MRFranchise, Inc. & Mike Rafipoor v. P Stratford Insurance Company
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Opinion
UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE
MRFranchise, Inc. & Mike Rafipoor
v. Civil No. 22-cv-572-LM Opinion No. 2024 DNH 093 P Stratford Insurance Company
ORDER
In this diversity action, plaintiffs MRFranchise, Inc. (“MRFranchise”) and
Mike Rafipoor bring suit against their former insurer, defendant Stratford
Insurance Company (“Stratford”). Plaintiffs allege that Stratford breached the
terms of their insurance policy when Stratford refused to defend and indemnify
them in an arbitration. Plaintiffs bring three claims, each under California state
law: breach of contract for failure to pay defense costs (Count I), breach of contract
for failure to indemnify (Count II), and tortious breach of the duty of good faith and
fair dealing (Count III).
Before the court are the parties’ cross-motions for summary judgment. Doc.
nos. 28 & 29. Plaintiffs move for partial summary judgment, requesting the court to
rule that they are entitled to insurance coverage and therefore judgment as a
matter of law on Counts I and II. Stratford moves for summary judgment on all
claims, arguing that it has no obligation to pay defense costs or to indemnify
Plaintiffs for the claims brought against them in arbitration. For the following reasons, the court denies Stratford’s motion (doc. no. 29) and grants Plaintiffs’
motion in part (doc. no. 28).
STANDARD OF REVIEW
A movant is entitled to summary judgment where he “shows that that there
is no genuine dispute as to any material fact and [that he] is entitled to judgment as
a matter of law.” Fed. R. Civ. P. 56(a). In reviewing the record, the court construes
all facts and reasonable inferences in the light most favorable to the nonmovant.
Pleasantdale Condos., LLC v. Wakefield, 37 F.4th 728, 733 (1st Cir. 2022). This
same standard applies when, as here, the parties file cross-motions for summary
judgment. Dixon-Tribou v. McDonough, 86 F.4th 453, 458 (1st Cir. 2023). In other
words, the court reviews each motion separately and draws all reasonable
inferences in favor of each respective nonmoving party. Motorists Com. Mut. Ins.
Co. v. Hartwell, 53 F.4th 730, 734 (1st Cir. 2022).
BACKGROUND
The following facts come from the parties’ summary judgment filings and
attached exhibits. Except where noted, the facts are undisputed.
I. MRFranchise Enters into a Franchise Agreement with Franchisees
MRFranchise is the franchisor of the “Panini Kabob Grill,” a restaurant chain
in Southern California. Rafipoor is the founder, President, and Chief Executive
Officer of MRFranchise. In 2016, James Borba, Phil Koontz, and Lindsey Koontz
(the “Franchisees”) inquired about opening a Panini Kabob Grill at a location in
2 California. On May 25, 2017, MRFranchise provided the Franchisees with a set of
required disclosures in a document called the “Franchise Disclosure Document” (the
“MRF Disclosure”).
By way of background, both federal and state law require franchisors to
provide a formal disclosure in writing (such as the MRF Disclosure) before entering
into a franchise agreement.1 Referred to as the Franchise Disclosure Document in
the federal regulations, 16 C.F.R. §§ 436.2, 436.3, these disclosures are required in
order to protect franchisees from deceptive practices in connection with the sale of
franchises. See 16 C.F.R. § 436.2 (“[I]t is an unfair or deceptive act or practice
. . . [f]or any franchisor to fail to furnish a prospective franchisee with a copy of the
franchisor’s current disclosure document . . . .”); Cal. Corp. Code § 31001
(“California franchisees have suffered substantial losses where the franchisor . . .
has not provided full and complete information regarding the . . . prior business
experience of the franchisor. It is the intent of this law to provide each prospective
franchisee with the information necessary to make an intelligent decision regarding
franchises being offered.”).
1 The Federal Trade Commission (“FTC”) has promulgated a set of disclosure
requirements which are located at 16 C.F.R. §§ 436 & 437. This is popularly referred to as the “FTC Rule.” California’s state analog to the FTC Rule is the California Franchise Investment Law (“CFIL”), located at California Corporations Code §§ 31000-31516. In the context of franchise sales, the FTC regulations only preempt state laws that provide franchisees with less protection. The CFIL supplements the obligation under the FTC Rule requiring franchisors to provide franchisees with a Franchise Disclosure Document before any franchise agreement. The CFIL imposes mandatory provisions regulating the sale of the franchise, fraudulent and prohibited practices, and enforcement.
3 In this case, the relevant disclosure obligation concerned whether
MRFranchise or any of its officers (including Rafipoor) had been held liable in—or
had paid money to settle—a civil case involving allegations of “fraud, unfair or
deceptive practices, or comparable allegations” in the ten years immediately
preceding the disclosures. 16 C.F.R. § 436.5(c)(iii)(B). Federal law requires the
franchisor to summarize the legal and factual nature of each case “in plain English.”
16 C.F.R. §§ 436.1(d); 436.5(c)(3). A willful violation of this disclosure requirement
is unlawful under the CFIL. See Cal. Corp. Code § 31119(a). Relevant here, in the
MRF Disclosure, MRFranchise answered the question about prior litigation as
follows: “No litigation is required to be disclosed . . . .” Doc. no. 32-5 at 10.
On June 15, 2017, after MRFranchise supplied the Franchisees with the
MRF Disclosure, they executed a franchise agreement (the “Franchise Agreement”)
pursuant to which the Franchisees agreed to operate a Panini Kabob Grill
franchise. Rafipoor signed the Franchise Agreement on behalf of MRFranchise.2 The
Franchise Agreement references the MRF Disclosure in several places. For
example, there is a provision in the Agreement that requires the Franchisees to
2One of the Franchisees, James Borba, signed the Agreement as a 98% shareholder in the franchise. Borba also signed the Guarantee, Indemnification, and Acknowledgment pages of the Franchise Agreement on behalf of the Franchisees. The two other Franchisees (Phil and Lindsey Koontz) each held a 1% interest in the franchise.
4 confirm that they have received and read the MRF Disclosure and any attached
exhibits. Doc. no. 32-6 at 67.3
In February 2018, the Franchisees entered into a separate contract with a
third party, Santa Montana Investments, Inc. (“Santa Montana”), to have Santa
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UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE
MRFranchise, Inc. & Mike Rafipoor
v. Civil No. 22-cv-572-LM Opinion No. 2024 DNH 093 P Stratford Insurance Company
ORDER
In this diversity action, plaintiffs MRFranchise, Inc. (“MRFranchise”) and
Mike Rafipoor bring suit against their former insurer, defendant Stratford
Insurance Company (“Stratford”). Plaintiffs allege that Stratford breached the
terms of their insurance policy when Stratford refused to defend and indemnify
them in an arbitration. Plaintiffs bring three claims, each under California state
law: breach of contract for failure to pay defense costs (Count I), breach of contract
for failure to indemnify (Count II), and tortious breach of the duty of good faith and
fair dealing (Count III).
Before the court are the parties’ cross-motions for summary judgment. Doc.
nos. 28 & 29. Plaintiffs move for partial summary judgment, requesting the court to
rule that they are entitled to insurance coverage and therefore judgment as a
matter of law on Counts I and II. Stratford moves for summary judgment on all
claims, arguing that it has no obligation to pay defense costs or to indemnify
Plaintiffs for the claims brought against them in arbitration. For the following reasons, the court denies Stratford’s motion (doc. no. 29) and grants Plaintiffs’
motion in part (doc. no. 28).
STANDARD OF REVIEW
A movant is entitled to summary judgment where he “shows that that there
is no genuine dispute as to any material fact and [that he] is entitled to judgment as
a matter of law.” Fed. R. Civ. P. 56(a). In reviewing the record, the court construes
all facts and reasonable inferences in the light most favorable to the nonmovant.
Pleasantdale Condos., LLC v. Wakefield, 37 F.4th 728, 733 (1st Cir. 2022). This
same standard applies when, as here, the parties file cross-motions for summary
judgment. Dixon-Tribou v. McDonough, 86 F.4th 453, 458 (1st Cir. 2023). In other
words, the court reviews each motion separately and draws all reasonable
inferences in favor of each respective nonmoving party. Motorists Com. Mut. Ins.
Co. v. Hartwell, 53 F.4th 730, 734 (1st Cir. 2022).
BACKGROUND
The following facts come from the parties’ summary judgment filings and
attached exhibits. Except where noted, the facts are undisputed.
I. MRFranchise Enters into a Franchise Agreement with Franchisees
MRFranchise is the franchisor of the “Panini Kabob Grill,” a restaurant chain
in Southern California. Rafipoor is the founder, President, and Chief Executive
Officer of MRFranchise. In 2016, James Borba, Phil Koontz, and Lindsey Koontz
(the “Franchisees”) inquired about opening a Panini Kabob Grill at a location in
2 California. On May 25, 2017, MRFranchise provided the Franchisees with a set of
required disclosures in a document called the “Franchise Disclosure Document” (the
“MRF Disclosure”).
