Federal Court Upholds Removal Based on Fraudulent Joinder of Non-Insurer Defendants

In a win for Wiley’s client, a federal district court applying California and federal law denied an insured’s motion to remand coverage litigation back to state court, holding that non-insurer defendants cannot be held liable for breach of contract or bad faith under an insurance policy and therefore were fraudulently joined to destroy diversity. FullStory, Inc. v. North Am. Capacity Ins. Co., No. CV 22-7344-GW-ASx (C.D. Cal. Jan. 6, 2023).

The insured, a software company, was sued by consumers in relation to keystroke recording software it created and sold to online retailers to monitor consumers. The company requested coverage for the lawsuits and the ultimate settlements under a cyber policy, which contained a quota share provision allocating payment responsibility between the two participating insurers. The insurers denied coverage for the lawsuits, and the insured filed coverage litigation in state court in California against the insurers, the policy’s producer, and the producer’s parent company. The insurer defendants removed the case to federal court, alleging fraudulent joinder of the producer and its parent company. The insured moved to remand on the basis that the producer is a non-diverse defendant and its parent company is a citizen of California, which it argued destroyed federal diversity jurisdiction.

The insured argued that the producer and its parent company were not fraudulently joined because the producer signed the policy and the policy included attached marketing materials for both entities. According to the insured, this made the producer and its parent company parties to the policy and made them jointly and severally liable for the insured’s claim for coverage. The court rejected this argument and ruled in favor of the defendants, holding that neither of the non-insurer defendants could be held liable under the policy because the parent company was not a signatory to the contract, neither the producer nor the parent company were listed as “insurers” under the policy’s quota share provision, and neither of the entities received a premium payment in exchange for insurance coverage under the policy. Rather, the court held, the producer and its parent company were “not parties to the insurance agreement such that they can be liable for the alleged claims of breach of contract or the covenant of good faith and fair dealing.” The court ordered that the matter move forward in federal court.