AMICUS CURIAE BRIEF: State Farm Case

APPLICATION OF CITIZENS FOR A SOUND ECONOMY FOUNDATION FOR PERMISSION TO FILE AMICUS CURIAE BRIEF IN SUPPORT OF PETITIONER

TO: THE PRESIDING JUSTICE AND ASSOCIATE JUSTICES OF THE COURT OF APPEAL, SECOND DISTRICT, DIVISION ONE

Citizens For A Sound Economy Foundation (CSE) requests permission to file a brief as amicus curiae in support of Petitioner State Farm Mutual Automobile Insurance Company (“State Farm”). CSE is a nonprofit, nonpartisan organization with approximately 280,000 members. Its mission is to educate citizens on, and to promote the adoption of, free-market policies, which it believes inure to the benefit of consumers and citizens generally.

Throughout its history, CSE has addressed insurance issues at both the state and federal level. In 1997, CSE launched an insurance reform project aimed at highlighting the proper role of insurance as a risk management tool that provides consumers an opportunity to insure against risk at competitive prices. CSE is vitally interested in ensuring that consumers have access to affordable insurance and that the insurance industry’s management decisions regarding its capitalization structure are influenced by market forces that reflect underlying economic conditions, rather than the judicial system.

CSE, through its undersigned attorney, is familiar with the questions involved in this case and the scope of their presentation and submits the following brief in order to address the following arguments not fully addressed in State Farm’s petition:

1) Applying contract law principles to State Farm’s board decisions concerning the payment of dividends and management of its surplus funds will create dangerous precedent that will have an adverse impact on the insurance industry as a whole, consumers nationwide, and California taxpayers.

If this request is granted, the following amicus curiae brief in support of State Farm is respectfully submitted.

DATED: July 21, 2003 LIVINGSTON & MATTESICH

LAW CORPORATION

By:

GENE LIVINGSTON, SBN 44280

JOHN MCCARRON, SBN 225217

STACY E. GILLESPIE, SBN 220928

Attorneys for Amicus Curiae Citizens

For A Sound Economy Foundation

TABLE OF CONTENTS

I. WHY THE WRIT SHOULD ISSUE 1

A. STATE FARM’S WRIT PETITION SHOULD BE GRANTED

BECAUSE IT PRESENTS PURELY LEGAL ISSUES OF FIRST IMPRESSION THAT ARE OF GREAT IMPORTANCE TO THE LITIGANTS AND THE PUBLIC 2

B. A WRIT OF MANDATE MUST ISSUE TO PREVENT STATE

FARM AND CALIFORNIA TAXPAYERS FROM INCURRING

THE EXPENSE OF A LENGTHY JURY TRIAL BASED ON

A DECISION THAT IS CERTAIN TO BE APPEALED 4

II. STANDARDS OF THE BUSINESS JUDGMENT RULE SHOULD GOVERN CHALLENGES TO A CORPORATE INSURER’S DECISIONS ABOUT PAYMENT OF DIVIDENDS AND MANAGEMENT OF ITS SURPLUS FUNDS, EVEN IF THOSE CHALLENGES ARISE UNDER CONTRACT CLAIMS 5

A. COURTS SHOULD NOT MAKE CORPORATE DECISIONS. 6

B. ALLOWING COURTS TO MAKE IMPORTANT CORPORATE DECISIONS WILL BE DETRIMENTAL TO CONSUMERS. 8

III. CONCLUSION 10

TABLE OF AUTHORITIES

CASES

American Int’l. Group, Inc. v. Superior Court

(1991) 234 Cal.App.3d. 749 [285 Cal.Rptr 765] 2, 3,4

Barnes v. State Farm Mut. Auto. Ins. Co.

(1993) 16 Cal.App.4th 365 [20 Cal.Rptr.2d 87] 6,7,8

Civil Service Employees Inc. Co. v. Superior Court

(1978) 22 Cal.2d 362[149 Cal.Rptr. 360] 3

County of Los Angeles v. Superior Court

(1998) 68 Cal.App.4th 1166 [80 Cal.Rptr.2d 860] 3

Elden v. Superior Court

(1997) 53 Cal.App.4th 1497 [62 Cal.Rptr.2d 322] 2

Hill v. State Farm Mut. Auto. Ins. Co.

