This case arises out of an insured’s claim against its insurer for property damages caused by an earthquake that struck the Los Angeles area in 1984.  After a protracted dispute (during which the insurer made substantial payments) over the value of the claimed damages, and the extent to which they were earthquake-related, the parties entered into a settlement agreement.  The insurer agreed to pay an additional $1.5 million, and the insured executed a standard release by which it waived its right to recover any undiscovered damages and agreed to forbear bringing suit on any and all claims, known or unknown.

Several years later, the insured brought a lawsuit seeking to recover additional damages under the policy.  It argued that it was fraudulently induced into entering into the settlement agreement and that under general contract principles it could elect to affirm the agreement (and thus keep the money it had already received) and sue for damages caused by the alleged fraud.  The trial court, relying on decades of precedent from the Supreme Court and the Court of Appeal, as well as the statutory scheme governing settlements and releases, granted dispositive motions in favor of the insurer.  The authorities, the court said, made clear that a party seeking to undo a settlement agreement must seek rescission and return any monies obtained as consideration for the release.  The Court of Appeal reversed.  Distinguishing the prior authorities on the basis that they involved third-party personal injury claims, rather than first-party breach of contract claims, the court found that public policy supports the rule (followed in several jurisdictions) that a policyholder may affirm, keep the money, and sue, despite having executed a full release.

The Supreme Court reversed the Court of Appeal. Village Northridge Homeowners Ass’n v. State Farm Fire and Casualty Company, __Cal.4th__ (Aug. 30, 2010).  The sole purpose of the settlement agreement (unlike in the cases cited by the Court of Appeal) was to permit the insurer to buy its peace and avoid future litigation.  There is no principled basis on which to distinguish this case from the personal injury cases, and the statutes enacted by the Legislature make clear that a party seeking to avoid its obligations under a settlement which includes a litigation waiver must do so through rescission, which requires it to return any consideration received.  To hold otherwise would lead to a palpably inequitable result – the insured could affirm that part of the agreement that was favorable to it (the receipt of money) while voiding that part of the agreement that favored the insurer (forbearance of litigation).  Neither public policy, case precedent, nor legislation support such a rule of law.