ALVAREZ v. COREGIS INSURANCE COMPANY (1998)

This case involves the question of whether an insurance carrier has the obligation to defend an employee who is charged with embezzling funds from the insured-employer.   In this opinion, we hold that the appellant-employee is an additional insured under the insurance policy.   We also hold that the express terms of the insurance policy require a defense and do not exclude claims or litigation between insureds.

STANDARD OF REVIEW

 Gladys Alvarez appeals from a judgment entered after a demurrer to her complaint was sustained without leave to amend.   On such an appeal, we are required to assume the truth of all facts, but not conclusions of law, properly pleaded by the appellant.  (Blank v. Kirwan (1985) 39 Cal.3d 311, 318, 216 Cal.Rptr. 718, 703 P.2d 58.)

 The duty of an insurer to defend is more extensive than the duty to indemnify.  (Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076, 1081, 17 Cal.Rptr.2d 210, 846 P.2d 792.)   Therefore, insurance policy provisions are liberally construed in favor of the broad duty to defend an insured, and are narrowly construed against the insurer.  (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 295, 24 Cal.Rptr.2d 467, 861 P.2d 1153;  Mariscal v. Old Republic Life Ins. Co. (1996) 42 Cal.App.4th 1617, 1623, 50 Cal.Rptr.2d 224.)

With those principles in mind, we turn to the facts alleged in the complaint.

THE COMPLAINT

Appellant alleges that from 1991 to 1995, she was employed as a bookkeeper for Victory Montessori Schools, Inc. In 1995, that corporation and its shareholders (hereafter collectively referred to as “Victory”) sued appellant and other defendants for a variety of causes of action, all of which allegedly stemmed from embezzlement.¹

Appellant tendered the suit to respondent Coregis Insurance Company (“Coregis”), which is the liability carrier for Victory.²  Coregis refused to provide a defense, so appellant sued Coregis for declaratory relief, breach of contract, and breach of the implied covenant of good faith and fair dealing.   The general demurrer of Coregis was sustained without leave to amend.   Appellant's subsequent motion for clarification was denied, setting the stage for this appeal.

It should be noted that prior to the time appellant filed the action against Coregis, Victory had already sued Bank of America for allowing appellant and others to misappropriate the funds of Victory.   Bank of America cross-complained against appellant for indemnity.   Appellant tendered the defense of the Bank of America cross-complaint to Coregis, who refused it.   Although appellant attached the refusal letters from Coregis as exhibits to her complaint, nowhere in the pleadings did she ask for relief relative to the refusal of Coregis to provide a defense to the Bank of America cross-complaint.

THE INSURANCE POLICY

The insurance policy is entitled “School Package Policy.”   Section I is not germane to this appeal.   That section is called “Property Coverage Form,” and deals with insurance coverage for real and personal property owned by or under the control of Victory.

Section II is relevant.   That section is entitled “General Liability and Errors and Omissions Coverage.”   The salient portions of Section II provide:  “A. INSURING AGREEMENT [¶] Subject to the Limits of Liability, we agree to pay those sums which the insured becomes legally obligated to pay as damages (1) because of personal injury, bodily injury or property damages caused by an occurrence, or (2) resulting from a wrongful act committed by the insured.”

An “insured” is defined at Paragraph C as:  “3. Insured.   The unqualified words ‘the Insured’ or ‘an Insured’ include:  a. You, the Insured named in the declarations.   b. The following additional insureds individually and collectively, when acting solely within the scope of their duties, office, or employment for you:  (1) Members of the governing board, (2) Officers, (3) Employees, (4) Individuals as [v]olunteers.”

A “wrongful act” is defined at Paragraph C, subsection 7 as “ ․ an error or omission, an inadvertent breach of duty, or a misstatement or misleading statement which occurs during the policy period.”

At Paragraph B, subsection 10 (hereafter “Paragraph B 10”), the policy excludes coverage for “claims for damages alleging fraud, dishonesty, criminal acts or omissions, or unlawful profit or advantage.   We will, however, defend the insured against such claims.”  (Italics added.)

