fails to adequately investigate a claim, the insurer can not meet this
burden and will be liable for breaching its duty to defend. In contrast,
when an insurer is negligent in selecting counsel, there is no underlying
contractual duty, and the insured must be able to sue in negligence or
not at all.
Plaintiffs also argue that the Ninth Circuit recognized the viability
of a negligence claim in Pershing Park Villas Homeowners Ass'n,
219 F.3d 895, when it affirmed an award for bad faith and negligence. The
only reference the court makes to negligence is in the statement of
facts. Id. at 899. Moreover, the court affirmed the judgment on bad faith
grounds without discussing negligence. See id. at 901-902. The Court
finds the isolated and singular reference does not support recognizing
negligence claims against an insured.
Plaintiffs do not cite a single example where a court has found an
insurer's failure to properly investigate capable of supporting a
separate negligence cause of action under California law. Instead,
Plaintiffs urge the Court to rely on fundamental tort principles to
recognize its negligence claim. The Court finds doing so would be an
expansion unwarranted by California case law and declines to do so.
An approach more consistent with California case law is to treat
negligent investigation as a predicate for breach of the duty to defend
and, if wrongful, a breach of the implied covenant. As this Court
previously discussed, an insurer breaches its duty to defend if it refuses
to defend a claim that may fall within policy coverage. See Order dated
May 1999, published as Everett Assoc. Inc. v. Transcontinental,
57 F. Supp.2d 874, 878 (N.D.Cal. 1999) (citing Montrose Chemical Corp., 6
Cal.4th at 300, 24 Cal.Rptr.2d 467, 861 P.2d 1153). In other words, the
insurer must prove that the claim cannot fall within policy coverage.
Id. Where an insurer negligently investigates the claim, the insurer will
not be able to establish that the claim cannot fall within policy
coverage. Negligent investigation thus results in a breach of the duty to
defend. See Bogard v. Employers Casualty Co., 164 Cal.App.3d 602, 615,
210 Cal.Rptr. 578 (1985) ("By alleging that [the insurer] did not
properly investigate the claims . . ., [the insureds] have only alleged a
breach of the duty to defend." (emphasis added)). If the refusal to
defend is unreasonable or made in bad faith, then it also breaches the
implied covenant and tort damages are available. California courts have
not treated negligent investigation as a separate cause of action in
negligence. Recognition of such a claim by a federal court sitting in
diversity jurisdiction would be an inappropriate expansion of state law.
This Court has already determined that Defendants breached their duty to
defend, but not the implied covenant. It now holds that Plaintiffs'
allegation of inadequate investigation can not, as a matter of law,
support a separate claim in negligence.
B. Negligent Infliction of Emotional Distress
Negligent infliction of emotional distress, although often pled as a
separate cause of action, is a subcategory of the tort of negligence.
Burgess v. Superior Court, 2 Cal.4th 1064, 1072, 9 Cal.Rptr.2d 615,
831 P.2d 1197 (1992); see generally, 6 Witkin, Summary of California Law
§ 838 (9th ed. 2000 Supplement). Defendants argue that if Plaintiffs
can not maintain an action in negligence, see discussion supra Part A,
Payne accordingly can not maintain his negligent infliction of emotional
distress claim.*fn3 Plaintiffs assert that California courts have
recognized negligent infliction of emotional distress claims by an
insured against its insurer.