No. B133262 (2d App. Dist. Jan 30, 2001) 1, 5, 7

Lee v. Interinsurance Exchange

(1997) 50 Cal.App.4th 694 [57 Cal.Rptr. 2d 798] 6

Smith v. Superior Court

(1992) 10 Cal.App.4th 1037 [13 Cal.Rptr.2d 133] 4

2nd Civ. No. B163160

STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY

Petitioner

v.

SUPERIOR COURT OF CALIFORNIA FOR THE COUNTY OF LOS ANGELES,

Respondent

________________

JERRY HILL, JOSEPHINE HILL, WILSON MALLORY AND NORENE MALLORY,

Real Parties in Interest

Taken from an order of the Los Angeles County Superior Court (Filed May 21, 2003)

The Honorable Charles W. McCoy, Judge

Case No. BC194491 (CLASS ACTION)

APPLICATION FOR LEAVE TO FILE AMICUS CURIAE BRIEF AND AMICUS CURIAE BRIEF OF CITIZENS FOR A SOUND

ECONOMY FOUNDATION

IN SUPPORT OF PETITIONER

GENE LIVINGSTON, State Bar No. 44280

JOHN MCCARRON, State Bar No. 225217

STACY E. GILLESPIE, State Bar No. 220928

Livingston & Mattesich

Law Corporation

1201 K Street, Suite 1100

Sacramento, CA, 95814-3938

(916) 442-1111

Attorneys for Amicus Curiae

Citizens For A Sound

Economy Foundation

_______________

AMICUS CURIAE BRIEF

I. WHY THE WRIT SHOULD ISSUE

The Superior Court has chosen “California contract principles,” including the implied covenant of good faith and fair dealing, to apply to the claims brought by the nationwide class of plaintiffs in this case. The plaintiffs claim that Petitioner State Farm Mutual Automobile Insurance Company (“State Farm”) failed to pay adequate dividends, and instead allowed State Farm’s surplus to become too large. State Farm maintains that these claims should be governed by corporate law doctrines such as the business judgment rule.

The Superior Court’s decision to apply purely contract law principles to plaintiffs’ claims is unprecedented and contrary to sound legal authority in this state and in others, that such fundamental corporate decisions must be evaluated under principles of corporate law. Indeed, this Court made clear in its earlier decision in this case that any determination of State Farm’s liability would have to take into consideration the broad discretion afforded to corporate decisions by the business judgment rule. Hill v. State Farm Mut. Auto. Ins. Co., No. B133262 at 7-8 (2d App. Dist. Jan 30, 2001). The Superior Court ignored that ruling. If the Superior Court’s decision is left undisturbed, a lengthy and expensive jury trial, with potentially broad national ramifications, will be conducted under the inappropriate legal principles.

Amicus Curiae, Citizens for a Sound Economy Foundation (“CSE”), urges this Court to accept State Farm’s writ petition and to correct the Superior Court’s decision. Allowing this case to go forward under purely contract law principles will pose a serious risk of undue harm to State Farm, the insurance industry as a whole, and consumers of insurance in California and nationwide. Application of standards of contract law, rather than corporate law, to the State Farm board’s dividend decisions could improperly expose State Farm to excessive liability that could irreparably damage the company. Other mutual insurance companies may reconsider whether doing business in California is prudent given the risks of being exposed to the same unfair liability that State Farm faces in this case. Fewer insurance options in California (and possibly the rest of the nation) would inevitably lead to higher insurance costs for consumers. CSE considers the Superior Court’s decision to be legally flawed and antithetical to the promotion of healthy insurance markets that provide a wide variety of products and services to consumers at competitive prices. Consequently, CSE strongly urges this Court to review State Farm’s writ on the merits and resolve this issue now before this case goes to trial.

Numerous California appellate decisions establish the factors that justify extraordinary interlocutory relief and acceptance of a petition for alternative and peremptory writ of mandate. This case fits squarely within those factors.

A. STATE FARM’S WRIT PETITION SHOULD BE GRANTED BECAUSE IT PRESENTS PURELY LEGAL ISSUES OF FIRST IMPRESSION THAT ARE OF GREAT IMPORTANCE TO THE LITIGANTS AND THE PUBLIC.

