A provision of California’s Insurance Code (Section 533.5) arms the state’s attorney general with the power to bar insurers from complying with their contractual duty to defend companies sued under California’s Unfair Competition Law (UCL) or False Advertising Law (FAL). Section 533.5 stacks the deck against every such defendant by preventing it from using funds legally purchased under director and officer (“D&O”) liability insurance policies for litigation fees and/​or settlements. Moreover, California’s attorney general doesn’t need any evidence, probable cause, reasonable suspicion, or hearing to trigger Section 533.5.

This is what happened when the state sued Adir International and then told its insurer, Starr Indemnity & Liability Co., that paying Adir’s legal fees under its contracted insurance policy violated state law. Adir immediately filed suit to challenge the constitutionality of Section 533.5 and enforce its policy with Starr. The legal issue is whether the Due Process Clause of the Fourteenth Amendment permits a state to prohibit private parties from using untainted funds, such as otherwise lawful insurance, to defend themselves against lawsuits, without providing a hearing or requiring any evidentiary showing of wrongdoing.

The U.S. Court of Appeals for the Ninth Circuit agreed with the district court that Section 533.5 wasn’t so extreme as to deprive Adir of its constitutional rights because it could still retain counsel using its own funds. The court reasoned that, in the civil context, courts have limited the reach of the Due Process Clause to cases in which the government has actively prevented hiring or communicating with counsel. Thus the Ninth Circuit reject Adir’s constitutional challenge.

Cato and the National Civil Liberties Alliance have now filed an amicus brief supporting Adir’s request that the Supreme Court hear its case. First, the Ninth Circuit’s opinion runs contrary to their Supreme Court’s landmark decision in Ex Parte Young decision and other lower-court precedent. Ex Parte Young is famous for holding that due process doesn’t permit states to shield their laws from judicial review by passing legislation that makes mounting a defense in court near impossible. In the modern world, corporations heavily rely on legal insurance to protect their directors’ and officers’ actions from bankrupting the company. If the Court doesn’t hold Section 533.5 unconstitutional, California will be able to bankrupt businesses at will by suing them and imposing legal costs that they otherwise insure against. The Ninth Circuit’s opinion also interferes with defendants’ right to counsel by denying the quality of legal defense they buy to defend themselves against potential litigation. The right to counsel includes the right to spend money to hedge and insure against losses, and to mount the legal defense of choice.

In short, the Supreme Court should review and reverse the Ninth Circuit (yet again) to preserve the enforcement of contractual obligations and protect the right to counsel.