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California’s First Appellate District recently squelched an excess liability carrier’s attempt to shift responsibility for settlements resulting from a pipeline explosion onto a co-defendant’s umbrella insurer, holding that the latter policy’s “professional services” exclusion barred coverage. Energy Insurance Mutual Limited v. ACE American Insurance Company, 14 Cal.App.5th 281 (2017). In doing so, the Court of Appeal gave broad effect to the exclusion, potentially narrowing the path to coverage in construction cases.

The insured under the excess policy, Kinder Morgan, Inc., owns and operates oil and gas pipelines. Kinder Morgan hired two temporary employees provided by Comforce Corporation — the insured under the umbrella policy — as construction inspectors in connection with a water supply line project. Kinder Morgan also had one of its own employees at the project serving as a “line rider,” whose primary function was to perform daily surveillance in order to protect the pipeline system from damage. During the course of the project, a petroleum line was punctured and the resulting explosion killed five employees and seriously injured four others, and also caused extensive property damage.

Subject to a $1 million self-insured retention, Kinder Morgan was insured under a $35 million “excess liability” policy. In addition, Energy Insurance Mutual Limited (“EIM”) issued Kinder Morgan a “following form” $100 million excess policy above that. Meanwhile, Comforce was insured under a $1 million primary commercial general liability (“CGL”) policy, as well as a $25 million umbrella policy, both issued by ACE American (“ACE”). The umbrella policy contained a professional services exclusion.

In settling the lawsuits arising from the explosion, EIM agreed to pay more than $30 million for the claims against Kinder Morgan. EIM then sued ACE for contribution under the Comforce umbrella policy, alleging that Kinder Morgan was an additional insured under that policy.

The Court of Appeal upheld the trial court’s grant of summary judgment in favor of ACE based on the professional services exclusion, which provided as follows: “This insurance does not apply to any liability arising out of the providing or failing to provide any services of a professional nature.”

The court noted that “A CGL policy is intended to cover general liability, not an insured’s professional or business skill.” (Emphasis in original). Citing Tradewinds Escrow, Inc. v. Truck Ins. Exchange, 97 Cal.App.4th 704 (2002), the opinion went on to explain that “California courts have defined ‘professional services’ as those arising out of a vocation, calling, occupation, or employment involving specialized knowledge, labor, or skill, and the labor or skill involved is predominantly mental or intellectual, rather than physical or manual.” The court then noted that the exclusion extends beyond services traditionally considered “professions,” such as medicine, law or engineering.

With these definitions in mind, the court ruled that the tasks assigned to the construction inspectors supplied by Comforce fell within the professional services exclusion. Moreover, because the exclusion used the term “arising out of,” the court further held that the exclusion extended to all of the claims alleged in the underlying case, including ordinary negligence, trespass and nuisance. In reaching its conclusion, the court distinguished North Counties Engineering, Inc. v. State Farm General Ins. Co., 224 Cal.App.4th 902 (2014), which had held that ordinary labor and construction work did not fall within a professional services exclusion.

EIM further argued that, because the umbrella policy contained a “separation of insureds” provision (or severability clause), there could still be coverage for Kinder Morgan as an additional insured even if the exclusion barred coverage for Comforce. The separation of insureds provision stated that, other than with respect to the limits of liability, the policy applies: “1. As if each INSURED were the only INSURED; 2. Separately to each INSURED against whom claim is made or SUIT brought.”

The Court of Appeal agreed that the relevant question in light of the severability clause was not whether Comforce had engaged in professional services, but whether Kinder Morgan did. However, the court found that the record established that Kinder Morgan was not just a passive owner of the pipeline, but rather had trained and supervised the inspectors provided by Comforce, and had used its own full-time employee as a line rider. Accordingly, the separation of insureds provision did not assist EIM.

In a decision which softens the normally harsh rules confronting policyholders with respect to rescission of insurance policies, California’s First Appellate District recently reversed a summary judgment of rescission. Duarte v. Pacific Specialty Ins. Co., 13 Cal.App.5th 45 (2017). The basis for doing so was the ambiguity of the questions at issue in the insurance application.

The policyholder, Duarte, obtained liability coverage effective April 19, 2012 for a residential rental property he owned. In June 2012, a tenant at the property filed a habitability lawsuit, which the carrier, Pacific Specialty, refused to defend. Duarte filed an action for declaratory relief to establish the duty to defend. Pacific Specialty asserted a number of affirmative defenses in response, including a right to rescind due to material misrepresentations in the application. The trial court granted summary judgment in favor of Pacific Specialty, but the Court of Appeal reversed.

