PCI Northeast General Counsel Seminar

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1 PCI Northeast General Counsel Seminar September 18-19, 2017 Insurance Law Developments Laura A. Foggan Crowell & Moring LLP Crowell & Moring 1

2 Zhaoyun Xia v. ProBuilders Specialty Insurance Co. No (Wash. 2017). Crowell & Moring 2

3 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law The Supreme Court of Washington held that an absolute pollution exclusion in a CGL policy did not bar coverage for loss arising from carbon monoxide infiltration where the efficient proximate cause of the loss was negligence. The policyholder a home construction company was sued after a water heater it negligently installed exposed the homeowner to harmful levels of carbon monoxide. The insurer denied coverage, citing: (1) a pollution exclusion similar to an ISO total pollution exclusion; and (2) a townhouse exclusion. The homeowner and policyholder entered into a settlement that included stipulated damages of $2 million. The homeowner agreed not to execute or enforce the judgment against the policyholder, and the policyholder assigned the homeowner all causes of action it had against the insurer. The homeowner sued the insurer, alleging inter alia that the insurer had acted in bad faith when it refused to defend the policyholder against the homeowner s claims. The trial court found that the townhouse exclusion applied and barred coverage. On appeal, the intermediate appellate court reversed in part, finding that while the townhouse exclusion did not apply, the pollution exclusion did. Crowell & Moring 3

4 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law On appeal, the Washington Supreme Court addressed: (1) whether the pollution exclusion precluded coverage; and (2) whether the refusal to defend was in bad faith. First, the Court considered whether the absolute pollution exclusion effectively precluded coverage for the homeowner s injuries. The Court stated that under established Washington precedent, the analysis of a pollution exclusion necessarily turns on a determination of whether an occurrence, as defined under the policy, stems from either: (1) a traditional environmental harm; or (2) a pollutant acting as a pollutant. If the answer is yes and the policy language is unambiguous, then courts must apply the pollution exclusion s terms to determine whether it applies to the facts at issue. Here, the Court found that the pollution exclusion would apply to the facts at issue. However, the Court then opined that the analysis does not end at this stage. Rather, it held that courts must next consider whether the excluded occurrence is the efficient proximate cause of the claimed loss before determining whether coverage is available under the policy. Crowell & Moring 4

5 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law Under Washington law, the efficient proximate cause rule means that, if the initial event giving rise to a claim is insured, then coverage is available regardless of whether subsequent events that are causes-in-fact of the loss are excluded by the policy. The Washington Supreme Court had not previously applied the rule to a CGL policy. However, the court stated that it had never suggested the rule applies only to one type of insurance policy. As such, the Court found the rule should apply here, where the CGL policy provided protection against harm caused by negligence, and the homeowner s claim arose from allegations that the water heater was negligently installed. In the Court s opinion, the insurer had received valuable premiums for protection against harm caused by negligence, and could not avoid liability simply because an excluded peril resulted from the initial covered peril. The Court held that the efficient proximate cause rule applies when two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss. Thus, the Court held, insurer may craft exclusions that deny coverage when an excluded occurrence initiates the causal chain and is the sole proximate cause of a loss. However, the Court cautioned, insurers cannot draft exclusions that expressly circumvent the efficient proximate cause rule. Crowell & Moring 5

6 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law In this case, the Court found that pollution exclusion inapplicable, as the efficient proximate cause of the homeowner s injury was a covered peril -- the negligent installation of the water heater. The Court first found that the insurer did not err in determining that the plain language of its pollution exclusion applied to the release of carbon monoxide into [the] home. However, the Court also held that the insurer should have noted that a potential issue of efficient proximate cause existed, as the homeowner alleged negligence in her original complaint. Additionally, the Court found that the record suggests the insurer conducted no investigation into Washington law regarding the potential applicability of the rule of efficient proximate cause before declining coverage. The Court found that the insurer wrongfully refused to defend the policyholder and granted the homeowner s appeal on bad faith as well as the existence of a duty to defend. Crowell & Moring 6

