News - June 2008

• Engineer’s Design Errors Are Not “Defective Methods In Construction” And Do Not Trigger Collapse Coverage
• Letter From Claimant’s Attorney To Insured Is “Claim” Under “Claims Made And Reported” Policy
• If Insurer’s Reservation Of Rights Triggers Insured’s Right To “Independent Counsel,” Any Dispute Regarding Independent Counsel’s Fees Must Be Arbitrated, Even If Insurer Does Not Retain “Panel Counsel”
• Uninsured Motorist Coverage: California Supreme Court Clarifies Scope Of Arbitrator’s Jurisdiction In UM/UIM Cases

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Engineer’s Design Errors Are Not "Defective Methods In Construction" And Do Not Trigger Collapse Coverage

The California Court of Appeal has held that an engineer’s design errors are not “defective … methods in construction” and do not trigger a policy’s collapse coverage. (Roberts v. Assurance Company of America (2008) 2008 WL 2468889)

Facts

Jim Roberts purchased an undeveloped lot located on a steep slope with the intention of building a home on it. Roberts also obtained a builder’s risk policy from Assurance Company of America.

Assurance issued two consecutive annual builder’s risk policies and, later, an unsold dwelling policy. The builder’s risk policies provided first-party property coverage during the course of construction and obligated Assurance to pay “for direct physical loss to Covered Property from any Covered Loss described in this Coverage Form.” The unsold dwelling policy provided first party property coverage for the property until it was sold or occupied and obligated Assurance to pay for “direct physical loss to Covered Property from a Covered Cause of Loss described in this Coverage Form.”

While construction was under way, Roberts noticed cracks in the foundation and a retaining wall next to the house, which worsened over the next few months. After a period of heavy rains, a landslide occurred, causing severe damage to the dwelling.

Assurance retained an engineer to investigate the causes of the landslide. The engineer concluded the damage was caused by an ancient landslide under the property, and that the ancient landslide was activated by the placement of fill soils on Roberts’ property and a neighboring lot during grading. The engineer also concluded that heavy rains accelerated the rate of slope subsidence that had already begun and constituted a second cause of the landslide.

Assurance’s policies contained exclusions for earth movement, weather conditions that contribute to a loss caused by earth movement, acts or decisions of any governmental, regulatory or controlling body, and loss caused by faulty, inadequate or defective planning, development, surveying, siting, design, construction or grading. The policies also provided coverage for “collapse”  if caused by various named perils, one of which was “[u]se of defective materials or methods in construction, remodeling or renovation if the collapse occurs during the course of construction, remodeling or renovation.” 

Ultimately, Assurance denied Roberts’ first-party claim. Thereafter, Roberts filed suit against Assurance for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief. The trial court granted summary adjudication in favor of Assurance, and Roberts appealed.

On appeal, Roberts argued that the predominant cause of the loss was a developer’s concealment of the existence of the underlying ancient landslide. Alternatively, Roberts argued that his own geotechnical expert’s failure to adequately survey, design or site the project—and the resulting overloading of the slope—was a “defective” method in construction and that the “collapse” coverage therefore applied.

Holding

The Court of Appeal held that the developer’s alleged concealment of the ancient landslide was not a conceptually distinct peril apart from the ancient landslide itself. According to the Court, the reason for the earth movement, whether due to the alleged concealment of the ancient landslide or due to the placement of fill, was immaterial. In addition, according to the Court, “[c]oncealment by the developer was not a separate cause for the loss, but merely a separate explanation for the single cause of the loss, i.e., earth movement.” The Court also noted that even if the predominant cause doctrine did apply, Roberts admitted that his own geotechnical engineer knew of the ancient landslide but failed to report its presence when performing engineering services for the lot.

Finally, the Court of Appeal held that Roberts’ geotechnical expert’s failure to adequately survey, design or site the project was a “design error,” not a “defective method in construction,” and that the collapse coverage provision therefore did not apply.

Comment

This case purports to draw a distinction between a “design error” and a “defective method in construction.” The Court appears to have relied upon the fact that there was no evidence that there was any defect in the fill soil placed on the slope. Instead, according to the Court, the fundamental cause of the failure was an excluded “design error”—Roberts’ geotechnical expert’s failure to detect the underlying ancient landslide and to then design and site the improvement accordingly.

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Letter From Claimant's Attorney To Insured Is "Claim" Under "Claims Made And Reported" Policy

The California Court of Appeal has held that a letter from a claimant’s attorney to the insured threatening litigation was a “claim” within the meaning of the insured’s “claims made and reported” policy. (Westrec Marina Management, Inc. v. Arrowood Indemnity Company (2008) WL 2406143)

Facts

Arrowood Indemnity Company issued two consecutive directors and officers liability insurance policies to Westrec Marina Management, Inc. The first policy was effective from July 1, 2002 to July 1, 2003, and the second policy was effective from July 1, 2003 to July 1, 2004. Each policy provided coverage for losses incurred in connection with claims “first made” against the insured during the policy period and reported to the insurer within 30 days after the expiration of the policy.