By way of background, both federal and state law require franchisors to
provide a formal disclosure in writing (such as the MRF Disclosure) before entering
into a franchise agreement.1 Referred to as the Franchise Disclosure Document in
the federal regulations, 16 C.F.R. §§ 436.2, 436.3, these disclosures are required in
order to protect franchisees from deceptive practices in connection with the sale of
franchises. See 16 C.F.R. § 436.2 (“[I]t is an unfair or deceptive act or practice
. . . [f]or any franchisor to fail to furnish a prospective franchisee with a copy of the
franchisor’s current disclosure document . . . .”); Cal. Corp. Code § 31001
(“California franchisees have suffered substantial losses where the franchisor . . .
has not provided full and complete information regarding the . . . prior business
experience of the franchisor. It is the intent of this law to provide each prospective
franchisee with the information necessary to make an intelligent decision regarding
franchises being offered.”).
1 The Federal Trade Commission (“FTC”) has promulgated a set of disclosure
requirements which are located at 16 C.F.R. §§ 436 & 437. This is popularly referred to as the “FTC Rule.” California’s state analog to the FTC Rule is the California Franchise Investment Law (“CFIL”), located at California Corporations Code §§ 31000-31516. In the context of franchise sales, the FTC regulations only preempt state laws that provide franchisees with less protection. The CFIL supplements the obligation under the FTC Rule requiring franchisors to provide franchisees with a Franchise Disclosure Document before any franchise agreement. The CFIL imposes mandatory provisions regulating the sale of the franchise, fraudulent and prohibited practices, and enforcement.
3 In this case, the relevant disclosure obligation concerned whether
MRFranchise or any of its officers (including Rafipoor) had been held liable in—or
had paid money to settle—a civil case involving allegations of “fraud, unfair or
deceptive practices, or comparable allegations” in the ten years immediately
preceding the disclosures. 16 C.F.R. § 436.5(c)(iii)(B). Federal law requires the
franchisor to summarize the legal and factual nature of each case “in plain English.”
16 C.F.R. §§ 436.1(d); 436.5(c)(3). A willful violation of this disclosure requirement
is unlawful under the CFIL. See Cal. Corp. Code § 31119(a). Relevant here, in the
MRF Disclosure, MRFranchise answered the question about prior litigation as
follows: “No litigation is required to be disclosed . . . .” Doc. no. 32-5 at 10.
On June 15, 2017, after MRFranchise supplied the Franchisees with the
MRF Disclosure, they executed a franchise agreement (the “Franchise Agreement”)
pursuant to which the Franchisees agreed to operate a Panini Kabob Grill
franchise. Rafipoor signed the Franchise Agreement on behalf of MRFranchise.2 The
Franchise Agreement references the MRF Disclosure in several places. For
example, there is a provision in the Agreement that requires the Franchisees to
2One of the Franchisees, James Borba, signed the Agreement as a 98% shareholder in the franchise. Borba also signed the Guarantee, Indemnification, and Acknowledgment pages of the Franchise Agreement on behalf of the Franchisees. The two other Franchisees (Phil and Lindsey Koontz) each held a 1% interest in the franchise.
4 confirm that they have received and read the MRF Disclosure and any attached
exhibits. Doc. no. 32-6 at 67.3
In February 2018, the Franchisees entered into a separate contract with a
third party, Santa Montana Investments, Inc. (“Santa Montana”), to have Santa
Montana make improvements and renovations at the planned Panini Kabob Grill
location. Rafipoor is the president and sole shareholder of Santa Montana. Santa
Montana agreed to renovate and prepare the restaurant for operation, in exchange
for the Franchisees’ payment of $1,950,000.
II. The Franchise Relationship Breaks Down
On May 3, 2019, the Franchisees opened their restaurant. By agreement, the
restaurant was under the acting management of an MRFranchise entity until the
Franchisees could be trained to take over operations. On August 27, 2019,
MRFranchise sent the Franchisees a notice of default under the Franchise
Agreement for their delay in completing the necessary training to operate the
restaurant. At some point in December 2019, it became clear to the Franchisees
that Phil Koontz (their would-be operating manager) was not going to obtain the
necessary training and that the franchise may not survive. Borba reached out to
MRFranchise to return complete control over (and sell back) the franchise to
3 There are two other references to the MRF Disclosure in the Franchise Agreement. The Agreement states that “nothing herein is intended to disclaim or require Franchisee to waive reliance on any representation made in the [MRF Disclosure].” Doc. no. 32-6 at 69. And there is a provision requiring the Franchisees to acknowledge that they have not relied on any representations or projections about the success of a franchise, “except as may have been contained in the [MRF Disclosure.]” Id. 5 MRFranchise. The parties then began negotiating the terms of a buy-back
arrangement for MRFranchise to acquire the restaurant. In the end, they could not
agree on the final terms of a buy-back arrangement. On February 19, 2020, the
Franchisees filed a complaint against Santa Montana and Rafipoor in a California
superior court. Plaintiffs sent the Franchisees another notice of default that same
day.
On May 8, 2020, MRFranchise sent the Franchisees notice that it was
terminating the Franchise Agreement. On May 26, 2020, Plaintiffs initiated
arbitration proceedings against the Franchisees as a group and against Borba
individually. They alleged two claims: breach of the Franchise Agreement against
all of the Franchisees, and a breach of guarantee against Borba.
On July 20, 2020, the Franchisees filed an arbitral counter-complaint (with
sixteen causes of action) against Plaintiffs and Santa Montana. Most of the claims
sounded in breach of contract and tort (including intentional and negligent
misrepresentation). However, the counter-complaint also included one statutory
claim alleging that MRFranchise and Rafipoor violated the CFIL in several ways,
including by failing to disclose—in the MRF Disclosure—prior fraud cases against
Rafipoor. Doc. no. 32-7. The instant coverage dispute concerns this counter-
complaint.
III. MRFranchise’s Insurance Policy with Stratford
Six months earlier, on January 31, 2020, MRFranchise had applied for the
liability insurance policy with Stratford that is at issue in the instant case. The
6 timing of this application occurred close in time to the Franchisees filing suit
(February 19, 2020) in California state court. In the policy application (“the
Application”), MRFranchise denied knowledge of “any act, error or omission” which
could give rise to a claim under the proposed policy.4 Doc. no. 37-1 at 4. To the
extent any such claim existed, the Application made clear that it would be excluded
from coverage under the proposed policy.
On February 13, 2020, Stratford issued a directors and officers liability
insurance policy to MRFranchise, with coverage to run from February 13, 2020, to
February 13, 2021 (the “Policy”). Doc. no. 28-3 at 2.
A. Coverage Provisions and Relevant Exclusions
The Policy provides MRFranchise with coverage for:
Loss arising from any Claim for any Wrongful Act of the Company taking place prior to the end of the Policy Period, and which is first made against the Insureds during the Policy Period . . . and is reported to the Insurer in the time and manner required by this Policy.
Id. at 18. Parallel coverage also extends to MRFranchise’s executives and
employees. “Wrongful Act” is defined as “any actual or alleged breach of duty, error,
4 Specifically, an agent of MRFranchise answered “No” to the question: “Does
the Applicant, or any director, officer, trustee, employed lawyer or employee of the Applicant know of any act, error, or omission which could give rise to a claim(s), suit(s), or action(s) under the proposed policy . . . .” Doc. no. 37-1 at 4. The Application further states that the parties agree that “if such claim(s), suit(s), investigation(s), loss(es), action(s), proceeding(s), inquiry, violation, knowledge, information or involvement exists, then . . . any claim, action, suit, investigations, loss, action, proceeding, or inquiry arising therefrom or arising from such violation, knowledge, information or involvement is excluded from the proposed coverage.” Id. at 5. 7 misstatement, act or omission” undertaken by MRFranchise, its executives, or its
employees, as well as “any Interrelated Wrongful Act.” Id. at 21.
With respect to defense of a claim, the Policy states that “[i]t shall be the
duty of the Insurer, and not the duty of the Insureds, to defend any Claim other
than a Wage and Hour Violation Claim,” id. at 31, and guarantees that Stratford
“shall pay, on behalf of the Insureds, all Defense Expenses incurred in the defense
of a Claim, other than a Wage and Hour Violation Claim, that is covered, in whole
or in part, under this Policy,” id. at 32.
The Policy also incorporates the Application, stating:
The Insureds further agree that in the event of any material misstatement, misrepresentation or omission in the Application, there shall be no coverage under this Policy for any Insured who had actual or imputed knowledge as of the inception date of the Policy Period of the facts that were misstated, misrepresented or omitted in the Application (whether or not such Insured was aware that such facts were misstated, misrepresented, or omitted in the Application). For purposes of determining the applicability of this Paragraph, any knowledge possessed by the Chief Executive Officer, the Chief Financial Officer, or the General Counsel of the Named Insured shall be imputed to the Company, but with the exception of the foregoing, any knowledge possessed by an Insured shall not be imputed to any other Insured.
Id. at 16. The court hereafter refers to this provision, with the incorporated
provisions of the Application, as the “Prior Notice Exclusion.”
The Policy also contains the following exclusion for intentional acts:
The Insurer shall not be liable to pay any Loss in connection with any Claim:
[B]rought about or contributed to by . . . the committing of any intentional criminal or deliberate fraudulent act, if 8 such . . . intentional criminal or deliberate fraudulent act is established by a final, non-appealable adjudication in the underlying action. For the purpose of applying this exclusion, any Wrongful Act of the Chief Executive Officer or the Chief Financial Officer of the Company shall be imputed to such Company. With the exception of the possible imputation of Wrongful Acts described in the preceding sentence, no Wrongful Act of an Insured may be imputed to any other Insured.
