Filed 4/29/14 Certain Underwriters at Lloyd’s London v. Mestmaker CA5




                  NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for
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              IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

                                       FIFTH APPELLATE DISTRICT

CERTAIN UNDERWRITERS AT LLOYD’S
LONDON,                                                                                    F066016

         Plaintiff and Respondent,                                      (Super. Ct. No. S-1500-CV-258541)

                   v.
                                                                                         OPINION
THOMAS MESTMAKER, et al.,

         Defendants and Appellants.



         APPEAL from a judgment of the Superior Court of Kern County. David R.
Lampe, Judge.
         Thomas Anton & Associates and Gina M. Cervantes for Defendants and
Appellants.
         Jampol Zimet, Alan R. Jampol, Marcus M. Dong, and Steven J. Markowitz for
Plaintiff and Respondent.
                                                        -ooOoo-
         Certain Underwriters at Lloyd’s London (Underwriters) brought this declaratory
relief action against its insured on an “Insurance Brokers and Agents Errors &
Omissions” policy, Thomas Mestmaker & Associates, Inc. (TMA), and TMA’s president,
Thomas Mestmaker (Mestmaker) (collectively appellants). Underwriters sought a
determination that it did not have a duty to continue defending appellants in an
underlying lawsuit brought against appellants in a Colorado federal court. This action
was stayed pending resolution of the Colorado action, which ultimately was resolved in
appellants’ favor. Appellants thereafter filed a cross-complaint in this action against
Underwriters for bad faith.
       Following a court trial on their competing claims, the trial court found for
Underwriters in the declaratory relief action, specifically finding that: the policy did not
cover the claims in the Colorado action and there was never any potential for coverage
under the policy; Underwriters had no obligation to indemnify appellants or provide them
a defense; Underwriters properly and timely reserved their rights at the outset of the
claim to deny coverage, withdraw the defense and seek restitution of all fees and costs
they paid in defense of appellants; and Underwriters was not estopped to assert, and did
not waive, their right to seek restitution. The trial court awarded Underwriters all of the
amounts it paid to defend appellants in the Colorado action, along with prejudgment
interest. The trial court found in Underwriters’ favor on the cross-complaint.
       On appeal, appellants challenge only the judgment entered on the declaratory
relief action. Appellants contend the trial court (1) erroneously determined there was no
potential for coverage and therefore no duty to defend, and (2) abused its discretion in
determining Underwriters was not estopped from denying coverage. As we shall explain,
we agree with the first contention and conclude that Underwriters is only entitled to
recover defense costs prospectively. Accordingly, we reverse the judgment on that claim
and remand for a determination of the defense costs to which Underwriters is entitled.
                  FACTUAL AND PROCEDURAL BACKGROUND
       In 2002, Underwriters issued an “Insurance Brokers and Agents Errors &
Omissions Insurance” policy to TMA (the policy); the policy was effective from
March 15, 2002 to March 15, 2003. As relevant here, the policy states: “The
Underwriters will indemnify the Insured for all sums which the Insured shall become

                                              2.
legally obligated to pay as damages by reason of any negligent act, error or omission
committed or alleged to have been committed by the Insured or by any person for whose
negligent acts, errors or omissions the Insured is legally responsible which arise out of
the conduct of the Insured’s professional activities as Insurance Brokers, Insurance
Agents or General Insurance Agents....”
       In May 2002, AdvantEdge Business Group, LLC (AdvantEdge), sued appellants
and others in the United States District Court for the District of Colorado seeking
injunctive relief and damages based on claims arising out of its purchase of a welfare
benefits program administered by Meridian Benefits, Inc. (Meridian). AdvantEdge
alleged that appellants and other defendants presented the Meridian welfare benefits
program to it and represented throughout the sales process that the Meridian plan was
compliant with all applicable laws including ERISA and state insurance laws, included
stop-loss coverage and reinsurance, and was fully funded. AdvantEdge also alleged that
Meridian in effect acted as an insurer, although it was not licensed as one. In its claim for
professional negligence, AdvantEdge alleged appellants breached their professional
duties by, among other things, presenting a plan to AdvantEdge that did not include stop-
loss or reinsurance coverage, failing to investigate Meridian and the plan’s deficiencies
and administration, and failing to ensure the plan did not violate state insurance laws and
was compliant with the requirements of ERISA (the AdvantEdge lawsuit). The first and
second amended complaints filed in the AdvantEdge lawsuit alleged eight causes of
action against appellants, including professional negligence and breach of fiduciary duty.
       Appellants tendered the AdvantEdge lawsuit to Underwriters for defense and
indemnity. Underwriters retained the services of attorney Alan Jampol to represent
Underwriters in connection with coverage issues under the policy. After reviewing the
policy and first amended complaint, Jampol believed the causes of action for negligence
and breach of fiduciary duty were either covered or potentially covered, while the
remaining causes of action clearly were not covered. Jampol, however, did not know

