Phillip C. UMANN et al., Plaintiffs and Appellants, v. EXCESS INSURANCE COMPANY, Defendant and Appellant.
In this case, we hold that the principal shareholder of an insured corporation has no separate cause of action against the insurer for personal injuries suffered and is not an implied beneficiary of the insurance contract. The insured corporation may recover “extra-contract” damages for breach of the covenant of good faith and fair dealing in the insurance contract, even though the statute of limitations has run on a tort complaint but is timely for a breach of contract action.
Plaintiff Phillip Umann was the principal shareholder in plaintiff corporation, Land/Sea Enterprises, Inc., (Land/Sea) which sold pleasure boats. On September 13, 1977, Umann completed a transaction with Parvis Parvin and Parvin Imports for the sale of six pleasure boats.1 Parvin, an Iranian national, planned to sell the boats in Iran and had Umann ship them to Baltimore to be loaded on an Iranian cargo ship. Parvin paid with a check on a closed account. The cost of boats and related equipment was alleged to be $106,984. Umann's attempt to stop the shipment and to recover the boats was unsuccessful.
At the time of the loss, Land/Sea was the sole named insured under a comprehensive “all-risk” business liability and indemnity policy issued by defendant Excess Insurance Company (Excess). The policy provided coverage for “all risks of direct physical loss of or damage to the insured property from any external cause․” The policy limits any one loss in the amount of $17,000 “[o]n property while in due course of transit,” and provided $50,000 “[o]n property located elsewhere within the territorial limits of the [United States].” The policy excluded from coverage an act of “[m]isappropriation, secretion, conversion, infidelity or any dishonest act on the part of ․ others to whom the property may be entrusted (carriers for hire excepted ).” (Emphasis added.)
In February 1978, Land/Sea instructed its insurance agent, Krueger Insurance, Inc., (Krueger) to file a claim under the policy. Excess was not listed as the insurer anywhere on the policy provided by Krueger. On several occasions, Mor-Ben Insurance Markets Corporation (Mor-Ben), Excess's agent, indicated that it was denying the claim. Finally, on August 30, 1978, Mor-Ben sent Land/Sea a written denial of the claim for the reason that Land/Sea did not establish the theft of the boats occurred within the territorial limits of the United States, as required under the policy.
On September 25, 1979, Umann, individually, and Land/Sea and Silver Sea filed suit against Trident Insurance Company, Mor-Ben and Krueger for breach of duty to pay under the policy. Because of the uncertainty as to the identity of the insurer, plaintiffs did not list Excess as a defendant. The complaint alleged (1) breach of contract, (2) fraud, (3) breach of the covenant of good faith and fair dealing and violation of the Unfair Practices Act (Ins.Code, § 790.03, subd. (h)), and (4) negligence. The negligence count named only Krueger. On May 11, 1982, plaintiffs filed an amended complaint naming Excess as a defendant, and realleged the first three causes of action only.
At trial, a judgment on the pleadings was entered against Umann on his personal causes of action on the ground that he was not a named insured under the policy.2 Additionally, a nonsuit was granted, disposing of Land/Sea's causes of action for fraud and the Insurance Code violations on the ground that each was barred by the three-year statute of limitations. Only Land/Sea's causes of action for breach of contract and breach of the duty of good faith and fair dealing were presented to the jury. The jury returned a general verdict against Excess for $350,000 in compensatory damages and $1.5 million in punitive damages. Land/Sea consented to a remittitur in the amount of $151,000 in compensatory damages and $750,000 in punitive damages.
Umann appeals from the judgment on the pleadings and contends that he is entitled to maintain a personal action for damages against Excess. Excess cross-appeals, contending the cause of action for breach of the implied covenants is time-barred, punitive damages were improperly awarded and the compensatory award was excessive even as reduced. Land/Sea also appeals, challenging the reduction of its compensatory and punitive damages awards.
Umann argues that even though he is not an insured under the policy, as founder, principal shareholder and general manager of the company he is an implied beneficiary and is therefore entitled to allege causes for damages personal to him. The novel argument asserts that in light of his close relation with the insured company the damages to him personally were foreseeable and he is entitled to state a cause of action for breach of the implied covenants of good faith and fair dealing. As a result of Excess's failure to pay him on the claim, his company could not obtain credit, and that despite making numerous personal loans to the company, Land/Sea ultimately ceased operations, causing him to sustain economic damages and emotional injury.
