News - September 2006

• Liability Policy Covers Property Damage Occurring During Policy Period, Even Though Claimant Does Not Own Property Until After Policy Period
• Insurer May Rescind Policy Based On Insured’s Failure to Disclose Prior Loss History
• Insurance Code Section 533 Does Not Necessarily Bar Coverage for Claims Alleging Breach of Fiduciary Duty
• Environmental Coverage: "Total Pollution Exclusion" Precludes Coverage for Liability Arising From Discharge of Dirt and Rocks into Creek

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Liability Policy Covers Property Damage Occurring During Policy Period, Even Though Claimant Does Not Own Property Until After Policy Period

The California Court of Appeal has held that a commercial general liability policy covered an insured for progressive property damage which occurred during the policy period, even though the claimant did not own the property until after the policy period. (Standard Fire Insurance Co. v. Spectrum Community Association (2006) 141 Cal.App.4th 1117)

Facts

Bristol House Partnership, Ltd. and related parties (Bristol) developed a large residential condominium project known as the Spectrum Condominiums. There was evidence that beginning as early as 1990 and continuing in subsequent years, defective construction caused progressive property damage at the condominium project.

From August 1991 through June 1992 (during the time that property damage potentially occurred at the project), Bristol was insured under a commercial general liability policy issued by Standard Fire Insurance Company (Standard). The policy covered Bristol’s liability for property damage occurring “during the policy period.”   

In August 1993 (after expiration of Bristol’s policy through Standard), the Spectrum Community Association (Association) was formed to manage the common areas of the condominium project. Sometime later, the Association filed a construction defect action against Bristol to recover for alleged property damage to the common areas of the project. Bristol tendered defense of the construction defect action to Standard, which agreed to defend Bristol under a reservation of rights.

Standard then filed a declaratory relief action seeking a determination that it had no duty to defend or indemnify Bristol in the construction defect action bought by the Association. Standard moved for summary judgment, arguing that because the Association was not formed and did not own any interest in the condominium project until after Standard’s policy period, the Association could not have suffered any property damage during the policy period. The trial court agreed and entered summary judgment in favor of Standard.

Holding

The Court of Appeal reversed. After an exhaustive review of prior case law, the court ruled that under an “occurrence-based” liability policy, the critical question is not when the third-party claimant was damaged, but rather, when the property now owned by the claimant was damaged. Because there was evidence that the condominium project itself suffered actual property damage while Standard’s policy was in force, Standard had a duty to defend Bristol in the underlying construction defect action brought by the Association. It was irrelevant that the Association had not come into existence and had not acquired any interest in the project until after the policy period.

Comment  

The Court of Appeal’s decision in this case is consistent with earlier precedent, namely Garriott Crop Dusting Co. v. Superior Court (1990) 221 Cal.App.3d 783 and Century Indemnity Co. v. Hearrean (2002) 98 Cal.App.4th 734. In essence, the insurer in this case sought to convince the Court of Appeal that Garriott and Century Indemnity were wrongly decided and should not control. The Court of Appeal refused to depart from the holdings in Garriott and Century Indemnity, reaffirming that the proper inquiry is not whether the claimant owned the property during the policy period, but rather whether the property now owned by the claimant was damaged during the policy period.  

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Insurer May Rescind Policy Based On Insured’s Failure to Disclose Prior Loss History

The United States District Court for the Eastern District of California has held that an insurer was entitled to rescind an insurance policy based on the insured’s misrepresentations about its loss history, and that the insurer did not unreasonably delay in seeking rescission. (Admiral Insurance Company. v. Debber (2006) 2006 WL 2051037)

Facts

Admiral Insurance Company (Admiral) provided Data Control Corporation (DCC) with a quote for an Employment Practices Liability Insurance (EPLI) policy. Admiral then issued DCC a binder which stated that Admiral’s review and acceptance of an original Admiral application was a condition precedent to coverage.

