Emerging Coverage Considerations for Insurers Relating to Claims in Connection with COVID-19

The only thing equally inevitable to the spread of the novel coronavirus 2019 disease (“COVID-19”) will be the resulting onslaught of first-party and third-party insurance claims and insurance coverage litigation seeking to mitigate business losses through recoveries from the insurance industry. Prominent policyholder firms are already pitching corporate America to seek coverage first and ask questions later. The immediacy of claims and litigation will be expedited and their impact multiplied because of the economic downturn. Policy language and actual coverage will be subject to sustained attacks and creative arguments reflecting the huge sums of money that will be at stake. The impact and aftermath of the COVID-19 pandemic stands to present coverage questions for insurers under a variety of coverage forms, including Commercial Property, Commercial General Liability, Professional Liability and Healthcare Liability, and Directors and Officers Liability coverage forms. We summarize below the issues that have already arisen, as well as those that we expect to arise as policyholders submit claims under their insurance assets in connection with COVID-19.

First Business Income Claim Filed

Louisiana appears to be the first state in which an insured filed a lawsuit seeking first-party insurance coverage for business income loss related toCOVID-19. Cajun Conti, LLC, et al. v. Certain Underwriters at Lloyd’s London, et al., Civil District Court for the Parish of Orleans, Louisiana. In response to the New Orleans mayor’s restrictions on restaurant operation in relation to the public health emergency, the restaurant owner sought coverage under its “all risks” policy, which provides coverage for “direct physical loss unless the loss is specifically excluded or limited.” In its complaint the policyholder asks the court to declare that s “because the policy provided by Lloyd’s does not contain an exclusion for a viral pandemic, the policy provides coverage to [the business] for any future civil authority shutdowns of restaurants in the New Orleans area due to physical loss from Coronavirus contamination and that the policy provides business income coverage in the event that the contamination has contaminated the insured premises.” Notably, however, the declaratory judgment specifically “do[es] not seek any determination of whether the Coronavirus is physically present in the insured premises, amount of damages, or any other remedy besides the declaratory relief.” Gordon Rees Scully Mansukhani will continue to monitor this developing litigation and advise of developments that may impact insurers.

ISO Commercial Property Forms Typically Exclude Coverage for Communicable Diseases

Essential to the resolution of the Cajun Conti case and future claims like it will be the scope of coverage afforded under ISO Commercial Property forms. In 2006, after learning from prior major viral outbreaks, ISO adopted a mandatory exclusion for business interruption policies that specifically excludes coverage for lost business income arising from viruses. ISO form CP 01 40 07 06, “Exclusion for Loss Due To Virus Or Bacteria,” specifically applies to business income, and provides in relevant part that the underwriter “will not pay for loss or damage caused by or resulting from any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease.”

Absent this exclusion, however, triggering business interruption coverage under the ISO form fundamentally requires “direct physical loss of or damage to property at premises which are described in the Declarations.” Needless to say the proper interpretation of the terms “direct physical loss of or damage to property at premises” is expected to be one of the foremost topics of disagreement between policyholders and their insurers as these claims begin to mount. From a policyholder advocate perspective, the presence of COVID-19 in the building may be sufficient. In this regard, recent articles published by policyholder firms point to cases in which courts have held that the presence of gaseous or other non-visible substances constituted a “direct physical loss” to premises where the substance rendered the premises uninhabitable, even absent physical alteration to the structure itself. These arguments unreasonably expand the plain meaning of the language used in property policies. Indeed, many courts confronted with coverage disagreements involving similar conditions—such as the presence of asbestos, mold, or other debris in a building–concluded that the requisite “direct physical loss of or damage to” covered property was lacking

In Some Instances Manuscript Policies May Present A Closer Question

The focus of coverage disputes under manuscript policies are far less easy to predict, as they contain terms negotiated by the insured or its broker. One such area of attention may be the applicability of Civil Authority Coverage, which in some cases may extend business interruption coverage to orders or actions of a governmental agency or other civil authority. With everything from auto production factories to nail salons closing pursuant to state government emergency orders this will likely be hot button issue in the courts. As is the case with all coverage questions, the scope of coverage will be determined by the particular facts and circumstances of the loss and the plain meaning of the terms of the policy.

State Efforts to Extend Coverage

Insurers are cautioned to pay particular attention to state efforts to mandate the payment of business income losses related to COVID-19 under the property provisions of the Commercial Package and Business owner policies. The first state to offer legislation of this type is New Jersey, which has proposed a law titled as an act “concerning certain covered perils under business interruption insurance.” The draft bill in the state is aimed to force insurers to cover business income loss relating to COVID-19 and the governmental efforts to prevent its spread—including for policies that explicitly exclude viral coverage (such as policies bearing the ISO exclusion)—regardless of the policy terms and provisions.

Despite the legislature’s effort to hold harmless a segment of the business sector with the foresight to purchase business interruption coverage, this proposed legislation seemingly shifts the burden of compensating businesses for virus-related losses from the state or federal government onto private insurers, including those who have specifically contracted out of this coverage. It also raises a significant question of due process and the freedom of insurers to contract to limit the coverage provided under their policies.

