Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_07-cv-04355/USCOURTS-cand-3_07-cv-04355-0/pdf.json

Nature of Suit Code: 110
Nature of Suit: Insurance
Cause of Action: 28:1441 Petition for Removal- Insurance Contract

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United States District Court

For the Northern District of California

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UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

CAPITAL BUSINESS SERVICE, INC., 

ET AL.,

Plaintiffs,

v.

TRAVELERS COMPANIES, INC.,

ET AL., 

Defendants.

___________________________________/

No. C-07-04355 JCS

ORDER DENYING MOTION TO DISMISS

PURSUANT TO FEDERAL RULE 12(b)(6),

OR IN THE ALTERNATIVE, MOTION TO

COMPEL ARBITRATION UNDER CIVIL

CODE SECTION 2860 [Docket No. 6]

I. INTRODUCTION

On August 2, 2007, Capital Business Service, Inc. and Stewart J. Burch filed this action in

the Superior Court for the State of California, County of San Francisco, against Defendants

Travelers Companies, Inc., St. Paul Mercury Insurance Company, St. Paul Marine Insurance

Company, and St. Paul Travelers, asserting claims for breach of contract and breach of implied

covenant of good faith and fair dealing. On August 23, 2007, Defendants removed the case to the

United States District Court for the Northern District of California. All parties have consented to the

jurisdiction of a United States magistrate judge, pursuant to 28 U.S.C. § 636(c). Defendants bring a

Motion to Dismiss Pursuant to Federal Rule 12(b)(6), or in the Alternative, Motion to Compel

Arbitration Under Civil Code Section 2860 (“the Motion”). The Court finds that the Motion is

suitable for determination without oral argument, pursuant to Civil Local Rule 7-1(b). For the

reasons stated below, the Motion is DENIED. The hearing scheduled for November 30, 2007 at

9:30 a.m. is VACATED.

Case 3:07-cv-04355-JCS Document 18 Filed 11/08/07 Page 1 of 9
United States District Court

For the Northern District of California

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 For the purposes of this Motion, the Court accepts Plaintiff’s allegations of fact as true.

Balistreri v. Pacifica Police Dep’t, 901 F.2d 696, 699 (9th Cir. 1990). 

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II. BACKGROUND

A. The Complaint1

Plaintiff Capital Business Service, Inc. (“Capital Business”) is a California corporation

conducting business in Napa County, California, as an enrolled agent and tax preparer. Compl. ¶ 1. 

Plaintiff Stewart Burch is an officer and employee of Plaintiff Capital Business, and is a licensed

enrolled agent and tax preparer. Compl. ¶ 2. Defendant Travelers Companies, Inc. (“Travelers”) is

a property and casualty insurer, and owns St. Paul Fire and Marine Insurance Company and/or St.

Paul Mercury Insurance Company (“St. Paul”). Compl. ¶ 3. In May 1991, Plaintiff Capital

Business purchased Enrolled Agents Professional Liability Insurance (the “Insurance Policy” or “the

Policy”) through Wraith & Associates, Inc., and authorized agent of Defendants. Compl. ¶ 6. In

May 2001, St. Paul renewed Plaintiff’s Insurance Policy for the period May 23, 2001, to May 23,

2002. Compl. ¶ 7, Ex. A. In their Complaint, Plaintiffs allege that Defendants agreed, pursuant to

the Insurance Policy, to defend Plaintiffs against claims made during the policy period and

indemnify them for covered losses resulting from the performance of professional services and

caused by a wrongful act committed before the end of the policy period. Compl. ¶ 8. 