7 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law The majority opinion was accompanied by a concurrence and a dissent. The dissenting opinion argued: that the Court erred by applying the efficient proximate cause rule to the facts of this case after the majority of the same Court in a recent decision (Quadrant) expressly declined to do so when faced with analogous facts; and that, even assuming the efficient proximate cause rule should apply, it was erroneous to find that the insurer acted in bad faith, as the insurer had no basis to presume that the rule would extend to these circumstances prior to the issuance of this decision. The concurring opinion joined with the majority s conclusion that the insurer had a duty to defend in this case, but agreed with the dissent that there should be no duty to indemnify given the Court s previous decision not to apply the efficient proximate cause rule in Quadrant. Crowell & Moring 7

8 Zhaoyun Xia Absolute Pollution Exclusion and Bad Faith Under Washington Law Discussion and Questions Crowell & Moring 8

9 Mount Vernon Fire Ins. Co. v. VisionAid, Inc. No. SJC (MA 2017) Crowell & Moring 9

10 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law The Massachusetts Supreme Court held that, under Massachusetts law, an insurer s duty to defend and/or reimburse defense costs does not require it to cover the costs associated with prosecuting a policyholder s affirmative counterclaim. This dispute arose when the policyholder, a company that manufactures and distributes lens cleaning and eye safety products, fired an employee in October 2011, when the policyholder employer discovered that he had misappropriated thousands of dollars in company funds. The employee filed a wrongful termination suit against the policyholder, who sought a defense from its insurer. The insurer agreed to defend the policyholder, but contended that it was not required to pay for the prosecution of the policyholder s counterclaims or affirmative actions for recovery of the misappropriated funds. Crowell & Moring 10

11 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law The district court s ruling in favor of the insurer was appealed to the First Circuit, which concluded that the case presented questions of first impression under Massachusetts Law. As such, the court certified three questions to the Massachusetts Supreme Court: 1. Whether an insurer has a duty to prosecute the policyholder s counterclaims, where the insurance contract provides that the insurer has a duty to defend any Claim? 2. Whether an insurer has a duty to fund the prosecution of the policyholder s counterclaims, where the insurance contract requires the insurer to cover Defense Costs, or the reasonable and necessary legal fees and expenses resulting from the investigation, adjustment, defense, and appeal of a Claim? 3. Assuming the existence of either duty, does a conflict of interest arise that entitles the insured to control and/or appoint independent counsel to control the entire proceeding, including both the defense of any covered claims and the prosecution of the subject counterclaims? Crowell & Moring 11

12 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law With respect to the insurer s duty to defend, the Court found that the policy obligated the insurer to defend the policyholder against any claim. The policy defined a claim as any proceeding initiated against [the policyholder], but left the term defend undefined. After considering its common usage, the Court found that the term defend meant to work to defeat a claim that could create liability against the individual being defended. Thus, the extent of the parties agreement was that the insurer would defend the policyholder in claims against it, and nothing more. Crowell & Moring 12

13 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law The Court rejected the policyholder s argument that the term defend was ambiguous, and could be read to mean anything a reasonable defense attorney would do to reduce the liability of the insured. In doing so, the Court recognized that courts in a number of other jurisdictions have considered similarly-worded insurance policies, and have found that the word defend is not ambiguous. The Court further found that adopting the policyholder s proposed interpretation would require the Court to read a number of provisions into the policy that the parties themselves did not include provisions which would place an additional duty on the insurer to indemnify its policyholder for the costs of prosecuting a compulsory counterclaim that is intertwined with the policyholder s defense where any reasonable attorney would ordinarily bring such a claim. This would lead to extensive preliminary litigation between insurers and policyholders regarding what claims are sufficiently intertwined, or what claims would be brought by any reasonable attorney. Crowell & Moring 13