The State of New York has also entered the fray, but not to coerce insurers to pay uninsured losses. On March 10, 2020, the New York Department of Financial Services (NYDFS) issued a letter directing insurers who write business interruption coverage to “explain” to policyholders the benefits under their policies and the protections provided in connection with COVID-19. While the directive is targeted to preemptively address insured questions concerning the scope of business interruption coverage, it fosters an erroneous “one size fits all” approach to construing policy coverage and it arguably requires insurers to issue advisory opinions concerning the interpretation of “covered perils” and “physical loss or damage” in their policies without first knowing the particular facts and circumstances of any given loss or claim. Notably, in October 2019, NYDFS implemented Section 308 of the Insurance Law requiring insurers to complete a questionnaire in order to ascertain the level of pandemic influenza preparedness, purportedly in the hope that this information would help raise the general level of preparedness of our licensees.

Most recently the Maryland Insurance Administration released and Advisory or Business Interruption on Business Interruption Insurance on March 18, 2020, which states that it has been received a high volume of inquiries related to business interruption insurance. The Advisory states in pertinent part:

Business Interruption coverage is typically triggered under a commercial insurance policy when a covered risk / peril causes physical damage to the insured premises resulting in the need to shut down business operations. For example, if a fire damages a business and the business cannot operate during repairs, business interruption coverage would be available subject to the terms and limits in the policy.

. . .

Some commercial policies provide Business Interruption coverage when a business is shut down due to an Order by a civil authority. However, the policy still typically requires a physical loss from a covered peril as the underlying cause of the business shut down to apply.

. . .

All insurance policies have exclusions of coverage for risks that are too great to be underwritten at an affordable price. For example, commercial and personal property insurance policies typically contain specific exclusions for loss or damage caused by war, nuclear action and radiation. The potential loss costs from such perils are so extreme that providing coverage would jeopardize the financial solvency of property insurers. Global pandemics like COVID-19 usually fall into this category. However, policies can be different. We recommend that businesses review their policies and reach out to their insurance professionals with any questions.

This approach is less aggressive than those taken by New Jersey and New York, and at least at this time Maryland has not required insurers to take on obligations for which they did not contract or otherwise issue advisory opinions. We will provided updates as other states and insurance departments begin to take positions on insurance coverage related to COVID-19.

Commercial General Liability

Commercial General Liability (“CGL”) policies will surely also be noticed by insureds and lead to extensive coverage litigation given the myriad of possible factual situations that will arise. Since CGL provides coverage for liability to third parties arising from “bodily injury” or “property damage” resulting from unintentional acts, there are many potential avenues for negligence claims around issues of exposure to COVID-19.

In CGL policies, the definition of “bodily injury” generally includes “sickness” or “disease.” The most likely avenue for claims will most likely be parties alleging liability for the spread of the coronavirus. Considering the ubiquitous effects of the virus on businesses worldwide, claims could come in many forms: restaurants, bars, or gyms that did not close, or theaters or concert venues that did not postpone events, are just a few examples. The early outbreak at the nursing home in Washington will raise many questions about the standard of care that should have been in place in any facility handling vulnerable populations. Airlines, hotels, conference centers, travel agents, or cruise ship companies could also be targets for moving forward with events or bookings in the face of worldwide news cycle warning of dangers. All of these entities could face liability for failing to take appropriate action to prevent infection from employees that appeared sick, or high-touch surfaces that were not appropriately de-contaminated. Similar claims could allege a lack of preparedness or training of employees that led to the spread of infection.

Other claims not directly related to the spread of disease, but rather as a result of the actions taken to prevent the spread, may arise. For example, if a real estate owner closes a building, there may be claims for wrongful eviction. This would fit within the standard definition of “personal and advertising injury.”

While it is true that CGL policies often include pollution exclusions, the effect of such exclusions will depend largely on the precise language of the exclusion and law of the state where it is being applied. Some CGL policies also contain exclusions for viruses or communicable diseases. The most difficult obstacle for claims will be sickened individuals attempting to pinpoint where they were sickened, and by whom. However, even the smallest claims that stick past the motion to dismiss stage may lead to a copycat effect. There are many jurisdictions where the insurance industry struggles to get fair treatment in the courts, which will present even greater peril if COVID-19 impacts a measurable percentage of the local population with serious permanent impairment or death.

Directors & Officers Liability

It is also worth considering the potential for claims against Directors & Officers, Errors & Omissions, Management Liability, or any form of Professional Liability Insurance policies, including Healthcare Professional Liability policies. Claims could be made against managers, directors, officers, or professionals for a failure to make decisions that would have prevented the spread of disease. Potentially more costly could be claims by investors, who have seen the value of their holdings dwindle, seeking to assert claims against officers alleging that a lack of response (or inadequate response) led to a reduction in share price. Policyholders will argue that pollution exclusions have limited effect against such claims.

Visit our COVID-19 Hub for ongoing updates.

Insurance Adjuster Employed by an Insurance Company May Be Liable for Bad Faith in Washington

As a general proposition, an adjuster working for an insurance company is not subject to personal liability under the common law or under state insurance laws for conduct within the scope of his/her employment. Recently, however, the Washington Court of Appeals, Division One, in Keodalah v. Allstate Ins. Co., 2018 Wash. App. LEXIS 685 (2018), held that an individual adjuster, employed by an insurance company, may be held liable for bad faith and violation of the Washington Consumer Protection Act (“CPA”).

