News - July 2006

• Appraisers Are Not Authorized to Determine Cause of Loss
• Excess Judgment Required Before Excess Insurer Can Sue Primary Insurer for Failure to Settle
• Defective Computer Chips Incorporated Into Disk Drives Do Not Cause “Property Damage”
• Bad Faith: Insured Can Assign Claim for Attorney Fees

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Appraisers Are Not Authorized to Determine Cause of Loss

The California Court of Appeal has held that appraisers only have authority to determine the amount of loss, and do not have authority to determine the cause of loss or any other coverage issue. (Kacha v. Allstate Insurance Company (2006) 45 Cal.Rptr.3d 92)

Facts

A fire destroyed houses on three sides of Jeff Kacha’s custom house. Heat and smoke from the fire damaged Kacha’s house and personal property.

Allstate insured Kacha’s house and personal property at the time of the fire. Allstate determined that the cost to clean the house and contents was $25,799, and paid that amount to Kacha.

Kacha believed the amount of his loss was $858,393. He retained a public adjuster and demanded that the amount of loss be established by the appraisal process, as set forth in the conditions of the policy. Each party designated an appraiser. Because the two appraisers could not agree on who should act as the neutral umpire of the appraisal panel, the superior court selected the umpire.

Throughout the appraisal process, Allstate maintained that many of the items for which Kacha was seeking recovery had sustained damage from causes other than fire.

At least initially, Kacha appeared willing to allow the appraisal panel to determine if the fire had caused all the damage in question. Later, however, Kacha’s public adjuster asserted that the appraisal panel only had authority to determine the amount of loss, not the cause of loss.

Allstate urged the appraisal panel to award Kacha nothing for items that Allstate contended had sustained damage from causes other than fire. Allstate’s appraiser and the umpire ultimately signed an appraisal award setting the replacement cost of the damage at $163,792 – far more than the amount Allstate previously had paid, but far less than the amount Kacha had been seeking. The appraisal award was itemized, and showed that Allstate’s appraiser and the umpire had not awarded Kacha anything for numerous items that clearly had sustained damage from some cause (even though the cause of damage was disputed).

The superior court confirmed the appraisal award, finding that Kacha initially had agreed to allow the appraisal panel to determine the amount of loss caused by the fire.

Holding

The Court of Appeal reversed, and ordered that the appraisal award be vacated.

The Court of Appeal noted that California’s statutory fire insurance policy provides as follows: “No permission affecting this insurance shall exist, or waiver of any provision be valid, unless granted herein or expressed in writing added hereto.” Pursuant to this statutory provision (which is deemed to be part of every fire insurance policy), the Court of Appeal found Kacha had not waived any rights, and had not expressly or impliedly agreed that the appraisers had authority to determine the cause of the damage.

Because the appraisal panel only determined the amount of loss caused by fire and did not determine the amount of loss of all claimed damage, the panel exceeded its authority.

Comment

Where the cause of damage is disputed, a coverage question exists. This case reaffirms the rule that appraisers can determine the amount of loss, but cannot determine the cause of loss (or any other coverage issue) unless the parties expressly authorize the appraisers to do so.

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Excess Judgment Required Before Excess Insurer Can Sue Primary Insurer for Failure to Settle

The California Court of Appeal has held that an excess judgment against an insured is required before an excess insurer can maintain an equitable subrogation action against a primary insurer for unreasonable failure to settle. (RLI Insurance Company v. CNA Casualty of California (2006) 2006 WL 1868457)

Facts

Several claimants filed a wrongful death action against the insured. The insured had a $1 million primary liability policy through one insurer, and $1 million excess liability policy through another insurer.

The claimants offered to settle the wrongful death action against the insured in exchange for the primary insurer’s $1 million policy limit. The primary insurer rejected the settlement offer. One year later, the claimants settled the wrongful death case against the insured for $2 million, with the primary insurer paying its $1 million limit and the excess insurer likewise paying its $1 million limit.

Following the settlement, the excess insurer filed an equitable subrogation action against the primary insurer. The excess insurer alleged that the primary insurer had failed to accept a reasonable settlement demand within the primary insurer’s policy limits and that, as a result, the underlying action ultimately had settled for $2 million rather than $1 million. The excess insurer sought to have the primary insurer bear the entire cost of the underlying $2 million settlement.

The trial court ruled that because the underlying action was settled instead of litigated to judgment, the excess insurer had no right to pursue an equitable subrogation claim against the primary insurer. The trial court thus entered judgment against the excess insurer and in favor of the primary insurer.

Holding

The Court of Appeal affirmed. The appellate court acknowledged that an excess insurer can recover damages from a primary insurer when the primary insurer unreasonably fails to settle a claim against the insured. However, as a general rule, in order for the excess insurer to prevail against the primary insurer, it must be shown that the primary insurer’s failure to settle resulted in an excess judgment against the insured.

According to the appellate court, if there is no excess judgment against the insured, the insured suffers no harm. If the insured suffers no harm, the insured has no direct claim against the primary insurer, and the excess insurer likewise has no derivative claim against the primary insurer.