In June 2001, Plaintiffs were sued in Napa County Superior Court by Andrew Nielsen and

Gudveig Nielsen (“the Nielsens”). The Nielsens asserted nine causes of action against Plaintiffs and

two other non-insured defendants – Tracy Visher and Bordeaux Limousine. Compl., Ex. B (“the

Underlying Complaint” or the “Underlying Case”). According to Plaintiffs, the Nielsens’ claim of

professional negligence and damages was directly covered, while other claims were potentially

covered by the Policy. Compl. ¶ 10. In July 2001, Plaintiffs tendered the defense of the Underlying

Complaint to St. Paul. Compl. ¶ 11. On February 18, 2002, Defendants issued a reservation of

rights letter which states in relevant part: 

There is a potential for coverage under the St. Paul policy to the

claims asserted against Stewart. J. Burch and Capital Business

Service, Inc. as allegations against these defendants have been made

that potentially involve wrongful acts as an enrolled agent. However,

the claims asserted against you may not be covered if they do not

Case 3:07-cv-04355-JCS Document 18 Filed 11/08/07 Page 2 of 9
United States District Court

For the Northern District of California

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involve wrongful acts as an enrolled agent. Most of the allegations

please (sic) in the Complaint fall in this category. Further, certain

claims are specifically excluded from the coverage. [. . . ] 

St. Paul will provide Stewart J. Burch and Capital Business Service,

Inc., with a defense to the suit, subject to a complete reservation of

rights, in view of the potential for coverage for some of the claims

asserted. As we discussed, we will agree to your continued

representation by the Gaw, Van Male, Smith, Myers & Miroglio law

firm. In view of the reservation of rights, you have the right to be

represented by counsel of your choice, subject to the requirements of

California Civil Code Section 2860 [. . .]. We have approved a rate up

to $140 per hour for partner for your selected counsel.

Under existing California law, St. Paul can reserve its rights to recover

from the insured defendants all defense costs incurred on non-covered

claims after the conclusion of this litigation. In lieu of this, we agreed

with you to pay 25% of your reasonable defense costs for the total

action. This means we will pay at the agreed upon rate for your

defense cost to the entire action, and are hereby waiving our rights to

seek a future apportionment of defense costs between covered and

non-covered claims. 

Compl., Ex. C (Reservation of Rights Letter (“RRL”)), at 18-19. Plaintiffs allege that from February

18, 2002, until October 2006, when the litigation in the Underlying Case was resolved, Defendants

failed to pay for Plaintiffs’ defense, other than on the basis stated in the RRL, and refused to renew

Plaintiffs’ professional liability insurance. Compl. ¶ 11:3-6.

On the basis of these factual allegations, Plaintiffs assert claims of breach of contract and

breach of implied covenant of good faith and fair dealing. Specifically, Plaintiffs claim that

Defendants have breached their contract with Plaintiffs by failing and refusing to defend Plaintiffs

and to pay for Plaintiffs’ defense costs in accordance with the terms of the Policy and applicable

law. Compl. ¶ 17. Further, Plaintiffs contend that, by allocating defense costs arbitrarily and

unreasonably, Defendants have violated the implied covenant of good faith and fair dealing implied

in the insurance contract between Plaintiffs and Defendants. In support of this claim, Plaintiffs

assert that around the time of the RRL and during the defense of the complaint in the Underlying

Case, Defendants had a policy of refusing to provide their insured clients with a defense and to pay

all defense expenses when the claims involved “mixed claims,” and unfairly and arbitrarily

allocating contribution to defense expenses. Compl. ¶ 20.

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B. The Underlying Case

In the Underlying Case, the Nielsens (or “Underlying Plaintiffs”) filed a complaint against

Defendants Capital Business, Stewart Burch, Tracy Visher, and Bordeaux Limousine Service

(collectively, “Underlying Defendants”). Compl., Ex. B (complaint in Underlying Case

(“Underlying Complaint”)). While Capital Business and Burch were insured under the St. Paul

Insurance Policy, Tracy Visher and Bordeaux Limousine Services were not. Compl., Ex. A

(Insurance Policy). The Underlying Plaintiffs asserted causes of action for breach of fiduciary duty,

breach of confidence, constructive fraud, fraud, fiduciary abuse, conversion, rescission, violation of

the California Corporations Code Section 25401, professional negligence, intentional infliction of

emotional distress, and civil conspiracy. Compl., Ex. B (Underlying Complaint).

