SUPREME COURT OF ARIZONA
En Banc
AMERICAN PEPPER SUPPLY COMPANY, ) Arizona Supreme Court
) No. CV-03-0290-PR
Plaintiff-Appellant, )
Cross-Appellee, ) Court of Appeals
) Division One
v. ) No. 1 CA-CV 00-0549
)
FEDERAL INSURANCE COMPANY, ) Maricopa County
) Superior Court
Defendant-Appellee, ) No. CV 98-004028
Cross-Appellant. )
_________________________________ ) O P I N I O N
Appeal from the Superior Court in Maricopa County
The Honorable Barry C. Schneider, Judge
REVERSED AND REMANDED
Court of Appeals, Division One
Memorandum Decision (filed Jul. 24, 2003)
REVIEW DISMISSED
Opinion of the Court of Appeals, Division One
205 Ariz. 465, 72 P.3d 1284 (App. 2003)
VACATED IN PART
HERMAN, GOLDSTEIN & FORSYTH, P.C. Phoenix
by Keith B. Forsyth
and Evan S. Goldstein
Attorneys for Plaintiff-Appellant, Cross-Appellee
SANDERS & PARKS, P.C. Phoenix
by Robert J. Bruno
and Mark R. Gilling
Attorneys for Defendant-Appellee, Cross-Appellant
HUMPHREY & PETERSEN, P.C. Phoenix
by Andrew J. Petersen
Attorneys for Amicus Curiae
The Arizona Association of Defense Counsel
B E R C H, Justice
¶1 We granted review to determine the appropriate burden
for proving an insurer’s policy defense of concealment or
misrepresentation. We have jurisdiction pursuant to Article 6,
Section 5(3) of the Arizona Constitution, and Arizona Revised
Statutes (“A.R.S.”) section 12-120.24 (2003).
BACKGROUND
¶2 On Tuesday, August 27, 1996, American Pepper Supply
Company reported to its insurer, Federal Insurance Company, a
theft of equipment left outside its building during the
preceding weekend. Within three weeks of American Pepper’s
initial report of the loss, Federal’s investigation revealed
facts and inconsistencies that rendered American Pepper’s claim
“suspicious”: (1) the equipment, which American Pepper claimed
had a replacement value of more than $87,000, was left in an
unfenced and unguarded area; (2) the equipment stolen was no
longer used in American Pepper’s business; (3) there were
inconsistencies between American Pepper’s initial reports and
later reports to both the insurance company and the police as to
the equipment reportedly stolen;1 (4) American Pepper wanted to
settle the claim quickly for two-thirds of the value of the
equipment; and (5) American Pepper was not forthcoming regarding
1
For example, American Pepper initially reported that 600
galvanized steel meat hooks were stolen, but revised the number
and quality to 3000 stainless steal meat hooks.
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details of the acquisition of the equipment. Federal therefore
turned the claim over to its special investigation unit.
¶3 The investigation revealed that, contrary to American
Pepper’s initial reports that the equipment had been left on the
ground outside its building, employees had actually left the
equipment in a scrap metal salvage bin, which was discovered
empty on Monday, August 26. When confronted with the
discrepancy, American Pepper’s general manager claimed that the
equipment had been stolen out of the bin, and that the bin was
empty when National Metals, a metal recycler, picked up the bin
on Tuesday, the day American Pepper reported the claim to
Federal. But further investigation revealed that when National
Metals picked up the bin on Tuesday, it contained more than four
tons of material.
¶4 On November 19, 1997, Federal sent a letter formally
denying American Pepper’s claim on the grounds that the
investigation revealed “that [the equipment reported stolen] was
sold for scrap metal” and that American Pepper “concealed or
misrepresented material facts in the claim presentment process.”
Federal concluded that the claim was “not covered due to the
misrepresentation/concealment provisions of the policy and under
the law.”2 Despite the denial of coverage, Federal invited
2
The concealment or misrepresentation provision states that
“[t]his insurance is void if you or any other insured
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American Pepper to submit for review and consideration any
information “that has not been made available to us that would
have a bearing on [Federal’s coverage] decision.”
¶5 Rather than submitting further information, American
Pepper sued Federal, alleging breach of contract and bad faith.
American Pepper asserted that the equipment had been stolen and
that its employees had refilled the bin on Monday, after
American Pepper discovered the theft. Federal defended by
asserting that American Pepper had not suffered a compensable
loss and that American Pepper’s representatives had concealed or
misrepresented material facts concerning the theft of the
equipment, thereby precluding coverage pursuant to the
concealment or misrepresentation policy exclusion.
