Can an insured settle a disputed claim with its first party insurer and then sue the insurer for allegedly fraudulently inducing a settlement of the claim for less than it is worth? The California Supreme Court answered no in Village Northridge Homeowners Assoc. v. State Farm Fire and Cas. Co., 2010 Cal. LEXIS 8304 (Cal. Aug. 30, 2010).
The 1994 Northridge earthquake caused damage to property owned by the Village Northridge Homeowner's Association. State Farm made several payments to the Association, totaling about $2,068,000. In 1996 and 1998, the Association sought additional benefits based on an assessment by a public adjuster. State Farm reinspected the property and concluded that some additional damage was earthquake related, while some damage was not. Consequently, State Farm paid an additional $7466.34.
In 1999, although both parties continued to dispute the amount owed under the policy, a settlement was reached, with State Farm paying an additional $1.5 million. Under the settlement, the Association released State Farm from all known or unknown claims related to the earthquake.
Subsequently, the Association sued State Farm, alleging that the $1.5 million additional settlement was grossly deficient and represented only a partial payment of an alleged total loss of $8 million. The trial court dismissed the complaint. The Court of Appeal reversed, concluding that the Association could avoid the release, keep the settlement proceeds and sue for fraud by affirming the agreement that it wished to invalidate.
On appeal to the Supreme Court, State Farm argued if an insured could settle a disputed claim, keep the money paid, and the sue without seeking to rescind the settlement agreement, no insurer would be willing to settle a disputed claim. On the other had, the Association asked, "How was the policy favoring settlement furthered by refusing a remedy at law to victims of fraud in connection with a fraudulently induced settlement?"
The Supreme Court was not receptive to the Association's argument. The court was not refusing a legal remedy to victims of fraud because they still had the option of rescinding the contract and the suing for damages. To allow the Association to settle with State Farm and sign a release, keep the money, and then sue State Farm for alleged fraud without rescinding the release would violate the terms of the bargain and frustrate its purpose.
