Lee v. Interinsurance Exchange

• Decision Date: 31 October 1996
• Docket Number: No. B089335,B089335
• Citation: 50 Cal.App.4th 694,57 Cal.Rptr.2d 798
• Court: California Court of Appeals Court of Appeals
• Parties: , 96 Cal. Daily Op. Serv. 8021, 96 Daily Journal D.A.R. 13,278 Woo Chul LEE, et al., Plaintiffs and Appellants, v. INTERINSURANCE EXCHANGE OF THE AUTOMOBILE CLUB OF SOUTHERN CALIFORNIA, et al., Defendants and Respondents.

Page 798

57 Cal.Rptr.2d 798

50 Cal.App.4th 694, 96 Cal. Daily Op. Serv. 8021,

96 Daily Journal D.A.R. 13,278

Woo Chul LEE, et al., Plaintiffs and Appellants, v. INTERINSURANCE EXCHANGE OF THE AUTOMOBILE CLUB OF SOUTHERN CALIFORNIA, et al., Defendants and Respondents.

No. B089335.

Court of Appeal, Second District, Division 3, California.

Oct. 31, 1996.

Review Denied Jan. 22, 1997.

Arter & Hadden, Edwin W. Duncan, Richard L. Fruin, William S. Davis, and Keith E. Hall, Los Angeles, for Plaintiffs and Appellants.

Morrison & Foerster, Seth M. Hufstedler and John Sobieski, Los Angeles, for Defendants and Respondents.

Greines, Martin, Stein & Richland, Robert A. Olson and Barry M. Wolf, Beverly Hills; Pillsbury, Madison & Sutro, Robert M. Westberg, San Francisco, and Joseph A. Hearst, Berkeley, as amici curiae on behalf of Defendants and Respondents.

CROSKEY, Acting Presiding Justice.

Three years ago, in Barnes v. State Farm Mut. Auto. Ins. Co. (1993) 16 Cal.App.4th 365, 20 Cal.Rptr.2d 87 (hereafter, "Barnes "), this court considered, among other issues, the question of whether a policyholder of a mutual insurance company can object to, or seek judicial assistance to control, the insurer's maintenance, management and disbursement of surplus funds. We answered that question in the negative. (Id. at pp. 378-380, 20 Cal.Rptr.2d 87.)

The present action, brought by subscribers and former subscribers of the Interinsurance Exchange of the Automobile Club of Southern California (hereafter, "the Exchange"), raises essentially the same question. ¹ However, unlike the defendant mutual insurer in Barnes, the Exchange is a reciprocal insurer, organized under chapter 3 Reciprocal insurers, alternatively called interinsurance exchanges, differ from mutual insurers in some details of structure and legal status. However, as we shall explain, the differences between mutual and reciprocal insurers are not of a kind which justify different rules respecting their insured's right to control business decisions of the insurer's governing board. We thus conclude that a reciprocal insurer, like a mutual insurer, is subject to the common law business judgment rule, which we relied upon in Barnes, supra, and which protects the good faith business decisions of a business organization's directors, including decisions concerning the maintenance, management and disbursement of an insurer's surplus funds, from interference by the courts.

(§ 1280 et seq., "Reciprocal Insurers,") of Division 1, Part 2 of the Insurance Code. ²

This action is against the Exchange; its Board of Governors and eleven of its members and former members (hereafter, collectively, "the Board"); the Automobile Club of Southern California ("the Club"); and ACSC Management Services, Inc. ("ACSC"). The plaintiffs appeal from a judgment of dismissal after the defendants' demurrer to the third amended complaint was sustained without leave to amend. We agree with the trial court's conclusion that plaintiffs failed to allege facts sufficient to constitute a cause of action against the defendants on any theory, because (1) the business judgment rule precludes judicial interference with the Board's good faith management of Exchange assets, (2) the plaintiffs have not alleged facts which establish a lack of good faith or a conflict of interest in the Board's management of Exchange assets, and (3) the plaintiffs, in executing Subscriber's Agreements with the Exchange, have contractually agreed to delegate control over Exchange assets to the Board, and such agreement is neither unconscionable nor unenforceable. We therefore affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

1. Introduction

The Exchange is a reciprocal insurer, organized by the Club to provide insurance to Club members. The Club is a nonprofit corporation. In addition to the Exchange, the Club also organized, and is the parent organization of, co-defendant ACSC. Section 1305 provides for a reciprocal insurer's insurance contracts to be executed by an attorney-in-fact, which may be a corporation. ACSC is the attorney-in-fact for the Exchange. ³

ACSC derives its management authority from powers-of-attorney which are included in the Subscriber's Agreements executed by subscribers when they purchase insurance from the Exchange. The Subscriber's Agreements also (1) delegate to the Board the subscribers' rights of supervision over the attorney-in-fact; (2) provide that the subscriber agrees to be bound by the Bylaws and Rules and Regulations adopted by the Board; (3) warrant that subscribers shall not be liable in excess of their premiums for any debts or liabilities of the Exchange; and (4) provide that dividends or credits may, by resolution of the Board, be returned to subscribers.

