additional damages, such as the Clark settlement and emotional distress.
The Court also found on summary judgment that Defendants did not breach
the implied covenant of good faith and fair dealing. The Court granted
summary judgment in favor of American on Plaintiffs' claim for
intentional infliction of emotional distress against American. On January
29, 2001, Plaintiffs dropped their intentional infliction of emotional
distress against Transcontinental. Defendants then filed a joint two-part
motion for summary judgment. As a result, the issues remaining to be
addressed via summary judgment are whether: (1) Plaintiffs' negligence
claims are viable; (2) Plaintiff Payne's negligent infliction of
emotional distress claims; (3) Plaintiff Payne can recover emotional
distress damages as a remedy for breach of contract; (4) Transcontinental
has a duty to indemnify Plaintiffs for the Clark settlement; and (5)
Plaintiffs are entitled to the Clark settlement as damages for breach of
duty to defend.
III. LEGAL STANDARD
Summary judgment is proper only when there is no genuine issue of
material fact and, when viewing the evidence in the light most favorable
to the nonmoving party, the movant is clearly entitled to prevail as a
matter of law. See Fed.R.Civ.P. 56(c); Cleary v. News Corp., 30 F.3d 1255,
1259 (9th Cir. 1994). Once a summary judgment motion is made and properly
supported, the nonmoving party may not rest on the mere allegations of
its pleadings, but must set forth specific facts showing that there is a
genuine issue for trial. See Fed.R. Civ.P. 56(e); Celotex Corp. v.
Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). The
court is not to make findings of fact, but to perform the threshold
inquiry to determine whether there exists any "genuine factual issues
that properly can be resolved only by a finder of fact because they may
reasonably be in favor of either party." Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).
If the factual context makes the nonmoving party's claim implausible,
that party must come forward with more persuasive evidence than would
otherwise be necessary to show that there is a genuine issue for trial.
See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574,
587, 106 S.Ct. 1348, 89 L.Ed.2d 538 (1986). Moreover, if the nonmoving
party has the burden of proof on a given issue, the moving party can
prevail by demonstrating "that there is an absence of evidence to support
the nonmoving party's case." Celotex, 477 U.S. at 325.
Plaintiffs allege that Transcontinental breached a duty of due care
owed them by failing to consult with an attorney regarding a novel legal
issue affecting the scope of coverage. Whether California law recognizes
a negligent investigation cause of action against an insurer is a
question of law appropriate for the court to address on summary
judgment. Although contract and tort are distinct branches of California
law, "the same wrongful act may constitute both a breach of contract and
an invasion of an interest protected by the law of torts." North American
Chemical Co. v. Superior Court, 59 Cal.App.4th 764, 774, 69 Cal.Rptr.2d 466
(1997). Where the cause of action "arises from breach of a promise set
forth in contract, the action is ex contractu, but where it arises from a
breach of duty growing out of contract[,] it is ex delicto." Id. at 775,
69 Cal.Rptr.2d 466. As a result, "[e]ven where there is a contractual
relationship between the parties, a cause of action in tort may sometimes
arise out of the negligent manner in which the contractual
duty is performed." Eads v. Marks, 39 Cal.2d 807, 810, 249 P.2d 257
(1952). Thus, failure to use reasonable care in performing contractual
duties may give rise to actions sounding in tort and in contract. See,
e.g., North American Chemical Co., 59 Cal.App.4th 764, 69 Cal.Rptr.2d 466
(allowing tort action where defendant negligently failed to perform its
duties to bag and ship plaintiff's product); Allred v. Bekins Wide World
Van Services, 45 Cal.App.3d 984, 989, 120 Cal.Rptr. 312 (1975) (finding
defendant mover bound, as a matter of law, to use reasonable care and
skill and negligent failure to do so is a tort as well as a breach of
contract); Eads, 39 Cal.2d 807, 249 P.2d 257; (allowing claim for
negligent milk delivery).
An insurance contract generally imposes three duties on an insurer: (1)
the duty to make immediate inquiry into the facts of any serious accident
as soon as practicable after its occurrence; (2) the duty to employ
competent counsel to represent its insured and to provide adequate funds
for the defense of the suit; and (3) the duty to keep abreast of the
progress and status of the litigation so that it may act intelligently and
in good faith on settlement offers. Merritt v. Reserve Ins. Co.,
34 Cal.App.3d 858, 882, 110 Cal.Rptr. 511 (1973).
Defendants argue that when an insured refuses to defend, extra-contract
damages attach only if the refusal is made in bad faith, and not for mere
negligence in handling or investigating the claim. In other words, the
insurer is liable for tort damages only for breach of the implied
covenant of good faith and fair dealing, and its insured may not support
a cause of action in negligence against it. Plaintiffs argue that because
an insurer has the duty to make an investigation, an insurer can be
liable for the negligent investigation of its claim, even when the
insurer did not breach the covenant of implied faith and fair dealing.