The duty of an insurer to deal fairly and to act in good faith is implied in every insurance contract. That duty extends to third party claimants against the insured as well as to claims of the insured himself. (Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 575, 108 Cal.Rptr. 480, 510 P.2d 1032.) But that duty does not extend to persons who are not parties to the insurance contract or who are not third party claimants. Here, only Land/Sea was named as an insured. Umann was not in privity with Excess nor can it be said that he was a third party claimant. He is no more than a stranger to the insurance contract. (See id., at p. 576, 108 Cal.Rptr. 480, 510 P.2d 1032.) A similar result was reached in Austero v. National Cas. Co. (1976) 62 Cal.App.3d 511, 133 Cal.Rptr. 107. There, the wife of the insured under a disability policy sued the insurer for bad faith refusal to pay her husband's claim. In rejecting the wife's claim for damages for emotional distress, the Court of Appeal acknowledged that emotional distress on her part was foreseeable. But the reviewing court viewed that as being irrelevant since no duty to the wife existed. The court reasoned that the implied covenants arise only out of a contractual relationship, and where no relationship exists, there is no recovery for the alleged damages suffered by her as an individual. (Id., at pp. 516–517, 133 Cal.Rptr. 107; accord C & H Foods Co. v. Hartford Ins. Co. (1984) 163 Cal.App.3d 1055, 1068, 211 Cal.Rptr. 765.) This same argument was raised and rejected in Williams v. Transport Indemnity Co. (1984) 157 Cal.App.3d 953, 203 Cal.Rptr. 868, wherein the noninsured wife of decedent was precluded from filing a claim based on a violation of Insurance Code section 790.03, subdivision (h) because only her husband was an insured under the policy. (Id., at p. 963, 203 Cal.Rptr. 868.)
Plaintiff cites Truestone, Inc. v. Travelers Ins. Co. (1976) 55 Cal.App.3d 165, 127 Cal.Rptr. 386, but that reliance is misplaced. There, shareholders of a closely held corporation were joint insureds along with the corporation under a liability policy. The reviewing court held that the insurers' duty of good faith and fair dealing ran to both the company and the shareholders, as insureds, and that the shareholders could prosecute an action for its breach. (Id., at pp. 170–171, 127 Cal.Rptr. 386.)
Plaintiff also erroneously relies on Delos v. Farmers Group, Inc. (1979) 93 Cal.App.3d 642, 155 Cal.Rptr. 843, for the proposition that a nonclaimant may sue for emotional distress damages which are reasonably foreseeable when an insurer is guilty of bad faith refusal to pay the insured's claim. There, the husband was permitted to file a claim of emotional distress he suffered as a result of the insurer's failure to pay for his wife's injuries under her uninsured motorist's policy. But, in that case, both husband and wife were named insureds under the policy. Umann was not a named insured under the subject policy. The only interests protected under the policy are those of the corporation. The injury to a shareholder of a closely held corporation is derivative. (See Truestone, Inc. v. Travelers Ins. Co., supra, 55 Cal.App.3d at pp. 170–171, 127 Cal.Rptr. 386.) Accordingly, Umann cannot maintain an individual action for damages against defendant insurance company on any of the theories he alleged in his complaint.
Relying on Lucas v. Hamm (1961) 56 Cal.2d 583, 15 Cal.Rptr. 821, 364 P.2d 685, Umann argues that the lack of privity should not foreclose his individual causes of action since he was the intended beneficiary of the insurance contract. We disagree. Lucas set forth the factors to be considered in determining when a defendant will be held liable to beneficiaries of a will in which it was said that the whole purpose for having the attorney prepare the will was to benefit these particular persons. Those general tort principles discussed in Lucas have no relevance to the relation between a corporate entity and its shareholders, which is wholly separate and derivative. A corporation is a separate legal entity which has an existence apart from its shareholders. The insurance policy was purchased to protect the assets of the corporation and not the individual assets of the shareholders. One of the primary reasons for forming a corporation is to insulate the shareholders from personal liability. In a general sense, the shareholders of any corporation suffer whenever the corporation has sustained economic loss, has failed to declare a profit or is unable to pay dividends. But this relationship is not sufficient to make a shareholder, officer, director or creditor, such as Umann, an implied beneficiary of a contract with the corporation. An action to recoup damages suffered by the corporation must be prosecuted either directly by the corporation or as a derivative action by the shareholders. (See Truestone, Inc. v. Travelers Ins. Co., supra, 55 Cal.App.3d at p. 170, 127 Cal.Rptr. 386.) An action for economic damages to the corporation already presumes injury to the value of the shareholders' interests in the corporation. The insurance contract was not intended to benefit any party other than the corporation. We conclude that the entry of the judgment on the pleadings was entirely proper.