In Keodalah, Moun Keodalah (“Keodalah”) was involved in an accident with a motorcycle, after which Keodalah sought uninsured/underinsured motorist (“UIM”) benefits of $25,000 under his auto policy issued by Allstate. Allstate offered $1,600 based on an assessment that Keodalah was 70 percent at fault, even though the Seattle Police Department and the accident reconstruction firm hired by Allstate concluded that the accident was caused by the excessive speed of the motorcyclist. When Keodalah questioned Allstate’s evaluation, Allstate increased its offer to $5,000. Thereafter, Keodalah sued Allstate for UIM benefits.  Despite having the police investigation report, its own accident reconstruction firm’s findings, and the 30(b)(6) deposition testimony of the Allstate adjuster, who acknowledged that Keodalah had not run a stop sign and had not been on his cell phone at the time of the accident, Allstate maintained its position that Keodalah was 70 percent at fault. At trial, the jury determined that the motorcyclist was 100 percent at fault and awarded Keodalah $108,868.20 for his injuries, lost wages, and medical expenses.

Keodalah then filed a second lawsuit against Allstate and the adjuster, including claims under the Insurance Fair Conduct Act (“IFCA”), the CPA, as well as for insurance bad faith. The adjuster moved to dismiss the claims against her under Rule 12(b)(6). The trial court granted the motion but certified the case for discretionary review. First, the court held that there was no private cause of action for violation of a regulation under the IFCA, following the recent Washington Supreme Court decision in Perez-Cristantos v. State Farm Fire & Cas. Ins. Co., 187 Wn.2d 669 (2017).

The Court of Appeals then addressed whether an individual insurance adjuster may be liable for bad faith and for violation of the CPA. The court looked to the Revised Code of Washington (“RCW”) 48.01.030, which serves as the basis for the tort of bad faith. RCW 48.01.030 imposes a duty of good faith on “all persons” involved in insurance, including the insurer and its representatives, and a breach of such duty renders a person liable for the tort of bad faith. The term “person” is defined as “any individual, company, insurer, association, organization, reciprocal or interinsurance exchange, partnership, business trust, or corporation.” RCW 48.01.070.  Because the adjuster was engaged in the business of insurance and was acting as an Allstate representative, she had the duty to act in good faith under the plain language of the statute. As a result, the Court of Appeals held that the adjuster can be sued for bad faith.

With respect to the CPA claim, the court noted that the CPA prohibits “[u]nfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce.” RCW 19.86.020. The Court of Appeals, Division One, previously ruled that under “settled law,” the “CPA does not contemplate suits against employees of insurers.” International Ultimate, Inc. v. St. Paul Fire & Marine Ins. Co., 122 Wn. App. 736, 87 P.3d 774 (Wash. App. 2004). There, the court held that to be liable under the CPA, there must be a contractual relationship between the parties and because there is no such relationship between an employee of the insurer and the insured, the employee cannot be liable for a CPA violation. The court in Keodalah, however, rejected the adjuster’s reliance on International Ultimate, holding that the prior decision was without any supporting authority, and it was inconsistent and irreconcilable with the Washington Supreme Court case of Panag v. Farmers Ins. Co. of Wash., 166 Wn.2d 27, 208 P.3d 885 (2009) (Washington Supreme Court declined to add a sixth element to the Hangman Ridge elements that would require proof of a consumer transaction between the parties). It appears that the holding in International Ultimate may be losing ground, as at least two federal district court cases have questioned the validity of that case. Lease Crutcher Lewis WA, LLC v. National Union Fire Ins. Co. of Pittsburgh, Pa., 2009 U.S. Dist. LEXIS 97899, *15 (W.D. Wash. Oct. 20, 2009), (statement at issue in International Ultimate “is unsupported by any citation or analysis); Zuniga v. Std. Guar. Ins. Co., 2017 U.S. Dist. LEXIS 79821, *5-6 (W.D. Wash. May 24, 2017) (pointing out at least two problems with the statement at issue in International Ultimate).

While the adjuster’s actions in Keodalah appear to have been extreme, presumably policyholders in Washington will rely on this case to sue an insurance company’s adjusters in their individual capacities for bad faith and CPA violations. The court’s holding may have far reaching consequences. For example, will insurers need to appoint separate counsel for their adjusters when the adjusters are personally named in litigation? How will this affect the practice of removing cases from state to federal court? To the extent an insured wants to destroy diversity jurisdiction for its out-of-state insurer, it may choose to name an in-state adjuster, which would limit the insurer to Washington State Court when litigating coverage issues. This is an extremely alarming development for insurers and their employee adjusters in Washington State, who should take this as a reminder to be vigilant in ensuring good faith claims handling and the aggressive defense of bad faith claims.

Court Enforces Automatic Additional Insured Provision’s Pre-Condition Requiring Underlying Contract to Be Fully Executed Pre-Loss

Many liability policies contain provisions, typically in endorsements, automatically bestowing additional insured status on third parties when called for in certain types of contracts. These endorsements usually require that such contracts be in writing and signed by both parties prior to the date of the event for which coverage is sought. In Selective Ins. Co. of Am. v. BSA, No. 15-0299, 2018 U.S. Dist. LEXIS 56178 (E.D. Pa. April 2, 2018), a Philadelphia federal judge recently enforced the signed written agreement requirement as an unambiguous condition precedent to coverage, denying additional insured status where the underlying contract had not been signed by the named insured.

At issue was a Blanket Additional Insured clause which provided coverage to any organization that the insured, Keystone College, agreed to add to the policy in a written contract, so long as the contract was signed by both the named insured and the additional insured before any loss. The Boy Scouts of America (“BSA”) sought coverage under this provision after a Keystone student was injured on campgrounds owned by BSA. The campground rental agreement required that Keystone add the BSA as an additional insured. Crucially, however, Keystone never signed it.

