Prudential Reinsurance Co. v. Superior Court, S014036

• Court: United States State Supreme Court (California)
• Writing for the Court: LUCAS; KENNARD; MOSK; KLINE
• Citation: 3 Cal.4th 1118,14 Cal.Rptr.2d 749,842 P.2d 48
• Parties: , 842 P.2d 48, 61 USLW 2370 PRUDENTIAL REINSURANCE COMPANY, Petitioner, v. The SUPERIOR COURT of Los Angeles County, Respondent. John GARAMENDI, as Insurance Commissioner, etc., Real Party in Interest.
• Docket Number: No. S014036,S014036
• Decision Date: 30 November 1992

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14 Cal.Rptr.2d 749 3 Cal.4th 1118, 842 P.2d 48, 61 USLW 2370 PRUDENTIAL REINSURANCE COMPANY, Petitioner,
v.
The SUPERIOR COURT of Los Angeles County, Respondent.
John GARAMENDI, as Insurance Commissioner, etc., Real Party in Interest. No. S014036. Supreme Court of California,
In Bank. Nov. 30, 1992.

Page 750

[3 Cal.4th 1122] [842 P.2d 49] Adams, Duque & Hazeltine, Robert M. Mitchell, Margaret Levy, John L. Viola, Vicki W.W. Lai, F. Christopher Chrisbens, Wilson, Elser, Moskowitz, Edelman & Dicker,

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[842 P.2d 50] Patrick M. Kelly, Thomas R. Manisero, Blanc, Gilburne, Williams & Johnston, Gary R. Klouse, John A. Kronstadt, Sidley & Austin, Peter R. Chaffetz, Janet M. Letson, Hoon Chun, Mendes & Mount, Valerie A. Gordon, Los Angeles, LeBoeuf, Lamb, Leiby & MacRae, Sanford Kingsley, San Francisco, Hufstedler, Miller, Kaus & Beardsley, John P. Olson, Los Angeles, Arnold & Porter, Daniel M. Lewis & Gary P. Poon, Washington, D.C., for petitioner.

Bryan, Cave, McPheeters & McRoberts, Martin J. Foley, Los Angeles, Phillip E. Stano, Daniel J. Conway, Washington, D.C., Richard E. Goodman, Schaumburg, Ill., Jack H. Blaine, Craig A. Berrington, Washington, D.C., Ronald S. Gass, Baltimore, Md., and John J. Nangle, Des Plaines, Ill., as amici curiae on behalf of petitioner.

No appearance for respondent.

Rubinstein & Perry, Karl L. Rubinstein, Kathleen M. McCain, Melissa S. Kooistra and Dana Carli Brooks, Los Angeles, John K. Van de Kamp and Daniel E. Lungren, [3 Cal.4th 1123] Attys. Gen., Edmond B. Mamer, Jack T. Kerry and Raymond B. Jue, Deputy Attys. Gen., for real party in interest.

Horvitz & Levy, Ellis J. Horvitz, Barry R. Levy, Lisa Perrochet, Encino, Spiegel & McDiarmid, Richard A. Brown, Spencer L. Kimball, Cynthia S. Bogorad, Diane J. Lautrup, Jeffrey R. Babbin, Washington, D.C., Hugh Alexander, San Francisco, and Charles E. Erdmann, II, Helena, Mont., as amici curiae on behalf of real party in interest.

LUCAS, Chief Justice.

Insurance Code section 620 (all further statutory references are to this code unless otherwise stated) defines a reinsurance contract as "one by which an insurer procures a third person to insure him against loss or liability by reason of such original insurance." Typically, under a reinsurance contract, the primary insurer "cedes" a portion of the premiums for its policies, and the losses on those policies, to the reinsurer.

In a reinsurance transaction, policyholders pay premiums to their original insurer, who, in turn, pays a reinsurer a percentage of the initial premiums as consideration for reinsuring a specified part of the original risk. If, after a loss, the original insurer must compensate its policyholders, the reinsurer in turn indemnifies the insurer. The advantage of reinsurance is to secure to the original insurer adequate risk distribution by transferring a portion of the risk assumed to another insurer. (Semple & Hall, The Reinsurer's Liability in the Event of the Insolvency of a Ceding Property and Casualty Insurer (hereafter Semple & Hall) (1986) 21 Tort & Ins.L.J. 407 ["A reinsurance agreement is one by which the reinsurer indemnifies the ceding company for losses paid"].)

We granted review to determine as a matter of first impression whether reinsurance debts and credits generated between a reinsurer and the original insurer, under the terms of their reciprocal reinsurance contracts, may be set off pursuant to section 1031, when the original insurer becomes insolvent. Section 1031 provides in pertinent part that: "In all cases of mutual debts or mutual credits between the person in liquidation under Section 1016 and any other person, such credits and debts shall be set off and the balance only shall be allowed or paid...."

