California Supreme Court Limits Insurers’ Duty to Defend and Policyholders’ Coverage for Claims of Disparagement

 Published for the California State Bar Business Litigation Committee’s E-Bulletin  July 8, 2014

Summary:

 In Hartford Casualty Insurance Company v. Swift Distribution, Inc. (June 12, 2014, S207172) 59 Cal.4th 277, the California Supreme Court (in a unanimous opinion by Justice Liu), clarified the scope of an insured’s policy coverage and the insurer’s corresponding duty to defend a claim for disparagement under the personal and advertising injury provision of a commercial general liability policy.  The Court held that a claim of disparagement requires a plaintiff to show a false or misleading statement that (1) specifically refers to the plaintiff’s product or business, and (2) clearly derogates that product or business.  Each requirement must be satisfied by either express mention or clear implication.

 Facts:

Defendant and Appellant, Swift Distribution, Inc., dba Ultimate Support Systems (“Ultimate”) sold a product called the Ulti-Cart, a multi-use cart marketed to help musicians load and transport their equipment.   Plaintiff and Respondent, Hartford Casualty Insurance Company (“Hartford”) issued a commercial general liability policy to Ultimate for the period January 29, 2009 to January 29, 2010.  The Hartford policy included coverage for “personal and advertising injury.”  It defined “personal and advertising injury” as “injury . . . arising out of . . . [o]ral, written or electronic publication of material that slanders or libels a person or organization or disparages a person’s or organization’s goods, products or services;” but specifically excluded coverage for personal or advertising injuries arising out of violations of intellectual property rights.  The Hartford policy stated that “it will pay those sums that the insured becomes legally obligated to pay as damages because of . . . ‘personal and advertising injury’ to which this insurance applies.  It will have the right and duty to defend the insured against any ‘suit’ seeking those damages.  However, [Hartford] will have no duty to defend the insured against any ‘suit’ seeking damages for . . . ‘personal and advertising injury’ to which this insurance does not apply.”  The Hartford policy did not provide a definition for the term “disparages.”

On January 26, 2010, Gary-Michael Dahl (Dahl), the manufacturer of the Multi-Cart, sued Ultimate in federal district court.  The Multi-Cart was a product similar to Ultimate’s Ulti-Cart, and had been sold commercially since 1997.  It was a collapsible cart used to transport music, sound and video equipment.  The Dahl suit included allegations of patent and trademark infringement, false designation of origin, unfair competition, and misleading advertising.  According to the complaint, Ultimate impermissibly manufactured, marketed, and sold the Ulti-Cart, and thereby infringed on Dahl’s patents and trademarks, and diluted the Multi-Cart trademark.  Dahl also alleged that Ultimate’s false and misleading advertisements and use of a “nearly identical mark” were likely to cause consumer confusion or mistake, or to deceive the public “as to the affiliation, connection, or association” of the two parties.  The complaint attached Ultimate’s advertisements, which did not name the Multi-Cart or any other product.

Ultimate tendered the defense of the Dahl suit to Hartford, contending that the Dahl suit involved a claim of disparagement covered by the policy.  Hartford denied coverage and refused to accept the tender.  Hartford asserted that it had no duty to defend or indemnify Ultimate in the Dahl suit, because it found no potential claim of disparagement.  Citing Total Call Internat., Inc. v. Peerless Ins. Co. (2010) 181 Cal.App.4th 161, Hartford’s counsel explained in a letter to Ultimate that there could be no disparagement in the absence of a specific statement about a competitor’s goods.  Furthermore, it relied on the policy’s exclusionary provisions, which denied coverage for personal or advertising injuries arising out of violations of intellectual property rights.

On July 27, 2010, Hartford filed a complaint in Los Angeles County Superior Court (Hon. Debre Katz Weintraub, Judge), seeking a declaratory judgment that it had no duty to defend or indemnify Ultimate in the Dahl action.  While the action was pending, the court in the Dahl action granted Ultimate’s motion for summary adjudication on the claims of patent infringement, and the Dahl action settled.  Hartford and Ultimate each filed motions for summary judgment or, in the alternative, summary adjudication. The superior court granted Hartford’s motion for summary judgment.  Ultimate appealed, and the Second District Court of Appeal affirmed.  The Court of Appeal (in an opinion by Justice Kitching, in which Justices Klein and Croskey concurred) observed that the Dahl action did “not allege that Ultimate’s advertisements specifically referred to Dahl by express mention” and that “Dahl did not allege that Ultimate’s publication disparaged Dahl’s organization, products, goods, or services” by reasonable implication.  The Court of Appeal noted that “Dahl alleged no claim for injurious false statement or disparagement that was potentially within the scope of the Hartford policy coverage for advertising injury,” and, therefore, Hartford had no duty to defend Ultimate in the underlying action.  The Supreme Court granted review of the matter de novo and affirmed the Court of Appeal’s decision.

Reasoning:

 In reaching its decision, the Supreme Court relied upon the language of the Hartford policy and prior case law that explained the common law roots of the tort of disparagement.  The Court noted that the ultimate issue was whether the Dahl action against Ultimate included a claim of disparagement covered by the Hartford policy.  Looking to Division 6 of the Restatement Second of Torts (1977) and California precedent, the Court distinguished disparagement from defamation, and concluded that the term disparagement in the context of an insurance policy should be considered as a common law tort:  “Whereas defamation, which includes libel and slander, concerns damage to the reputation of a person or business, [commercial] disparagement concerns damage to the reputation of products, goods, or services.”  (Hartford, slip op. at 8).   The Court acknowledged the confusion attached to the term disparagement in a commercial context, which is attributable to the fact that commercial disparagement has also been denominated to be claims for injurious falsehood, product disparagement, trade libel, slander of goods, and disparagement of property—all of which describe the same legal claim.

