Washington Supreme Court Defines Collapse in a Property Policy

Until recently, Washington law on what constitutes “collapse” in a first-party property insurance policy has been unsettled. But that issue has now been resolved with the Washington Supreme Court’s answer to the Ninth Circuit Court of Appeals certified question on the definition of “collapse” as “substantial impairment of structural integrity.”

The Queen Anne Park Condominium in Seattle, Washington, was originally constructed in the 1980’s. In 2009, the Queen Anne Park Homeowners Association (“HOA”) discovered that the siding on the buildings was leaking, which caused hidden decay. The building was insured by State Farm Fire and Casualty Company (“State Farm”) from October 18, 1992 to October 18, 1998 (“Policy”). The Policy included a collapse coverage form, which provided coverage for “any accidental direct physical loss to covered property involving collapse of a building or any part of a building caused only by one or more of the following: …(2) hidden decay.” The collapse coverage form further stated that “[c]ollapse does not include settling, cracking, shrinking, bulging or expansion.” The term “collapse” was not defined in the State Farm Policy.

5-25The Washington Supreme Court held that the undefined term “collapse” is ambiguous because it is susceptible to more than one reasonable interpretation. In support of its holding, the Court noted that in Sprague v. Safeco Ins. Co. of America, 174 Wn.2d 524, 276 P.3d 1270 (2012), different definitions of “collapse” were proposed by the dissent (“to break down completely: fall apart in confused disorganization: crumble into insignificance or nothingness…fall into a jumbled or flattened mass”) and by the concurrence (“a breakdown of vital energy, strength, or stamina”). The Court also noted that courts throughout the country have adopted different but reasonable definitions of “collapse” in insurance policies, i.e. Olmstead v. Lumbermens Mut. Ins. Co., 22 Ohio St. 2d 212,259 N.E.2d 123, 126 (1970) (“collapse” defined as “a falling down, falling together, or caving into an unorganized mass”); Am. Concept Ins. Co. v. Jones, 935 F. Supp. 1220, 1227 (D. Utah 1996) (collapse” defined as substantial impairment of structural integrity); Buczek v. Cont’l Cas. Ins. Co., 378 F.3d 284, 290 (3d Cir. 2004) (“collapse” defined as substantial impairment of structural integrity that “’connotes imminent collapse threatening the preservation of the building as a structure or…health and safety”). In particular, the Court observed that in at least one other case, State Farm had agreed with the insured that the term “collapse” meant “substantial impairment of structural integrity.” Mercer Place Condominium Assoc. v. State Farm Fire & Cas. Co., 104 Wn. App. 597, 17 P.3d 626 (2000).

Because the term “collapse” was ambiguous, the Court adopted a definition that is reasonable and most favorable to the insured, i.e. “substantial impairment of structural integrity.” The Court explained that the “structural integrity” of a building means a building’s ability to remain upright and that “substantial impairment” means a severe impairment. The Court stated that, “[t]aken together, ‘substantial impairment’ of ‘structural integrity’ means an impairment so severe as to materially impair a building’s ability to remain upright. Considering the Policy as a whole, we conclude that ‘substantial impairment of structural integrity’ means the substantial impairment of the structural integrity of all or part of a building that renders all or part of the building unfit for its function or unsafe and, in this case, means more than mere settling, cracking, shrinkage, bulging, or expansion.”

Because the newer collapse coverage forms usually define the term “collapse” as an actual falling down or caving in of a building or any part of a building, the Washington Supreme Court’s clarification on the definition of “collapse” will not be an issue. However, when the term “collapse” is undefined, the parties will likely engage in an expensive and prolonged battle of the experts as to what constitutes a building or part of a building to be “unfit for its function or unsafe,” and when such condition occurred.


Image courtesy of Flickr by Paul Sableman

Federal District Court Rejects Insureds’ $40 Million Bad Faith Claim

In Kollman v. National Union Fire Insurance Co. of Pittsburgh, Pa., No. 1:04-cv-3106-PA, Judge Owen Panner of the United States District Court for the District of Oregon recently ruled as a matter of law that even though National Union incorrectly denied coverage to its insureds, National Union did not act in bad faith in refusing to defend the underlying case. Therefore, the Court found that National Union was not liable for a $40 million judgment against the insureds.