14 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law Next, the Court addressed this issue in the context of Massachusetts in for one, in for all rule. Under the in for one, in for all rule, an insurer who is obligated to defend its policyholder against one count must defend that policyholder against all counts alleged against it, even those that are not covered. The Court found that the rule did not change the meaning of the word defend, and thus could not require an insurer to prosecute an affirmative claim. To hold otherwise, the Court found, would misalign[] the interests of the party who stands to benefit from the counterclaim (the [policyholder]) and the party who bears the costs of prosecuting the counterclaim (the insurer). Furthermore, the policyholder s approach would lead to increased litigation between insurers and policyholders the very issue that the in for one, in for all rule was designed to avoid. Lastly, the Court held that under Massachusetts law, where an insurer has both a duty to defend and the duty to pay defense costs, the scope of both duties are identical. As such, the insurer s duty to reimburse defense costs also does not require it to fund the prosecution of a counterclaim on behalf of its policyholder. Crowell & Moring 14

15 Mount Vernon Fire Ins. Co. v. VisionAid The Duty to Defend and Affirmative Claims Under Massachusetts Law Discussion and Questions Crowell & Moring 15

16 Harleysville Group Ins. v. Heritage Communities Slip. Op. No (S.C. Jul. 26, 2017) Crowell & Moring 16

17 Harleysville Group v. Heritage Communities Reservations of Rights, Allocation, and Punitive Damages Under South Carolina Law This decision arose from consolidated appeals involving the same insurer and policyholder, and substantially the same controversy. The policyholder, a development company that designed and constructed two condominium complexes, was sued for construction defects related to both projects. The insurer agreed to defend under a purported reservation of rights. At trial, the policyholder conceded liability, and after a trial on damages the jury returned verdicts against the policyholder in both suits, including for compensatory and punitive damages. Because faulty workmanship is not a covered occurrence under South Carolina law, but damage to other nondefective construction components is covered, the insurer filed suit to determine what portion of the judgments would be covered. The policyholder defaulted, but the judgment-creditor continued to seek coverage for the jury awards. The matter was referred to a Special Referee, who found that: (1) the Insurer s reservation of rights was insufficient; (2) coverage under the policies was triggered because the general verdicts included some covered damages; (3) the Insurer was responsible for a share of the actual damages proportionate to its pro rata time on the risk; (4) punitive damages were covered; and (5) the award of punitive damages was not subject to prorata allocation. The parties subsequently filed cross-appeals of the Special Referee s findings. Crowell & Moring 17

18 Harleysville Group v. Heritage Communities Reservations of Rights, Allocation, and Punitive Damages Under South Carolina Law The South Carolina Supreme Court largely affirmed the Special Referee s findings. The Court found that the insurer s reservation of rights letter was insufficient to effectively reserve the right to contest coverage, because it consisted of generic denials of coverage coupled with verbatim recitation of portions of policy language. This did not provide the policyholder with sufficient information to understand why the insurer believed the policy may not provide coverage for portions of the loss, or that it would be necessary to allocate between covered and uncovered loss. The Court specifically took issue with the insurer s failure to alert the policyholder to the need to obtain an allocated verdict in light of South Carolina law, which permits recovery under insurance policies for construction defect damages for harm to non-defective components of a construction project, but not for those attributable to correcting faulty workmanship. The Court also found that the policies covered loss attributable to punitive damages, because they require indemnification for any sums the policyholder becomes obligated to pay. The Court found the policy language to be ambiguous on the point of punitive damages, and thus construed it in favor of the policyholder. Crowell & Moring 18

19 Harleysville Group v. Heritage Communities Reservations of Rights, Allocation, and Punitive Damages Under South Carolina Law With respect to the allocation issues, the Court first found that progressive injuries, like the loss of property use attributable to water infiltration, were subject to pro rata allocation based on an insurer s time on the risk. The Court rejected the policyholder s argument that portions of the general verdicts were attributable to nonprogressive injuries, and thus should not be subject to pro rata allocation. The Court found that it would be too speculative and inappropriate to allocate the jury verdicts between progressive damages subject to time on the risk allocation, and fixed losses which were not. Finally, the Court found that the award of punitive damages should not be subject to pro rata allocation like the actual damages. In doing so the Court stressed that it was not establishing a categorical rule on this issue. Rather, the Court found that in this case there was no evidence that some of the acts underlying the punitive damages award occurred outside the policy period. Unfortunately, although the Court recently granted the Insurer s petition for reconsideration, it issued an order that was in all material respects identical to its original ruling. The only change in the Court s order was the addition of an umbrella section discussing the unique facts and circumstances of this case that justified the Special Referee s decision to permit the third-party judgment creditors to challenge the sufficiency of the insurer s reservation letter to its policyholder. Crowell & Moring 19

