National Insurance Law Forum : Insurance Litigation Lawyer & Attorney : National Insurance Law Forum : Insurance Coverage, Bad Faith Litigation

Centex asserted that Travelers had a conflict in controlling its defense as Travelers insured both Centex and its named insured subcontractors in the construction defect actions, and Centex had filed cross-complaints against the subcontractors. The court rejected this argument on the ground that Centex’s cross-complaints against the subcontractors were for indemnification. Centex’s liability in the actions would be derivative of the liability of the subcontractors who performed the work. The court recognized that Travelers would have the same interest in defending both its named insured subcontractors and Centex against the plaintiffs’ claims in both lawsuits.    Centex also argued that Travelers’ reservation of rights to deny an indemnity obligation for property damage occurring outside of the Travelers’ policy periods created a conflict of interest. The court rejected that argument, noting that a conflict exists only “when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel… retained by the insurer for the defense of the claim.”    The court found that independent counsel was not required under California Civil Code Section 2860 as Travelers’ reservation  did not give rise to a conflict of interest because the timing of the property damage was a factual issue outside of defense counsel’s control.

Olympic Pools had been hired by a homeowner in 2002 to build a “negative edge” swimming pool in his backyard in Texas. The pool underwent several repairs over the next few years as four leaks and a large crack developed. In April 2003, just after the pool had been completed and filled with water for the first time, there was a leak under the northeast flower bad planter that the insured repaired. Two years later, however, a second and third leak occurred in the pump equipment area and another under the pool shell near the main drain. The leak under the pool shell caused the pool level to drop two feet in a day, eventually draining the pool within two days. After the pool had drained, the plaintiff’s property manager noticed a long crack running the length of the negative edge wall across the basin. A different company was hired to fix the leak under the shell and to chisel, epoxy and re-plaster the cracked area. The fourth leak occurred in late 2005, after which the customer hired an engineer to analyze the pool structure and filed suit against Olympic Pools.

Olympic Pools tendered the defense of the suit to Maryland Casualty and Acceptance Indemnity that had respectively insured it between 2002 and 2006. Maryland agreed to accept the defense of the case under its 2002-2003 policy but Acceptance, which had been on the risk from August 2003 until 2006, disclaimed any obligation to defend, citing the anti-Montrose wordings in its policy. After Maryland Casualty paid $590,000 to settle the lawsuit, it sued Acceptance under theories of contribution, contractual subrogation and equitable subrogation.

In the ensuing coverage litigation, a federal district court in Texas ruled that Acceptance did have a duty to defend and must therefore reimburse Maryland Casualty for a pro rata share of the costs of defense. While holding that there is no right of equitable contribution among successive insurers in light of the Texas Supreme Court’s opinion in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007), the court allowed the surviving subrogation claim to proceed to trial, where a jury concluded that 75% of the insured’s damages were attributable to property damage that first occurred during one of Acceptance’s policy periods.

On appeal, the U.S. Court of Appeals for the Fifth Circuit agreed with the District Court that Mid-Continent did not preclude an insurer’s right of subrogation against another carrier, even where the insured itself had been fully indemnified. Further, the Court of Appeals declined to hold that there was insufficient evidence to support the jury’s verdict on when property damage “first occurred.” The Fifth Circuit found that in this case the swimming pool problems for which the insured had been sued had resulted from two different causes, the second of which had resulted during Acceptance’s policy period. Accordingly, even if the underlying cause of the problem had resulted from negligent work by the insured contractor during Maryland Casualty’s policy, the Fifth Circuit held that the property damage occurring during Acceptance’s policy was covered since it had resulted from a different cause than that which had occurred during Maryland’s policy.

These cases illustrate a trend that we are likely to see more of in the future, where damages are dissected into separate “occurrences” so as to trigger additional policies and avoid issues with respect to common law “known loss” as well as “Montrose” language of the sort discussed here.

Grange argued that the negligent fracturing of the storm drain pipes determines coverage and that West Bend should pay all of the damages resulting from the flood as the fracturing of the pipe took place in West Bend’s policy period.   West Bend argued that the policy implicated is the policy in effect when the claimant was actually damaged, and not when the negligence of the insured took place. 

The Court of Appeals held that the timing of the “occurrence” is irrelevant to the coverage determination.   It found that the Grange policy was triggered because significant property damage actually occurred during its policy period as a result of the flooding and there was no suggestion that McGurdy was aware of the damage to the storm drain prior to the inception of the Grange policy.  

It also found that West Bend’s policy was triggered as the storm drain pipe was damaged by McCurdy during the West Best policy period.   It noted: “West Bend’s policy provides that this initial property damage includes any continuation, change or resumption of that ‘property damage’ after the end of the policy period.”   It held that because the West Bend policy was triggered at the time McGurdy negligently fractured the drain pipe, the policy covered all damages that flowed from the original damage, including the extensive flood damage.    It concluded that the loss should be allocated between Grange and West Bend pursuant to the “other insurance” provisions in the policies, which both provide for equal shares.   

