Insurance Law News - April 2009

• California Supreme Court Restricts Insurers’ Ability to Rely on “Qualified” Pollution Exclusion
• New California Law Further Defines "Agents" and "Brokers"

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California Supreme Court Restricts Insurers’ Ability to Rely on "Qualified" Pollution Exclusion

The California Supreme Court has issued a ruling which will significantly restrict the insurance industry’s ability to deny indemnity coverage based on the “qualified” (i.e., “sudden and accidental”) pollution exclusion. (State of California v. Allstate Insurance Company (2009) 45 Cal.4th 1008) 

Facts

During the 1950’s, the State of California undertook to design and construct a Class I hazardous waste disposal site (i.e., one capable of accepting all types of liquid wastes). The site later became known as the “Stringfellow Acid Pits.” The facility, located in Riverside County, sat on the floor of a canyon drained by Pyrite Creek. In 1955, a State geologist briefly inspected the Stringfellow site and assumed that there was an impermeable layer of rock, with no water in it, beneath the site. As a result of the State geologist’s investigation of the site, the State concluded that with construction of a watertight barrier dam across the canyon, and with adequate measures to divert runoff, the site would pose no threat of environmental pollution.

Thereafter, the State directed construction of unlined evaporation ponds to contain the hazardous waste; channels to divert rainwater around the site; and a barrier dam at the bottom of the site. In 1956, the State opened the site, and over the next 17 years, various companies deposited more than 30 million gallons of liquid industrial waste in the Stringfellow ponds.

The State’s initial assessment of the Stringfellow site proved inaccurate. In fact, the site was underlain by decomposed granite and fractured bedrock, through which an underground alluvial channel ran. As a result, by 1960, chemical pollution begun seeping into the groundwater through the fractured rock.

In addition to underground leaking, two major overflow episodes occurred at the site. In March 1969, a 50-year rainstorm flooded the site, causing the waste ponds to overflow and send polluted water down the canyon. In March 1978, again following extraordinarily heavy rains, the ponds were near overflowing and the retention dam began to fail; as a result, the State made a series of controlled discharges from the ponds, releasing about one million gallons of diluted waste down the Pyrite Creek channel.

Later, the State and the United States filed a federal court action against companies that had disposed of waste at the Stringfellow Acid Pits. The companies counterclaimed against the State. In 1998, the federal district court held the State 100 percent liable for claims under California law, and 65 percent liable for claims under federal law, for past and future costs of remediating contamination of land and groundwater. (The remediation costs are now expected to exceed $500 million.) 

The State requested coverage for the liability imposed in the federal action from several excess insurers, including Allstate Insurance Company, Century Indemnity Company and Westport Insurance Corporation. All three insurers denied coverage based on a “qualified” pollution exclusion which provided as follows: “This policy does not apply to … property damage arising out of the discharge, dispersal, release or escape of … pollutants into or upon land or the atmosphere, but this exclusion does not apply if such discharge, dispersal, release or escape is sudden and accidental. It is further agreed that the policy does not apply to … property damage arising out of the discharge, dispersal, release or escape of … pollutants into or upon any watercourse or body of water.”

Following the insurers’ denial of coverage, the State filed a state court action against the insurers for breach of contract and bad faith. After proceedings in both the trial court and the California Court of Appeal, the parties ended up before the California Supreme Court.

Holding

On appeal, the insurers unsuccessfully advanced various arguments as to why the pollution exclusion barred coverage for all – or at least some – of the State’s liability for the costs of cleaning up the pollution.

First, the insurers argued that since the initial discharges of pollutants into the containment ponds were not “sudden and accidental,” the pollution exclusion necessarily barred coverage for any liability the State might have. The Supreme Court disagreed, reasoning that in the underlying action, the State was not held liable for polluting the containment ponds, but rather for polluting the land and groundwater outside the containment ponds. According to the Court, the analysis must focus on the discharge which formed the basis for the insured’s liability. Thus, the pollution exclusion did not necessarily relieve the insurers of the duty to indemnify the State for any property damage arising out of a “sudden and accidental” dispersal, release or escape of pollutants from the containment ponds into the surrounding soils and groundwater. 

