American Pepper Supply Co. v. Fed. Ins. Co.

• Decision Date: 15 July 2004
• Docket Number: No. CV-03-0290-PR.,CV-03-0290-PR.
• Citation: 93 P.3d 507,208 Ariz. 307
• Parties: AMERICAN PEPPER SUPPLY COMPANY, Plaintiff-Appellant, Cross-Appellee, v. FEDERAL INSURANCE COMPANY, Defendant-Appellee, Cross-Appellant.
• Court: Arizona Supreme Court

93 P.3d 507

208 Ariz. 307

AMERICAN PEPPER SUPPLY COMPANY, Plaintiff-Appellant, Cross-Appellee, v. FEDERAL INSURANCE COMPANY, Defendant-Appellee, Cross-Appellant.

No. CV-03-0290-PR.

Supreme Court of Arizona, En Banc.

July 15, 2004.

Herman, Goldstein & Forsyth, P.C. by Keith B. Forsyth and Evan S. Goldstein, Phoenix, Attorneys for Plaintiff-Appellant, Cross-Appellee.

Sanders & Parks, P.C. by Robert J. Bruno and Mark R. Gilling, Phoenix, Attorneys for Defendant-Appellee, Cross-Appellant.

Humphrey & Petersen, P.C. by Andrew J. Petersen, Phoenix, Attorneys for Amicus Curiae, The Arizona Association of Defense Counsel.

OPINION

BERCH, Justice.

¶ 1 We granted review to determine the appropriate burden for proving an insurer's policy defense of concealment or misrepresentation. We have jurisdiction pursuant to Article 6, Section 5(3) of the Arizona Constitution, and Arizona Revised Statutes ("A.R.S.") section 12-120.24 (2003).

BACKGROUND

¶ 2 On Tuesday, August 27, 1996, American Pepper Supply Company reported to its insurer, Federal Insurance Company, a theft of equipment left outside its building during the preceding weekend. Within three weeks of American Pepper's initial report of the loss, Federal's investigation revealed facts and inconsistencies that rendered American Pepper's claim "suspicious": (1) the equipment, which American Pepper claimed had a replacement value of more than $87,000, was left in an unfenced and unguarded area; (2) the equipment stolen was no longer used in American Pepper's business; (3) there were inconsistencies between American Pepper's initial reports and later reports to both the insurance company and the police as to the equipment reportedly stolen;¹ (4) American Pepper wanted to settle the claim quickly for two-thirds of the value of the equipment; and (5) American Pepper was not forthcoming regarding details of the acquisition of the equipment. Federal therefore turned the claim over to its special investigation unit.

¶ 3 The investigation revealed that, contrary to American Pepper's initial reports that the equipment had been left on the ground outside its building, employees had actually left the equipment in a scrap metal salvage bin, which was discovered empty on Monday, August 26. When confronted with the discrepancy, American Pepper's general manager claimed that the equipment had been stolen out of the bin, and that the bin was empty when National Metals, a metal recycler, picked up the bin on Tuesday, the day American Pepper reported the claim to Federal. But further investigation revealed that when National Metals picked up the bin on Tuesday, it contained more than four tons of material.

¶ 4 On November 19, 1997, Federal sent a letter formally denying American Pepper's claim on the grounds that the investigation revealed "that [the equipment reported stolen] was sold for scrap metal" and that American Pepper "concealed or misrepresented material facts in the claim presentment process." Federal concluded that the claim was "not covered due to the misrepresentation/concealment provisions of the policy and under the law."² Despite the denial of coverage, Federal invited American Pepper to submit for review and consideration any information "that has not been made available to us that would have a bearing on [Federal's coverage] decision."

¶ 5 Rather than submitting further information, American Pepper sued Federal, alleging breach of contract and bad faith. American Pepper asserted that the equipment had been stolen and that its employees had refilled the bin on Monday, after American Pepper discovered the theft. Federal defended by asserting that American Pepper had not suffered a compensable loss and that American Pepper's representatives had concealed or misrepresented material facts concerning the theft of the equipment, thereby precluding coverage pursuant to the concealment or misrepresentation policy exclusion.

¶ 6 After being instructed by the trial court that Federal had to prove the policy defense of concealment or misrepresentation by "clear and convincing" evidence, the jury found in favor of American Pepper and awarded $15,000. The court of appeals affirmed, concluding that Federal's defense was comparable to a claim of fraud and thus should be proved by clear and convincing evidence. Am. Pepper Supply Co. v. Fed. Ins. Co., 205 Ariz. 465, 469-70, ¶ 18, 72 P.3d 1284, 1288-89 (App.2003). We granted review to determine the appropriate burden by which an insurer must prove its policy defense of concealment or misrepresentation.

DISCUSSION

¶ 7 Federal argues that the trial court erred by instructing the jury that Federal had to prove its policy defense of concealment or misrepresentation by clear and convincing evidence rather than merely by a preponderance of the evidence. To warrant reversal, the jury instruction must have been not only erroneous, but "prejudicial to the substantial rights of the appealing party." Gemstar Ltd. v. Ernst & Young, 185 Ariz. 493, 504, 917 P.2d 222, 233 (1996) (quoting Walters v. First Fed. Sav. & Loan Ass'n of Phoenix, 131 Ariz. 321, 326, 641 P.2d 235, 240 (1982)).

