What happens when a condominium or homeowners association enters into a settlement agreement with an insurance company and later finds out that the settlement was not enough or was fraudulently induced? That is exactly what happened in California in the case of Village Northridge Homeowners Ass’n v. State Farm Fire and Cas. Co., 237 P.3d 598 (Cal. 2010).

Village Northridge Homeowners Association entered into a settlement agreement with its insurance company for $1.5 million for earthquake damage, based on representations from the insurance company that the insurance policy only provided $4.9 million worth of coverage. The settlement agreement expressly stated that the association could not bring suit against the insurance company for any issue related to the earthquake damage after the settlement. The association later learned that the policy actually provided $11.9 million worth of coverage, and filed suit against the insurance company for fraudulent inducement into the settlement agreement.

The problem with the homeowners association’s lawsuit for fraudulent inducement was the settlement agreement expressly prohibited it from filing a lawsuit against the insurance company. The trial court told the homeowners association that it would have to return the $1.5 million in settlement funds if it wanted to proceed on the lawsuit for fraudulent inducement, but the appellate court reversed the trial court’s ruling. The California Supreme Court sided with the trial court and told the association it would have to return the $1.5 million it received in settlement benefits if it wished to pursue its case for fraudulent inducement.

The homeowners association would have to return the money because of the legal doctrine of rescission. The dictionary defines rescission as the act of taking back or canceling. Often coupled with the word rescission, is the word restitution. Restitution is the act of restoring something to its rightful owner. In the context of contract law, this means canceling the contract and putting the parties back into the positions they occupied before the contract was entered into, which includes repaying any money that was paid in consideration for the contract.

In the Northridge Homeowners case, this meant that the homeowners association would have to choose between keeping the $1.5 million in settlement money and foregoing its suit for fraudulent inducement, or returning the $1.5 million to the insurance company so it could file suit. This California decision was based on several factors, including the language in the settlement contract, California case law, and California statutes. While the outcome of similar facts may vary depending on the jurisdiction, the same result may occur in areas outside of California based on the common law doctrines of rescission and restitution.