50 Cal. 4th 913, 237 P.3d 598, 114 Cal. Rptr. 3d 280
Filed 8/30/10
IN THE SUPREME COURT OF CALIFORNIA
VILLAGE NORTHRIDGE
HOMEOWNERS ASSOCIATION,
Plaintiff and Appellant,
S161008
v.
Ct. App. No. B188718
STATE FARM FIRE AND CASUALTY
COMPANY
Los Angeles County
Defendant and Respondent.
Super. Ct. No. BC265328
We granted review to determine whether an insured who suffered property
damage in the 1994 Northridge, California, earthquake may settle a disputed insurance
claim with its first party insurer, execute a full and complete release of the claim, keep
the money the insurer paid in the claim settlement without rescinding the release, and
then sue the same insurer for allegedly fraudulently inducing the insured to settle the
claim for less than it was worth under the policy. Although the insured here signed a
release and waiver of all future claims, it seeks to bypass the statutory and common law
rules governing rescission of a release, and instead to take advantage of a more general
contract rule that a party to a contract may elect to affirm the contract and sue for fraud
damages. (See 5 Witkin, Summary of Cal. Law (10th ed. 2005) Torts ?? 827-828,
pp. 1200-1201.) Consistent with long-settled case law and the relevant state statutory
scheme that specifically governs rescission of contracts, including releases, under Civil
Code sections 1691 through 1693, we conclude that a release of a disputed claim, like the
one here, does not permit a party to elect the remedy of a suit for damages when the
1
release itself bars that option. 1 Instead, the insured party to the release must follow the
rules governing rescission of that release before suing the insurer for damages.
FACTUAL AND PROCEDURAL BACKGROUND
The 1994 Northridge earthquake caused considerable damage to property that
plaintiff Village Northridge Homeowners Association (Village Northridge) owned.
Village Northridge filed a timely property damage claim with its insurer, State Farm Fire
and Casualty Company (State Farm). According to declarations filed in the trial court,
State Farm?s policy limits for earthquake damage were $4,979,900, with a 10 percent
deductible. State Farm made several payments to Village Northridge on the earthquake
loss, totaling about $2,068,000, which included the deductible calculation. In 1996, and
again in 1998, Village Northridge sought additional policy benefits based on the opinion
of a public adjuster who recalculated the deductible amount under the State Farm policy
after the insured found a different declarations page in storage. State Farm reinspected
the property and concluded that some of the additional damage was earthquake related,
while other damage was not. State Farm initially paid Village Northridge an additional
$7,466.34.
In November 1999, although both parties continued to dispute the policy limits
and the amount of money owed, they negotiated a compromise settlement of the claim,
with State Farm paying an additional $1.5 million. Under the settlement, Village
Northridge released State Farm from all known or unknown claims related in any way to
Village Northridge?s earthquake claim. In the release?s first paragraph, Village
1
Civil Code section 1691 provides in relevant part: ?Subject to Section 1693, to
effect a rescission a party to the contract must, promptly upon discovering the facts which
entitle him to rescind if he is free from duress, menace, undue influence or disability and
is aware of his right to rescind: [?] (a) Give notice of rescission to the party as to whom
he rescinds; and [?] (b) Restore to the other party everything of value which he has
received from him under the contract or offer to restore the same upon condition that the
other party do likewise, unless the latter is unable or positively refuses to do so.? Section
1693 modifies the timing requirement in ways we discuss further below.
All statutory references are to the Civil Code unless otherwise noted.
2
Northridge specifically agreed to ?refrain and forbear from commencing, instituting, or
prosecuting any lawsuit, action, or any other proceeding against [State Farm] based on,
arising out of, or in connection with any claims, actions, causes of action, charges,
demands, contracts, covenants, liabilities, obligations, expenses . . . and damages that are
released and discharged.? Paragraph one also unconditionally released State Farm from
?damages of every nature, kind, and description whatsoever? that ?arise out of or are in
any way related to the Earthquake Claim.? In addition, Village Northridge waived any
benefit it might derive under section 1542 (stating principally that a general release does
not extend to unknown claims), including the right to assert those claims, ?if any, which
they do not know about or suspect that they may have and even those, if any, which they
may not learn about or discover until after they sign? the release.2
The pertinent insurance regulations (Cal. Code Regs., tit. 10, ?? 2695.4, subd.
(e)(2), 2695.7, subd. (h)) specifically permit an insurer to include a provision in release
agreements requiring insureds to waive section 1542 claims, or those unknown to them at
the time of settlement and release. Such waiver allows an insured to assume the risk that
it may discover new damage claims in the future. In exchange, the insured receives
consideration and settlement of the claims known at the time of the release. (See San
Diego Hospice v. County of San Diego (1995) 31 Cal.App.4th 1048, 1053-1054 [parties
may expressly waive future ? 1542 claims].) In late 2000, Village Northridge asked State
Farm to reopen the claim. The insurer declined to do so.