Plaintiff next contends that he should have been afforded the opportunity to allege causes of action for negligence, negligent infliction of emotional distress and intentional infliction of emotional distress.
Plaintiff did not allege causes of action for negligence or intentional infliction of emotional distress at trial. Nor did he move to amend the complaint to allege these counts until after trial began. It is axiomatic that a party cannot raise new theories on appeal. (See generally, Webster v. Southern Cal. First Nat. Bank (1977) 68 Cal.App.3d 407, 416–417, 137 Cal.Rptr. 293; also Great American Ins. Co. v. Globe Indem. Co. (1970) 8 Cal.App.3d 938, 948, 87 Cal.Rptr. 653.)
Plaintiff argues that the trial court abused its discretion in denying his belated motion to amend to state a cause of action for intentional infliction of emotional distress. On May 11, 1982, the trial court granted plaintiff's motion to amend his complaint to name Excess as a defendant. On August 28, the case proceeded to trial. On August 31, the trial court granted Excess's motion for judgment on the pleadings. Subsequently, plaintiff moved to amend his complaint to allege intentional infliction of emotional distress, which was denied. The decision to allow plaintiff to amend the complaint rests within the sound discretion of the trial court, and the motion may be denied when plaintiff has unjustifiably delayed in seeking the amendment. (See Fisher v. Larsen (1982) 138 Cal.App.3d 627, 649, 188 Cal.Rptr. 216.) Plaintiff's motion was made after the start of the trial, over three months after he filed his amended complaint. Plaintiff does not contend new evidence came to his attention to justify the amendment. He certainly knew or should have known the cause of action existed at the time he added Excess as a named defendant. (Compare Hirsa v. Superior Court (1981) 118 Cal.App.3d 486, 488–490, 173 Cal.Rptr. 418.) The trial court did not abuse its discretion in denying the motion to amend.
In any event, plaintiff could not state a cause of action for negligent infliction of emotional distress. That cause of action has been limited (1) to close relatives who have sustained a shock from contemporaneously observing injury directly inflicted on the victim by a defendant (Ochoa v. Superior Court (1985) 39 Cal.3d 159, 168–170, 216 Cal.Rptr. 661, 703 P.2d 1), or (2) to a close relative who is a “direct victim” of defendant's conduct (Molien v. Kaiser Foundation Hospitals (1980) 27 Cal.3d 916, 923, 167 Cal.Rptr. 831, 616 P.2d 813; Andalon v. Superior Court (1984) 162 Cal.App.3d 600, 603–612, 208 Cal.Rptr. 899). Plaintiff has not cited and we have found no case which imposes this liability in the absence of a close familial relationship. The relation between a shareholder and a corporation does not rise to that level. The duty of the insurer ran only to the company, and plaintiff is neither an intended beneficiary nor one whose interests are directly implicated in the insurance contract. The interests of plaintiff as principal shareholder are wholly derivative and incidental to the corporation.