                                             3.
enough about the nature of Meridian or the precise nature of the services appellants
performed in connection with Meridian’s relationship with AdvantEdge to make a final
coverage determination. In light of the potential risk of a bad faith finding if
Underwriters denied the claim immediately and later were held to have done so
wrongfully, Underwriters elected to provide a defense to appellants in the AdvantEdge
lawsuit subject to a reservation of rights.
       In a July 30, 2002 letter, Jampol advised appellants that Underwriters had accepted
the tender of the defense of AdvantEdge’s claims subject to the policy’s terms, conditions
and provisions. The letter stated that the policy did not cover most of the causes of action
alleged against appellants in the first amended complaint. The letter further stated that,
“[w]hile the reach and scope of the allegations of the First Amended Complaint are not
entirely clear,” if the claims involved appellants’ actions as a managing agent or
managing general agent for Meridian or any other involved company, they were excluded
from coverage. The letter also stated, in pertinent part, as follows: “Underwriters’
acceptance of this tender is also subject to the condition that Underwriters reserve their
rights under the policy as follows:
       “1. The right to continue to conduct an investigation of coverage and, if they so
elect, to ask you for information or conduct an examination under oath pursuant to § 1
under CONDITIONS.
       “2. The right to modify their coverage position, to withdraw the defense tendered
as herein provided, to deny coverage, and to decline to pay any judgment, award or
settlement if additional facts become known to them, either through their own coverage
investigation or otherwise, that demonstrate that the claim against you is not covered or if
such lack of coverage is determined by a court.
       “3. The right to seek a legal determination that the claim is not covered and, if
such a determination is made, to withdraw providing a defense and decline to pay any
judgment, settlement or award.

                                              4.
       “4. The right to seek a reimbursement of any and all sums paid on your behalf by
Underwriters, whether in the form of legal defense costs or indemnity, if and to the extent
any of the claims against you are not covered. . . .”
       Jampol retained the services of Denver attorney Ellis Mayer to defend appellants
in the AdvantEdge lawsuit. During the AdvantEdge lawsuit, Mayer and Underwriters
repeatedly attempted to settle the claim, but were unsuccessful. On April 6, 2007, the
federal district court dismissed the AdvantEdge lawsuit without prejudice for lack of
prosecution by AdvantEdge. AdvantEdge appealed to the Tenth Circuit Court of
Appeals, which affirmed the judgment of dismissal on January 22, 2009.
       On July 29, 2003, the plaintiff in the AdvantEdge lawsuit took Mestmaker’s
deposition. Jampol did not recall precisely when he received the deposition transcript or
reviewed it, but he reviewed it at some point before early 2006. By early 2006, after
reviewing the deposition, as well as appellants’ written discovery responses in the
AdvantEdge lawsuit, Jampol concluded the policy did not cover any of the claims in the
AdvantEdge lawsuit. Since the AdvantEdge lawsuit was far along, Jampol decided to
have Underwriters continue to defend appellants while seeking a declaration they had no
obligation to indemnify or defend appellants.
       Underwriters filed this declaratory relief action on July 6, 2006, in which it alleged
it had no duty to defend or indemnify appellants because the claim reflected in the
complaint in the AdvantEdge lawsuit does not arise out of appellants’ performance of
professional services as an insurance broker, insurance agent, or insurance general agent
and, if appellants were acting as insurance agents, they were doing so as managing
general agents. Underwriters sought a declaration that it had no duty to defend or
indemnify appellants and restitution for the fees and costs paid to defense counsel on
appellants’ behalf in defense of the AdvantEdge lawsuit.
       In September 2006, the trial court granted appellants’ motion to stay the action
pending the resolution of the AdvantEdge lawsuit. The stay was not lifted until July