In December 2001, after the Legislature revived insurance claims that the statute
of limitations otherwise barred, Village Northridge sued State Farm for breach of contract
2
Section 1542, which governs general releases, states: ?A general release does not
extend to claims which the creditor does not know or suspect to exist in his or her favor at
the time of executing the release, which if known by him or her must have materially
affected his or her settlement with the debtor.?
3
and breach of the implied covenant of good faith and fair dealing.3 The complaint
alleged that State Farm had undervalued the earthquake loss to Village Northridge?s
property and had induced Village Northridge to forgo proper repairs and payment of
sums owed under the policy. Village Northridge also alleged that it ?was required to sign
a release and did so under compulsion and with no other option afforded to secure partial
benefits owed,? and that it did not agree ?that the partial payments provided fully
compensated [Village Northridge] for the actual damages and loss sustained at Village
Northridge?s property. . . .? Throughout the litigation, Village Northridge insisted that it
did not seek to rescind the settlement agreement and that it did not intend to do so.
Instead, as noted, it wanted to bypass the rescission requirements to affirm the release and
to seek additional damages.
State Farm filed a motion for summary judgment, contending that the release
Village Northridge executed barred its lawsuit for additional coverage. In its opposition
to the motion, Village Northridge claimed that its insurance policy provided coverage
limits of $11,905,500, with a 10 percent deductible. Village Northridge alleged that in
the course of adjusting its claim and inducing it to execute the release, State Farm
misrepresented the policy limits to be only $4,979,900, with the same deductible. The
trial court granted State Farm?s summary judgment motion. The court concluded that
State Farm had not procured the release agreement through undue influence or fraud, and
that the release was therefore binding on the parties.
The Court of Appeal reversed the judgment, concluding there were triable issues
of fact as to whether the release contained in the settlement agreement was enforceable.
The Court of Appeal remanded the matter to the trial court, which granted State Farm?s
motion for judgment on the pleadings with leave to amend. The trial court observed that
3
In January 2001, Code of Civil Procedure section 340.9 (added by Stats. 2000, ch.
1090, ? 1) became effective and revived previously time-barred claims for damages
arising out of the Northridge earthquake, as long as the insured had contacted the insurer
before January 1, 2000, which is the case here.
4
the complaint did not allege fraud in the inducement or rescission and that, under
California law, Village Northridge ?need[ed] to either rescind the agreement or affirm the
agreement and sue for damages.?4
Village Northridge then filed a second amended complaint that was substantially
similar to the first. The complaint alleged that the $1.5 million additional settlement
State Farm paid was grossly deficient and represented only a partial payment of an
alleged total loss of $8 million. The complaint also stated that the court had the inherent
power to set aside a release procured by fraud. Again, State Farm demurred to the
complaint, asserting that Village Northridge ?could not affirm the settlement agreement
and simultaneously assert claims that were explicitly released in it.? The trial court
sustained the demurrer without leave to amend. The court observed that Village
Northridge sought to affirm the settlement agreement and keep the money paid in the
settlement without releasing its additional claims, and that it ?can?t have it both ways.?
Village Northridge appealed, and the Court of Appeal again reversed the trial
court judgment. The court distinguished the case from Garcia v. California Truck Co.
(1920) 183 Cal. 767 (Garcia) and Taylor v. Hopper (1929) 207 Cal. 102 (Taylor), which
hold that a plaintiff cannot avoid an allegedly fraudulently induced contract of release
unless it rescinds the contract and restores the money it received as consideration. The
court limited application of both cases to the personal injury context, concluding that
neither applies in the insurance or contract contexts.
As we explain in greater detail below, the rules governing rescission of settlement
release agreements require the parties to follow the statutory and common law rescission
procedures before suing for damages.
4
In its answer brief, Village Northridge claims that sections 1667 and 1668 apply.
These sections generally govern contracts that are fraudulent and contrary to public policy;
however, as the trial court observed, such contracts are not at issue in this case.
5
DISCUSSION
? ?On review of the judgment of the Court of Appeal reversing the superior court?s
orders sustaining defendants? demurrers, we examine the complaint de novo to determine
whether it alleges facts sufficient to state a cause of action under any legal theory, such
facts being assumed true for this purpose.? ? (Betancourt v. Storke Housing Investors
(2003) 31 Cal.4th 1157, 1162-1163, quoting McCall v. PacifiCare of Cal., Inc. (2001) 25
Cal.4th 412, 415.) We begin with a discussion of the rules governing contracts and their
release and rescission.
A. Rules for Rescission
As noted above, Village Northridge alleges State Farm committed fraud in the
inducement in the settlement and release process by misrepresenting policy limits.
