Insurers should be aware of the recent Washington State Supreme Court decision in Xia v. ProBuilders Specialty, No. 92436-8 ___ Wn.2d ____ (2017) handed down on April 27, 2017. The decision may have significant impacts not only in coverage litigation regarding environmental contamination, but across a broad spectrum of liability claims under CGL policies. In short, the Washington State Supreme Court has unequivocally adopted the “efficient proximate cause rule,” normally reserved for first party policies, in its analysis of coverage under a liability policy.

The case involved a homeowner that moved into a home built by Issaquah Highlands (homebuilder) in May of 2006. Shortly after moving in she began to feel ill. It was eventually discovered that an exhaust vent attached to the hot water heater had not been installed correctly and was discharging carbon monoxide into the basement of the home. The homebuilder’s insurer denied the claim for defense and indemnity under the pollution exclusion and a townhome exclusion.

The injured plaintiff ultimately entered into a $2 million stipulated settlement with the homebuilder with a covenant not to execute against the homebuilder, and an assignment of all plaintiff’s rights against its insurer, ProBuilders. The plaintiff then sued ProBuilders directly for bad faith, violation of Washington statutes related to claims handling, as well as breach of contract. The parties brought cross motions for summary judgment and ProBuilders won on the basis that the townhouse exclusion applied and it had no obligation to defend. On appeal, the Court of Appeals disagreed with the trial court regarding the townhome exclusion, but held that the pollution exclusion barred coverage and that ProBuilders had no duty to defend.

The Supreme Court, however, reversed the Court of Appeals decision by applying the “efficient proximate cause rule” to the duty to defend analysis. This is the first time the Court has applied the efficient proximate cause rule in the third party liability context.  The Court acknowledged that the Pollution exclusion applied to bar coverage for bodily injury caused by a release of contaminants (Carbon Monoxide); however, it held that the negligent installation of the vent on the hot water heater was a potentially covered cause under the policy in the first instance.   Under the efficient proximate cause rule, where “two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss,” the loss is covered.  The court stated: “by applying the efficient proximate cause rule, it becomes equally clear that the ProBuilders policy provided coverage for this loss. The polluting occurrence here happened only after an initial covered occurrence, which was the negligent installation of a hot water heater that typically does not pollute when used as intended.”

The Court then explained that “the allegations of Xia’s complaint provided a reasonable and conceivable basis to believe that the negligent installation of the hot water heater, itself a covered occurrence under the policy provisions, set in motion a causal chain wherein the venting of exhaust lowered the oxygen content of the room such that a normally nonpolluting appliance began discharging toxic levels of carbon monoxide fumes.”  The Court held that ProBuilders failed to conduct an investigation into Washington law that might have alerted them to the rule of efficient proximate cause, and the court’s unwillingness to permit insurers to draft language to avoid it.  Thus, the insurer wrongfully refused to defend. The Court reversed the trial court decision and granted summary judgment on the breach of contract and bad faith claims in favor of Plaintiff.  The statutory claims regarding the Insurance Fair Conduct Act and Consumer Protection Act were remanded for further proceedings.

The end result is that the insurer was found in bad faith, because it did not consider application of a first-party insurance concept to a third-party liability insurance claim, that had never been done before, and now faces at a minimum the $2 million in stipulated damages for failing to defend.