It's no secret that California permits policyholders to asserteither contract or tort remedies for an insurer's breach of theimplied covenant of good faith and fair dealing.  Thedifference between the two remedies, available at thepolicyholder's election, is significant; "[i]f the insured electsto proceed in tort, recovery is possible for not only all unpaidpolicy benefits and other contract damages, but alsoextra-contractual damages such as those for emotional distress,punitive damages and attorney fees."[2] The ability to seek punitive damages, in addition to otherpotential tort recovery, makes California an attractive forum forpolicyholders seeking to maximum damages for an insurer'sunreasonable or unjustified denial of policy benefits.[3]

New York, on the other hand, does not permit tort recovery forbad faith, thereby also precluding an insured from recoveringpunitive damages.[4] Because California potentially allows a broad spectrum of damagesfor an insurer's bad faith and New York allows much less, it is notsurprising that many policyholders elect to pursue their bad faithactions in California while many insurers seek to confine anyaction on the policy to New York by including a choice-of-lawprovision in their policy.  But are such provisionsenforceable with respect to claims for breach of the impliedcovenant of good faith and fair dealing asserted under Californialaw?

Recently, a federal district court in California held achoice-of-law provision in an insurance policy was not enforceablewith respect to a policyholder's claim for breach of the impliedcovenant of good faith and fair dealing.  SeeTri-Union Seafoods, LLC v. Starr Surplus Lines Ins. Co., 2015U.S. Dist. Lexis 23441 (Feb. 5, 2015).  Although federaldecisions are not binding on California courts with respect toissues of state law,[5]Tri-Union raises the issue of whether California willenforce a valid choice-of-law provision where doing so woulddeprive a policyholder of potential tort and punitive damages forthe insurer's bad faith.  In other words, do Californiapolicyholders have a public policy right to recover tort andpunitive damages against an insurer for its bad faith? The Tri-Union court answered this question in theaffirmative, but would a California court do the same?

In California, insurance policies are contracts, subject to thesame construction principles as other contracts.[6] Provisions in insurance policies are given effect and are notrewritten or omitted to advance some perceived publicpolicy.[7] California courts acknowledge the parties' freedom tocontract,[8]while recognizing the potential for disparate bargaining powerbetween policyholders and insurers.  California courtsenforce contracts as written – including policies – unless doing soviolates public policy.[9]

With respect to choice-of-law provisions specifically,California has a strong policy of enforcing such provisions thatsatisfy the principles set forth in section 187(2) of theRestatement Second of Conflict of Laws ("Restatement").[10]

The Restatement sets forth a multi-part test; under the firstpart, the court determines whether the state in the choice-of-lawprovision has a substantial relationship to the parties, theirtransaction or whether there is any other reasonable basis for thelaw chosen by the parties.  The first part may besatisfied if one of the parties resides in the chosen state or hasits principal place of business there.[11] If the first part is met, the court then determines if the lawchosen by the parties is contrary to a fundamental policy ofCalifornia.[12] If there is no contradiction, the court will enforce thechoice-of-law-provision.  But if the court finds aconflict between the law of the chosen state and a fundamentalpolicy of California, it will analyze if California has a"'materially greater interest than the chosen state'" in resolvingthe specific controversy.[13]

In Tri-Union, the policyholder argued a choice-of lawprovision, which stated "[t]he construction, validity, andperformance of this Policy will be governed by the laws of theState of New York …", was unenforceable because it violated afundamental policy of California.[14] That fundamental policy, the insured argued, was its right to suean insurer in tort for breach of the implied covenant, aremedy not recognized under New York law. 

Notwithstanding the California Supreme Court's conclusion that"a valid choice-of-law clause … encompasses all causes ofaction arising from or related to that agreement, regardlessof how they are characterized, including tortious breachesof the duties emanating from the agreement …,"[15]the insured in Tri-Union successfully arguedNedlloyd did not apply to insurance contracts. This argument was bolstered by reference to Comment (g) of Section187 of the Restatement, which provides:  "A fundamentalpolicy may be embodied in a statute which makes one or more kindsof contracts illegal or which is designed to protect a personagainst the oppressive use of superior bargaining power. Statutes involving the rights of an individual insured as againstan insurance company are an example of this sort." Relying on Comment (g) and various California cases explaining therationale for affording tort liability in the insurance context,the Tri-Union court concluded "a tort remedy for the[sic] an insurer's breach of the implied covenant of goodfaith and fair dealing implicates a substantial and thusfundamental public policy in California."[16] And after finding California had a materially greater interest thanNew York, the court refused to enforce the choice-of-law provisionin the policy.

