UNOCAL CORPORATION, a California corporation; and Union Oil Company of California, a California corporation, Petitioners, v. SUPERIOR COURT of the State of California For the County of Los Angeles, Respondent; HARBOR INSURANCE CORPORATION, a California corporation, Real Party in Interest.
The Unocal Corporation seeks a writ of mandate to restore its cause of action against Harbor Insurance for violation of the federal Racketeering Influenced Corrupt Organizations Act (RICO), 18 United States Code section 1961, ff.1 The trial court sustained a demurrer to this cause of action without leave to amend. We issued an alternative writ of mandate because this case presents important questions about pleading RICO claims never before addressed by a California appellate court. These questions involve (1) the degree of specificity required in alleging the underlying “racketeering activity” of mail fraud based on concealment of facts; (2) whether an insurer may be liable for fraud if it fails to disclose a specific circumstance which will trigger cancellation when the policy gives both parties the right to cancel at will; (3) if the concealment of this intent in the circumstances and for the purposes alleged in this complaint would constitute a violation of the federal mail fraud statute and thus sustain a RICO cause of action.
Having carefully considered the briefs and oral argument on these issues, we have determined the complaint is sufficiently specific in pleading the facts constituting fraud; Harbor owed Unocal a duty to disclose its intent to cancel the policy upon a hostile takeover attempt; and, concealment of this intent to cancel for the alleged purpose of obtaining premiums for coverage not actually provided and to place insureds in a disadvantaged bargaining position so higher premiums could be extracted would constitute a violation of the federal mail fraud statute. Accordingly, we issue the peremptory writ to restore the RICO cause of action to Unocal's complaint.
FACTS AND PROCEEDINGS BELOW
According to the allegations of the complaint, in October 1982 Unocal purchased a directors' and officers' liability insurance policy (D & O policy) from Harbor Insurance. The policy provided coverage in the amount of $20 million for any “wrongful act” of a Unocal officer or director while serving in such capacity. A “wrongful act” was defined as “․ any breach of duty, neglect, error, misstatement, misleading statement, omission or other act done or wrongfully attempted by the directors or officers․” Unocal paid Harbor a premium of $110,685 for such coverage. The full premium was paid at the commencement of coverage.
Unocal's policy contained a mutual cancellation clause which provided, “Notwithstanding anything contained in this policy to the contrary, this policy may be cancelled at any time by written notice․” If Harbor was the party cancelling it was required to give 60 days' notice.
Harbor believed the definition of “wrongful act” included acts the directors might take in fighting a hostile takeover 2 because it mailed Unocal a notice of cancellation on February 15, 1985, the day after a partnership headed by T. Boone Pickens and Mesa Petroleum publicly announced it had purchased a significant number of Unocal shares. Based on Pickens' previous hostile attempt to take over Cities Service Oil Company, Phillips Petroleum and Gulf Oil Corporation, among others, it was widely speculated Pickens was attempting a hostile takeover of Unocal. (See Note, Protecting Corporate Directors and Officers: Insurance and Other Alternatives, (1987) 40 Vand.L.Rev. 775, 779 (hereafter cited as “Director and Officer Liability”.)
Concurrently with its notice of cancellation, Harbor offered Unocal a new policy which would exclude coverage for losses arising from directors' and officers' attempts to prevent a hostile takeover and which increased the deductible for certain losses from $75,000 to $2.5 million, an increase of 3,233 per cent.
Unocal ultimately replaced its directors' and officers' coverage with policies purchased through other insurers. These policies provided substantially the same coverage as the original Harbor policy but with a substantial increase in premiums and deductibles.
Thereafter, Unocal filed an action against Harbor alleging breach of contract, fraud and bad faith among other things. Initially, the complaint did not contain a RICO cause of action. The RICO claim was added a year later after Unocal discovered evidence Harbor had been engaging in a deliberate practice of cancelling directors' and officers' policies any time it became aware, or even suspected, one of its insureds would be the target of a hostile takeover attempt. The amended complaint alleged five other instances in a two-year period where Harbor cancelled insured corporations' D & O policies after learning of hostile takeover attempts directed at those corporations. Unocal also alleged Harbor never informed Unocal or the other insured corporations of its intent to cancel their policies at the first hint of a hostile takeover. The complaint alleged, and it is undisputed, Harbor used the United States mail to deliver the notices of cancellation.
