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

Insurance for construction defect claims is not a one way street. Comprehensive general liability policies impose duties and obligations that apply to both parties to the insurance contract. On claims that are potentially covered by the policy, the insurer has a duty to pay for the defense of the construction defect litigation. For defect claims that are covered by the policy, the insurer has a duty to indemnify the contractor or, in other words, pay for the cost of repair. Given these responsibilities, the policy generally grants the insurer the right to control the litigation.

On the other hand, CGL policies impose on contractors the duty of cooperation throughout the claims and litigation process. A contractor who breaches this duty can unwittingly give its insurance company a free pass that excuses the insurer from its duties to defend and indemnify the contractor. Such was the result in Travelers Property v. Centex Homes, a United States District Court for the Northern District of California case. As a district court case, it has no precedential value but it is a cautionary tale for those who take positions that could be construed as a violation of the duty to cooperate. Centex could appeal the decision to the Ninth Circuit Court of Appeals in which case there may be more to report in the future.

Centex Homes was the defendant in two construction defect cases pending in the Sacramento Superior Court. Centex was being defended by its wrap policy insurance carriers (a wrap policy covers all parties in a construction project under one umbrella policy, including the owner, general contractor, and the subcontractors). Two of the subcontractors on the project, though, had separate CGL policies and Centex, as a named additional insured on the policies, tendered its defense to Travelers, the subcontractors' insurer. For each tender, Centex stated that the tender only applied to non-wrap homes.

Travelers acknowledged the tenders and on several occasions asked for information concerning the wrap policies, construction contracts for non-wrap homes, pleadings in the lawsuits, and the attorney fee rates and budgets of Centex's attorneys for the litigation involving the three "non-wrap" homes in question. Believing it had not received satisfactory information, Travelers filed a declaratory relief action in federal court and, eventually, a motion for summary judgment on the grounds that Centex breached the duty to cooperate. The district court granted the motion which meant that Travelers was excused from its duties to defend and indemnify Centex.

The factual details and legal authority supporting the district court's decision can be reviewed by clicking here. However, there are some recurring issues that are worth noting.

• When an insurance company agrees to defend under a reservation of rights, a conflict of interest or at least the perception of a conflict of interest can arise. The reservation of rights means that the insurer will pay for the defense and maybe even the indemnity but reserves the right to demand the reimbursement of those funds in the event the claims are not actually covered by the policy.
• The concern for the contractor is this: what if the attorneys hired by the insurance company to defend the contractor steer the defense of the case towards a conclusion that the claims are not covered by the policy, leaving the contractor to pay for the repair costs and the obligation to reimburse the insurance company for the defense costs?
• From the contractor's perspective, the perception is that the attorneys assigned by the insurance company may feel a divided loyalty: (1) to the contractor client and (2) to the insurance company that is paying the bills.
• From the insurer's perspective, the policy grants it the right to control the litigation, including the right to assign defense counsel to the case, and the policy also gives the insurer the right to expect the cooperation from its insured in terms of providing information and taking other steps to assist the insurer evaluate and defend the claims.
• When an actual conflict of interest exists because of the insurer's control over the litigation, the contractor is entitled to independent counsel at the expense of the insurer under California Civil Code section 2860. Independent counsel hired under this statute are sometimes know as "Cumis counsel" based on the decision in San Diego Credit Union v. Cumis Ins. Society (1984) 162 Cal App 3d 358.
•  Under California law, there are four circumstance in which a conflict will require the insurer to pay for independent counsel are: (1) where the insurer reserves its rights on an issue and the outcome of that coverage issue can be controlled by the insurer's retained attorneys; (2) where the plaintiff (property owner) and the defendant (contractor) are both insured by the same insurance company; (3) where the insurer files a lawsuit against the insured; and (4) where the insurer pursues a settlement for an amount that exceeds the policy limits without the insured's consent and leaves the insured exposed to claims by third parties.
• Contesting these types of issues must be done carefully in light of the insured's duty to cooperate. Actions to secure independent counsel or the protection of other rights under the policy must be done in such a way that does not undermine the perception that the insured is cooperating with the insurer and meeting all of its obligations under the terms of the policy. All communications from the contractor to the insured, including letters, faxes, and e-mail, should be written with the cooperation clause in mind. The same is true for telephone conversation as discussions with insureds and others are routinely noted in the claim adjuster's log.
• Pursuing a strategy of obtaining Cumis counsel has its own risks and rewards. Policyholders need to understand that an insurance company's obligations to pay for independent counsel are limited and that the potential exists that the policyholder will have to pay for a portion of the fees. This may happen, for example, when Cumis counsel's hourly rate is higher than the rate the insurance company is obligated to pay. 