Comments:   The loss for which the insurers paid the Sullivan’s subrogated insurer was limited to the flood damage. No payment was made for the cost of repairing the damaged pipe – which is the only “property damage” that took place in the West Bend policy.  The damaged pipe, in many jurisdictions, would not be considered “property damage” caused by an “occurrence,” in the first instance as the property damage was limited to the insured’s own product.   See, e.g.,  Stoneridge Dev. Co. v. Essex Ins. Co., 888 N.E.2d 633 (Ill. App. 2d Dist. 2008)(cracking in the walls caused by the construction of the residence near soil which was not properly compacted by the developer’s subcontractor was not “property damage” caused by an "occurrence" as the cracks were the natural and ordinary consequences of defective workmanship). Under that rationale, it is only when “property damage” causes injury or damage to third party property (e.g, the flooding), that it is considered “property damage” caused by an occurrence.”   That would result in only Grange’s policy being implicated for the damages resulting from the flood, not West Bend’s policy.   Indiana courts, however, have taken a different position on whether defective workmanship constitutes an “occurrence.”    In Sheehan Const. Co., Inc. v. Continental Cas. Co., 935 N.E.2d 160 (Ind. 2010), the Indiana Supreme Court adopted the view that improper or faulty workmanship does constitute an accident [or "occurence"] so long as the resulting damage to the building is an event that occurs without expectation or foresight. Id. at 169.   Under that rationale, it is possible a court could view the initial property damage, albeit restricted to the pipe itself, as being caused by an “occurrence.”  That still begs the question as to whether the later flooding damage is a continuation, change or resumption of that “property damage” (i.e., the fractured pipe).    One might argue that the  flooding is a consequence of the initial “property damage.” It could be viewed as having been proximately caused by the fractured pipe. But is the flooding damage a “continuation, change or resumption” of the fractured pipe?     

In MW Builders, Inc. v. Safeco Ins. Co. of Am. 2010 U.S. App. LEXIS 13960 (9th Cir. Or. July 8, 2010), the Ninth Circuit held that “[t]he district court erred in granting MW Builders the entire arbitration award because that award included uncovered repair costs.”  The plaintiff argued that the entire amount of the underlying arbitration award should be covered because the award amount was less than the total, actual cost to repair damage caused by the insured subcontractor’s defective work.  The Ninth Circuit rejected this argument, explaining:

That the actual repair costs, excluding uncovered repairs, ended up exceeding the $620,000 arbitration award does not justify awarding MW Builders the entire award.  MW Builders was never entitled to recover all the repair costs from Safeco.  It was only entitled to recover a portion of the damage to the hotel caused by Safeco’s insured.

Although the Ninth Circuit’s opinion is unpublished, it can be cited pursuant to FRAP 32.1.  Unless and until Oregon’s Supreme Court or Court of Appeals issues a contrary decision, the Ninth Circuit’s opinion in MW Builders should provide a sound basis for apportionment arguments in Oregon.

Based on the “selective tender” rule, which states that “where an insured has not tendered a claim to an insurer, that insurer is excused from its duty to perform under the policy or to contribute to a settlement of the claim,” the Court ruled that “if the insured has not tendered a claim to an insurer prior to settlement or the end of trial, other insurers cannot recover in equitable contribution against that insurer.” The Court further reasoned that because equitable contribution is a claim an insurer has of its own right to recover from another insurer that is independently obligated to cover the same loss, “the insurer who seeks contribution does not sit in the place of the insured and cannot tender a claim to the other insurer.”

Unlike the equitable contribution claim, the Court held that the “selective tender” rule did not apply to bar the conventional subrogation claim, which MOE and CUIC took by reason of assignment from the insured.  (The Court distinguishes “conventional subrogation” from “equitable subrogation” and expressly states that its analysis does not apply to equitable subrogation.)  By taking the assignment, the insurers were able to stand in the shoes of the insured and exercise the insured’s rights to tender the claim to the additional insurer. MOE and CUIC were then also able to assert the “late tender” rule to raise an issue of fact as to USF’s late notice defense. That rule provides that “even where an insured fails to give an insurer timely notice of a claim, the insurer is not relieved of its obligation to perform on the policy unless it can show that the late notice actually and substantially prejudiced it.” Significantly, the Court found that “While we need not decide whether conventional subrogation and assignment are equivalent in all respects, this court recognizes that an insurer who receives full contractual assignment of an insured’s rights may bring a conventional subrogation claim to enforce those rights.” This leaves open the question of whether an insurer’s subrogation claim against other insurers would be safe from the “selective tender” rule without a full assignment of the insured’s rights against those insurers.

The Court also provides insight as to what it will take to prove that an insurer was prejudiced by late notice under the “late tender” rule. The Court held that “in order to show prejudice, the insurer must prove that an insured’s breach of a notice provision had an identifiable and material detrimental effect on its ability to defend its interests.” The Court also provides a nonexhaustive list of factors to be considered. It also found that, contrary to a prior Washington Court of Appeals decision, a lost opportunity to conduct a meaningful investigation alone will not be enough.