Id. at 8. The court hereafter refers to this exclusion as the “Intentional Acts
Exclusion.”
The Policy also contains the following set of seven exclusions (labeled “E”
through “K”), with the two relevant exclusions in bold:
The Insurer shall not be liable to pay any Loss arising from any Claim:
E. arising out of, based upon or in consequence of, resulting from or in any way involving any violation of any statutory, regulatory or common law, governing any of the following activities: unfair trade practices, anti-trust, unfair competition, or tortious interference in another's business or contractual relationships;
F. arising out of, based upon or in consequence of, resulting from or in any way involving any Insured's performance of or failure to perform professional services for others; . . . .
G. based upon or attributable to liability under any oral or written contract or agreement, including but not limited to any express warranties or guarantees, or liability assumed under any oral or written contract or agreement; provided, however, that this exclusion shall not be applicable to an Insured's alleged liability that exists in the absence of such contract or agreement; or to any Securities Claim[;]
H. for infringement or violation of patent, trademark, trade secret copyright, misappropriation, plagiarism or any other intellectual property rights;
9 I. arising out of, based upon or in consequence of, resulting from or in any way involving any [specific torts];
J. arising out of, based upon or in consequence of, resulting from or in any way involving . . . any violation of the Telephone Consumer Protection Act . . .; or
K. arising out of, based upon or in consequence of, resulting from or in any way involving any of the following [four actions that are not relevant].
Id. at 23-24, 41, 44. The court hereafter refers to Exclusion F as the “Prof. Services
Exclusion” and Exclusion G as the “Contract Exclusion.”
IV. Stratford Denies Coverage for the Counter-Complaint
On July 30, 2020, Plaintiffs provided to Stratford copies of the Franchisees’
counter-complaint. On February 22, 2021, eight months before the arbitration,
Stratford notified Plaintiffs that it was denying coverage and disclaiming any duty
to defend. Specifically, Stratford took the position that the Franchisees’ claims are
barred by: (1) the Prior Notice Exclusion because plaintiffs knew of a likely claim
prior to the Policy’s start date but failed to disclose it; (2) the Prof. Services
Exclusion because the claims arose out of Plaintiffs providing “professional
services”; and (3) the Contract Exclusion because the claims are premised on
liability under the Franchise Agreement.
The arbitration took place over seven days in October 2021. Of the sixteen
original counterclaims brought against Plaintiffs, only seven went to a hearing: four
10 breach of contract claims, two tort claims, and the statutory claim under the CFIL.5
On March 18, 2022, the arbitrator found in favor of Plaintiffs on all counterclaims
except for the statutory claim. On that claim, the arbitrator found that
MRFranchise’s failure to disclose prior litigation against it (as required under
federal franchise regulations) constituted a misrepresentation under the CFIL.
Specifically, the arbitrator found that MRFranchise failed to disclose three prior
fraud cases against Rafipoor—all of which he had settled before issuing the MRF
Disclosure. The arbitrator found that MRFranchise’s statutory violation was willful
and found Plaintiffs jointly and severally liable for damages.6 The arbitrator
rescinded the Franchise Agreement and awarded the Franchisees $1,030,000 in
consequential damages.7
On June 6, 2022, Plaintiffs again requested coverage for the counter-
complaint and Stratford stood by its original denial. Plaintiffs then brought this suit
against Stratford, alleging claims for breach of the Policy for failing to defend and
5 The following seven counterclaims remained: breach of the Franchise Agreement (Count 1); breach of an oral contract related to the Franchise Agreement (Count 2); the CFIL violation (Count 6); breach of a tenant improvement contract (Count 8); repayment of money paid to an unlicensed contractor (Count 11); misappropriation (Count 15); and tortious interference with a contract (Count 16).
6 The CFIL provides that, “[a]ny person who offers or sells a franchise in violation of [the CFIL], shall be liable to the franchisee or subfranchisor who may sue for damages caused thereby.” Cal. Corp. Code § 31300. If the violation is willful, a franchisee may also obtain rescission as a remedy. Id.
7 The consequential damages awarded to the Franchisees was offset by $201,801.36, an award to Plaintiffs of “support fees” for Plaintiffs’ role in taking over and managing the business on behalf of the Franchisees. 11 indemnify them, and a claim for tortiously breaching the implied covenant of good
faith and fair dealing.
DISCUSSION
The parties have filed cross-motions for summary judgment. Stratford moves
for summary judgment on all of Plaintiffs’ claims, contending that the Policy’s
Contract Exclusion bars coverage for the entire counter-complaint because all
claims therein stem from a contract, the Franchise Agreement. Stratford has not
moved for summary judgment on any other basis.8 Stratford argues that the
Contract Exclusion absolves it of any duty to pay defense costs or to indemnify
Plaintiffs. Plaintiffs move for summary judgment on Counts I and II, contending
that coverage of the Franchisees’ counter-complaint is not barred by any exclusion,
and that Stratford therefore breached its duty to pay defense costs and its duty to
indemnify.
Because resolution of this dispute hinges on the interpretation of language in
the Policy, the court begins by reviewing applicable principles governing the
interpretation of contracts and insurance policies, and the law governing the duty to
defend, the duty to indemnify, and the implied covenant of good faith. Following
8 At oral argument on the motions, Stratford argued that it was also seeking
summary judgment on the bases asserted in its objection to Plaintiffs’ motion for summary judgment. Under this court’s Local Rules, however, a party cannot move for summary judgment by way of an objection. See LR 7.1(a) (“Objections to pending motions and affirmative motions for relief shall not be combined in one filing.”). Dionne v. Fed. Nat. Mortg. Ass'n, 110 F. Supp. 3d 338, 341 (D.N.H. 2015). Stratford is therefore limited to the single ground asserted in its motion for summary judgment. 12 that review, the court considers whether either party is entitled to summary
judgment in its favor, beginning with Stratford’s motion.
I. California Rules for Insurance Contract Interpretation
Both parties agree that California substantive law applies to this diversity
action. “When the parties have agreed about what law applies, a federal court
sitting in diversity need not engage in an independent choice-of-law analysis.” CVS
Pharm., Inc. v. Lavin, 951 F.3d 50, 55 n.4 (1st Cir. 2020).
Under California law, “[i]nterpretation of an insurance policy is a question of
law.” Palmer v. Truck Ins. Exch., 988 P.2d 568, 572 (Cal. 1999) (quoting Waller v.
Truck Ins. Exch., Inc., 900 P.2d 619, 672 (Cal. 1995)). Insurance policies are
contracts “to which the ordinary rules of contractual interpretation apply.” Id.
(quotation omitted). The interpretation of an insurance policy is governed by the
parties’ mutual intention “at the time the contract is formed.” Id. (quotation
omitted).
When interpreting an insurance contract, the court must first look to the text
of the contract to discern its plain meaning. Waller, 900 P.2d at 627. “If contractual
language is clear and explicit, it governs.” Energy Ins. Mut. Ltd. v. Ace Am. Ins. Co.,
221 Cal. Rptr. 3d 711, 718 (Ct. App. 2017) (quotation omitted). “Words in an
insurance policy are to be interpreted as a layperson would interpret them, in their
ordinary and popular sense.” Id. (quotation omitted). “If particular policy language
is ambiguous, it is to be resolved by interpreting the ambiguous provisions in
accordance with the insured’s objectively reasonable expectations.” Id. (quotation
13 omitted). “The proper question is whether the provision or word is ambiguous in the
context of this policy and the circumstances of this case.” Medill v. Westport Ins.
Corp., 49 Cal. Rptr. 3d 570, 580 (Ct. App. 2006) (brackets and quotation omitted);
see also Energy Ins. Mut., 221 Cal. Rptr. 3d at 718 (“In determining the objectively
reasonable expectations of the insured, the court must interpret the language in
context, with regard to its intended function in the policy.” (quotation omitted)).
“An insurance policy, like any other contract, must be construed as an
entirety, with each clause lending meaning to the other.” Holz Rubber Co. v. Am.
Star Ins. Co., 533 P.2d 1055, 1061 (Cal. 1975). “[I]t is not a court’s function to select
a particular definition of a single word and apply it without regard to other
language in the policy.” Mirpad, LLC v. Cal. Ins. Guar. Ass’n, 34 Cal. Rptr. 3d 136,
144 (Ct. App. 2005); accord Century Transit Sys., Inc. v. Am. Empire Surplus Lines
Ins. Co., 49 Cal. Rptr. 2d 567, 571 (Ct. App. 1996) (“[T]he context in which a term
appears is critical.”). Insurance contracts are also “construed to avoid rendering
terms surplusage.” ACL Techs., Inc. v. Northbrook Prop. & Cas. Ins. Co., 22 Cal.
Rptr. 2d 206, 213 (Ct. App. 1993).
“Moreover, insurance coverage is ‘interpreted broadly so as to afford the
greatest possible protection to the insured, whereas exclusionary clauses are
interpreted narrowly against the insurer.’” MacKinnon v. Truck Ins. Exch., 73 P.3d
1205, 1213 (Cal. 2003) (brackets and ellipses omitted) (quoting White v. Western
Title Ins. Co., 710 P.2d 309, 313 (Cal. 1985) (en banc)). “The courts will not sanction
a construction of the insurer’s language that will defeat the very purpose or object of
14 the insurance.” Gray v. Zurich Ins. Co., 419 P.2d 168, 178 (Cal. 1966) (in bank)
(quotation omitted).
