A New Phoenix Rising From the Ashes: CCP Section 340.9 Constitutionally Extends the Statute of Limitations on Northridge Earthquake Claims
By Heather M. McKeon and Brian S. Kabateck
I. Introduction
The holdings in 20th Century Insurance Company v. Superior Court (Linda Ahles) (2001) 90 Cal.App.4th 1247 [hereinafter referred to as Ahles], and in Hellinger v. Farmers Ins. Exchange (2001) 91 Cal.App.4th 1049, have far broader implications than just upholding the constitutionality of Code of Civil Procedure § 340.9, which re-opened many Northridge earthquake claims. Because Section 340.9 extends the statute of limitations for lawsuits arising out of the Northridge earthquake, the insurance industry challenged the constitutionality of the statute pursuant to the Contracts Clause and the Due Process Clause of both the U.S. and California Constitutions. In upholding Section 340.9 as constitutional, both courts made it clear that far greater impairment of contracts is allowed when the industry is heavily regulated. Therefore, these opinions will have consequences beyond lawsuits involving the Northridge earthquake and even the insurance industry and provide good insight into how the Court of Appeal will decide future Contracts Clause cases involving heavily regulated industries.
II. Earthquake Litigation Before SB 1899 and Code of Civil Procedure § 340.9
Prior to the enactment of Code of Civil Procedure Section 340.9, insurers had substantial latitude in avoiding claims arising out of the 1994 Northridge earthquake. Defendant insurers benefitted from the judicial interpretation that the phrase "inception of the loss" within the standard policy one-year suit provisions turned on the occurrence of the event causing the loss. While this definition of "inception of loss" is appropriate with respect to events like fires, where damage is immediately recognizable, it is much less applicable in the earthquake context where damage is often discovered long after the event causing the loss. Consequently, after inspection, insurers frequently misrepresented to insureds that earthquake damage did not exist. By the time the insureds became aware that they had sustained appreciable damage, they were often barred from suit because the "inception of the loss" had occurred more than a year before they filed.
Nevertheless, plaintiff insureds achieved a modicum of success in earthquake cases by taking advantage of the rules promulgated in Prudential LMI Com. Ins. v. Superior Court (1990) 51 Cal.3d 674 and Spray, Gould & Bowers v. Associated Int'l. Ins. Co. (1999) 71 Cal.App.4th 1260. In Prudential-LMI, the California Supreme Court adopted the delayed discovery rule and applied it in conjunction with the equitable tolling doctrine to permit the plaintiff's claim to proceed. (Prudential-LMI, supra, 51 Cal.3d at 678-679.) The California Court of Appeal took a different approach in Spray, Gould where it applied the doctrine of equitable estoppel to allow a claim arising out of the Northridge earthquake to proceed. (Spray, Gould, supra, 71 Cal.App.4th at 1263.)
In Prudential-LMI, the Court held:
[T]he one-year suit provision begins to run on the date of inception of the loss, defined as that point in time when appreciable damage occurs and is or should be known to the insured, such that a reasonable insured would be aware that his notification duty under the policy has been triggered. (Prudential-LMI, supra, 51 Cal.3d at 678.)
In other words, California applies a delayed discovery rule and a statute of limitations does not begin to run until a reasonable insured discovers the loss. Because earthquakes cause a substantial amount of hidden damage, determining when the insured knew of appreciable damage was an issue contested by both insureds and carriers.
In Spray, Gould, the court held that an insurance carrier owes its insured an affirmative duty to speak, i.e., communicate all relevant information to its insured. (Spray, Gould, supra, 71 Cal.App.4th at 1268-69.) At the heart of that duty is the obligation to communicate honestly and without deception. (See Ins. Code § 790.03(h), et seq.; California Code of Regulations §§ 2695.4, 2695.7; Spray, Gould, supra, 71 Cal.App.4th 1260.) Therefore, the statute of limitations on an insurance case only begins to run once the carrier provides the insured with an unequivocal, written denial of the claim and informs the insured of the exact date that the insured's statute of limitations expires. (Ibid.) Unfortunately, even with the protections provided by Prudential-LMI and Spray, Gould, many insureds were denied their earthquake benefits solely on the grounds of the statute of limitations.
