Diamond Woodworks, Inc. v. Argonaut Ins.

• Decision Date: 13 June 2003
• Docket Number: No. G027949.,G027949.
• Citation: 135 Cal.Rptr.2d 736,109 Cal.App.4th 1020
• Court: California Court of Appeals Court of Appeals
• Parties: DIAMOND WOODWORKS, INC., et al. Plaintiffs and Appellants, v. ARGONAUT INSURANCE COMPANY, Defendant and Appellant.

135 Cal.Rptr.2d 736

109 Cal.App.4th 1020

DIAMOND WOODWORKS, INC., et al. Plaintiffs and Appellants, v. ARGONAUT INSURANCE COMPANY, Defendant and Appellant.

No. G027949.

Court of Appeal, Fourth District, Division 3.

June 13, 2003.

Stevens & Carlberg, Daniel P. Stevens; Rizio & Nelson and R. Shawn Nelson for Plaintiffs and Appellants.

Horvitz & Levy, Peter Abrahams, Julie L. Woods, Encino; Murtaugh, Miller, Meyer & Nelson and Lawrence J. DiPinto, Costa Mesa, for Defendant and Appellant.

OPINION

IKOLA, J.

Before us are an appeal and a cross-appeal from a judgment awarding $658,000 in compensatory damages for fraud, breach of contract and insurance bad faith and $5.5 million in punitive damages. Briefly, defendant Argonaut Insurance Company (Argonaut) issued a workers' compensation insurance policy to Builders Staff Corporation (BSC), a now-defunct employee leasing company.¹ Plaintiff Diamond Woodworks (Diamond), a client of BSC, transferred all of its employees to BSC, and BSC leased the employees back to Diamond. Argonaut issued certificates of insurance listing Diamond as the insured, with the caveat that the certificate did not alter or amend the policy and that only BSC's employees working at the job-site were covered under the policy. Argonaut, BSC, and Argonaut's registered agent, Arthur Gallagher and Company (Gallagher) understood Diamond was not insured. Under the BSC/Diamond employee leasing contract, coverage of new hires was dependent upon Diamond's timely submission and BSC's approval of employment application packets for each employee. In practice, the provision was never enforced.

Diamond hired an employee whose BSC employment application packet had not yet been submitted to BSC when, on his first day of work, he cut off four fingers in a woodcutting accident. BSC contended the injured worker was not a BSC employee under the contract, and Argonaut denied the workers' compensation claim on that ground. The employee sought to recover workers' compensation benefits from Diamond, and also sued Diamond in a separate civil action for tort damages based on Diamond's alleged failure to obtain workers' compensation insurance for its employees. Diamond tendered its defense to Argonaut, but the insurer refused to provide a defense in either proceeding. Eventually, 18 months into the litigation, Argonaut negotiated a global settlement with the employee, disposing of all of his claims.

Diamond then sued Argonaut and BSC, contending the insurer should have defended and alleging Diamond was insured under Argonaut's policy or, if not, it had suffered detriment from Argonaut's deceit leading it to believe it was, in fact, insured. BSC was dismissed before trial. The jury's three separate general verdicts were in favor of Diamond on its claims for breach of contract, insurance bad faith and fraud. Awarding damages for each cause of action, respectively for $24,780.75, $229,209.30, and $424,100, the jury found Argonaut did not act with malice or oppression as statutorily defined (Civ.Code, § 3294), but assessed $14 million in punitive damages based on fraud. The trial court denied Argonaut's motion for judgment notwithstanding the verdict (JNOV), but conditionally granted its motion for new trial dependent upon Diamond's acceptance of a nominal remittitur of fraud compensatory damages to $404,270 and a significant reduction of punitive damages to $5.5 million. Diamond agreed.

Argonaut appeals, contending plaintiff did not prove any cause of action, but even if liability exists, the insurance bad faith, fraud and punitive damages awards should be reversed or further reduced for a plethora of reasons. Argonaut also seeks a new trial, asserting the jury's verdicts are irreconcilably inconsistent. In its cross-appeal, Diamond argues the court erred in remitting the punitive damages. Robert Erdtsieck (Erdtsieck), Diamond's founder, against whom Argonaut obtained a summary judgment prior to trial, presents no argument on his own behalf.