II. Duty to Defend, Duty to Indemnify, and Duty of Good Faith
“It is well established that an insurer has a duty to defend its insured against
a suit ‘which potentially seeks damages within the coverage of the policy.’” Medill,
49 Cal. Rptr. 3d at 577 (quoting Gray, 419 P.2d at 176) (emphasis in Medill). “This
obligation can only be excused when the third-party complaint ‘can by no
conceivable theory raise a single issue which could bring it within the policy
coverage.’” Id. (emphasis omitted) (quoting Montrose Chem. Corp. v. Superior Ct.,
861 P.2d 1153, 1160 (Cal. 1993) (in bank)). “In other words, the insured need only
show that the underlying claim may fall within policy coverage; the insurer must
prove it cannot.” Id. (quotation omitted). “[T]he determination whether the insurer
owes a duty to defend usually is made in the first instance by comparing the
allegations of the complaint with the terms of the policy.” Waller, 900 P.2d at 627.
If, however, “extrinsic facts eliminate the potential for coverage, the insurer may
decline to defend even when the bare allegations in the complaint suggest potential
liability.” Id. at 628.
By contrast, the duty to indemnify “runs only to claims that are actually
covered by the policy,” not to claims that are only potentially covered. Crawford v.
Weather Shield Mfg., Inc., 187 P.3d 424, 427 (Cal. 2008). While the duty to defend
arises upon the commencement of a proceeding involving claims which may be
within the policy’s coverage, “the duty to indemnify does not arise until liability is
15 proven.” Aluma Sys. Concrete Constr. of Cal. v. Nibbi Bros. Inc., 206 Cal. Rptr. 3d
394, 401 (Ct. App. 2016).
An insured may also bring a claim for breach of the implied covenant of good
faith and fair dealing.9 Every contract, including insurance contracts, contains an
implied covenant of good faith to discourage a contracting party from inhibiting
another party’s rights under the contract. See Waller, 900 P.2d at 639. However,
where “there is no potential for coverage and, hence, no duty to defend under the
terms of the policy, there can be no action for breach of the implied covenant of good
faith and fair dealing.” Id.
The parties do not dispute that, unless an exclusion applies, Stratford had a
duty to pay defense fees and to indemnify Plaintiffs for damages awarded in the
arbitration. The court begins with Stratford’s motion.
III. Stratford’s Motion for Summary Judgment
To prevail on its motion for summary judgment, Stratford must demonstrate
that the Contract Exclusion bars coverage as a matter of law. To do so, Stratford
must clear two hurdles. Stratford must show (1) that the language of the Exclusion
applies, and (2) that its exception does not apply. Stratford can clear neither hurdle.
In relevant part, the Contract Exclusion and its exception (in bold) state:
The Insurer shall not be liable to pay any Loss arising from any Claim. . . based upon or attributable to liability under
9 Under California insurance law, an insured party may seek both tort and
contract damages for a breach of the covenant of good faith. See Foley v. Interactive Data Corp., 765 P.2d 373, 390 (Cal. 1988) (in bank). A tortious breach claim, such as the claim alleged in this case, allows the insured to seek attorney’s fees. Brandt v. Superior Ct., 693 P.2d 796, 798 (Cal. 1985) (in bank). 16 any oral or written contract or agreement . . . ; provided, however, that this exclusion shall not be applicable to an Insured's alleged liability that exists in the absence of such contract or agreement . . . .
Supra, Background Section III.A. The court first considers whether the Contract
Exclusion applies, then turns to the exception.
A. The Franchisees’ CFIL Claim Is Not “Based Upon or Attributable to Liability Under” the Franchise Agreement
The Contract Exclusion bars coverage for claims “based upon or attributable
to liability under any oral or written contract or agreement.” Resolution of the
parties’ dispute turns on whether the Franchisees’ CFIL claim is “based upon or
attributable to liability under” the Franchise Agreement. To determine the
contracting parties’ intent as to the meaning of this language, the court looks first
to the plain text. See, e.g., Waller, 900 P.2d at 627. The California Supreme Court
has used Webster’s Dictionary to help it discern the plain, ordinary meaning of text.
See, e.g., Smith v. Superior Ct., 137 P.3d 218, 222 (Cal. 2006).
The dictionary definition of the word “base” is “to make or form a foundation
for.” Base, Webster’s Third New International Dictionary 180 (1993). The phrase
“based upon” is therefore synonymous with “founded upon” or “made upon.” The
definition of “attribute” is “to explain as caused or brought about by.” Attribute,
Webster’s Third New International Dictionary 142. Like the phrase “based upon,”
the phrase “attributable to” refers to the genesis or cause of something. Therefore, a
purely textual reading of the Contract Exclusion suggests that a claim “based upon
17 or attributable to liability under any [contract]” is one that originates from or is
caused by a party’s legal responsibility or obligation under a contract.10
What is not clear from this language, however, is how close the nexus
between the insured’s liability and the contract must be in order for the exclusion to
apply. According to Stratford, the Contract Exclusion bars coverage when the
insured’s liability has only an incidental, or minimal, causal connection to the
contract. Stratford argues that the Contract Exclusion applies because all of the
Franchisees’ counterclaims are related to the conduct that formed the basis for the
franchisees’ breach of contract counterclaim. Stratford’s interpretation is, however,
untethered from the language of the Exclusion and the Policy as a whole.
In addition to the rule requiring the court to start with the text’s plain
meaning, several other bedrock principles of textual construction aid the court here.
First, and most important in this case, the court must look to the entirety of the
contract “with each clause lending meaning to the other.” Holz Rubber, 533 P.2d at
1061; accord, e.g., Medill, 49 Cal. Rptr. 3d at 582 (“Language in a contract must be
construed in the context of that [contract] as a whole, and in the circumstances of
that case, and cannot be found to be ambiguous in the abstract.”); Mirpad, 34 Cal.
Rptr. 3d at 144 (“[I]t is not a court’s function to select a particular definition of a
single word and apply it without regard to other language in the policy.”). In
10 The meaning of the word “liability” is not in dispute. “Liability” means the
“quality state, or condition of being legally obligated or accountable; legal responsibility to another or to society, enforceable by civil remedy or criminal punishment.” Liability, Black’s Law Dictionary (11th ed. 2019). 18 applying this “context canon,” California courts avoid constructions that would
produce redundancies and surplusage in policies. See AIU Ins. Co. v. Superior Ct.,
799 P.2d 1253, 1268 (Cal. 1990) (in bank); ACL Techs., 22 Cal. Rptr. 2d at 213.
Here, the canon requiring that the court read language in the context of the
whole contract (and not in isolation) compels a conclusion that the Contract
Exclusion requires more than merely a minimal or incidental factual connection.
Medill, 49 Cal. Rptr. 3d at 580 (stating that courts “must consider “the context of
this policy and the circumstances of this case” (quoting E.M.M.I. Inc. v. Zurich Am.
Ins. Co., 84 P.3d 385, 389 (Cal. 2004))). The Contract Exclusion is one in a list of
several other exclusions, most of which bar coverage using broad nexus language
not included in the Contract Exclusion. The set of exclusions (with the Contract
Exclusion in bold) state:
The Insurer shall not be liable to pay any Loss arising from any Claim:
E. arising out of, based upon or in consequence of, resulting from or in any way involving any violation of any statutory, regulatory or common law, governing any of the following activities: unfair trade practices, anti-trust, unfair competition, or tortious interference in another's business or contractual relationships;
F. arising out of, based upon or in consequence of, resulting from or in any way involving any Insured's performance of or failure to perform professional services for others; . . . .
G. based upon or attributable to liability under any oral or written contract or agreement, including but not limited to any express warranties or guarantees, or liability assumed under any oral or written contract or agreement; provided, however, that this exclusion shall not be applicable to an Insured's
19 alleged liability that exists in the absence of such contract or agreement; or to any Securities Claim[;]
... I. arising out of, based upon or in consequence of, resulting from or in any way involving any [specific torts];
J. arising out of, based upon or in consequence of, resulting from or in any way involving . . . any violation of the Telephone Consumer Protection Act . . .; or
K. arising out of, based upon or in consequence of, resulting from or in any way involving any of the following [four actions that are not relevant].
Supra, Background Section III.A.
Specifically, all five of these other exclusions (Exclusions E, F, I, J, and K)
begin with the following phrases (underlined words are not present in the Contract
Exclusion): coverage is barred for “any claim arising out of, based upon or in
consequence of, resulting from or in any way involving any [enumerated act].” Id.
(emphasis added). The court must read the nexus language in the Contract
Exclusion (i.e., “based upon or attributable to”) in the context of the nexus language
in the other exclusions (i.e., “or in any way involving”). The Contract Exclusion is
the only exclusion in the list of seven that uses the phrase “based upon or
attributable to” to describe the factual nexus required for the exclusion to apply.11
And, it is the only exclusion with nexus language that does not include the broad
clause “or in any way involving.”
11 Exclusion H is unique and does not have any “arising from” nexus
language. It bars coverage for any claims “for infringement or violation of patent, trademark, trade secret copyright, misappropriation, plagiarism or any other intellectual property rights.” See supra Background Section III.A.
