The Critical Path: Tools for Resolving Construction Disputes : California Construction Lawyer & Attorney for Dispute Resolution in Los Angeles, San Diego & the S.F. Bay Area

This is part two of my series regarding insurance coverage issues in construction defect cases. In part one, I addressed common indemnity and defense issues. In this post, I will address how excess policies come into play when the exposure to liability for construction defects exceeds the policy limit of your primary insurance policy, typically a commercial general liability or CGL policy.

Depending on the size of the project, many contractors will have an added layer of insurance protection in the form of an excess or umbrella policy. These are policies that provide additional coverage for claims that exceed the limits of primary coverage and can be purchased for a relatively modest sum, compared to the premiums for primary insurance coverage.

Construction defects, which typically manifest slowly over time, will likely implicate the successive primary insurance policies of the general contractor and its subcontractors on large projects, and quite possibly their respective umbrella or excess policies. The questions of which excess policies are subject to the claims and when does an excess carrier’s duty to defend arise are common issues and often stand as barriers to the resolution of construction defect cases. The case of Padilla Construction v. Transportation Insurance Co. (PDF) illustrates some of these complexities.

Padilla Construction was a stucco subcontractor to a developer who was sued by the owners of two houses in an upscale development in Castro Valley, California. The developer filed a cross-complaint for indemnity against Padilla.  The primary defect claims that evolved over a seven year period included foundation drainage problems, excessive crawl space moisture problems, and decay and mold contamination to the under-floor framing. Padilla’s work was implicated by the allegations that the foundation vents at some locations were blocked with stucco.

Padilla was covered by various primary policies over an eight year span and one excess policy for two of those years.  The Court of Appeal summarized the applicable policies as follows:

          
The insured had four successive primary liability policies from January 1995 until March 1, 2003:
—From the beginning of 1995 to end of 1996: Transcontinental Insurance.
—From the beginning of 1997 to end of 1997: Reliance Insurance.
—From the beginning of 1998 to March 1, 2001: Legion Indemnity.
—From March 1, 2001, to March 1, 2003: Steadfast Insurance. Editor's Note: These policies required Padilla to pay $25,000 in self-insured retention (SIR) before Steadfast’s obligations came into effect.

Additionally, coincident with Transcontinental's primary policy (Jan. 1995 through the end of 1997), the insured had two yearly commercial umbrella policies issued by Transportation Insurance Company.

In tabular form, over the period of the continuing loss, the policies may be expressed this way:

Initially, Padilla tendered its defense to Transcontinental which was accepted. On the other hand, Reliance and Legion were insolvent and nothing was available from either carrier by way of defense. Padilla did not want Steadfast to get involved because it did not want to pay the $25,000 self-insured retention. Instead, when the Transcontinental policy was exhausted due to the payment of defense and indemnity costs on the Castro Valley project case and other claims, Padilla tendered the defense to its excess carrier, Transportation, on the basis that all other primary policies were either exhausted or their carriers were insolvent, and that there was no primary insurance available under the Steadfast policy because Steadfast had no obligation to defend due to the self-insured retention requirement. In other words, Padilla did not have any primary insurance through Steadfast unless and until Padilla paid the first $25,000 in defense or indemnity costs.

Eventually the parties in the Castro Valley project case reached a settlement, which included a $60,000 contribution from Padilla who, in turn, filed the subject insurance coverage case against the excess carrier, Transportation. The trial court ruled in favor of the excess carrier and the California Court of Appeal affirmed, stating that  “an excess insurer does not have a duty to defend an insured until ‘primary insurance’ in the form of a so-called ‘self-insured retention’ is exhausted applies here. The statement obtains with just as much force even if the excess insurer's 'other insurance' clause does not contain a direct reference to 'self-insurance'.

For a variety of reasons, the Padilla case is useful reading for anyone facing construction defect claims and trying to figure what insurance may be available to defend and indemnify the claims.