Unocal discovered more than just a pattern of cancelling D & O policies without warning at the first sign of a hostile takeover. It discovered the most sought after piece of evidence in a corruption case: the smoking gun. (See Cal. Arch. Bldg. Prod. v. Franciscan Ceramics (9th Cir.1987) 818 F.2d 1466, 1470.) Here the smoking gun is a Telex message written by Daniel Milazzo, Harbor's most senior underwriter. The message, dated March 22, 1985, states in pertinent part: 3
‘As you may have noted, the Harbor has taken a ground breaking stand on the current wave of merger activity. We are issuing the attachment endorsements ․ on all policies where there is or we suspect there will be a take-over attempt. We are in some cases amending these by way of separate retentions, usually 2 1/212 MM to 5MM. It's hard ball and we've declined as much as 5 MM in A/P's [additional premiums] to stick to our guns. In reference to the above, we have sent out cancellation notices on dozens of accts. It is our intentions [sic ] to protect our common reinsurers and re-direct the market. This is just one of many such steps we have taken over the last few months.’ (Emphasis in original.)
Unocal alleges Harbor's “ground breaking stand” was never communicated to it or any of Harbor's other insureds and this failure constituted a fraudulent concealment of facts.
Believing it had discovered sufficient evidence to establish a pattern of racketeering activity in the form of mail fraud, Unocal amended its complaint to allege a violation of RICO. To allege a violation of the mail fraud statute, the plaintiff must show “(1) the defendant devised a scheme or artifice to defraud; (2) defendant used the mails in furtherance of the scheme; and (3) defendant did so with the specific intent to deceive or defraud.” (Sun Sav. and Loan Ass'n. v. Dierdorff (9th Cir.1987) 825 F.2d 187, 195.)
The trial court sustained Harbor's demurrer to the RICO cause of action without leave to amend on the ground Unocal had not alleged facts sufficient to constitute mail fraud and therefore had not alleged a “racketeering activity” required by RICO.. This petition followed.
I. OVERVIEW OF RICO.A. How Civil Liability Is Established Under Rico.
There was a time when it could be argued the Racketeering Influenced Corrupt Organization's Act (RICO) (18 U.S.C., §§ 1961–1968) only reached the activities of organized crime and enterprises affiliated with organized crime. However, that is no longer the case. The United States Supreme Court has made it clear RICO applies to “legitimate” businesses as well as mob-controlled enterprises. (See Sedima, S.P.R.L. v. Imrex Co., (1985) 473 U.S. 479, 492, 105 S.Ct. 3275, 3283, 87 L.Ed.2d 346, see also Coffee, From Tort To Crime (1981) 19 Am.Crim.L.Rev. 117.)
RICO authorizes criminal penalties and civil remedies for violation of its provisions. On the civil side, section 1964 allows a private party to recover treble damages and reasonable attorney's fees for injury sustained “in his business or property by reason of a violation of section 1962.” Section 1962 makes it unlawful to use income derived through a “pattern of racketeering activity” to acquire, maintain or operate an enterprise engaged in interstate or foreign commerce or to conduct an enterprise engaged in interstate or foreign commerce through a pattern of racketeering activity. “Racketeering activity” is defined as acts involving enumerated state and federal crimes including mail fraud. (§ 1961(1).) A “pattern of racketeering activity” requires at least two acts of racketeering activity within ten years of each other. (§ 1961(5).) Thus, a RICO cause of action requires (1) an enterprise affecting interstate or foreign commerce; (2) a pattern of racketeering activity, and; (3) a nexus between the enterprise and the pattern of racketeering activity such as use of income acquired through a pattern of racketeering activity to operate the enterprise. (Tyson & August, The Williams Act After RICO (etc.) (1983) 35 Hast. L.J. 53, 74–75.)
In the case before us it is not disputed Harbor is an enterprise engaged in interstate commerce and that it used the premiums it collected from Unocal and similarly situated corporations in the operation of the enterprise. Harbor also admits it used the mail to send notices of cancellation to Unocal and other corporations faced with hostile takeover attempts.
The dispute centers around the question whether, accepting the allegations in the complaint as true, the cancellation notices constituted a “racketeering activity,” specifically: mail fraud.
B. State Court Jurisdiction of Civil Rico Claims.
In Cianci v. Superior Court (1985) 40 Cal.3d 903, 221 Cal.Rptr. 575, 710 P.2d 375, our Supreme Court held state courts have concurrent jurisdiction with federal courts over alleged violations of the civil RICO provisions. So far as we know, the case before us is the first reported state court case to address RICO pleading requirements.
II. THIS IS AN APPROPRIATE CASE FOR REVIEW AT THE PLEADING STAGE.
Our Supreme Court has set the guidelines for appellate court intervention at the pleading stage. “[M]andamus will lie when it appears that the trial court has deprived a party of an opportunity to plead his cause of action ․ and when that extraordinary relief may prevent a needless and expensive trial and reversal.” (Coulter v. Superior Court (1978) 21 Cal.3d 144, 148, 145 Cal.Rptr. 534, 577 P.2d 669.) Here, the trial court struck Unocal's RICO cause of action without opportunity for further amendment. A RICO cause of action is unique because it allows the plaintiff to recover treble damages and attorneys fees (§ 1964, subd. (c)) not generally available in a breach of contract, fraud or declaratory relief action. Thus, we conclude mandamus is available as a remedy in this case and proceed to inquire into the propriety of the trial court's rulings. (Cf. Coulter, supra, 21 Cal.3d at p. 148, 145 Cal.Rptr. 534, 577 P.2d 669.)