The plaintiffs' theories of recovery have shifted somewhat over the course of this litigation. However, the lawsuit's primary aim throughout the litigation has been to alter the Exchange's practice of maintaining large amounts of unallocated surplus. The plaintiffs claim, in effect, that it is inherent in the concept of interinsurance that subscribers have a greater ownership interest in the funds of an exchange and greater rights of control over the funds than are recognized by the operating rules and practices of the Exchange. They also claim it would be in the best interests of the Exchange and its subscribers if surplus funds were maintained, not as unallocated surplus, but in subscriber savings accounts, from which subscribers

may withdraw their accumulated funds upon withdrawal from membership in the Exchange.

2. The Historical And Current Nature Of Reciprocal Insurance

The first interinsurance exchanges were formed in the 1880's by groups of merchants and manufacturers. These exchanges were a form of organization by which individuals, partnerships or corporations, which were engaged in a similar line of business, undertook to indemnify each other against certain kinds of losses by means of a mutual exchange of insurance contracts, usually through the medium of a common attorney-in-fact, who was appointed for that purpose by each of the underwriters, or "subscribers." (Reinmuth, The Regulation Of Reciprocal Insurance Exchanges (1967) ch. I, "The Development and Classification of Reciprocal Exchanges," pp. 1-2 [hereafter, "Reinmuth"]; see also Delos v. Farmers Insurance Group (1979) 93 Cal.App.3d 642, 652, 155 Cal.Rptr. 843.) In the early twentieth century, the concept of reciprocal insurance spread to consumer lines. The Exchange, organized by the Club in 1912, was the first reciprocal to offer automobile insurance. (Reinmuth, supra, ch. I, p. 3.)

Under the historical form of interinsurance contracts, each subscriber became both an insured and an insurer, and had several, not joint, liability on all obligations of the exchange. (Delos v. Farmers Insurance Group, Inc., supra, 93 Cal.App.3d at p. 652, 155 Cal.Rptr. 843, 2 Couch on Insurance 2d (Rev. ed. 1984) § 18.11, p. 613 [hereafter, "Couch"]; Reinmuth, supra, ch. II, "The Legal Status Of Reciprocal Exchanges," pp. 10-20.) Accordingly, reciprocal insurers originally had no stock and no capital. The subscribers' contingent liability stood in place of capital stock. (Mitchell v. Pacific Greyhound Lines (1939) 33 Cal.App.2d 53, 59-60, 91 P.2d 176; Couch, supra, § 18.11, pp. 614-615; Reinmuth, supra, ch. I, p. 2.) Originally, funds for the payment of losses and other debts were collected from subscribers as they occurred. However, this system resulted in frequent delays, hence subscribers later agreed to pay annual "premium deposits." (Reinmuth, supra, ch. I, p. 2.) These deposits remained to the credit of each subscriber in a separate account. (Ibid.; see also Cal. State Auto. Etc. Bureau v. Downey (1950) 96 Cal.App.2d 876, 879-880, 216 P.2d 882.) Subscribers' pro rata shares of losses and expenses, including a commission to the attorney-in-fact, were deducted as they occurred. Any balance remaining in a subscriber's account at the end of the year reverted to the subscriber as his or her "savings" or "surplus" and was distributed to the subscriber or was available to the subscriber upon withdrawal from the exchange. (Reinmuth, supra, ch.I, p. 2, ch. II, pp. 30-31.) On the other hand, if the subscriber's share of losses and expenses was greater than his deposit, the subscriber could be assessed for a specified maximum amount beyond the deposit. (Couch, supra, §§ 18:26-18:30, pp. 633-641; Reinmuth, supra, ch. I, p. 2.) By approximately the 1960's, this amount, in a number of states, came to be specified by statute and was commonly limited to an amount equal to one additional premium deposit. (Reinmuth, supra, ch. II, pp. 17-19; see, e.g., § § 1397, 1398.)

The original concept of reciprocal insurance contemplated the allocation of all surplus to the individual subscribers. (Reinmuth, supra, ch.II, pp. 30-31.) Over time, however, it became customary for reciprocals to accumulate unallocated surplus, which was not subject to withdrawal by departing subscribers, but was held perpetually in anticipation of catastrophic losses. (Reinmuth, supra, ch. II, pp. 32-37; ch. X, "Conclusions and Policy Alternatives," pp. 186-187.) By maintaining substantial surpluses of this kind, many reciprocals eventually obtained statutory rights to issue nonassessable poli cies, under which subscribers had no contingent liability for claims, expenses or losses of the exchange. The practice of issuing nonassessable policies is now common both in California and elsewhere. (Reinmuth, supra, ch. II, p. 18.) This, together with other lesser differences between today's reciprocals and those of the past, has led one commentator to conclude that the only remaining substantive difference between a reciprocal exchange and a mutual company is The reciprocal form of insurance organization as it now exists in California has been characterized by both parties to this action as difficult to define. Howe...