The general contract rules that govern this case are as follows: If a party believes
it has been fraudulently induced to enter into a contract, ? ? ?[i]n order to escape from its
obligations the aggrieved party must rescind . . . .? ? ? (Rosenthal v. Great Western Fin.
Securities Corp. (1996) 14 Cal.4th 394, 415, italics omitted.) The party?s rescission
obligations depend on the type of fraud alleged. Our state distinguishes between fraud in
the execution or inception of a contract, and fraud in the inducement of a contract. (Ibid.)
If the fraud goes to the execution or inception of the contract, so that the promisors do not
know what they are signing, the contract lacks mutual assent and is void. It thus ? ? ?may
be disregarded without the necessity of rescission.? ? ? (Ibid.) ? ?In the usual case of
fraud, where the promisor knows what he is signing but his consent is induced by fraud,
mutual assent is present and a contract is formed, which, by reason of the fraud, is
voidable . . . .? ? In that case, the party seeking to void the contract must rescind under
our statutory and common law rules. (Ford v. Shearson Lehman American Express, Inc.
(1986) 180 Cal.App.3d 1011, 1028, italics omitted.) Rescission requires that the
aggrieved party provide the other party to the agreement with ? ?prompt notice? ? and an
? ?offer to restore the consideration received, if any.? ? (Ibid.)
6
The principal rule regarding rescission of a release contract that may have been
induced by fraud dates back to the late 19th and early 20th centuries. The rule was first
stated in section 1691 (enacted in 1872), and it is now embodied in the holdings of
Garcia, supra, 183 Cal. 767, and Taylor, supra, 207 Cal. 102. As noted in footnote 1,
ante, section 1691 requires the party seeking rescission to give notice to the other party
?as to whom he rescinds,? and to restore all consideration or ?everything of value which
he has received? under the contract. The statute?s language is clear. With certain
exceptions discussed below, it generally requires that the rescinding party return any
consideration received as a condition of rescission before judgment in the rescission
action. As originally enacted, section 1691 did not make pre-lawsuit restoration an
absolute condition of rescission, but instead required ?the use of . . . reasonable
diligence? to restore or offer to restore any consideration received. We thereafter
recognized various specific equitable exceptions, including when, ?without any fault of
plaintiff, there have been peculiar complications which make it impossible for plaintiff to
offer full restoration . . . .? (Kelley v. Owens (1897) 120 Cal. 502, 511.)
In Garcia, supra, 183 Cal. 767, a trucking company?s horse struck plaintiff,
injuring him. After receiving a monetary settlement and signing a release as to all causes
of action, the plaintiff claimed that the settlement was obtained through fraud and that he
wished to pursue damages. (Id. at p. 768.) Garcia observed that the question on appeal
was the effect to be given the release contract, ?which, of course, unless avoided in some
legitimate way, constitutes an insuperable bar to recovery in this action for damages for
injuries caused by the negligence of defendant. At no time prior to the commencement of
the action did plaintiff attempt to rescind this contract of release, and his complaint in this
action for damage for the original tort was altogether silent regarding it. At no time has
he restored or offered to restore to defendant any part of the consideration paid by
defendant therefor, or attempted to show any reason why he should not be compelled to
do this as a condition precedent to rescission.? (Id. at p. 769.) The court held that the
plaintiff could not avoid the release?s terms unless he first rescinded the arguably
7
voidable contract and restored the consideration he received in return for the settlement
and release. Finding section 1691 ?explicit on the subject of rescission? (Garcia, at p.
769), Garcia observed that the statute requires that, on deciding to rescind a contract, the
plaintiff must ?use reasonable diligence to comply with certain specified rules,? one of
which is that he ?[r]estore to the other party everything of value which he has received
from him under the contract or offer to restore the same . . . . ? (? 1691, subd. (b).) This
action places the parties in the positions they occupied prior to the agreement. The court
specifically stated that it was ?aware of no good reason why [section 1691] is not as fully
applicable to a contract of release of claim for damages for personal injuries as to any
other contract.? (Garcia, supra,183 Cal. at pp. 769-770.) As noted, the plaintiff had not
tried to show reasonable diligence to comply with the restoration requirement.
Nine years later, this court decided Taylor, in which the plaintiff alleged the
defendants negligently ran over her with their automobile. (Taylor, supra, 207 Cal. at p.
102.) The parties reached a compromise settlement, but the plaintiff subsequently
claimed the settlement was fraudulently induced. (Id. at pp. 102-103.) In order to avoid
the application of Garcia and section 1691, the plaintiff claimed she did not seek to
rescind the compromise agreement, but rather wished to affirm it, to retain the money she
received from it, and then to sue for fraud damages ? as Village Northridge seeks to do
here. (Id. at p. 103.) Taylor followed Garcia?s reasoning, and, in quoting that case, held
that ? ?[w]here the claim is for unliquidated damages or where the settlement is made to
adjust a matter in dispute, or where there is a controversy as to the amount owing, and the
parties agree upon a sum that shall be paid in settlement, the amount so paid shall be
returned if the party settled with seeks to avoid the settlement on the ground of fraud.? ?
