Ambiguous Instructions from the Ninth Circuit Result in a Potentially Problematic Ruling for Insurers in Allocation Cases
In MW Builders, Inc. v. Safeco Ins. Co. of America, District Court Judge Haggerty held that an insurance company must bear the burden of establishing which portions of an arbitration award were reasonably allocable to covered claims where “circumstances of the underlying action should have compelled the insurer to seek an allocated verdict or advise the insured of the need for one.”
MW Builders, the general contractor for the construction of the Candlewood Suites Hotel in Hillsboro Oregon, tendered the defense to and sought indemnity from subcontractor Portland Plastering and its insurer, Safeco, for claims for water damage caused by faulty work on the hotel’s exterior siding (EIFS). Safeco denied the tender and refused to defend or indemnify MW Builders. MW Builders settled with the hotel owner for $2 million, then filed a separate demand for arbitration against Portland Plastering. Safeco defended Portland Plastering at the arbitration, where the arbitrator determined that Portland Plastering was 31% at fault for the damages sustained by the hotel, awarding MW Builders $620,000 in damages, plus defense costs and attorney fees.
In the subsequent coverage action, the district court initially awarded MW Builders the full $620,000 arbitration award. On appeal, the Ninth Circuit held that Safeco was obligated to provide coverage for damage to the hotel, but not for the costs associated with replacing the EIFS. 267 Fed. Appx. 552, 555 (9th Cir. 2008). Because the arbitration award was not partitioned into costs associated with repair of the EIFS and other damages to the hotel, the Ninth Circuit remanded the issue to the district court for a determination of this issue. Id.
On remand, Magistrate Judge Acosta interpreted the Ninth Circuit’s instructions as requiring him to “calculate what portion of the $620,000 award is attributed to the hotel damage claim, excluding the EIFS repair claim.” Based on information submitted by the parties, the Magistrate Judge issued a Findings and Recommendation that MW Builders was entitled to recover 60% of the arbitration award, or $372,000.
Reviewing MW Builders’ objections to the Findings and Recommendation, the district court held that the Ninth Circuit’s instructions were ambiguous. Instead of relying on the Magistrate Judge’s interpretation of the instructions, the court adopted MW Builders’ proposed alternative interpretation, “that the Ninth Circuit remanded the case ‘for this court to conduct a factual inquiry into the extent of the covered damages sustained by the hotel to ensure that these damages were equal to or greater than $620,000.’”
Relying on this alternative interpretation of the Ninth Circuit’s instructions, the court concluded that the Magistrate Judge’s partition of the arbitration award unfairly rewarded Safeco. While the insured generally bears the burden of establishing what portion of a settlement is reasonably allocable to covered claims, there are exceptions to the rule that will shift the burden to the insurer. Shifting the burden of proof is appropriate where “circumstances in the underlying action should have compelled the insurer to seek an allocated verdict or advise the insured of the need for one, or the insurer failed to adequately apprise the insured of the importance of apportionment.”
The court concluded that this exception applied here, citing Safeco’s refusal to defend MW Builders, which compelled MW Builders to negotiate settlement of the claims against it, and noting, “[d]efendant Safeco subsequently retained counsel to defend Portland Plastering in the subsequent arbitration and neglected to seek an allocation of damages in the resulting Knoll award.”
Having placed the burden on Safeco to prove allocation of the arbitration award, the court relied on its alternate interpretation of the Ninth Circuit’s instructions to hold that Safeco could not meet its burden because “such an apportionment at this point in the litigation is unavoidably and unfairly speculative and arbitrary.” Finding no dispute that the total property damaged incurred by the hotel exceeded $620,000, the court awarded MW Builders the full arbitration award amount.
The MW Builders decision appears alarming at first glance, but its applicability may be limited. The outcome springs from the district court’s conclusion that the Ninth Circuit’s remand instructions were ambiguous. That conclusion allowed the district court to bypass Safeco’s evidence of how the arbitration award should have been allocated because the court had already concluded that the only remaining question was whether the hotel sustained covered damages greater than $620,000. Because of this, the district court’s foray into the question of burden of proof is puzzling, and may constitute mere dicta.
Despite the opinion’s questionable general applicability, the court’s decision does raise questions about burden of proof in allocation cases. The district court’s conclusion that Safeco should bear the burden of proof because it should have sought an allocated verdict or advised the insured of the need for one relies mainly on an unpublished Delaware case, Premier Parks, Inc. v. TIG Ins. Co., C.A. No. 02C-04-126, 2006 Del. Super. LEXIS 383 (September 21, 2006). Assuming that Safeco appeals the decision, the Ninth Circuit could resolve the issue by simply clarifying its instructions and remanding the case again.