In proclaiming a policyholder has a fundamental right to seekand obtain tort and even punitive damages against an insurer forbad faith, the Tri-Union court appeared to ignore severalkey California decisions.  For example, California courtsgenerally express great reticence in proclaiming what is and whatis not public policy.[17] But in choosing to nullify the insurer's choice-of-law provision,the Tri-Union court appeared to express no suchhesitancy.

The Tri-Union court also appeared to pay little heed toCalifornia's long tradition of enforcing policy provisions aswritten, confirming the parties' right to contract as theyplease.[18] In finding an insurance policy "exception" to choice-of-lawanalysis, the Tri-Union court held that while otherbusiness entities may rely upon choice-of-law provisions, insurancecompanies may not.[19]

More importantly, the Tri-Union court appeared toignore the California Supreme Court's decision in Boghos v.Certain Underwriters at Lloyd's of London, 36 Cal.4th 495(2005), where the court rejected the notion that an insured has afundamental public policy right to seek tort remedies for badfaith.

In Boghos, an insured brought claims for breach ofcontract and bad faith against a disability insurer.  Theinsurer moved to compel arbitration under a provision in the policythat stated the parties agreed to waive the right to a jury trialand to submit to binding arbitration.[20] The trial court and the appellate court refused to enforce thearbitration provision and the California Supreme Court grantedreview.

In determining whether the arbitration provision wasenforceable, the court construed the policy language "based on thesame state law standards that apply to contractsgenerally."[21] After finding the arbitration provision unambiguous, the courtdetermined whether the insured's breach of contract and bad faithclaims were protected by public policy and concluded they werenot.[22]

Specifically, after explaining that fundamental public policiesare unwaivable rights "tethered" to statutes or constitutionalprovisions, the court found the insured's "claims for nonpayment ofbenefits and breach of the covenant of good faith and fair dealingcannot properly be so described."[23] A failure to pay benefits under the policy "is a claim for breachof contract, pure and simple" and a claim such failure was in badfaith "may properly be described either as a tort claim … or as aspecial type of contract claim for which we allow tort damages…."[24] In reaching its conclusion to enforce the arbitration provision,the Boghos court explicitly rejected the insured'sargument that a bad faith claim reflects a fundamental publicpolicy of California:

While insurance bad faith claim were for a time thought to havea statutory basis in the Unfair Practices Act (Ins. Code, §790et seq.), we definitively rejected that position inMoradi-Shalal v. Fireman's Fund Ins. Cos. (1988) 46 Cal.3d287, 304 … and expressly overruled prior contrary authority … Forthe same reason, insurance bad faith claims also cannot properly bedescribed as tethered to a statute, in the sense thatTameny claims subject to arbitration under Littleare necessarily "'based on policies "carefully tethered tofundamental policies …delineated in constitutional or statutoryprovisions"'" … While the business of insurance is sufficientlyaffected with a public interest to justify its regulation by thestate … the fact of regulation does not suffice to demonstrate thatany given insurance-related claim entails an unwaivable statutoryright, or that any given claim seeks to enforce a public policyarticulated in a statute.[25] 

Because enforcing an arbitration provision would deprive apolicyholder of its ability to recover tort remedies in a courtproceeding, the Boghos court necessarily considered andrejected the notion that a policyholder has a fundamentalpublic policy right to pursue such damages against an insurer.

And while Foley, 47 Cal.3d 654, 683-700, Egan v.Mutual of Omaha Ins. Co. 26 Cal.3d 809, 820 (1979) and otherdecisions certainly recognize the special nature of insurancecontracts and the rationale for permitting tort remedies for aninsurer's bad faith, such cases do not hold that the ability torecover tort damages against an insurer is a fundamentalpolicy in California.

In California, "[p]ublic policy is defined as a policy coveringhealth, safety or welfare and established by constitutionalprovision, statute, or administrative rule."[26] Boghos confirmed that the right to sue an insurer in tortis not established by statute.[27] Nor are such causes of action established by constitutionalprovision or administrative rule.  It is the lack of theseattributes, which should have precluded the Tri-Unioncourt from concluding an insured has a fundamental policy right toseek tort remedies for bad faith.

