In fact, the limitations of part 1 apparently induced La Jolla to purchase part 2, or the employers’ liability coverage, as a “gap-filler” with the expectation that the workers’ compensation provisions would not provide coverage for every claim, and in particular would not provide coverage for “any claim, proceeding or suit against [La Jolla] for damages.” (Pt. 2, par. D.)

2. Potential for Damages Within the Coverage of the Policy

In the alternative, we have held that a duty to defend arises when the suit “potentially seeks damages within the coverage of the policy.” (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 275, italics in original; Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 299.) We recognized, however, that “the insurer need not defend if the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage.” (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 276, fn. 15.)

No such potential existed in this case. Regardless of the merit of the claims alleged in Saleh’s complaint, the superior court never had jurisdiction to award workers’ compensation benefits. Rather, the award of such benefits is within the exclusive jurisdiction of the WCAB. (Lab. Code, § 5300.) Thus, a civil suit for damages is no more a claim for workers’ compensation benefits than a criminal or disciplinary action is a civil suit for damages. (See Perzik v. St. Paul Fire & Marine Ins. Co., supra, 228 Cal.App.3d at pp. 1276-1278; United Pacific Ins. Co. v. Hall, supra, 199 Cal.App.3d at p. 556; Hackethal v. National Casualty Co., supra, 189 Cal.App.3d at p. 1110; Jaffe v. Cranford Ins. Co., supra, 168 Cal.App.3d at p. 934.)

La Jolla argues that such potential did exist in this case because the civil suit provided the opportunity to “resolve virtually all of the factual preconditions to entitlement to workers’ compensation benefits.” Nothing in Gray or its progeny, however, suggests that the duty to defend one action is triggered by the prospect that the insured may face a claim for materially

Rather, the test is whether the underlying action for which defense and indemnity is sought potentially seeks relief within the coverage of the policy. (AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d at p. 843 [not clear as a matter of law that all of the relief for which insured “potentially liable in the underlying suits” cannot be deemed covered]; Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 302 [“underlying suit” sought “damages of the nature and kind covered by the policy”]; Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 276 [“instant action presented the potentiality of” covered judgment].) Thus, the Court of Appeal fundamentally misconstrued the kind of potential coverage that gives rise to a duty to defend when it concluded that Industrial had a duty to defend the civil action merely because Saleh might, at some indeterminate time in the future, file a workers’ compensation claim that did fall within Industrial’s coverage.

Likewise, we reject La Jolla’s argument that “The employer faces the risk that any settlement of the civil suit will include payment of the workers’ compensation loss.” It may be that some employers will elect to foreclose any possibility of a subsequent workers’ compensation claim by including such claims within the terms of their individual settlement. Such an agreement between the employer and ex-employee does not, however, modify the terms of the insurance contract, or create a duty to defend the civil action on the part of the workers’ compensation insurer.

Relying on AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d 807 , La Jolla also asserts that any reliance on the statutory distinction between “compensation,” and thereby benefits, and “damages,” “fashions a strained, technical reading of the Policy.” Not so.

The issue in AIU was whether the phrase “legally obligated” to pay as “damages” (or “ultimate net loss”) incurred because of “property damage” in

First, we declined to interpret the phrase “legally obligated” as providing coverage for only those actions traditionally brought at law and not in equity. (AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d at pp. 824-825.) We observed that because the distinction between law and equity in California had generally been abolished, “even a legally sophisticated policyholder might not anticipate that the term ‘legally obligated’ precludes coverage of equitably compelled expenses.” (Id. at p. 825.) “Thus, as a matter of plain meaning, the term ‘legally obligated’ cover[ed] injunctive relief and recovery of response costs.” (Ibid.) Moreover, even if the phrase raised doubts about whether a law-equity distinction was intended, it would be unreasonable to conclude that it unambiguously incorporated this sophisticated distinction into the policies. Thus, any ambiguity was resolved in favor of coverage. (Ibid.)

Second, we determined whether the various forms of relief sought were damages, and as relevant to La Jolla’s argument here, concluded that reimbursement of government response costs was covered under the CGL “damages” provision. (AIU Ins. Co. v. Superior Court, supra, 51 Cal.3d at p. 830.) In particular, we rejected the argument that “because CERCLA distinguishes response costs from damages, it mandates the same distinction in the insurance context because the agencies [did] not seek ‘damages’ as prescribed by statute.” (Ibid.) Contrary to AIU’s assertion, we did not interpret CERCLA as intending that reimbursement of response costs be treated as conceptually distinct from recovery of damages. (Id. at pp. 830-831.) More significantly, we determined we were “not bound by distinctions or definitions contained in CERCLA itself, if such distinctions do not reflect the intent of the parties to the CGL policies at the time of their formation.” (Id. at p. 831.) We noted, “The parties’ intent in entering the CGL policies could not possibly have been influenced by the niceties of statutory language adopted many years after the policies were drafted.” (Ibid.)

The application of these factors to this case compels a contrary result. Here, unlike law and equity courts, the jurisdiction of the WCAB and the superior court has always been and remains distinct. Moreover, the workers’