Rejecting the BSA’s argument that Keystone’s post-accident ratification of the contract sufficed to make BSA an additional insured, the Court held that Selective was entitled to insist upon true compliance with policy’s express requirement of “a written agreement signed by both parties.” The Court thus distinguished the legally-irrelevant issue of whether the policy holder and the BSA had entered a binding agreement among themselves from the distinct, and controlling, issue of whether the policy’s express conditions for automatic coverage had been satisfied. Because they were not, the court refused to find that the third-party agreement expanded the insurer’s coverage obligations under the policy.

The takeaway from this decision is that insurers are entitled to insist that unambiguous conditional language of policies be enforced as written. The relevant inquiry was not whether the parties to the incompletely-executed underlying contract considered themselves bound to it, but whether those conditions had been complied with. As is should be, the insurer was only bound by the terms it had agreed to in the policy, and the policyholder’s failure to comply with this unambiguous condition precedent precluded automatic additional insured status under the policy for its contractual counterparty.

No Duty to Defend Drug Makers in Actions Alleging Deceptive Marketing Fueled Opioid Abuse and Addiction

On November 6, 2017, the California Court of Appeal for the Fourth Appellate District affirmed a trial judge’s decision that The Traveler’s Property Casualty Company of America (“Travelers”) did not owe a duty to defend various pharmaceutical manufacturers in two actions alleging deceptive marketing of opioid products because the alleged injuries in the underlying actions were not caused by an accident. Traveler’s Prop. Cas. Co. of Am. v. Actavis, Inc. (Nov. 6, 2017, No. G053749) 2017 Cal. App. LEXIS 976.

The County of Santa Clara and the County of Orange brought a lawsuit (the “California action”) against Actavis, Inc. and other pharmaceutical companies engaged in a “common, sophisticated, and highly deceptive marketing campaign” designed to increase the sale of opioid products by promoting them for treatment of long-term chronic pain, a purpose for which Actavis allegedly knew its opioid products were not suited. The City of Chicago brought a separate lawsuit (the “Chicago action”) against Actavis making essentially the same allegations. Both actions alleged that Actavis’ marketing scheme resulted in a “catastrophic” and nationwide “opioid-induced ‘public health epidemic’” and a resurgence in heroin use. Both actions also alleged that the Counties and City have and will incur increased costs of care and services to their citizens injured by prescription and illegal opioid abuse and addiction.

Travelers declined any duty to defend under commercial general liability policies issued by Travelers and St. Paul Fire and Marine Insurance Co. (collectively “Travelers”), and brought this action seeking a declaration that it had no duty to defend or indemnify Actavis with respect to both actions.

The St. Paul policies cover “damages for covered bodily injury or property damage” that are “caused by an event.” The policies defined “event” to mean “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Similarly, the Travelers policies cover damages “because of ‘bodily injury’ or ‘property damage’” caused by an “occurrence.” The term “occurrence” is also defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The St. Paul and Travelers policies also include product exclusions that bar coverage for bodily injury or property damage resulting from or arising out of “your product” or “your work.”

Following a bench trial on stipulated facts, the trial court issued a statement of decision concluding that neither the California nor Chicago action alleged an “accident” as required by the policies to create a duty to defend, and the product exclusions precluded coverage for the claims.

The Court of Appeal agreed, noting that under California law, a deliberate act is not an accident, even if the resulting injury was unintended, unless the injury was caused by an additional, unexpected, independent, and unforeseen happening. The Court found that the allegations that Actavis engaged in “a common, sophisticated, and highly deceptive marking campaign” to increase the sale of opioids and corporate profits “can only describe deliberate, intentional acts” for which there could be no insurable “accident” unless “some additional, unexpected, independent, and unforeseen happening” produced the injuries alleged in the underlying actions.

The Court rejected Actavis’ assertion that the injuries were indirect and unintended results caused by “mere negligence and fortuities” outside of Actavis’ control. “[W]hether [Actavis] intended to cause injury or mistakenly believed its deliberate conduct would not or could not produce injury is irrelevant to determining whether an insurable accident occurred.” Instead, the Court must look to “whether the California Complaint and the Chicago Complaint allege, directly or by inference, it was [Actavis’] deliberate conduct, or an additional, unexpected, independent, and unforeseen happening, that produced the alleged injuries.” The Court found that it was neither unexpected nor unforeseen that a massive marketing campaign to promote the use of opioids for purposes for which they are not suited would lead to a nation “awash in opioids” or an increase in opioid addiction and overdoses.

The Court also rejected Actavis’ contention that the alleged injuries are not the “normal consequences of the acts alleged” because in order for the opioid products to end up in the hands of abusers, doctors must prescribe the drugs to them. “The test, however, is not whether the consequences are normal; the test is whether an additional, unexpected, independent, and unforeseen happening produced the consequences.” The Court opined that the role of doctors in prescribing, or even misprescribing, opioids is not an independent or unforeseen happening.

Although the trial court declined to determine whether the California or Chicago actions sought damages because of potentially covered “bodily injury,” the Court found that those actions alleged two categories of “bodily injury”: (1) the use and abuse of opioid painkillers including overdose, addiction, death, and long-term disability; and (2) use and abuse of heroin, the resurgence of which was alleged to have been triggered by use and misuse of opioids. Applying a broad interpretation of “arising out of” as used in the product exclusions, the Court held that both categories of “bodily injury” arise out of Actavis’ opioid products, and are, therefore, barred by the product exclusions in the policies.

The Court also noted a split of authority whether product exclusions apply only to defective products. Although recognizing that the California Supreme Court has not addressed the issue, the Court agreed with the Florida Supreme Court’s reasoning in Taurus Holdings v. U.S. Fidelity (Fla. 2005) 913 So.2d 528, that the term “any product” in the product exclusions applies broadly and does not limit the application of the exclusions to defective products.

