Hill v. State Farm Mutual Automobile Ins. Co.

• Citation: 166 Cal.App.4th 1438,83 Cal. Rptr. 3d 651
• Decision Date: 19 September 2008
• Docket Number: No. B194463.,B194463.
• Court: California Court of Appeals
• Parties: JERRY HILL et al., Plaintiffs and Appellants, v. STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, Defendant and Respondent.

166 Cal.App.4th 1438

83 Cal. Rptr. 3d 651

JERRY HILL et al., Plaintiffs and Appellants, v. STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, Defendant and Respondent.

No. B194463.

Court of Appeals of California, Second District, Division Three.

September 19, 2008.

Hennigan, Bennett & Dorman, J. Michael Hennigan, Robert L. Palmer, Mark Anchor Albert; Gianelli & Morris, Timothy J. Morris; Ernst & Mattison, Raymond E. Mattison; Law Offices of Robert S. Gerstein and Robert S. Gerstein for Plaintiffs and Appellants.

Skadden, Arps, Slate, Meagher & Flom, Raoul D. Kennedy, Joren S. Bass, Sheila L. Birnbaum, Douglas W. Dunham, Ellen P. Quackenbos; Heller Ehrman, Paul Alexander; Robie & Matthai and James R. Robie for Defendant and Respondent.

Sonnenschein Nath & Rosenthal and Barry Leigh Weissman for National Association of Insurance Commissioners as Amicus Curiae on behalf of Defendant and Respondent.

Sedgwick, Detert, Moran & Arnold and Christina J. Imre for Association of California Insurance Companies, American Insurance Association and Pacific Association of Domestic Insurance Companies as Amici Curiae on behalf of Defendant and Respondent.

Katten Muchin Rosenman, Stuart M. Richter and David M. Newman for National Association of Mutual Insurance Companies as Amicus Curiae on behalf of Defendant and Respondent.

Dewey & LeBoeuf, Dean Hansell and Sharon C. Corda for National Conference of Insurance Legislators as Amicus Curiae on behalf of Defendant and Respondent.

Horvitz & Levy, Barry R. Levy, Jeremy B. Rosen and S. Thomas Todd for Personal Insurance Federation of California as Amicus Curiae on behalf of Defendant and Respondent.

Lisa Madigan, Attorney General of the State of Illinois; and Robert E. Wagner for Illinois Division of Insurance as Amicus Curiae on behalf of Defendant and Respondent.

OPINION

MALLANO, J.^*

In this nationwide class action, 50 million present and former policyholders of State Farm Mutual Automobile Insurance Company (State Farm) contend that during the class period, 1983 to 1998, State Farm breached a duty to pay billions of dollars in dividends and, as a result, created an excessive surplus.

State Farm moved for summary judgment based on the business judgment rule, asserting that the board of directors (Board) had made its financial decisions on an informed basis, in good faith, and with the honest belief that it was acting in the company's best interests. Plaintiffs countered that the rule was not applicable because (1) the Board did not adequately consider whether to declare dividends but merely rubberstamped management's recommendations; (2) the Board was not sufficiently informed about dividends; (3) the Board's dividend practices were fraudulent or dishonest; and (4) the Board's dividend decisions were totally without merit.

(1) The trial court granted summary judgment, concluding that the business judgment rule applied as a matter of law. We agree. First, the Board could properly rely on information from State Farm's management and actuarial department in its deliberative process. Second, the Board was sufficiently informed—through written financial materials, oral presentations from company officers, and discussions during Board meetings—to make independent decisions about dividends. Third, State Farm did not engage in fraud by failing to indicate in its insurance policies and bylaws that it paid dividends from certain sources of income and did not sell invested assets for that purpose. It had no duty to disclose that type of information. Nor was there anything fraudulent about the financial information annually sent to policyholders; it was based on audited reports prepared by independent accountants in compliance with state regulatory principles of accounting. Fourth, in applying the business judgment rule, a court does not consider the merits of a board's decisions. Rather, the court focuses on the decisionmaking process to ensure that it was not tainted by fraud, oppression, illegality, or the like. Thus, plaintiffs' attack on the merits of State Farm's decisions is of no import. We accordingly affirm.

I BACKGROUND

On June 17, 1998, plaintiffs filed this class action against State Farm, alleging that, as policyholders, they were entitled to dividends under their insurance policies and that State Farm had improperly withheld dividends in order to increase its "surplus." The term "surplus" means an insurance company's assets less liabilities. Put another way, "surplus" is the capital available to back up an insurer's obligations under its policies.

