Insurers File Brief in Corporate Governance Case

July 29, 2003

The Alliance of American Insurers and several other insurance trade associations have reportedly filed a letter brief asking the California Court of Appeal to take up a corporate governance case that could have wide-ranging implications for mutual insurers in terms of their decisions to declare dividends or retain earnings.

The case, Hill, et al. v. State Farm, is a countrywide class action that seeks distribution of State Farm’s “excess surplus” to the approximately 50 million members of the class.

It was filed in 1999 by a group of past and present policyholders who claim a breach of duty by State Farm’s board of directors for failing to declare policyholder dividends. The plaintiffs contend that State Farm has accumulated surplus beyond that which is “reasonably and prudently” necessary, and seek to compel the company to distribute as much as $47 billion in “excess surplus” to class members (State Farm’s current surplus is $31 billion).

Of the approximately 50 million present and past State Farm policyholders included in the class, approximately 45 million, or 90 percent, reportedly neither reside in, nor have any contact with, the State of California.

“This case has broad ramifications for the insurance industry, particularly mutual insurance companies,” said Joyce Kraeger, an Alliance attorney who helped author the brief. “A finding for the plaintiffs in this case could jeopardize State Farm’s financial viability, and, by taking the authority for declaring a policyholders’ dividend out of the hands of company management, put the financial health of every other mutual insurer at risk.”

At issue in the appeal is whether the principles of contract or corporation law should apply in the case and whether California or Illinois law should take precedence. A trial court rejected State Farm’s motion that principles of corporation law, namely the “internal affairs doctrine,” applied to dividend declaration, rather than contract law, and that Illinois law should be the controlling factor since that is where State Farm is incorporated. Instead, the trial court ruled that it would apply California contract law to all policyholders, even those who reside in other states and have no connection with California.

The insurance industry’s letter brief in support of State Farm asks the California Appeals Court, Second Appellate District, to intervene in the case and reverse the trial court’s ruling regarding choice of law. In the brief, the amici urge the court that immediate review is warranted for the following reasons:

·The issue of what law applies is fundamental to the case;

·The issues are of significant importance to the public nationwide since the trial court’s rulings could jeopardize the continued viability of one of the country’s leading insurers;

·The trial court’s ruling with respect to a nationwide class raises serious constitutional questions;

·The trial court’s order conflicts with the appellate court’s prior written opinion holding that the business judgment rule is the appropriate legal standard in the case;

·The trial court’s order violates recognized and established corporation law in that it rejects the deeply entrenched internal affairs doctrine, which recognizes that a corporation’s internal affairs should be judged by the laws of the state with which the corporation has the most significant contacts.

Joining the Alliance in the brief is the American Insurance Association and the National Association of Independent Insurers.

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