Note: My colleagues at  IVAMS are sponsoring a webinar on "Cumis Counsel" on June 30, 2011, at 10:00 a.m. Click here to sign up for the event. One hour of CLE credit is available to webinar participants.

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Resolving construction defect claims often turns on the availability of insurance to pay for the repairs. However, disputes sometimes arise between builders and their insurance companies over the question of whether or not the insurance policy covers the construction defects being claimed. In other words, will the insurance company pay for the cost of repairs. In addition to the coverage dispute, the question of whether the insurance company will pay the attorney fees and other costs of defending the lawsuit can also come into play. Generally speaking, the insurers obligation to defend is greater than its obligation to cover the claim since a defense must be provided if there is a possibility for coverage whereas the payment of the cost of repairs is only required if the policy language actually covers the claims and there are no applicable exclusions in the policy. All of this means that if the insurer denies coverage or a defense, a builder can be engaged in 2 lawsuits at the same time when construction defect claims arise: (1) the construction defect lawsuit with the homeowners and (2) the insurance coverage lawsuit with the insurance company. A recent Arizona case shows how this can happen. (Click here to read the recent opinion in Lennar Corporation v. Transamerica Insurance Company.)

In the early 1990's, Lennar Corporation, a Fortune 500 home builder, oversaw the development of 105 homes in Glendale, Arizona. According to the opinion, nearly all of the homes in the development had construction defects. Lennar made some repairs but the complaints continued and eventually several of the homeowners filed suit and others threatened litigation. In December 1998, Lennar tendered the claims to its various insurance companies that had issued commercial general liability policies. In October 2000, two of the insurers, Transamerica and USF&G,  filed a complaint seeking a declaratory judgment that they owed no duty to defend or indemnify Lennar. Lennar filed a cross-complaint against its insurance companies for breach of contract and bad faith.  

In July 2003, the trial court granted summary judgment in favor of the insurers, dismissing all of Lennar's claims based on the court's conclusion that the defects in the homes did not constitute an "occurrence" within the meaning of the policies. The Arizona Court of Appeals reversed, holding the homeowners' allegations of damage resulting resulting from faulty construction were sufficient  to allege an "occurrence" under the policies. A year later, the insurers filed another summary judgment motion on Lennar's bad faith claim. The motion was based on the proposition that, as matter of law, the trial court's initial ruling in their favor on the occurrence issue established that the insurers had a reasonable basis for denying coverage. The trial court agreed and entered summary judgment on the bad-faith cause of action.

Lennar appealed but now it was more than 15 years after the homeowners starting complaining about the construction defects and Lennar had settled with all of the homeowners and all but three of the insurers. The appellate court reversed the trial court, holding that an erroneous grant of summary judgment does not conclusively establish that coverage is fairly debatable. As a result the case was remanded to the trial court where the case will now finally go to trial on the breach of contract and bad faith causes of action, or it may settle.

LESSONS LEARNED

• As construction defect cases are so expensive to litigate and the cost of repair is so high, it is important to lock in the coverage and defense issues as soon as possible. Some law firms have the capacity to both defend construction defect claims and provide insurance coverage counsel. Some are not expert in both fields. Assuming there is a denial of coverage or a reservation of rights, you may want to retain outside coverage counsel as early in the process as possible. Preferably one with experience securing insurance coverage for construction defect claims.
• The Lennar case has some additional points that are beneficial to policyholders. First, the court opened the door for juries to consider additional evidence on the question of whether the insurers acted reasonably in challenging Lennar's claims based on the meaning of "occurrence" in the policies. "On remand, in addition to the policy itself, the superior court may decide to admit extrinsic evidence such as judicial opinions interpreting the policy language and evidence of the understandings of these insurers and the insurance industry in general concerning the meaning of the disputed policy language." The court said the "subjective beliefs" of the insurers may also be relevant. "Also relevant may be evidence of prior positions these insurers have taken in other cases and their knowledge of positions other insurers or industry groups have taken in similar cases." 
• Second, the appellate court held that an insurer's duty to investigate a claim continues unabated even if there is a coverage dispute.