III. THE COMPLAINT CONTAINS SUFFICIENT ALLEGATIONS OF MAIL FRAUD TO STATE A CAUSE OF ACTION UNDER RICO.
A violation of section 1962, subdivision (a), on which Unocal relies, requires the defendant to have received income from a pattern of “racketeering activity.” A “racketeering activity” is defined in section 1961 as any act “indictable” under enumerated federal criminal statutes. Unocal's claim is predicated on mail fraud, section 1341, one of the enumerated crimes.
To allege a violation of the mail fraud statute plaintiff, in turn, must plead “(1) the defendants formed a scheme or artifice to defraud; (2) the defendants used the United States mails ․ in furtherance of the scheme; and (3) the defendants did so with the specific intent to deceive or defraud.” (Schreiber Distributing v. Serv–Well Furniture Co. (9th Cir.1986) 806 F.2d 1393, 1400.) To these substantive pleading requirements is added the procedural rule applicable to all fraud actions that such claims are subject to strict requirements of particularity in pleading. (See 5 Witkin, Cal.Procedure (3d ed. 1985) Pleading, § 662; cf. F.R.C.P. rule 9, subd. (b).) The specificity requirement serves two purposes. The first is to give the defendant notice of the time, place, and content and participants in the alleged misrepresentation so defendant can prepare an adequate answer. (Hills Trans. Co. v. Southwest Forest Industries, Inc. (1968) 266 Cal.App.2d 702, 707, 72 Cal.Rptr. 441; Schreiber Distributing, supra, 806 F.2d at p. 1401.) The second is so that “the court can weed out nonmeritorious actions on the basis of the pleadings.” (Committee on Children's Television v. General Foods Corp. (1983) 35 Cal.3d 197, 216–217, 197 Cal.Rptr. 783, 673 P.2d 660.)
Unocal alleges violations of the mail fraud statute under two theories. Under the first theory, Unocal alleges that at the time Harbor issued the insurance policy it had formed the intent to cancel at the first sign of a hostile takeover attempt and coerce Unocal into accepting a replacement policy with higher deductibles, higher premiums and excluding coverage for acts related to a hostile takeover. Harbor concealed this intent from Unocal. The second theory alleges Harbor concealed its intention to cancel the policy at the first hint of a hostile takeover but that this secret intent arose some time after the policy was issued and before the Pickens Group commenced its hostile takeover attempt. Both theories are based on the existence of Harbor's secret intention to cancel the policy at the first sign Unocal might be the target of a hostile takeover attempt. The difference is under the first theory defendant “harbored” the intent to cancel at the inception of the policy; under the second theory the intent to cancel arose after the inception of the policy.
Harbor objects to the first theory on two grounds: (a) the complaint fails to plead with specificity facts supporting the allegation Harbor maintained the intent to cancel at the inception of the policy; (b) the policy provision allowing either party the right to cancel for any reason precludes Unocal from contending Harbor concealed an intent to cancel under certain circumstances. Harbor objects to the second theory on the ground fraudulent concealment must relate to facts in existence but not disclosed at the time the policy was issued. Harbor repeats its contention the unfettered cancellation provision in the policy negated any duty on its part to disclose the circumstances under which it would cancel no matter when those circumstances were selected.
Since we conclude appellant properly pleaded a RICO violation under its first theory and order reversal of the demurrer on that basis, we find it unnecessary to discuss the second theory.
A. The Allegation Harbor Had an Existing Undisclosed Intent to Cancel When It Issued the Policy Is Supported by Sufficient Facts to Give Harbor Notice of the Charges and Assure the Court of Its Merit.
Aside from citing federal cases holding mail fraud must be pled with specificity and asserting Unocal failed to meet this requirement, Harbor offers little argument on this point. Harbor does not, for example, suggest what sort of facts Unocal failed to allege.
It is true the complaint does not specifically allege when the concealment took place, where it took place or who participated in the concealment but these facts can be inferred from other allegations in the complaint or are within Harbor's knowledge.
We know from the complaint Unocal purchased the policy on or about October 8, 1982. That would be the date the concealment commenced. We also know the content of the concealed fact: that Harbor intended to cancel the policy at the first sign of a hostile takeover. That much is specifically alleged. As to where this plot was hatched and by whom, the facts are within the knowledge of the defendant, Harbor.