¶ 8 The appropriate burden of proof is a question of law, which this court reviews de novo. See Nielson v. Patterson, 204 Ariz. 530, 531,

¶ 5, 65 P.3d 911, 912 (2003) (approving de novo review of legal issues). Although a few jurisdictions require that exclusions from coverage be proved by clear and convincing evidence, the burden of proving insurance policy exclusionary provisions is usually a "preponderance of the evidence." Lee R. Russ & Thomas F. Segalla, 17 Couch on Insurance § 254:14 (3d ed.2003) [hereinafter "Couch"]; compare Rego v. Conn. Ins. Placement Facility, 219 Conn. 339, 593 A.2d 491, 494-95 (1991) (following the majority of courts and commentators suggesting that insurers must prove policy defenses by a preponderance of the evidence), with Am. Family Mut. Ins. Co. v. Schley, 978 F.Supp. 870, 874-75 (E.D.Wis.1997) (applying Wisconsin law, which requires that an insurer prove the policy defense of misrepresentation "by clear, satisfactory and convincing evidence").

¶ 9 By requiring clear and convincing proof in this case, the trial court and court of appeals adopted the minority approach. In doing so, the court of appeals analogized Federal's defense to a charge of common-law fraud. Am. Pepper Supply Co., 205 Ariz. at 469, ¶¶ 14, 16, 72 P.3d at 1288. Observing that allegations of concealment or misrepresentation implicitly charge the maker with "deceitful" conduct, the court reasoned that such allegations may harm an individual's reputation in the same way that allegations of fraudulent conduct do. Id. ¶ 15. The court of appeals therefore concluded that it should require the defendant to meet the heavier burden of proving clear and convincing evidence to help prevent unwarranted harms to insureds' reputations caused by insurance policy defenses sounding in fraud. Id. ¶ 14 (citing Wells Fargo Bank v. Ariz. Laborers, Teamsters & Cement Masons Local No. 395 Pension Trust Fund, 201 Ariz. 474, 498 n. 24, ¶ 98, 38 P.3d 12, 36 n. 24 (2002)).

¶ 10 Such reasoning comports with the notion that "[t]he degree of proof should generally correspond to the elements required to be proved before the insurer escapes liability. The closer the elements come to intentional wrongdoing, the stricter the degree of proof is likely to be." 17 Couch, supra ¶ 8, § 254:94 (second "Observation").

¶ 11 Arizona has adopted this approach. As explained in State v. Renforth, 155 Ariz. 385, 387, 746 P.2d 1315, 1317 (App.1987), burdens of proof correlate positively with the significance of the interests at stake. In a criminal case, for example, the state must prove guilt beyond a reasonable doubt, a heavy burden rooted in the belief that "it is far worse to convict an innocent [person] than to let a guilty [person] go free." Id. (quoting In re Winship, 397 U.S. 358, 373, 90 S.Ct. 1068, 25 L.Ed.2d 368 (1970)). The clear and convincing burden imposed on fraud claims similarly stems from the societal importance of an untarnished reputation. Id. (citing Addington v. Texas, 441 U.S. 418, 424, 99 S.Ct. 1804, 60 L.Ed.2d 323 (1979)). In a non-fraud civil case, however, an erroneous verdict for either party is no less unjust for one party than it would be if it were rendered for the opposing party. Id. (quoting In re Winship, 397 U.S. at 372, 90 S.Ct. 1068). For that reason, civil claims generally need be established only by a preponderance of the evidence.

¶ 12 American Pepper cites several cases in support of its argument that a higher burden is appropriate when a defense sounds in fraud. See Sunseri v. Katz, 53 Ariz. 234, 87 P.2d 797 (1939) (addressing suit to rescind a deed because of incapacity or fraud); Cole v. Town of Miami, 52 Ariz. 488, 83 P.2d 997 (1938) (addressing the Industrial Commission's alleged concealment of a worker's health condition in a worker's compensation case); Kingsbury v. Christy, 21 Ariz. 559, 192 P. 1114 (1920) (addressing fraudulent transfers in a debtor/creditor dispute); Hall v. Warren, 5 Ariz. 127, 48 P. 214 (1897) (same); Rhoads v. Harvey Publ'ns, Inc., 145 Ariz. 142, 700 P.2d 840 (App.1984) (addressing a claim sounding in tort resulting from an employment relationship); Pinnacle Peak Developers v. TRW Inv. Corp., 129 Ariz. 385, 631 P.2d 540 (App.1980) (addressing whether the parol evidence rule bars evidence of fraud in the inducement); Universal Inv. Co. v. Sahara Motor Inn, Inc., 127 Ariz. 213, 619 P.2d 485 (App.1980) (addressing a claim to rescind a real estate contract on the basis of fraudulent concealment of a material defect); Douglas v. Vancouver Plywood Co., 16 Ariz.App. 364, 493 P.2d 531 (1972) (addressing formation of a real estate contract); Ulan v. Richtars, 8 Ariz.App. 351, 446 P.2d 255 (1968) (addressing a claim sounding in tort resulting from a real estate transaction). But none of these cases analyzes the distinction between...