Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-4_04-cv-03791/USCOURTS-cand-4_04-cv-03791-5/pdf.json

Parties Involved:
Gregory S. Daily
Counter-defendant
Federal Insurance Company
Counter-claimant
Royal Insurance Company of America
Counter-claimant

Document Text:

United States District Court

For the Northern District of California

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United States District Court

For the Northern District of California

NOT FOR CITATION

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

GREGORY S. DAILY,

Plaintiff, No. C 04-3791 PJH

v. ORDER DENYING MOTION 

TO DISMISS

FEDERAL INSURANCE COMPANY,

et al.,

Defendants.

_______________________________/

Before the court is the motion of defendant Federal Insurance Company for an order

dismissing the second and third causes of action in the second amended complaint. Having

read the parties’ papers and carefully considered their arguments and the relevant legal

authority, and good cause appearing, the court hereby DENIES the motion for the following

reasons.

INTRODUCTION

This is an insurance coverage dispute involving an executive liability and

indemnification policy (“the D&O policy”). The action was filed by plaintiff Gregory S. Daily in

the San Francisco Superior Court, and was removed to this court by defendants Federal

Insurance Company (“Federal”) and Royal Insurance Company of America (“Royal”). In the

original complaint, filed August 20, 2004, Daily alleged a single cause of action against

Case 4:04-cv-03791-PJH Document 125 Filed 08/19/05 Page 1 of 6
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For the Northern District of California

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Federal (which issued the D&O policy) – for declaratory relief regarding coverage. In the

prayer for relief, Daily also requested “injunctive relief to compel Federal to comply with its

coverage obligations, including without limitation the obligation to advance defense costs.” In

the first amended complaint, filed August 26, 2004, Daily added Royal (which had issued the

excess liability policy) as a defendant. 

Federal and Royal filed counterclaims, which were dismissed in the order granting

Daily’s motion to dismiss. Federal filed a motion for summary judgment on the issue of

coverage, which was denied. Daily then filed a second amended complaint (“SAC”) on May

31, 2005, alleging additional facts and causes of action against Federal only, for breach of

contract and breach of the implied covenant of good faith and fair dealing. The SAC asserts

that Federal breached the contract by failing to pay Daily’s defense costs incurred to date in

the underlying state court suit, and that this breach was in “bad faith.” Daily seeks

compensatory and punitive damages. Federal now moves to dismiss the causes of action for

breach of contract and breach of the implied covenant, for failure to state a claim.

DISCUSSION

A. Legal Standard

Motions to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a

claim are disfavored, see Gilligan v. Jamco Dev. Corp., 108 F.3d 246, 249 (9th Cir. 1997),

and 12(b)(6) dismissals are proper only in “extraordinary” cases. See United States v. City of

Redwood City, 640 F.2d 963, 966 (9th Cir. 1981). A court should dismiss for failure to state a

claim only where it appears beyond doubt that plaintiff can prove no set of facts in support of

the claim which would entitle the plaintiff to relief. See Conley v. Gibson, 355 U.S. 41, 45-46

(1957); Pillsbury, Madison & Sutro v. Lerner, 31 F.3d 924, 928 (9th Cir. 1994). Review is

limited to the contents of the complaint. Allarcom Pay Television, Ltd. v. Gen. Instrument

Corp., 69 F.3d 381, 385 (9th Cir. 1995). All allegations of material fact are taken as true and

construed in the light most favorable to the nonmoving party. Smith v. Jackson, 84 F.3d 1213,

1217 (9th Cir. 1996). 

/ / /

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 According to the SAC, Daily has submitted “defense bills totaling $4,604,257.22.” 

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B. Federal’s Motion to Dismiss

Federal moves to dismiss the breach of contract and breach of the implied covenant

claims, arguing that in a situation where Federal and the insured cannot agree on the amount

of defense costs to be advanced, the policy requires Federal to “advance on a current basis”

those defense costs “which the Company [Federal] believes to be covered under this

coverage section until a different allocation is negotiated, arbitrated, or judicially determined.” 

Federal Policy, ¶ 12, as amended by Endorsement No. 1, ¶ 7. Federal has advanced some

costs to Daily, but argues that the parties have not come to any agreement regarding the

proper allocation of costs, and that Federal is therefore within its rights to refuse to pay the

entire amount that Daily claims is owing.1

Federal also asserts that the “bills” submitted by Daily cannot be considered

“reasonable defense costs” because the information submitted by Daily is so inadequate that

it is impossible for Federal to determine whether the costs were “incurred in defending or

investigating Claims” (as specified in the policy). Federal asserts that it has repeatedly

advised Daily’s counsel about the deficiencies in the submitted bills, and has invited

submission of the bills to a neutral evaluator, but that Daily’s counsel has never responded to

Federal’s questions or concerns. Thus, Federal asserts, the parties are apparently at an

impasse, and Federal is permitted under the terms of the policy to advance only those costs

that it believes to be covered. Federal asserts that after applying the policy’s $250,000

deductible, it has advanced to Daily the sum of $511,420, and has satisfied its contractual

obligations. 