¶6 After being instructed by the trial court that Federal
had to prove the policy defense of concealment or
misrepresentation by “clear and convincing” evidence, the jury
found in favor of American Pepper and awarded $15,000. The
court of appeals affirmed, concluding that Federal’s defense was
comparable to a claim of fraud and thus should be proved by
clear and convincing evidence. Am. Pepper Supply Co. v. Fed.
Ins. Co., 205 Ariz. 465, 469-70, ¶ 18, 72 P.3d 1284, 1288-89
(App. 2003). We granted review to determine the appropriate
intentionally conceals or misrepresents any material fact or
circumstance relating to this insurance at any time.”
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burden by which an insurer must prove its policy defense of
concealment or misrepresentation.
DISCUSSION
¶7 Federal argues that the trial court erred by
instructing the jury that Federal had to prove its policy
defense of concealment or misrepresentation by clear and
convincing evidence rather than merely by a preponderance of the
evidence. To warrant reversal, the jury instruction must have
been not only erroneous, but “prejudicial to the substantial
rights of the appealing party.” Gemstar Ltd. v. Ernst & Young,
185 Ariz. 493, 504, 917 P.2d 222, 233 (1996) (quoting Walters v.
First Fed. Sav. & Loan Ass’n of Phoenix, 131 Ariz. 321, 326, 641
P.2d 235, 240 (1982)).
¶8 The appropriate burden of proof is a question of law,
which this court reviews de novo. See Nielson v. Patterson, 204
Ariz. 530, 531, ¶ 5, 65 P.3d 911, 912 (2003) (approving de novo
review of legal issues). Although a few jurisdictions require
that exclusions from coverage be proved by clear and convincing
evidence, the burden of proving insurance policy exclusionary
provisions is usually a “preponderance of the evidence.” Lee R.
Russ & Thomas F. Segalla, 17 Couch on Insurance § 254:14 (3d ed.
2003) [hereinafter “Couch”]; compare Rego v. Conn. Ins.
Placement Facility, 593 A.2d 491, 494-95 (Conn. 1991) (following
the majority of courts and commentators suggesting that insurers
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must prove policy defenses by a preponderance of the evidence),
with Am. Family Mut. Ins. Co. v. Schley, 978 F. Supp. 870, 874-
75 (E.D. Wis. 1997) (applying Wisconsin law, which requires that
an insurer prove the policy defense of misrepresentation “by
clear, satisfactory and convincing evidence”).
¶9 By requiring clear and convincing proof in this case,
the trial court and court of appeals adopted the minority
approach. In doing so, the court of appeals analogized
Federal’s defense to a charge of common-law fraud. Am. Pepper
Supply Co., 205 Ariz. at 469, ¶¶ 14, 16, 72 P.3d at 1288.
Observing that allegations of concealment or misrepresentation
implicitly charge the maker with “deceitful” conduct, the court
reasoned that such allegations may harm an individual’s
reputation in the same way that allegations of fraudulent
conduct do. Id. ¶ 15. The court of appeals therefore concluded
that it should require the defendant to meet the heavier burden
of proving clear and convincing evidence to help prevent
unwarranted harms to insureds’ reputations caused by insurance
policy defenses sounding in fraud. Id. ¶ 14 (citing Wells Fargo
Bank v. Ariz. Laborers, Teamsters & Cement Masons Local No. 395
Pension Trust Fund, 201 Ariz. 474, 498 n.24, ¶ 98, 38 P.3d 12,
36 n.24 (2002)).
¶10 Such reasoning comports with the notion that “[t]he
degree of proof should generally correspond to the elements
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required to be proved before the insurer escapes liability. The
closer the elements come to intentional wrongdoing, the stricter
the degree of proof is likely to be.” 17 Couch, supra ¶ 8, §
254:94 (second “Observation”).
¶11 Arizona has adopted this approach. As explained in
State v. Renforth, 155 Ariz. 385, 387, 746 P.2d 1315, 1317 (App.
1987), burdens of proof correlate positively with the
significance of the interests at stake. In a criminal case, for
example, the state must prove guilt beyond a reasonable doubt, a
heavy burden rooted in the belief that “it is far worse to
convict an innocent [person] than to let a guilty [person] go
free.” Id. (quoting In re Winship, 397 U.S. 358, 373 (1970)).
The clear and convincing burden imposed on fraud claims
similarly stems from the societal importance of an untarnished
reputation. Id. (citing Addington v. Texas, 441 U.S. 418, 424
(1979)). In a non-fraud civil case, however, an erroneous
verdict for either party is no less unjust for one party than it
would be if it were rendered for the opposing party. Id.