(Taylor, supra, 207 Cal. at p. 105, quoting Garcia, supra, 183 Cal. at p. 772.) In sum, the
plaintiff could not avoid the obligation to return the consideration by ?affirm[ing]? the
settlement agreement and seeking damages for fraud. (Taylor, supra, 207 Cal. at p. 103.)
Two decades later, this Court held in Carruth v. Fritch (1950) 36 Cal.2d 426, 430?
431 (Carruth), that Garcia and Taylor did not bar a rescission claim by a plaintiff who?
8
unlike the plaintiff in Garcia?acknowledged the restoration requirement, but alleged
that she could not satisfy that requirement because, after defendants had paid her for her
release, she had spent the money on medical expenses. (Ibid.) Because Village
Northridge has disclaimed any interest in seeking rescission, Carruth is not applicable in
this case. In Part C below, we discuss both Carruth and Civil Code section 1693, a 1961
amendment to the rescission statutes that codified much of Carruth?s rule.
B. Applying Taylor and Garcia
According to the Court of Appeal, two general principles are involved in this case:
the ?Garcia principle? that a personal injury plaintiff cannot avoid a fraudulently induced
release without rescinding it and restoring the consideration received, and the ?more
general? principle that a party who is fraudulently induced to execute a contract can
either rescind the contract and restore the consideration, or can affirm the contract and
recover damages for fraud. The Court of Appeal limited application of Garcia and
Taylor to personal injury cases, and applied the more general rule for fraud actions that
do not involve the rescission of a contract or release agreement. As we explain, the court
concluded that Village Northridge may avoid the release in its settlement agreement,
keep the settlement proceeds, and sue for fraud by affirming the agreement that it wishes
in large part to invalidate.
The Court of Appeal relied on two California cases that applied this affirm-and-
sue principle. The court initially cites Denevi v. LGCC, LLC (2004) 121 Cal.App.4th
1211, 1220 (Denevi) for the proposition that a victim of fraud has the right to ? ?affirm
the contract, and simply sue for damages for the fraud.? ? (Italics omitted.) In Denevi,
the plaintiff held a contractual right to purchase a parcel of real property for $8 million.
(Id. at p. 1215.) The plaintiff entered into an agreement with several investors to form a
venture to purchase the property. Following a disagreement between the parties over the
escrow account, the property owner sold the property to another party. (Ibid.) The
plaintiff later filed both a derivative action against the seller on the venture group?s behalf
9
and a personal claim against his fellow investors in the venture group for, inter alia, fraud
in failing to provide adequate funding to purchase the property. (Id. at p. 1216.)
In ruling on the personal fraud claim, the Court of Appeal observed that the
plaintiff never elected to rescind the original venture contract and that, in any event,
rescission ?became impossible when the property reverted to the owner, who transferred
it to a complete stranger.? (Denevi, supra, 121 Cal.App.4th at p. 1221.) In short, the
court recognized that it had no power to order return of the property to the plaintiff and
that rescission was therefore impossible. (Ibid.) The court stated that the plaintiff, as an
alleged fraud victim, may not be required to undo the transaction in its entirety when the
fraud occurred at the moment the venture group?s management induced the plaintiff to
part with his purchase rights, i.e., at the inception or formation of the contract. (Id. at p.
1219.) The court reasoned: ?[The plaintiff] has the right to ?retain the benefits of the
contract . . . , and make up in damages the loss suffered by the fraud. . . . [H]e may
affirm the contract, and simply sue for damages for the fraud.? ? (Denevi, supra, at p.
1220, quoting 5 Witkin, Summary of Cal. Law (9th ed. 1990) Torts, ? 725, p. 825, italics
added by the Denevi court.)
Denevi does not apply here because it assumes the existence of a contract fully
executed by both sides and affirmed in its entirety, followed by a suit for fraud. (Denevi,
supra, 121 Cal.App.4th at pp. 1220-1221.) That case did not involve a settlement and
release of all disputed claims, and a release was not the object of any agreement between
the parties. In Denevi, because there was no settlement and release of all claims, there
was simply no indication that the plaintiff ?ever invoked any of the procedures generally
reflecting a rescission.? (Id. at p. 1220.) In sum, in contrast to the Denevi facts, the
purpose of the settlement and release in this case was to ?buy[] peace,? i.e., freedom from
the threat of suit in a case in which the damage amounts were disputed. The Court of
Appeal reasoned that State Farm was not simply ?buying peace,? as in the release of a
personal injury claim, but was also satisfying an underlying contractual obligation.
Whether or not defendant?s sole objective in this settlement was to buy peace, that end
10
was part of the consideration defendant expected to receive as a result of the settlement
and release between the parties. Indeed, the Court of Appeal acknowledges this is so.