[T]he saga of this litigation illustrates the injury an insured may suffer when (as Lennar alleges here) an insurer sues over the meaning of a disputed policy term and effectively ignores its obligation to investigate the claim during ensuing protracted legal proceedings.

It will be interesting to follow this case now that it has been remanded to the trial court for further proceedings. If the case does not settle, it will go to trial. If it goes to trial, will there be another appeal? And another trial? A Fortune 500 Company like Lennar can afford to stay in the fight as long as it takes. Most smaller construction companies would have a hard time outlasting an insurance company in protracted insurance coverage litigation. In Arizona, at least, the discovery of both objective and subject evidence of insurer conduct and the possibility that such evidence may be admissible could help resolve coverage disputes earlier which would help resolve construction defect cases more effectively.

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Appraisals. Real estate appraisals, art appraisals, antique appraisals, insurance appraisals. Huh? What's an insurance appraisal, you might ask?  In California, Insurance Code section 2071 provides an appraisal process to resolve disputes between policyholders and their insurance companies over the actual cash value of the property losses being claimed. The scope of the appraiser's authority is the subject of a recent case from the California Court of Appeals called Kirkwood v. California State Automobile Association Inter-Insurance Bureau. More about that case in a moment.

Actual cash value is an important term in standard fire insurance policies in California. The standard insuring clause calls for coverage

to the extent of the actual cash value of the property at the time of loss, but not exceeding the amount it would cost to repair or replace the property with material of like kind and quality within a reasonable time after the loss....

 Following the 2003 wildfires in Southern California, Insurance Code section 2051 was amended to provide exactly how actual cash value should be determined. The applicable regulations now require insurance companies to

• Justify and fully explain all adjustments to the amount claimed, including for depreciation
• Depreciation must be attributable to the to the condition and age of the property
• The basis for any adjustment must be fully explained to the claimant in writing

When there is a loss, the claimant is required to give the insurance company written notice of the loss, and furnish a "complete inventory" of the destroyed property, "showing in detail quantities, costs, actual cash value and the amount of loss claimed." In the event of a dispute as to the actual cash value or amount of the dispute, the parties are supposed to take part in an informal appraisal process where each side selects an appraiser to come up with the actual cash value, and if they can not agree, the matter is submitted to a neutral umpire. A lawsuit is not sustainable unless the appraisal procedure has been followed, although lawyers for policyholders have used various legal theories such as waiver and estoppel to argue to argue the appraisal provision is not enforceable.

The plaintiff in the Kirkwood case asserted another reason for filing a lawsuit without complying with the appraisal provision of the insurance policy. In response to Kirkwood's claim for fire losses, the insurance company provided a contents inventory which showed a blanket depreciation schedule of 50 to 80% based on age without any consideration for the condition of the personal property. Kirkwood claimed that this violated the requirements of section 2051 and filed a lawsuit for declaratory relief, among other causes of action, asking the trial court to determine the proper standards the insurance company must follow in determining actual cash value and depreciation under section 2051. The insurance company demanded that Kirkwood dismiss the lawsuit and proceed with appraisal. Kirkwood refused. The trial court dismissed the insurance company's motion to compel appraisal without prejudice, so that a motion to compel appraisal could be refiled  after the court resolved the issue of the interpretation of section 2051. The Court of Appeals affirmed.

LESSON LEARNED

The role of appraisers under California Insurance Code section 2071 is limited to appraising the loss, nothing more. Appraisal can be deferred by the trial court until such time as the interpretation issues regarding section 2051 and the related regulations are resolved.

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On June 28, 2010, the California Court of Appeal published Pennsylvania General Insurance Company vs. American Safety Indemnity Company (2010), Cal. App. 4^th, a case involving the following recurring coverage issue in construction defect litigation that vexes primary and excess insurers alike: what, if any, obligation does an insurer owe to its policyholder where: (1) the commencement date of the damages is not certain, (2) the damages caused by the defective workmanship are continuous, and (3) the damages span the successive annual policies of one or more carriers? The short answer is it depends on the language of the insurance policy. But the Pennsylvania General case tells us more than that; it is a primer on the basic coverage issues arising from continuous damage claims.

While no new ground will be plowed for seasoned insurance coverage lawyers, it is hoped that some seeds of understanding will be planted for construction lawyers and other construction industry professionals. One aspect of the case is most interesting because the policy language at issue was a direct effort by the insurer to draft language that would avoid coverage in these kinds of continuous damage cases and thereby circumvent the holding in the seminal California Supreme Court case, Montrose Chemical Company v. Admiral Insurance Company.