(quoting In re Winship, 397 U.S. at 372). For that reason,
civil claims generally need be established only by a
preponderance of the evidence.
¶12 American Pepper cites several cases in support of its
argument that a higher burden is appropriate when a defense
sounds in fraud. See Sunseri v. Katz, 53 Ariz. 234, 87 P.2d 797
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(1939) (addressing suit to rescind a deed because of incapacity
or fraud); Cole v. Town of Miami, 52 Ariz. 488, 83 P.2d 997
(1938) (addressing the Industrial Commission’s alleged
concealment of a worker’s health condition in a worker’s
compensation case); Kingsbury v. Christy, 21 Ariz. 559, 192 P.
1114 (1920) (addressing fraudulent transfers in a
debtor/creditor dispute); Hall v. Warren, 5 Ariz. 127, 48 P. 214
(1897) (same); Rhoads v. Harvey Publ’ns, Inc., 145 Ariz. 142,
700 P.2d 840 (App. 1984) (addressing a claim sounding in tort
resulting from an employment relationship); Pinnacle Peak
Developers v. TRW Inv. Corp., 129 Ariz. 385, 631 P.2d 540 (App.
1980) (addressing whether the parol evidence rule bars evidence
of fraud in the inducement); Universal Inv. Co. v. Sahara Motor
Inn, Inc., 127 Ariz. 213, 619 P.2d 485 (App. 1980) (addressing a
claim to rescind a real estate contract on the basis of
fraudulent concealment of a material defect); Douglas v.
Vancouver Plywood Co., 16 Ariz. App. 364, 493 P.2d 531 (1972)
(addressing formation of a real estate contract); Ulan v.
Richtars, 8 Ariz. App. 351, 446 P.2d 255 (1968) (addressing a
claim sounding in tort resulting from a real estate
transaction). But none of these cases analyzes the distinction
between the common law tort of fraud, for which a heavier burden
of proof is usually imposed, and explicit contractual
undertakings not to conceal or misrepresent, which are usually
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proved by a preponderance of the evidence. None therefore
provides a persuasive rationale for imposing the heavier burden
in the insurance context.
¶13 Although we agree that allegations of concealment or
misrepresentation, like allegations of fraud, may harm an
insured’s reputation, several countervailing concerns persuade
us that for insurance contract defenses, the preponderance of
the evidence standard properly balances the parties’ and
society’s interests. First is ease of application. Applying an
identical preponderance burden of proof for both the insured in
establishing coverage and the insurer in establishing a contract
defense will reduce juror confusion. This is especially true in
a case like this one, in which the insurer’s defense is simply
the flip-side of the plaintiff’s claim. A jury will more easily
comprehend that the plaintiff-insured must prove “theft” and the
defendant-insurer must prove “not theft” by the same legal
standard.
¶14 Applying the same burden of proof to all contract
defenses an insurer raises also simplifies the analyses for the
jury. An insurer will often pursue in the same case several
related policy exclusions, such as arson, dishonesty, and
concealment or misrepresentation. See, e.g., Rego, 593 A.2d at
491; Am. Family Mut. Ins. Co., 978 F. Supp. at 874-75, 877. The
distinction between “dishonesty” and “concealment or
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misrepresentation” seems elusive at best and certainly is not
one that supports the imposition of different burdens. Thus to
require different burdens to establish them is unwarranted.3 As
another court succinctly explained, to require different burdens
of proof for dishonesty, arson, and concealment or
misrepresentation is “illogical and impractical.” Rego, 593
A.2d at 494.
¶15 Second, we rely upon the inherent difference between
the common-law tort of fraud, which is traditionally required to
be established by clear and convincing evidence, and the
contract defenses of concealment and misrepresentation, which
most states require be proved by a preponderance of the
evidence. In the former, a plaintiff sues for his justifiable
reliance on a material misrepresentation by a defendant. In a
contract defense case, however, it is the plaintiff himself who
is charged with making the false statement — after having
contractually obligated himself not to make such statements.
3
The court of appeals suggested that imposing a lower burden
for concealment or misrepresentation would create an
inconsistency between the standard for determining “dishonesty”
and the standard for determining “concealment or
misrepresentation.” Am. Pepper Supply Co., 205 Ariz. at 469, ¶
17, 72 P.3d at 1288. Couch suggests, however, that dishonesty
exclusionary provisions are subject to a preponderance burden.
10 Couch, supra ¶ 8, § 149:56 (stating that generally all
affirmative defenses are subject to a preponderance of the
evidence burden). Because no dishonesty provision is at issue
in this case, we reserve for another day the determination of
the proper burden for proving that defense.