In Committee on Children's Television, supra, the court observed there are “certain exceptions which mitigate the rigor of the rule requiring specific pleading of fraud. Less specificity is required when ‘it appears from the nature of the allegations that the defendant must necessarily possess full information concerning the facts of the controversy’․ ‘[E]ven under the strict rules of common law pleading, one of the canons was that less particularity is required when the facts lie in the knowledge of the opposite party․’ ” (35 Cal.3d at p. 217, 197 Cal.Rptr. 783, 673 P.2d 660, citations omitted.) Relaxation of the specificity requirement is particularly appropriate in a concealment case. Unlike intentional misrepresentation which requires an affirmative act—a suggestion, assertion or promise (Civ.Code, § 1710 (1), (2), (4)), a fraudulent concealment is a nonhappening—the suppression of a fact. (Civ.Code, § 1710(3).) This distinction was recognized in Turner v. Milstein (1951) 103 Cal.App.2d 651, 230 P.2d 25, one of the cases cited in Committee on Children's Television, supra. In rejecting a demurrer based on uncertainty the Turner court pointed out,
The only specification of uncertainty was that it could not be determined how, or in what manner, Milstein concealed from plaintiff the time and place of the sale of the real property. The ultimate fact is pleaded. It is an old and elemental rule of pleading that a demurrer for uncertainty does not lie if what is sought is a statement of matter already within the knowledge of the demurring party․ If, in truth, Milstein concealed from plaintiff the fact that the property was to be sold, he knows it and he knows the time and place of concealment, if there was a time and place. It would seem that concealment is negative and that it would occur without any time or place. Milstein knows the facts. (103 Cal.App.2d at p. 658.)
Furthermore, Unocal did plead specific facts which support its allegation Harbor maintained the intent to cancel at the inception of the policy and which satisfy the court's need for a showing of bona fides, to the extent that need is still recognized.4 The complaint alleges five other instances in 1985 where Harbor cancelled directors' and officers' policies upon learning of a possible takeover attempt of the insured corporation.
What is true about an attribute of one's state of mind at the present time is relevant on the question of this attribute of one's state of mind a year or several years earlier. Indeed this principle has already been applied to sustain a finding of intent to defraud. In Santoro v. Carbone (1972) 22 Cal.App.3d 721, 99 Cal.Rptr. 488 plaintiff successfully sued to quiet title to property conveyed to him and defendant as joint tenants. Plaintiff alleged he put title in joint tenancy in reliance on defendant's false representation if he did so she would marry him. On appeal defendant argued there was no proof of intent to defraud. The appellate court rejected this argument saying, “Since direct proof of fraudulent intent is often impossible, the intent may be established by inference from acts of the parties․ The subsequent failure to perform as promised warrants the inference that defendant did not intend to perform when she made the promise.” (Id. at pp. 727–728; citations omitted.)
The evidence in Santoro established that less than two months after plaintiff purchased the house defendant left him and returned to her husband. The court viewed this as evidence of her intent at the inception of the agreement. In the case before us, Harbor cancelled six policies, including Unocal's, which had only been in effect for a few months to a few years as soon as it learned of a possible takeover.5 This consistent pattern of conduct permits an inference the intent to cancel, if a hostile takeover arose, existed at the time Harbor issued the policies.
B. The Mutual Cancellation Clause Did Not Relieve Harbor from Liability for Concealing Its Intent to Cancel at the First Sign of a Hostile Takeover.
Harbor does not deny an insurance company can be liable for fraud if it conceals facts it was bound to disclose. Harbor's position is the unlimited mutual cancellation provision in its D & O policies relieved it of any duty to disclose a specific ground for cancellation it would invoke in given circumstances. Because it claims to possess the “unfettered contractual right to cancel for any reason” Harbor concludes there was no concealment of a material fact. Its cancellation at the first sign of a hostile takeover “is totally consistent with the terms of the mutual cancellation provision [which gave Unocal and Harbor both the right to cancel without cause]․”
We first note the identical argument was rejected in Murphy v. Seed–Roberts Agency, Inc. (1977) 79 Mich.App. 1, 261 N.W.2d 198, 205. We further conclude, on the basis of California law and cases from other jurisdictions, that notwithstanding an unrestricted cancellation provision in the policy, an insurer can be held liable for fraud if it fails to disclose a ground for cancellation with intent to injure the insured.