Therefore, plaintiff does not seek to affirm the release in its entirety, nor can it assert with
any merit that it does so.
The Court of Appeal next relied on Sime v. Malouf (1949) 95 Cal.App.2d 82
(Sime), which involved a sophisticated corporate conspiracy and complicated factual and
procedural situation. Sime analyzed a release that was included in a sales agreement
under which the defendants acquired the plaintiff?s interest in a project. (Id. at pp. 108-
109.) In contrast to the release signed by Village Northridge and State Farm, the release
at issue in Sime was a general release that did not include unknown claims (id. at p. 110;
see ? 1542), and no monetary consideration was paid for the release. (Sime, supra, 95
Cal.App.2d at pp. 109-110.) Sime stated that restoration was not necessary where the
plaintiff had a right, ?independently of the release itself,? to retain the money. (Id. at p.
111.) Sime clearly articulated the difference between cases involving fraud in a release
over a disputed amount and fraud in inducing one to buy something: ?In such cases
[Garcia and Taylor] it is clear that the plaintiff must restore what he has received in
settlement of the disputed claim before suing upon it. He cannot retain the benefits of the
release and sue, for to sue would violate the terms of his bargain. To hold otherwise
would frustrate the very purpose of the release and destroy its effectiveness as a favored
device for eliminating litigation. Hence rescission is necessary[,] and may be effectively
accomplished only by returning the entire consideration received, for if plaintiff should
fail to establish his cause of action, he would not be entitled to retain anything. The rule
in such circumstances appears to be well settled.? (Id. at pp. 110-111.)
The Sime court also recognized that ?[e]qually well established, however, is the
exception to the rule: A restoration is not necessary, in order to avoid the bar of a release,
where there is no question as to the right of the plaintiff, arising independently of the
release itself, to retain what he received. [Citations.]? (Sime, supra, 95 Cal.App.2d at p.
111; see id. at pp. 111-112, construing Montes v. Peck (1931) 112 Cal.App. 333, 341, and
11
cases involving fraud in the sale of property.) Other cases are in agreement. (See, e.g.,
Stefanac v. Cranbrook Educ. Community (Mich. 1990) 458 N.W.2d 56, 60 [?A
compromise and release is not to be confused with the law of contract, in which
equivalents are exchanged, for the very essence of a release is to avoid litigation, even at
the expense of strict right.?].)
Here, the additional $1.5 million State Farm paid to Village Northridge in
exchange for the settlement and release of all claims is not wholly ?independent[] of the
release itself.? (See Sime, supra, 95 Cal.App.2d at p. 111.) The release was not included
in a contract that had another purpose: it was the sole purpose of the settlement. Indeed,
the underlying claim was the subject of dispute. State Farm maintained that not all of the
damage was earthquake related and that the amount of the benefits owed was less than
the claim. The settlement was intended to resolve that dispute, and the release was
intended to apply to it.
In a related argument, which the Court of Appeal accepted, Village Northridge
relies on Bagdasarian v. Gragnon (1948) 31 Cal.2d 744, 750, for the rule that a party has
the option of affirming the settlement agreement and recovering fraud damages.
However, this rule requires the affirming party ? ?on his part [to] comply with the terms
of the contract . . . . ? ? (Ibid., quoting Schmidt v. Mesmer (1897) 116 Cal. 267, 270-271.)
Here, Village Northridge seeks to affirm those parts of the agreement that benefit it, but
to invalidate a major part of the agreement that benefits State Farm. Therefore, the ?more
general principle? in Bagdasarian does not apply.
As State Farm observes, Persson v. Smart Inventions, Inc. (2005) 125 Cal.App.4th
1141, on which Village Northridge and the Court of Appeal also rely, is easily
distinguished. The dispute in Persson was over the price the defendant had to pay to
purchase the plaintiff?s stock certificates. (Id. at pp. 1149-1150.) The court relied on its
equitable power to set aside the contract, which it believed was procured by fraud. (Id. at
p. 1156.) In Persson, the plaintiff was allowed to affirm a settlement agreement, keep the
settlement money, and sue for damages based on fraud. (Id. at pp. 1152-1156.) Persson,
12
however, was a case, like Sime, supra, 95 Cal.App.2d 82, in which the plaintiff was
entitled to a portion of the money he received independent of the settlement. Village
Northridge relies on Persson to claim that, because State Farm had an underlying
contractual obligation not to misrepresent the terms of its policy, Village Northridge was
entitled to payment for insured losses independent of the release it signed. As State Farm
observes, however, in contrast to the parties in Persson, the parties here were settling a
disputed claim, as the settlement agreement specifically recited. Indeed, even Persson
recognized that Garcia controls whenever the release ?was the sole object of the contract,
for which the consideration was paid.? (Id. at p. 1156.)