Pacific Specialty asserted that Duarte untruthfully answered “no” to the following questions: “(4) Has damage remained unrepaired from previous claim and/or pending claims, and/or known or potential (a) defects, (b) claim disputes, (c) property disputes, and/or (d) lawsuits?” and (9) “Is there any type of business conducted on the premises?”

The appellate court began by acknowledging that material misrepresentations or concealments are grounds for rescission of an insurance policy, and actual intent to deceive need not be shown. Moreover, “the fact that the insurer has demanded answers to specific questions in an application for insurance is in itself usually sufficient to establish materiality as a matter of law.” Id. at 53, citing Thompson v. Occidental Life Ins. Co., 9 Cal.3d 904 (1973). However, the court went on to note that, as with the construction of insurance policies generally, ambiguities in the application are construed against the insurer, and that the insurer cannot rely on answers given based on vague or ambiguous questions. Id. at 54.

With respect to Question No. 4, the record did show that the tenant had complained about issues with the property in February 2012, prior to the policy’s inception. However, this was insufficient in light of the “utterly ambiguous” nature of the question. In particular, the court noted that the question did “not include any form of the verb ‘to be,’ and therefore it is not at all clear that it asks, ‘Are there any pending claims?’” Id. at 60 (emphasis in original). Instead, the court agreed with Duarte that the question could reasonably be interpreted as asking “whether the property has unrepaired damage associated in some way with previous or pending claims.” Id. at 61 (emphasis added). Since Pacific Specialty had not shown that the insured knew of any unrepaired damage, it could not meet its burden on summary judgment as to this question.

As to Question No. 9, Pacific Specialty pointed to evidence that Duarte knew that the tenant had sometimes sold motorcycle parts from the basement to show that his answer was inaccurate. However, Duarte argued that he reasonably interpreted the phrase “business [being] conducted on the premises” to refer to “regular and ongoing business activity.” The Court of Appeal agreed that Duarte’s interpretation was reasonable, and that there was accordingly a disputed question of fact as to whether Duarte misrepresented the existence of a business on the premises in the insurance application. Summary judgment was therefore reversed.

The lesson of Duarte for policyholders when confronted with a rescission claim is to pay careful attention not only to the answers provided on the insurance application, but to the questions themselves. Since ambiguities will be interpreted against the insurance company, convoluted, vague or confusing questions may be a policyholder’s best friend.

In a victory for policy holders, California’s Second Appellate District recently held that when an insurance policy expressly provides coverage for litigation expenses on appeal, an exclusion requiring repayment to the insurer upon a “final determination” of the insured’s culpability applies only after the insured’s appeals have been exhausted.  Stein v. Axis Ins. Co., 10 Cal.App.5th 673, 676 (2017).

In 2007, a medical device company, Heart Tronics, Inc., purchased a $5 million directors and officers liability insurance policy from Houston Casualty Company (HCC).  The policy covered litigation expenses incurred in connection with both civil and criminal proceedings, including appeals, based on an alleged breach of duty by officers and directors, or their functional equivalents.

An exclusion in the policy provided that “Except for Defense Expenses, the Insurer shall not pay Loss in connection with any Claim” occasioned by willful misconduct.  Upon a “final determination” that the insured committed willful misconduct, the insured would be obligated to repay HCC for any defense expenses paid on the insured’s behalf.

When an officer of Heart Tronics was convicted of federal securities fraud and tendered his appeal of the conviction to HCC, HCC denied coverage, arguing, in part, that the conviction was a “final determination” of willful misconduct.  Thus, the insurance dispute turned on the meaning of “final determination.”  HCC argued that since, under federal law, a trial court judgment is deemed a final adjudication until reversed on appeal, the officer’s criminal conviction should also be deemed a final determination.

The Court of Appeal disagreed and in applying the ordinary rules of contractual interpretation to the policy, found no reason to apply the meaning of “final adjudication” proffered by HCC.  The Court of Appeal also noted that even under federal law, an adjudication that is “final until reversed” is not final for all purposes, and that an appellate ruling is more final than a trial court’s judgment.  Moreover, the exclusion provision by its own terms provided that the exclusion did not apply to defense expenses.  Thus, the contractual language of the policy precluded HCC’s argument.