Actavis reaffirms California law that a deliberate act resulting in unintended injuries is not an “accident,” unless the injuries were caused by an additional, unexpected, independent, and unforeseen happening. This decision also reiterates California’s broad interpretation of “arising out of” as used in coverage provisions and exclusions.

Washington Supreme Court Denies Reconsideration of Its Decision to Apply the Efficient Proximate Cause Rule to a Third-Party Liability Policy

We previously reported the Washington Supreme Court’s decision in Xia, et al. v. ProBuilders Specialty Insurance Company, et al., 188 Wn.2d 171, 393 P.3d 748 (2017), in which the Court applied the efficient proximate cause rule to a third-party liability policy to find a duty to defend.

To recap, Washington law requires insurers to assess and investigate coverage under first-party insurance policies by applying the efficient proximate cause analysis. Until Xia, the efficient proximate cause rule has only been applied to first party insurance policies in Washington. But the Washington Supreme Court’s decision in Xia changed that by holding that an insurer must consider the efficient proximate cause rule in determining its duty to defend under a CGL policy.

The issue in Xia was whether the pollution exclusion applied to relieve ProBuilders of its duty to defend a claim against the insured alleging that carbon monoxide was released into the claimant’s house through a defectively installed vent. ProBuilders denied coverage to the insured contractor, in part, under the pollution exclusion. The Washington Supreme Court held that while ProBuilders did not err in determining that the plain language of its pollution exclusion applied to the release of carbon monoxide into Xia’s home, “under the ‘eight corners rule’ of reviewing the complaint and the insurance policy, ProBuilders should have noted that a potential issue of efficient proximate cause existed,” as Xia alleged negligence in her original complaint, i.e. failure to properly install venting for the hot water heater and failure to properly discover the disconnected venting.

Ultimately, the Court concluded that the efficient proximate cause of the claimant’s loss was a covered peril – the negligent installation of a hot water heater. Even though ProBuilders correctly applied the language of its pollution exclusion to the release of carbon monoxide into the house, the Court ruled that ProBuilders breached its duty to defend as it failed to consider an alleged covered occurrence that was the efficient proximate cause of the loss. The Court granted judgment as a matter of law to the claimant with regard to her breach of contract and bad faith claims.

Soon after the Washington Supreme Court’s decision, ProBuilders filed a motion asking the Court to reconsider its decision. However, on August 17, 2017, the Washington Supreme Court denied the motion, leaving in place the holding that insurers must take the efficient proximate cause rule when analyzing coverage under third-party policies.

As discussed in our earlier post, the efficient proximate cause rule applies “when two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss.” Vision One, LLC v. Philadelphia Indemnity Insurance Co., 174 Wn.2d 501, 276 P.3d 300 (2012). “If the initial event, the ‘efficient proximate cause,’ is a covered peril, then there is coverage under the policy regardless of whether subsequent events within the chain, which may be causes-in-fact of the loss, are excluded by the policy.” Key Tronic Corp., Inc. v. Aetna (CIGNA) Fire Underwriters Insurance Co., 124 Wn.2d 618, 881 P.2d 210 (1994).

Insurers must be extremely cautious when assessing the duty to defend and an exclusion that could potentially preclude coverage. Under Xia, liability insurers must examine the underlying complaint very carefully to determine whether there could potentially be multiple causes of a loss, and if so, which cause is the initiating cause. If the initiating cause is potentially a covered event, then there may be coverage and the insurer must provide a defense under reservation of rights in order to minimize bad faith exposure.

If you would like more information on the efficient proximate cause rule in Washington, please feel free to contact Sally S. Kim (sallykim@grsm.com or 206-695-5147) or Stephanie Ries (sries@grsm.com or 206-695-5123).

The Ninth Circuit Resolves Split in Authority, Holds that Only Insureds Under First-Party Policies Can Bring Claims Under Washington’s IFCA

Washington’s Insurance Fair Conduct Act (“IFCA”) provides insureds with a statutory cause of action against their insurers for wrongful denials of coverage, in addition to a traditional bad faith cause of action. Unlike a bad faith cause of action, the IFCA allows for enhanced damages under certain circumstances. Under the language of the statute, “any first party claimant to a policy of insurance” may bring a claim under IFCA against its insurer for the unreasonable denial of a claim for coverage or payment of benefits. There has been a split of authority in Washington among both the state appellate courts and federal district courts regarding whether the term “first-party claimant” refers only to first-party policies (i.e., a homeowner’s policy or commercial property policy) or whether it refers to insureds under both first-party and liability policies (e.g., CGL policies which cover the insured’s liability to others). The IFCA expressly defines the phrase “first-party claimant” as “an individual, … or other legal entity asserting a right to payment as a covered person under an insurance policy or insurance contract arising out of the occurrence of the contingency or loss covered by such a policy or contract.”

The Washington Court of Appeals, Division One, held that a “first-party claimant” means an insured under both first-party and liability policies (Trinity Universal Ins. Co. of Kansas v. Ohio Casualty Ins. Co., 176 Wn.App. 185 (2013)), but Division Three held that the IFCA applies exclusively to first-party insurance contracts (Tarasyuk v. Mutual of Enumclaw Insurance Co., 2015 Wash. App. LEXIS 2124 (2015)).