Plaintiffs rely on Bogard v. Employers Casualty Co., 164 Cal.App.3d 602,
210 Cal.Rptr. 578 (1985). In Bogard, the appellate court granted the
insured leave to amend the complaint to state a cause of action for the
negligent infliction of emotional distress against its insured arising
out of the insurer s failure to defend its insured. Defendants argue that
because Bogard relied on Jarchow v. Transamerica Title Ins. Co.,
48 Cal.App.3d 917, 122 Cal.Rptr. 470 (1975) which was overruled by Soto
v. Royal Globe Insurance Co., 184 Cal.App.3d 420, 229 Cal.Rptr. 192
(1986), Bogard is no longer valid precedent. Plaintiffs assert that
Bogard is still good law since neither Soto nor a subsequent decision has
overruled or criticized Bogard.*fn4 Although the California Supreme
Court did not explicitly mention Bogard in Soto, its holding that "a
cause of action for recovery of damages for emotional distress based on
garden variety negligence concepts" is an extension "unwarranted by
California law" leaves little room for Bogard survival. Id. at 434,
210 Cal.Rptr. 578.
Assuming arguendo, Bogard survives Soto and an insured may state a
claim of negligent infliction of emotional distress against its insurer,
Payne must meet all the traditional tort elements of a legal duty,
breach, damages, and proximate causation. Burgess, 2 Cal.4th at 1072,
9 Cal.Rptr.2d 615, 831 P.2d 1197. To establish Transcontinental owed
Payne a duty of care and proximate causation, Plaintiff must establish
that he qualifies as a "direct victim" of Defendants' breach under Molien
v. Kaiser Foundation Hospitals, 27 Cal.3d 916, 167 Cal.Rptr. 831,
616 P.2d 813 (1980) or as a "bystander" under Dillon v. Legg,
68 Cal.2d 728, 69 Cal.Rptr. 72, 441 P.2d 912 (1968). "Bystander" cases
are limited to circumstances where the plaintiff witnesses negligently
inflicted injury on a close family relation. See, e.g., Krouse v.
Graham, 19 Cal.3d 59, 137 Cal.Rptr. 863, 562 P.2d 1022 (1977)
(husband-wife); Archibald v. Braverman, 275 Cal.App.2d 253,
79 Cal.Rptr. 723 (1969) (parent-child) (criticized on other grounds);
Kately v. Wilkinson, 148 Cal.App.3d 576, 582, 195 Cal.Rptr. 902 (1983)
(family friend insufficient). As the relationship between Payne and his
company is a business, rather than familial, relationship, Payne can not
seek emotional distress damages on the bystander theory.
"Direct victims" are plaintiffs who suffer emotional distress damages
resulting from a breach of duty owed the plaintiff that is "assumed by
the defendant, or imposed on the defendant as a matter of law, or that
arises out of a relationship between [plaintiff and defendant]."
Burgess, 2 Cal.4th at 1074, 9 Cal.Rptr.2d 615, 831 P.2d 1197. Plaintiffs
assert that Defendants owed Payne a duty of care arising out of the
insurance policy, under which Payne is "an insured." The difficulty
arises in that Defendants refused to defend Everett, not Payne, in the
Clark action and Payne's emotional distress claims
flow from Defendants' refusal to defend Everett. Plaintiffs fail to
explain how Defendant's failure to defend Everett was "directed at"
Payne. As recognized in Schwarz v. Regents of Univ. of Calif.,
226 Cal.App.3d 149, 163, 276 Cal.Rptr. 470 (1990), "that a third party
suffers an adverse consequence does not mean the defendant's conduct was
directed at the third party." It would turn the "foreseeable plaintiff'
doctrine on its head to allow one insured to sue for negligent infliction
of emotional distress arising from an insurer's refusal to defend a
separate insured. To borrow the court's language in Biakanja v. Irving,
49 Cal.2d 647, 649-50, 320 P.2d 16 (1958), there is no nexus between
Payne's status as an insured and the "end and aim" of the contractual
relationship between Everett and Defendants. Without such a nexus,
Defendants' actions toward Everett can not be the proximate cause of
Payne's emotional distress.
C. Emotional Distress Damages flowing from breach of the duty to
Plaintiffs also seek to recover Payne's emotional distress damages as
damages flowing from Defendants' breach of contract in failing to defend
Everett, while Defendants argue that tort damages are unavailable absent
a breach of the implied covenant.
Plaintiffs rely on State Farm v. Allstate, 9 Cal.App.3d 508,
88 Cal.Rptr. 246 (1970) as support for recovering emotional distress
damages from a breach of the duty to defend. In State Farm, the appellate
court upheld emotional distress damages for breach of the duty to
defend. The court recognized that "[t]hus far, California decisions
dealing with refusal to defend tend to conceptualize it as a breach of
contract rather than a tort," but found that the insurer is liable for
all the detriment, including emotional distress, caused by its breach.
