News - August 2008

• Insurer Cannot Enforce Time Limit to Collect Replacement Cost Benefits Where Insurer Fails to Promptly Advise Insured Regarding Estimated Replacement Cost and Engages in Other Delays
• Insurers Have No Duty to Defend Insured in Class Actions Alleging Product Defects in Video Game System
• "Flood" Exclusion That Did Not Mention "Wind" Was Not Ambiguous

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Insurer Cannot Enforce Time Limit to Collect Replacement Cost Benefits Where Insurer Fails to Promptly Advise Insured Regarding Estimated Replacement Cost and Engages in Other Delays

The California Court of Appeal has held that an insurer was estopped from enforcing a policy’s time limit to collect replacement cost benefits where the insurer engaged in conduct and delays that prevented the insured from satisfying the policy’s replacement condition. (City of Hollister v. Monterey Insurance Company (2008) 165 Cal.App.4th 455)

Facts

The City of Hollister (City) owned an old building and insured it under a policy issued by Monterey Insurance Company (MIC). After the building was damaged by fire, the City sought to recover the building’s “functional replacement value.” The policy provided that if the City wished to recover such benefits, the City had to enter into a contract to repair or replace the building within 180 days after the fire. The policy also provided that if the City did not enter into a contract to repair or replace the building within 180 days, the most the City could recover was the actual cash value of the building.

The actual cash value of the building was about $150,000. The parties disputed the replacement cost of the building, and had various estimates that ranged from as low as $950,000 to as high as $2,600,000.

During the 180 days after the fire, MIC refused to confirm that it would honor such a claim for replacement cost, apparently because there was some evidence that, before the fire, the City had been considering demolishing the building. In addition, during the 180 days after the fire, MIC delayed in communicating basic determinations affecting coverage, refused to disclose its best estimate of the functional replacement value, permitted the City to labor under misapprehensions concerning its rights under the policy, and ignored communications from the City seeking clarification of these and other matters.

MIC agreed to a brief extension of the 180-day period. Before the expiration of the extension, the City filed suit to obtain a judicial declaration that MIC was estopped from asserting the relevant provision in light of MIC’s alleged failure to cooperate in the performance of the condition. The trial court found for the City, ruling that the 180-day time limit would be extended and would run from the date of the judgment.  MIC appealed.

Holding

The Court of Appeal followed rulings by courts in several other jurisdictions, and held that an insurer is estopped from requiring actual replacement of the damaged property as a condition to recovery where the insurer’s conduct frustrates the insured’s ability to satisfy the replacement condition. The Court of Appeal also noted that principle applies whether or not the insurer acted in bad faith. Because of MIC’s appeal, the Court held the 180-day time limit would be extended and would run from the date the Court of Appeal’s opinion becomes final and the time to seek review from the California Supreme Court expires.

Comment

This case contains an excruciatingly long and detailed discussion of the underlying facts surrounding MIC’s investigation and adjustment of this claim. Although the underlying facts were very much in dispute, the Court of Appeal was required to view the facts in the light most favorable to the party (the City) that prevailed in the trial court. Because of the Court of Appeal’s characterization of the facts, the Court had no difficulty affirming the trial court’s finding of estoppel.

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Insurers Have No Duty to Defend Insured in Class Actions Alleging Product Defects in Video Game System

The Ninth Circuit Court of Appeals has held that neither a media liability insurer nor a commercial general liability insurer had any duty to defend an insured in class action lawsuits alleging product defects in the insured’s video game system. (Sony Computer Entertainment America, Inc. v. American Home Assurance Co. (9th Cir. 2008) 532 F.3d 1007)

Facts

Sony Computer Entertainment America, Inc. (Sony) marketed and distributed the “PlayStation 2,” a home entertainment system that supposedly was capable of playing audio and video CDs and DVDs as well as video games.

PlayStation users filed two class action lawsuits against Sony in California state court. In those lawsuits the plaintiffs alleged that the PlayStation 2 systems suffered from an “inherent” or “fundamental” design defect that rendered them unable to play DVDs and certain game discs. The plaintiffs’ complaints included causes of action for breach of express and implied warranties, negligent misrepresentation, false advertising and unfair business practices. The plaintiffs’ negligent misrepresentation and false advertising claims were based on statements Sony made in press releases, product packaging and advertising that the PlayStation 2 would function as a DVD player as well as a game player.

Sony was the named insured on both a media liability policy issued by American International Specialty Lines Insurance Company (AISLIC) and a commercial general liability policy issued by American Home Assurance Company (American Home). Sony tendered the class action lawsuits to AISLIC and American Home, but both insurers rejected Sony’s tenders.

Sony then filed a breach of contract / bad faith lawsuit against AISLIC and American Home in federal court, alleging that AISLIC and American Home had wrongfully failed to defend Sony in the underlying class action lawsuits. The district court granted summary judgments in favor of both AISLIC and American Home, and Sony appealed.

Holding     

The Ninth Circuit Court of Appeal, applying California law, affirmed the judgments in favor of AISLIC and American Home.