The Underlying Complaint alleged that Stewart Burch was retained by the Nielsens as a tax

and financial advisor in December 1999. Underlying Compl. ¶ 7-22. In May 2000, Burch allegedly

convinced the Nielsens to join him and Visher in investing in Bordeaux Limousine Service, in the

Napa Valley. Underlying Compl. ¶ 15. The Nielsens agreed and borrowed $450,000 against their

residence in order to make the loan. Underlying Compl. ¶ 18. The Nielsens alleged that, after they

made the $450,000 investment, the Underlying Defendants refused to perform their promises and

excluded the Nielsens from any involvement in Bordeaux’s business. Underlying Compl. ¶ 22. 

Burch and Capital Business tendered the defense against Nielsens’ claims to St. Paul on June

13, 2001. Compl. ¶ 11.

C. The Motion

In the Motion, Defendants assert that the Court should dismiss the Complaint pursuant to

Rule 12(b)(6) of the Federal Rules of Civil Procedure on the basis that there was a defense

agreement between the parties governing the payment of attorneys’ fees in the Underlying Case and

Defendants abided by that agreement. In support of their position, Defendants point to the RRL,

which is considered part of the complaint on a Rule 12 Motion, and in particular, to the sentence, 

“we have agreed with you to pay 25% of your reasonable defense costs for the total action.” Compl.

Ex. C at 7 (emphasis added). Even if the Court finds that there is a material dispute of fact regarding

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Plaintiffs’ entitlement to attorneys’ fees, Defendants argue, this action should be submitted to

binding arbitration pursuant to California Civil Code Section 2860. 

Plaintiffs argue that dismissal under Rule 12(b)(6) is improper because they do not concede

the existence of a defense agreement with Defendants and the RRL attached to the Complaint does

not amount to an admission that such an agreement existed. Rather, Plaintiffs argue, the RRL

merely indicates that there is a material dispute of fact as to whether the parties entered into a

defense agreement. Plaintiffs also reject Defendants’ assertion that arbitration is appropriate under

California Civil Code Section 2860, arguing that that provision requires arbitration only where the

sole issue to be resolved is the amount of attorneys’ fees. 

IV. ANALYSIS

A. Subject Matter Jurisdiction 

Pursuant to 28 U.S.C. § 1332, “[t]he district courts shall have original jurisdiction of all civil

actions where the matter in controversy exceeds the sum or value of $75,000, exclusive of interests

and costs, and is between . . . citizens of different states.” Pursuant to 28 U.S.C. § 1441(b), any civil

action of which the district courts have original jurisdiction, except if founded on a claim or right

arising under the Constitution, treaties or laws of the United States, “shall be removable only if none

of the parties of interest properly joined and served as defendants is a citizen of the State in which

such action is brought.” Here, Plaintiffs Capital Business and Stewart Burch are citizens of the State

of California. Defendants Travelers Companies, Inc., St. Paul Mercury Insurance Company, St. Paul

Marine Insurance Company, and St. Paul Travelers are citizens of the State of Minnesota. Because

Plaintiffs assert two causes of action alleging damages in excess of $122,000, the matter in

controversy exceeds $75,000, exclusive of interests and costs. Accordingly, this Court has subject

matter jurisdiction under 28 U.S.C. §§ 1332 and 1441. 

B. Choice of law 

A federal district court sitting in diversity applies state substantive law and federal

procedural rules. See Erie R. Co. v. Tomkins, 304 U.S. 64, 78 (1938). In determining which state’s

substantive law applies to state law claims, a federal district court applies the choice of law

principles of the state in which it sits. Arno v. Club Med. Inc., 22 F.3d 1464, 1467 (9th Cir. 1994). 

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Under California choice of law principles, California substantive law applies, unless a “true conflict”

is found between the laws of the potentially interested states. Id. Because the parties are in

agreement that the applicable substantive law is the law of California, the Court applies California

law in addressing the arguments raised in Defendants’ Motion.