Id. at 530, 88 Cal.Rptr. 246.
Although no court has explicitly criticized State Farm, subsequent
decisions construe State Farm as allowing tort damages when an insurer
breaches the implied covenant, rather than the duty to defend alone. For
example, Aero-Crete, Inc. v. Superior Court cited to State Farm to
support its statement: "[B]ecause of the special duties owed by insurers
to insureds, an insurer which acts unreasonably in failing to defend its
insured may be liable for enhanced tort damages in a bad faith cause of
action." 21 Cal.App.4th 203, 213, 25 Cal.Rptr.2d 804 (1993). Similarly,
Frazier v. Metropolitan Life Ins. Co., stated that State Farm "stands for
the proposition that damages for distress may be awarded in an action for
breach of the covenant of good faith and fair dealing . . . ."
169 Cal.App.3d 90, 101, 214 Cal.Rptr. 883 (1985) (criticized on other
grounds). Likewise, Grywczynski v. Shasta Beverages, Inc., relied on
State Farm in recognizing the possibility of emotional distress damages
that resulted from the defendants' alleged breach of an implied covenant
of good faith and fair dealing. 606 F. Supp. 61, 66 (N.D.Cal. 1984).
More recently, the California Supreme Court in Erlich v. Menezes,
21 Cal.4th 543, 87 Cal.Rptr.2d 886, 981 P.2d 978 (1999), addressed
whether emotional distress damages were recoverable for breach of a
construction contract. The Supreme Court's review of cases allowing
emotional distress damages for breaches of contract did not include
breach of insurance contracts by failing to defend, although it did
recognize that tort damages were available for the breach of the implied
covenant. See id. at 551-52, 568-61, 87 Cal.Rptr.2d 886, 981 P.2d 978.
Plaintiffs' reliance on Crisci v. Security Ins. Co., 66 Cal.2d 425,
58 Cal.Rptr. 13,
426 P.2d 173 (1967) is unpersuasive. Crisci recognized that "peace of
mind and security" are among the considerations in purchasing insurance
and "recovery of damages for mental suffering has been permitted for
breach of insurance contracts." Id. at 434, 58 Cal.Rptr. 13, 426 P.2d 173.
Crisci, however, clearly viewed the failure to accept reasonable
settlements to be a duty within the implied covenant of good faith and
fair dealing. Id. at 430, 58 Cal.Rptr. 13, 426 P.2d 173. Because the
"breach also constitute[d] a tort," the court in Crisci recognized
emotional distress damages. Id. at 434, 58 Cal.Rptr. 13, 426 P.2d 173.
Finally, Plaintiffs are unable to provide the Court with a single example
of where an insured has recovered emotional distress damages in the
absence of a breach of the implied covenant.
This Court finds that California law does not support recovery of
emotional distress damages where insurer breached only its duty to
defend, but not the implied covenant. Since this Court has previously
found Defendants did not violate the implied covenant, Defendants can
not, as a matter of law, be liable for tort damages, such as Payne's
emotional distress damages, as a remedy for Defendants' breach of
D. Contractual Duty to Indemnify the Clark Settlement
In the underlying Clark action, Plaintiffs entered into a settlement in
which Plaintiffs promised to pay Clark $25,000 for past infringement, a
$5.00/unit royalty on future sales with an annual minimum of $26,500, and
$225,000 for Clark's attorney fees. Plaintiffs now seek to recover the
Clark settlement under the indemnification clause in the insurance
policies. The CGL policies obligate Defendants to pay "sums that the
Insured becomes legally obligated to pay as damages because of . . .
`advertising injury'" during the policy period. (FAC, Ex. A & B) The
question here is whether the Clark settlement or any component of it
qualify as "damages because of advertising injury."