In its cross-appeal, Excess claims that even the reduced amounts awarded for the insurance claim ($51,000) and the fair market value of the business ($100,000) were improperly calculated. Excess claims that the $17,000 policy limit should apply because the boats were lost in transit. The policy limited liability to $17,000 for “any one loss, disaster or casualty ․ to․ [¶] ․ property while in due course of transit.” A $50,000 limit was imposed for any one loss “[o]n property located elsewhere within the territorial limits of the policy․”
The six boats were shipped to Baltimore: On September 9, 1977, three of the boats were shipped directly from plaintiff company in Concord to Baltimore; on September 13, the three remaining boats were transported directly from the manufacturer in Wisconsin to Baltimore on two separate transports; on September 15, the boats were loaded aboard the vessel Gulf Bear for shipment to Iran. The vessel departed Baltimore on September 16. In support of its contention, Excess argues that the boats were lost while in transit to Iran, and this constituted a single loss for which the policy limits of $17,000 applies. The trial court, in awarding damages in the amount of $51,000, concluded that there were three separate losses in transit; i.e., 3 x $17,000. The trial court's determination was a reasonable one. We believe the losses occurred once the boats left the physical control of plaintiff company and the manufacturer and were shipped to Baltimore in reliance on the fraudulent check. The mere possibility that the shipments could have been intercepted by plaintiff while en route to Baltimore does not change the result. Parvin's scheme was to have the boats arrive at the loading dock in Baltimore before plaintiff realized the check was drawn on a nonexistent account. Under the facts, plaintiff had no real opportunity to recover the boats before they were loaded onto the Iranian cargo ship and thus the boats were completely out of his control. We conclude that the three separate shipments of boats were irretrievably lost while in the due course of transit as required under the policy. This result is in keeping with the requirement that the coverage clauses of an insurance contract be interpreted broadly so as to afford maximum coverage to the insured. (See Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800, 807–808, 180 Cal.Rptr. 628, 640 P.2d 764.)
Excess also challenges the award of $100,000 as damages for the fair market value of the business. Excess argues that Land/Sea is estopped from recovering more than $75,000; the value it alleged in a separate law suit against Parvin. We agree. That suit ended in a default judgment in favor of Land/Sea for compensatory and punitive damages. “A judgment by default is as conclusive as to the issues tendered by the complaint as if it had been rendered after answer filed and trial had on allegations denied by the answer.” (Fitzgerald v. Herzer (1947) 78 Cal.App.2d 127, 131, 177 P.2d 364; also Martin v. General Finance Co. (1966) 239 Cal.App.2d 438, 443, 48 Cal.Rptr. 773.)
At the hearing on the motion to enter default judgment, Land/Sea represented to the court that $75,000 was the fair market value of the business at the time of the breach by Excess in September 1977. Land/Sea concedes that this representation was made, but it argues that the default judgment has no estoppel effect since the issue was not actually litigated. Land/Sea cites no decision in support of this position, and its citation to 7 Witkin, California Procedure (3d ed. 1985) Judgment, section 279, page 718, misstates the law. Accordingly, we conclude that the amount of damages awarded to Land/Sea for the loss of the fair market value of the business cannot exceed $75,000.
Relying on Civil Code section 3294, Excess challenges the award of punitive damages, contending that it violates the prohibition of punitive damages arising from breach of contract. In its motion for a judgment notwithstanding the verdict, Excess argued that the cause of action for breach of the implied covenants of good faith and fair dealing was barred by the two-year statute of limitations applicable to tort claims. (Code Civ.Proc., § 339, subd. (1).) The trial court disagreed, concluding that this cause of action is a “hybrid contract-tort type of action” and it applied the four-year statute of limitations applicable to claims based upon written contracts. (Code Civ.Proc., § 337, subd. (1).) We agree that the gravamen of this claim arises out of the insurance contract, and the four-year contractual limitation period controls. (See Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 662, 328 P.2d 198; Frazier v. Metropolitan Life Ins. Co. (1985) 169 Cal.App.3d 90, 102, 214 Cal.Rptr. 883.)
The action for breach of the implied covenants was filed more than two years but within four years after the cause of action arose, and accordingly it is not time-barred.
Excess also contends that the action for breach of the implied covenant of good faith and fair dealing is barred by the 12–month limitation period to commence suit contained in the policy.3 This identical argument was rejected in Frazier v. Metropolitan Life Ins. Co., supra, 169 Cal.App.3d 90, 214 Cal.Rptr. 883. The cause of action for bad faith arises out of the contractual relationship but is not an action “under the policy,” and, as such, is not governed by the 12–month limitation included in the insurance contract. (See id., at p. 104, 214 Cal.Rptr. 883; Murphy v. Allstate Ins. Co. (1978) 83 Cal.App.3d 38, 49, 147 Cal.Rptr. 565.)