Insureds also tried other arguments to extend the statute of limitations. In the Ninth Circuit Court of Appeals opinion in Vu v. Prudential Prop. & Cas. Ins. Co. (1999) 172 F.3d 725, the insurance company's adjuster concluded that damage to Vu's home was below his policy deductible. Twenty months later, Vu found additional damage. (Ibid.) Prudential denied the claim on statute of limitations grounds. (Ibid.) In the subsequent lawsuit, Vu argued that Prudential should be estopped from arguing the statute of limitations as a defense, because Vu relied on Prudential's adjuster's assessment of damage. (Ibid.)
In Vu, the Ninth Circuit certified the following question to the California Supreme Court:
Where an insured presents a timely claim to his insurer for property damage under a policy, and the insurer's agent inspects the property but does not discover the full extent of covered damage, does California Insurance Code section 2071 bar a claim brought by the insured more than one year after the damage was sustained but within one year of his discovery of the additional damage? (Vu, supra, 172 F.3d at 727.)
The Ninth Circuit appeared to favor a reading of Section 2071 that would have allowed Mr. Vu to proceed with his lawsuit, but deferred its judgment to that of the California Supreme Court. The California Court accepted the question. (Vu v. Prudential Prop. & Cas. Ins. Co., 1999 Cal. LEXIS 5000; 99 Cal. Daily Op. Service 6041; 99 Daily Journal DAR 7699.) On November 5, 2001, in Vu v. Prudential Property and Casualty Company (2001) 201 DJDAR 11827, 2001 Cal. LEXIS 7136, the California Supreme Court answered the federal court's referred question by ruling that an insurer could be estopped from asserting a statute of limitations defense when the insured relied on the representations of the carrier's adjuster regarding the extent of earthquake damage.
III. California's Decision to Re-Open the Majority of Northridge Earthquake Claims
After reviewing the current status of the law including Prudential-LMI and Spray, Gould, the Legislature decided that it must act to provide relief from the statute of limitations to promote the public policy interest of bringing "needed relief to the victims of the Northridge earthquake." (Assem. Com. on Judiciary, Analysis of Sen. Bill No. 1899, p. 2.) The Committee found that insurers had engaged in "a systematic program of misleading consumers about the nature and extent of damage to their homes." (Id. at 5.) When it later became clear that the damage to consumers' homes was significant, the insurers refused to pay claims on the basis that the claims had become time-barred. (Ibid.)
Additionally, consumers were unable to obtain relief from the Department of Insurance, because of Commissioner Quackenbush's secret deals with various carriers. The Department of Insurance was prompted to investigate insurer's conduct because of the high number of complaints it received from aggrieved policyholders. The resulting investigation revealed that 20th Century Insurance, State Farm Insurance, Allstate Insurance and others had engaged in serious misconduct. (State of Calif. Dept. of Ins., Consumer Services Div., Market Conduct Examination Reports (Market Conduct Bureau 1998).) Based on the findings of misconduct, Quackenbush's legal staff recommended imposing $3.37 billion in penalties. (Ibid.) Instead of imposing these penalties, Quackenbush instead accepted a total of $12.8 million dollars in "voluntary donations" to organizations selected by Quackenbush. In turn, most of this money was used to further Quackenbush's political career. (Skelton, Quackenbush Aftermath Shows System Works, Los Angeles Times, Sept. 14, 2000.) Thus, the Department of Insurance did not assist insureds whose homes were damaged as a result of the Northridge earthquake.
In Hellinger v. Farmers Ins. Exchange, supra, the California Court of Appeal explained why the commercial practices of the insurance companies led to the Legislature's action. According to the legislative record, the Legislature acted because "many [homeowners] were tragically misled about the extent of damage suffered as a result of the earthquake." (Office of Senate Floor Analyses, Third Reading Analysis of Sen. Bill No. 1899, as amended July 6, 2000, pp. 1-2.) In addition, the Hellinger Court took notice of a Los Angeles Times article which asserted that one insurance company "failed to properly explain benefits or misled policyholders in over a third of 825 claims files reviewed...." (Ellis, Virginia, Reports on Quake Claims Made Public, Los Angeles Times, June 13, 2000, p. A1.)
