State Farm Mut. Auto. v. Superior Court

• Decision Date: 16 December 2003
• Docket Number: No. B168662.,B168662.
• Citation: 114 Cal.App.4th 434,8 Cal.Rptr.3d 56
• Court: California Court of Appeals
• Parties: STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, Petitioner, v. The SUPERIOR COURT of Los Angeles County, Respondent; Jerry Hill et al., Real Parties in Interest.

8 Cal.Rptr.3d 56

114 Cal.App.4th 434

STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, Petitioner, v.The SUPERIOR COURT of Los Angeles County, RespondentJerry Hill et al., Real Parties in Interest.

No. B168662.

Court of Appeal, Second District, Division 1.

December 16, 2003.

Heller Ehrman White & McAuliffe, Paul Alexander, Pamela Davis, Robin

Schaefers, San Francisco; Skadden, Arps, Slate, Meagher & Flom, Raoul D. Kennedy, San Francisco, Sheila L. Birnbaum, Douglas W. Dunham and Ellen P. Quackenbos, New York, NY, for Petitioner.

LeBoeuf, Lamb, Greene & MacRae, Dean Hansell and Sharon C. Corda, Los Angeles, for National Conference of Insurance Legislators as Amicus Curiae on behalf of Petitioner.

Robert E. Wagner, Springfield, IL, for Illinois Department of Insurance as Amicus Curiae on behalf of Petitioner.

Sonnenschein Nath & Rosenthal, Paul E.B. Glad and Sonia Martin, San Francisco, for National Association of Mutual Insurance Companies as Amicus Curiae on behalf of Petitioner.

Alschuler Grossman Stein & Kahan, Barry Leigh Weissman and Daniel A. Fiore, Santa Monica, for National Association of Insurance Commissioners as Amicus Curiae on behalf of Petitioner.

Livingston & Mattesich, Gene Livingston, John McCarron and Stacy E. Gillespie, Sacramento, for Citizens for a Sound Economy Foundation as Amicus Curiae on behalf of Petitioner.

Sedgwick, Detert, Moran & Arnold and Christina J. Imre, Encino, for National Association of Independent Insurers, Alliance of American Insurers and American Insurance Association as Amici Curiae on behalf of Petitioner.

Horvitz & Levy, Barry R. Levy and Jeremy B. Rosen, Encino, for Personal Insurance Federation of California and Association of California Insurance Companies as Amici Curiae on behalf of Petitioner.

Victoria E. Fimea; Mayer, Brown, Rowe & Maw and Donald M. Falk, Palo Alto, for American Council of Life Insurers as Amicus Curiae on behalf of Petitioner.

No appearance for Respondent.

Hennigan, Bennett & Dorman, J. Michael Hennigan, Jeanne E. Irving, Los Angeles, Mark Anchor Albert; Gianelli & Morris, Timothy J. Morris, Los Angeles; Law Offices of Robert S. Gerstein and Robert S. Gerstein for Real Parties in Interest.

MALLANO, J.

This is an action against a mutual automobile insurance company incorporated and headquartered in Illinois, where the board of directors holds its meetings.A group of policyholders contends that the insurance company's board of directors did not pay dividends it promised.The trial court certified the case as a nationwide class action and ruled that California law governs the policyholders' causes of action.

The insurance company has filed a petition for a writ of mandate, challenging the trial court's ruling as to the choice of law.We conclude that, because the declaration of dividends concerns the internal affairs of the insurance company, Illinois law applies in this case.We therefore grant the petition.

IBACKGROUND

DefendantState Farm Mutual Automobile Insurance Company(State Farm) was created in 1922 under the laws of the State of Illinois.It is incorporated there and is headquartered in Bloomington, Illinois.The board of directors meets in Bloomington when making decisions about whether to declare dividends.State Farm's primary financial records are maintained there.

During the early to mid-1980's, State Farm automobile insurance policies provided that "the 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."At some point in the late 1980's, the policy language was changed to 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."

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...."

The bylaws of State Farm provide: "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."

On June 17, 1998, State Farm policyholders filed this action, alleging causes of action for breach of contract and breach of the covenant of good faith and fair dealing, among others.In general, the complaint alleges that the policyholders were entitled to dividends under their State Farm policies and that State Farm improperly withheld dividends in order to increase its surplus.The nationwide class certified by the trial court consists of 50 million former and current State Farm automobile insurance policyholders, 5 million of whom live in California.