C. Policy Considerations
The Court of Appeal supported its conclusion that Garcia, supra, 183 Cal. 767,
and Taylor, supra, 207 Cal. 102, do not apply to insurance settlements by reference to
policy considerations articulated in a limited number of cases from other jurisdictions that
apply common law principles in the absence of an operative statute similar to section
1691. (See, e.g., Matsuura v. Alston & Bird (9th Cir. 1999) 166 F.3d 1006, 1008, fn. 4,
mod. 179 F.3d 1131 [applying Del. election of remedies law to a claim that settlement of
products liability suits for property damage was fraudulently induced]; DiSabatino v. U.S.
Fidelity & Guar. Co. (D.Del. 1986) 635 F.Supp. 350, 352-353 [granting tort plaintiff
election of remedies to stand on fraudulently induced release and proceed on fraud cause
of action]; Phipps v. Winneshiek County (Iowa 1999) 593 N.W.2d 143, 146 [?election of
remedies doctrine should generally be available to a defrauded party to a settlement
agreement . . .?]; see also Kordis v. Auto Owners Ins. Co. (Mich. 1945) 18 N.W.2d 811,
813 [no restitution or rescission necessary as a condition precedent to maintaining action
for damages arising from false representation and deceit].) The above-cited cases are
inapposite, for they simply reject the Garcia and Taylor rescission rule and hold that,
even in a personal injury case, a defrauded party may elect rescission or an independent
action for damages.
13
More significantly, the California Legislature had the opportunity to overrule
Garcia and Taylor when it amended section 1691 in 1961. It chose not to do so. As
State Farm observes, the legislative history behind the 1961 amendments to the rescission
statutes supports the continuing viability of Garcia and Taylor. Indeed, during its
evaluation of the proposed amendments, the California Law Revision Commission
(Commission) considered whether the rescission and restoration of consideration
requirement was sound. (See Recommendation on Rescission of Contracts, supra, at pp.
D-8 to D-14.) One proposal would have allowed the trial court first to determine the
validity of the release. The proposed statute would have stated that if the settlement
contract was found invalid, the consideration paid to the plaintiff would be set off against
any judgment in the fraud action. (Recommendation on Rescission of Contracts, supra,
at pp. D-8, D-29 [discussing a proposed, but not enacted, Code Civ. Proc. provision].)
The Commission was aware that some of the parties seeking to sue for fraud in the
inducement might have spent the money received in the original settlement to mitigate
their damages, making restoration nearly impossible in these cases. One case the
Commission discussed was Carruth, supra, 36 Cal.2d 426, in which the court addressed
the equitable concerns that eventually formed the basis for section 1693?s relaxation of
the timing for the restoration of consideration mandated by section 1691. In Carruth, the
plaintiff suffered injuries in an automobile accident and sued the defendant owner of the
automobile in which she was injured for damages. Under ?pressure of financial need?
the plaintiff eventually executed a settlement and release of her right to recover any
damages in exchange for $2,000. She later asked the court to set aside the release and
award damages to her, asserting that the defendants never intended to honor their
promises to pay for her future medical expenses and lost income. She included in her
complaint a second cause of action for fraud in inducing her to sign the release. The
defendants claimed that because the plaintiff did not return the $2,000 received in the
settlement, she could not pursue her rescission claim, because restoration of the
14
consideration for the release was a necessary prerequisite to maintaining the rescission
action. (Carruth, at pp. 429-430.)
The court allowed the rescission lawsuit to proceed, concluding that the rule
requiring ?tender or return of consideration. . . . is not inflexible.? (Carruth, supra, 36
Cal. 2d at p. 430.) The court observed that because the defendants knew that the plaintiff
?would be obliged immediately to pay out the consideration for medical expenses
incurred by reason of the alleged tort,? and knew that she then would not be able to
restore the original consideration received for her injuries, there would be ?no legal
reason for requiring her to restore the consideration? she received. (Id. at p. 431.)
Relying on several earlier cases, the court held that ?[h]aving known that the entire
amount was to be applied to payment of medical expenses and she was without means to
repay it, neither the [defendants] nor their insurer is prejudiced by her failure to do so.?
(Ibid.)
The Legislature was aware of Carruth as it sought to promote a flexible approach
toward the restoration requirement. Although the Legislature did not specifically adopt
Carruth?s holding, it also clearly did not intend to repeal the case. (Recommendation on
Rescission of Contracts, supra, at pp. D-34 to D-35.) Therefore, consistent with the rule
against implied repeals, we find that Carruth v. Fritch, supra, 36 Cal.2d 426 remains
good law, subject to certain modifications embodied in section 1693, as noted below.
(See e.g., Brodie v. Workers? Comp. Appeals Bd. (2007) 40 Cal.4th 1313, 1325.)
