News - June 2006

• Despite Rescission, Policy’s Contractual Limitation Clause Bars Insured’s Suit
• Spouse of Named Insured Can Sue For Bad Faith, Even Though Spouse Not a Defendant in Underlying Action
• D&O Policy Allows Allocation of Defense Fees While Suit Pending
• “Damages” Means Court-Ordered Judgments, And Affirmative Defenses Are Not “Suits”
• New Regulations: No Depreciation of Labor Expense

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Despite Rescission, Policy’s Contractual Limitation Clause Bars Insured’s Suit

The California Court of Appeal has ruled that, even if an insurer’s rescission of a policy was improper, the insured must still file suit within the time prescribed in the policy’s contractual limitation clause. (Akin v. Certain Underwriters at Lloyd’s of London (2006) 2006 WL 1330821)

Facts

Akin purchased a homeowners policy from Certain Underwriters at Lloyd’s of London. The policy contained a standard one-year contractual limitation clause which provided: “No action shall be brought unless there has been compliance with the policy provisions and the action is started within one year after the occurrence causing loss of damage.”   

Akin made two claims to Lloyd’s for water damage. Lloyd’s denied the claims and purported to rescind her policy in March 2002. 

About two years later, in March 2004, Akin filed a complaint in which she sought to recover for breach of contract and breach of the duty of good faith and fair dealing. Later, she amended her complaint to include a claim for “improper” rescission. She sought damages for nonpayment of policy benefits, personal injury, mental and emotional distress, and punitive damages. 

Akin argued that, by purporting to rescind the policy, Lloyd’s had forfeited the right to rely on the policy’s provisions, including its one-year contractual limitation clause. The trial court disagreed, and ruled that Akin’s suit (filed two years after the purported rescission) was time-barred.

Holding

The Court of Appeal held that, even if Lloyd’s rescission of the policy was unjustified, the policy’s one-year contractual limitation clause barred the suit. The Court noted that because Akin sought, among other things, to obtain the benefits of the contract (i.e., payment of policy proceeds), she had elected to affirm the contract. Thus, because Akin had affirmed the contract, she was required to file suit before expiration of the one-year period specified in the policy’s limitation clause.

In addition, the Court held that Civil Code section 1692 did not provide Akin a basis for relief for Lloyd’s alleged “improper” rescission. Instead, the Court held that section 1692 merely provided Akin a basis to obtain return of any premiums that Lloyd’s might have failed to refund.

Comment

Where a claim for “improper” rescission is, in essence, a suit to recover contractual damages, the insured must sue for breach of contract before the expiration of the limitation period—whether the limitation period is based on a statute or on a policy clause. Although it appears California law does not recognize an independent claim for “improper” rescission, an unjustified rescission could provide at least some support for a claim of bad faith. 

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Spouse of Named Insured Can Sue For Bad Faith, Even Though Spouse Not a Defendant in Underlying Action

The California Court of Appeal has ruled that a named insured’s spouse had standing to sue a CGL insurer for breach of contract and bad faith, even though the spouse was not a named defendant in the underlying suit. (Century Surety Company v. Polisso (2006) 43 Cal.Rptr.3d 468)

Facts

Charles Polisso and his wife, Therese, jointly owned a sole proprietorship known as “Kinzel Glass Company.” Century Surety issued a general liability policy to “Chuck Polisso dba Kinzel Glass Company.” The policy did not expressly name Therese as an insured, but did provide liability coverage for a named insured’s “spouse … with respect to the conduct of a business….”

A contractor filed a civil action against “Kinzel” and “Charles Polisso, an individual doing business as Kinzel” for damage allegedly caused by glass installed by Kinzel. Therese was not named as a defendant in the suit. 

Century Surety initially denied Charles’ tender of defense based on “care, custody and control” and “faulty work” exclusions. Later, after receiving coverage advice from counsel, Century Surety reversed its position and agreed to defend Charles under a reservation of rights. 