The case law is unclear whether the negligent investigation is a breach
of the implied covenant of good faith and fair dealing, a predicate to
breach of the duty to defend, or sustainable as an independent tort. In
Egan v. Mutual of Omaha Ins. Co., the California Supreme Court found the
insurer breached the covenant of good faith and fair dealing when it
failed to thoroughly investigate the foundation for denying disability
payments to its insured. 24 Cal.3d 809, 817-19, 169 Cal.Rptr. 691,
620 P.2d 141 (1979). The court held that "it is essential that an insurer
fully inquire into possible bases that might support the insured's
claim," and "an insurer cannot reasonably and in good faith deny payments
to its insured without thoroughly investigating the foundation for its
denial." Id. at 818-19, 169 Cal.Rptr. 691, 620 P.2d 141. It viewed
failure to do so as a breach of the implied covenant of good faith and
fair dealing.*fn2 See id. at 818-19, 169 Cal.Rptr. 691, 620 P.2d 141.
See also, California Shoppers, Inc. v. Royal Globe Ins. Co.,
175 Cal.App.3d 1, 50-51, 221 Cal.Rptr. 171 (1985) (treating allegation of
inadequate investigation as an allegation of breach of the implied
More recently, in Eigner v. Worthington, 57 Cal.App.4th 188,
66 Cal.Rptr.2d 808 (1997), the court treated negligent investigation as
both a predicate for breach of the duty to defend and a possible breach
the implied covenant. While discussing an insurer s duty to defend, the
[A]n insurer may breach the implied covenant of good
faith and fair dealing by failing to properly
investigate its insured's claim. The risk that an
insurer takes when it denies coverage without
investigation is that the insured may later be able to
prove that a reasonable investigation would have
uncovered evidence to establish coverage or a
potential for coverage. In that case, the insurer will
be liable for the costs of defense already incurred by
the insured and could also be exposed to tort
liability. Id. at 195, 66 Cal.Rptr.2d 808. (internal
Whether the Eigner court meant "tort liability" to mean the implied
covenant or a separate action in negligence is unclear.
The implication that negligent investigation breaches the implied
covenant sits in tension with a second cluster of cases that require more
than negligence before finding a breach of the implied covenant. In
Sanchez v. Lindsey Morden Claims Services, Inc., the court stated that
"negligence is not among the theories of recovery generally available
against insurers. 72 Cal.App.4th 249, 254,-84 Cal.Rptr.2d 799 (1999). The
Ninth Circuit has also recognized that "[i]n California, mere negligence
is not enough to constitute unreasonable behavior for the purpose of
establishing a breach of the implied covenant of good faith and fair
dealing in an insurance case." Aceves v. Allstate Ins. Co., 68 F.3d 1160,
1166 (9th Cir. 1995); see also, National Life & Accident Ins. Co. v.
Edwards, 119 Cal.App.3d 326, 339, 174 Cal.Rptr. 31 (1981); Brown v.
Guarantee Ins. Co., 155 Cal.App.2d 679, 319 P.2d 69 (1957).
Defendants rely on Tento International v. State Farm, 222 F.3d 660 (9th
Cir. 2000) for their argument that California does not recognize a
separate negligence claim against insurers. In Tento, an insured sued its
insurer for negligently denying coverage. The trial court found the claim
was not covered by the insurance policy. On appeal, the Ninth Circuit
found that the policy covered the claim, but in remanding, the court
questioned whether the negligent handling claim was viable under
California law after Sanchez and Aceves. See id. at 664. This, of
course, is dicta since it is not necessary to determining coverage.
Furthermore, neither Sanchez nor Aceves are negligent handling claims
against an insurer. Sanchez held that an independent insurance adjuster
did not owe a duty of care to an insured, but did not speak to whether
the insurer itself owes its insured such a duty. 72 Cal. App.4th at
253-55, 84 Cal.Rptr.2d 799. Aceves involved negotiations between the
insurer and insured for damage done to the insureds' house. 68 F.3d 1160.
There the court held that the standard of care an insurer owes its
insured under the covenant of good faith and fair dealing when
negotiating with its insured depends on whether the insured is
represented by counsel. Id. at 1167.
Plaintiffs argue that California law does support a negligence
investigation claim against an insurer separate from the duty to defend
and the implied covenant. Plaintiffs principally rely on Merritt,
34 Cal.App.3d 858, 110 Cal.Rptr. 511 (1973) and Pershing Park Villas
Homeowners Ass'n. v. United Pacific Ins. Co., 219 F.3d 895 (9th Cir.
2000). In Merritt, the insured sued its insurer for the negligent conduct
of the litigation. The Court, after holding the insurer was not liable
for the negligence of counsel, indicated that the insurer "remains liable
for the negligent performance of its own duties." 34 Cal.App.3d at
881-82, 110 Cal.Rptr. 511. Merritt involved an insurer's duty to select
counsel, not the' duty to investigate. The duty to
select counsel differs from the duty to investigate in that there is an
underlying duty to defend flowing from the duty to investigate. An
insurer's duty to defend is triggered by the possibility of coverage, and
an insurer has the burden of showing that at the time of tender, the
tendered claim can not be covered under the policy. See Montrose Chemical
Corp. v. Superior Court, 6 Cal.4th 287, 300, 24 Cal.Rptr.2d 467,
861 P.2d 1153 (1993). When an insurer 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,
229 Cal.Rptr. 192.
Assuming arguendo, Bogard survives Soto and an insured may state a
claim of negligent infliction of emotional distress against its insured,
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. Brayerinan, 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. Metropolilan 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. 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.