The right of insurance companies to cancel policies is not absolute. Cancellation provisions in an insurance policy are subject to the covenant of good faith and fair dealing just as are other provisions of the contract. (Spindle v. Travelers Ins. Companies (1977) 66 Cal.App.3d 951, 957–958, 136 Cal.Rptr. 404.) Thus, it has been held an insurance company cannot cancel a policy to retaliate against the insured, (Spindle v. Travelers Ins. Companies, supra; L'Orange v. Medical Protective Company (6th Cir.1968) 394 F.2d 57), to avoid liability where the loss has commenced or is imminent (Harman v. American Casualty Co. of Reading Pa. (S.D.Cal.1957) 155 F.Supp. 612, 613–614; Home Life Ins. Co. of New York v. Heck (1872) 65 Ill. 111, 114) or to coerce the insured into purchasing less extensive coverage at a higher premium. (Murphy v. Seed–Roberts Agency, Inc., supra, 79 Mich.App. 1, 261 N.W.2d 198, 204–205.)
Harbor seeks to distinguish the bad faith cancellation cases on the grounds the facts in this case do not suggest Harbor cancelled Unocal's policy in retaliation for some act by Unocal or that cancellation came when a loss had already occurred or was imminent. The question whether Harbor acted in bad faith when it cancelled the policies of Unocal and others is a question of fact. And, whether it harbored an intent to engage in this practice of cancellation at the time it issued the policy likewise is a question of fact. However, we are not prepared to say, as a matter of law, Unocal cannot establish a bad faith cancellation under the facts pled. Furthermore, it is incorrect to assume the foregoing examples of bad faith cancellation exhaust the possible applications of that doctrine. The policy considerations which led the Spindle court to prohibit retaliatory cancellations are just as applicable here as are the qualities of decency and humanity underlying the doctrine of good faith and fair dealing.
In Home Ins. Co. of New York v. Heck, supra, the insurance company cancelled Heck's fire insurance policy while fires were burning in the surrounding clearings and forests. In upholding a judgment for Heck, the court held that despite the terms of the policy giving the insurer the unrestricted right to cancel, “It cannot be claimed ․ that an insurer against fire can, when the fire is approaching the property insured, cancel the policy. This would be acting in bad faith, and would not be justified by the law of the contract.” (65 Ill. at p. 114.) In Harman v. American Casualty, supra, the insurance company attempted to cancel a policy covering fire and landslides after a massive and continuing land movement had commenced in the area where the property was located. The insurance company conceded its liability for damage from the earth slippage which had already commenced but claimed it could cancel fire coverage because no fires had yet occurred. The court disagreed. The fact the risk of fire is greatly increased by the earth movement did not justify cancelling the fire insurance where the earth movement had already commenced. (155 F.Supp. at p. 614.)
In contrast to Home Insurance and Harman, Harbor cites cases holding an insurer may cancel a policy when the risk of loss from a hazard insured against has increased. (See Treadwell v. International Travelers Assurance Co. (Tex.1933) 60 S.W.2d 536, 537; Silver Eagle Co. v. National Union Fire Ins. Co. (1967) 246 Or. 398, 423 P.2d 944.) In Treadwell the court found the insurance company was justified in cancelling an accidental death and injury policy when the insured acquired an illness that made him a greater risk to suffer an accidental death or injury. The court concluded, “The present facts show no imminent and impending danger to the insured of injury or death by accidental means. It is simply shown that he had become a very hazardous risk for accident insurance.” (60 S.W.2d at p. 537.) Silver Eagle involved the cancellation of products liability insurance after the insurance company became aware two of two-hundred-fifty units were defective and had caused accidents. The court upheld the insurer's right to cancel saying, “There is in the instant case no element of physical inevitability․ There is nothing in the record to show that future accidents could not have been avoided by a vigorous effort to call back the defective merchandise. This case is not, therefore, a landslide or prairie fire case in which the loss had become unavoidable at the time notice of cancellation was given.” (423 P.2d at p. 947.)
From the cases cited by both parties the following rule emerges. An insurer breaches the implied covenant of good faith and fair dealing when it cancels coverage because of circumstances that were reasonably foreseeable at the policy's inception and the risk of loss has developed to the point where it is unavoidable by the insured. A fortiori, an insurer breaches this covenant when at the time the insurance contract is executed it harbors an intent to cancel under these circumstances and with an intent to disadvantage insureds yet conceals this intent from those insureds.
In Home Insurance and Harman cancellation was impermissible because the risks of loss from a prairie fire or a landslide touching off a fire were reasonably foreseeable at the policy's inception and, at the time the insurance company attempted to cancel, the risks had developed to the point where they were unavoidable through any reasonable steps on the part of the insureds. In Treadwell the insurer agreed to insure against the risk of accidental death or injury to persons in normal health and engaged in regular work. It did not bargain for the risk to a person suffering from arteriosclerosis, cerebral hemorrhage, staggering, drowsiness, confusion and hypertension. Although the insurer could foresee the possibility of Treadwell's illness, in order to support a charge of bad faith, there must be knowledge of circumstances not merely possible, but probable. (Cf. MacPherson v. Buick Motor Co. (1916) 217 N.Y. 382, 111 N.E. 1050, 1053.) In Silver Eagle the risk of loss from defective products was a foreseeable probability and one the insurer had contracted to cover but the risk had not yet developed to the point where it was unavoidable by the insured. Consumers could be warned of the defect or the product could be recalled.
