Is Employment Practices Insurance Coverage a Good Risk?
Employment lawsuits in California routinely assert a panoply of statutory and common law tort claims, each of which carries the potential for a large and unpredictable jury award of emotional distress and punitive damages. Given the large and unpredictable exposure of these cases, it is hardly surprising that there has been an explosion in the number of companies purchasing Employment Practices Liability Insurance (or "EPLI").
These policies seemingly offer coverage for damages arising from "wrongful termination," "retaliation" and "sexual harassment." To evaluate the true costs and benefits of EPL insurance, however, employers need to look beyond the mere covering language of the policy itself -- they must also examine whether the apparent indemnity rights are actually permitted under California law. Many employers will be surprised to learn that much of the coverage promised by EPL insurance is illusory under California law.
Limits On Indemnification
The reason is California Insurance Code § 533. This statute precludes indemnity for "willful" acts of the insured and "is an implied exclusionary clause statutorily read into all insurance policies." J.C. Penny Casualty Ins. Co. v. M.K., 52 Cal.3d 1009, 1019 (1991). "Section 533 reflects a fundamental public policy of denying coverage for willful wrongs." Id. at n. 8. "The parties therefore cannot contract for such coverage." Id.
Moreover, while contractual coverage exclusion are normally interpreted narrowly in favor of coverage, courts are instructed to interpret Section 533 broadly in order to effect the statutes' public policy rationale of "discourag[ing] willful torts." Id. at 1021.
Thus, the California Supreme Court has explained that, where legislation specifically prohibits certain conduct, the "willfullness" necessary to trigger the exclusion does not require proof of a "subjective intent" or "preconceived design" to do harm. Id. Rather, where an act is "wrongful" by law, the insured's motive in doing the act is irrelevant for purposes of applying the statutory exclusion. Id. at 1026. In the context of employment-related lawsuits, Section 533 will therefore bar most of the coverage that many insureds assume they have purchased with an EPL policy.
For example, in B&E Convalescent Center v. State Compensation Insurance Fund, 8 Cal.App.4th 78 (1992), the insured-employer was sued by a former employee for wrongful termination, breach of the implied covenant of good faith and fair dealing, discrimination based on her age, gender and ethnicity, and in retaliation for engaging in protected union activities. In short, precisely the sort of claims for which employers would contemplate buying EPL coverage. The Court affirmed summary judgment in favor of the insurer, however, on the ground, inter alia, that Section 533 bared coverage of these alleged employment claims as a matter of law. As the Court explained:
A termination affirmatively undertaken with the intent to interfere with protected labor union rights or discriminate on the basis of gender, age, or ethnic origin cannot be the result of negligence. An affirmative act which can only violate the law when it is accompanied by such an impermissible motivation necessarily involves willful and intentional misconduct. [Plaintiff's] complaint clearly alleges such activity. She could not have prevailed in the underlying action by proving anything short of such affirmative and willful misconduct.
Id. at 96 (emphasis in original). Thus, as the Court explained, section 533 precludes indemnification for an illegal termination of employment because "It is well established and generally self-evident that the act of terminating an employee is an intentional act." Id. at 98.
The insurability of sexual harassment claims under Section 533 was also cast into doubt in Coit Drapery, Inc. v. Sequoia Ins. Co., 14 Cal.App.4th 1595 (1993). In that case the harassment had allegedly been perpetrated by the president of the company himself, with the advanced knowledge and after-the-fact ratification of the Board. In granting summary judgment to an insurance carrier in an ensuing coverage dispute, the court concluded that "section 533, and the public policy that it represents, bar the attempt to shift liability for intentional sexual harassment and associated employment-related torts (claims of wrongful discharge, infliction of emotional distress, battery, and sexual assault) to an insurer." Id. at 1603. As a result, the court concluded that there could be no duty to defend or indemnify against allegations that the company's president had engaged in a well known and implicitly tolerated pattern of sexual harassment. Id.
Notwithstanding Coit Drapery, however, some categories of harassment and discrimination allegations may be insurable to the extent they can be pleaded based on solely on the basis of negligent acts. For example, Melugin v. Zurich Canada, 50 Cal.App.4th 658, (1996), held that Section 533 would not necessarily bar insurance coverage for a corporation that is held vicariously liable for the acts of a subordinate employee outside the course and scope of employment which the employer "did not authorize, ratify or condone." Id. at 667-668. Allegations that an employment policy had an unintentional disparate impact on a protected group or that an employer negligently failed to accommodate a disabled worker are other potentially covered claims. Melugin, supra, at 658.
Limits on The Employer's Choice of Counsel
In addition to the obvious costs of premiums, most EPL policies also restrict the employer's choice of defense counsel to a list of counsel pre-approved by the carrier. Yet, since employment lawsuits almost invariably assert at least one intentional (and hence uninsurable claim), the carrier will routinely "reserve rights" at the outset of the litigation. Thus, upon tendering a newly filed employment lawsuit, an employer may find itself in the uncomfortable position of being forced to defend itself with counsel it did not choose against a possible judgment that would not be covered.
Conclusion
The purpose of any insurance instrument is to manage risks, especially large and unpredictable risks. And while EPL insurance is one tool to accomplish this objective, employers should be aware that California law sharply limits the ability to mitigate the risk of employment-related tort claims. An employer's investment in training, effective human resources policies, and early investigation of complaints may often be a more effective risk avoidance strategy than reliance on EPL coverage.