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Indeed most insurance contracts affirmatively require insureds
to deal fairly and in good faith with the insurer. In short,
the societal concerns that support the imposition of the clear
and convincing burden in common-law fraud cases do not support
the imposition of the same burden with respect to contract
defenses.
¶16 Third, applying the preponderance of the evidence
burden to a concealment or misrepresentation defense comports
with sound reason and is supported by major commentators in the
field. See, e.g., 22A Appleman, Insurance Law and Practice §
14062 (J. Appleman ed. 1979) (proposing a jury instruction for
fraud in the context of insurance litigation using a
preponderance of the evidence burden of proof); 10 Couch, supra
¶ 8, § 149:56 (stating that generally all affirmative defenses
are subject to a preponderance of the evidence burden). Indeed,
our own court of appeals has held that the defense of arson,
which by its nature may impute fraudulent representations to the
insured, must be proved only by a preponderance of the evidence.
Godwin v. Farmers Ins. Co. of Am., 129 Ariz. 416, 418-20, 631
P.2d 571, 573-75 (App. 1981).
¶17 Finally, although it is a minor consideration, we note
that adopting the preponderance burden puts Arizona in the solid
mainstream of jurisdictions that have decided this issue. See
Rego, 593 A.2d at 494-95 (following the majority of courts and
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commentators suggesting that insurers must prove policy defenses
by a preponderance of the evidence); accord 17 Couch, supra ¶ 8,
§ 254:14. Although joining the majority is not, by itself,
reason for adopting a preponderance burden of proof, there is
value in applying a uniform and consistent standard to
commercial transactions.
¶18 We recognize that important interests motivate both
insureds and insurers: insureds wish to recover for legitimate
claims and insurers wish to avoid paying invalid ones. While we
do not want to encourage insureds to submit fraudulent claims,
we also do not want to make it easier for insurers to reject
valid claims. The tort of bad faith, however, protects the
insured’s interests against abuse in the latter case. Given
these legitimate interests and the remedy in place for abuse by
insurers, we conclude that an equally applied preponderance
burden is appropriate to properly balance the competing
concerns.
¶19 Although plaintiffs worry that insurers will escape
payment too easily, we do not see that application of the
preponderance burden of proof has resulted in harmful
consequences when applied to related contract defenses. In
Godwin, 129 Ariz. at 418-20, 631 P.2d at 573-75, for example,
the court of appeals applied the preponderance burden to the
contract defense of arson, which, like the defense of
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concealment or misrepresentation, often involves the insured’s
concealment or misrepresentation of the true cause of the fire.
In the nearly quarter century since that decision, we have seen
no evidence that the application of the preponderance standard
has led to a flood of denied claims or an onslaught of
litigation.
¶20 Therefore, because we find that the integrity of jury
deliberations outweighs the negligible potential for
reputational harms and the equities are appropriately balanced
by an equal burden, we conclude that the trial court erred by
instructing the jury that Federal had to prove the contract
defense of concealment or misrepresentation by clear and
convincing evidence. The burden of proving a concealment or
misrepresentation exclusion is met by convincing a jury, by a
preponderance of the evidence, that the insured has materially
misrepresented its claim or concealed evidence that would permit
a fair resolution of its claim.
¶21 Having concluded that the jury instruction requiring
proof of the contract defense by clear and convincing evidence
was erroneous, we must now determine whether that error
prejudiced Federal’s substantial interests. See Gemstar Ltd.,
185 Ariz. at 504, 917 P.2d at 231. In this case, the jury found
that American Pepper established its breach of contract claim by
a preponderance of the evidence, but did not find that Federal
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proved concealment or misrepresentation by clear and convincing
evidence. We cannot say that the jury might not have found
concealment or misrepresentation by a preponderance of the
evidence had it been properly instructed. For that reason we
conclude that the erroneous jury instruction did prejudice
Federal and a new trial is therefore required.
CONCLUSION
¶22 The proper burden of proof applicable to a policy
defense of concealment or misrepresentation is proof by a
preponderance of the evidence. We therefore reverse the
judgment on the breach of contract claim and vacate that portion
of the court of appeals opinion addressing the burden of proof.
We further remand American Pepper’s breach of contract claim to
the trial court for a new trial.4
__________________________________
Rebecca White Berch, Justice
CONCURRING:
_________________________________________
Charles E. Jones, Chief Justice
_________________________________________
Ruth V. McGregor, Vice Chief Justice
_________________________________________
Michael D. Ryan, Justice
_________________________________________
Andrew D. Hurwitz, Justice
4
The court of appeals opinion addressed another issue that
was not the subject of this petition for review.
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