News - November 2007

• Misrepresentations on Application Allow Liability Insurer to Rescind Policy and Obtain Reimbursement of Defense/Settlement Costs
• Pollution Exclusion Bars Coverage for Insured’s Liability for Odors and Dust Emanating from Compost Facility
• Primary Auto Insurer Entitled to Contribution from Excess Auto Insurer for Defense Fees Pursuant to Insurance Code Section 11580.9(g)
• California Wildfires: Mudslide Damage May Be Covered if Fire is Predominant Cause of Loss

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Misrepresentations on Application Allow Liability Insurer to Rescind Policy and Obtain Reimbursement of Defense/Settlement Costs

The California Court of Appeal has held that an insured’s misrepresentations on an application for insurance allowed a liability insurer to rescind the policy and obtain reimbursement of defense/settlement costs the insurer had paid on behalf of the insured prior to the rescission. (LA Sound USA, Inc. v. St. Paul Fire & Marine Insurance Company (2007) WL 3358373)

Facts

LA Sound USA, Inc. (LA Sound) and its directors, Ancle Hsu and David Ji, entered into a written joint venture agreement with Hollywood Sound, Inc. (Hollywood Sound) to produce, market and sell audio equipment. The joint venturers used another entity, LSY Trading Development, Inc. (LSY), to begin consolidating their businesses.

Several months after the joint venture was formed, an LA Sound employee contacted an insurance broker about renewing an expiring policy issued by St. Paul Fire & Marine Insurance Company (St. Paul). Based on information supplied by LA Sound, the broker completed the application and submitted it to St. Paul. The application asked “Has applicant been active in or is currently active in joint ventures?” and “Is there a labor interchange with any other business or subsidiaries?”  Both questions were answered “No.”  Based on the information in the application, St. Paul issued a $1 million general liability policy covering LA Sound as named insured and its directors and officers as additional insureds.

Sometime later, disputes arose amongst the joint venturers. As a result, Hollywood Sound sued LA Sound, Hsu, Ji and LSY for trademark infringement. LA Sound, Hsu, Ji and LSY tendered defense of the trademark infringement action to St. Paul. St. Paul agreed to provide a defense under reservation of rights to LA Sound, Hsu and Ji, but denied coverage as to LSY. Thereafter, St. Paul paid a portion of the defense costs incurred by LA Sound, Hsu and Ji. 

Eventually, the trademark infringement action was partially settled. Pursuant to the partial settlement, St. Paul paid $1 million on behalf of LA Sound, Hsu and Ji to Hollywood Sound, and Hollywood Sound dismissed its claims against LA Sound and its claims against Hsu and Ji in their capacities as officers and directors of LA Sound. However, Hollywood Sound did not dismiss its claims against Hsu and Ji in their individual capacities, and did not dismiss its claims against LSY. After further litigation, Hsu, Ji and LSY paid an additional $2.85 million to Hollywood Sound to settle Hollywood Sound’s remaining claims.

Following conclusion of the underlying trademark infringement action, LA Sound, Hsu, Ji and LSY filed a bad faith action against St. Paul, seeking to recover defense costs St. Paul had not paid in the underlying action as well as the $2.85 million which Hsu, Ji and LSY had paid to settle the remaining claims of Hollywood Sound. St. Paul cross-complained, alleging that LA Sound had made misrepresentations on the application, and that as a result St. Paul was entitled to rescind the policy and obtain reimbursement of the defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji.

The trial court ruled that LA Sound had made material misrepresentations on the application justifying rescission of the policy, and that St. Paul was thus entitled to recover all of the defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji in the underlying action. The trial court further held that LA Sound, Hsu and Ji were jointly and severally liable for the entire amount of reimbursement. LA Sound, Hsu, Ji and LSY appealed.  

Holding       

The Court of Appeal affirmed the finding that LA Sound had made material misrepresentations on the application, and that St. Paul was thus entitled to rescind the policy. The appellate court emphasized that the application specifically asked whether LA Sound was involved in joint ventures, that LA Sound had misrepresented its involvement in a joint venture, and that LA Sound had then demanded that St. Paul defend LA Sound against trademark claims related to the joint venture. LA Sounds’ misrepresentations, whether intentional or unintentional, were sufficient to give St. Paul a right to rescind. Further, because St. Paul had a right to rescind the policy, St. Paul was entitled to reimbursement of all defense and settlement costs it had paid on behalf of LA Sound, Hsu and Ji.