Indeed, the insurance companies, faced with massive losses after the Northridge earthquake, employed bad faith tactics to lower their overall liability exposure. These practices included "low-balling" claims, unfairly denying claims, misrepresenting the deductible to policyholders, and failing to adequately investigate claims. (Ellis, Bustillo, New Insurance Laws Boost Public's Right, Los Angeles Times, October 2, 2000, p. A1.)
In response to the Quackenbush scandal and the carriers' abuse of the statute of limitations, Governor Gray Davis signed SB 1899 into law on September 30, 2000, which created Code of Civil Procedure § 340.9. Section 340.9 allows the majority of insureds to file complaints against their carriers for unpaid policy benefits arising out of the Northridge earthquake until December 31, 2001. (Ibid.)
The statute is subject to three limitations: (1) the insured must have contacted the insurer or its representative about "potential Northridge earthquake damage" prior to January 1, 2000; (2) the statute does not apply to claims which have been litigated to finality in any court of competent jurisdiction, so the one judgment rule still applies; and (3) the statute will not apply to any claim which has been resolved by a written settlement agreement, provided the insured was represented by a California attorney and said attorney signed the agreement. (Code Civ. Proc. § 340.9.)
The Legislature considered the arguments by insurers that the reopening of claims they had "legally denied from Northridge claimants through the introduction of retroactive legislation ... raises serious constitutional questions" but determined these objections were meritless. (Assem. Com. on Judiciary, Analysis of Sen. Bill No. 1899, p.2.)
IV. The Constitutionality of Code of Civil Procedure § 340.9
Even though the Legislature addressed the constitutionality of Section 340.9, the insurance industry immediately challenged the constitutionality of the statute. To date, the Court of Appeal has denied the insurance carriers' challenges to the constitutionality of Section 340.9 in at least two published opinions. In the first published decision, Ahles, supra, the California Court of Appeal upheld the constitutionality of Section 340.9 and provided a detailed analysis of why the law is constitutional and what certain phrases in Section 340.9 mean, including the wording "litigated to finality." (20th Century's petition for review in Ahles to the California Supreme Court has been denied.)
In Ahles, the Court of Appeal held that Section 340.9 did not impermissibly impair the insurer's right of contract or deny it substantive due process by the destruction of vested contract rights. In holding Section 340.9 constitutional, the Court performed an extensive analysis of the statute and its purpose.
In another published decision, Hellinger v. Farmers Ins. Exchange (2001) 91 Cal.App.4th 1049, the Court of Appeal again held that Section 340.9 was constitutional. The Hellinger Court ruled that : (1) the revival of the insured's earthquake claim impaired the insurer's contract only to the extent that the insurer lost the limitation defense for one year; (2) Section 340.9 had a significant, compelling and legitimate public purpose; and (3) Section 340.9 was reasonably limited in both time and application. (Id.)
A. The Legislature's Power to Revive Barred Claims
The Ahles Court relied on the well-established principle of law that the Legislature can revive a civil cause of action that has expired under a former statute of limitations without violating the constitution. (Chase Securities Corp. v. Donaldson (1945) 325 U.S. 304, 315; see also Hellinger, supra.) In Chase, the Court held that a defendant's disappointment at not being able to assert the statute of limitations as a defense did not rise to the level of a constitutional violation because "whatever grievance appellant may have at the change of policy to its disadvantage, it had acquired no immunity from this suit that has become a federal constitutional right." (Chase, supra, 324 U.S. at 314.) More recently, the Supreme Court has noted that statutes of limitation "can be extended, without violating the Due Process Clause, after the cause of action arose and even after the statute itself has expired." (Plaut v. Spendthrift Farm, Inc. (1995) 514 U.S. 211, 229.)
The rule in California is no different. When Code of Civil Procedure § 340.1, which revived time-barred tort claims of victims of sexual molestation, was challenged, the court held that "the Legislature has the power to expressly revive time-barred civil common-law causes of action." (Liebig v. Superior Court (1989) 209 Cal.App.3d 828, 835.) In Tietge v. Western Province of the Servites, Inc. (1997) 55 Cal.App.4th 382, 386, the court found "no constitutional impediment to the revival of a personal cause of action ...." In People v. Frazer (1999) 21 Cal.4th 737, 767, where the challenged statute retroactively extended the criminal statute of limitations for certain sex crimes, the California Supreme Court recognized that the reasoning in Chase had been reaffirmed by the U.S. Supreme Court and reiterated that "no constitutionally protected right arises once a statute of limitations has run, and that such protection can be retroactively withdrawn consistent with due process." (Ibid.)