The coverage litigation stemmed from a lawsuit filed in 2002 by Daryl Kollman against National Union’s insureds. The insureds tendered Kollman’s claims under an Executive and Organization Liability Policy. National Union denied coverage, relying primarily upon the “insured-versus-insured” exclusion, which excluded coverage for claims brought by an insured against another insured. Kollman was a former director of the insured’s subsidiary, and National Union stated that coverage for his claim was excluded. National Union declined to participate in the defense of the insureds and did not attempt to settle the matter within the $5 million policy limits.

The state court trial resulted in a $40 million judgment against the insureds. The insureds sued National Union, alleging they were entitled to coverage and that National Union acted in bad faith by unreasonably denying coverage and by failing to settle with Kollman for policy limits when it purportedly had the opportunity to do so. The insureds sought to hold National liable for the $40 million judgment, plus attorney fees and costs.

On summary judgment, the Court concluded that National Union had incorrectly denied coverage based on the policy’s insured-versus-insured exclusion, and it therefore had a duty to defend. However, the Court granted National Union’s Motion for Summary Judgment on the bad faith claims. Relying upon Georgetown Realty v. Home Ins. Co., 313 Or. 97, 831 P.2d 7 (1992), the Court ruled that Oregon law did not permit a bad faith failure-to-settle claim against an insurer that did not assume the duty to defend in the first instance. The Court also ruled that even though National Union was incorrect in its coverage determination with respect to the insured-versus-insured exclusion, its coverage decision was reasonable. The Court therefore dismissed all bad faith claims.

Through the Magnifying Glass: What an Insured May Recover Beyond Damages against its Insurer under Washington Law

Earlier this year, the United States District Court for the Western District of Washington provided a detailed analysis of the categories of damages available to a prevailing insured in a breach of contract action against an insurer, including prejudgment interest, costs and attorneys’ fees. MKB Constructors v. Am. Zurich Ins. Co., 2015 U.S. Dist. LEXIS 9325 (W.D. Wash. Jan. 27, 2015). In MKB, the insured was awarded more than $2.35 million in damages, comprised of (1) $1,083,424.24 for breach of contract, (2) $274,482.47 for violation of Washington’s Insurance Fair Conduct Act (“IFCA”), (3) $862,000 in enhanced damages under IFCA, and (4) $138,000 for failure to act in good faith (later overturned as duplicative of the IFCA damages). Following the verdict, the insured moved for prejudgment interest, nontaxable costs, and attorneys’ fees.

Prejudgment Interest

The parties did not dispute that the insured was entitled to prejudgment interest on the liquidated portions of its award. Rather, the issues were which rate to apply and when the interest began to accrue. Under Washington law, a twelve percent prejudgment interest rate is applied to contract disputes, but a lower rate of two percentage points above prime is applied to tort claims. RCW 4.56.110. The parties agreed that only one rate should apply, but disagreed as to whether the judgment was primarily based in tort or in contract. The insured asserted that the judgment was based primarily in contract because the majority of the liquidated portion of the award was for breach of contract. The insurer argued that the Court must consider the judgment as a whole and not just its liquidated components. The Court agreed with the insurer, citing Unigard Ins. Co.v. Mutual of Enumclaw Ins. Co., 160 Wn.App. 912 (Wash. Ct. App. 2011). The Court then compared the amount awarded for breach of contract to the greater total amount awarded for the tort claims based on bad faith and IFCA and concluded that the judgment was primarily based in tort. Accordingly, the Court applied the lower pre-judgment interest rate.

For the prejudgment interest accrual date, the parties agreed that under Washington law prejudgment interest should run from the date each particular invoice was paid. The insured argued, however, that the volume of invoices would make such a calculation an unreasonable burden. The Court agreed to two dates proposed by the insured for the commencement of prejudgment interest, one with respect to the invoices related to the breach of contract and another for its attorney’s invoices, based on the insured’s confirmation that these dates would not prejudice the insurer, and in fact would result in a net benefit to the insurer.