Plaintiffs assert that they are entitled to indemnification of the
Clark settlement because the settlement is Clark's damages from Everett's
"offer to sell" patent infringement and such infringement is an
advertising injury. Under the CGL policies issued by Defendants, an
advertising injury includes injury arising out of the "misappropriation
of advertising ideas or style of doing business" or the "infringement of
. . . title." This Court held in May 1999 that policy language was
ambiguous and could reasonably be construed to cover claims for "offer to
sell" patent infringement. The Court held that Defendants owed a duty to
defend Everett in the underlying Clark suit. Plaintiffs assert that this
ruling entitles them to indemnification of the amount of the final
settlement in the Clark suit. Contrary to Plaintiffs' assertions, the May
1999 Order did not find that "offer to sell" patent infringement
constitutes a covered "advertising injury" offense. Rather, it found that
there was the possibility that "offer to sell" patent infringement
constituted an advertising injury which triggered Defendants' duty to
defend. At issue today is not the possibility of coverage, but rather the
actual existence of coverage.
At the time of the Court's ruling, the Court faced a question of first
impression as to whether "advertising injury" was broad enough to include
the "offer to sell" patent infringement created by the 1994 amendment to
Section 271 of the Patent
Act.*fn5 Subsequent to the Court's May 1999 Order, a California court
has addressed whether "advertising injury" includes "offer to sell"
patent infringement. In Maxconn Inc. v. Truck Insurance Exchange,
74 Cal.App.4th 1267, 88 Cal.Rptr.2d 750 (1999), the insurer refused to
defend its insured Maxconn against allegations that Maxconn had infringed
upon a patent by offering to sell an infringing product. Like the CGL
policies at issue here, advertising injury included misappropriation and
infringement of title. Id. at 1271, 88 Cal.Rptr.2d 750. The court held:
The advertising injury offenses contained in the Truck
policy consist of common and distinct categories of
actionable conduct. A claim for patent infringement is
also a distinct legal claim governed by a vast body of
statutory and case law. Yet, there is no mention of
patent infringement anywhere in this CGL policy. The
absence of any express reference to patent
infringement in the policy would lead a reasonable
layperson to the conclusion that patent infringement
is not covered. Id. at 1276, 88 Cal.Rptr.2d 750.
When a state court of appeals subsequently indicates that a federal court
incorrectly interpreted state law, the state court's interpretation
governs. See Owen v. United States, 713 F.2d 1461, 1464 (9th Cir. 1983).
Thus, this Court must heed the Maxconn court. Other courts have also
found that advertising injury does not include "offer to sell" patent
infringement.*fn6 See, e.g., United National v. SST Fitness, 182 F.3d 447
(6th Cir. 1999) (finding no duty to defend where complaint alleged SST
advertised an infringing product on grounds that policy did not provide
coverage for patent infringement without discussion of the 1994
amendment); Miller, Inc. v. Travelers Indem. Co., 162 F.3d 454 (6th Cir.
1998) (finding patent infringement arising from promotional material did
not constitute an "advertising injury" on the grounds that if the insurer
had intended to cover patent infringement, it would have included it in
the policy language expressly); Heritage Mutual Ins. Co. v. Advanced
Polymer Technology, Inc., 97 F. Supp.2d 913, 925-31 (S.D.Ind. 2000)
(finding that the advertising of an alleged infringing product is not
"misappropriation"); Tradesoft Technologies, Inc. v. The Franklin Mut.
Ins. Co., 329 N.J. Super. 137, 746 A.2d 1078, 1085-86 (2000); Abb Flakt,
Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA., 731 A.2d 811
(Del. 1999); FileNet Corp. v. Chubb Corp., 324 N.J. Super. 476,
735 A.2d 1203, 1215-16 (1997). In light of this recent case law, the
Clark settlement, even if wholly comprised of damages for "offer to sell"
patent infringement, is not an "advertising injury" covered under the
policies' indemnification clauses.*fn7
E. The Clark Settlement as Breach of Contract Damages
Alternatively, Plaintiffs seek to recover the Clark settlement as
damages flowing from Defendants' breach of contract in failing to defend
It is a general rule that when an insurer "improperly refused to defend
an insured, the insured is entitled to make a reasonable settlement of
the claim in good faith, and then maintain an action against the insurer
to recover the amount of the settlement." National Steel Corp. v. Golden
Eagle Ins. Co., 121 F.3d 496, 501 (9th Cir. 1997) (quoting Isaacson v.