The policyholders allege in the complaint that "State Farm breached its duty [to them] by amassing surpluses far in excess of what State Farm reasonably needed to meet its present and future insurance obligations," thereby reducing dividends.According to the policyholders, State Farm's board of directors improperly withheld dividends by (1) overstating underwriting losses, (2) understating investment income, (3) excluding from operating return the investment income derived from its surplus, and (4) falsely claiming that State Farm's surplus had to cover the obligations of its affiliated insurance companies.¹

After the pleading stage, State Farm filed a motion to determine the substantive law applicable to the policyholders' causes of action and to dismiss the case.State Farm argued that, under the "internal affairs" doctrine, Illinois law applied and required that the case be dismissed in favor of an Illinois forum.The policyholders filed opposition papers, claiming that California law governed.In a statement of decision filed on May 21, 2003, the trial court denied the motion to dismiss and ruled that California law controlled.

State Farm filed a petition for a writ of mandate with this court, challenging the trial court's decision.We issued an order to show cause why the trial court's decision should not be vacated.We also established a briefing schedule and calendared the matter for oral argument.Having considered the parties' written and oral presentations, as well as the amici curiae briefs, we now consider the merits of the petition.

IIDISCUSSION

Because this appeal involves the application of legal principles to undisputed facts, we review the trial court's decision de novo.(SeeIn re Marriage of Armato(2001)88 Cal.App.4th 1030, 1034, 106 Cal.Rptr.2d 395;State Farm Mut. Auto. Ins. Co. v. Department of Motor Vehicles(1997)53 Cal.App.4th 1076, 1081, 62 Cal.Rptr.2d 178.)

We first discuss how surplus funds are used by an insurance company.We then address the conflict of laws issue, namely, whether California or Illinois law applies to the policyholders' causes of action.Finally, we discern the pertinent legal principles from the applicable substantive law.²

A.The Importance of Surplus

State Farm is a mutual insurance corporation.As such, it "issues no capital stock and is cooperatively owned by its policyholders, who are both the insurers and the insureds...."(1A Fletcher, Cyclopedia of the Law of Private Corporations (2002 rev.)§ 75, p. 40.)Mutual insurers issue about one-third of property and liability insurance in the United States.(See1 Ainslie et al., Business Insurance Law and Practice Guide(2003)§ 1.01[3], p. 1-5.)

"Mutual insurance companies are organized, maintained, and operated solely for the benefit of their policyholders....Such companies do not generate traditional entrepreneurial profits, but rather seek to meet their obligations at the lowest possible cost to the policyholders who, by paying premiums, provide the companies' exclusive source of capital."(Allegaert, Derivative Actions by Policyholders on Behalf of Mutual Insurance Companies(1996)63 U. Chi. L.Rev. 1063, 1067.)

"Policyholders in mutual companies are denominated `members' of the company; their ownership rights in the company are their `membership interests.'Members of mutual insurance companies have many of the same rights as stockholders in corporations, including the right to vote and the right to residual surplus upon liquidation."(UNUM Corp. v. U.S.(1st1997)130 F.3d 501, 503, fn. 1.)

State Farm does not offer insurance policies as investment opportunities but instead provides policyholders with protection against loss.In contrast, a stock insurance company seeks to earn a profit for the benefit of its stockholders, who may or may not be policyholders.(See1A Fletcher, Cyclopedia of the Law of Private Corporations, supra,§ 75, p. 40;3 Russ & Segalla, Couch on Insurance(3d ed.1997) § 39:3, p. 39-7;id.,§ 39:15, pp. 39-18 to 39-19.)

"[M]utual insurers have greater difficulty [than stock insurers] in raising capital to fund growth, and hence, must rely to greater extent on accumulated surplus and income from new members to support growth....[M]anagers of mutual insurers tend to exercise more discretion which tends to favor long-term stability over greater risk."(Klein, A Regulator's Introduction to the Insurance Industry (Nat. Assn. of Ins. Comrs.1999)p. 5-4.)

As a practical matter, a mutual insurance corporation operates much like a stock insurance corporation.(See1 Ainslie et al., Business Insurance Law and Practice Guide, supra,§ 1.01[3], pp. 1-5 to 1-6;5 Russ & Segalla, Couch on Insurance, supra,§ 80:53, p. 80-48.)Given that similarity, we rely on case law concerning stock companies where appropriate.

An...