California has long recognized and protected the freedom tocontract.  It has eschewed rewriting contracts by failingto give effect to plain and unambiguous wording. California recognizes the special nature of insurance policies andhas in that regard regulated such contracts and even allowed fortort recovery where an insurer breaches a policy in badfaith.  But California has not elevated the right toredress such grievances with tort remedies as a fundamental publicpolicy that overrides enforcement of a valid choice-of-lawprovision where it satisfies Nedlloyd.  Insurers,like any other business entity, should be entitled to rely uponsuch provisions.

[1] Kathryn C. Ashton is Senior Counsel at Clyde & Co LLP'sSan Francisco office.  She is a certified appellatespecialist by the California Bar of Legal Specialization andpractices primarily in insurance coverage.

[2] Archdale v. American Int'l Specialty Lines Ins.Co., 154 Cal.App.4th 449, 467 & fn.19  (2007),citing Foley v. Interactive Data Corp, 47 Cal.3d 654, 684(1988).

[3] See, Chateau Chambray Homeowners Assn. v. Assoc. Int'lIns. Co., 90 Cal.App.4th 335, 346-347 (2001) ("'The mistaken[or erroneous] withholding of policy benefits, if reasonable orbased on a legitimate dispute as to the insurer's liability underCalifornia law, does not expose the insurer to bad faithliability.'").

[4] See, e.g., Rocanova v. Equitable Life Assur. Society ofthe U.S., 634 N.E.2d 940, 945 (N.Y. 1994). 

[5] Frazier Nuts, Inc. v. American A.G. Credit, 141Cal.App.4th 1263, 1274 fn.12 (2006).

[6] Bank of the West v. Superior Court, 2 Cal.4th1254, 1264 (1992). 

[7] See Rosen v. State Farm Gen. Ins. Co., 30 Cal.4th1070, 1077-1078(2003).

[8] Aerojet-General Corp. v. Transport Indemn. Co., 17Cal.4th 38, 75 (1997) ("But the pertinent policies provide whatthey provide.  [The insured] and the insurers weregenerally free to contract as they pleased….").  

[9] See, e.g., Downey Venture v. LMI Ins. Co., 66Cal.App.4th 478 (1998).

[10] Nedlloyd Lines B.V. v. Superior Court, 3 Cal.4th459, 464-467 (1992) ("Nedlloyd"); see alsoFrontier Oil Corp. v. RLI Ins. Co., 153 Cal.App.4th 1436,1450 fn.7 (2007) (citing Nedlloyd as the applicable testwhere a policy contains a choice-of-law provision).

[11] Nedlloyd, at 467 citing Restatement (Second) ofConflicts of Law, s. 187, comment f.; see also HughesElectronics Corp. v. Citibank Delaware, 120 Cal.App.4th 251,258 (2004) ("'If one of the parties resides in the chosen state,the parties have a reasonable basis for their choice.'").

[12] Nedlloyd, at 466 & fn.5.

[13] Id. at 466-467.

[14] 2015 U.S. LEXIS 23441 at *9 & *23. 

[15] 3 Cal.4th at 470, emphasis added.

[16] 2015 U.S. LEXIS 23441 at *31, emphasis added.

[17] See, e.g., Gantt v. Sentry Ins., 1Cal.4th 1083, 1090 (1992) overruled on other grounds by Greenv. Ralee Eng'r Co., 19 Cal.4th 66, 80 fn.6 (1998) (". . .courts should venture into this area, if at all, with great careand due deference to the judgment of the legislative branch, 'lestthey mistake their own predilections for public policy whichdeserves recognition at law.'"); Hentzel v. SingerCo.,  138 Cal.App.3d 290, 297 (1982) ("We continue tobelieve that, aside from constitutional policy, the Legislature,and not the courts, is vested with the responsibility to declarethe public policy of the state.").

[18] See, Foster-Gardner, Inc. v. Nat. Union Fire Ins.Co., 18 Cal.4th 857, 882 (1997) ("Although insureds certainlydeserve no less than the benefit of their bargain, insurers shouldbe held liable for no more."); Aerojet, 17 Cal.4th at 75("But the pertinent policies provide what they provide. [The insured] and the insurers were generally free to contract asthey pleased … We may not rewrite what they themselveswrote.").

[19] See 2015 U.S. LEXIS 23441 at *31.

[20] Boghos, 36 Cal.4th at 499-501. 

[21] Id. at 509.

[22] 36 Cal.4th at 506-508. 

[23] Id., at 505-507.

[24] Id., at 507, citations omitted.

[25] Boghos, at 507, citations omitted.

[26] Foley, at 694 fn.31. 

[27] Bogus, at 507, citing Moradi-Shalal, at304.