Federal contends that the breach of contract claim should be dismissed for failure to

state a claim. Federal argues in addition that because Daily has not stated a claim for breach

of contract, Daily cannot state a claim for “bad faith.” In California, an insurer cannot base a

claim for breach of the implied covenant of good faith and fair dealing on conduct by an

insurer that does not violate the express terms of the insurance policy. Waller v. Truck Ins.

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Exchange, Inc., 11 Cal. 4th 1, 36 (1995). Thus, Federal asserts, a “bad faith” claim cannot lie

where the insurer’s action is authorized by the contract. 

In opposition, Daily argues that he has stated both a valid breach of contract claim and

a valid “bad faith” claim, and that the motion to dismiss should be denied. He contends that

Federal is not really arguing that the complaint is insufficient to state a claim for breach of

contract, but rather is arguing that evidence from outside the complaint shows that there has

been no breach of contract. According to Daily, Federal is arguing that under the policy, in the

event of a disagreement about the payment of costs, Federal is entitled to unilaterally decide

how much it should pay, and that in this case, because Daily and Federal disagree about the

allocation, Federal’s decision that 80% of the defense costs are not covered is appropriate

and cannot be a breach of contract as a matter of law. 

Daily contends, by contrast, that the SAC alleges that Federal breached the contract by

insisting on an allocation where none is required under the policy, and that Federal has

breached the contract by failing to pay defense costs as the invoices have been submitted for

payment. Daily also asserts that the language regarding “allocation” quoted by Federal

applies only where a claim results in a loss that is covered and a loss that is not covered under

the policy, and that in such a case the parties must reach agreement on allocation. Daily

contends that under this provision, a claim that involves only costs incurred to defend a

director or officer for covered matters – as is the case here – will involve no allocation, and the

insurance company must pay on a current basis without allocating. If it fails to do so, as Daily

claims Federal has done here, then it has breached the contract. Daily contends that Federal

is attempting to mislead the court when it says that Daily and Federal have been unable to

agree on the allocation of defense costs, because, in fact, there is no question of “allocation.” 

Daily claims that the definition of “Loss” in the policy, which includes defense costs, requires

that a D&O insurer pay legal expenses as they are incurred (citing Gon v. First State Ins. Co.,

871 F.2d 863, 868 (9th Cir. 1989; Okada v. MGIC Indem. Corp., 823 F.2d 276, 280 (9th Cir.

1986)). 

Finally, Daily argues that there is no basis to dismiss the bad faith claim, as Federal’s

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argument is based on its erroneous argument that Daily has not stated a claim for breach of

contract. Daily contends in addition that Federal’s behavior in making an arbitrary decision to

pay far less than the amount of the bills submitted by Daily can be interpreted as acting in bad

faith, and that the SAC so alleges. Thus, Daily argues, the motion to dismiss the bad faith

claim should be denied. 

In reply, Federal reiterates that Daily has not stated either a breach of contract claim or

a bad faith claim. Federal disputes Daily’s interpretation of the “allocation” provision, arguing,

in essence, that the parties do disagree on which of the claimed costs are covered and which

are not – and that the “allocation” provision therefore applies. Federal argues that the result of

adopting Daily’s interpretation of the policy would be the conclusion that so long as Daily

argues that all submitted bills are for covered costs, then Federal is obligated to pay the full

amount. 

Federal notes that under the policy, Daily has always been free, if dissatisfied with the

amount Federal had advanced, to seek a different allocation through negotiation, arbitration,

or judicial determination. However, he has not done this, and instead has taken the position

that whatever legal bills he submits to Federal – in whatever amount – must be paid when

submitted. Federal argues that the only reasonable construction of § 12 of the policy is that

the phrase “advance on a current basis” means that Federal’s obligation to pay arises only

when Federal actually has, or could reasonably have, formulated a belief as to the scope and

amount of coverage available under the policy. 

Federal argues further that its position is supported by an unreported decision from the

Southern District of California, Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co., 2004 WL

2958479 (S.D. Cal. 2004), in the which the district court rejected the same argument that

Daily has made here, and has distinguished the cases on which Daily relies here. Federal

asserts that under the reasoning of the Pan Pacific court, Daily has not pleaded, and cannot

plead, a breach of contract claim on the basis of Federal’s decision to advance what it

believes to be covered. 

The court finds that the motion must be DENIED. Construing the allegations in the light

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most favorable to Daily, the court finds that the SAC states a claim for breach of contract and

breach of the implied covenant. The real question raised by Federal’s motion – whether the

policy requires Federal to pay defense costs on an ongoing basis – should be resolved on

summary judgment, not on a 12(b)(6) motion. In addition, the present motion papers refer to

evidence from outside the complaint, and there appear to be disputed factual issues, not

appropriate for resolution on a 12(b)(6) motion. 

CONCLUSION

In accordance with the foregoing, the court hereby DENIES Federal’s motion to

dismiss. Because Daily amended the complaint to add the causes of action for breach of

contract and breach of the implied covenant after the court had ruled on Federal’s previous

motion for summary judgment, the court will permit Federal to file a second motion for

summary judgment after the close of discovery, on those two claims and only those two

claims. 

IT IS SO ORDERED.

Dated: August 19, 2005 

______________________________

PHYLLIS J. HAMILTON

United States District Judge

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