Deceptive Business Practices Exclusion Does Not Bar Coverage for Kickback Suit

The United States District Court for the Northern District of California has held that a deceptive practices exclusion contained in an errors and omissions policy issued to a real estate brokerage did not bar coverage for a suit alleging the brokerage engaged in a kickback scheme with a vendor because two causes of action asserted did not necessarily require a finding of deception or fraud.  Hanover Ins. Co. v. Paul M. Zagaris, Inc., 2017 WL 713146 (N.D. Cal. Feb. 23, 2017).

The insured, a real estate brokerage company, was sued by a group of California residents who alleged that the company was receiving secret kickbacks through the sale of natural-hazard disclosure reports that the brokerage firm purchased from a shell corporation for half the price the brokerage company then charged the consumer.  The putative class action alleged that the shell corporation then shared that profit with the brokerage firm, who never disclosed that interest to its clients, allegedly in breach of its fiduciary duties. The complaint also asserted claims for violation of California’s Unfair Competition Law, constructive fraud, unjust enrichment, and civil conspiracy.

After agreeing to defend the brokerage company, subject to a reservation of rights, the professional liability insurer filed a declaratory judgment action seeking a ruling that it had no duty to defend, as well as the reimbursement of attorney’s fees and costs paid to defend the underlying suit.  On the parties’ cross-motions for summary judgment, the insurer contended that the exclusion precluding coverage for claims that “arise out of . . . deceptive business practices” applied to the action in its entirety, eliminating the insurer’s duty to defend.  The brokerage company argued that certain allegations of the underlying action did not necessarily fall within the exclusion.

The court determined that the key question was whether the causes of action for breach of fiduciary duty and constructive fraud “arise out of . . . deceptive business practices” such that the exclusion applied to the entire underlying suit.  The court rejected the insurer’s reliance on Vandenberg v. Superior Court, 21 Cal. 4^th 815 (1999), for the contention that the action as a whole arose out of deceptive business practices, opining that the Vanderberg case did not stand for such a sweeping a proposition.  The court pointed out that the count for breach of fiduciary duty may constitute negligence or fraud, depending on the circumstances of the case, and that the constructive fraud count can be comprised of not otherwise fraudulent conduct such as an omission.  According to the court, it is possible that the brokerage firm could be found to have breached its fiduciary duties by failing to disclose its interest in the sale of the reports, or engaged in constructive fraud via the same omission, independent of any alleged deception.  In other words, the insurer could not meet its burden to show “through conclusive evidence, that the exclusion applies in all possible worlds.”  The court granted the brokerage company’s motion for summary judgment, leaving the insurer responsible for continuing the defense of its insured.