For the reasons we discuss, post, we affirm the judgment on the breach of contract and bad faith claims. We also affirm the finding of liability for fraud, but the compensatory damages based on fraud must be further remitted. So must the punitive damages award, which, under the United States Supreme Court's recent decision, State Farm Mut. Auto. Ins. Co. v. Campbell (2003) 538 U.S. 408, 123 S.Ct. 1513, 155 L.Ed.2d 585 (Campbell), does not comport with due process. Thus, we reverse and remand for new trial only on compensatory and punitive damages for fraud unless Diamond consents to a remittitur of the fraud damages to $258,570 and the punitive damages to $1 million (approximately 3.8 times the compensatory damages). (Cal. Rules of Court, rule 26(d).)

FACTS

In the factual recitation, we cull from the voluminous record only those facts necessary to an overview. Additional facts will be set forth in the legal discussion, as germane to the specific issues on appeal.

Employee Leasing

BSC was an employee leasing company. Such an enterprise contracts with client companies to provide leased labor and labor-related services, i.e., payroll, safety and tax services and employment benefits, including workers' compensation insurance. In a typical arrangement, the employee leasing company does not bring employees to the client company. Rather, the client company already has the personnel, and it selects which of its workers will become employees of the leasing company and which, if any, will be maintained as the client company's direct employees. For example, in a construction context, the client company might choose to retain direct employment of its white collar workers, but place its work crews in the lease-back program.

Because an employee leasing company becomes the employer of the workers leased to the client company, it must "secure the payment of compensation" by obtaining workers' compensation insurance or a certificate of self-insurance for those workers. (See Lab.Code, § 3700.) An employee leasing company may have thousands of employees working at several hundred client companies.² Therefore, it can purchase workers' compensation insurance at a more favorable rate than would be paid directly by the respective client companies themselves. The latter thus obtain an economic benefit since the fee they pay the employee leasing company covers the cost of the workers' compensation premiums. As long as the employee leasing company obtains such coverage for the leased workers, the client company has also "secured the payment of compensation" and cannot be sued for tort damages by a leased worker who is injured while working for the client company. (Lab. Code, § 3602, subd. (d); 1 Herlick, Cal. Workers' Compensation Law (6th ed.2000) § 3.31, p. 3-43.) However, the client company needs to obtain workers' compensation insurance for those workers who are not leased from the employee leasing company.³

Additionally, for about $200 per year, client companies without employees of their own can purchase an "if-any" policy covering any worker who might be deemed an employee of the client company.

BSC and the Argonaut Policy

BSC's clients were primarily construction companies. Beginning in 1994 and for approximately four more years, Argonaut provided workers' compensation insurance to BSC, the first employee leasing account it had ever written. The policy identified Argonaut as the insurer and BSC as the named insured. It was a retrospective premium policy, under which the leasing company pays an initial up front premium to the insurer and, if the losses are less than the premium, the insurer refunds the balance after deducting certain expenses. If losses exceed the premium, the leasing company owes an additional premium up to a maximum amount. The insurer pays for losses over that amount.

Part of BSC's leasing charge to its client companies was the cost of BSC's workers' compensation premiums. BSC did not pass along to the client companies any premium refund it received at the end of the policy period, nor did BSC charge additional fees if it was assessed additional premiums. During the period Argonaut insured BSC, BSC paid Argonaut more than $10 million in premiums, and Argonaut paid BSC claims totaling $6.4 million.

Certificates of Insurance

When a contractor such as Diamond wants to obtain a building permit, it must show the city or municipality it "[has] and will maintain workers' compensation insurance, as required by Section 3700 of the Labor Code, for the performance of the work for which [the] permit is issued." (Health & Saf.Code, § 19825, subd. (a); see also Lab.Code, § 3800.) The mandate is intended to make sure employees injured on construction projects are covered by workers' compensation insurance.⁴ (Morris v. County of Marin (1977) 18 Cal.3d 901, 917, 136 Cal.Rptr. 251, 559 P.2d 606.) Client companies often asked BSC for certificates of insurance, which BSC promised to provide, its contract stating, "BSC shall carry worker's compensation insurance and shall deliver to Contracted Company a certificate evidencing such insurance." Ordinarily, Argonaut's agent, Gallagher, would issue the certificate of insurance. Argonaut received no additional fees when the certificates were issued.

The certificate of insurance routinely used in the construction industry is the Acord certificate, a single-page standardized form, expressly stating it "does not amend, extend or alter the coverage afforded by the [referenced] policies." The Acord certificate, with its boxed categories of information, is not easily adapted to explaining employee leasing, i.e., that the client company—the construction company submitting the certificate for a building permit—has "secure[d] ... payment of compensation" under Labor Code section 3700 by leasing employees from a company with a workers' compensation insurance policy.

Originally, and for about six months, the Acord certificates BSC issued for client...