                                              5.
2009, after the AdvantEdge lawsuit concluded. Appellants thereafter filed a cross-
complaint against Underwriters for bad faith.
       A bench trial commenced on February 6, 2012. Testimony was received from
Mestmaker, Jampol and Mayer. It was shown at trial that Meridian was a third-party
administrator of ERISA programs with reinsurance, not an insurer or an insurance
company, and its plan was not insurance, but instead was an ERISA-compliant self-
funded health care plan. According to Mestmaker, appellants were both “consulting”
with Meridian and were “consulting agent[s]” for Meridian. Mestmaker had a broker’s
license in California, but was not a licensed broker in Colorado. Appellants solicited
brokers to market the Meridian plan.
       After testimony concluded, the parties submitted post-trial briefs and presented
closing arguments to the trial court. The trial court thereafter issued a tentative decision
finding in Underwriters’ favor on the complaint and against appellants on the cross-
complaint. Appellants requested a statement of decision.
       The trial court subsequently issued a statement of decision, in which it made
factual findings and legal conclusions. As pertinent here, the trial court found that (1)
there was no coverage under the policy for the claims asserted in the AdvantEdge lawsuit
because appellants were not transacting insurance with an insurer, as Meridian was not an
insurer and its product was not insurance, (2) there was never a potential for coverage of
the AdvantEdge lawsuit because it was undisputed that appellants were not acting as
insurance brokers or insurance agents and, since Meridian was not an insurer, they were
not transacting insurance, and (3) Underwriters did not waive and were not estopped to
deny coverage or seek restitution of defense fees incurred in the AdvantEdge lawsuit.
The trial court found that Underwriters was entitled to recover defense costs and
prejudgment interest.
       Judgment was entered in Underwriters’ favor in the total amount of $235,958.98,
comprised of $142,557.50 in principal and $89,103.78 in interest through March 9, 2012

                                              6.
and $4,297.70 in interest from March 9, 2012 through June 27, 2012. Underwriters’ was
awarded its costs of suit.
                                      DISCUSSION
       Appellants present two issues for our determination: (1) whether the trial court
erred in finding there was no coverable claim and no duty to defend; and (2) whether the
trial court abused its discretion in finding Underwriters was not estopped from denying
coverage.
       We begin with the coverage issue. The interpretation of an insurance policy is a
pure question of law. (Waller v. Truck Ins. Exchange (1995) 11 Cal.4th 1, 18 (Waller);
Dolan-King v. Rancho Santa Fe Assn. (2000) 81 Cal.App.4th 965, 974.) When
interpreting an insurance policy, the court reviews the policy’s terms under the ordinary
rules of contract interpretation. (Bank of the West v. Superior Court (1992) 2 Cal.4th
1254, 1264 (Bank of the West).) Accordingly, if the policy language is clear and explicit,
it governs. (Ibid.) If the policy terms are in any respect ambiguous or uncertain, the
court must attempt to determine whether coverage is consistent with the insured’s
objectively reasonable expectations. (Bank of the West, supra, 2 Cal.4th at p. 1265.) If
this does not resolve the ambiguity, it must be resolved against the insurer. (Ibid.)
       The words used must be interpreted according to the plain meaning a layman
would ordinarily attach to them. (Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d
800, 807.) “Courts will not adopt a strained or absurd interpretation in order to create an
ambiguity where none exists.” (Ibid.) Moreover, the language must be interpreted in the
context of the policy as a whole, and in the circumstances of that case. It cannot be found
to be ambiguous in the abstract. (Bank of the West, supra, 2 Cal.4th at p. 1265.)
       Here, the policy provides indemnity for damages the insured becomes legally
obligated to pay as a result of any “negligent act, error or omission” committed by the
insured “which arise[s] out of the conduct of the Insured’s professional activities as
Insurance Brokers, Insurance Agents, or General Insurance Agents.” The trial court