1.Summary of Underlying Construction Defect Case

Whitacre Construction was insured under a commercial general liability policy issued by Pennsylvania General Insurance Company for the period October 1998 through December 2001. During this time, Whitacre entered into a subcontract to perform framing and rough carpentry work on a project. At the conclusion of Pennsylvania General's policy period, and after Whitacre's work on the project was completed, American Safety Indemnity Company issued a CGL policy to Whitacre for the period December 2001 through December 2002.

In the underlying construction defect litigation, various parties alleged that Whitacre’s work was improperly done and had created various problems with the project. Whitacre tendered its defense to both Pennsylvania General and American Safety Indemnity. Pennsylvania General accepted Whitacre’s tender of the defense under a reservation of rights and ultimately paid the defense and settlement costs for Whitacre. American Safety declined Whitacre’s tender, asserting there was no possibility of coverage under its policy since the work was completed prior to the inception date of its policy, and did not participate in defending or indemnifying its insured.

After the settlement of the construction defect case against Whitacre, Pennsylvania General filed suit against American Safety seeking equitable contribution from American Safety for a portion of the defense and indemnity costs paid by Pennsylvania General. The trial court, ruling on cross-motions for summary judgment, concluded American Safety had no responsibility to pay any portion of the defense or indemnity costs because there was no potential coverage under American Safety's policy for the claims asserted against Whitacre and entered summary judgment for American Safety. Pennsylvania General filed an appeal.

2. General Coverage Issues

A. First Party Claims vs. Third Party Claims

How coverage is triggered in an insurance policy depends on whether the policy is a first party property insurance policy, such as a homeowners policy, or a third party liability policy, such as the CGL policy at issue in the Pennsylvania General case. A first party homeowners policy provides coverage for a homeowner in case of a fire, theft, or some other covered peril like earthquake, water, or wind. A third party liability policy, on the other hand, provides coverage for the liability of the insured to a third party, such as a building owner who sues for defective workmanship.

Just as the risks being insured are different in first party and third party policies, so too is the coverage analysis for each policy."[T]he right to coverage in the third party liability insurance context draws on traditional tort concepts of fault, proximate cause and duty. This liability analysis differs substantially from the coverage analysis in the property insurance context, which draws on the relationship between perils that are either covered or excluded in the contract. In liability insurance, by insuring for personal liability, and agreeing to cover the insured for his own negligence, the insurer agrees to cover the insured for a broader spectrum of risks." Garvey v. State Farm Fire & Casualty Co. (1989) 48 Cal. 3d 395,407.

Another difference in first party homeowner policies and third party CGL policies centers on the notice of loss requirements. Standard homeowner policies have time limitations within which damages must be discovered, notice to the insurer must be given, and a lawsuit must be filed. CGL policies do not have time limitations on coverage based on the date of discovery of the loss. Instead, CGL policies cover damages caused by an “occurrence” which is typically defined as an accident or continuous exposure to conditions that result in bodily injury or property damage during the policy period. Likewise, there is no limitation period for filing suit in a CGL policy. It is the damaged party who makes the claim against the insured and, if coverage is established, the insurer is required to indemnify the insured up to the limits of the CGL policy.

As has been noted, for CGL policies the focus is on whether there has been an “occurrence” during the policy period. But what if, as was alleged in the Pennsylvania General case, the inception date of the occurrence can not be determined and the damages are continuous, spanning more than one policy and implicating the policies of more than one carrier? That question was answered fifteen years ago in Montrose Chemical Corp. v. Admiral Ins. Co.(1995) 10 Cal.4th 645, 655-58.

B. The Montrose Case

Montrose Chemical Company manufactured the pesticide known as DTD from 1947 until 1982.

In 1983 it became embroiled in the infamous Stringfellow cases where the State of California and the U.S. government sued Montrose for the clean up cost at several disposal sites where the company had dumped its chemicals.The governments alleged there was progressively deteriorating property damage caused by chemicals being released into, or migrating through, soil, groundwater, and surface water. Montrose tendered the claims to its insurance carriers (warning: the following is a gratuitous editorial comment), seeking the defense and indemnity for which it had paid handsome premiums for many years.

Between 1960 and 1986, seven different insurers, ending with Admiral Insurance, issued CGL policies to Montrose. Admiral’s four CGL policies covered the periods from 1982 to 1986, and contained the standard language requiring Admiral to "pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of ... bodily injury, or ... property damage to which this insurance applies, caused by an occurrence...." "Occurrence" is defined as "an accident, including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured."