In the case before us, Harbor bargained for the risk of director and officer liability and should have expected to be exposed to the risk of claims arising from actions taken by management in response to the tactics of a hostile bidder. (See “Director and Officer Liability”, supra, at p. 778, fn. 18.) At the time Harbor mailed the cancellation notice to Unocal the hostile takeover attempt had already commenced. The risk of loss had developed to the point where it was unavoidable through any steps Unocal itself could take.
As an independent and sufficient grounds for our holding the complaint alleges concealment of an intent to engage in a practice of bad faith cancellations, we observe Harbor's right to cancel the policy was restricted by the principle forbidding an insurer an unconscionable advantage in an insurance transaction even though the policy holder has manifested fully informed consent. (Keeton, Insurance Law Rights At Variance With Policy Provisions, (1970) 83 Harv.L.Rev. 961, 963.) Application of this principle can be seen in Spindle v. Travelers Ins., supra, and Mission Ins. Group, Inc. v. Merco Construction Engineers, Inc. (1983) 147 Cal.App.3d 1059, 195 Cal.Rptr. 781, both of which rejected the insurers' claims that its actions were specifically authorized by a provision in the policy.
The plaintiff in Spindle was a medical doctor to whom Travelers had issued an individual malpractice insurance policy pursuant to a master contract between Travelers and a medical association of which plaintiff was a member. Travelers and the medical association were negotiating a new contract. Travelers was seeking a 141 per cent increase in premiums and the association was offering a 15 per cent increase. While these negotiations were going on Travelers abruptly canceled Spindle's malpractice policy. Spindle claimed the cancellation was intended as a threat and a warning to other doctors in the association that they could expect similar treatment if they continued to oppose Travelers' premium increase. Spindle further alleged Travelers knew he would be unable to practice medicine in hospitals without malpractice insurance. Eventually Spindle replaced his malpractice insurance but was forced to go with an undercapitalized company at a premium 350 per cent higher than he had paid to Travelers.
Spindle sued Travelers on the theory it had acted in bad faith in cancelling his policy. Travelers demurred on the ground the policy gave it the absolute right to cancel for any reason. Indeed this cancellation provision was almost identical to the one used by Harbor in the case at bar. The appellate court reversed the order dismissing the complaint. The court held an insurer is liable to its insured for “cancelling a malpractice insurance policy in accordance with permissible terms of the cancellation provisions of the policy, if the reasons for such cancellation are such as to make the cancellation a violation of the implied covenant of good faith and fair dealing.” (66 Cal.App.3d at p. 959, 136 Cal.Rptr. 404.)
In Spindle, the violation of good faith and fair dealing was the unconscionable advantage Travelers took of Spindle's need for malpractice insurance. According to the allegations in the complaint Travelers knew Spindle had to have malpractice insurance in order to pursue his profession as a neurosurgeon. Without it, no hospital would allow him to perform surgery. (66 Cal.App.3d at pp. 953, 955, 136 Cal.Rptr. 404.) Travelers also knew it would be difficult or impossible for Spindle to replace its policy at competitive rates from a sound insurer. (Id. at p. 955, 136 Cal.Rptr. 404.) As the court pointed out, “[T]he deprivation to the insured of the benefit of his bargain is greater than average due to the lack of competition in the field of malpractice insurance alleged in the amended complaint.” (Id. at p. 958, 136 Cal.Rptr. 404.) Finally, Spindle's complaint alleged he was told by a senior Travelers' official his insurance would not have been cancelled if the association had agreed to the 141 per cent premium increase. (Id. at p. 955, 136 Cal.Rptr. 404.)
In Mission Insurance, supra, the court held the insured stated a cause of action for bad faith in alleging the insurance company arbitrarily and unreasonably reduced the dividend payable to the insured and attempted to obtain a release from the insured of all further claims as a condition to paying the dividend the insurance company conceded was due and owing. (147 Cal.App.3d at pp. 1066, 1068, 195 Cal.Rptr. 781.) The unconscionable advantage was Mission's refusal without legal justification to pay a substantial sum, $22,000, it conceded it owed the insured unless the insured dropped its claim to an additional $11,000. (Id. at p. 1068, 195 Cal.Rptr. 781.) The court rejected Mission's contention its acts were justified by a provision in the policy giving its board of directors the “unfettered discretion” to set the amount of the dividend. (Id. at pp. 1063–1064, 195 Cal.Rptr. 781.) Citing the Spindle case among others, the court responded, “The days of ‘unfettered’ discretion, if they ever existed, are no more.” (Id. at p. 1065, 195 Cal.Rptr. 781.)