                                             7.
found the claims asserted in the AdvantEdge lawsuit were not covered by the policy
because they did not arise out of appellants’ professional activities as insurance brokers,
insurance agents, or general insurance agents, since Meridian was not an insurer, its
product was not insurance, and appellants were not transacting insurance with an insurer
when they acted as a consulting agent for Meridian.
       We agree with Underwriters that the insuring provision is not ambiguous and
therefore is applied according to its plain meaning. (Bank of the West, supra, 2 Cal.4th at
p. 1264.) Appellants assert the terms “Insurance Brokers,” “Insurance Agents” and
“General Insurance Agents” are ambiguous, but fail to explain the ambiguity. While
these terms are not defined in the policy, they are defined in the Insurance Code.
“Insurance” is defined as “a contract whereby one undertakes to indemnify another
against loss, damage, or liability arising from a contingent or unknown event” (§ 22);1
section 23 provides that “[t]he person who undertakes to indemnify another by insurance
is the insurer, and the person indemnified is the insured”; “Insurance agent” is defined as
“a person authorized, by and on behalf of an insurer, to transact all classes of insurance
other than life, disability, or health insurance, on behalf of an admitted insurance
company” (§ 31); “Insurance broker” is defined as “a person who, for compensation and
on behalf of another person, transacts insurance other than life, disability, or health with,
but not on behalf of, an insurer” (§ 33); and section 35 defines “transact” as applied to
insurance as “(a) Solicitation,” “(b) Negotiations preliminary to execution,”
“(c) Execution of a contract of insurance,” and “(d) Transaction of matters subsequent to
execution of the contract and arising out of it.”
       The policy’s meaning is evident on its face. It is an “Insurance Brokers and
Agents Errors and Omissions” policy designed to cover the insured’s activities as an
insurance broker or insurance agent. All of the potentially covered activities of an
       1   Undesignated statutory references are to the Insurance Code.



                                              8.
insurance broker or insurance agent under the policy must involve the transaction of
insurance, as noted in the statutory definitions. An insurance broker or agent transacts
insurance by soliciting, negotiating and executing contracts of insurance, and handling
matters arising from the contract subsequent to its execution.
       It is undisputed that, based on the facts developed during the underlying lawsuit
and trial in this action, appellants’ activities upon which the AdvantEdge lawsuit is based
did not involve the transaction of insurance. Appellants do not contend otherwise.
Instead, they argue there is a question of whether they understood the policy terms
excluded ERISA plans. But the policy is clear that it only covers activities involving
insurance. The issue here is not whether the Meridian plan is an ERISA plan, but that the
plan is not insurance and Meridian is not an insurance company. The claims against
appellants in the AdvantEdge lawsuit, which arise from the marketing and sale of a
product that is not insurance, are simply not covered by the policy.
       The trial court also found there was never any potential for coverage under the
policy. Since the duty to defend is broader than the duty to indemnify, that there
ultimately proved to be no coverage for the claims asserted in the AdvantEdge lawsuit
does not dispose of this question. As summarized by our Supreme Court, “[a]n insurer
must defend its insured against claims that create a potential for indemnity under the
policy. [Citations.] The duty to defend is broader than the duty to indemnify, and it may
apply even in an action where no damages are ultimately awarded. [Citation.] [¶]
Determination of the duty to defend depends, in the first instance, on a comparison
between the allegations of the complaint and the terms of the policy. [Citation.] But the
duty also exists where extrinsic facts known to the insurer suggest that the claim may be
covered. [Citation.] Moreover, that the precise causes of action pled by the third-party
complaint may fall outside policy coverage does not excuse the duty to defend where,
under the facts alleged, reasonably inferable, or otherwise known, the complaint could