Montrose filed a declaratory relief action against the various carriers to establish the rights and duties of the parties under the policies of insurance. Admiral moved for summary judgment on the issue of its duty to defend, arguing that there was no potential for coverage under its policies given the effective dates of its policies and the fact that the dumping of the waste predated its policies. The trial court granted the motion for summary judgment, finding there was no potential for coverage, and thus Admiral had no duty to defend the lawsuits.

Montrose appealed the ruling and the Court of Appeal reversed the order granting summary judgment. Admiral’s petition to the California Supreme Court was granted, but the decision of the Court of Appeal was affirmed, with the Supreme Court explaining:

[W]e conclude that the standard CGL policy language, such as was incorporated into Admiral's policies in issue in this case, provides coverage for bodily injury and property damage that occurs during the policy period. In the case of successive policies,bodily injury and property damage that is continuous or progressively deteriorating throughout several policy periods is potentially covered by all policies in effect during those periods. Stated in the insurance industry's parlance, we conclude the "continuous injury" trigger of coverage should be adopted for third party liability insurance cases involving continuous or progressively deteriorating losses. In this case, because the potential of coverage arose under Admiral's policies, so too did its duty to defend Montrose in the underlying lawsuits.

The “continuous injury trigger” rule in Montrose has been applied to construction defect claims over the years. In the Pennsylvania General case, it was alleged that the insured’s framing and rough carpentry work caused damages that continued beyond Pennsylvania General’s policy period, and into the policy period of American Safety. Interestingly, the Court noted that when American Safety denied the claim, it was relying upon its policy language that “was designed to 'circumvent the continuous injury trigger of the coverage rule laid down' in [Montrose]."

3. Interpretation of American General’s Insurance Policy

The Court analyzed the American General policy based upon three important principles of insurance law: (1) “[w]hen construing an insurance policy, [a court ] must resolve ambiguities in coverage clauses most broadly in favor of coverage”; (2) “[a] policy provision is ambiguous when it is capable of two of more constructions, both of which are reasonable”; and (3) when the language of the policy is not clear it should be construed in a manner the “satisfies the hypothetical insured's objectively reasonable expectations.”

The Court summarized the relevant policy provisions as follows:

ASIC's CGL policy provided it would indemnify Whitacre for any amount Whitacre became obligated to pay as " 'property damage' to which this insurance applies," and specified that "[t]his insurance applies to . . . 'property damage' only if: [¶] (1) The . . . 'property damage' is caused by an 'occurrence' that takes place in the 'coverage territory'; and [¶] (2) The . . . 'property damage' occurs during the policy period." (CGL, Section I, Coverage A, ¶ 1(a) & (b).) ASIC's CGL policy provided a "per occurrence" {Slip Opn. Page 11} limit of $1 million, and provided a "Products/Completed Operations" aggregate limit of $1 million

ASIC's CGL policy also contained two 1999 endorsements that modified the standard policy provisions. The standard definition of "occurrence" contained in the 1997 version of the CGL policy was replaced by ASIC's 1999 endorsement that refined the definition of "occurrence" by adding the following italicized language: " 'Occurrence' means an accident, including continuous or repeated exposure to substantially the same general harmful conditions that happens during the term of this insurance. 'Property damage' . . . which commenced prior to the effective date of this insurance will be deemed to have happened prior to, and not during, the term of this insurance." (Italics added.)

At the same time, ASIC added another 1999 endorsement, entitled "PRE-EXISTING INJURY OR DAMAGE EXCLUSION," which stated: "This insurance does not apply to: [¶] 1. Any 'occurrence', incident or 'suit' . . . [¶] [(a)] which first occurred prior to the inception date of this policy . . .; or [¶] [(b)] which is, or is alleged to be, in the process of occurring as of the inception date of this policy . . . even if the 'occurrence' continues during this policy period.