20 Reading the Contract Exclusion in the context of these other exclusions
suggests that the Contract Exclusion requires a closer relationship between the
insured’s liability and the circumstance barring coverage than does its neighboring
exclusions. Stratford knew how to draft a broad exclusion in the Policy—as it did
with the other immediately surrounding exclusions—but elected not to use that
broad nexus language in the Contract Exclusion. “[E]xclusionary clauses are
interpreted narrowly against the insurer.” MacKinnon, 73 P.3d at 1213 (quotation
omitted). Had Stratford wanted the Contract Exclusion to apply broadly and
whenever the liability was “in any way involving” a contract, it could have
included—and knew how to include—that language in the Contract Exclusion.
The rule against surplusage provides further support for a narrow reading of
the Contract Exclusion. To read the phrase “based upon or attributable to” as
broadly as Stratford asserts would render meaningless the broad language present
in the other exclusions (i.e., “in any way involving”). The rule against surplusage
requires that the court give meaning to the broad language in the surrounding
exclusions, AIU Ins. Co., 799 P.2d at 1268, in light of its absence in the Contract
Exclusion. Thus, the rule against surplusage supports an interpretation of the
Contract Exclusion as requiring more than an incidental nexus between a contract
and the insured’s liability.
An additional canon that supports a narrow interpretation of the Contract
Exclusion is the California Supreme Court’s instruction that courts should avoid
interpretations that would “defeat the very purpose or object of the insurance.”
21 Gray, 419 P.2d at 179 (quotation omitted). Barring coverage for a claim with an only
incidental connection to a contract would swallow Plaintiffs’ otherwise
comprehensive coverage, particularly in a contract-dependent business such as
franchising. Interpreting the exclusion narrowly, however, gives effect to the
Policy’s purpose: protecting MRFranchise and its employees.
These bedrock principles of construction compel a conclusion that the
Contract Exclusion does not apply here. While most of the counterclaims sounded in
breach of contract and torts pertaining to the Franchise Agreement—such that
those claims would be “based upon or attributable to liability under” the Franchise
Agreement—the one claim for which Plaintiffs were found liable was not “based
upon or attributable to liability under” that (or any) contract. Plaintiffs’ liability
here stems from the single statutory claim alleging a violation of the CFIL. This
claim was premised on Plaintiffs’ misrepresentations in the MRF Disclosure. The
liability for that claim was therefore “based upon or attributable to” Plaintiffs’
misrepresentations in that document. The liability did not in any way flow from the
Franchise Agreement. Indeed, the MRF Disclosure is separate from and
independent of the Franchise Agreement. While the MRF Disclosure has a factual
relationship to the Franchise Agreement, there is no direct (or causal) nexus
between Plaintiffs’ statutory liability and the Agreement.
Stratford urges the court to ignore the context and language of this Policy
and to apply a line of California cases which—Stratford contends—holds that the
phrase “based upon” requires only a minimal or incidental connection between the
22 liability and a contract. The court agrees that there is a line of California
intermediate appellate cases that have broadly interpreted the phrases “arising out
of,” “arising from,” and “based upon” in insurance policies. See, e.g., Health Net, Inc.
v. RLI Ins. Co., 141 Cal. Rptr. 3d 649, 673 (Ct. App. 2012); Medill, 49 Cal. Rptr. 3d
at 578-79; Century Transit Sys., 49 Cal. Rptr. 2d at 571 n.4. Specifically, California
intermediate appellate courts interpret “arising out of” or “arising from” to “broadly
link[] a factual situation with the event creating liability, . . . connot[ing] only a
minimal causal connection or incidental relationship.” Medill, 49 Cal. Rptr. 3d at
578-79; see also Nestle USA, Inc. v. Travelers Cas. & Sur. Co. of Am., 10 F. App’x
438, 439-40 (9th Cir. 2001) (“This is true even when the term is used in an
exclusionary provision and a broad interpretation results in limiting coverage.”).
This caselaw comes from California intermediate appellate courts, e.g., Medill, 49
Cal. Rptr. 3d at 578-79, and federal courts applying those cases, e.g., Cont’l Cas. Co.
v. City of Richmond, 763 F.2d 1076, 1080 (9th Cir. 1985).
These courts have also extended this broad reading to the phrase “based on.”
See Century Transit Sys., 49 Cal. Rptr. 2d at 571 n.4 (“In our view the term ‘based
on’ has the same effect as ‘arising out of.’”); see also Foster Farms, LLC v. Everest
Nat’l Ins. Co., 670 F. Supp. 3d 953, 966 (N.D. Cal. 2023) (“In California, the clause
‘based upon’ is given the same broad reading as ‘arising out of.’” (quotation
omitted)). When either phrase is present in an exclusion, California’s intermediate
appellate courts examine the conduct underlying the claim for which coverage is
sought, rather than the legal theories upon which the claim relies, to determine
23 whether an exclusion applies. See, e.g., Century Transit Sys., 49 Cal. Rptr. 2d at
571 n.4.
To date, however, the court has not located—and the parties have not cited—
any California case interpreting language in a contract exclusion that is materially
similar to this Contract Exclusion. And the California appellate cases on which
Stratford relies involve policies with exclusions written more broadly than the
language at issue in this Policy. For example, in Medill v. Westport Insurance Co.,
the policy barred coverage for claims “arising out of breach of any contract, whether
oral, written or implied.” 49 Cal. Rptr. 3d at 575. However, the policy in Medill
defined “arising out of” to mean “based upon, arising out of, or in connection with.”
Id. (emphasis added). Thus, the language “in connection with” provided textual
support for the holding. Likewise, in Southgate Recreation and Park District v.
California Ass’n for Park and Recreation Insurance, an exclusion barred coverage
for claims “arising out of or related to” construction contracts. 130 Cal. Rptr. 2d at
733 (emphasis added). It is no surprise, therefore, that the court in Southgate
construed the required factual nexus broadly. The language at issue in Southgate,
like that in Medill, was unambiguous in that the nexus between the liability needed
only to be “related to” a contract.
Stratford also relies on a number of federal cases to support its argument
that California law construes the phrases “based upon” and “arising under” as
synonymous, and requires only a minimal or incidental nexus to trigger insurance
exclusions. See, e.g., Office Depot, Inc. v. AIG Specialty Ins. Co., 829 F. App’x 263,
24 263 (9th Cir. 2020); L.A. Lakers, Inc. v. Fed. Ins. Co., 869 F.3d 795, 801 (9th Cir.
2017); Continental Cas., 763 F.2d at 1080; Foster Farms, 670 F. Supp. 3d at 966;
AKN Holdings, LLC v. Great Am. E & S Ins. Co., No. 2:21-cv-02216-SB-E, 2021 WL
2325647, at *2 (C.D. Cal. May 14, 2021).
Each case, once again, is distinguishable based on the broad nexus language
in those exclusions.12 See Office Depot, Inc., 829 F. App’x at 263 (precluding
coverage for claims “alleging, arising out of or resulting, directly or indirectly, from
any liability or obligation under any contract or agreement or out of any breach of
contract” (emphasis added)); L.A. Lakers, 869 F.3d at 800 (excluding coverage for
claims “based upon, arising from, or in consequence of . . . [an] invasion of privacy”
(emphasis added)); Continental Cas., 763 F.2d at 1079 (barring coverage for loss “in
connection with any claim . . . arising directly or consequentially from” physical or
mental injury, property damage, or tort (emphasis added)); AKN Holdings, 2021 WL
2325647, at *2 (excluding coverage for claims “based upon, arising from, or in any
way related to any actual or alleged breach of contract” (emphasis added)); Church
12 Stratford also cites to Nestle USA v. Travelers Casualty and Surety Co. of
America, in which the Ninth Circuit summarily affirmed the district court’s grant of summary judgment in favor of the insurer. 10 F. App’x at 440. In that case, however, the Ninth Circuit did not analyze the full exclusionary language. Id. at 439-40. In a short, two-page decision, the court only analyzed “arising out of,” without additional context. Id. Nestle is, therefore, unhelpful for interpreting the language in the Contract Exclusion before this court. Likewise, Stratford relies on Trenches, Inc. v. Hanover Insurance Co., No. SACV 12-627 AG (RNBx), 2012 WL 12507967, at *6 (C.D. Cal. Aug. 10, 2012), which construes “based upon” and “arising from” broadly to require only an incidental nexus between the liability and contract. However, the contract in that case—a settlement agreement—is unlike the Policy at issue here. See Trenches, 2012 WL 12507967, at *2. Moreover, the reasoning of Trenches is conclusory and not particularly persuasive for that reason. See id. at *6-7. 25 Mut. Ins. Co. v. U.S. Liab. Ins. Co., 347 F. Supp. 2d 880, 884 (barring coverage for
“any Claim made against any Insured arising out of, directly or indirectly resulting
from or in consequence of, or in any way involving . . . any actual or alleged breach
of contract” (emphasis added)).
But even if the analyses deployed in these cases were applied here, Stratford
would fare no better. These cases generally reason that, when the phrase “arising
out of” or “based upon” appear in an exclusion, the court should determine the
exclusion’s applicability by comparing the conduct giving rise to the liability for
which coverage is sought with the category of conduct to which the exclusion
applies. See, e.g., Medill, 49 Cal. Rptr. 3d at 578-79. Importantly, however,
“California courts have clarified that some causal connection is necessary” between
the excluded conduct and the conduct giving rise to the liability for which coverage
is sought. Foster Farms, 670 F. Supp. 3d at 966; see also Acceptance Ins. Co. v.