                                            9.
fairly be amended to state a covered liability.” (Scottsdale Ins. Co. v. MV Transportation
(2005) 36 Cal.4th 643, 654 (Scottsdale).)
       “The defense duty arises upon tender of a potentially covered claim and lasts until
the underlying lawsuit is concluded, or until it has been shown that there is no potential
for coverage. [Citation.] When the duty, having arisen, is extinguished by a showing
that no claim can in fact be covered, ‘it is extinguished only prospectively and not
retroactively.’” (Scottsdale, supra, 36 Cal.4th at p. 655, citing Buss v. Superior Court
(1997) 16 Cal.4th 35, 46 (Buss).) As explained in Buss, “before, the insurer had a duty to
defend; after, it does not have a duty to defend further.” (Scottsdale, supra, 36 Cal.4th at
p. 657.)
       “On the other hand, ‘in an action wherein none of the claims is even potentially
covered because it does not even possibly embrace any triggering harm of the specified
sort within the policy period caused by an included occurrence, the insurer does not have
a duty to defend. [Citation.] “This freedom is implied in the policy’s language. It rests
on the fact that the insurer has not been paid premiums by the insured for [such] a
defense. . . . [T]he duty to defend is contractual. ‘The insurer has not contracted to pay
defense costs’ for claims that are not even potentially covered.”’” (Scottsdale, supra,
36 Cal.4th at p. 655.)
       The Supreme Court distilled these principles as follows: “If any facts stated or
fairly inferable in the complaint, or otherwise known or discovered by the insurer,
suggest a claim potentially covered by the policy, the insurer’s duty to defend arises and
is not extinguished until the insurer negates all facts suggesting potential coverage. On
the other hand, if, as a matter of law, neither the complaint nor the known extrinsic facts
indicate any basis for potential coverage, the duty to defend does not arise in the first
instance.” (Scottsdale, supra, 36 Cal.4th at p. 655, italics added.)
       “Any doubt as to whether the facts establish the existence of the defense duty must
be resolved in the insured’s favor.” (Montrose Chemical Corp. v. Superior Court (1993)

                                             10.
6 Cal.4th 287, 299–300 (Montrose).) A court may conclude that no duty to defend exists
only where the underlying complaint “‘can by no conceivable theory raise a single issue
which would bring it within the policy coverage.’” (Ibid., quoting Gray v. Zurich
Insurance Co. (1966) 65 Cal.2d 263, 275, fn. 15, italics added in Montrose.) “Facts
merely tending to show that the claim is not covered, or may not be covered, but are
insufficient to eliminate the possibility that resultant damages . . . will fall within the
scope of coverage, therefore add no weight to the scales.” (Montrose, supra, at p. 300.)
       “‘“If a duty to defend arises, the insurer must defend the action in its entirety,
including claims that are not potentially covered.”’” (Sprinkles v. Associated Indemnity
Corp. (2010) 188 Cal.App.4th 69, 77; see also Crawford v. Weather Shield Mfg., Inc.
(2008) 44 Cal.4th 541, 547 [“‘The [insurer’s] defense duty is a continuing one, arising on
tender of defense and lasting until the underlying lawsuit is concluded [citation], or until
it has been shown that there is no potential for coverage....’”].) But in defending so-
called “mixed” third party actions, in which some of the claims are at least potentially
covered and others are not, the insurer is entitled, under a reservation of rights, to recoup
its costs of defense attributable to the claims for which there was no potential for
coverage. (Scottsdale, supra, 36 Cal.4th at p. 658.)
       Until either the third party litigation ends or the insurer “proves, by facts
subsequently developed, that the potential for coverage which previously appeared
cannot possibly materialize, or no longer exists[,] [t]he insurer must absorb all costs it
expended on behalf of its insured while the duty to defend was in effect – i.e., before the
insurer established that the duty had ended.” (Scottsdale, supra, 36 Cal.4th at p. 657.)
       But when the “third party suit never presented any potential for policy coverage,
the duty to defend does not arise in the first instance, and the insurer may properly deny a
defense.” (Scottsdale, supra, 36 Cal.4th at p. 657.) Moreover, “subsequent case law can
establish, in hindsight, that no duty to defend ever existed. ‘If the terms of the policy
provide no potential for coverage, . . . the insurer acts properly in denying a defense even