Second, the insurers argued that any damages from the 1969 overflow fell within the scope of the pollution exclusion’s absolute bar of coverage for damages arising from the “discharge, dispersal, release or escape of … pollutants into or upon any watercourse ….” The Supreme Court rejected this argument as well, noting that a “watercourse” is usually defined as “a channel through which … water … usually or periodically flows.” According to the Court, the insurers had not conclusively established that the 1969 overflow was confined to the Pyrite Creek channel itself, as opposed to land outside the channel.    

Third, the insurers argued that since the State intentionally made a series of controlled discharges from the containment ponds in 1978, those discharges were not “accidental” within the meaning of the exception to the pollution exclusion. The Supreme Court disagreed, reasoning that the State made the controlled discharges only to prevent a larger “accidental” discharge which would have occurred if the dam had broken due to the extraordinarily heavy rains. According to the Court, liability policies can “cover damages resulting from an act undertaken to prevent a covered source of injury from coming into action, even if that [preventive] act would not otherwise be covered.”

Fourth, the insurers argued that the State was barred from recovery because the State could not prove what portion of the property damage was caused by the “covered” sudden and accidental discharges in 1969 and 1978, and what portion of the property damage was caused by otherwise “uncovered” gradual or nonaccidental leakage from the containment ponds. The Supreme Court rejected this argument, reasoning that where both covered and uncovered events cause indivisible damage, the insurer must indemnify the insured for all the damage as long as the covered event was a “substantial factor” in causing the damage. Thus, to the extent the State could prove that covered “sudden and accidental” discharges were a “substantial factor” in causing the contamination of the soils and groundwater, the State would be entitled to full indemnification from the insurers.   

Comment  

One of the more significant aspects of this case is the Supreme Court’s ruling with respect to indivisible injuries resulting from both covered and noncovered causes. Relying heavily on its prior decision in Partridge v. State Farm Fire & Casualty Co. (1973) 10 Cal.3d 94, the Supreme Court emphasized that if an insured’s covered conduct is a “substantial cause” of indivisible injuries suffered by the claimant, that conduct is sufficient to render the insured fully liable to the claimant under tort law. In that situation, the insured is then entitled to full indemnification from the insurer under the policy – even if the insured’s noncovered conduct also contributed to the claimant’s indivisible injuries. The Supreme Court expressly overruled a prior Court of Appeal decision – Golden Eagle Refinery Co. v. Associated International Ins. Co. (2001) 85 Cal.App.4th 1300, which had held that in this situation the insured must prove how much of the indivisible amount of damages resulted from covered causes. 

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New California Law Further Defines "Agents" and "Brokers"

Generally, an insurance “agent” is a person who transacts insurance on behalf of an admitted insurer. In contrast, an insurance “broker” is a person who transacts insurance with, but not on behalf of, an admitted insurer. (Insurance Code Section 1621.) The distinction is important, because an insurer generally is not responsible for errors and omissions of a broker, but can be responsible for errors and omissions of an agent.

Pursuant to legislation effective January 1, 2009, there is now a rebuttable presumption that a licensee is a broker if the licensee (1) is licensed as a broker, (2) maintains a bond in a specified amount, and (3) discloses, in a written agreement signed by the consumer, all of the following:

(a) That the licensee is transacting insurance on behalf of the consumer;

(b) The general nature of the services the licensee will perform as a broker;

(c) The fees being charged by the licensee;

(d) Whether the insurer will compensate the licensee in connection with the transaction.

The presumption that a licensee is a broker is rebutted in case of any of the following: (1) the insurer has filed with the California Department of Insurance a notice appointing the licensee as an agent; (2) the insurer and the licensee have entered into a written agreement that authorizes the licensee to bind coverage; (3) the insurer and the licensee have entered into a written agreement that authorizes the licensee to appoint other licensees as agents; or (4) the insurer and the licensee have entered into a written agreement that authorizes the licensee to pay claims on behalf of the insurer.

In all other cases, the presumption that a licensee is a broker is rebutted if the “totality of the circumstances” indicates that the licensee is acting on behalf of the insurer. (Insurance Code Section 1623.) However, a broker who merely collects and transmits premiums and delivers policies is not deemed to be the insurer’s agent. (Insurance Code Section 1732.)

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