At Paragraph D, subsection 1, Coregis agreed that “[a]s respects the insurance afforded by Section II of this policy, we shall:  a. defend in his name and behalf any suit against the Insured alleging injury or damage to which this insurance applies and seeking damages on account thereof, even if such suit is groundless, false, or fraudulent․”

ISSUES ON APPEAL

 In most cases of this nature, the question of whether there is a duty to defend turns on whether the potential exists under the policy for the insurer to indemnify the insured from a judgment.  (Horace Mann Ins. Co. v. Barbara B., supra, 4 Cal.4th at p. 1081, 17 Cal.Rptr.2d 210, 846 P.2d 792;  Montrose Chemical Corp. v. Superior Court, supra, 6 Cal.4th at p. 295, 24 Cal.Rptr.2d 467, 861 P.2d 1153.)   That is not the situation here.

It is of paramount importance to keep the following in mind:  While the subject policy excludes a duty to pay for claims of fraud or criminal acts, such as embezzlement, by its express terms it does provide a defense against such claims.   The primary question to be answered is whether such defense must be provided where the victim of the wrongful acts is also an insured under the policy.   A secondary issue is whether appellant should be given leave to amend to require a defense to the Bank of America cross-complaint.

DISCUSSION

1. Duty to Defend the Victory Complaint

Appellant contends that she qualifies as an insured under the insurance policy in that she acted within the scope of her employment at all relevant times.

Likening the situation to Milazo v. Gulf Ins. Co. (1990) 224 Cal.App.3d 1528, 274 Cal.Rptr. 632, Victory responds that when an employee defrauds an employer, the employee is acting outside the scope of employment, thus precluding coverage under the policy.

Milazo involved a situation where a partner appropriated a partnership opportunity.   When he was sued by the other partners, Milazo demanded a defense, which Gulf provided, subject to a reservation of rights.   The trial between the partners and Milazo was bifurcated between liability and damages.   After a jury determined that Milazo was liable, a settlement was reached as to damages.   Under a continued reservation of rights, Gulf contributed to the settlement.   The subsequent declaratory relief action between Milazo and Gulf involved the language of the general liability policy of the partnership.   In deciding that coverage under the policy was not available, Division Three of this District said that “[t]o hold that a partner could be covered under a partnership general liability policy for his acts against the very business organization that gives him his status as an insured person would turn the concept of partnership coverage on its head.   We therefore conclude that when a partner acts to misappropriate a partnership asset, interest or economic opportunity or to otherwise deprive the partnership thereof he cannot, as a matter of law, be deemed to be acting in his capacity as a partner.   There can be no partnership liability for such conduct.   Consequently, the breaching partner would have liability only as an individual, not as a partner.”   (Id., at p. 1539, 274 Cal.Rptr. 632, italics in original.)

Thus, Milazo is both applicable and inapplicable to the case before us.   It is applicable in that the insurance carrier provided a defense, which is all that appellant is seeking here.

Milazo is inapplicable in that the appellate issue was whether there was a duty to pay.   That is not the present situation, as it is clear Coregis has no duty to pay for acts of fraud or embezzlement.   However, the insurance policy before us, while excluding indemnity coverage, specifically provides a defense to “the insured” against claims of such acts.

 The only reason that appellant would be not entitled to a defense is if she were deemed not to be an insured.   Victory argues that (as in Milazo) where an employee is charged with embezzlement, the employee cannot be “solely acting within the scope of her duties,” as is required by the subject policy.   We disagree for three reasons.

First, as previously stated, in Milazo, the tortfeasor-partner was provided with a defense, even though he was alleged to have committed acts in derogation of the partnership.

Second, if charges of criminal conduct or acts of dishonesty or fraud automatically result in placing an employee outside the “scope of duties” to prevent that employee from being “an insured,” there would be no reason for the policy say that it will defend “an insured” against such claims.   Such an interpretation would render Paragraph B 10 meaningless.   Accordingly, because an ambiguity in an insurance policy is construed against the insurer and in favor of the insured (Miller v. American Home Assurance Co. (1996) 47 Cal.App.4th 844, 849, 54 Cal.Rptr.2d 765), we hold that appellant is not automatically excluded as an insured simply because she has been charged with conduct amounting to a crime, fraud or dishonesty.