The Legislature eventually adopted the Commission?s proposal for a new statute
to address any unfairness that the rescinding parties might face if they were insolvent or
without the funds to restore consideration prior to filing suit. The statute, section 1693,
as adopted in 1961, states that ?[a] party who has received benefits by reason of a
contract that is subject to rescission and who in an action or proceeding seeks relief based
upon rescission shall not be denied relief because of a delay in restoring or in tendering
restoration of such benefits before judgment unless such delay has been substantially
prejudicial to the other party; but the court may make a ?tender of restoration a condition
15
of its judgment.? ? 5 (? 1693; Carruth, supra, 36 Cal.2d at p. 430; see also Paularena v.
Superior Court (1965) 231 Cal.App.2d 906, 913 [imputing an offer of restoration from
the filing of an action alleging both rescission and fraud].)6 Thus, although the
Legislature specifically rejected the ?affirm and sue? principle adopted by several states,
it also, through section 1693, permitted plaintiffs who are unable to restore the
consideration received in their original settlements and releases to delay the restoration of
consideration until final judgment consistent with equitable principles, including that
defendants not be substantially prejudiced by the delay. Had Village Northridge sued for
rescission of its release under the statutory scheme governing rescission, it may have had
the opportunity to delay restoration of the consideration it received in settling the
property damage matter. State Farm agreed in supplemental briefing and at oral
argument that section 1693 may have allowed the trial court to postpone any restoration
requirement until judgment in the case. Instead, Village Northridge proceeded under an
?affirm and sue? trial strategy that is barred in this state under section 1691 and existing
precedent. (Taylor, supra, 207 Cal. at p. 105; Garcia, supra, 183 Cal. at p. 773.)
5
Section 1693 narrowed the Carruth exception in one respect: where in Carruth
we permitted the plaintiff to proceed without any assurances to defendant, section 1693
now authorizes a court to make restoration of the original consideration a condition of
any judgment. But it also expanded upon Carruth in another respect: the justification for
postponing restoration is no longer confined to circumstances where a defendant has
engaged in the sort of intentional manipulation alleged in Carruth, as the focus has now
been shifted to an inquiry into whether there has been substantial prejudice to a
defendant.
6
One case has taken a restrictive view of section 1693, concluding that plaintiff?s
delay in restoring consideration alone is sufficient to demonstrate prejudice to defendant.
(Myerchin v. Family Benefits, Inc. (2008) 162 Cal.App. 4th 1526, 1535 [failure to restore
settlement payment and sue for fraud prejudicial as a matter of law because defendant
?would lose the sole benefit it had contracted for in the settlement? (italics omitted)].)
We disapprove Myerchin to the extent it ignores section 1693?s express grant of authority
to courts to exercise their discretion in delaying restoration until judgment.
16
D. Insurer?s Alleged Quasi-fiduciary Duty to the Insured
Village Northridge asserts that, as between insurer and insured, a quasi-fiduciary
relationship exists as a matter of law. (Love v. Fire Ins. Exchange (1990) 221 Cal.App.3d
1136, 1147.) It asks us to factor that relationship into our decision here. State Farm is in
a legally recognized special relationship with plaintiff, and it has duties that clearly
encompass forthright and affirmative disclosure of available policy limits. However,
?[a]n insurer is not a fiduciary, and owes no obligation to consider the interests of its
insured above its own.? (Morris v. Paul Revere Life Ins. Co. (2003) 109 Cal.App.4th
966, 973.)
As noted above, we see no need to impose a new rule that might or might not
further the insured-insurer relationship. State Farm does not claim that a release exempts
it from a potential fraud claim. Instead, it asserts only that if Village Northridge brings
suit based on alleged fraud after entering into a valid settlement and release, it must
comply with our rescission statutes, sections 1688 to 1693. In addition, the Legislature
subjects the insurance industry to strict and enforceable standards of conduct through
laws against misrepresenting insurance policy limits and fraud in the inducement. (See,
e.g., Ins. Code, ? 790.03 et seq.)
E. The Law Favoring Settlement
?The law favors settlements.? (Bush v. Superior Court (1992) 10 Cal.App.4th
1374, 1382.) State Farm contends that if an insured can settle a disputed claim, keep the
money paid, and then sue anyway without complying with our rescission statutes, no
insurer would ever settle a disputed claim. Village Northridge asserts that a decision
against it would hinder settlement, because the courts would be ?tolerating
misrepresentation of policy limits by precluding any remedy for the crime in instances
where a release is involved.? Village Northridge asks, ?How is the policy favoring
settlement furthered by refusing a remedy at law to victims of fraud in connection with a
fraudulently induced settlement?? The answer is simple. The court is not refusing a legal
remedy to victims of fraud, because they still have the option of rescinding the contract
17
and then suing for damages. Village Northridge further contends that if the settlement
process is to be viable, insureds must have a legal remedy for misrepresentation of policy
limits. Rescission under sections 1688 to 1693 is such a remedy.