However, the Court of Appeal reversed the finding that LA Sound, Hsu and Ji were jointly and severally liable for the entire amount of reimbursement. According to the appellate court, although St. Paul was entitled to recover the policy benefits it conferred on LA Sound, Hsu and Ji, St. Paul still had to establish the amount of benefits conferred separately on each insured. In other words, St. Paul bore the burden of allocating its defense and indemnity costs separately amongst LA Sound, Hsu and Ji. The appellate court thus remanded the case to the trial court to make findings as to the amount owed by LA Sound, Hsu and Ji as restitution of the benefits received by each under the rescinded policy.

Comment    

An insured’s material misrepresentations on an application—whether intentional or unintentional—will give the insurer the right to rescind the policy and to obtain reimbursement of all policy benefits the insurer paid on behalf of the insured prior to the rescission. However, as this case makes clear, where the insurer has paid policy benefits on behalf of more than one insured, the insurer must prove what portion of the benefits are allocable to each insured, and the insurer can only recover from each insured the benefits allocable to that particular insured.

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Pollution Exclusion Bars Coverage for Insured’s Liability for Odors and Dust Emanating from Compost Facility

The California Court of Appeal has held that a pollution exclusion relieved an insurer of any duty to defend or indemnify an insured against claims for injuries caused by offensive odors and excessive dust emanating from the insured’s compost facility. (Cold Creek Compost, Inc. v. State Farm Fire and Casualty Company (2007) WL 4105551) 

Facts

Cold Creek Compost, Inc. (Cold Creek) operated a facility that composted organic materials including animal waste, grape pomace and yard trimmings. Plaintiffs, a group of individuals living within two miles of Cold Creek’s facility, filed an action for nuisance against Cold Creek, seeking both damages and injunctive relief. Plaintiffs alleged that Cold Creek had imported and stored on its property huge quantities of animal waste, grape pomace and yard trimmings, and that the composting materials caused noxious odors and excessive dust which injured the plaintiffs.

Cold Creek tendered defense of the action to its business liability insurer, State Farm Fire and Casualty Company (State Farm). The State Farm policies covered an insured’s liability for “bodily injury,” “property damage” and “personal injury,” but excluded coverage for liability “arising out of the actual, alleged or threatened discharge, seepage, migration, dispersal, spill, release or escape of ‘pollutants’.”  The policies defined “pollutants” as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste included material to be recycled, reconditioned or reclaimed.” In response to the tender, State Farm agreed to defend Cold Creek under a reservation of rights.

The plaintiffs proceeded to trial against Cold Creek. Following trial, the jury awarded five of the plaintiffs a total of $125,000 for injuries caused by the odors and dust. At that point, State Farm concluded that plaintiffs’ claims against Cold Creek were barred from coverage by the policies’ “pollution” exclusions. State Farm thus withdrew from Cold Creek’s further defense and refused to indemnify Cold Creek for the damages awarded to the plaintiffs.

Cold Creek later filed an action against State Farm for breach of contract and bad faith, alleging that State Farm had wrongfully failed to defend and indemnify Cold Creek in the underlying action brought by the plaintiffs. The trial court ruled in favor of State Farm, finding that policies’ pollution exclusions barred coverage for any liability Cold Creek might have to plaintiffs in the underlying action. Cold Creek appealed.

Holding

The Court of Appeal affirmed. According to the appellate court, to the extent the plaintiffs suffered bodily injury arising from noxious odors and excessive dust emanating from Cold Creek’s compost facility, the odors and dust would be considered “pollutants” within the meaning of the pollution exclusions in the State Farm policies. Because the pollution exclusions clearly and unambiguously barred coverage for any liability Cold Creek might have had to the plaintiffs in the underlying action, State Farm had no duty to defend or indemnify Cold Creek  in that action. Thus, State Farm could not be liable to Cold Creek for either breach of contract or bad faith.

Comment 

In California, a pollution exclusion only bars coverage for injuries arising from “traditional environmental pollution” into the air, water and soil, and does not bar coverage for injuries arising from the “negligent use or handling of toxic substances that occur in the normal course of business.” (See MacKinnon v. Truck Ins. Exchange (2003) 31 Cal.4th 635.) In this case, the appellate court concluded that the insured’s alleged widespread dissemination of offensive odors and excessive dust from its compost facility was “traditional environmental pollution” under MacKinnon, and thus excluded from coverage by the pollution exclusion in the policies.