Policy drafters and holders should note that the Stein holding may not apply in all cases, and that the outcome of these kinds of disputes ultimately depends on policy language.  For example, the Court of Appeal noted that the phrase, “judgment or other final adjudication,” in an exclusion construed in two cases relied upon by HCC, was disjunctive such that either condition would alone suffice to trigger the exclusion.   This was not the case in Stein, where the exclusion was not disjunctive, and only a “final adjudication” triggered the exclusion.

Insurance Law is published by the State Bar Litigation Section in its California Litigation Review (2016 Edition), co-authored by RRB attorney Stephen L. Raucher, along with Michael Sohigian, who have provided insurance updates together for the fourth consecutive year.

On Wednesday, March 8, 2017, Stephen L. Raucher was one of the panelists presenting a continuing legal education program entitled “Third Annual Update on Developments in Insurance.” The program examined the most important new cases from 2016 regarding insurance coverage and bad faith, focusing particularly on liability and property policies.

Insurance Law is published by the State Bar Litigation Section in its California Litigation Review (2015 Edition), co-authored by RRB attorney Stephen L. Raucher, along with Michael Sohigian, who have provided insurance updates together for the third consecutive year.

On Tuesday, February 9, 2016, Stephen Raucher was one of the panelists presenting a continuing legal education program entitled “Second Annual Update on Developments in Insurance.” The program examined the most important new cases from 2015 regarding insurance coverage and bad faith, focusing particularly on liability and property policies.

Approximately 12 years ago, the California Supreme Court permitted an insurer, after a loss has occurred, to refuse to honor an insured’s assignment of the policy coverage for such a loss. Henkel Corp. v. Hartford Accident & Indemnity Co., 29 Cal.4th 934 (2003). However, the Court reached that conclusion without consideration or analysis of Insurance Code section 520. The Court recently reexamined its decision in Fluor Corp. v. Superior Court, 208 Cal. App. 4th 1506 (2015), and after reviewing section 520, related authorities, and decisions of other courts, determined that its holding in Henkel, 29 Cal.4th 934, conflicts with the rule prescribed by statute. Accordingly, the Fluor court held that an insurer cannot refuse to honor an assignment of an insurance policy which takes place after the loss has happened.

The Henkel case involved an insured entity spinning off into a newly created corporation that assumed the assets and liabilities of the original entity. Various workers sued the corporation alleging personal injuries arising from exposure to metallic chemicals. The Henkel Court held that “when a liability insurance policy contains a consent-to-assignment clause an insured may not assign its right to invoke coverage under the policy without the insurer’s consent until there exists a ‘chose in action’ against the insured,” which the Court found, occurs only when the claims against the insured have “been reduced to a sum of money due or to become due under the policy.” 29 Cal. 4th 934, 944. Thus, because the workers’ claims were based on losses that occurred prior to the assignment, but had not yet been reduced to judgment, the court found that the consent-to-assignment clause had been violated and the insurance policy did not have to respond to the claims.

The Fluor case involved facts similar to Henkel. In 1971, Hartford became one of many insurers of Fluor, issuing to it 11 “comprehensive general liability” policies for approximately 15 years between 1971 and 1986. Personal injury liability was covered by each policy. The policies also contained a consent-to-assignment clause, preventing an assignment of the insured’s interest under each policy without Hartford’s consent.

Approximately 20 years later, in 2000, Fluor undertook a corporate restructuring and incorporated a newly formed subsidiary with no prior corporate existence (“Fluor-2”). Meanwhile, Fluor changed its name to Massey Energy Company and transferred all of its assets – including the insurance policies – and liabilities to Fluor-2.

After the reverse spinoff, Hartford continued to provide defense and indemnification coverage for Fluor-2 for seven years and never raised concerns or objections to coverage for third party liability claims. However, a coverage lawsuit ensued in 2006 after questions arose concerning the scope of Hartford’s obligations under the liability policies. Hartford claimed that the original Fluor Corporation had attempted to assign its insurance coverage claims to Fluor-2, but the original corporation had failed to comply with the consent-to-assignment clause.

Fluor argued that section 520 barred Hartford from refusing to honor the assignment. Section 520 provides: “An agreement not to transfer the claim of the insured against the insurer after a loss has happened, is void if made before the loss except as otherwise provided in Article 2 of Chapter 1 of Part 2 of Division 2 of this code.” The Court of Appeal found that “section 520 applies only in the context of first party insurance – not to cases . . . involving third party liability insurance.” The California Supreme Court reversed. In reaching its conclusion, the Supreme Court reviewed the legislative history of section 520 and various out-of-state cases.