A writ of mandate should be heard on the merits where a case presents issues that have not yet been examined by the appellate courts. Elden v. Superior Court (1997) 53 Cal.App.4th 1497, 1504 [62 Cal.Rptr.2d 322, 325] (“regardless of whether the order is appealable, a writ review is permissible here since the petition raised a novel issue of law.”) Extraordinary relief is particularly justified when a case presents purely legal questions. American Int’l. Group, Inc. v. Superior Court (1991) 234 Cal.App.3d. 749, 756 [285 Cal.Rptr 765, 768] (writ entertained on merits where issue presented was “purely legal in nature”). State Farm’s writ petition meets both of these factors.

State Farm’s writ petition seeks immediate interlocutory review of the Superior Court’s decision to apply standards of contract law rather than corporate law to State Farm’s corporate decisions. As such, this writ raises purely legal issues. These legal issues are also novel because the plaintiffs have thus far successfully avoided the requirements of the business judgment rule by attacking corporate governance decisions through contract claims. CSE is not aware of any appellate decisions in California that have applied purely contract law to claims made by a policyholder of a mutual insurance company questioning the dividend decisions of a corporate board of directors. Indeed, the Superior Court’s decision relies primarily on declarations from law professors as legal authority. This case clearly presents novel issues of law that merit pretrial review by this Court.

The case for hearing a writ of mandate on its merits becomes even more compelling when the issues carry with them important consequences for other litigants, and for the public. See County of Los Angeles v. Superior Court (1998) 68 Cal.App.4th 1166, 1170 [80 Cal.Rptr.2d 860, 863] (extraordinary pretrial writ in matters of pleading appropriate where case presents “an issue of great public importance.”). This factor is certainly present in this case.

State Farm’s writ addresses issues that are obviously of great importance to State Farm and other mutual insurance companies, and, consequently, to all consumers of the products they provide. Such companies rely upon the business judgment rule to prevent courts from second-guessing their decisions. But, this case also has broader ramifications; it is of considerable importance to the public. The public relies on companies like State Farm to provide affordable insurance products as a means of risk management. Insurance will be more affordable if market forces and the business judgment rule are allowed to guide informed corporate decisions about dividend payments. There is general agreement among economists that markets for insurance are conducive to competition, which suggests that, when allowed, market forces provide a powerful discipline for pricing policies and other business practices. If courts and juries are allowed to second guess such fundamental corporate decisions through the application of principles of contract law, insurance companies will face increased liability, and insurance rates are sure to increase as well. State Farm’s writ, therefore, raises issues that are of considerable public importance and should be accepted for that reason as well.



B. A WRIT OF MANDATE MUST ISSUE TO PREVENT STATEFARM AND CALIFORNIA TAXPAYERS FROM INCURRING THE EXPENSE OF A LENGTHY JURY TRIAL BASED ON A DECISION THAT IS CERTAIN TO BE APPEALED.

Extraordinary relief is appropriate where it may prevent a needless and expensive trial and reversal. Smith v. Superior Court (1992) 10 Cal.App.4th 1037 [13 Cal.Rptr.2d 133, 135] (“the delay and expense of a trial make the remedy of appeal inadequate.”) The Superior Court’s decision will unnecessarily subject State Farm to the expense of discovery and trial to defend the decisions of its board against claims that will be heard under the wrong legal standards. As a result, it is likely that a second trial would ultimately be required. State Farm should not have to incur the expense of a second trial due to an incorrect trial court decision involving threshold legal issues that can and should be reviewed now.

California taxpayers will also be financially burdened if the Superior Court’s decision is not reviewed at this juncture. The taxpayers of California should not have to bear the expense of two trials in this matter, particularly when that result may well be avoided by acceptance of this writ.



II. STANDARDS OF THE BUSINESS JUDGMENT RULE

SHOULD GOVERN CHALLENGES TO A CORPORATE

INSURER’S DECISIONS ABOUT PAYMENT OF DIVIDENDS AND MANAGEMENT OF ITS SURPLUS FUNDS, EVEN IF THOSE CHALLENGES ARISE UNDER CONTRACT CLAIMS

The Superior Court’s decision to apply California contract law to plaintiffs’ claims is an affront to the sanctity of the decisions made by State Farm’s board about payment of dividends and management of its surplus funds. Although the Superior Court did not elaborate on the precise contract law standard it would apply, it appears that the jury will be asked to apply an objective, “reasonableness” standard in reviewing the board’s decisions. See Hill v. State Farm Mut. Auto. Ins. Co., No. B133262 at 17 (2d App. Dist., Jan. 30, 2001) (“[T]he covenant of good faith can be breached for objectively unreasonable conduct, regardless of the actor’s motive.”). Allowing a jury to simply apply this reasonableness standard to the board’s management decisions gives no deference to the board’s expertise and authority to make its own business decisions.