California Ins. Guarantee Assn., 44 Cal.3d 775, 791-92, 244 Cal.Rptr. 655,
750 P.2d 297 (1988)). Furthermore, a reasonable settlement made by the
insured to terminate the underlying claim constitutes presumptive
evidence of the insured's liability on the underlying claim and the
amount of such liability. See Isaacson, 44 Cal.3d at 791,
244 Cal.Rptr. 655, 750 P.2d 297. When a settlement of the underlying
claim has been made, the question of whether the liability of the
insured was one which the contract of insurance covered is still open
and may be litigated and determined in the action brought by the insured
to recover the amount so paid in judgment. The settlement becomes
presumptive evidence only of the liability of the insured and the amount
thereof. Lamb v. Belt Casualty Co., 3 Cal.App.2d 624, 631-32, 40 P.2d 311
(1935) (relied on in Isaacson, 44 Cal.3d at 791, 244 Cal.Rptr. 655,
750 P.2d 297); see also, Pruyn v. Agricultural Ins. Co.,
36 Cal.App.4th 500, 527-28, 42 Cal.Rptr.2d 295 (1995) (quoting Lamb).
This parallels the process for recovering damages rendered in final
judgments. "When the issues upon which coverage depends are not raised or
necessarily adjudicated in the underlying action, then the insurer is
free to litigate those issues in the subsequent action and present any
defenses not inconsistent with the judgment against its insured." Pruyn,
36 Cal.App.4th at 514 n. 15, 42 Cal.Rptr.2d 295 (citing to Hogan v.
Midland National Ins. Co., 3 Cal.3d 553, 564-65, 91 Cal.Rptr. 153,
476 P.2d 825 (1970)); see also, Geddes & Smith, Inc. v. St. Paul Mercury
Indemnity Co., 51 Cal.2d 558, 561-62, 334 P.2d 881 (1959). "If, in that
subsequent action, it is determined that there was no coverage, then the
measure of damages for a wrongful failure to defend would be limited to
the costs and attorney fees expended by the insured in defending the
underlying action." Pruyn, 36 Cal.App.4th at 514 n. 15, 42 Cal.Rptr.2d 295;
see also Amato v. Mercury Casualty Co., 18 Cal.App.4th 1784, 1793-1794,
23 Cal.Rptr.2d 73 (1993). Thus, the insurer may litigate whether the
policy covered the liability underlying the settlement in the subsequent
action, and damages paid pursuant to a settlement are recoverable if the
insurance policy covered such damages.
This is consistent with Gray v. Zurich Ins. Co., in which the
California Supreme Court held an insurer liable for judgment even though
the "judgment ha[d] not necessarily been rendered on a theory within the
policy coverage." 65 Cal.2d 263, 266, 54 Cal.Rptr. 104, 419 P.2d 168
(1966) (emphasis added). The insurer in Gray had argued that it only had
to reimburse the insured's expenses in defending the third party action,
but not payment of the judgment
which the policy might not have covered. Id. at 279-80, 54 Cal.Rptr. 104,
419 P.2d 168. The court rejected this hard-and-fast rule because it would
"impose upon the insured `the impossible burden' of proving the extent of
the loss caused by the insurer's breach." Id. at 280, 54 Cal.Rptr. 104,
419 P.2d 168. The court explained:
Having defaulted such agreement the company is
manifestly bound to reimburse its insured for the full
amount of any obligation reasonably incurred by him.
It will not be allowed to defeat or whittle down its
obligation on the theory that plaintiff himself was of
such limited financial ability that he could not
afford to employ able counsel, or to present every
reasonable defense, or to carry his cause to the
highest court having jurisdiction. Id. (quoting
Arenson v. National Auto. & Cas. Ins. Co., 48 Cal.2d 528,
539, 310 P.2d 961 (1957)).