With respect to the AISLIC media liability policy, that policy provided that AISLIC would indemnify Sony and provide defense costs for lawsuits seeking damages because of specified “wrongful acts,” including “negligent publication.” The appellate court rejected Sony’s argument that the term “negligent publication” should be broadly interpreted to include any “communication of information to the public … exhibiting a lack of due care,” and that it should thus extend to the claims of negligent misrepresentation and false advertising made in the underlying class action lawsuits. Rather, the appellate court held that when read in the context of the policy as whole, the term “negligent publication” referred to “a very narrow tort in which the publication of material encourages or instructs readers to engage in harmful conduct.” Since the plaintiffs in the underlying class action lawsuits did not allege that Sony had led readers to engage in harmful conduct, the coverage for “negligent publication” was inapplicable. Thus, AISLIC had no duty to defend or indemnify Sony.

With respect to the American Home general liability policy, that policy provided that American Home would indemnify and defend Sony against lawsuits seeking damages because of “property damage,” which was defined so as to include (1) “physical injury to tangible property” and (2) “loss of use of tangible property that is not physically injured.” As to the issue of “physical injury to tangible property,” the underlying class representative plaintiffs did not allege that Sony’s PlayStation 2 systems had scratched or damaged discs which were inserted into the systems, and in fact the class representative plaintiffs specifically denied that any such damage had occurred. Nor was it sufficient that other members of the putative class may have claimed scratches or other damage to discs, since any such claims were never incorporated into the underlying class action lawsuit. As to the issue of “loss of use of tangible property that is not physically injured,” the class representative plaintiffs did not allege that defects in the PlayStation 2 had caused them to suffer a “loss of use” of game discs or DVDs. Moreover, even if class representative plaintiffs had made that claim, any such claim would fall within the scope of the policy’s “impaired property” exclusion, which barred coverage for “loss of use” property damage arising out of a “defect, deficiency, inadequacy or dangerous condition in [Sony’s] product.” The appellate court concluded that under the circumstances, American Home had no duty to defend Sony in the underlying class action lawsuits.

Comment                  

One judge on the panel dissented from the ruling that AISLIC had no duty to defend Sony in the underlying class action lawsuits. According to the dissenting judge, a layperson could reasonably understand that AISLIC’s coverage for “negligent publication” would extend to “a publication distributed negligently.” Thus, according to the dissenting judge, the term “negligent publication” was broad enough to include the negligent misrepresentation and false advertising claims alleged in the underlying class action lawsuits.              

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"Flood" Exclusion That Did Not Mention "Wind" Was Not Ambiguous

The Ninth Circuit Court of Appeals has held that, under California law, a “flood” exclusion that did not mention “wind” was not ambiguous in the context of a claim for damage allegedly caused by storm surge. (Northrop Grumman Corporation v. Factory Mutual Insurance Company (2008) 2008 WL 3484877)

Facts

Northrop Grumman Corporation owned a shipbuilding subsidiary that conducted operations throughout several Gulf states. Northrop purchased a blanket primary layer of all risk property coverage that expressly included coverage for damage caused by flood.  

Northrop also purchased a blanket excess layer of all risk property coverage that purported to exclude coverage for damage caused by flood.

Factory Mutual Insurance Company was responsible for fifteen percent of any loss covered by the primary layer of insurance and one hundred percent of loss covered by the excess layer of insurance.

The primary policy defined “flood” as “all physical loss or damage caused by or resulting from flood waters, rising waters, waves, tide or tidal water, surface waters, or the rising, overflowing, or breaking of boundaries of lakes, reservoirs, rivers, streams or other bodies of water, whether driven by wind or not ...”

The excess policy excluded loss or damage caused by “flood,” but the “flood” exclusion did not mention “wind.”

During Hurricane Katrina, high winds caused a storm surge, i.e., high winds created a tidal surge that pushed water onto the shore. The storm surge covered Northrop’s buildings by as much as ten feet of water.

Factory Mutual paid Northrop for the flood damage covered by the primary policy. However, Factory Mutual informed Northrop that Factory Mutual was planning to examine the damages under the excess policy to determine whether wind (which would be covered) or flood (which would not be covered) was the predominant cause of the loss.

Northrop sued Factory Mutual in California state court, demanding coverage for the water damage under the excess policy. Factory Mutual removed the case to federal court, and the parties filed cross-motions for partial summary judgment on the issue of whether the flood exclusion in the excess policy barred coverage for the water damage from Hurricane Katrina.

Among other things, Northrop argued that the phrase “whether driven by wind or not” was used in the primary policy’s definition of the term “flood,” but that the phrase “whether driven by wind or not” did not appear in the excess policy’s definition of the term “flood.” The trial court agreed with Northrop that the “flood” exclusion in the excess policy was ambiguous because it did not “plainly and clearly reference hurricanes or damage caused by wind.”  Factory Mutual then appealed.

Holding

The Ninth Circuit Court of Appeals applied California law and reversed, ruling that the flood exclusion in the excess policy was not ambiguous. The Court of Appeals held that the term “flood” is commonly understood to mean “an overflowing or inundation of water over usually dry land,” and that Northrop’s shipbuilding facilities unquestionably experienced “an inundation of water over normally dry land.” In addition, the Court of Appeals declined to find an ambiguity based on differing language in the primary policy and the excess policy.

Comment

Although the Court of Appeals reversed the district court's summary judgment in favor of Northrop, the Court of Appeals remanded the case to the district court for consideration of Northrop’s argument that California’s efficient proximate cause doctrine required coverage of the water damage notwithstanding the language of the contract. The Court of Appeals refused to address this issue because it involved “factual considerations” that the district court had not yet decided.

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