B. Public Policy Considerations
Both the Ahles and Hellinger decisions illustrate how the California Court of Appeal analyzes legislation affecting a heavily regulated industry. In Ahles, the Court acknowledged "the serious public policy considerations that were involved in the enactment of Section 340.9." (Ahles, supra, 90 Cal.App.4th at 1264.) The insurance industry impacts the public interest to such a great extent that it is viewed as a "quasi-public" business. "Insurers hold themselves out as fiduciaries, and with the public's trust must go private responsibility consonant with that trust," even to the point that insurers must take the public's interest so seriously that when necessary, it is placed before their interest in profitability. (Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d 809, 820.) The court explained that the relationship between the insurer and the insured is inherently unbalanced due to the adhesive nature of insurance contracts which place the insurer in a superior bargaining position. (Ibid.)
The significant public interest in the special relationship between the insurer and the insured distinguishes insurance contracts from other types of contracts. (Ahles, supra, 90 Cal.App.4th at 626.) For instance, unlike other forms of contracts, tort remedies such as punitive damages are available in insurance contract cases. (Egan, supra, 24 Cal.3d at 820.) Furthermore, insurance contracts are not limited by the usual contract interpretation rules. Contractual provisions contained within insurance policies and statutes regarding such policies must be construed in light of the public policy of protecting the insured and the public at large. (Barrera v. State Farm Mut. Automobile Ins. Co. (1969) 71 Cal.2d 659, 669.) "So too, statutes which affect existing insurance contracts, enacted to promote the public interest, are invariably upheld as a reasonable exercise of the State's police power." (Ahles, supra, 90 Cal.App.4th at 1266-1267.) Accordingly, the Ahles court held that "it is clear that the state's significant public policy concerns for the less powerful insureds, which bolster its power to regulate this 'quasi-public' business of insurance, also prompted the enactment of Section 340.9." (Id. at 1267.)
C. There Is No Impermissible Impairment of Contract by Section 340.9
After determining that Section 340.9 had a legitimate public purpose, the Ahles Court applied the three part test for determining whether a statute violates the Contracts Clause of the California and Federal Constitution, as enunciated in Energy Reserves Group v. Kansas Power & Light Co. (1983) 459 U.S. 400, 412-413. The first prong of the test is: "whether the state law has, in fact, operated as a substantial impairment of a contractual relationship." (Ahles, supra, 90 Cal.App.4th at 1269, citing Energy Reserves, supra, 459 U.S. at 411-412.) In determining whether Section 340.9 amounted to substantial impairment of contractual rights, the Court relied on the fact that the insurance industry is heavily regulated and should have expected the exercise of legislative power to assist the victims of the Northridge earthquake. Therefore, the Court found, the revival of barred claims for one year fails to rise to the level of an "impairment" of contract, because it merely affects the remedy for the violation of the contract, not the obligations contained within it. (Ahles, supra, 90 Cal.App.4th at 1270, citations omitted.)
The Court applied the same analysis to settlement agreements and found no constitutional violation in allowing cases with settlement agreements to be re-addressed. (Ibid.)
The Court quickly dealt with the second prong which is whether or not the legislation addresses a significant and legitimate public purpose. (Ahles, supra, 90 Cal.App.4th at 1269, citing Energy Reserves, supra, 459 U.S. at 411-412.) As discussed above, the Court found that, the Legislature enacted section 340.9 to alleviate a broad and significant problem caused by the insurers' conduct; to help thousands of policyholders who were misled by the insurers into waiving their right to make claims in a timely manner. (Ahles, supra, 90 Cal.App.4th at 1271.)