Thus, the settlement is presumptive evidence of the liability of the
insured and the amount. Gray does not preclude the insurer from
establishing that the damages were not covered under the policy in the
first place, i.e., that the insurer's breach did not proximately cause
The Court recognizes that some California courts have sanctioned
"automatic [. . .] liability for both the costs of defense and any
adverse judgment the insured suffers, even when the judgment was rendered
on a theory not within the policy coverage." Kapelus v. United Title
Guaranty Co., 15 Cal.App.3d 648, 653, 93 Cal.Rptr. 278 (1971). In support
of the statement, however, the court in Kapelus cited only to a law
review article. In Cravens, Dargan & Co. v. Pacific Indem. Co.,
29 Cal.App.3d 594, 602, 105 Cal.Rptr. 607 (1972), for example, the court
stated that "[t]he penalty for failure to defend is liability for the
full amount of a reasonable settlement." The statement, however, was
dicta because the defense was never tendered to the insurer in Cravens.
Furthermore, the support for the statement was merely that "Appellants
cite Gray v. Zurich Ins. Co. [and other cases]" indicating that the court
relied on appellants' statement of the law without independent
verification by the court. Id. Finally, in Cravens the insurance policies
at issue did cover the underlying damages. Similarly, in Wint v. Fidelity
& Casualty Co., 9 Cal.3d 257, 261, 107 Cal.Rptr. 175, 507 P.2d 1383
(1973), the pronouncement that "[i]f there is potential liability on the
part of the insurer under a policy of insurance, there is a duty to
defend, and the insurer is liable for all damages reasonably incurred by
the insured in the event of a failure to defend" was made in a case where
the insurance policy at issue covered the underlying damages.
Furthermore, Wint is consistent with Gray in that noncovered damages
would not be "reasonably incurred" as a result of the failure to defend.
Much of this confusion arises because where the failure to defend also
violates the covenant of good faith and fair dealing, courts have
generally held the insurer liable for the full settlement. As the Ninth
Circuit recently explained: "The distinction is a reasonable one. The
insured is relieved of proving the extent of damages in a bad faith
action in order to remove the insurer's incentive to strategically
disavow responsibility for the insured's defense with everything to gain
and nothing to lose." Pershing Park Villas Homeowners Ass'n, 219 F.3d at
An insured is entitled to recover all damages proximately caused by the
insurer's failure to defend. An insurer, however, is not responsible and
not required to reimburse its insured for inevitable
and unavoidable damages.*fn8 When a plaintiff defends itself in the
underlying action and incurs liability, the plaintiff may not contend
that the outcome would have been different if the insurer had defended
the action. Having chosen to defend the underlying action, Plaintiffs are
not entitled to a second bite at the apple. The Clark settlement
compensated Clark for Plaintiffs' patent infringement, and both
Plaintiffs and Defendants are bound to that outcome. This is a matter of
simple causation. Plaintiffs must show that "but for" Defendants'
breach, they would not have been liable for the Clark settlement.
However, Plaintiffs would have been liable in the Clark action whether
they defended themselves or been defended by Defendants. As a result,
Plaintiffs' obligations to pay the Clark settlement were not, as a matter
of law, caused by Defendants' failure to defend. Since there is no
coverage under the indemnification clause, "the measure of damages for a
wrongful failure to defend [is] limited to the costs and attorney fees
expended by the insured in defending the underlying action." Pruyn, 36
Cal.App.4th at 514 n. 15, 42 Cal.Rptr.2d 295. This Court has previously
awarded Plaintiffs their attorney fees in defending the Clark
For the reasons set forth above, the Court hereby GRANTS Defendants'
motion for partial summary judgment as to:
(1) Plaintiffs' Fifth and Sixth Causes of Action for
(2) Plaintiffs' Thirteen and Fourteenth Causes of
Action for Negligent Infliction of Emotional
(3) Plaintiffs' Demand for Emotional Distress Tort
Damages under their Seventh, Eighth, Ninth and Tenth
Causes of Action for Breach of Contract;
(4) Plaintiffs' Demand for Indemnification of the
Clark settlement under their Third, Fourth, Ninth and
Tenth Causes of Action; and
(5) Plaintiffs' Demand for Reimbursement of the Clark
Settlement as Damages under their Seventh, Eighth,
Ninth and Tenth Causes of Action for Breach of
The Court DENIES Plaintiffs' cross-motion for summary judgment as to
negligence, negligent infliction of emotional distress, consequential
damages for breach of the duty to defend, and Payne's standing to seek
emotional distress damages.