The Court of Appeal summarized the trial court’s reasoning in granting American Safety’s motion for summary judgment as follows:

ASIC's policy excluded coverage for the claims asserted against Whitacre in the construction defect litigation because Whitacre's work was completed before the inception of ASIC's policy. The trial court reasoned that under ASIC's CGL policy: "The terms 'occurrence' and 'property damage' are distinctly defined and are not synonymous. In evaluating the trigger of coverage in the policies, there are two separate triggers, 'occurrence' and 'property damage' which are not the same, in light of the fact that 'property damage'' is caused by an 'occurrence.' [Citations.] An occurrence is a causal event. [Citation.] [¶] . . . [ASIC's] policy requires that . . . the occurrence [both] . . . 'happen during the term of the insurance' . . . and cause property damage during the policy period. It also excludes a prior 'occurrence' . . . .In the context of the underlying action, the Court finds that the 'occurrence' (the act causing the injury/damage), here the defective framing work performed by Whitacre, could arise no later than the time Whitacre's framing work on the project was completed. The undisputed evidence establishes that Whitacre's work was completed by June of 2001. . . . Therefore, the evidence establishes that the 'occurrence' commenced during [Pennsylvania General's] policy period, which was prior to the inception of [ASIC's] policy.

The Court did not agree with the analysis of the trial court. In analyzing the policy, the Court stated the proper construction of “occurrence,” as defined by the policy, requires a focus on “when the damages caused by the negligent causal acts of the insured first commenced, and is not on when the insured completed its work.” Since summary judgments are appropriate only if there are no triable issues of fact, the Court noted “the facts were disputed on when those damages first commenced and the trial court's entry of summary judgment in favor of ASIC was based solely on its conclusion that there was no potential for coverage because Whitacre's causal acts happened before the inception of ASIC's policy. We conclude, however, the policy was reasonably susceptible to the interpretation that the trigger of coverage was not when the insured completed its work, but was instead based on when the damages caused by the negligent causal acts of the insured first commenced.”

The Court reversed the judgment and awarded Pennsylvania General its costs on appeal. Presumably, the case will be remanded to the trial court for a trial on the disputed fact of when the damages caused by Whitacre’s negligent construction first commenced. Even if the trier of fact concludes the damages commenced prior to American Safety’s policy period, under Montrose, the findings will not be complete, and American General will not be off the hook, unless there is also a finding that there is no continuous or progressively deteriorating losses that fall within its policy periods.

Alternatively, the parties may elect to resolve the dispute through mediation rather than risking an unacceptable outcome by a judge or a jury. That’s an option I can support.

Editor's Note: This article originally appeared in Mealy's Litigation Report: Consruction Defect Insurance, Vol.7, #7, August 2010.

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In response to an onslaught of construction defect cases, California enacted statutory procedures to encourage settlement of claims before a lawsuit is even filed. But those procedures usually involve attorneys and experts, and they cost money, so are insurance companies obligated to pay the defense costs even though a lawsuit has not officially been filed? In a case of first impression, a California Court of Appeal has answered that question in the affirmative.

 In Clarendon America Insurance Company v StarNet Insurance Co. (2010) Cal App 4^th, Centex Homes was the developer of a residential development in Simi Valley, California known as Westwood Ranch. In July 2006, the Westwood Ranch Homeowners Association served a notice of commencement of legal proceedings pursuant to California Civil Code section 1375 on Centex that set forth a list of alleged construction defects at Westwood Ranch. This step was taken in compliance with the Calderon Act which requires that developers and homeowners associations engage in a prelitigation effort to settle construction defect claims. If the claims can nor be settled, the homeowners association is then authorized to file a lawsuit.

StarNet Insurance had issued two successive CGL policies to one of Centex’s subcontractors on the project, and Clarendon America Insurance had issued a CGL policy to another subcontractor. Centex was a named additional insured on the policies issued by both carriers.

In December 2007, Centex filed a complaint against Clarendon seeking payment of defense fees and costs incurred in defending against the construction defect claims in the prelitigation proceeding known in California as the Calderon Process. Clarendon filed a cross-complaint against the other insurers, including StarNet, seeking a declaration they were obligated to provide Centex a defense and/or coverage. In the first amended cross-complaint, Clarendon sought indemnity, declaratory relief, and contribution from the additional insurers. Clarendon reached settlements with all of the other CGL insurers except StarNet.

StarNet moved for summary judgment asserting the prelitigation process did not constitute a "suit" within the meaning of the defense agreement in the StarNet CGL policies. The trial court denied the motion, holding the prelitigation procedure “ is a civil proceeding in which damages are alleged and therefore falls within the StarNet CGL policies' definition of ‘suit’…Additionally, the definition of 'suit' also includes alternative dispute resolution procedures to which the insured submits with the insurer's consent…Thus, even if the Calderon process is not considered to be a 'civil proceeding' if that phrase is narrowly interpreted to mean 'court action[,'] but rather is considered an 'alternative dispute resolution proceeding[',] there is a question of fact as to whether or not Star[N]et has a duty to defend once the Calderon process has begun."