C. The Motion under Rule 12(b)(6)

1. Legal Standard Under Rule 12(b)(6)

A complaint may be dismissed for failure to state a claim for which relief can be granted

under Rule 12(b)(6) of the Federal Rules of Civil Procedure. Fed. R. Civ. P. 12(b)(6). “The purpose

of a motion to dismiss under Rule 12(b)(6) is to test the legal sufficiency of the complaint.” N. Star

Int’l v. Ariz. Corp. Comm’n, 720 F.2d 578, 581 (9th Cir. 1983). Generally, a plaintiff’s burden at the

pleading stage is relatively light. Rule 8(a) of the Federal Rules of Civil Procedure states that “[a]

pleading which sets forth a claim for relief . . . shall contain . . . a short and plain statement of the

claim showing that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a). 

 In ruling on a motion to dismiss under Rule 12, the court analyzes the complaint and takes

“all allegations of material fact as true and construe(s) them in the lights most favorable to the nonmoving party.” Parks Sch. of Bus. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995). Dismissal may

be based on a lack of a cognizable legal theory or on the absence of facts that would support a valid

theory. Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1990). A complaint must

“contain either direct or inferential allegations respecting all the material elements necessary to

sustain recovery under some viable legal theory.” Bell Atl. Corp. v. Twombley, 127 S. Ct. 1955,

1969 (2007) (citing Car Carriers, Inc. v. Ford Motor Co., 745 F.2d 1101, 1106 (7th Cir. 1984)). 

The factual allegations must be definite enough to “raise a right to relief above the speculative

level.” Id. at 1965. However, a complaint does not need detailed factual allegations to survive

dismissal. Id. at 1964. Rather, a complaint need only include enough facts to state a claim that is

“plausible on its face.” Id. at 1974. That is, the pleadings must contain factual allegations

“plausibly suggesting (not merely consistent with)” a right to relief. Id. at 1965 (noting that this

requirement is consistent with Fed. R. Civ. P. 8(a)(2), which requires that the pleadings demonstrate

that “the pleader is entitled to relief”). 

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The Court “may consider material which is properly submitted as part of the complaint on a

motion to dismiss without converting the motion to dismiss into a motion for summary judgment.”

Gordon v. Impulse Mktg. Group, Inc., 375 F. Supp. 2d 1040, 1044 (E.D. Wash. 2005) (citing Lee v.

City of Los Angeles, 250 F.3d 668, 688 (9th Cir. 2001)). If the documents are not physically

attached to the complaint, they may be considered if the documents’ authenticity is not contested and

the plaintiff’s complaint necessarily relies on them. Id. at 1044. 

2. Significance of Purported Defense Agreement

Plaintiffs claims in this case are based, in large part, upon the right of insureds to retain socall “Cumis counsel” where the insurer defends under a reservation of rights. See San Diego Fed.

Credit Union v. Cumis Ins. Soc’y, 162 Cal. App. 3d 358 (1984). California Civil Code Section

2860(c) sets forth rules governing payment by the insurer of Cumis counsel fees but states that

“[t]his subdivision does not invalidate other different or additional policy provisions pertaining to

attorney's fees or providing for methods of settlement of disputes concerning those fees.” 

Defendants assert that this language permits insurers and insureds not only to include policy

provisions that modify the obligations set forth in section 2860 but also to enter into defense

agreements that modify those obligations. Defendants further assert that the RRL attached to the

Complaint represents an admission by Plaintiffs of the existence of such an agreement and that as

Plaintiffs have conceded that Defendants abided by the terms of the agreement described in th RRL,

their claims fail. Defendants’ argument has no merit.