                                              11.
if that duty is later evaluated under case law that did not exist at the time of the defense
tender.’” (Id. at pp. 657-658, original italics.) Our Supreme Court held in Scottsdale that
these principles also apply where “the insurer does not deny a defense at the outset, but
instead elects to provide one under a reservation of its right to reimbursement. By law
applied in hindsight, courts can determine that no potential for coverage, and thus no duty
to defend, ever existed. If that conclusion is reached, the insurer, having reserved its
right, may recover from its insured the costs it expended to provide a defense which,
under its contract of insurance, it was never obliged to furnish.” (Id. at p. 658.)
       Here, the trial court found Underwriters was entitled to recover its defense costs
from the beginning of its defense of appellants in the AdvantEdge lawsuit because, based
on facts developed during the lawsuit, there was never any potential for coverage of any
claims asserted therein. Whether the trial court was correct depends on whether there
was a potential for coverage when appellants first tendered the AdvantEdge lawsuit to
Underwriters. If there was not a potentially covered claim at that time, then Underwriters
is entitled to recoup all defense costs expended on appellants’ behalf, but if a potential for
coverage on at least one claim existed, then Underwriters is entitled to recover only costs
expended defending those claims that were not potentially covered from the inception of
the AdvantEdge lawsuit and costs expended on the potentially covered claims from the
inception of this declaratory relief action.
       Underwriters concedes that there was a potential for coverage under the policy
when the AdvantEdge lawsuit was first tendered based on the allegations in the first
amended complaint. Underwriters admits in their respondent’s brief that, “[a]t the outset
of the AdvantEdge Lawsuit, the negligence allegations appeared to be at least potentially
covered; however, Underwriters, at the time of the reservation o[f] rights letter, did not
have a complete picture of Appellants’ role with respect to the Meridian Plan.” Jampol
testified to as much at trial, when he explained that the claims for negligence and breach
of fiduciary duty “certainly had a potential for coverage based on the first-amended

                                               12.
complaint.” Appellants assert that, if the allegations in the first amended complaint were
taken as true, there was a potential for coverage, as they were either agents or brokers of
Meridian who were transacting insurance.
       Underwriters nevertheless asserts the trial court correctly found it is entitled to
recover all of its defense costs because the facts Jampol discovered after Underwriters
agreed to provide a defense showed there was never any potential for coverage. Pointing
to the facts developed during the course of the AdvantEdge lawsuit and this action which
show that appellants were acting as marketing or consulting agents for Meridian,
Meridian was not an insurer, and the Meridian plan was not an insurance product,
Underwriters argue there was never any potential for coverage because appellants were
never transacting insurance. Underwriters assert that because they did not know the true
nature of appellants’ relationship to Meridian until the AdvantEdge lawsuit was far along
and they reserved their rights, under Scottsdale they could seek to recoup their fees
because no potential for coverage ever existed.
       Scottsdale does not hold, as Underwriters suggest, that an insurer may recoup all
of its defense costs where, as here, the insurer undertakes the defense of a claim that is
potentially covered based on the factual allegations in the complaint and subsequently
discovers facts that show there never was a potential for coverage. Such a holding would
fly in the face of the “well-established precepts of insurance coverage” by which the
insurer has a duty to defend even “claims that are ‘groundless, false, or fraudulent.’”
(Waller, supra, 11 Cal.4th at p. 19.) While it may be true, as Underwriters asserts, that it
was “always the case” that appellants were marketing agents and the Meridian plan was
not insurance, Underwriters did not discover those facts until after it found a potential for
coverage based on facts alleged in the AdvantEdge complaint. Accordingly, this case is
like those described in Tamrac, Inc. v. California Ins. Guarantee Assn. (1998) 63
Cal.App.4th 751 (Tamrac) “where there was factually a potential for coverage which
imposed the duty to defend, and the insurer subsequently developed facts showing there