In the federal courts, the majority of decisions from the Western District of Washington have held that an insured with third-party coverage or first-party coverage can be a “first-party claimant” under IFCA. Navigators Specialty Ins. Co. v. Christensen, Inc., 140 F. Supp. 3d 11097 (W.D. Wash. Aug. 3, 2015 ) (Judge Coughenour); City of Bothell v. Berkley Regional Specialty Ins. Co., 2014 U. S. Dist. LEXIS 145644 (W.D. Wash. Oct. 10, 2014) (Judge Lasnik); Cedar Grove Composting, Inc. v. Ironshore Specialty Ins. Co., 2015 U. S. Dist. LEXIS 71256 (W.D. Wash. June 2, 2015) (Judge Jones); Workland & Witherspoon, PLLC v. Evanston Ins. Co., 141 F.Supp.3d 1148 (E.D. Wash. Oct. 29, 2015) (Judge Peterson). These decisions held that any insured who has a right to file a claim under the insurance policy is a “first-party claimant” under the IFCA regardless of whether the policy provides first-party or third-party coverage.

However, Judge Pechman of the Western District of Washington ruled that an insured with third-party coverage is not a “first-party claimant” under IFCA in Cox v. Continental Casualty Co., 2014 U. S. Dist. LEXIS 68081 (W.D. Wash. May 16, 2014) and two subsequent cases. In Cox, Judge Pechman dismissed plaintiff’s IFCA claim on the ground that the insurance policy was a “third-party policy,” i.e. a third-party liability policy, and therefore the insured (who assigned his claim to the plaintiffs) was not a “first-party claimant.” The Ninth Circuit Court of Appeals recently affirmed the Cox decision on appeal, effectively resolving the split of authority in the federal courts in favor of a more limited interpretation of the IFCA. Cox v. Continental Casualty Co., 2017 U.S. App. 11722 (9th Cir. June 30, 2017).

Those watching this issue and looking for a reasoned analysis resolving the split of authority among the federal district courts in Washington will be disappointed, as the Ninth Circuit provided no basis for its holding on the issue, not even a recognition of the split among the courts. On the issue, the Court merely stated “[t]he policy in question is not a first party policy; thus, the Plaintiffs, standing in [the insured’s] shoes, cannot be a first party claimant.” The court’s failure to provide its reasoning for this holding is surprising, given that the parties addressed the split of authority in their briefs. Nonetheless, insurers should take note of this important decision limiting the scope of the IFCA in Washington’s federal courts.

Washington Supreme Court Applies the Efficient Proximate Cause Rule to Third Party Liability Policy to Find a Duty to Defend

The efficient proximate cause rule is one of the more confusing analyses that an insurance company must undertake when investigating certain coverage issues under first party insurance policies. And until now, the efficient proximate cause rule has only been applied to first party insurance policies in Washington. But that has now changed with the Washington Supreme Court’s decision in Xia, et al. v. ProBuilders Specialty Insurance Company, et al., Case No. 92436-8 (April 27, 2017). In Xia, the Washington Supreme Court not only ruled that an insurer must consider the efficient proximate cause rule in determining its duty to defend under a CGL policy, but that ProBuilders acted in bad faith by failing to do so, despite no prior precedent for application of the rule in a CGL coverage analysis.

In Xia, the claimant purchased a new home constructed by Issaquah Highlands 48 LLC (“Issaquah”), which was insured under a CGL policy issued by ProBuilders. The claimant fell ill soon after moving in due to inhalation of carbon monoxide, caused by improper installation of an exhaust vent.

The claimant notified Issaquah about the issue, and Issaquah notified ProBuilders. ProBuilders denied coverage under the pollution exclusion and a townhouse exclusion. The claimant filed a lawsuit, which Issaquah then settled by a stipulated judgment of $2 million with a covenant not to execute and an assignment of rights against ProBuilders. The claimant filed a declaratory judgment action against ProBuilders for breach of contract, bad faith, violation of the Consumer Protection Act and the Insurance Fair Conduct Act.

At the trial court level, ProBuilders won summary judgment on the townhouse exclusion. Division One of the Washington Court of Appeals reversed in part, finding that the pollution exclusion applied, but not the townhouse exclusion.

The Washington Supreme Court accepted review to determine whether the pollution exclusion applied to relieve ProBuilders of its duty to defend. The Court held that even though ProBuilders did not err in determining that the plain language of its pollution exclusion applied to the release of carbon monoxide into Xia’s home, “under the ‘eight corners rule’ of reviewing the complaint and the insurance policy, ProBuilders should have noted that a potential issue of efficient proximate cause existed,” as Xia alleged negligence in her original complaint, i.e. failure to properly install venting for the hot water heater and failure to properly discover the disconnected venting.

Ultimately, the Court concluded that the efficient proximate cause of the claimant’s loss was a covered peril – the negligent installation of a hot water heater. Even though ProBuilders correctly applied the language of its pollution exclusion to the release of carbon monoxide into the house, the Court ruled that ProBuilders breached its duty to defend as it failed to consider an alleged covered occurrence that was the efficient proximate cause of the loss. The Court granted judgment as a matter of law to the claimant with regard to her breach of contract and bad faith claims.

The application of the efficient proximate cause rule to CGL policies in Washington is troublesome for insurers. The Washington courts have long held in cases involving first party policies that under the efficient proximate cause rule, “[i]f the initial event, the “efficient proximate cause,’ is a covered peril, then there is coverage under the policy regardless whether subsequent events within the chain, which may be causes-in-fact of the loss, are excluded by the policy.” Key Tronic Corp., Inc. v. Aetna (CIGNA) Fire Underwriters Insurance Co., 124 Wn.2d 618, 881 P.2d 210 (1994). Also, the efficient proximate cause rule applies only “when two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss.” Vision One, LLC v. Philadelphia Indemnity Insurance Co., 174 Wn.2d 501, 276 P.3d 300 (2012).