The Superior Court’s decision improperly allows the plaintiffs to circumvent the business judgment rule and to ask a single California jury to second-guess the decisions of State Farm’s board, simply because the plaintiffs allege contract claims and assert they are suing as policyholders, rather than owners. The Superior Court’s decision is further misguided because it requires the jury to apply California law to second-guess the State Farm board. State Farm is an Illinois corporation, and applicable legal authority and public policy dictate that its corporate governance decisions should be subject to Illinois law, under which the business judgment rule would clearly apply to the board decisions at issue here.

A. COURTS SHOULD NOT MAKE CORPORATE DECISIONS.

On at least two occasions, this Court has spoken persuasively about preventing courts from second-guessing corporate decisions by insurance companies about their surplus funds. See Barnes v. State Farm Mut. Auto. Ins. Co. (1993) 16 Cal.App.4th 365, 378 [20 Cal.Rptr.2d 87, 95] (“whether a private corporation should declare and pay a dividend, or make a distribution of its assets is a matter committed to the sound business judgment of the corporation’s board of directors.”); Lee v. Interinsurance Exchange (1997) 50 Cal.App.4th 694, 710-711 [57 Cal.Rptr. 2d 798, 808] (“Decisions as to the strategies for managing the surplus funds of an insurer are quintessential exercises of business judgment . . . there can be no doubt that the courts are unqualified to second-guess the determinations made by the insurer . . . as to the amount of funds that are reasonably necessary to assure adequate funds to cover catastrophic losses . . . .”). The plaintiffs’ claims here–that State Farm has acquired too large of a surplus and has not paid enough dividends–are equally as inappropriate for judicial second-guessing as were the same claims in Barnes and Lee

.

The purpose behind the business judgment rule is not to cloak the board with impunity to make any decisions it chooses. Rather, as this Court pointed out, the business judgment rule provides “protection for the board’s lawful decisions.” Hill v. State Farm Auto. Ins. Co., No. B133262 at 8. Whether a policyholder brings an action sounding in contract or tort, State Farm’s lawful internal financial decisions regarding its dividends and surplus must be given proper deference. A board member’s decisions are presumed to be based on sound business judgment and are lawful, provided that they are made in good faith and are believed to be in the best interests of the corporation where no fraud or conflict of interest exists. Barnes, 16 Cal.App.4th at 378 [20 Cal.Rptr. at 95]. The implied covenant of good faith and fair dealing imparts a lesser objective standard of “reasonableness” upon the State Farm board’s dividend decisions that renders the important presumptions of the business judgment rule meaningless.

If this case goes forward under contract law principles that do not give deference to the board’s good faith decisions about its surplus funds, the jury will be effectively substituting its unskilled judgment for that of the board. Under these circumstances, there is a risk that the jury would be overly swayed by the arguments of counsel representing the past policyholders to the detriment of the current and prospective policyholders.

A jury simply lacks the expertise to make an informed decision about the amount of surplus that should be maintained by an insurance company. Allowing a jury to do so could be devastating to State Farm and its current policyholders, and would set dangerous precedent that could do similar damage to other insurance companies.



B. ALLOWING COURTS TO MAKE IMPORTANT CORPORATE DECISIONS WILL BE DETRIMENTAL TO CONSUMERS.

Over time, insurance markets have become more diversified, more efficient, and more accurate in assessing risk. Today, consumers have a wide variety of options when shopping for insurance, which has become a major industry in the United States, with revenues estimated at roughly $800 billion and net income of approximately $40 billion annually. Numerous brokers and agents supply a wide variety of products to meet the needs of consumers.

Where allowed, competition has generated the results that would be expected in any competitive market—lower prices, a wider variety of goods and services, and more fully informed producers and consumers who can make more knowledgeable decisions about the insurance products they need. Nonetheless, insurance markets in most states remain heavily regulated, which may protect consumers, but which also increases the cost of insurance.