Century Surety filed a declaratory relief action against Kinzel and Charles, but not Therese. In turn, Charles and Therese filed a cross-complaint against Century Surety for breach of contract and bad faith. At trial, the jury found that Century Surety acted in bad faith by filing a declaratory relief action when Century Surety’s internal documents reflected it knew it had a duty to defend. The jury also found Century Surety had engaged in numerous delays in paying defense costs. The jury awarded Charles and Therese $637,911 in damages for Century Surety’s breach of contract and bad faith, and $2,015,000 in punitive damages.

Holding

The Court of Appeal affirmed, finding that Century Surety had breached the terms of the insurance contract by failing to defend Charles, that both Charles and Therese had standing to sue Century Surety, and that Century Surety was liable to both Charles and Therese for breach of contract and bad faith. The Court reasoned that, even though Therese was not named as a defendant in the underlying action, she qualified as an insured because she was Charles’ spouse. The Court also reasoned that, because Charles and Therese jointly owned the business as community property, the community estate would be liable for any money judgment arising from the underlying action. Therefore, the Court found there was a potential that Therese, through her community estate interest, could be legally obligated to pay damages as a result of the underlying action.

Moreover, the Court found the “genuine dispute” defense did not preclude liability on the bad faith and punitive damage claims because there was no genuine dispute as to Century Surety’s obligation to defend Charles and Therese. The Court noted that Century Surety’s coverage counsel had advised that assertions of fact relayed by the Polissos’ attorney created a potential for coverage and a duty to defend under Century Surety’s policy.

Finally, the court also found that there was coverage under a first-party property installation floater which provided coverage for damage to the window Kinzel had installed and that a flood exclusion did not apply because the glass was damaged before the flood occurred.

Comment

This case points out that in those instances where an insurer engages in multiple acts of unreasonable conduct during the processing of a claim, the “genuine issue” doctrine might not insulate the insurer from extra-contractual exposure.

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D&O Policy Allows Allocation of Defense Fees While Suit Pending

A United States District Court held that a D&O insurer had no duty to advance 100 percent of the legal fees incurred by the insured to defend an underlying lawsuit, based on a policy provision giving the insurer power to allocate between covered and uncovered defense fees. (Commercial Capital Bankcorp, Inc. v. St. Paul Mercury Insurance Company (C.D. Cal. 2006) 419 F. Supp. 2d 1173)

Facts

A third party filed suit against various officers of Commercial Capital Bankcorp (CCB). In the suit, the third party alleged  certain claims for various intentional torts.

CCB asserted that its D&O insurer, St. Paul, had a duty to advance on a current basis 100 percent of CCB’s costs to defend the officers. The St. Paul policy provided “[i]t shall be the duty of the Insureds and not the duty of the Insurer to defend any claim,” except that St. Paul had a duty to advance defense costs incurred by an insured.  

The policy also contained an allocation provision that applied to suits alleging both covered and uncovered claims. The allocation provision stated “If there can be an agreement on an allocation of Defense Costs [between covered and uncovered claims], the Insurer shall advance on a current basis Defense Costs allocated to covered Loss. If there can be no agreement on allocation of Defense Costs, the Insurer shall advance on a current basis Defense Costs which the Insurer believes to be covered under this Policy until a different allocation is negotiated, arbitrated or judicially determined.” Based on these provisions and its contention that the intentional torts were not covered, St. Paul offered to advance payment for only 50 percent of CCB’s defense costs, thereby prompting CCB to file the suit for declaratory relief.

Holding

The Court held that St. Paul had no duty to advance payment of 100 percent of CCB’s defense costs. Generally, California law requires contemporaneous payment of all reasonable defense costs. (See Buss v. Superior Court (1997) 16 Cal.4th 35.) However, St. Paul and CCB contracted around the Buss rule with the policy language quoted above that included an allocation provision. The allocation provision in the policy was conspicuous based on its location in the policy, and its terms were unambiguous. The allocation provision applied since the underlying lawsuit against CCB’s officers alleged both covered and uncovered claims and because the parties could not agree on an allocation. 