In Xia, the Court noted that like any other covered peril under a general liability policy, an act of negligence may be the efficient proximate cause of a particular loss. “Having received valuable premiums for protection against harm caused by negligence, an insurer may not avoid liability merely because an excluded peril resulted from the initial covered peril.” Xia at *14. The Court stated:

…it is clear that a polluting occurrence happened when the hot water heater spewed forth toxic levels of carbon monoxide into Xia’s home. However, by applying the efficient proximate cause rule, it becomes equally clear that the ProBuilders policy provided coverage for this loss. The polluting occurrence here happened only after an initial covered occurrence, which was the negligent installation of a hot water heater that typically does not pollute when used as intended.

Xia at *17.

Justice Madsen took issue with the majority decision in a dissenting opinion, specifically with respect to a finding of bad faith when no other case prior to this decision had ever applied the efficient proximate cause rule to CGL policies. Justice Madsen also disagreed with the majority in extending the application of the efficient proximate cause rule to CGL policies when this Court specifically declined to do so in the earlier case of Quadrant Corp. v. American States Insurance Co., 154 Wn.2d 165, 110 P.3d 733 (2005).

The State of Washington unfortunately has been historically unkind to insurers on the duty to defend, and the Xia decision only further cements that reputation.

If you would like more information on the efficient proximate cause rule in Washington, please feel free to contact Sally S. Kim at sallykim@gordonrees.com or (206) 695-5147.

No “Occurrence” Found Where Contractor Intentionally Performed Defective Work With The Hope It Would Not Cause Property Damage

The California Court of Appeal, Fourth Appellate District, affirmed in part and reversed in part an order awarding an insurance company its $1 million policy limits used to settle a construction defect claim on behalf of an insured general contractor.

In Navigators Specialty Insurance Company v. Moorefield Construction, Inc., 2016 Cal. App. LEXIS 1132 (December 27, 2016), a building owner, JSL Properties, LLC (“JSL”), and a developer, D.B.O. Development No. 28 (“DBO”), sued a general contractor, Moorefield Construction, Inc. (“Moorefield”), for floor leaks which occurred at a Best Buy electronics store between 2003 and 2009. In its second amended complaint, JSL claimed that Moorefield had defectively installed flooring on top of a concrete slab despite knowing that the existing slab contained excessive moisture levels. Navigators Specialty Insurance Company (“Navigators”) defended Moorefield in the action subject to a reservation of rights under a commercial general liability insurance policy. The litigation settled for $1,310,000 of which Navigators contributed its $1 million policy limits.

Navigators filed a declaratory relief lawsuit against Moorefield seeking a declaration that it had no duty to defend or indemnify the general contractor in the underlying construction defect action. Following a bench trial, the trial court issued a decision in favor of Navigators and against Moorefield. The trial court found that the flooring defects did not constitute an “occurrence” or accident under the policy. The trial court also held that Navigators had no duty to make any payments under the “supplementary payments” portion of the policy. Navigators received an award which required Moorefield to reimburse Navigators its $1 million policy limits contributed to settle claim.

The Court of Appeal agreed with the trial court that Navigators had no duty to indemnify Moorefield in the underlying action. The appellate court found evidence which established that Moorefield knew about the excessive moisture in the concrete slab and that it deliberately installed the flooring despite this known condition. Thus, the Court of Appeal held that no unexpected or unintended event constituted an “occurrence” to trigger an indemnity obligation under the policy. Moorefield and amicus curiae argued that construction defects could not be considered intentional conduct unless the contractor expected or intended its work to be defective and cause property damage. The Court of Appeal rejected that argument by stating, on the record before it, Moorfield knew about and intended to perform defective work with the hope it would not cause property damage. Even though Moorfield did not intend to cause property damage, the insured’s subjective belief was irrelevant.

However, the Court of Appeal reversed the portion of the trial court’s ruling which found that Navigators had no duty to make payments under the “supplementary payments” provision of the policy. The Court of Appeal determined that Navigators owed a duty to pay for attorneys’ fees and costs as part of the settlement because such amounts were recoverable under the construction contract and were awardable as taxed costs in litigation. Although no duty to indemnify existed, the appellate court found that Navigators was obligated to pay “supplementary payments” as part of its broader duty to defend.

The Court of Appeal also found that the trial court had improperly determined that the entire $1 million settlement payment was made for damages, rather than attorneys’ fees. The evidence indicated that JSL and DBO had only incurred $377,000 in damages related to the floor leaks. The appellate court further held that the trial court had committed prejudicial error in placing the burden of proof for this issue on Moorefield. Accordingly, the Court of Appeal remanded the case for a new trial seeking allocation of the settlement payment between damages and attorneys’ fees.

Click here for the opinion.

The opinion in Navigators Specialty Insurance Company v. Moorefield Construction, Inc., 2016 Cal. App. LEXIS 1132 (December 27, 2016), is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority in California state courts.

Insurer Barred From Contesting Coverage Due to Generic Reservation of Rights Letter

In an opinion filed January 11, 2017, the South Carolina Supreme Court held that an insurer’s reservation of rights must contain more than verbatim recitation of policy provisions to properly reserve its right to later dispute coverage. Harleysville Group Insurance v. Heritage Communities, Inc., et al., 2017 S.C. LEXIS 8 (Jan. 11, 2017). The state supreme court also upheld a pro rata allocation of progressive damages under a time-on-risk analysis, and rejected the argument that punitive damages were subject to the time-on-risk allocation. The decision emphasizes the importance of drafting reservations of rights specific to the facts of the case, and informing the insured of why certain provisions may limit coverage under the facts of the case.