Although the Legislature likely did not contemplate liability insurance in 1872 when the predecessor to section 520 was enacted, by 1935, when section 520 was adopted, and by 1947 when that section was amended, third party liability insurance had become “prevalent and well developed.” The Court then determined that the 1935 Legislature intended for section 520 to apply generally to all classes of insurance. Then, in 1947, section 520 was amended to exempt two specific types of insurance policies (life and disability) from its coverage. The Court relied on the well-established rule in Sierra Club v. State Bd. Of Forestry that “if exemptions are specified in a statute, we may not imply additional exemptions unless there is a clear legislative intent to do so.” 7 Cal.4th 1215, 1230 (1994).

The Court’s next task was to determine how section 520 applies in the context of third party liability insurance. Specifically, the Court needed to decide how to interpret the phrase “after a loss has happened” in section 520. Fluor-2 argued that the phrase referred to the time period after the injury (loss) to a third party happened. In contrast, Hartford contended that “after a loss has happened” referred not to the event leading to the underlying bodily injury but to the period after the insured has incurred a loss by virtue of the entry of a judgment, or finalization of a settlement, fixing a sum of money due on a claim against the insured by a person or entity injured by the insured. The Court again looked to the legislative history to determine the most reasonable interpretation of the phrase. Since the Court received no assistance from the sole published opinion citing section 520 or secondary sources, it turned to the history of the predecessor statute (former Civil Code section 2599) and old decisions from New York and California, “relating to and preceding that statute, addressing assignability of rights to invoke coverage in the context of first party insurance.” 61 Cal. 4th 1175, 1200. The case law associated loss with the time that the injury occurs and demonstrated that former Civil Code section 2599 “was intended to codify a rule precluding an insurer from prohibiting assignment of an insured’s rights to invoke policy coverage in situations in which the insurer’s restriction would be . . . ‘unjust’ and ‘grossly oppressive.’” Id. at 1205.

This did not end the analysis, however. “Merely because the phrase ‘after the loss has happened’ has a certain accepted meaning in the first party context, however, does not necessarily indicate that the phrase has the same meaning in the third party liability insurance context.” Id. at 1206.

However, the Court ultimately concluded that it does indeed have the same meaning. The Court reached this conclusion by reviewing subsequent early third party liability insurance cases from various jurisdictions. In American Casualty Ins. Company’s Case, the Maryland Supreme Court determined that “a liability insurer’s inchoate obligation to indemnify the insured arises when personal injury or property damage results during the term of the policy, even though the dollar amount of the liability continues to be unascertained until later.” 34. A. 778 (Md. 1986). That key principle was “repeated and applied in subsequent decisions over the following decades.”

Another a leading case was decided in 1939, just a few years after the enactment of section 520. In Ocean Accident & Guarantee Corp. v. Southwestern Bell Telephone Co., the appellate court held that “after the event occurs giving rise to the liability the reason for the rule [against assignment] disappears and the cause of action arising under the policy is assignable.” 100 F.2d 441 (8th Cir. 1939). It further determined that “the liability, the loss and the cause of action arise simultaneously with the happening of the accidental injury to the employee.” Id. at 446. The appellate court’s holding was quickly recognized and quoted and continues to be. Furthermore, the underlying principle (that a loss occurs at the time of injury during the policy period) in Ocean Accident and the cases that built upon its holding has been recognized in California. Although the California cases do not address the assignability of a right to invoke policy coverage, interpretation of “loss” is consistent with the overwhelming majority approach. State of California v. Continental Ins. Co. 55 Cal.4th 186 (2012) (equating the term “loss” with the occurrence of bodily injury and property damage).

The Court ended its analysis by applying the principles recognized from its review of the legislative history and case law to the interpretation of section 520. It ultimately held that the phrase “after a loss has happened” does not “contemplate that there need have been a money judgment or approved settlement before such a claim concerning that loss may be assigned without the insurer’s consent.” This interpretation protects the insured and prevents unjust or grossly oppressive enforcement of a consent-to-assignment clause.

Insurance Law is published by the State Bar Litigation Section in its California Litigation Review, co-authored by RRB attorney Stephen L. Raucher, along with Michael Sohigian, who have provided insurance updates together for the second consecutive year.

On Thursday, March 19, 2015, Stephen Raucher was one of the panelists presenting a continuing legal education program entitled “First Annual Update on Developments in Insurance.”  The program examined the most important new cases from 2014 regarding insurance coverage and bad faith, focusing particularly on liability and property policies.