The question remains whether Land/Sea can avoid the time-bar under the four-year contract theory and still collect punitive damages under a tort theory. This issue was resolved in Frazier, which held that when a plaintiff has elected to proceed on the contract theory for breach of the implied covenants of good faith and fair dealing, he may not also collect punitive damages under the time-barred tort theory. (Frazier v. Metropolitan Life Ins. Co., supra, 169 Cal.App.3d at pp. 106–107, 214 Cal.Rptr. 883.) In reaching this result, that court felt “pure logic must give way to the strict statutory prohibition of [Civil Code] section 3294․” (Id., at p. 107, 214 Cal.Rptr. 883.) Here, we part company with Frazier.
Plaintiff has done nothing which could be construed as an “election” to proceed under one theory to the exclusion of another. There exists a four-year statute of limitations as a matter of law. Plaintiff did not have to proceed “in contract” to benefit from this statute. An action for breach of the implied covenant of good faith and fair dealing sounds in both tort and contract. (Comunale v. Traders & General Ins. Co., supra, 50 Cal.2d at p. 663, 328 P.2d 198.) A plaintiff who sues alleging breach of the duty of good faith and fair dealing must prove the same set of facts, whatever the label, in order to prevail. The defendant must respond to the same allegations and have the same defenses available whether the action is technically considered to be “in contract” or “in tort.” Further, the jury is instructed in identical language whether the action is labeled as a “tort” or “contract” cause of action. The common legal principle underlying this action is that an insurer owes to its insured an implied-in-law duty of good faith and fair dealing that it will do nothing to deprive the insured of the benefits of the policy. (Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425, 429, 58 Cal.Rptr. 13, 426 P.2d 173.) That obligation is breached when the insurer fails to act reasonably and in good faith to settle claims under the policy. (See Gruenberg v. Aetna Ins. Co., supra, 9 Cal.3d at p. 574, 108 Cal.Rptr. 480, 510 P.2d 1032.) None of the cases cited by Excess has supplied a sufficient reason for not awarding punitive damages when the facts support the complaint.
It is not logical to award a successful plaintiff punitive damages if the claim is filed within the two-year tort limitation period but to deny that same plaintiff punitive damages if that action is filed after two years but within the four-year statute of limitations period for written contracts. We see no additional prejudice to defendant in the latter situation that would justify denying that plaintiff a right to be fully compensated for the damages caused by the tortious breach.
We read Civil Code section 3294, which prohibits punitive damages in cases of breach of contract, to be inapplicable here where the breach sounds in both tort and contract. The breach also constitutes a tort and plaintiff is entitled to recover “extra-contract” damages, a recovery measure widely recognized in bad faith litigation. (Kornblum et al., Cal.Prac.Guide, Bad Faith (TRG 1986) § 11.39 p. 11–9; Crisci v. Security Ins. Co., supra, 66 Cal.2d at p. 434, 58 Cal.Rptr. 13, 426 P.2d 173.) Recently, our Supreme Court allowed plaintiff to recover attorney fees in his action for breach of the duty of good faith and fair dealing as a measure of tort damages. (Brandt v. Superior Court (1985) 37 Cal.3d 813, 817, 210 Cal.Rptr. 211, 693 P.2d 796.) In doing so, the court restated the rule that “ ‘if an insurer, in discharging its contractual responsibilities, “fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing.” [Citation.]’ ” (Id., at p. 817, 210 Cal.Rptr. 211, 693 P.2d 796.) The recovery of “tort damages” is proper in cases of breach of the duty of good faith and fair dealing; we hold that plaintiff should be entitled to claim punitive damages in this case.
In light of our conclusion, we do not need to address the remaining contentions.
The award of compensatory damages for the fair market value of the business must be reduced to $75,000 and we remand this matter to the superior court to enter judgment accordingly. In all other respects, the judgment is affirmed. Both sides to bear their own costs on appeal.
1. Plaintiff corporation, Silver Sea Enterprises, Inc., was created to handle this particular transaction. It is not a party to this appeal.
2. A directed verdict was entered on Silver Sea's claims. No appeal is taken from this judgment.
FOOTNOTE. See footnote *, ante.
3. The policy provided: “15. Suit. No suit, action or proceeding for the recovery of any claim under the policy shall be sustainable in any court of law or equity unless the same be commenced within twelve (12) months next after discovery by the insured of the occurrence which gives rise to the claim․”
LOW, Presiding Justice.
KING and HANING, JJ., concur.