                                             13.
was no duty in the particular circumstances. In those situations[,] the insurer’s duty to
defend ceases prospectively from the subsequent determination but not retroactively to
the beginning.” (Id. at p. 758, original italics.)
       What Scottsdale does hold is that when a third party action never presented any
possibility of coverage as a matter of law, the duty to defend never arose and an insurer
who defends the insured under its reservation of rights may recover amounts expended
retroactively in that defense. (Scottsdale, supra, 36 Cal.4th at p. 649.) Thus, in
Scottsdale, there was never a duty to defend as a matter of law where it was ultimately
determined under a California Supreme Court case decided during the pendency of the
insurer’s declaratory relief action that there was no potential coverage for facts alleged in
the underlying complaint. (Scottsdale, supra, 36 Cal.4th at pp. 652-653.) Similarly, in
Tamrac, there was never a potential for coverage nor a duty to defend where the
California Supreme Court issued a decision during the pendency of a coverage dispute
over whether a workers’ compensation insurance carrier has a duty to defend a civil suit
that resolved the legal issue in the insurer’s favor. (Tamrac, supra, 63 Cal.App.4th at pp.
752-753.) In that case, the only potential for coverage turned on a legal question, not a
factual issue. (Id. at p. 758.)
       The present case, however, does not present a situation where an intervening legal
decision resulted in there never being a potential for coverage and therefore never a duty
to defend. Instead, the facts alleged in the first amended complaint created a duty to
defend. It was only when Underwriters discovered the “true” facts that the potential for
coverage ended. Underwriters’ duty to defend was not extinguished until Underwriters
negated all facts suggesting potential coverage, which it did here by proving that the
Meridian plan was not insurance and therefore appellants’ activities in relation to it were
not covered under the policy.
       We agree with Underwriters that the case it relies on, Saylin v. California Ins.
Guarantee Ass’n (1986) 179 Cal.App.3d 256 (Saylin), is almost precisely on point, but

                                              14.
disagree as to its import. As our Supreme Court described that decision in Montrose,
supra, 6 Cal.4th at p. 296, in Saylin, “the third party complaint alleged that the insured
committed tortious acts within the policy period. However, discovery revealed
undisputedly that the insured had in fact done nothing concerning the third party while
the policy was in force. The Court of Appeal noted that had the insurer known these facts
at the outset of the litigation, it would have been justified in denying a defense. Citing
[State Farm Mut. Auto. Ins. Co. v.] Flynt [(1971) 17 Cal.App.3d 538], the court held that
the California Insurance Guarantee Association [(CIGA)], on behalf of the insolvent
insurer, had a duty to determine independently whether the third party claim was covered,
and properly denied a defense on ascertaining the facts. (Saylin[,] supra, 179 Cal.App.3d
at p. 264.).”
       Significantly, Saylin did not hold, or even discuss, whether the insurer or CIGA
was entitled to recover defense costs retroactively. It held only that after CIGA acquired
the insolvent insurer’s obligations, it could independently determine there was no
coverage based on facts developed during the underlying litigation and withdraw from
defending the insured. (Saylin, supra, 179 Cal.App.3d at pp. 260, 264.) Underwriters
urges us to find that their ignorance of the facts when appellants tendered the defense did
not create a potential for coverage. But Saylin shows that a duty to defend arises when
the complaint alleges potentially covered conduct and the insurer is unaware of facts that
show no potential for coverage; in that situation, the duty to defend is not extinguished
until the insurer learns of facts that prove there is no coverage.
       In deciding that there was never a potential for coverage in this case, the trial court
noted that “[a] potential for coverage means that coverage depends upon the resolution
[of] a disputed material fact by the jury in the underlying action[,]” citing Tamrac, supra,
63 Cal.App.4th at p. 758. On appeal, Underwriters argues that because “[t]here were no
facts which could be developed or decided by the trier of fact in the AdvantEdge Lawsuit



                                             15.
which would determine the existence of coverage,” a determination of non-coverage does
not operate only prospectively, citing Scottsdale and that Court’s reliance on Tamrac.
       These cases, however, do not support Underwriters’ assertion.2 In Tamrac, the
appellate court concluded that because insurance coverage and the costs and duties of
defense were not issues that would be determined in the underlying case, a dispute
between the insured and insurer over the duty to defend could be determined after the
underlying suit was finished, and where the potential for coverage turned on the
resolution of a legal, not a factual, question, the insurer could recover all of its defense
costs retroactively. (Tamrac, supra, 63 Cal.App.4th at p. 758.) The Court in Scottsdale
cited Tamrac for its rejection of the insured’s argument “that a determination of
noncoverage operates prospectively only[,]” quoting Tamrac’s distinction between cases
where there was factually a potential for coverage and the insurer subsequently developed
facts showing there was no duty to defend, which terminates the duty to defend only