Third, there is no definition in the policy of the term “acting solely within the scope” of employment duties.   We therefore interpret such term in a common sense manner.  (Ray v. Farmers Ins. Exchange (1988) 200 Cal.App.3d 1411, 1416, 246 Cal.Rptr. 593.)   Under that principle, we hold that the term means that the alleged acts of wrongdoing must be connected with the business of the employer.   If, for example, appellant was alleged to have stolen from a retail store items of clothing for her personal use, such activity would bear no relationship to her employment, and she would not qualify as an insured.   However, the result is otherwise where the alleged acts are related to the business.   For example, if appellant were being sued by the parents of one of the students at Victory for stealing the student's property, there is no doubt that under paragraph B 10, Coregis would owe appellant a duty to defend.   Under the factual scenario presented by appellant's complaint, appellant is charged with misusing her position as Victory's bookkeeper to embezzle funds.   Ergo, the alleged wrongdoing is clearly within the scope of appellant's employment.

 The next question to be answered is whether the duty to defend is owed where one insured is suing another.   In analyzing that question, one has to be careful not to be misled by the seductive argument that it would be absurd for an insurance policy paid for by an employer to be used to shield an employee from a suit by the employer to recoup losses sustained by the wrongful acts of the employee.

It is important to note that there is nothing in the policy that excludes coverage of claims between insureds.   Further, the policy does not require that Victory be actually or potentially liable on a claim in order for coverage to apply.   As we have stated, policy language that excludes a duty to defend is to be narrowly construed against the insurer.   Coregis advances no reason why it could not have simply excluded claims between insureds from its duty to defend, had it wished to do so.³

It appears that the policy before us would provide a defense to the employer for an action brought by an employee (for a non-worker's compensation covered act), such as an assault by the employer (or a co-employee) on an employee.   Therefore, we see no reason why the reverse situation should not be true, to wit, a defense for an employee-insured against the claims of the employer-insured.

At this moment, the allegations against appellant are unproved, and thus may or may not be true.   It is also possible that appellant was simply negligent or a mere dupe for other persons.   We see nothing unfair or illogical in providing appellant with a defense that would have been available to her had the suit been brought by a third party.

For all of the foregoing reasons, we hold that appellant is an insured and under the specific language of the policy, Coregis owes appellant a duty to defend the action by Victory.

2. Duty to Defend the Bank of America Cross-Complaint

As mentioned, the hearing on the demurrer to appellant's complaint involved only the refusal of Coregis to defend against the Victory action.   Neither at the hearing nor thereafter did appellant simply ask for leave to amend her complaint to seek a duty to defend on the Bank of America cross-complaint.   Instead, appellant sought a clarification of the court's ruling.   The factual scenario is as follows.

At the hearing on the demurrer, the trial court announced it was ruling in favor of Coregis on the basis that there was no duty on the part of Coregis to defend appellant for wrongful acts she may have perpetrated against Victory.   Subsequently, counsel for Victory submitted a formal order, which the court signed.   That order expanded on the comments made by the trial court, and stated, in sum, that as to the causes of action for declaratory relief and breach of contract, “since her acts of alleged embezzlement are not solely within the scope of her employment,” Coregis owed no duty to defend.   The order further stated that inasmuch as there was no breach of contract and no duty to defend, appellant could not maintain a cause of action for breach of the implied covenant of good faith and fair dealing.

Appellant then filed a motion for clarification, claiming that the formal order exceeded the reasons given orally by the trial court.   Appellant requested that the trial court clarify:  “1. Whether the court held that the allegations of fraud leveled against plaintiff were not solely within the scope of Ms. Alvarez's employment as a matter of law.   2. Whether the court held that plaintiff was not entitled to indemnity for the defense in a related action which does not allege fraud, notwithstanding, conclusive proof that plaintiff was innocent of the conduct alleged therein.   3. Whether the court ruled that plaintiff was not an ‘insured’ under the relevant policy for all purposes.   4. What constituted conduct ‘solely within the scope of Ms. Alvarez's employment.’ ”

The trial court denied the motion.   A notice of ruling was prepared by counsel for Victory.⁴  The notice of ruling included the statement that “the Court also found that Coregis and California owe no duty to defend or indemnify Plaintiff with respect to any action arising out of Plaintiff's alleged embezzlement from her employer which includes the Cross-Complaint filed against Plaintiff by the Bank of America.”  (Italics added.)   However, as we shall discuss, there is conflicting evidence in the record as to whether the trial court made such a finding.