Attorney’s Fees

The insured sought a 33% increase of the total award to account for the contingent fee paid to its counsel. The Court rejected this request as unprecedented. Rather, Washington law presumes that a properly calculated lodestar figure represents reasonable compensation for counsel. A “lodestar” fee is determined by multiplying a reasonable hourly rate by the number of hours reasonably expended in the lawsuit.

The insurer disputed the reasonableness of the attorneys’ hours based on improper block-billing, unnecessary participation by a third attorney added just before trial, and for time spent on unsuccessful claims. Based on its review of the invoices, the Court reduced the block-billed entries by 20%. The Court did not deduct time for the third attorney added just before trial, because the addition of the attorney for trial was neither unusual nor excessive. The Court found that certain work related to discovery and dispositive motions were unnecessary and insufficiently related to the overall success of the litigation to warrant an award of fees. Rather than undertake an hour-by-hour analysis of the attorneys’ fees in order to excise the precise number of hours attributable to these items, the Court estimated, based on its experience with the case that an overall 20% reduction in the claimed fees would sufficiently account for the hours spent on these items.

Litigation Costs

Lastly, the insured sought reimbursement of litigation costs, totaling $160,580.50, which consisted of (1) expert witness fees; (2) travel expenses; (3) the insured’s labor costs; and (4) litigation costs advanced by counsel. The expert fees and travel expenses were uncontested.  In dispute were the labor costs and litigation costs advanced by counsel.

The Court held that the insured’s recovery of wages for employees who testified or otherwise participated in the lawsuit would be an unprecedented stretch of both IFCA and case authority permitting an award of costs. On the same basis, the Court denied recovery for fees paid to secure the attendance at trial of its former employees that were in excess of the statutory amount for fact witnesses provided by RCW 2.40.010. The Court rejected the insured’s argument that the payment of these witnesses was “akin” to an expert witness fee, since Washington courts have expressly disallowed such fees to fact or occurrence witnesses.

The Court also trimmed the insured’s request for over $52,000 in costs advanced by counsel.  “Actual and statutory litigation costs, including expert witness fees” may be awarded under IFCA.  Additionally, Washington case authority permits the court to award “all of the expenses necessary to establish coverage” in order to make the insured “whole.” Panorama Village Condo. Owners Ass’n Bd. Of Dirs. v. Allstate Ins. Co., 26 P.3d 910, 917 (Wash. 2001) (bolding in original). The Court ruled that the following costs should be reimbursed: (1) costs associated with electronic legal research; (2) photocopying; (3) messenger and Federal Express fees; (4) court reporter and videographer fees; (5) travel to depositions; (6) telephone conference fees; (7) PACER fees; and (8) hotel rooms near the courthouse for witnesses.

However, the Court declined to award certain costs that were not “litigation costs” such as a mediation fee; costs that were part of routine daily life and would have been incurred without trial such as costs for local attorneys’ commuting, lodging and meals during trial; and costs that were excessive, such as daily trial transcriptions.

The MKB decision should serve as a useful guide in future fee award cases and as a warning that courts in Washington should not “rubber stamp” an award in favor of the insured but should carefully scrutinize all components of the insured’s demand.

Cedell v. Farmers – Where Are We Now?

In Cedell v. Farmers Insurance Company of Washington, 176 Wn.2d 686 (2013), the Washington Supreme Court significantly restricted an insurer’s ability to assert the attorney-client privilege over communications with counsel by ruling that there is a presumption of no attorney-client privilege in first-party bad faith claims handling lawsuits.  The insurer may, however, overcome the presumption by showing that its attorney was “not engaged in the quasi-fiduciary tasks of investigating and evaluating or processing the claim, but instead in providing the insurer with counsel as to its own potential liability; for example, whether or not coverage exists under the law.”