20 Harleysville Group v. Heritage Communities Reservations of Rights, Allocation, and Punitive Damages Under South Carolina Law Discussion and Questions Crowell & Moring 20

21 Pulte Home Corp. v. American Safety Indem. Co. No. D (Cal. Ct. App., 4th Dist. Aug. 30, 2017) Crowell & Moring 21

22 Pulte Home Corp. v. American Safety Additional Insured Endorsements and Completed Operations Coverage under California Law In a case involving California law, an intermediate California appellate court has held that the inclusion of the phrase but only as respects ongoing operations in an additional insured endorsement was insufficient to preclude coverage for completed operations, as its inclusion created an ambiguity that should be construed against the insurer. This case arose from two similar lawsuits filed against the Developer of two residential housing projects. The suits alleged that construction defects in the concrete foundations permitted water to intrude into the homes. The Developer sought a defense as an additional insured under Additional Insured Endorsements ( AIEs ) that it had required its subcontractors to add to their policies. The Insurer refused to defend both suits, however, asserting that the AIEs did not provide coverage for completed operations, and that coverage also was barred by a number of faulty workmanship exclusions. Crowell & Moring 22

23 Pulte Home Corp. v. American Safety Additional Insured Endorsements and Completed Operations Coverage under California Law After a trial, the trial court found that the AIEs did not effectively exclude coverage for completed operations, and that the several coverage exclusions cited by the insurer were inapplicable. It also held that Insurer had acted in bad faith when it refused to defend the cases. On appeal, the intermediate appellate Court largely upheld the trial court s decision, finding that the insurer had incorrectly interpreted the policy language and had acted unreasonably. Crowell & Moring 23

24 Pulte Home Corp. v. American Safety Additional Insured Endorsements and Completed Operations Coverage under California Law The Court first addressed the availability of completed operations coverage under the AIEs. The AIEs provided coverage for liability arising out of your work, but only as respects ongoing operations. (emphasis added). The insurer argued that this phrase was a limiting term that excluded completedoperations coverage. The Court disagreed, finding that this language was at best ambiguous. The Court placed heavy emphasis on the fact that the AIE provided coverage for your work, which could reasonably be read as a grant of coverage for the insured s completed operations, if property damage ensued from them. The Court also stressed that the phrase your work as defined elsewhere in the policies included warranties and representations, which it found inherently involved completed work, not work in progress. The Court found that this ambiguity should be construed against the insurer, particularly when considering the insurer s duty to defend. Crowell & Moring 24

25 Pulte Home Corp. v. American Safety Additional Insured Endorsements and Completed Operations Coverage under California Law With respect to bad faith, the trial court had found that the insurer had demonstrated a pattern and practice of using every conceivable argument to deny coverage, whether the arguments are weak or strong, valid or invalid. The trial court had also found that the Insurer knew that there were trial court decisions against its position on the interpretation of ongoing operations, and that it had disregarded these decisions when declining to defend the underlying actions. The appellate court found this conduct showed that the Insurer was primarily protecting its own interest in refusing to defend its additional insureds in construction defect cases. The court further found that these actions, in the context of the Insurer s pattern of issuing AIEs knowing that coverage would never be honored and knowing that the additional insureds intended that they would be receiving a defense if they were sued in construction defect cases, constituted intentional malice, trickery, or deceit justifying an award of punitive damages. Crowell & Moring 25

26 Pulte Home Corp. v. American Safety Additional Insured Endorsements and Completed Operations Coverage under California Law Discussion and Questions Crowell & Moring 26

27 Final Questions? Laura Foggan Crowell & Moring LLP Crowell & Moring 27