Appellant contends that it was error for the trial court to rule that Coregis had no duty to defend the Bank of America cross-complaint.   Despite the language in the notice of ruling which we have set forth in the preceding paragraph, the record is replete with confusing language as to any ruling relative to the Bank of America cross-complaint.   In fact, in many instances the trial court emphasized that it was only considering the allegations in appellant's complaint, which solely related to the Victory complaint against appellant, and not to the Bank of America cross-complaint.

For example, at the start of the hearing when appellant's counsel started talking about “different” facts, the trial court stated:  “What do you mean by different facts?   I don't understand.   I ruled on a demurrer, all right, and when I rule on a demurrer all I do is look at the complaint, and I'm not allowed to go outside the complaint.   I have to only consider what you pled in the complaint, and I rule on the complaint.”

The trial court then said (relative to the Victory complaint):  “So I ruled that they didn't have to defend her, that you had no cause of action against the [Coregis] Insurance Company.   I didn't rule on anything else.   That's all I ruled on.”

Later, the court said that it had not “said anything about any other underlying action,” and that “they [Coregis] don't have to provide coverage for [the Victory] claim under the insurance policy.   That's all I've said.”

Finally, the trial court restated its position that the purpose of the insurance policy was to protect the employer in case appellant did something to someone else, not to protect her to steal money from the employer.   Counsel for appellant pointed out that Bank of America was “someone else,” i.e., a third party.   The trial court replied with the ambiguous statement, “I don't want to talk about Bank of America, that's your problem.”

On the other hand, there is language tending to indicate that the trial court did in fact rule that there was no duty to defend on the cross-complaint.   After the court stated that “all it was saying” was that Coregis did not have to provide a defense to the Victory claim, the following colloquy ensued:

“MR. OBIORA:  And even if they-the Bank of America [cross-]complaint which is different from the original complaint, they [Coregis] don't have to provide a defense for that as well, okay.

“THE COURT:  For the same reason-.”

Despite the confusing state of the record, the parties seem to agree that the trial court did indeed rule that there was no duty to defend on the cross-complaint.   Since the parties have fully briefed the issue of the duty to defend, we will interpret appellant's motion for clarification to encompass a convoluted request for leave to amend, and we will further find that the leave to amend was denied by the trial court.   Thus, the next issue to be decided is whether appellant should have been given leave to amend to request a defense to the Bank of America cross-complaint.

 When a complaint is sustained without leave to amend, we are required to determine if the complaint may be amended to state a viable cause of action.   If it can be so amended, the judgment must be reversed and the matter remanded to the trial court.  (Blank v. Kirwan, supra, 39 Cal.3d 311, 318, 216 Cal.Rptr. 718, 703 P.2d 58.)

 We have just held that Coregis owes appellant a duty to defend against the Victory complaint.   It would therefore be illogical for appellant not to receive a defense to the Bank of America cross-complaint for indemnity, which is based on the identical acts of wrongdoing as is alleged by Victory.   Accordingly, for the same reasons that apply to the defense of the Victory complaint, appellant should be given the opportunity to amend her complaint to require a defense to the Bank of America cross-complaint.

DISPOSITION

The judgment is reversed and the matter is remanded to the trial court for proceedings consistent with this opinion.   Appellant is awarded costs on appeal.

FOOTNOTES

1.   The other defendants included Alma Prismantas (the director of operations at Victory) and her husband, Manfred Prismantas, who was the director of operations at the Montessori school known as the Arroyo Vista Academy.

2.   Coregis is the parent corporation of California Insurance Company.

3.   We note, for example, that under Insurance Code section 11580.1, subdivision (c)(5), an insurer is permitted to exclude coverage for claims between insureds in a policy for automobile liability insurance.  (Farmers Ins. Exchange v. Cocking (1981) 29 Cal.3d 383, 173 Cal.Rptr. 846, 628 P.2d 1.)

4.   The record contains no formal order signed by the trial court.

NOTT, Associate Justice.

BOREN, P.J., and ZEBROWSKI, J., concur.