In the case before us the facts alleged suggest Harbor sought to use the cancellation clause to take unconscionable advantage of Unocal's predicament in being the target of a hostile takeover attempt. The complaint alleges Harbor sought to take unconscionable advantage of Unocal and other similarly situated corporations by keeping silent about its intent to cancel their D & O policies upon a hostile takeover attempt. By keeping silent, Harbor intended the corporations would not seek insurance elsewhere and be trapped into accepting Harbor's replacement policy because in the corporations' vulnerable position replacing their D & O coverage would either be impossible or extremely expensive.
To summarize, we are not saying an insurer cannot refuse coverage for liability arising from directors' and officers' wrongful acts in repelling a hostile takeover attempt or that an insurer can never cancel a policy containing such coverage. Nor are we saying an insurer must disclose every ground on which it might cancel the policy. We only hold an insurer can be held liable for fraud if it conceals a ground for cancellation intending injury to the insured.
C. The Mail Fraud Statute Applies to a Defendant Who Uses His Contractual Relationship with Another to Deprive That Person of Money or Property Through Fraudulent Concealment.
As discussed earlier, the civil liability provisions of RICO have been construed to reach far beyond the realm of organized crime. Perhaps the major remaining constraint is that civil liability attaches only when the activity involved would constitute a violation of a criminal law, in the instant case a violation of the federal mail fraud statute. Thus, having already concluded the allegations of appellant's complaint, if true, properly allege fraudulent concealment we must still inquire whether that fraudulent concealment would support a prosecution under the mail fraud statute. Although it is a fairly close question, we hold it would.
Harbor argues the conduct in which it is alleged to have engaged should not be held to violate the mail fraud statute because it is not a classic fraud but a mere breach of contract. We first observe the boundaries of a “scheme or artifice to defraud” under section 1341 are not limited to common law or state law concepts of fraud. Secondly, the history of the mail fraud statute shows that while its reach is broad, courts and juries have had no trouble distinguishing between deceit and a breach of contract.
In enacting the mail fraud statute Congress expressed itself in most expansive language. It prohibited “any scheme or artifice to defraud.” The question quickly arose what types of “schemes” the statute covered. Durland v. United States (1896) 161 U.S. 306, 16 S.Ct. 508, 40 L.Ed. 709, the first Supreme Court case to construe the statute, answered that the phrase “scheme or artifice to defraud” was to be interpreted broadly. The court rejected the argument that “the statute reaches only such cases as, at common law, would come within the definition of ‘false pretenses' [for which] there must be a misrepresentation as to some existing fact and not a mere promise as to the future.” (Id. at p. 312, 16 S.Ct. at p. 511.) Instead, the court construed the statute to include “everything designed to defraud by representations as to the past, or present, or suggestions and promises as to the future.” (Id. at p. 313, 16 S.Ct. at p. 511.) Subsequently, the court stated the words “to defraud” commonly refer “to wronging one in his property rights by dishonest methods or schemes” and “usually signify the deprivation of something of value by trick, deceit, chicane or overreaching.” (Hammerschmidt v. United States (1924) 265 U.S. 182, 188, 44 S.Ct. 511, 512, 68 L.Ed. 968; see McNally v. United States (1987) ––– U.S. ––––, 107 S.Ct. 2875, 2879–2881, 97 L.Ed.2d 292.) In addition, there are numerous cases holding a “scheme to defraud” need not constitute fraud under state law. (See, e.g., United States v. Foshee (5th Cir.1979) 606 F.2d 111, 113 and cases cited therein.)
Although criminal prosecution of an insurance company under the mail fraud statute is rare it is not unknown. In United States v. Sylvanus (2d Cir.1951) 192 F.2d 96 the court upheld the conviction of an insurance company which used the mails in a scheme to defraud the public in the sale of accident and sickness insurance. The evidence established the insurance company “grossly misrepresented the company's accident and sickness insurance policies ․ in circular letters mailed to prospective customers․ [T]he company issued policies not such as advertised but limited in character, misleading, ambiguous and inconsistent.” (Id. at p. 100.)
There is even federal precedent for mail fraud based RICO claims against insurance companies. In Marcial v. Coronet Insurance Co. (E.D.Ill.1987) [Available on WESTLAW, 1987 WL 19532], U.S. Dist., Lexis 10175, page 4, the court held the plaintiff had pled the fraud element with sufficient particularity in alleging: defendant's insurance policies falsely stated automobile theft was covered; defendants knew the representation as to coverage was false; the representation was intended to induce plaintiffs to buy insurance policies; plaintiffs relied on defendant's representation in purchasing the policies; plaintiffs suffered damages in that they paid premiums for non-existent coverage. (See also Grabowski v. Agriculture Ins. Co. (E.D.Penn.1986) 646 F.Supp. 841, 842; Chicago HNO v. Trans Pacific Life Ins. Co. (N.D.Ill.1985) 622 F.Supp. 489, 493–494.)