Allowing a jury to question the informed business decisions of State Farm’s board, without giving that board’s decisions the deference afforded by the business judgment rule, regardless of the outcome, will have a negative effect on the cost of insurance in California and possibly elsewhere. Obviously, a large award of damages would have the greatest impact on insurance rates, but merely allowing California courts to invade the boardroom and potentially force State Farm to deplete its surplus will likely cause many mutual insurance companies to raise their rates to offset such risks to themselves. If corporate boards are not afforded the protection of the business judgment rule, some insurance companies may even leave the California market altogether in order to avoid this risk. The net result will be higher insurance costs.

Some corporate boards may also be overly influenced to make dividend decisions designed to avoid litigation risk without proper regard for the future financial needs of the company. This will cause an obvious tension between the corporate boards’ desires to avoid liability and laws which require insurance companies to maintain an adequate surplus. Consumers nationwide will ultimately pay higher insurance premiums if litigation risks, rather than traditional market forces, are allowed to dictate corporate decisions on dividends.

It should be noted, also, that increased pressure to limit the size of a company’s surplus poses the threat of insolvency in the wake of a catastrophic loss. Should this occur, consumers face a higher burden, because in the case of an insurance company failure, losses are paid by state guarantee funds. These funds are financed by assessments on solvent insurers. In addition to the potential for higher premium costs, this also poses problems of “moral hazard,” where insurance companies facing the possibility of insolvency know that others will bear the cost of that insolvency.

Policyholders who disagree with State Farm’s management of its surplus funds have an option that is better and more efficient than litigation. Such policyholders can simply buy insurance from another company. Competitive market forces and sound business judgment will influence corporate decisions about dividend disbursements and management of surplus funds. This will ultimately result in more affordable insurance products for consumers. Allowing courts to make such important corporate decisions will have just the opposite effect. CSE urges this Court to prevent that from happening.



III. CONCLUSION



For the foregoing reasons and authorities, CSE respectfully requests that this Court accept State Farm’s petition for a peremptory writ of mandate directing the trial court to vacate its May 19, 2003 order determining that only California contract principles apply in deciding the merits of plaintiff’s claims, and enter a new order directing the trial court to apply the standards of the business judgment rule to those claims.

DATED: July ____, 2003 LIVINGSTON & MATTESICH

LAW CORPORATION

By:

GENE LIVINGSTON, SBN 44280

JOHN MCCARRON, SBN 225217

STACY E. GILLESPIE, SBN 220928

Attorneys for Amicus Curiae

Citizens For A Sound Economy Foundation

CERTIFICATION OF WORD COUNT

Pursuant to California Rule of Court Rule 14(c), the undersigned hereby certifies that the Amicus brief previously filed by the Citizens For A Sound Economy contained 3,611 words, according to the word count software included in the Microsoft Word 2003 software with which the brief was written.

DATED: July 21, 2003 LIVINGSTON & MATTESICH

LAW CORPORATION

By:

GENE LIVINGSTON, SBN 44280

JOHN MCCARRON, SBN 225217

STACY E. GILLESPIE, SBN 220928

Attorneys for Amicus Curiae

Citizens For A Sound Economy Foundation

Endnotes

1. Similarly, extraordinary relief has been granted where the availability of a particular type of claim would have great impact on California litigation between insurers and insureds. American Int’l Group, Inc. supra, 234 Cal.App.3d 749, 755 [285 Cal.Rptr. 765, 769] and where the issues raised involved questions of significance for class action litigation throughout the state. Civil Service Employees Inc. Co. v. Superior Court (1978) 22 Cal.2d 362, 371 [149 Cal.Rptr. 360, 365]. Both of these factors are also present in this case.

2. Scott Harrington, Insurance Deregulation and the Public Interest, AEI-Brookings Joint Regulatory Center, Washington, D.C. 2000, p. 16.

3. Moreover, applying a reasonableness standard to the board’s business decisions contravenes the discretionary authority rightfully placed on the directors and mandated by State Farm’s bylaws. Plaintiffs’ contract claims, if there is an enforceable contract, surely would incorporate State Farm’s bylaws, which provide the appropriate standard with which dividends may be issued in the board’s discretion. State Farm’s bylaws provide that the board may authorize dividends at such amounts “as may, in their judgment, be proper, just and equitable.” The bylaws do not authorize the board to issue dividends pursuant to an “industry standard” or a “reasonableness” standard.

4. James G. Bohn and Brian J. Hall, “The Costs of Insurance Company Failures, in The Economics of Property-Casualty Insurance, David F. Bradford (ed.), University of Chicago Press, 1998, pp. 139-166.