As one Washington federal district court noted, while it is difficult to assess when a particular communication involves an attorney performing quasi-fiduciary duties, “as a general matter, there will likely be no privilege for a lawyer investigating facts to reach a coverage decision, but there likely will be a privilege for a lawyer giving an insurer strictly legal advice about potential liability that could result from a coverage decision or some other course of action.”  Anderson v. Country Mut. Ins. Co., 2014 U.S. Dist. LEXIS 112360 (W.D. Wash. August 13, 2014).  However, the attorney-client privilege can still be overcome if the insured asserts that the insurer engaged “in an act of bad faith tantamount to civil fraud” and makes a showing that “a reasonable person would have a reasonable belief that an act of bad faith has occurred” or that an insurer engaged in a “bad faith attempt to defeat a meritorious claim.”  Such analysis would, however, require something more than an honest disagreement between the insured and the insurer about coverage under the policy. For a prior G&R Insurance Bulletin on Cedell, click here.

Unfortunately, the Cedell Court caused some confusion regarding the process through which an insurer can overcome the presumption.  In short, it is unclear if there is a two-step process which requires the insurer to show that its attorney was not performing quasi-fiduciary (investigating and evaluating or processing the claim), followed by an in camera review of the allegedly privileged documents, or if the in camera review is part of the initial showing.  As one federal district court noted, “the opinion creates rather than alleviates confusion about what must be produced, and under what circumstances.”  Phil. Indem. Ins. Co. v. Olympia Early Learning Center, 2013 U.S. Dist. LEXIS 93067, at *3 (W.D. Wash. July 2, 2013).  There has been no Washington state court decision that explains the process identified in Cedell, but recent Washington federal district court decisions applying Cedell may shed some light on this confusion, at least in federal court practice. MKB Constructors v. Am. Zurich Ins. Co., 2014 U.S. Dist. LEXIS 78883 (W.D. Wash. May 27, 2014)

In MKB Constructors, Judge James L. Robart held that because state substantive law applies to the attorney-client privilege, an insurer must demonstrate that the attorney was not engaged in the “quasi-fiduciary tasks of investigating and evaluating or processing” a claim under Cedell.  However, federal law applies to the manner in which the court determines the existence of the privilege because the process through which an insurer can overcome the presumption is procedural in nature.  As a result, the court may use its discretion and utilize mechanisms other than an in camera review, i.e. privilege log, affidavit, declaration, to determine the applicability of Cedell in the specific context of the case.  Even so, most of the federal court decisions since MKB Constructors utilized in camera review to assess whether the insurer’s counsel engaged in quasi-fiduciary tasks.  See MKB Constructors v. Am. Zurich Ins. Co., 2014 U.S. Dist. LEXIS 102759 (W.D. Wash. July 28, 2014); Anderson v. Country Mut. Ins. Co., 2014 U.S. Dist. LEXIS 112360 (W.D. Wash. August 13, 2014); Johnson v. Allstate Prop. & Cas. Ins. Co., 2014 U.S. Dist. LEXIS 121342 (W.D. Wash. August 29, 2014); Collazo v. Balboa Ins. Co., 2014 U.S. Dist. LEXIS 109336 (W.D. Wash. August 7, 2014); Palmer v. Sentinel Ins. Co., 2013 U.S. Dist. LEXIS 103079 (W.D. Wash. July 23, 2013).

Another important aspect of the MKB Constructors decision is the holding by Judge Robart that Cedell is inapplicable in federal court when the work-product doctrine is invoked.  The work product doctrine is governed by Federal Rules of Civil Procedure Rule 26(b)(3); thus, Cedell is inapplicable when an insurer withholds documents under the work product doctrine in federal court.  It is important to keep in mind, however, that in the Ninth Circuit, a document is eligible for work product protection only if the document was prepared or obtained because of the prospect of litigation.  In re Grand Jury Subpoena (Mark Torf), 357 F.3d 900, 907 (9th Cir. 2004).  If a document would have been created in substantially similar form in the normal course of business, however, the fact that litigation is afoot will not protect it from discovery.  Id. at 908.  Under this analysis, Washington federal courts have held that draft denial letters prepared by the insurer’s coverage counsel are discoverable.  See Anderson v. Country Mut. Ins. Co., 2014 U.S. Dist. LEXIS 118400 (W.D. Wash. August 25, 2014); Tilden-Coil Constructors, Inc. v. Landmark Am. Ins. Co., 2010 U.S. Dist. LEXIS 106369 (W.D. Wash. September 23, 2010).