Comment

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"Damages" Means Court-Ordered Judgments, And Affirmative Defenses Are Not "Suits"

The California Court of Appeal has held that the term “damages” under a standard CGL policy means court-ordered judgments and that affirmative defenses are not “suits” that trigger a duty to defend. (CDM Investors v. Travelers Cas. And Sur. Co. (2006) 43 Cal.Rptr.3d 669)

Facts

CDM Investors (CDM) owned commercial real property that it had leased to tenants. In 1989, the California Water Quality Control Board (Board) suspected that CDM was discharging pollutants into the soil and groundwater in the vicinity of the property and ordered CDM to test the property for pollutants. CDM claimed coverage under two standard CGL policies issued by Transamerica Insurance Group (TIG) and Travelers Casualty and Surety Company (Travelers).  Both Travelers and TIG denied CDM’s claim. At issue before the court was whether either of the policies provided coverage for “response costs” i.e., the costs CDM incurred when the Board ordered CDM to test for pollutants. 

Holding

The Court of Appeal held that there was no coverage under TIG’s policy because it expressly excluded “loss cost or expense arising out of governmental direction or request that [CDM] test for, monitor, clean up, remove, contain, treat, detoxify or neutralize pollutants.”  

The insuring agreement in the Travelers policy stated that Travelers would pay “the ultimate net loss which the insured [would] become legally obligated to pay as damages.” CDM argued that because the definition of “ultimate net loss” included all expenses incurred by the insured in the investigation and defense of claims or suits seeking damages, that provision expanded the definition of “damages” to include the response costs the Board had ordered CDM to incur. The Court of Appeal rejected that argument, holding that the “ultimate net loss” was what Travelers would pay, after it became obligated to pay, and the trigger of its obligation to pay was “damages.” The term “damages” the Court ruled, clearly denoted only court-rendered damages.

Finally, CDM asserted that shortly after the Board’s order, it sued its former tenants under CERCLA in federal court to apportion its liability for the response costs. The tenants raised affirmative defenses seeking to apportion the responsibility to CDM. CDM asserted that, because of those affirmative defenses, TIG and Travelers had an obligation to defend CDM with respect to the tenants’ claims. The Court also rejected that argument, holding that the tenants’ affirmative defenses did not constitute a “suit.”

Comment

This case reiterates earlier rulings in Foster-Gardner, Inc. v. National Union Fire Ins. Co. (1998) 18 Cal.4th 857 and Certain Underwriters at Lloyd’s of London v. Superior Court (2001) 24 Cal.4th 945, in which the California Supreme Court found no coverage for environmental liability imposed by state and federal administrative agencies.

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New Regulations: No Depreciation of Labor Expense

The expense of labor necessary to repair, rebuild or replace covered property is not a component of physical depreciation and is not subject to depreciation or betterment, per recent additions to the California Department of Insurance’s Fair Claims Settlement Practices Regulations. 

In addition, according to the new regulations, an insurer can apply depreciation only to property normally subject to repair and replacement during the useful life of the property, and must explain the basis for the depreciation in writing.

The new regulations, identified as Section 2695.9 (f) (1), become effective August 30, 2006, and read as follows:

(f) When the amount claimed is adjusted because of betterment, depreciation, or salvage, all justification for the adjustment shall be contained in the claim file. Any adjustments shall be discernable, measurable, itemized, and specified as to dollar amount, and shall accurately reflect the value of the betterment, depreciation, or salvage. Any adjustments for betterment or depreciation shall reflect a measurable difference in market value attributable to the condition and age of the property and apply only to property normally subject to repair and replacement during the useful life of the property. The basis for any adjustment shall be fully explained to the claimant in writing.

(1) Under a policy, subject to California Insurance Code Section 2071, where the insurer is required to pay the expense of repairing, rebuilding or replacing the property destroyed or damaged with other of like kind and quality, the measure of recovery is determined by the actual cash value of the damaged or destroyed property, as set forth in California Insurance Code Section 2051. Except for the intrinsic labor costs that are included in the cost of manufactured materials or goods, the expense of labor necessary to repair, rebuild or replace covered property is not a component of physical depreciation and shall not be subject to depreciation or betterment.

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