In addition, the Court of Appeal stated that ?[t]he consequences of applying this
principle [of allowing plaintiff to settle, keep the money paid, and then sue for fraud] are
not dire,? and so they will not deter settlement. In essence, the court reasons that the
insurer needs only to avoid misrepresenting policy limits. The Court of Appeal
?seriously doubt[s] insureds who settle their claims can be expected thereafter to assert
groundless claims of misrepresentation of policy limits on a routine basis.? Although we
agree the consequences may not be ?dire,? especially if the holding is specifically limited
to allowing a suit for fraudulent inducement by misrepresenting policy limits rather than
applying to fraudulent inducement in general, this contention is beside the point. Such a
claim, by itself, cannot justify the break from settled law that the Court of Appeal?s
holding would represent. The fact that the consequences may not be dire does not mean
they will be desirable. A settlement agreement is considered presumptively valid, and
plaintiffs are bound by an agreement until they actually rescind it. We cannot ignore the
equities of contract law simply because the Court of Appeal deems its holding to be a
narrow one that applies only to those few cases where a plaintiff alleges that its insurer
misrepresented policy limits when settling a claim. We find that the established rule is
more likely to favor settlements, particularly when the parties have the equitable
safeguards available to them under section 1693 discussed above.
CONCLUSION
To allow Village Northridge to settle with State Farm and sign a release, keep the
money, and then sue its insurer for alleged fraud without rescinding the release under our
statutory scheme (?? 1688-1693) would violate the terms of the bargain and frustrate its
purpose. It would also likely inhibit insurance companies? practice of using a release as a
settlement device. The Court of Appeal justified its decision based on policy
considerations enumerated in out-of-state and federal cases allowing affirmation and suit.
18
However, California does not follow those cases, and Garcia, supra,183 Cal. 767, and
Taylor, supra, 207 Cal. 102, are controlling precedent in this situation. We see no reason
to turn to other courts? decisions when our own statutory scheme is clear. The
Legislature has created a fair and equitable remedy to address the alleged fraud problem:
rescission of the release, followed by suit. When restoration is impossible because the
settlement monies have been spent, the financially constrained parties can turn to section
1693 to delay restoration until judgment, unless the defendants can show substantial
prejudice. Our statutory scheme therefore effectively ensures that plaintiffs who may
have been defrauded in the settlement process will be allowed access to the courts. For
the reasons stated, we reverse the Court of Appeal?s judgment and remand the matter for
reconsideration in light of the reasoning set forth above.
CHIN, J.
WE CONCUR:
GEORGE, C.J.
KENNARD, J.
BAXTER, J.
WERDEGAR, J.
MORENO, J.
CORRIGAN, J.
19
See next page for addresses and telephone numbers for counsel who argued in Supreme Court.
Name of Opinion Village Northridge Homeowners Assn. v. State Farm Fire and Casualty Co.
__________________________________________________________________________________
Unpublished Opinion
Original Appeal
Original Proceeding
Review Granted XXX 157 Cal.App.4th 1416
Rehearing Granted
__________________________________________________________________________________
Opinion No.
S161008
Date Filed: August 30, 2010
__________________________________________________________________________________
Court:
Superior
County: Los Angeles
Judge: Wendell Mortimer, Jr.
__________________________________________________________________________________
Attorneys for Appellant:
Engstrom, Lipscomb & Lack, Jerry A. Ramsey, Brian J. Heffernan and Alexandra J. Thompson for Plaintiff and
Appellant.
Sharon J. Arkin for United Policyholders as Amicus Curiae on behalf of Plaintiff and Appellant.
__________________________________________________________________________________
Attorneys for Respondent:
Robie & Matthai, James R. Robie, Kyle Kveton, Steven S. Fleischman; LHB Pacific Law Partners, Clarke B.
Holland, Sandra E. Stone; Crandall, Wade & Lowe and Michael J. McGuire for Defendant and Respondent.
Greines, Martin, Stein & Richland, Robert A. Olson and Alana H. Rotter for Association of Southern California
Defense Counsel as Amicus Curiae on behalf of Defendant and Respondent.
Fred J. Hiestand for The Civil Justice Association of California as Amicus Curiae on behalf of Defendant and
Respondent.
Chapman, Popik & White, Susan M. Popik and Carol D. Quackenbos for Personal Insurance Federation of
California as Amicus Curiae on behalf of Defendant and Respondent.
Counsel who argued in Supreme Court (not intended for publication with opinion):
Brian J. Heffernan
Engstrom, Lipscomb & Lack
10100 Santa Monica Boulevard, 16th Floor
Los Angeles, CA 90067-4107
(310) 552-3800
Clarke B. Holland
LHB Pacific Law Partners, LLP
5858 Horton Street, Suite 370
Emeryville, CA 94608
(510) 841-7777