Finally, as predicted, the federal district court in Carolina Cas. Ins. Co. v. Omeros Corp., 2013 U.S. Dist. LEXIS 53225 (W.D. Wash. April 12, 2013), rejected the insurer’s argument that Cedell only applies to first-party claims, not to third-party liability claims.  The federal district court reasoned that the Cedell court based its ruling on the quasi-fiduciary duty of an insurer to its insured, which exists in both first-party and third-party claims.  Id. at *6-7.

Cedell is still very much alive and well in Washington and insurers should continue to pay close attention to how it impacts reliance on the attorney-client privilege in discovery in both first and third-party bad faith litigation.

Washington’s Insurance Fair Conduct Act Only Applies to First-Party Claims

Ever since the Washington Insurance Fair Conduct Act (“IFCA”) took effect on December 6, 2007, insureds have asserted a claim for IFCA violation in lawsuits against an insurance company.  While IFCA specifies that “[a]ny first party claimant to a policy of insurance who is unreasonably denied a claim for coverage or payment of benefits by an insurer may bring an action,” insureds under both first-party policies and third-party liability policies have asserted IFCA claims in light of Washington courts’ very pro-policyholder attitude.  An IFCA claim is very attractive to the insureds because if a court finds that an insurer acted unreasonably in denying a claim for coverage or payment of benefits, an insured is entitled to actual damages (not limited to the benefits that were unreasonably denied), treble of those damages, and attorneys’ fees and costs.

Earlier this year, however, Judge Marsha Pechman dismissed plaintiffs’ IFCA claim against Continental Casualty Company (Continental), ruling that IFCA does not apply to third-party liability claims.  Cox v. Cont’l Cas. Co., 2014 U.S. Dist. LEXIS 68081 (W.D. Wash. May 15, 2014). Judge Pechman explained that only a “first party claimant to a policy of insurance” has a right of action under IFCA.

Cox arises out of a malpractice action against retired dentist, Dr. Henri Duyzend.  In the malpractice action, a group of Dr. Duyzend’s former patients secured a judgment totaling $35,212,000 against Dr. Duyzend for their malpractice claims.  Thereafter, on an assignment of claims from Dr. Duyzend, the dental patients sued Continental, alleging in part that Continental acted in bad faith and violated the IFCA by not pursing a global settlement with them and risking an excess judgment against Dr. Duyzend.  Continental had issued a professional liability policy to Dr. Duyzend.

With regard to the plaintiffs’ IFCA claim, Judge Pechman explained that “[a]n IFCA claim arises when ‘any first party claimant’ to a policy of insurance … is unreasonably denied a claim for coverage or payment of benefits by an insurer.”  Judge Pechman noted that a third-party insurance policy “indemnif[ies] an insured for covered claims which others [third-party claimants] file against him.”  The professional liability policy at issue in Cox was a third-party liability policy, not a first-party insurance policy.  As a result, Dr. Duyzend was never a first-party claimant under the IFCA and could not assign an IFCA claim to the plaintiffs.  Therefore, Judge Pechman dismissed the plaintiffs’ IFCA claim.

In one subsequent case, Judge Pechman held consistently with her decision in Cox.  Judge Pechman denied a plaintiff’s motion to amend the complaint to assert an IFCA violation against an insurer under a third-party liability policy, holding that such claims are not permitted under the rule.  Judge Pechman refused to certify to the Washington Supreme Court the question of whether an insured under a third-party liability policy may have an IFCA claim.  In so holding, the court affirmed that under Washington law, coverage which “indemnif[ies] an insured for covered claims which others [third-party claimants] file against him is third-party coverage.  As discussed in Cox, the IFCA defines ‘first party claimant’ in a narrow way that applies only to first-party insurance.”

Washington Court Holds Agency Action Must Be Adversarial or Coercive to Trigger Insurer’s Duty to Defend

While Washington courts have long held that an insurer must indemnify an insured for cleanup costs under the Model Toxics Control Act (MTCA), even where the Washington State Department of Ecology (DOE) has made no threat of formal legal action, the Washington courts had not addressed the issue of what triggers an insurer’s duty to defend.