Syufy Enterps., 81 Cal. Rptr. 2d 557, 329 (Ct. App. 1999) (suggesting that the
required causal connection is somewhere between but-for causation and proximate
cause). Thus, if the court were to apply the analysis urged by Stratford, it would
discern whether the conduct giving rise to liability in the arbitration—the CFIL
violation—bears a causal connection with the category of conduct to which the
exclusion applies—breach of contract.
The CFIL violation bears no causal connection to a breach of contract. The
franchisees’ CFIL claim alleged that Plaintiffs failed to disclose certain information
in the MRF Disclosure regarding Rafipoor’s civil litigation history in violation of
26 statutory law. The CFIL requires these disclosures in connection with the sale or
offer of a franchise, regardless of whether a contract is ultimately executed. See Cal.
Corp. Code §§ 31300, 31202. Indeed, the conduct upon which the Franchisees
sought to hold Plaintiffs liable under the CFIL was entirely different conduct for
which they sought to hold Plaintiffs liable for breach of contract—and the
Franchisees’ breach-of-contract claims were ultimately unsuccessful.
The Northern District of California’s recent opinion in Foster Farms is
instructive. The plaintiffs in Foster Farms were large-scale producers of poultry
products. 670 F. Supp. 3d at 956-57. After the plaintiffs were named as defendants
in various antitrust lawsuits alleging anticompetitive conduct in connection with
the production and sale of its chicken products, they obtained insurance coverage
providing coverage for antitrust suits. Id. at 957-61. The policy, however,
specifically excluded any claim “based upon, arising out of, or attributable to” the
previously instituted chicken antitrust lawsuits. Id. at 962.
Subsequent to issuance of the policy, the plaintiffs were named as defendants
in a series of antitrust actions related to their turkey products. Id. at 959. When
plaintiffs sought coverage, the insurer denied coverage pursuant to the above-
quoted exclusions. Id. at 963. Plaintiffs thereafter instituted an action seeking a
declaration that the exclusion did not apply to the turkey antitrust suits. Id.
While noting that the phrases “arising from” and “based upon” are
“consistently given a broad interpretation” by California courts “and broadly
excludes from coverage claims with a minimal causal connection . . . to the
27 [excluded] actions or allegations,” the court nevertheless ruled that the exclusions
did not apply as a matter of law because “[n]one of the claims in the Turkey
Litigation Suits . . . have sufficient causal connection with the claims, facts,
circumstances, acts, or allegations in the Chicken Antitrust Suits.” Id. at 966-67
(quotation omitted). While both sets of cases contained allegations of using certain
reports to engage in price-fixing with competitors in a similar manner with similar
goals, “the allegations in the Turkey cases are independent from the facts and
circumstances of the Chicken cases.” Id. at 967. More critically, there was no
evidence “that the alleged anticompetitive [behavior] in the chicken market caused
similar anticompetitive behavior in the turkey market.” Id. Ultimately, because the
sets of suits premised liability on separate and distinct acts, they lacked a causal
connection triggering the at-issue exclusion—even though the allegations between
the chicken suits and the turkey suits were similar. Id.
Here, while both the CFIL claim and the franchisees’ breach-of-contract
claims relate to the Franchise Agreement, there is no evidence that the conduct
found to have violated the CFIL (nondisclosure of statutorily required information)
caused the conduct alleged by the franchisees to amount to breach of contract. The
Franchisees’ breach-of-contract claims generally focused on conduct such as not
opening the restaurant on time and not providing on-site training after the
restaurant opened, conduct without causal connection to the CFIL violation. Thus,
even if the court were to ascribe the broad reading of “based upon” to the Contract
28 Exclusion that Stratford urges, Stratford would still not be entitled to judgment as
a matter of law.
In sum, the Contract Exclusion is different in fundamental respects from the
exclusions analyzed in the California intermediate appellate cases (and the federal
cases citing those state cases). The nexus language in the Contract Exclusion is
narrower than the language in cases like Southgate or Medill. And the Contract
Exclusion is located among a number of other exclusions with nexus language
providing additional textual support for a narrow interpretation. Stratford has not
cited any California case interpreting the same kind of policy language as in this
case.
In reaching its conclusion, the court is guided by the California Supreme
Court’s directive that courts must infer the mutual intent of the parties, “if possible,
solely from the written provisions of the contract.” TRB Invs., Inc. v. Fireman’s
Fund Ins. Co., 145 P.3d 472, 477 (Cal. 2006) (emphasis added). Considering the
plain language of the Contract Exclusion, the context in which it appears in the
Policy, the rule against surplusage, the rule requiring exclusions to be read
narrowly, and the purpose of the Policy, the court finds the Exclusion is too narrow
to encompass statutory liability that has only an incidental nexus to a contract.
B. The Exception to the Contract Exclusion Applies Here
Even if Stratford could show that the language of the Contract Exclusion
applies, it still must show that its exception does not. The exception to the Contract
Exclusion states that “this exclusion shall not be applicable to an Insured’s alleged
liability that exists in the absence of such contract or agreement . . . .” Supra, 29 Background Section III.A. Thus, this Exclusion does not apply to liability that exists
independent of a contract.
The arbitrator found Plaintiffs liable only for a violation of the CFIL. The
arbitrator found that Plaintiffs violated that law by failing to disclose to the
Franchisees prior litigation involving “allegations of fraud . . . or comparable
allegations.” 16 C.F.R. § 436.5(c)(iii)(B). As noted, by the terms of the statute, a
contract is not a prerequisite for liability; a violation may occur from a mere offer.
See Cal. Corp. Code § § 31300, 31202. Here, Plaintiffs’ liability flows from this
California statute, is based on a document (the MRF Disclosure) that is separate
and distinct from any contract, and is based on conduct that predated the Franchise
Agreement. Because Plaintiffs’ alleged liability under the CFIL exists in the
absence of a contract, the CFIL claim falls squarely within the exception to the
Contract Exclusion.
The existence of Plaintiffs’ liability in the absence of a contract is not merely
theoretical. As a remedy for the Franchisees’ statutory claim, the arbitrator
rescinded the Franchise Agreement. Despite the Agreement’s rescission, Plaintiffs’
liability under the CFIL still exists. Indeed, because the arbitrator rescinded the
Franchise Agreement, it is as if the Agreement never existed. See Cal. Civ. Code
§ 1688 (“[a] contract is extinguished by its rescission”); Little v. Pullman, 162 Cal.
Rptr. 3d 74, 82 (Ct. App. 2013) (“Once a contract has been rescinded it is void ab
initio, as if it never existed.”); Sharabianlou v. Karp, 105 Cal. Rptr. 3d 300, 310 (Ct.
App. 2010) (remedy of rescission “terminates further liability, and restores the
30 parties to their former positions by requiring them to return whatever consideration
they have received”). The arbitrator recognized this; given the franchisees’ decision
to seek rescission as a remedy for the CFIL violation, the arbitrator declined to
enter judgment for the franchisees on their contract claims in part because the
franchisees could not “inconsistently seek to enforce an alleged breach of the
Franchise Agreement which has been rescinded.” Doc. no. 32-2 at 26. For these
reasons, the exception to the Contract Exclusion applies, and Stratford cannot rely
on that Exclusion to bar coverage.
In sum, the court finds that the Contract Exclusion does not bar coverage for
Plaintiffs on the CFIL claim, and that—in any event—the exception to the Contract
Exclusion applies here. Accordingly, Stratford has failed to demonstrate that it is
entitled to judgment as a matter of law. The court therefore denies Stratford’s
motion for summary judgment.
IV. Plaintiffs’ Cross-Motion for Summary Judgment
Plaintiffs cross-move for summary judgment, arguing that they are entitled
to judgment as a matter of law because no exclusion bars coverage under the Policy.
In response, Stratford asserts that several exclusions—in addition to the Contract
Exclusion—prevent Plaintiffs from obtaining summary judgment in their favor.
Having already concluded that the Contract Exclusion does not preclude coverage
for Plaintiffs’ claims, see supra Discussion Section III, the court grants Plaintiffs’
motion as to that Exclusion. The court now considers the three other exclusions
Stratford raises in its objection to Plaintiffs’ motion for summary judgment: the
31 Prof. Services Exclusion, the Prior Notice Exclusion, and the Intentional Acts
Exclusion.
A. The Prof. Services Exclusion
Stratford first contends that Plaintiffs are not entitled to summary judgment
because the Prof. Services Exclusion applies. The Prof. Services Exclusion bars
coverage for “any Claim arising out of, based upon or in consequence of, resulting
from or in any way involving any Insured’s performance of or failure to perform
professional services for others . . . .” Supra Background Section III.A.
While the term “professional services” is not defined in the Policy, it has a
“generally accepted meaning” in the context of an insurance policy. See Energy Ins.
Mut., 221 Cal. Rptr. 3d at 719. Courts have applied professional services exclusions
“broadly to bar coverage for damages resulting from a wide range of professional
services that extend beyond those traditionally considered ‘professions,’ such as
medicine, law, or engineering.” Id. at 720 (quotation omitted). To constitute a
professional service under California law, a service must involve “specialized
knowledge, labor, or skill, and the labor or skill involved [must be] predominantly
mental or intellectual, rather than physical or manual.” Id. at 719 (quotation
omitted). Examples of professional services range from ear piercing, plumbing, and
chiropractic treatment, to escrow services, surveying land, drilling, and supervision
of the location of pipelines. Id. at 720 (collecting cases).