DCC’s insurance broker later provided Admiral with the completed application in which DCC represented that there had been no claims against DCC, its officers or employees for harassment or wrongful discharge within the last five years, and that DCC, its officers and its employees had not been involved in any lawsuit, charges, investigations or other governmental proceedings within the last five years. DCC representatives filled out the application and a renewal application consistent with its broker’s advice that DCC need not disclose two prior lawsuits because the claims were first made more than five years earlier. Based on the application, Admiral issued an EPLI policy to DCC.

Sometime later, Vickie and Scott Altman (the Altmans) sued DCC and its Chief Executive Officer, J. Dale Debber (Debber), for sexual harassment and retaliation. In their complaint the Altmans alleged that DCC and Debber had defended at least three similar sexual harassment and retaliation suits since 1996. Two of the lawsuits were pending within five years of DCC’s application for the Admiral EPLI policy.

DCC and Debber tendered the action Admiral, and Admiral agreed to defend DCC and Debber subject to a reservation of rights. Three months later, Admiral decided to file an action to rescind DCC’s policies based on DCC’s failure to disclose the two prior legal claims against DCC and Debber. Shortly thereafter, Admiral, on behalf of Debber and DCC, settled with the Altmans.

Nine months after receiving notice of the prior legal claims against DCC and Debber, Admiral filed a complaint seeking rescission of the Admiral EPLI policies and reimbursement of defense/indemnity payments it had made pursuant to those policies.

Holding

The United States District Court, applying California law, held that DCC’s failure to disclose prior lawsuits on the policy application was material to the contract and provided Admiral with a sufficient basis for rescinding the policy. DCC’s reliance on the advice of its insurance broker in omitting claims history from an application was not a defense to rescission.

The District Court also held that Admiral’s issuance of a conditional binder before receipt of a policy application did not show lack of reliance on the application in issuing the policy, and that Admiral had no obligation to investigate the veracity of DCC’s responses.

Last, District Court held that Admiral’s nine-month delay in filing a rescission suit was not unreasonable for purposes of a laches defense, and that DCC was not substantially prejudiced when it pursued an “aggressive” litigation strategy.

Comment

Generally speaking, an insured’s misrepresentations about its prior claims history, whether intentional or unintentional, will provide a basis for rescission. As the court noted in this case, “even an unintentional non-disclosure is sufficient to support rescission of an insurance contract, if the non-disclosed information was material to the contract.” According to the court, “DCC’s loss history was material information to the contract” and “non-disclosure of the information merits rescission of the contract.”

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Insurance Code Section 533 Does Not Necessarily Bar Coverage for Claims Alleging Breach of Fiduciary Duty

The Ninth Circuit Court of Appeals has held that California Insurance Code section 533 does not necessarily preclude coverage for claims arising from an insured’s alleged breach of fiduciary duties.  (Unified Western Grocers, Inc. v. Twin City Fire Ins. Co.  (9th Cir. 2006) 457 F.3d 1106)

Facts

In 1990 Unified Western Grocers, Inc. (Unified) acquired Hawaiian Grocery Stores (HGS) for $2.3 million, and over the next several years Unified invested a total of $7 million in HGS. By 1996, Unified decided to sell HGS, and Unified appointed six of its own corporate officers, including Daniel Bane, to act as officers and/or directors of HGS. These appointed officers and directors then approved a leveraged buy-out transaction to sell all of the common shares of HGS sale from Unified to RHL, Inc. for $2.4 million.

To fund the transaction, Unified obtained a $4.5 million line of credit which was secured by HGS’s assets. Unified’s appointed directors, acting as HGS’s board, also approved a secured promissory note from HGS to Unified for $5.3 million, which converted Unified’s investment into HGS into secured debt. All of the officers and directors Unified appointed to HGS’s board, except Bane, resigned after HGS was sold.