Back in December, the Florida Supreme Court had answered a certified question from the Eleventh Circuit in Auto-Owners Ins. Co. v. Pozzi Window Co., No. SC06-779 (Fla. December 20, 2007) that a lawsuit brought against a contractor for water damage caused by the defective installation of windows at a multi-million dollar house in Coconut Grove was not covered since CGL policies do not cover the cost of repair and replacement of defective work.

In Pozzi Window Co. v. Auto-Owners Ins. Co., 446 F.3d 1178 (11th Cir. 2006), the Eleventh Circuit certified to the Supreme Court the issue of whether the defective windows were completed works such that the cost of repairing or replacing the defective windows fell within the scope of the policy’s coverage for claims within the “products/completed operations hazard.” In light of recent Florida appellate decisions that have split on the issue of whether repair or replacement costs are covered under a CGL policy, the Eleventh Circuit asked the Florida Supreme Court to answer whether a standard CGL policy that included coverage for claims within the products/completed operations hazard would cover a general contractor’s liability to a third party for the cost of repairing or replacing defective work by its subcontractor. Unlike its opinion J.S.U.B., the Florida Supreme Court observed that in this case, while the defective installation of the windows was an “occurrence,” the cost of repairing and removing defective work was not a claim for “property damage.”

Last week, however, the Florida Supreme Court withdrew its December 20, 2007 opinion and declared in Auto Owners Ins. Co. v. Pozzi Window Co., No. SCO6-779 (Fla. June 12, 2008) that it was unable to answer the Eleventh Circuit’s certified question owing to the fact that the court had failed to clarify whether the water damage resulted from defective installation, for which there would not be coverage, or defects in the installed windows themselves. In keeping with its  opinion  in U.S. Fire Ins. Co. v. JSUB, the Supreme Curt noted that if the windows were not defective prior to their installation, coverage would exist for the cost of repair or replacement of the windows because there was physical injury to tangible property (the windows) caused by their defective installation by a subcontractor. However, a different result would follow if the windows were in a defective condition before being installed and the damage to the completed project was therefore caused by defective windows rather than faulty installation alone.

In this case, MOE defended its insured, Dan Paulson Construction, Inc. (“DPCI”) under a reservation of rights against construction defect claims brought by the Martinellis related to damages to their personal residence that DPCI constructed. DPCI and the Martinellis proceeded to arbitration on the claims. Shortly before the arbitration hearing, MOE filed a declaratory judgment action in the state court against both DPCI and the Martinellis seeking a declaration that it had no duty to defend or indemnify on the basis of the “Your Work” exclusion. MOE did not serve this action on either DPCI or the Martinellis. 

On December 30, 2003, MOE issued a subpoena duces tecum in the un-served state court declaratory judgment action on the arbitrator seeking documents and the arbitrator’s thoughts regarding the arbitration. With the subpoena, MOE sent the arbitrator an ex parte cover letter explaining its coverage issues with DPCI.  Both DPCI and the Martinellis received the subpoena two business days prior to the arbitration hearing. MOE did not serve the cover letter to the arbitrator on either DPCI or the Martinellis. MOE then sent a second letter to the arbitrator slightly narrowing its original requests and further explaining its coverage dispute with DPCI. Subsequently MOE struck the subpoena and dismissed its first declaratory judgment action. The parties thereafter negotiated a settlement and entered into a stipulated settlement agreement which provided in part that DPCI would assign its coverage and bad faith claims against MOE to the Martinellis. 

MOE subsequently filed the subject coverage action against DPCI and the Martinellis.  On several motions for summary judgment, the trial court found that MOE acted in bad faith but that MOE had successfully rebutted the presumption of harm. The Court of Appeals reversed holding that MOE did not act in bad faith. The Washington Supreme Court reinstated the trial court’s decision that MOE acted in bad faith and further found that MOE failed in rebutting the presumption of harm.  As to bad faith, the court found that through its subpoena and two ex parte letters to the arbitrator, MOE “clearly showed great concern for its monetary interest in establishing which of the Martinellis’ claims were excluded from coverage under DPCI’s policy [while displaying] little to no concern for how its conduct might affect DPCI’s financial risk, which was then being litigated in the arbitration hearing.” The court found that MOE’s actions therefore “conclusively” demonstrated that it had a greater concern for its monetary interest than for DPCI’s financial risk.

The court then determined that MOE did not rebut the presumption of harm arising from its bad faith conduct as it failed to show that its subpoena and ex parte communications did not harm or prejudice DPCI. To the contrary, the court found that the record supported a finding that MOE’s conduct caused significant uncertainly and increased risk for DPCI’s defense. The court rejected the trial court’s initial conclusion that DPCI’s decision to proceed with the arbitration coupled with a subsequent settlement within policy limits effectively rebutted the presumption that MOE’s bad faith harmed DPCI. The court stated that “loss of control of the case is in itself prejudicial to the insured.” 

The court specifically stated that it was not expanding its prior rulings on the presumption of harm to conduct that occurs in connection with an insurer’s coverage duties. Rather, the finding of harm in this case was directly related to conduct during the defense case as, despite the fact that the bad faith conduct was perpetrated by coverage counsel, MOE’s conduct was associated with its underlying defense of DPCI and could not be “reasonably segregated from that defense [as it] interfered directly in that defense.”