The coverage action arose out of two underlying construction defect actions. Harleysville Group Insurance (“Harleysville”) insured related corporate entities that developed and constructed two separate condominium complexes (collectively referred to as “Heritage”), who were sued for damages arising out of alleged construction defects, including significant water intrusion damages. Harleysville agreed to defend under a reservation of rights and retained defense counsel. After verdicts against Heritage for actual and punitive damages were rendered, Harleysville filed a declaratory relief action to determine the amount of covered damages. The matter came before the state supreme court after certification by the court of appeals.

The court first addressed the adequacy of Harleysville reservation of rights, and concluded that the letters were not specific enough to contest coverage. Although Harleysville had quoted policy language verbatim in its initial reservation of rights, the court found that – except with regard to punitive damages – the letters failed to explain how specific policy provisions might preclude coverage and, to the extent exclusions may apply, did not inform the insured that Harleysville may seek declaratory judgment to allocate between covered and non-covered damages. As a result, Harleysville was precluded from raising coverage defenses regarding compensatory damages.

Although the court found Harleysville had properly reserved its rights regarding punitive damages, neither the policy’s insuring agreement nor its “expected or intended” exclusion applied to preclude coverage for punitive damages. According to the court, absent explicit language that excluded coverage for punitive damages, the insuring agreement could not be construed as limiting coverage to compensatory damages only. Regarding the exclusion, the court found Harleysville failed to meet its burden that Heritage acted intentionally and intended the specific type of loss or injury.

Finally, with regard to the compensatory damage award, the court upheld a pro rata allocation of the progressive damage. Because some definable portion of the damage in the underlying cases was unrelated to an injury during the policy period, a progressive damages analysis was proper for the compensatory damages, but not the punitive damage award.

There are various takeaways from this decision, but the most concerning is that the South Carolina Supreme Court expanded the scope of coverage beyond that provided by the policy because it found that the insurer did not properly reserve rights. To avoid such an absurd result, and to properly preserve coverage defenses, insurers should revisit the use of generic or form reservation of rights letters, and consider updating the reservation of rights letter during the life of the underlying case if certain provisions appear to be particularly relevant.

The Scope of Continuous Trigger in Pennsylvania

The continuous trigger rule is well-known to those in the insurance industry. However, the scope of its application continues to evolve as new risks emerge. While the concept of continuous trigger generally came about to address long-tail environmental pollution and asbestos bodily injury claims, the courts that first implemented and adopted the rule were not facing claims based on sexual molestation, sports-related concussions, wrongful incarceration, large-scale construction defects, complex food recalls, etc.

Pennsylvania has long been a first manifestation state, meaning that only the policy on the risk when underlying bodily injury or property damage is first known or reasonably ascertainable must respond to a loss. The Pennsylvania Supreme Court adopted the continuous trigger rule in J.H. France, which involved coverage for asbestos bodily injury claims. J.H. France Refractories Co. v. Allstate Ins. Co., 626 A.2d 502 (Pa. 1993). The continuous trigger rule, over time, has also been applied to pollution cases.

For that reason, the industry took great interest in the St. John case, decided at the end of 2014, in which the Pennsylvania Supreme Court rejected efforts by an insured to trigger four years of consecutive policies in connection with an underlying lawsuit alleging that the insured’s defective installation of a new plumbing system caused damage to a dairy farm. Pennsylvania Nat. Mut. Cas. Ins. Co. v. St. John, 106 A.3d 1 (Pa. 2014). Specifically, the insured installed the new plumbing system in 2003, the dairy farm’s cows suffered health problems and produced less milk starting in 2004, and the dairy farm owners discovered the cause – contaminated drinking water due to defects in the plumbing system – in 2006. The court ruled that the 2004 policy was the only triggered policy, but it made a few comments that raised eyebrows. The court noted that Pennsylvania follows the first manifestation rule, “with the lone exception of asbestos injury claims” and that “[o]ur holding in J.H. France remains an exception to the general rule under Pennsylvania jurisprudence that the first manifestation rule governs a trigger of coverage analysis for policies containing standard CGL language.”

The Pennsylvania Supreme Court’s strict application of the manifestation trigger, and its characterization of the exception being limited to asbestos claims, caused a ripple effect in non-asbestos related coverage actions such as pollution cases involving damage that occurs across multiple policy periods. While experience thus far has shown that trial courts are hesitant to apply St. John to limit coverage for pollution claims to a single policy year, the issue is still lingering in many cases. St. John most recently surfaced in the Penn State coverage action related to underlying claims brought against the school by victims of convicted child molester Jerry Sandusky. There, a Philadelphia trial court judge ruled that a victim’s continued sexual abuse over time does not justify application of the continuous trigger rule, and that Penn State could only access the policy during which the bodily injury to a particular victim first manifested. Pa. State Univ. v. Pa. Manufacturers’ Ass’n Ins. Co., 2016 Phila. Ct. Com. Pl. LEXIS 158 (May 4, 2016). Interestingly, the court stated that sexual abuse was different from “environmental pollution or asbestos coverage,” meaning that perhaps the court did not read St. John so literally.

Whether the court intended it or not, the sound bites in the St. John decision still have insurers and insureds paying close attention to the scope of the continuous trigger rule.