Section 1031 allows the setoff of all mutual debts and credits in the course of liquidation proceedings and is patterned after the federal Bankruptcy Act of 1898 (11 U.S.C. § 108, repealed and reenacted as 11 U.S.C. § 553), and an identical New York statute that has been adopted by several states (N.Y.Ins.Law,[3 Cal.4th 1124] former § 420, recodified as § 7427). The federal and New York provisions were in turn derived from the equitable right of setoff established in 17th century England, and later adopted in early federal court cases allowing equitable setoff in the insurance context. (Downey v. Humphreys (1951) 102 Cal.App.2d 323, 335-336, 227 P.2d 484; see also Scammon v. Kimball (1876) 92 U.S. (2 Otto) 362, 23 L.Ed. 483 [allowing banker to setoff insolvent[842 P.2d 51] insurer's deposits against unrelated

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insured losses].) ¹

Assuming setoff is permitted, there remain questions pertaining to the relative priorities of setoff and other claims in liquidation against the insurer. An exception to the general rule of section 1031 is provided in section 1031, subdivision (a) (hereafter section 1031(a)), which does not allow setoff when the "obligation of the person in liquidation to such other person does not entitle such other person claiming such setoff to share as a claimant in the assets of such person in liquidation." Accordingly, we must also consider whether section 1031(a) allows setoff claims if the estate has insufficient assets to satisfy fully all primary policyholders and claims of the California Insurance Guarantee Association (CIGA) whose claims, absent setoff, have priority (under section 1033) over those of reinsurers and other general creditors. ² Because reinsurers are not considered priority claimants in an insolvency proceeding, the amount of setoff money remaining after priority claimants are paid would be less than that available before statutory preference is given to other claimants.

We conclude that section 1031 may not reasonably be construed as conditioning a reinsurer's right to set off on the insolvent insurer's ability to [3 Cal.4th 1125] pay in full the claims of those in higher priority classes. As we explain, the majority of state and federal courts addressing the statutory right of setoff adopt this position. Thus, we hold that the reciprocal reinsurance contracts at issue here created "mutual credits and debts" under section 1031.

We also conclude that section 1031(a) does not preclude setoff in this case. Plaintiff reinsurer has shown a contractual and legal entitlement to the status of creditor of the insolvent insurer, and the contract between the two entities does not make setoff contingent on the ultimate financial ability of the original insurer or its estate to first pay all claimants in higher priority classes.

Finally, we determine that any policy considerations favoring payment of insureds under original policies may not override the unequivocal language of section 1031 or policies favoring setoff. To disallow setoff in this case would not only subvert clear legislative intent, but would also lead to an increased cost of insurance for the consumer, because offsetting an insurer's debts spreads the risk incurred by the insurer and often allows smaller insurers to remain in business. (See Stamp v. Insurance Co. of North America (7th Cir.1990) 908 F.2d 1375, 1380 [offsetting debts spreads risk and acts as mutual security for performance].)

I. BACKGROUND

On February 2, 1982, the Commissioner of Insurance (Commissioner) placed Mission Insurance Company (Mission) and its affiliated insurance companies into conservatorship due to insolvency. ( § 1011, subd. (d) [vesting title to assets in Commissioner when insurer's transaction of business is hazardous to policyholders].) Several weeks later, the Commissioner obtained an

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[842 P.2d 52] order pursuant to section 1016, authorizing liquidation of the Mission companies. The Commissioner was appointed liquidator, and thereafter demanded all reinsurers of Mission pay in full the amounts owed under their reinsurance contracts. The reinsurers refused to make any such payments, claiming that under section 1031, they were entitled to set off the amounts owed by Mission for reinsurance proceeds and "unearned premiums" (or amounts insureds prepaid for coverage in the days and months ahead), owed to them by the insolvent insurers, against the debts they owed the insolvent insurers under reinsurance contracts executed prior to insolvency. The Commissioner commenced the underlying action against 144 reinsurers, and brought the present summary judgment motion against petitioner Prudential Reinsurance Company (Prudential Reinsurance) to compel payment, without setoff, of moneys owed the Mission companies.

The trial court granted the Commissioner's summary judgment motion on the ground that section 1031 allows a setoff only when the assets of the [3 Cal.4th 1126] liquidating estate are sufficient to pay in full all the claims asserted by claimants in priority classes higher than the claimant asserting the setoff right. In other words, the court concluded that section 1031 makes the statutory right of setoff contingent on the ultimate financial ability of the liquidation estate to pay in full all claimants in section 1033 priority classes higher than the setoff claimant.

The Court of Appeal followed the rule of every state and federal court that has considered the reinsurer's right to statutory setoff and issued a peremptory writ of mandate ordering the trial court to vacate its order granting summary judgment and to enter a new order allowing Prudential Reinsurance the right of setoff. The Commissioner seeks our review of this judgment.

As we explain, we adopt the thoughtful analysis of the Court of Appeal and conclude that a plain reading of sections 1031 and 1033 allows an insolvent insurer and a reinsurer to set off debts and credits after the appointment of a liquidator. Because we agree with the Court of Appeal that Prudential Reinsurance is entitled to set off Mission's debts, we affirm the Court of Appeal's judgment.

II. DISCUSSION

A. The Reinsurance Contracts

Reinsurance contracts, as contracts of indemnity,...