After analyzing the language of StarNet’s policy according to the standard rules of insurance policy interpretation, the Court of Appeal made this important observation:

The Calderon Process is more than a prelitigation alternative dispute resolution requirement: It is part and parcel of construction or design defect litigation initiated by an association and, as such, cannot be divorced from a subsequent complaint.

In affirming the trial court’s ruling, the Court stated, “The function and significance of the Calderon Process in construction or design defect litigation, and the StarNet CGL policies' definition of "suit" to include civil proceeding, lead to the reasonable inference the parties' intended StarNet would have a duty to defend the insured in the Calderon Process. Extending the duty to defend to the Calderon Process is therefore consistent with a hypothetical insured's reasonable expectations.”

This is good news for contractors, developers and, of course, homeowner associations. Hopefully CGL carriers will be more forthcoming in participating in prelitigation procedures such as the Calderon Process in California. This holding should lead to more prelitigation resolutions of construction defect cases and facilitate the public policy reasons for the enacting such laws.

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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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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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Tyler Gerking of Farella Braun + Martell LLP recently posted that Kemper Insurance is close to being put in a liquidation proceeding. According to Kemper's website, as of January 1, 2008, Kemper Insurance Companies in the U.S. included Lumbermens Mutual Casualty Company and its affiliated property and casualty insurers:

• American Manufacturers Mutual Insurance Company
• American Motorists Insurance Company
• Kemper Casualty Insurance Company
• Kemper Insurance Company of Texas
• Specialty Surplus Insurance Company

If you have a claim or potential claim on a commercial general liability policy or some other Kemper policy, you should check out Tyler's post. Here are some of the highlights:

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

Given the economic condition of Kemper and the potential for a liquidation proceeding, now is the time to review your files to determine if you have any claims or potential claims under any Kemper policies. Tyler's post concludes with this sound advice:

Given the limited recovery available in a liquidation, policyholders should evaluate whether such claims can be resolved now, even at discount. Kemp er may entertain such agreements since it could improve its balance sheet by removing reserves.  Thus, it is vital for policyholders to evaluate their risks in a Kemp er liquidation on a state-by-state basis and develop a strategy to mitigate those risks. We have done this for a number of clients and have been able to creatively reduce their exposure.

 

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A recent insurance case by the California Court of Appeal that denied insurance coverage to a contractor  Forecast Homes v. Steadfast Insurance Company (PDF), reminds me of the wisdom of this Japanese proverb: "When you’re thirsty it’s too late to start thinking about digging a well."  

It appears from the case that Forecast Homes followed standard procedure by getting its subs to name Forecast as a named additional insured in the subs' respective insurance policies prior to the start of construction. When sued for construction defects, Forecast tendered the claims to its subs' insurance company. The insurance company denied the claims and Forecast filed a declaratory relief action which, in essence, asked the court to declare that the insurance company was wrong in denying the claim.

The trial court found that the insurance company had acted properly because the policies had self-insured retentions that had to be paid by the subcontractors before the insurance company's obligations kicked in. Since the SIR limits had not been paid by the subcontractors, even though Forecast has paid defense costs that exceeded the SIR limits, the insurance company's did not have an obligation to defend and indemnify Forecast.

The proverbial wisdom contractors can learn from this case is this: "When a contractor is sued for construction defects caused by a subcontractor, it is too late to start thinking about coverage as a named additional insured on the sub's policy." 

Instead of simply filing the additional named insured certificate in the project file, it would be wise for contractors to spend some time asking questions about the scope and conditions of coverage under the terms of the subcontractors' policies.Even  though there are many other things that must be considered prior to construction, the benefits of fully understanding the actual insurance protection that is available will more than compensate for the time required for this risk avoidance exercises. It may also be prudent to include experienced construction insurance coverage counsel in this process.

My friend and construction insurance counselor Scott Turner of San Fransisco indicated that another avenue for the contractor to obtain insurance coverage under the facts of the Forecast case would be to file suit against the subcontrators for indemnity: " While not nearly as good as being an additional insured, the developer here may still have coverage of his indemnity claim against the insured sub." Scott is the author of Insurance Coverage of Construction Disputes (West Group 2nd ed. 2009).

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