1. The way the Court organized the chronology of the applicable insurance policies is a good template for anyone trying to figure out the availability of insurance.
2.  There is a good discussion of the duty to defend in construction defect cases involving continuous damages. In the Padilla case, the blocked vents led to allegations of damages that spanned several years and therefore, implicated many policies. Thus even though the inception of the loss occurs in the policy period of one policy, the continuous nature of the damages can spill into the policy periods of additional carriers, making the successive carriers also  responsible for the defense of the claims.
3. The case points out that in California, anyway, the duty to defend the whole action arises when any portion of the damages falls within the policy period, even though the increments of harm preceding the policy period would not be covered by way of indemnity, reminding us that a carrier’s duty to defend is broader than its duty to indemnify.
4. We are also reminded that a carrier can seek reimbursement from its policyholder for defending that portion of the claims that may come before the inception date of the policy. Thus the good news in that situation is the carrier may have to fund the defense of all of the litigation, even the defense of damage claims that precede the policy, but the bad news is the carrier has the right to seek reimbursement for defending the uncovered damages.
5. Self Insured Retention or SIR must be paid and the primary policy exhausted before the excess carrier is required to defend and indemnify a claim.
6. The case has a good definition of self-insured retention: “while there ‘is no dispositive case law differentiating deductibles from SIRs,’ a deductible ‘usually relates only to the damages sustained by the insured, not to defense costs’ where an ‘SIR is generally a specific amount of loss that is not covered by the policy but instead must be borne by the insured.’”
7.  The case also provides a good explanation of the differences between excess and umbrella policies:" Technically, there is a difference between umbrella and excess policies. Umbrella coverage is a "type" of excess coverage, typically providing, as in the present case, for losses for which there may be no "underlying' insurance." The other type of excess coverage is "‘following form" coverage” which, as the name indicates, follows the form of a specific underlying policy. Because umbrella insurance provides coverage ‘for certain losses for which there may be no underlying insurance,’ they provide ‘broader coverage than the underlying insurance. By the same token they provide broader coverage than “form following” excess policies."
8. Finally, the case identifies the timing of when an excess insurer is obligated to defend a lawsuit in California: "The rule of “horizontal exhaustion” in liability insurance law requires all primary insurance to be exhausted before an excess insurer must “drop down” to defend an insured, including in cases of continuing loss. Unless there is excess insurance that describes underlying insurance and promises to cover a claim when that specific underlying insurance is exhausted (“vertical exhaustion”), the rule of horizontal exhaustion applies to cases of alleged continuing property damage—as often happens when the insured is sued for construction defects."

Being knowledgeable about insurance is the first step in the process of getting a carrier to defend and indemnify defect claims but, as Malcolm Gladwell said in his marvelous book,Blink,: ”The key to good decision making is not knowledge. It is understanding. We are swimming in the former. We are desperately lacking in the latter (p.265).” When construction defect claims arise, it is not enough to know you have excess insurance coverage. Padilla Construction knew it had an excess policy but did not understand  when or how to access it. I hope this post (and my prior one) will help you understand how to secure the full extent of insurance protection that is available to you.  

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It is a fact that a high percentage of construction disputes are resolved through mediation in the United States. Although the voluntary, collaborative nature of the mediation process seems inimical to the highly competitive, hard-charging  world of  the U.S. construction industry, the record of success is quite impressive. It would seem, then, if mediation can thrive in the U.S., it can also work in other countries.

 I have often thought that mediation is especially well-suited for the resolution of disputes involving Japanese entities. In Japan (and other Asian cultures), saving face, honor and loyalty remain fixed in the Japanese character. I learned a lot about this during the two years I lived there. Frankly, as a Westerner, in some ways it was harder to comprehend the culture than it was to learn the language. For example, it took me a little while to apprehend  the Japanese tendency of avoiding public conflict. In my first few months there, I am sure I offended some people because I did not appreciate the fact that what appeared to me to be evasiveness was actually an attempt to avoid conflict and public embarrassment-mostly mine. Now as a mediator, I can see that private mediation can help Japanese construction professionals resolve their disputes in an honorable way, consistent with their culture and traditions.

Prominent construction lawyer Robert S. Peckar recently posted an outstanding article in Who'sWhoLegal about the application of U.S.-style mediation in other countries. I have quoted below parts of the article that explain the mediation process and other parts which explore its benefits and barriers in the context of international construction disputes.

US-style mediation is the voluntary participation by disputing parties in negotiations facilitated by a third-party neutral known as the “mediator”. The mediator typically is a lawyer (although he or she need not be) who is trained in the art of negotiation used in the mediation process. The key elements of the typical mediation process are:

• The process is voluntary. While some speak of “binding mediation”, that term is misleading. The only aspect of mediation that is binding is the agreement made by the parties to settle their dispute (more on that later). All parties must agree to participate or there is no mediation. Although some contracts require mediation as a condition precedent to the next step in the process, there is agreement at least at the time of contracting.
• Because the process is voluntary, the parties are making a commitment that they are willing to listen, to learn, and to make compromises to achieve a fair settlement with the other party.
• The process depends on the good faith of all parties to participate with an open mind and a desire to settle.
• The process is conducted under the guidance of a mediator, who is selected by all of the parties because they trust and respect the mediator’s skills, knowledge and integrity. The mediator is neutral and independent. The mediator typically is highly trained in the art of negotiation and mediation, knowledgeable in construction, and experienced in construction law. Mediation simply introduces a trusted expert into the negotiation process to facilitate a resolution of the dispute. There are several organizations that offer mediation services to members of the construction industry.
• Before and during the mediation, the mediator is provided with confidential information from each party about the strengths and weaknesses of their case, their settlement goals, financial concerns that might affect the settlement, personal relationships impacting settlement, other matters of value to each party, such as maintaining relationships or receiving expedited payment, and other confidences that may assist the mediator. Armed with this information, the parties’ trust and negotiation skills, the mediator is in an excellent position to guide the parties to an acceptable settlement.
• US-style mediators act in a facilitative manner, however, many will be quite strong in providing advice to the individual parties during their confidential sessions. That advice may range from “encouragement” that a party modify its position in order to achieve a settlement to a polite confrontation in which the mediator informs the party in clear terms why the mediator believes that party is not properly advancing the potential for settlement. The mediator may explain to the party that its resistance to make meaningful counter-offers is unhelpful. The mediator may also express a belief that the party is operating on an erroneous legal or factual position or that it is attempting to use a negotiating strategy that simply will not work. Many of the most successful construction-industry mediators in the United States are respected for their ability to bring strong guidance and the personal qualities of effective facilitation to the mediation process.
• Because of the sensitivity of the information provided to the mediator, the parties must have complete trust that he or she will maintain its confidentiality and help them reach the best settlement possible. Trust in the mediator is the cornerstone of a successful mediation.
• The mediator acts as an “honest broker of information” and never shares one party’s confidential information with another party without express permission. Thus, the parties are able to talk with the mediator about various options, including their “bottom-line number”, and other highly confidential considerations, without fear that they will be improperly disclosed to any other party. Mediators treat this obligation as a matter of sacred trust and do not violate that trust. Furthermore, the laws in most US states provide that all communications (oral and written) during the mediation process are confidential and may not be repeated in a legal proceeding.
• The mediation progresses through a rather predictable process to conclusion. Typically there are short pre-mediation submissions exchanged between the parties and with the mediator, an opening joint session, at which all the parties make presentations to each other about their case and their perceptions of the other parties’ cases, followed by a series of private caucuses with the mediator held in separate rooms. However, the parties are not constrained by a specific format and joint sessions may follow a caucus, sessions may be held with principals only and the mediator, or any other process may be used that will help achieve settlement. Flexibility is a key to mediation.
• An important element of the opening session of mediation is that the parties speak to each other and in particular the principals, not to the mediator. Sometimes the opening session is the first time a principal has heard a fair presentation of the other party’s position. The mediator is not a judge or arbitrator; and therefore, there is little advantage to try to convince the mediator of the merits of the party’s position. That shift in emphasis, from speaking to the third-party finder of fact to speaking directly to the other party, is at the heart of what makes mediation successful. The mediator’s role is to keep that dialogue appropriate in tone and direction both in the opening public session and then in the private caucuses.
• The mediator tries to help the parties focus on what is in their best business interests as opposed who is right or wrong on the issues, since it is often difficult to convince someone that they are wrong, and the matter may have little to do with a party’s best interest as far as settlement is concerned.
• The mediator helps the parties remove emotional issues or personal conflicts from the negotiation.
• The mediator has the ability to use many well-tested closing techniques to achieve the final resolution.
• Finally, in certain circumstances and as a last resort, the mediator can offer his or her opinion on certain issues and can suggest a settlement to assist the parties. If the parties trust the mediator, his or her opinion or suggestion may be enough to cause them to make the last move to settlement.
• The mediation process continues until a settlement is achieved by the parties or until the mediator (not the parties) concludes that settlement is unachievable and declares an “impasse”, at which time the parties revert to the formal dispute resolution process provided in their contract or as required by law. It is not unusual for mediation to continue late into the night or continue day-to-day with little time for sleep as momentum towards a settlement increases. It is also not unusual for the mediation to be postponed after the parties have exchanged information, discovery has occurred, or the parties have reassessed their positions and interests. The passage of time can be used to facilitate settlement.
• If the parties reach a settlement, they sign a settlement memorandum or agreement on the spot, in the mediation room, to avoid the chance that they will sleep on their agreement and change their minds the next day.
• The parties’ lawyers play an important role in mediation. They advise their clients throughout, may make presentations, and, if they are experienced in the mediation process, can help their client and the mediator steer through the challenges of mediation. However, unlike arbitration and litigation, jurists are not the central figures in the drama. At the end of the day it is the client who has control of the company’s destiny in mediation, as the client is the decision maker who must make the choices on what to say, when to say it, and whether to accept a settlement.

In summary, mediation in the United States is a negotiation in which an independent, trusted expert in negotiation and construction law is inserted between the parties, is provided with all of the parties’ confidential information, and then, armed with this information, tries to guide the parties to a settlement. It has a very high success rate. So, why wouldn’t the rest of the world jump at the chance to settle international construction disputes through US-style mediation as often as the construction industry in the United States?