Plaintiffs alleged that "State Farm breached its duty [to policyholders] by amassing surpluses far in excess of what State Farm reasonably needed to meet its present and future insurance obligations," thereby reducing dividends. As relief, plaintiffs requested damages, attorney fees, and an injunction barring State Farm from pursuing the practices that had reduced the dividend payments.

The complaint set forth six causes of action: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligent misrepresentation, violation of the Consumers Legal Remedies Act (Civ. Code, §§ 1750-1784), and violation of the unfair competition law (Bus. & Prof. Code, §§ 17200-17209).

State Farm demurred to the complaint on the ground that the payment of dividends was subject to the discretion and business judgment of the Board. Plaintiffs filed opposition. By order dated October 16, 1998, the trial court sustained the demurrer without leave to amend as to the cause of action under the Consumers Legal Remedies Act. On the remaining claims, the trial court sustained the demurrer with 20 days' leave to amend. The trial court also instructed plaintiffs to attach their insurance policies to the amended complaint.

On October 27, 1998, plaintiffs filed a first amended complaint, realleging the five causes of action that survived the demurrer. In essence, plaintiffs alleged that State Farm had overstated its losses and understated its income so as to reduce the dividends to policyholders. Plaintiffs attached their policies, as instructed.

Between 1983 and 1989, the policies in most states provided, "[T]he first insured named in the declarations is entitled ... to share in the earnings and savings of the company in accordance with the dividends declared by the Board of Directors on this and like policies." After 1989, the policies in most states read, "[T]he first insured named in the declarations is entitled ... to receive dividends the Board of Directors in its discretion may declare in accordance with reasonable classifications and groupings of policyholders established by such Board." (Italics added.)

Further, in a newsletter sent to California policyholders in 1998, State Farm described dividends as "a return of part of your premium because claim costs were less than anticipated." The newsletter also stated that "[o]ur goal as a mutual company is to put your interests first."

Throughout the class period, the bylaws of State Farm provided: "Subject to the provisions of law regarding return of excess premiums, the Board of Directors may authorize from time to time such refunds or credits to policyholders from the savings and gains of the Corporation and upon such terms and conditions and in such amounts or percentage as may, in their judgment, be proper, just and equitable."

A. Demurrer to Amended Complaint

On November 23, 1998, State Farm filed a demurrer to the first amended complaint, arguing again that the Board had properly exercised its discretion and business judgment with respect to declaring dividends. Plaintiffs filed opposition.

In January 1999, the trial court, Commissioner Bruce E. Mitchell presiding, sustained the demurrer without leave to amend as to all causes of action and entered a judgment of dismissal. Plaintiffs filed a timely appeal.

On January 30, 2001, Division One of this district filed a split decision, reversing the judgment of dismissal and reinstating the claims for breach of contract, breach of the covenant of good faith and fair dealing, and violation of the unfair competition law (Hill v. State Farm Mutual Automobile Insurance Co. (Jan. 30, 2001, B133262) [nonpub. opn.] (State Farm I)). The court concluded that plaintiffs had adequately pleaded their claims under California law and that an accounting would be an appropriate remedy if plaintiffs prevailed on the contract or covenant claim.

In rejecting State Farm's contention that the action was barred by the business judgment rule, the court distinguished this division's decision in Barnes v. State Farm Mut. Auto. Ins. Co. (1993) 16 Cal.App.4th 365 (Barnes). The court explained that, in Barnes, "a policyholder sued State Farm Auto, seeking to `compel [it] to distribute "its unjustifiably large surplus" back to its policyholders.' (Id. at p. 370.) The plaintiff alleged that `State Farm had accumulated a surplus fund consisting of premiums and investment income in excess of $10 billion . . . [and] that such conduct by State Farm amounted to an unjustified hoarding of surplus funds, for no legitimate business purpose and all to the detriment of policyholders who otherwise could have received either reduced premium rates or substantial dividends.' (Ibid.)

"In Barnes, the trial court sustained State Farm Auto's demurrer without leave to amend. The Court of Appeal affirmed, stating:

"`Whether "a private corporation should declare and pay a dividend, or make a distribution of its assets is a matter committed to the sound business judgment of the corporation's board of directors." . . . It is thus the general rule that a court will not interfere with a corporate decision to withhold dividends in the absence of a showing of abuse of the wide discretion which the courts grant to corporate directors.

"`As one California court recently summarized the rule, "The common law `business judgment rule' refers to a judicial policy of...