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California Court Protects Against Post-Litigation Discovery

June 24, 2016

In an instructive reminder about the benefits of an adversarial legal system, even in the often topsy-turvy world of insurance coverage litigation, a California federal district court recently held that an insured was not entitled to discovery of information in its insurer’s file that post-dated the filing of coverage litigation. 

In Genesis Insurance Co. v. Magma Design Automation, Inc., No. 5:06-cv-05526 (N.D. Cal. May 31, 2016), the insured technology company was named in a patent infringement lawsuit and two subsequent shareholder securities actions. The technology company sought coverage for the securities actions from its directors and officers (D&O) insurers. In the coverage litigation that followed,[1] the technology company requested discovery of its excess insurer’s “claims handling information.” The excess insurer had previously produced all of its claim file documents for the time period from the initiation of the securities lawsuits through the date when the technology company had sued the excess insurer in the coverage action. The technology company then sought the excess insurer’s file for the period following the initiation of the coverage litigation, including information about the excess insurer’s reinsurance and reserves. 

In their submissions to the court regarding the discovery dispute, the technology company and the excess insurer both focused primarily on the scope of the litigation privilege created by California Civil Code § 47(b). That statute makes privileged a “publication” made “[i]n any … judicial proceeding.” Arguing that the insurer’s duty of good faith and fair dealing continues even after coverage litigation commences, the technology company cited to White v. Western Title Insurance Co., 710 P.2d 309 (Cal. 1985), in which the court upheld a bad faith judgment against an insurer that was based on evidence that the insurer had made two lowball settlement offers to the insured during the course of the coverage litigation. In the 30 years since White was decided, however, California courts have limited the holding to its facts and have not interpreted White as allowing the admission of evidence of litigation conduct, techniques, and strategies more generally.[2]

White and the cases that followed it concerned whether an insured’s bad faith claim could be based on evidence of an insurer’s conduct during coverage litigation—but in all of those cases, the conduct at issue was already known to the insured.  In Magma, by contrast, the insured technology company was seeking discovery of information unknown to it, contained within the excess insurer’s own internal files. 

While noting the line of post-White cases declining to “open wide” the “crack in the door” created by White, the Magma court did not actually address whether the documents sought by the technology company from the excess insurer actually fell within the scope of the litigation privilege. Instead, the court rejected as purely speculative the insured’s rationale that the excess insurer’s continued refusal to acknowledge coverage for the securities actions must be in bad faith. Deeming the technology company’s request a “fishing expedition into the heart of the insurer’s litigation strategy,” the court held that “the insurer has an absolute right to defend against the insured’s claims, and opening up its litigation file to its insured would undermine its fair day in court.”

Although the court’s reasoning seized upon language in the post-White litigation privilege cases about an insurer’s right to its fair day in court and ability to conduct a vigorous defense, these sentiments also find root in the work-product privilege codified in Federal Rule of Civil Procedure 26(b)(3)(A). That rule states that, “[o]rdinarily, a party may not discover documents and tangible things that are prepared in anticipation of litigation or for trial by or for another party or its representative . ...” In the insurance context, parties frequently dispute the point in time at which an insurer’s claims investigation transitions from its ordinary course of business to the anticipation of litigation stage.  An insured asserting a bad faith claim may also argue that its discovery requests fall within the rule’s exception for “substantial need” where the requesting party cannot, “without undue hardship,” obtain the substantial equivalent of the materials by other means. However, courts in California and elsewhere have long recognized that the purpose of this work-product privilege is “to protect the integrity of the adversary process.”[3]

When viewing the Magma court’s ruling in light of the stated purposes behind both the litigation privilege embodied in California Civil Code § 47(b) and the Rule 26(b)(3)(A) work-product privilege for documents produced in anticipation of litigation—that is, protecting the adversarial nature of our legal system—it is not surprising. Discovery of internal documents created by another party after litigation has already been initiated should not occur lightly because of the potential unfair advantage if and when litigation strategy or tactics are inevitably uncovered. This holds true even when the party in question is an insurer.

In short, while California courts have entertained the notion that an insurer’s conduct during coverage litigation may be considered as evidence of bad faith under extremely limited circumstances, they more consistently recognize that an insurer—like any litigant—is entitled to a fair day in court and has the accompanying right to prepare its litigation strategy and tactics without fear that they will be exposed to the opposing party. The Magma court reaffirmed that principle.

[1] The procedural history of the case is circuitous to say the least. The litigation was initiated by the technology company’s excess insurer for the 2003-04 policy year. The technology company later named as third-party defendants its primary insurer, which had issued policies for both the 2003-04 and 2004-05 policy years, and the excess insurer involved in the discovery dispute here, which had issued an excess policy for the 2004-05 policy year. The technology company advocated, and the court originally held, that the 2003-04 policies should respond to the securities actions. However, after a series of appeals to the Ninth Circuit, the court determined that the claim instead fell under the 2004-05 policies. The 2004-05 excess insurer’s appeal of that ruling is currently pending in the Ninth Circuit.

[2] See Arbol Media Inc. v. Hartford Cas. Ins. Co. (C.D. Cal. July 7, 2003) (holding insurer’s discovery tactics in coverage litigation were not admissible or relevant to bad faith claim and permitting expert testimony as to litigation conduct would “wrongfully impair the defendants’ right to have their day in court”); Cal. Physicians’ Serv. v. Super. Ct., 12 Cal. Rptr. 2d 95, 100 (Cal. 1992) (holding defensive pleadings are protected by absolute litigation privilege and cannot form basis for bad faith claim); Nies v. Nat’l Auto. & Cas. Ins. Co., 245 Cal. Rptr. 518, 524 (Cal. Ct. App. 1988) (expressing concern that “insurers will be disabled from conducting a vigorous defense in a bad faith insurance action if their pleadings may be used to prove pre-existing bad faith”).

[3] See, e.g., U.S. v. Christensen, 801 F.3d 970, 1010 (9th Cir. 2015).