The Prof. Services Exclusion does not appear on its face to apply to the
conduct of Plaintiffs in their role as franchisors. Fundamentally, a franchise is a
32 business relationship, akin to an investment or a partnership. See Thueson v. U-
Haul Internat’l, Inc., 50 Cal. Rptr. 3d 669, 672 (Ct. App. 2006); see also Cal. Corp.
Code § 31005(a)(1)-(3) (defining a “franchise” as a contractual arrangement whereby
a franchisee is granted certain rights to engage in business pursuant to the
franchisor’s trademark and brand). Indeed, “professional liability policies generally
do not cover . . . business management activities [or] business decisions of a
nonprofessional nature.” Utica Mut. Ins. Co. v. Herbert H. Landy Ins. Agency, Inc.,
820 F.3d 36, 42 (1st Cir. 2016) (applying Massachusetts’ construction of
“professional services,” which is materially similar to California’s). Stratford argues,
however, that — as part of the Franchise Agreement — Plaintiffs promised but
failed to perform a professional service for the Franchisees. Specifically, Stratford
contends that Plaintiffs agreed to provide the Franchisees with the training and
resources to run a franchise, which requires the “specialized skill” that qualifies
under state law as “professional service.” Stratford asserts that the Franchisees’
claims arise out of Plaintiffs’ failure to provide the training and resources they
needed to run the Franchise.
Stratford’s argument might succeed if the claim that generated Plaintiffs’
liability was “in any way” related to Plaintiffs’ failure to honor its promise to
provide training and resources.13 The claim for which Plaintiffs seek coverage,
13 Stratford is correct that some of the claims asserted in the Franchisees’
complaint included allegations that involved Plaintiffs’ failure to provide those training and services. But the relevant question is whether the claims triggering coverage under the Policy involve “in any way” the performance of professional services. They do not. 33 however, arose from MRFranchise’s misrepresentations in the MRF Disclosure and
its violation of the CFIL. See Medill, 49 Cal. Rptr. 3d at 577 (duty to defend
triggered when insurer is notified of “a suit which potentially seeks damages within
the coverage of the policy” unless the insurer demonstrates that “the third party
complaint can by no conceivable theory raise a single issue which could bring it
within policy coverage” (emphasis and quotations omitted)). It is undisputed that
the misrepresentations in the MRF Disclosure preceded the franchise relationship.
Even read favorably to Stratford, the record reveals that MRFranchise’s liability
under the CFIL is in no way related to its alleged failure to provide training and
resources to the Franchisees. See EFGroupATL, LLC v. Eat Fit Go Healthy Foods,
LLC, No. 8:20-CV-286, 2020 WL 7493220, at *7 (D. Neb. Dec. 21, 2020) (noting a
paucity of cases “in which misrepresentations made during the course of
negotiations were deemed . . . professional services”).
The Prof. Services Exclusion does not apply to bar coverage here. Plaintiffs
are, therefore, entitled to judgment as a matter of law on the non-applicability of
this Exclusion.
B. The Prior Notice Exclusion
Stratford next contends that summary judgment is precluded by the Prior
Notice Exclusion, which bars coverage for claims an insured knew or had notice of
before obtaining insurance. As the movant, Plaintiffs must show that there is no
genuine factual dispute as to whether they knew—when they applied for the Policy
on January 31, 2020—of an “act, error, or omission which could give rise to a claim.”
34 Doc. no. 37-1 at 4. Plaintiffs contend that there is no evidence that they were, in
fact, aware of any potential claim.
Under California law, the language used in the Prior Notice Exclusion
requires that the insured be subjectively “aware of acts that caused a . . . claim to be
filed against’ it.” Associated Indus. Ins. Co., Inc. v. McNicholas & McNicholas LLP,
495 F. Supp. 3d 869, 876 (C.D. Cal. 2020) (quoting Weddington v. United Nat’l Ins.
Co., No. C 07-1733 SBA, 2008 WL 590512, at *5 (N.D. Cal. Feb. 29, 2008)). In
addition, the acts must be of a nature that would put a reasonable professional on
notice that a potentially meritorious claim could result. Id. On this record, there is
sufficient evidence (viewed favorably to Stratford) from which a reasonable jury
could find that Plaintiffs knew of a potential claim stemming from their disputes
with the Franchisees. The timing of these early disputes raise a material factual
question about whether Plaintiffs had actual knowledge of a potential claim prior to
January 31, 2020.
Specifically, several months after the franchise opened (in August 2019),
Plaintiffs issued the Franchisees a notice of default under the Franchise Agreement
due to the Franchisees’ failure to complete their training. The Franchisees
struggled to “operat[e] the franchise in accordance with [Plaintiffs’] specifications,”
which led to Plaintiffs assuming control of the restaurant. Doc. no. 28-2 ¶ 7.
Plaintiffs and the Franchisees then attempted to enter into a buy-back agreement.
However, disagreements ensued over the terms of the buy-back. When Rafipoor
asked if the Franchisees wanted to proceed with the buy-back, Borba responded
35 that the Franchisees would seek damages for breach of the Franchise Agreement if
Rafipoor attempted to close the restaurant.
On February 19, 2020, six days after the Policy went into effect, the
Franchisees filed suit in California state court against Rafipoor and Santa Montana
for claims related to the franchise relationship. That day, Plaintiffs gave the
Franchisees another notice of default. Thus, within a period of roughly six months,
the relationship between Plaintiffs and the Franchisees had devolved into litigation.
A reasonable jury could consider this timeline of events to infer that Plaintiffs
knew, before January 31, 2020, that a lawsuit could ensue.
Additionally, in the Franchisees’ counter-complaint, the Franchisees alleged
that they contacted Rafipoor about potential contract breaches before January 31,
2020. For example, the Franchisees alleged that discussions in 2019 about the buy-
back occurred “after numerous oral and written correspondence with Rafipoor
related to his failure to live up to his oral and . . . written promises.” Doc. no. 28-5
¶ 57 (emphasis added). The Franchisees also alleged that after “continuing to
complain” to MRFranchise’s representatives about violations of the Franchise
Agreement, Rafipoor (on behalf of MRFranchise) offered to buy back the restaurant.
Id. ¶ 58. Although Rafipoor states in his affidavit that he first learned of a breach of
contract allegation from Borba on February 18, 2024, the Franchisees’ allegations
suggest otherwise. At this stage, the court cannot “weigh evidence or make
credibility determinations.” Taylor v. Gallagher, 737 F.2d 134, 137 (1st Cir. 1984).
36 Reading these facts favorably to Stratford, a reasonable jury could conclude
that Plaintiffs knew on January 31, 2020, about acts or omissions that could give
rise to a claim. Under this view of the evidence, the Prior Notice Exclusion would
bar coverage. Therefore, Plaintiffs have failed to show there is no genuine dispute of
material fact as to the applicability of the Prior Notice Exclusion. On that issue,
then, the court denies Plaintiffs’ cross-motion for summary judgment.14
C. The Intentional Acts Exclusion
Stratford also argues that the Policy’s Intentional Acts Exclusion precludes
summary judgment in Plaintiffs’ favor.15 The Policy’s Intentional Acts Exclusion
14 Stratford also relies on the findings of the arbitrator to argue that the record
contains sufficient evidence for a jury to find that Rafipoor had prior knowledge of his own fraud (i.e., the CFIL violation)—at the time the MRF Disclosure was provided to the Franchisees—and therefore Rafipoor had notice of a potential claim for that fraud before January 31, 2020. The problem with this argument is that the arbitrator made a specific finding that—while the evidence established MRF Franchise’s liability under CFIL—it was insufficient to show that Rafipoor committed a willful or knowing CFIL violation. The arbitrator concluded that one of MRF Franchise’s executives was responsible for the fraudulent MRF Disclosure (hence the finding that MRFranchise was liable), but that the record did not establish that Rafipoor was that executive. The parties have not briefed to the court’s satisfaction the interplay between the court’s obligations, on the one hand, to construe the record favorably to Stratford here (as the nonmovant) while also, on the other, to give preclusive effect to the findings of the arbitrator. See Exec. Risk Indem., Inc. v. Jones, 89 Cal. Rptr. 3d 747, 757 (Ct. App. 2009) (holding it is “well settled” under California law that an insurer who elects not to defend, after receiving notice, is bound by the tribunal’s material findings of fact). Since the record contains other facts sufficient to deny summary judgment on this exclusion, the court leaves this precise question for another day.
15 Stratford also relies on a statutory exclusion which states that “[a]n insurer
is not liable for a loss caused by the wilful act of the insured.” . In California, this statutory exclusion is implied in all insurance policies. J.C. Penney Casualty Ins. Co. v. M.K., 804 P.2d 689, 694 (Cal. 1991). Courts rely on § 533 to interpret intentional act exclusions such as the one at issue here. See Delgado v. Interinsurance Exch. Of Auto. Club of S. Cal., 211 P.3d 1083, 1090 (Cal. 2009). 37 states in relevant part that Stratford “shall not be liable to pay any Loss in
connection with any Claim . . . brought about or contributed to by . . . the
committing of any intentional criminal or deliberate fraudulent act, if such
. . . intentional criminal or deliberate fraudulent act is established by a final, non-
appealable adjudication in the underlying action.” Doc. no. 32-1 at 8. The exclusion
further provides that no insured’s intentional criminal or deliberate fraudulent act
may be imputed to another insured (subject to certain exceptions not relevant here).