A statement of fact made by a party in its pleadings is considered a judicial admission, and is

conclusive with respect to that fact unless the pleading is amended or the statement is otherwise

withdrawn. Sicor Ltd. v. Cetus Corp., 51 F.3d 848, 859-60 (9th Cir.1995). However, to be binding,

judicial admissions must be unequivocal. In re Teleglobe Commc’ns Corp., 493 F.3d 345, 377 (3rd

Cir. (Del.) Jul.17, 2007). There is no unequivocal admission here. The RRL, at the most, reflects

that Defendants’ may have believed that they had entered into an agreement with Plaintiffs regarding

defense costs. There is no basis for construing attachment of the RRL to the Complaint as an

endorsement by Plaintiffs of Defendants’ belief. To the contrary, the allegations in the Complaint

indicate that Plaintiffs interpreted the RRL as a refusal by Defendants to meet their obligations under

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 In their Reply brief, Defendants appear to suggest, for the first time, that the terms set forth

in the RRL were proper, as a matter of law, because the Underlying Case involved claims against

individuals who were not insured under the Policy as well as claims against individuals who were.

Because this argument was not raised in the original Motion, the Court declines to address it.

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the Policy. See Compl., ¶ 11. In the absence of an admission regarding the existence of a defense

agreement between the parties, Defendants’ assertion that the Complaint should be dismissed under

Rule 12(b)(6) fails.2

C. The Motion to Compel Arbitration 

1. Binding Arbitration Under California Civil Code Section 2860

Defendants assert that even if there is a factual dispute regarding Plaintiffs’ entitlement to

fees for Cumis counsel, it should be resolved by binding arbitration under Cal. Civ. Code Section

2860(c). The Court disagrees.

Section 2860(c) provides, in relevant part, as follows:

The insurer’s obligation to pay fees to the independent counsel

selected by the insured is limited to the rates which are actually paid

by the insurer to attorneys retained by it in the ordinary course of

business in the defense of similar actions in the community where the

claim arose or is being defended. This subdivision does not invalidate

other different or additional policy provisions pertaining to attorney’s

fees or providing for methods of settlement of disputes concerning

those fees. Any dispute concerning attorney fees not resolved by these

methods shall be resolved by final and binding arbitration by a single

neutral arbitrator selected by the parties to the dispute.

Cal. Civ. Code § 2860(c). California courts have held that this provision applies only to disputes

that are limited to the amount of legal fees or the hourly billing rates. See Fireman’s Fund Ins. Cos.

v. Younesi, 48 Cal. App. 4th 451, 459. (Ct. App. 1996); Gray Cary Ware & Freidenrich v. Vigilant

Ins. Co., 114 Cal. App. 4th 1185, 1192 (Ct. App. 2004). 

In Younesi, a liability insurer (“FFI”) brought an action against insured’s independent

counsel alleging six causes of action: excessive duplicative billings, fraud, negligent

misrepresentation, breach of contract, conversion, malpractice and violation of the California Unfair

Trade Practices Act. Younesi, 48 Cal. App. 4th at 455. The defendant, in turn, filed a motion

seeking to compel arbitration pursuant to Section 2860(c). Id. at 456. The trial court denied the

motion and the court of appeal affirmed, holding that Section 2860(c) did not apply because the case

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was not merely a dispute about billing rates; rather, FFI alleged that Younesi’s conduct was part of a

fraudulent scheme to cheat insurance companies of thousands of dollars. Id. at 458. Therefore, the

court reasoned, compelling arbitration would effectively violate FFI’s right to a jury trial. Id. at 458-

59. The court concluded that the arbitration provision in Section 2860(c) only covers disputes “in

which only the amount of legal fees or the hourly billing rates are at issue.” Id. at 459.

Here, Plaintiffs claim that Defendants have breached the insurance contract, and breached the

implied covenant of good faith and fair dealing. In support of these claims, Plaintiffs allege that

around the time of the RRL and during the defense of the complaint in the Underlying Case,

Defendants had a policy of refusing to provide their insured clients with a defense and to pay all

defense expenses when the claims involved “mixed claims,” and unfairly and arbitrarily allocating

contribution to defense expenses. Thus, Plaintiffs’ complaint involves more than just an issue of the

amount of Cumis counsel fees and falls outside the ambit of Section 2860(c). 

V. CONCLUSION

For the reasons stated above, the Court DENIES the Motion in its entirety. 

IT IS SO ORDERED. 

Dated: November 8, 2007

__________________________

JOSEPH C. SPERO

United States Magistrate Judge

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