Citing several cases, including Nichols v. Great American Ins. Companies (1985) 169 Cal.App.3d 766 and  Atlantic Mutual Ins. Co. v. J. Lamb, Inc. (2002) 100 Cal.App.4th 1017the Court held that disparagement with respect to commercial liability insurance coverage has been understood to mean a “knowingly false or misleading publication that derogates another’s property or business and results in special damages.” (Hartford, slip op. at 11)  The Court emphasized the “false or misleading statement” element of the tort, noting the requirement that such a statement have a degree of specificity as to the plaintiff.  Therefore, to constitute disparagement, a false or misleading statement must (1) make specific reference to the plaintiff’s product or business, and (2) clearly derogate the product or business, either by express mention or clear implication.  The Court referred to its decision in Blatty v. New York Times Co. (1986) 42 Cal.3d. 1033, where it held that, in order to pass muster under the First Amendment, “all injurious falsehoods must specifically refer to, or be ‘of and concerning,’ the plaintiff in some way.”  The Court reasoned that the “specific reference requirement” is important because it distinguishes and reserves the right of action for disparagement for those who are the direct object of criticism, as opposed to those who merely complain of nonspecific statements they believe have caused them harm.

Although the Court recognized that placing these requirements on disparagement claims would significantly limit the type of statements that could constitute disparagement with respect to advertisements or promotional materials, it noted that other causes of actions would still be available for plaintiffs to pursue in appropriate cases (e.g., patent and trademark infringement, false advertising, or unfair competition).

Applying the above-mentioned rationale, the Court concluded that given the facts and allegations known to, or reasonably inferable by, Hartford at the time of Ultimate’s tender of its defense in the Dahl suit, there was no evidence to suggest a potential claim for express or implied disparagement to trigger a duty to defend.  Ultimate’s advertisements made no specific reference to Dahl’s products, nor did they contain disparaging statements concerning Dahl’s products.

The Court rejected the two theories advanced by Ultimate to support a claim for disparagement in the Dahl suit.  The first theory focused on Dahl’s claim that the similarity between the two companies’ designs and product names led to consumer confusion.  The second theory contended that Ultimate’s advertisements included false statements of superiority, which in turn implied the inferiority of the Dahl product.  (Ultimate’s 2010 catalog included such statements as “superior customer service,” “superior products,” and “patent-pending,” without any mention as to the Multi-Cart or Dahl’s company.)

The Court responded to the first theory by noting that “[a] false or misleading statement that causes consumer confusion, but does not expressly assert or clearly imply the inferiority of the underlying plaintiff’s product, does not constitute disparagement.” (Hartford, slip op. at 21). Furthermore, citing Homedics, Inc. v. Valley Forge Insurance Company (9th Cir. 2003) 315 F.3d 1135, the Court held that there is no coverage for disparagement simply because one party tries to sell another’s goods or products as its own.  Addressing the second theory, the Court held that statements in advertisements that boast the superiority of a product or business, without making specific derogatory reference to another’s product or business by express mention or clear implication are analogous to “mere puffing,” and do not constitute disparagement.

In reaching its decision, the Court expressly disapproved the holding in TravelersProperty Casualty Company of America v. Charlotte Russe Holding, Inc. (2012) 207 Cal.App.4th 969 (Second District, Division 1) due to its departure from the “specificity requirements” with respect to the tort of disparagement.  There, the simple act of a price reduction by retailer, Charlotte Russe, of its exclusively licensed brand, People’s Liberation, was held to constitute disparagement, which triggered coverage and the duty to defend on the part of insurer.  The Supreme Court noted that reducing the price of goods, without more, cannot constitute disparagement.  Although Charlotte Russe’s price reduction specifically related to People’s Liberation products, it could not reasonably be implied to be derogatory, as Charlotte Russe had contended.  Disparagement by reasonable implication requires clear and necessary inference which the act of price reduction alone does not satisfy.

 Author’s Comment:

With this opinion, the Court clarifies the elements for the tort of disparagement and solidifies its specificity requirements, thus limiting coverage and the insurer’s duty to defend under the personal and advertising injury provisions in many CGL policies, which mirror Hartford’s policy language.  What this means is that the policyholder who faces a significant risk of claims of infringement should take the appropriate steps to mitigate against that risk, either by expanding the scope of its own coverage via appropriate endorsements, or by other contractual means, such as obtaining indemnification from suppliers.  On the other hand, business owners claiming to be injured due to a competitor’s advertisement should be mindful of the specific elements required to advance a viable claim for disparagement.

It is also important to note that even though this opinion has a limiting effect on the liability coverage for business owners, it reaffirms, without any equivocation, the breadth and scope of an insurer’s duty to defend its insured.  If there is potential for coverage, the duty exists, even if the evidence may suggest that the loss is not covered.

Practitioners also should note the Court’s analysis of the difference between the torts of “commercial disparagement” (diminishing the reputation of products, goods and services) and “defamation” (diminishing personal or business reputation).  The terms often are used interchangeably, as in “Non-Disparagement Clauses” that are primarily meant to avoid harm to the reputation of a person or business – not products, goods or services.  In commercial reputation issues, we should determine whether the issue is disparagement, defamation, or both.

These materials were prepared for the Business Litigation Committee by Sarvey Askarieh (saskarieh@yevraslaw.com) of Yevras Law Group (YLG), Los Angeles, California.  Editing contributions were provided by BLC members George Cooper Rudolph, Jeffrey Makoff of Valle Makoff LLP, and Peter Bronson.