The distinction between breach of contract and mail fraud is that the latter can occur where the defendant uses his contractual relationship with another to deprive that person of property through deceit. In United States v. George (7th Cir.1973) 477 F.2d 508 a purchasing agent was convicted of mail fraud in a kick back scheme with a supplier which “deprived [the agent's employer] of its lawful money and property.” In United States v. Barta (2d Cir.1980) 635 F.2d 999, the defendant used his status with his employer to obtain credit for a company in which he had an interest. He concealed from his employer the true financial situation of the company and his interest in it. Defendant was convicted of mail fraud after the company became insolvent and defendant's employer had to bear a $2 million loss.
In the instant case, Unocal alleges at the time Harbor issued the D & O policy, October 1982, Harbor possessed the intent to cancel the policy at the first sign of a hostile takeover and to conceal that intent from Unocal. Unocal alleges Harbor's action was more than just a bad faith breach of contract. Unocal alleges, “Harbor derived income under this scheme by knowingly soliciting and retaining premiums for D & O insurance policies from plaintiffs ․ even though Harbor had already formed the intent to cancel said policies and to thereafter coerce its insureds into accepting additional exclusionary language limiting coverage under such policies and/or to pay additional premiums․”
The complaint alleges Harbor concealed its intent to cancel Unocal's policy in order to deprive Unocal of money in two ways. First, by not disclosing its intent to cancel Unocal's D & O policy until a hostile takeover attempt occurred Harbor hoped to take advantage of Unocal's vulnerable position to force Unocal to accept a substitute policy with less coverage at a higher premium. Because it had a mandatory duty to indemnify its directors and officers for their successful defense of certain actions (Corp. Code, § 317, subd. (d)) and because of the increase in suits against corporate management,6 Unocal could not realistically do business without a D & O policy. (Cf. Spindle v. Travelers Ins., supra, 66 Cal.App.2d at p. 955, 136 Cal.Rptr. 404.) Furthermore, as was the case in Spindle, there was a very limited market in the type of insurance Unocal needed. (Cf. 66 Cal.App.3d at p. 958; and see Director and Officer Liability, supra, 40 Vand.L.Rev. 776–778.) The fact Harbor did not succeed in selling Unocal a replacement policy would not affect Unocal's RICO cause of action. Success of the fraudulent endeavor is not a prerequisite to the crime of mail fraud. (DeMier v. United States (8th Cir.1980) 616 F.2d 366, 369.) Second, by concealing its intent not to cover hostile takeover attempts, Harbor was able to charge Unocal more than it could have for a policy that did not include such coverage. If the allegations of the complaint are true, Harbor charged Unocal for unleaded premium but delivered only regular.
The petition is granted. Let a peremptory writ of mandate issue to the Superior Court of Los Angeles County directing that court to vacate its order sustaining without leave to amend the demurrer of defendant Harbor Insurance Corporation to the eleventh cause of action in plaintiffs' fifth amended complaint and thereafter make a new and different order overruling said demurrer.
1. Unless otherwise stated, all future statutory references are to Title 18 of the United States Code.
2. See Heckman v. Ahmanson (1985) 168 Cal.App.3d 119, 127, 214 Cal.Rptr. 177.
3. This document was not pled in the complaint. Its contents are quoted in the petition and the full document is attached an exhibit. Harbor's answer to the petition admits the authenticity of this document.
4. Committee on Children's Television, supra, 35 Cal.3d at page 216, footnote 7, 197 Cal.Rptr. 783, 673 P.2d 660 and Sedima, S.P.R.L. v. Imrex Co., supra, 473 U.S. at page 492, 105 S.Ct. at page 3283 suggest plaintiffs in fraud and RICO actions cannot be required to show some special legitimacy for their actions.
5. Unocal's policy was issued in October 1982 and cancelled in February 1985. Johnson Controls' policy was issued in January 1983 and cancelled in March 1985. The other four companies' policies were cancelled less than a year after issuance. MCA's policy only lasted three months.
6. (Note, Void Ab Initio: Application Fraud as Grounds for Avoiding Directors' and Officers' Liability Insurance Coverage (1986) 74 Cal.L.Rev. 929, 932; Director and Officer Liability, supra, 40 Vand.L.Rev. at 776, fn. 11.)
JOHNSON, Associate Justice.
LILLIE, P.J., and THOMPSON, J., concur.