       2  It appears that Underwriters’ assertion arises from the principle that it may be
necessary to stay an insurer’s declaratory relief action on the issue of the duty to defend
until the resolution of the underlying litigation. As explained in Montrose: “[T]o
eliminate the risk of inconsistent factual determinations that could prejudice the insured,
a stay of the declaratory relief action pending resolution of the third party suit is
appropriate when the coverage question turns on facts to be litigated in the underlying
action. [Citations.] For example, when the third party seeks damages on account of the
insured’s negligence, and the insurer seeks to avoid providing a defense by arguing that
its insured harmed the third party by intentional conduct, the potential that the insurer’s
proof will prejudice its insured in the underlying litigation is obvious. This is the classic
situation in which the declaratory relief action should be stayed. By contrast, when the
coverage question is logically unrelated to the issues of consequence in the underlying
case, the declaratory relief action may properly proceed to judgment. An illustration of
this latter sort of case is found in Flynt, supra, 17 Cal.App.3d 538. There, the question
whether the owner had granted permission for the driver’s use of the car was irrelevant to
the third party’s personal injury claim, and could properly be determined in the
declaratory relief action independently of the timing of the third party suit.” (Montrose,
supra, 6 Cal.4th at pp. 301-302.) Since the present declaratory action was stayed pending
resolution of the AdvantEdge lawsuit, it is irrelevant whether the factual issue here also
arose in that lawsuit.



                                              16.
prospectively, and those where, as a matter of law, there was never a potential for
coverage, which allows the insurer to recoup all of its defense costs. (Scottsdale, supra,
36 Cal.4th at p. 661.) Neither case held that a potential for coverage is determined by
whether there are disputed material facts that the jury must resolve in the underlying
action. Instead, as we have explained, these cases support our conclusion here, namely
that the potential for coverage turned on a factual, not a legal, question that terminated
Underwriters’ duty to defend only prospectively.
       Our conclusion renders it unnecessary to address appellants’ alternate claim that
Underwriters is estopped from denying coverage if it knew there was no coverage when it
first accepted defense of the AdvantEdge lawsuit. “An insurer can be estopped from
raising coverage defenses if, knowing of the grounds of noncoverage, it provides a
defense under the policy without a reservation of rights, and the insured reasonably relies
on this apparently unconditional defense to his detriment. (Miller v. Elite Ins. Co.
[(1980)] 100 Cal.App.3d 739[,] 754-755 [(Miller)].)” (State Farm Fire & Casualty Co.
v. Jioras (1994) 24 Cal.App.4th 1619, 1626, italics added.) We note, however, that there
generally can be no estoppel where, as in this case, the insurer accepts defense under a
reservation of rights. (Miller, supra, 100 Cal.App.3d at p. 755.) Moreover, the trial court
specifically found that Jampol did not know the facts that ultimately would determine no
coverage existed when Underwriters elected to provide a defense.
       In sum, there was a potential for coverage of the negligence claims when the
AdvantEdge lawsuit was first tendered to Underwriter based on the facts alleged in the
first amended complaint. That potential was not extinguished until Underwriters proved
in this litigation that there was no coverage. Accordingly, Underwriters is entitled to
recover all of the costs paid in defense of all claims except for the professional
negligence and breach of fiduciary duty claims to the extent such costs can be allocated,
and to recover defense costs on the negligence claims from the inception of this lawsuit
until the final resolution of the AdvantEdge lawsuit.

                                             17.
                                     DISPOSITION
       The judgment in favor of Underwriters and against appellants is reversed. The
matter is remanded for a determination of the defense costs to which Underwriters is
entitled consistent with this decision. Costs on appeal are awarded to appellants.



                                                                _____________________
                                                                             Gomes, J.
WE CONCUR:


 _____________________
Cornell, Acting P.J.


 _____________________
Peña, J.




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