Mr. Peckar describes some of the challenges of international mediation as follows:

 However, in the truly international case that brings parties from different parts of the globe together, the confidence that a mediator and the process will be conducted in a way that is “comfortable” for that party is often not present. For example:

• International parties to construction disputes may approach any negotiation with very different perspectives on how to negotiate. For parties from some countries, it is culturally unacceptable to offer or accept a reduced amount or to even share a willingness to settle for less with the mediator, as to do so may be perceived as personal weakness. It may be more acceptable for parties from such countries to lose in arbitration or court than to make concessions voluntarily. Such attitudes make the mediator’s job very difficult. An example of a particular issue that has resulted in non-US parties becoming uncomfortable about a US-style mediator’s approach to the facilitation of a settlement is the following: US-style mediators typically remind the parties of the expense they will suffer if they fail to settle their disputes and go on to arbitration or litigation. That reminder is accepted and often appreciated by construction-industry members in a dispute in the United States. Some international parties have been heard to complain that such a consideration is not relevant or even appropriate in a discussion about how much to pay to or accept from the other party.
• The language barrier can present tremendous problems, even with a translator. How easily can a party trust someone who does not speak their language? This becomes even more of a problem if the mediator speaks the adversary’s language.
• For parties from some countries, because the mediator goes into a room with the other party for hours (the caucus) to discuss the dispute this can be extremely worrisome and can undermine their trust in the mediator and the process.
• For others the sharing of highly confidential information, particularly if the mediator does not share their nationality, culture, or religion, is very difficult. As a result, even if they participate in the mediation they may be unwilling to share their confidences, which will make it less likely that the process will be successful.
• For some, the mere fact that they have never participated in mediation before, but have been in court or arbitration, is sufficient reason to reject mediation.

Construction disputes happen in all parts of the world. Regardless of cultural differences or legal traditions, all construction professionals want to resolve their disputes as efficiently as possible. Given the high settlement rate of mediated disputes in the United States, reasonable businessmen and legal counsel everywhere should find ways to implement mediation as an alternative dispute resolution method in their respective countries. The alternative to mediation is a fight in a court of law or in an arbitration proceeding. Mediation provides a confidential forum to fully explore both sides of a dispute with the knowledge that the failure to reach a compromise will lead to increased legal fees and costs and an uncertain outcome at trial. Indeed, the wisdom of mediation is reflected in two of my favorite Japanese proverbs: (1) Even a sheet of paper has two sides and (2) A good sword is the one left in its scabbard. 

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The resolution of construction defect cases and the availability of insurance coverage go together like the Los Angeles Lakers and NBA Championships (sorry Celtics fans). In addition to coverage issues that arise when defect claims are made, contractors and subs will want to quickly tender the defense of claims to their carriers. Generally speaking, policies of insurance include limitations on the time in which claims can be made, so my rule has always been, “When in doubt, send the notice of claim out.”

When a claim arises, some may question if they have insurance coverage or if they are entitled to  have the cost to defend the claim paid by their insurance companies. Don’t. Assume the claims are covered and make your carrier confirm in writing one way or the other.  First, an insurance carrier’s duty to defend is broader then its duty to indemnify. That means, in most states, you are entitled to a defense if it is possible that the claim is covered. On the other hand, a carrier is only required to indemnify the claim (in other words, pay the settlement or judgment) if the defect is actually covered by the terms of the policy. 

By tendering the claim to your carrier, you will trigger statutory time lines by which the carrier must confirm in writing its position on its coverage and defense obligations. Sometimes an insurance company will agree to defend the claim under a reservation of rights. That means the insurance company believes the possibility of coverage exists, triggering its duty to defend but it is reserving the right to withdraw the defense if it is established that there is no coverage under the terms of the policy.

Especially for large claims, you should not be surprised if the insurance company sues you at the same time it is defending you on the construction defect claim. The suit will not be for monetary damages but rather, for a declaration by the court of the rights and duties of the parties under the terms of the insurance contract. The insurance company will argue its interpretation of the policy language and why there is no coverage, and you will have to argue why there is coverage. While inconvenient for you, this is the prudent course of action for the carrier. When the tender of defense or coverage is wrongfully denied, the policyholder has the right to sue for contract damages, bad faith, and in some cases, punitive damages. Rather than risk being wrong, a carrier will often ask the court to decide questions about coverage.

If the tender of defense or coverage is denied, you should engage legal counsel to help you evaluate your options. There are outstanding insurance coverage lawyers who can help you. Look for one who specializes in insurance coverage of construction claims.  Construction defects present unique issues in terms of coverage that a generalist made not understand.

My next post will continue this theme about insurance coverage for construction defect claims. I plan to address recurring problems when successive policies are implicated by the claims and how so-called self-insured retention may affect the obligations of umbrella or excess carriers.

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