HGS then filed for bankruptcy, and the bankruptcy trustee representing HGS’s bankruptcy estate sued Unified and all of the officers and directors it had appointed to run HGS, including Bane. The bankruptcy trustee asserted claims for breach of fiduciary duty, aiding and abetting and civil conspiracy, alleging that Unified, the officers and directors it appointed to run HGS, and RHL had all conspired to drain assets from HGS while misleading creditors as to HGS’s credit-worthiness and concealing damaging information. The trustee sought $13.5 million in damages and further alleged that around $8.5 million was transferred from HGS to Unified after it was sold to RHL.

Twin City Insurance Company had issued a directors and officers’ liability policy to Unified, which also insured all of the officers and directors Unified had appointed to run HGS. The officers and directors filed a declaratory relief action seeking a declaratory judgment that Twin City was obligated to pay defense costs and reimburse them for the losses resulting from the bankruptcy trustee’s lawsuit.

The United States District Court granted summary judgment for Twin City, ruling that coverage was barred by California Insurance Code section 533, which states that an insurer is not liable for losses caused by the insured’s “willful act.” The District Court also held that because the bankruptcy trustee’s complaint only sought “restitution,” Twin City had no duty to indemnify because California law precludes indemnification and reimbursement of claims that seek restitution of an ill gotten gain.

Holding

The Ninth Circuit Court of Appeals reversed. The Court of Appeals concluded that although the bankruptcy trustee’s conspiracy claim contained allegations of willful conduct, the bankruptcy trustee’s breach of fiduciary duty claim did not depend on a knowing, intentional or purposeful act, and could have occurred without any intent or expectation to cause harm. Nor were the allegations of breach of fiduciary duty inseparably intertwined with the allegations of willful conduct. Therefore, section 533 did not necessarily bar coverage for the bankruptcy trustee’s claims.

The Ninth Circuit further held that although the bankruptcy trustee sought the return of all monies improperly funneled to Unified, only $8.5 million of the $13.5 million in damages was alleged to have been transferred to Unified. Therefore, at least some of the monies sought by the trustee constituted “damages,” rather than “restitution” and, thus, there was a genuine issue of material fact as to whether all of the damages sought by the bankruptcy trustee constituted restitution.

Comment

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Environmental Coverage: "Total Pollution Exclusion" Precludes Coverage for Liability Arising From Discharge of Dirt and Rocks into Creek

In Ortega Rock Quarry v. Golden Eagle Insurance Co. (2006) 141 Cal.App.4th 969, the insured operated a rock quarry at leased premises, and allegedly caused dirt and rocks to fill portions of a creek on the leased premises. The insured filed a bad faith suit against its insurers for refusing to defend the insured against (1) an administrative proceeding by the Environmental Protection Agency (EPA) and (2) a lawsuit by the lessor.

The Court of Appeal held that the insurers had no duty to defend or indemnify the insured against the EPA administrative proceeding and subsequent “clean up orders” issued by the EPA, because an EPA proceeding was not a “suit” within the meaning of the insurers’ policies.

The Court also held that the “total pollution exclusion” in the insurers’ policies was unambiguous and eliminated any duty to defend the insured against the lessor’s lawsuit. The total pollution exclusion applied to “property damage which would have not occurred in whole or in part but for the actual, alleged or threatened discharge … of pollutants.” The policies defined “pollutants” as “any solid … irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”

After analyzing case law and the statutory definition of pollutants in the federal Clean Water Act, the Court ruled that dirt and rocks discharged into water were “pollutants” within the meaning of the total pollution exclusion. The Court rejected the insured’s argument that the insurers’ failure to specifically adopt the federal statutory definition of “pollutants” rendered the total pollution exclusion ambiguous. The Court also rejected the insured’s argument that the total pollution exclusion’s definition of “pollutants” was limited to items after the word “including.”  According to the Court, the list of “pollutants” in the total pollution exclusion is not exhaustive. (See Garamendi v. Golden Eagle Insurance Co. (2005) 127 Cal.App.4th 480 [silica dust is a “pollutant”].) 

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