Comment

The RLI court declined to follow Fortman v. Safeco Ins. Co. (1990) 221 Cal.App.3d 1394, which reached a contrary result. According to the RLI court, the Fortman decision is inconsistent with various California Supreme Court cases requiring an excess judgment before the insured (or an excess insurer standing in the insured’s shoes) can sue a primary insurer for unreasonable failure to settle.

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Defective Computer Chips Incorporated Into Disk Drives Do Not Cause "Property Damage"

The United States District Court for the Northern District of California has held that defective computer chips that were incorporated into computer disk drives did not cause “property damage” within the meaning of a commercial general liability policy. (Atmel Corporation v. St. Paul Fire & Marine Insurance Co. (N.D. Cal. 2006) 430 F.Supp.2d 989)

Facts

Atmel Corporation manufactured and sold allegedly defective computer chips to Seagate Corporation. Seagate incorporated the allegedly defective chips into computer disk drives, and then sold the disk drives to its customers. The defective chips later short circuited, causing the disk drives to fail. The defective chips did not cause any physical damage to the disk drives, but did cause the drives to become inoperable.

As a result of customer complaints, Seagate voluntarily repaired the disk drives which contained the defective computer chips. Customers who returned disk drives to Seagate received either a new drive or a refurbished drive with the Atmel chip replaced.

Seagate sued Atmel, alleging that Atmel’s computer chips were defective and had caused Seagate’s disk drives to fail. Atmel tendered defense of the action to St. Paul Fire & Marine Insurance Company under various commercial general liability policies. However, St. Paul failed to defend Atmel against Seagate’s claims. As a result, Atmel defended the action on its own and ultimately settled the action by agreeing to pay Seagate $5.9 million.

Atmel then sued St. Paul for breach of contract and bad faith arising from St. Paul’s failure to defend and indemnify Atmel in the underlying action. St. Paul moved for partial summary judgment that it had no duty to indemnify Atmel for the $5.9 million Atmel paid in settlement of the underlying action.

Holding

The federal district court, applying California law, granted St. Paul’s motion, holding that St. Paul had no duty to indemnify Atmel for its settlement with Seagate.

The court first held that St. Paul’s failure to defend Atmel in the underlying action did not preclude St. Paul from challenging whether it had a duty to indemnify Atmel. Rather, the court concluded that even if an insurer breaches its duty to defend, the insured still has the burden of proving a right to indemnification under the policy.

Turning to the issue of indemnification, the court noted that the St. Paul policies covered Atmel’s liability for “property damage,” defined as either “physical damage to tangible property of others” or “loss of use of tangible property of others that isn’t physically damaged.” Here, it was undisputed that Atmel had not paid any sums to Seagate for “physical damage” to Seagate’s disk drives. Moreover, according to the court, Atmel had not paid any sums to Seagate for “loss of use” of the disk drives. Rather, Atmel had only paid sums to Seagate for the cost of repairing and replacing drives containing the defective chips. Because there was no “property damage,” St. Paul had no duty to indemnify Atmel for its $5.9 million settlement with Seagate.

Comment

Note that the only issue before the district court was whether the insurer had a duty to indemnify the insured (which depended on whether the underlying settlement was actually covered under the policy). The court specifically did not consider whether the insurer had a duty to defend the insured (which would depend on whether the underlying claims were merely potentially covered). The district court distinguished Anthem Electronics, Inc. v. Pacific Employers Insurance Co. (9th Cir. 2002) 302 F.3d 1049 – an earlier case involving somewhat similar facts – on the ground that Anthem involved an insurer’s duty to defend and on the ground that Anthem involved a claimant who had specifically alleged “loss of use” damages.

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Bad Faith: Insured Can Assign Claim for Attorney Fees

An insured generally can assign a claim for contract damages, and certainclaims for extra-contractual damages. Among the extra-contractual claims an insured cannot assign are claims for emotional distress and claims for punitive damages.

In Brandt v. Superior Court, the California Supreme Court held that when an insured sues an insurer for bad faith, the insured may recover attorney fees incurred to recover policy benefits the insurer has wrongfully withheld. These fees typically are known as “Brandt fees.”

In a very recent case, Essex Insurance Company v. Five Star Dye House, Inc. (2006) WL 1843278, the California Supreme Court held that, when an insured assigns a claim for bad faith, the insured can assign a claim for Brandt fees. In Essex, Five Star sued Sanchez for negligence. Sanchez tendered defense of the action to his liability insurer, Essex. However, Essex refused to defend Sanchez in the action, and Five Star ultimately obtained a judgment against Sanchez for $1.35 million. Sanchez then assigned to Five Star all of his claims and causes of action against Essex.

In subsequent litigation, Five Star proved that Essex had breached its contractual duty to defend Sanchez, and that Essex had acted in bad faith. Five Star obtained a judgment against Essex for $1.6 million dollars, but the trial court refused to award Brandt fees, ruling that Sanchez could not assign such a claim. However, the California Court of Appeal and, ultimately, the California Supreme Court ruled that an insured can assign a claim for Brandt fees. Thus, Sanchez’ assignee, Five Star, was entitled to recover from Essex the attorney fees Five Star had incurred in proving coverage.

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