Bette Clark was a former employee of Westrec. In June 2003 (during the first policy period), Clark’s attorney faxed a letter to Westrec stating that Clark had been subjected to sex discrimination at Westrec, had been wrongfully terminated from Westrec, and had received a “right to sue” notice from the Department of Fair Employment and Housing allowing her to sue Westrec. The letter from Clark’s attorney stated that Westrec might prefer “to resolve or mediate this matter” rather than become involved in expensive litigation, and asked Westrec to contact Clark’s attorney to discuss the matter. Westrec did not notify Arrowood of this letter within 30 days after the expiration of the first policy.

In December 2003 (during the second policy period), Clark sued Westrec for employment discrimination and wrongful termination. Westrec promptly tendered the lawsuit to Arrowood for defense. However, Arrowood rejected Westrec’s tender on the ground that the letter from Clark’s attorney to Westrec in June 2003 constituted a “claim” made against Westrec during the first policy period, and Westrec had failed to provide notice of that claim to Arrowood within 30 days after the expiration of the first policy.

Westrec then filed a breach of contract/bad faith lawsuit against Arrowood alleging that Arrowood had wrongfully refused to defend Westrec in the underlying lawsuit brought by Clark. The trial court ruled in favor of Arrowood, and Westrec appealed.

Holding

The Court of Appeal affirmed the judgment in favor of Arrowood.

According to the appellate court, the letter that Clark’s attorney sent to Westrec in June 2003 constituted a “claim” that was made against Westrec during the first policy period. Both Arrowood policies defined a “claim” so as to include “a written demand for civil damages or other relief,” and the June 2003 letter from Clark’s attorney to Westrec was “a settlement demand seeking monetary compensation” from Westrec. The appellate court stated that “although the [June 2003] letter did not expressly demand payment or refer to any specific amount, its meaning was clear that, absent some form of negotiated compensation, Clark would commence a lawsuit against Westrec.” In short, the letter Clark’s attorney sent to Westrec in June 2003 constituted a “claim” that was made against Westrec during the first policy period, and Westrec failed to provide notice of that “claim” to Arrowood within 30 days after the expiration of the first policy.  

Moreover, the court concluded that the letter Clark’s attorney sent to Westrec in June 2003 (during the first policy period) was the “same claim” as the lawsuit Clark filed against Westrec in December 2003 (during the second policy period). In that regard, both Arrowood policies stated that “all claims based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving the same or related facts, circumstances, situations, transactions or events, shall be deemed to be a single claim.” According to the court, the December 2003 lawsuit and the June 2003 letter “constituted a single claim that was first made at the time of the [June 2003] letter.” Because Westrec failed to provide Arrowood with notice of that claim within 30 days after expiration of the first policy, Arrowood had no duty to defend or indemnify Arrowood.

Comment

This case should serve as a warning to insureds under “claims made and reported” policies. If there is any doubt as to whether the third party is making a “claim” against the insured, the insured should put its insurer on notice. Here, the June 2003 letter from the claimant’s attorney to the insured did not expressly demand payment in any specific amount. Nevertheless, according to the court, the letter made it clear that unless the parties reached a settlement, the claimant would sue the insured. That being the case, the letter constituted a “claim” that the insured was required to report to its insurer within the time specified in the policy.

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If Insurer’s Reservation Of Rights Triggers Insured's Right To "Independent Counsel," Any Dispute Regarding Independent Counsel’s Fees Must Be Arbitrated, Even If Insurer Does Not Retain "Panel Counsel"

The California Court of Appeal has held that if a liability insurer’s reservation of rights creates a conflict of interest that gives the insured the right to have “independent counsel,” any dispute regarding the independent counsel’s fees is subject to mandatory arbitration, even if the insurer does not retain “panel counsel” to assist in the defense. (Long v. Century Indemnity Company (2008) WL 2426599)

Facts

In 1996 the California Department of Toxic Substance Control (DTSC) filed an environmental cleanup action against G. Harris International (Harris). Harris’ personal attorney, Jay B. Long (Long), tendered Harris’ defense to Harris’ general liability insurer, Insurance Company of North America (INA). INA agreed to defend Harris under a “reservation of rights” (the exact nature of which was not disclosed in the case).

INA asked Long to represent Harris in the cleanup action brought by the DTSC. However, INA was unwilling to pay Long the hourly rate he requested, contending that Long was subject to the “rate cap” established by California Civil Code section 2860(b). When Long and INA were unable to resolve their dispute regarding hourly rates, they agreed that INA would pay Long at the capped hourly rate that INA contended was applicable, with Long reserving his right to seek payment of his normal hourly rate at some later date.

By July 2002 the DTSC had settled its claims as against Harris. In July 2005 Long demanded that INA pay Long the additional attorney fees Long claimed were due for his representation of Harris (i.e., the difference between what INA had paid Long pursuant to section 2860(b) and Long’s normal hourly rate). Without conceding that the “mandatory arbitration” provision of section 2860(c) applied, Long also demanded that INA submit the dispute concerning hourly rates to arbitration. INA refused Long’s demand for payment and declined to submit the matter to arbitration, asserting that Long’s claim for additional attorney fees was barred by the statute of limitations.