On June 2, the Washington Court of Appeals addressed the latter issue in Gull Industries, Inc. v. State Farm Fire and Cas. Co. and Transamerica Ins. Group, et al., 2014 Wash. App. LEXIS 1338, and held that an agency action must be adversarial or coercive to qualify as the functional equivalent of a “suit” when that term is undefined in the policy.

In Gull Industries, Gull undertook voluntary remediation of his gas station after finding contamination from an underground storage tank.  Gull notified the DOE, which acknowledged receipt of Gull’s notice of contamination.  The DOE letter also stated that DOE has not determined that Gull is a potential liable party; advised Gull to be aware of state requirements but did not advise of any consequences in failing to comply with such requirements; and noted that Gull may request assistance from the DOE.

Gull subsequently tendered its defense and indemnity to Transamerica Insurance Group (TIG) and State Farm, which both provided liability coverage for the gas station.  The policies provided a duty to defend “any suit against the insured,” but “suit” was undefined.  After TIG and State Farm denied the tender and Gull filed suit, the trial court granted summary judgment to TIG and State Farm on the duty to defend.

On appeal, the Court of Appeals adopted the analysis in Ryan v. Royal Ins. Co. of America, 916 F.2d 731 (1st Cir. 1990) to determine what triggers the duty to defend “any suit” when the owner of contaminated property faces strict liability under MTCA.  The Court of Appeals held that the term “suit” is ambiguous in this context and may include administrative enforcement acts that are the functional equivalent of a suit to trigger the duty to defend if the governmental agency communication involves an explicit or implicit threat of immediate and severe consequences by reason of the contamination.

In this case, the Court of Appeals held that the DOE letter to Gull did not present an express or implied threat of immediate and severe consequences by reason of the contamination.  As a result, Gull was not faced with the functional equivalent of a suit, and TIG and State Farm had no duty to defend.

In light of this case, it will be important for insurers to carefully examine agency communications to determine whether such communications would qualify as a functional equivalent of a suit to implicate the duty to defend.

Washington Court Finds Stipulated Judgment Against Insured Is Minimum Measure of Damages in Failure to Settle Case

It is a general principle that insurers face liability beyond their policy limit when they fail to settle a claim against an insured that presents an exposure beyond the limit.  States approach the rule in different ways. As demonstrated recently in a Washington appellate decision, Miller v. SAFECO Ins. Co., 2014 Wash. App. LEXIS 1030 (April 28, 2014), insurers need to be very careful there because the ultimate judgment against the insured, even if reached by stipulation between the insured and underlying plaintiff, presents the minimum measure of damages for the nonsettling insurer.

Miller involved an automobile accident in which Patrick Kenny hit a cement truck while driving a vehicle owned by one of his passengers.  Safeco Insurance Co. wrote a $500,000 per person and accident primary and $1 million umbrella policies.  Despite severe injuries, Safeco did not settle with passenger Miller for policy limits.

Kenny settled with Miller, which included a covenant not to execute with an assignment of Kenny’s rights against Safeco.  Safeco later agreed $4.15 million was a reasonable judgment amount. Interestingly, Washington does not require the action be tried to establish its value despite a “no action” policy condition, contrary to many states.

Miller sued Safeco and the jury rendered a verdict for Miller of $13 million, of which $11.9 million was on the assignment.  The $11.9 million included the $4.15 million judgment and $7.75 million for other damages such as lost or diminished assets or property; lost control of the case or settlement; damage to credit; effects on insurability; and emotional distress or anxiety.  The judgment against Safeco ultimately totaled $21,837,286.73 after interest was added.

The Court of Appeals affirmed, essentially ruling against Safeco on every contested issue.  The court rejected Safeco’s argument the stipulated judgment was the only measure of damage.  It noted an insured’s damages may also include other damages such as the jury found here.

Another important lesson is that the Court of Appeals agreed Safeco’s reserve information was admissible because it indicates whether the insurer adjusted the claim in good faith.  There was evidence Safeco set its reserve at $1.5 million and repeatedly concluded that Kenny was exposed to liability in excess of policy limits.  Yet it did not offer that amount to settle.

The Court of Appeals remanded to recalculate the post-judgment interest and it is possible further proceedings could occur.  We will report further as they do.