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Primary Auto Insurer Entitled to Contribution from Excess Auto Insurer for Defense Fees Pursuant to Insurance Code Section 11580.9(g)

The California Court of Appeal has ruled that a primary auto insurer was entitled to contribution from an excess auto insurer for defense fees the primary insurer paid to defend a mutual insured, pursuant to Insurance Code Section 11580.9(g). (Mercury Casualty Company v. Scottsdale Indemnity Company (2007) 2007 WL 3355678)

Facts

Mercury and Scottsdale each issued personal automobile policies to the same insured. Mercury’s policy was primary and Scottsdale’s policy was excess. Scottsdale’s policy contained a provision stating that it had no duty to defend a suit unless “no other insurer has an obligation to do so.”

The insured was involved in an auto accident with a third party, who filed suit against the insured. Mercury defended the insured and paid its policy limits toward a settlement of the case. Scottsdale funded the remaining portion of the settlement.

Mercury then sued Scottsdale to obtain contribution for defense fees, pursuant to Insurance Code Section 11580.9(g). That statute states that “Where two or more personal policies affording … liability insurance apply to the same motor vehicle in an occurrence out of which a loss shall arise, and one policy … is primary … and one [is] excess … each insurer shall pay … the percentage of the total defense costs equal to the amount of damage paid by that insurer as a percentage of total damages paid by all insurers ….”   

The trial court granted summary judgment to Mercury based on the terms of the statute, and Scottsdale appealed.

Holding

The Court of Appeal affirmed, holding that Mercury was entitled to contribution based on the terms of the statute. The Court also stated that the purpose of the statute is to spread the burden of defense costs in auto liability lawsuits and to encourage excess auto liability insurers to involve themselves in settlement discussions at an earlier time. The Court rejected Scottsdale’s argument that Insurance Code Section 11580.9(g) is unconstitutional, and held that the trial court properly denied Scottsdale’s request to continue hearing of the motion to allow discovery pertaining to that issue.

Comment

The Insurance Code governs allocation and “order of coverage” issues in automobile liability insurance and will take priority over contrary terms in auto insurance policies. Further, in light of the purpose of Section 11580.9(g), excess auto liability carriers would be wise to become involved early in evaluating high-damage auto liability claims and perhaps offer settlement funds with the primary carrier prior to the claimant’s filing of a suit and, if necessary, negotiate a defense-fee sharing agreement with the primary auto carrier in those cases that have gone to lawsuit.

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California Wildfires: Mudslide Damage May Be Covered if Fire is Predominant Cause of Loss

Insurers processing claims arising out of the recent California wildfires fires need to be aware that, if fire is deemed to be the predominant cause of a mudslide, then a mudslide exclusion that seems to be “ironclad” might not be enforceable.

The leading case on this issue is Howell v. State Farm Fire & Casualty Company (1990)218 Cal.App.3d 1446. In Howell, the insured alleged that fire (a covered peril) had stripped a hillside of its vegetation, that rains had caused a mudslide and that the mudslide had damaged various buildings on the insured’s property. Various all-risk policies that State Farm had issued to the insured provided that damage caused by mudslide was not covered under any circumstances, “regardless of … whether other causes acted concurrently or in any sequence with the excluded event to produce the loss….” 

The Court of Appeal in Howell held that the exclusion in State Farm’s policy was contrary to California’s “predominant cause” rule and, therefore, not enforceable. Pursuant to the “predominant cause” rule (sometimes the called “efficient proximate cause” rule), coverage depends upon which peril—the covered peril or the non-covered peril—was the predominant cause of the loss. (Garvey v. State Farm Fire & Casualty Company (1989) 48 Cal.3d 395.) Thus, no matter how clearly they are worded, exclusions that purport to circumvent the predominant cause rule generally are invalid.

When a mudslide occurs in an area that has sustained fire damage and the mudslide causes damage to covered property, the insurer should retain appropriate experts to determine whether the fire was the predominant cause of the mudslide. If fire is a covered peril, and if fire was the predominant cause of the mudslide, then damage to covered property likely will be covered, per the Howell case.

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