Harris then assigned rights to Long, and Long filed a bad faith action against INA. Long essentially sought to recover from INA the difference between what he was paid by INA and what he would have been paid at his normal hourly rate. Notably, however, Long did not allege facts showing that INA’s reservation of rights did not create a conflict of interest that triggered a right to independent counsel.

The trial court dismissed Long’s claim against INA on the ground that Long’s claim against INA involved a fee dispute regarding the rates to be paid to independent counsel, and that the claim and was therefore subject to mandatory arbitration under Civil Code section 2860(c). Long appealed.

Holding

The Court of Appeal affirmed, holding that Long’s fee dispute with INA was subject to arbitration under Civil Code section 2860(c).

The appellate court began by rejecting Long’s argument that because INA had never retained “panel counsel” to represent Harris in the underlying environmental cleanup lawsuit, INA could not compel arbitration of the fee dispute. According to the appellate court, there is nothing in Civil Code section 2860 that requires the insurer to retain “panel counsel” before section 2860 can apply. Rather, if the insured has a right to be represented by independent counsel, then section 2860 applies whether or not the insurer retains panel counsel to join with independent counsel in defending the insured.

The appellate court then observed that Long had not alleged that INA’s reservation of rights did not trigger a right to independent counsel. Since Long had not alleged that INA’s reservation did not trigger a right to independent counsel, the appellate court essentially presumed that INA’s reservation of rights did trigger a right to independent counsel and that section 2860 therefore did apply. Since section 2860 applied, any fee dispute between Long and INA was subject to mandatory arbitration. 

Comment

This is an unusual case in that it was the insurer—not the insured—who was arguing that the insurer’s reservation of rights created a conflict of interest sufficient to give the insured a right to “independent counsel.” The insurer obviously took that position so that it could assert that any dispute regarding fees owed to independent counsel was subject to mandatory arbitration under Civil Code section 2860(c). 

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Uninsured Motorist Coverage: California Supreme Court Clarifies Scope Of Arbitrator’s Jurisdiction In UM/UIM Cases

Insurance Code section 11580.2 requires insurers to provide coverage for bodily injury or wrongful death caused by uninsured or underinsured motorists. Section 11580.2(f) provides that “the determination as to whether the insured shall be legally entitled to recover damages, and if so entitled, the amount thereof, shall be made by agreement between the insured and the insurer or, in the event of disagreement, by arbitration.”  In a recent decision involving two consolidated appeals, the California Supreme Court clarified exactly what issues an arbitrator has jurisdiction to decide during a UM/UIM  arbitration.

In Bouton v. USAA Cas. Ins. Co. (case no. S149851), Lloyd Bouton was injured in an automobile accident allegedly caused by Kevin Daniels, and settled his claim against Daniels for Daniels’ automobile insurance policy limit of $15,000. Bouton then demanded UIM arbitration with Bouton’s sister’s insurer, USAA Casualty Insurance Company, seeking damages exceeding the $15,000 policy limit payment he received from Daniels’ insurer. USAA denied coverage, claiming that Bouton was not a resident of his sister’s household, and was therefore not an “insured” under her policy. Bouton filed a motion to compel arbitration. The trial court denied the motion to compel, finding that under section 11580.2(f) and USAA’s policy, the parties were only bound to arbitrate the issues of liability and damages, not coverage.

The Supreme Court agreed that a court, not an arbitrator, must determine whether Bouton is an “insured” under his sister’s policy. The Supreme Court held that whether Bouton is an insured under the insurance policy is not a question regarding the underinsured tortfeasor’s liability to the insured or the amount of damages. Rather, it is a question of coverage that must be decided by a court, not an arbitrator.

In the companion case, O’Hanesian v. State Farm Mut. Automobile Ins. Co. (case no. S149847), Charles O’Hanesian was injured when his car was rear-ended by Curtis Thurlow’s car. O’Hanesian sued Thurlow, who failed to appear after being properly served. O’Hanesian submitted evidence regarding the extent of his injuries at a bench trial, and the court awarded him over $2.7 million in compensatory damages and $1 million in punitive damages. O’Hanesian made a demand on Thurlow’s liability insurer and received the policy limit of $100,000.O’Hanesian then made a demand for $900,000 under the UIM provisions of his own policies through State Farm Mutual Automobile Insurance Company. When State Farm asserted that it was not bound by O’Hanesian’s default judgment against Thurlow, O’Hanesian sued State Farm for breach of contact and bad faith. The trial court ruled that O’Hanesian’s lawsuit against State Farm was premature, because no arbitration had occurred as required by the State Farm policies.

The Supreme Court upheld the trial court’s decision, concluding that it was for an arbitrator, not a court, to decide whether O’Hanesian’s default judgment against Thurlow was enforceable against State Farm. The Supreme Court reasoned that the default judgment pertained directly to the underinsured tortfeasor’s liability to O’Hanesian and the amount of damages owed, and that those were both issues subject to arbitration under section 11580.2(f) and the State Farm policies.

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