As for settlement agreements, the Ahles Court held that the "application of section 340.9 to settlement agreements entered into without California counsel does not substantially impair such contracts." (Id., at 1270.) Moreover, the court stated that even if Section 340.9 could be said to substantially impair settlement agreements, "it may constitutionally do so to address a legitimate public purpose...." (Ibid., citation omitted.)
The Court dispatched the third prong of whether the impairment was limited in time and appropriateness as swiftly as the second prong by merely stating that the remedy was appropriate because it was limited in time to only one year. (Id., at 1272.)
After the decision in Ahles, 20th Century Insurance Company petitioned the California Supreme Court for review. The petition was denied. An explanation for this denial is found in the fact that Section 340.9 is limited in time (suits must be filed by December 31, 2001), and because it only applies to insurance claims arising out of the Northridge earthquake (and is thus limited in its geographic area).
V. The Legislature's Decision Requires Deference by the Courts
California courts have made it clear that the proper forum for resolving the competing policy interests involved in the decision to revive a time-barred claim is the Legislature, not the courts. (Tietge, supra, 55 Cal.App.4th at 388.) The Ahles Court noted that the Legislature's detailed analysis and rejection of the insurers' constitutional objection to Section 340.9 demanded increased deference. The court cited Pacific Legal Foundation v. Brown (1981) 29 Cal.3d 168, which stated that where, the statute represents a considered legislative judgment as to the appropriate reach of the constitutional provision ... a focused legislative judgment on the question enjoys significant weight and deference by the courts. (Id., at 180)
VI. The Definition of "Litigated to Finality"
After determining that Section 340.9 was constitutional the Ahles Court addressed the phrase "litigated to finality" in the statute. The Court held that any case pending on January 1, 2001, when the statute became effective, was not litigated to finality and could take advantage of Section 340.9. The Court concluded that even cases that were on appeal as of January 1, 2001 were not litigated to finality, and thus, could use Section 340.9 to revive any claims allegedly affected by the statute of limitations. (Ahles, supra, 90 Cal.App.4th at 1278-1279.)
In Campanelli v. Allstate Ins. Co., (2000) 119 F.Supp.2d 1073, a District Court judge held that a grant of summary judgment to defendant meant that a plaintiff's case was "litigated to finality." Both the Ahles Court and the Hellinger Court have expressly stated that they decline to follow the holding of the Campanelli case. (Ahles, supra, 90 Cal.App.4th at 1279, n.35; Hellinger, supra, 91 Cal.App.4th at 1060-1061.)
VII. Section 340.9 Applies to Insurance Bad Faith Claims
The Ahles Court extended the revival of earthquake claims to insured's bad faith claims as well. (Ahles, supra, 90 Cal.App.4th at 1279-1280; see also, Jang v. State Farm Fire and Cas. Co. (2000) 80 Cal.App.4th 1291 [the statute of limitations for a bad faith claim is the same as the statute of limitations stated in the insurance contract].) The Ahles Court held that certain tort claims are "insurance claim[s] for damages" under the insurance policy. (Ahles, supra, 90 Cal.App.4th at 1279.) The Court specifically stated that the "express language of the statute applies not only to contract damage claims, but also to tort claims for insurer bad faith...." (Ibid.)
In Ahles, the Court also expressly stated that an insured's claim for fraud is not extended by Section 340.9. (Ahles, supra, 90 Cal.App.4th at 1280.) The Court held that Ahles' fraud claim was not an "insurance claim for damages" and thus remained subject to the three-year limitation period for fraud set out by Code of Civil Procedure section 337. (Id. at 1281.)
Therefore, an insured can file a complaint against their carrier throughout 2001 for benefits arising out of the Northridge earthquake and include a bad faith claim, but other causes of action are subjected to their regular statute of limitations. As tort damages such as attorney's fees and punitive damages are available with insurance bad faith claims, the exclusion of fraud claims is not a serious blow to the viability of a Northridge earthquake insurance lawsuit.
VIII. Conclusion
The Ahles and Hellinger decisions provide a thorough analysis of why Section 340.9 is constitutional and why it was necessary for the California Legislature to extend the statute of limitations for earthquake claims. These decisions also illustrate how the current California Court of Appeal analyzes Contracts Clause cases involving heavily regulated industries.
Copyright CAOC, Forum, December 2001. Reprinted with permission.