Id. This kind of exclusion “is treated as having the same meaning as the language
in Insurance Code section 533, which provides that an insurance company is not
liable for a loss caused by a willful act of the insured.” Delgado v. Interinsurance
Exch. of Auto. Club of S. Cal., 211 P.3d 1083, 1090 (Cal. 2009); Primary Color Sys.
Corp. v. Hiscox Ins. Co., Inc., 654 F. Supp. 3d 982, 988 (C.D. Cal. 2023) (applying
the willfulness standard from § 533 to an exclusion barring coverage for “any
deliberate criminal or deliberate fraudulent act” (emphasis omitted)), aff’d, No. 23-
55199, 2024 WL 489171 (9th Cir. Feb. 8, 2024).
In this case, the arbitrator found that MRFranchise, as a corporate entity,
willfully violated the CFIL by failing to disclose information about prior litigation in
the MRF Disclosure. However, the arbitrator found there was “insufficient evidence
to find Rafipoor, himself, was the particular agent of” MRFranchise that decided to
intentionally omit information about that litigation from the Disclosure. Doc. no. 32-
2 at 19 (emphasis omitted). Accordingly, the arbitrator concluded there was
insufficient evidence to find that Rafipoor willfully violated the CFIL. Plaintiffs
38 argue that the Intentional Acts Exclusion does not preclude coverage for Rafipoor
because the arbitrator did not find that Rafipoor committed an intentional criminal
or deliberate fraudulent act and because the exclusion expressly prohibits
MRFranchise’s intentional act from being imputed to Rafipoor. Moreover, since the
arbitrator held Rafipoor jointly and severally liable for the CFIL violation, plaintiffs
contend that the full amount of the final award is covered despite the Intentional
Acts Exclusion.
Plaintiffs’ argument has merit. The Intentional Acts Exclusion precludes
coverage of an insured’s intentional criminal or deliberate fraudulent act. And
Section 533 precludes coverage of an insured’s “wilful” act. Here, Rafipoor was not
found to have committed an intentional criminal or deliberate fraudulent act, or to
otherwise have acted willfully, and MRFranchise’s intentional acts may not be
imputed to Rafipoor by the plain terms of the exclusion. Nevertheless, he was held
jointly and severally liable for the arbitral award. Applying the Intentional Acts
Exclusion or Section 533 to bar coverage of Rafipoor’s liability would result in a
denial of coverage despite the arbitrator’s failure to find that Rafipoor committed a
willful CFIL violation. Such a result would be inconsistent with a reasonable
insured’s interpretation of the Intentional Acts Exclusion, and with Section 533’s
recognition that an insurer may be liable for an insured’s negligent acts, even
though it may not be liable for an insured’s willful acts. See Cal. Ins. Code § 533.
Stratford nevertheless contends that the Intentional Acts Exclusion bars
coverage of Rafipoor’s liability. Stratford points out that the arbitrator’s basis for
39 holding Rafipoor jointly and severally liable for the CFIL violation was the
arbitrator’s finding that Rafipoor “materially aid[ed]” the violation. Id. at 22; see
also Cal. Corp. Code § 31302 (providing joint and several liability for “every
principal executive officer or director of a corporation” held liable under § 31300
“who materially aids in the act or transaction constituting the violation”). The
arbitrator reasoned that the civil actions MRFranchise failed to disclose “were those
of Rafipoor,” and that Rafipoor was MRFranchise’s “principal executive officer and
individual responsible for and tasked with the duty to prepare” the MRF Disclosure.
Doc. no. 32-2 at 23. Stratford contends that the Intentional Acts Exclusion and
§ 533 extend to “an insured who aids another in committing an intentional act.”
Doc. no. 35 at 12.
Stratford is incorrect. Stratford cites two cases in support of its argument
that one who aids another’s intentional act is subject to an Intentional Acts
Exclusion or Section 533. See Interinsurance Exch. v. Flores, 53 Cal. Rptr. 2d 18
(Ct. App. 1996); Allstate Ins. Co. v. Pira, No. C 11-3511 CW, 2013 WL 1703381, at
*12 (N.D. Cal. Apr. 19, 2013), aff’d, 608 F. App’x 496 (9th Cir. 2015). Neither case
suggests that the exclusion or Section 533 extend to Rafipoor.
In Flores, an insured drove an accomplice to an intersection so that his
accomplice could shoot someone. 53 Cal. Rptr. 2d at 20. The insured knew that his
accomplice planned to shoot someone. Id. After his accomplice committed the
shooting, the insured was arrested and entered a plea of nolo contendere to the
felony of aiding and abetting an assault with a deadly weapon. See id.; Cal. Penal
40 Code § 245(a)(2). After the victim’s guardian ad litem brought suit against the
insured, the insurer that issued the insured’s automobile policy brought a separate
declaratory judgment action to determine the scope of its duty to defend or
indemnify the insured. See Flores, 53 Cal. Rptr. 2d at 20.
The California Court of Appeal found that the insured owed no duty to
defend or indemnify pursuant to Section 533. The court explained that, “under
section 533, an insurer bears no liability if the insured acted with intent to harm or
committed an inherently wrongful act without legal justification.” Id. at 23. To come
within Section 533, one who aids and abets another’s intentionally harmful or
inherently wrongful act “must share the specific intent of the perpetrator.” Id. at 24
(emphasis omitted). The court noted that the insured intentionally drove his
accomplice to the intersection so that his accomplice would commit a shooting, and
he knew that a shooting was likely. See id. In other words, the insured intended for
the shooting to occur, and took action to effect his intent. Because the insured
“expected harm to occur here and he acted deliberately to help bring it about,”
Section 533 precluded coverage. Id. at 674.
Flores is a far cry from the facts of this case. The arbitrator did not render a
finding that Rafipoor shared in MRFranchise’s intent to conceal information about
the prior civil litigation. Rather, the arbitrator determined there was “insufficient
evidence” to find that Rafipoor intended to deceive the Franchisees. Flores does not
stand for the proposition that all those who take action that furthers another’s
intentional wrongdoing come within Section 533 regardless of the person’s intent in
41 so acting. Rather, Flores supports the unremarkable proposition that one who
intends to accomplish a criminal act may be subject to Section 533.
Pira is of even less assistance to Stratford. In Pira, the insured orchestrated
the shooting of a person whom he was indebted to, though the insured did not
himself fire the gun. 2013 WL 1703381, at *1. After the victim obtained a judgment
against the insured, the insurer brought an action seeking a declaration that it
owed no duty to defend or indemnify its insured for his conduct. See id. at *4. The
court, however, did not reach the issue of whether Section 533 or any intentional
acts exclusion applied to bar coverage. See id. at *11-12. Rather, the court found
that no duty to defend or indemnify arose because the relevant policies only covered
“accidents,” and the shooting was not an accident. Id. at *11. Therefore, Pira does
not support Stratford’s contention that the Intentional Acts Exclusion or Section
533 preclude coverage of Rafipoor’s liability.
Stratford also quotes language from the CFIL, which states that one who
“materially aids” in another’s CFIL violation is “jointly and severally liable with and
to the same extent as” the person whose actions violated the CFIL. Cal. Corp. Code
§ 31302. To the extent Stratford intends to argue that the “same extent” language
makes Rafipoor’s conduct willful or otherwise imputes MRFranchise’s willful
violation to Rafipoor, that argument fails. Courts have characterized Section 31302
as a “secondary liability provision[ ]” that allows a victim of a CFIL violation to hold
those who materially aid a company’s CFIL liable “where the primary offender is
insolvent or otherwise unavailable.” Courtney v. Waring, 237 Cal. Rptr. 233, 236-37
42 (Ct. App. 1987) (quotation omitted). The statute does not impute MRFranchise’s
intent to Rafipoor; it merely makes Rafipoor liable for the damages flowing from
MRFranchise’s willful CFIL violation.
Ultimately, the arbitrator did not find that Rafipoor committed willful,
intentional, or knowing misconduct. Therefore, there is no genuine dispute as to
whether coverage of Rafipoor’s liability is precluded by the Intentional Acts
Exclusion or Section 533. Plaintiffs are entitled to summary judgment as to the non-
applicability of the Intentional Act Exclusion to Rafipoor.
CONCLUSION
Stratford’s motion for summary judgment (doc. no. 29) is denied. Plaintiffs’
cross-motion for summary judgment (doc. no. 28) is granted in part and denied in
part. Plaintiffs’ cross-motion is granted as to the Contract Exclusion, Prof. Services
Exclusion, and the Intentional Acts Exclusion. Plaintiffs’ cross-motion is denied as
to the Prior Notice Exclusion.
This case shall be placed back on the trial docket.
SO ORDERED.
__________________________ Landya McCafferty United States District Judge November 1, 2024
cc: Counsel of Record
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Cite This Page — Counsel Stack
2024 DNH 093, Counsel Stack Legal Research, https://law.counselstack.com/opinion/mrfranchise-inc-mike-rafipoor-v-p-stratford-insurance-company-nhd-2024.