CONSTRUCTION RISK MANAGEMENT UPDATE

The California Supreme Court recently issued an important ruling on the scope of general liability insurance coverage for liability arising out of an alleged breach of contract. This paper reviews the recent decision in Vandenberg v. Superior Court and several other recent California decisions impacting insurance coverage for claims arising on a construction project.

CGL Policies Can Cover Contractual Liabilities

In Vandenberg v. Superior Court (1999) 21 Cal.4th 815, the California Supreme Court ruled that a commercial general liability insurance policy (a "CGL policy") can provide coverage for liability arising out of a contractual relationship. Prior to this decision, there was a body of California law that suggested that such policies only covered liability stemming from tort claims.

The insured in this case operated an automotive sales and services facility on leased property. When the insured ceased its business after 30 years, the land reverted to the landlord. Environmental contamination was subsequently discovered on the property and the landlord filed an action against the insured. The insured was defended in this action by one of its insurers and this action was settled. As part of the settlement, it was agreed that the landlord could still pursue a claim that the contamination constituted a breach of the lease agreement. This claim was submitted to private arbitration and the arbitrator issued an award of $4 million in favor of the landlord.

The insured sought indemnification for the arbitration award from its insurers who denied the claim on the ground that the insured's contractual liability under the lease was not covered under the standard-form CGL policy.

The insured filed a coverage action and the trial court ruled in favor of the insurers, finding that the term ~legally obligated to pay as damages~ in the insurers' CGL policies only described liability imposed by law (tort liability) and not liability arising out of a contractual obligation. This decision was reversed on appeal and that decision was accepted for review by the California Supreme Court.

The Court's decision focused on the interpretation of the phrase Niegally obligated to pay as damages." Although there was a long line of appellate court decisions supporting the trial court's ruling, the Court refused to limit the meaning of the "legally obligated" language to tort liability. Instead, the Court reiterated that insurance policy provisions are to be "interpreted in their 'ordinary and popular sense,"' and that ambiguities created by "sophisticated legal distinction[s]" are to be construed in favor of coverage. Likewise, the Court stated that coverage should not turn on the ~choice of remedy or form of action" sought by the plaintiff. Applying these fundamental principles, the court found that the phrase ~legally obligated to pay as damages" could not be interpreted to apply only to liability arising from a tort claim.

The Court's decision was important for insureds in the construction industry since liability for developers, contractors and subcontractors frequently arises out of contract. For example, if the Court had accepted the insurer's argument, insurers would have likely argued that developers would not be entitled to CGL coverage for condominium defect claims since a developer's liability for such claims arises out of the sales contracts to the individual homeowners.

Insured Does Not Have To Pay Multiple Deductibles

The court in California Pacific Homes, Inc. v. Scottsdale /nsurance Co. (1999) 70 Cal.App.4th 1187, reaffirmed that an insured does not have to pay multiple deductibles to obtain coverage for liability caused by continuous property damage. In this case, a condominium defect claim was settled for payment of

$1,975,000. It was agreed between the developer insured and its insurers that the claim arose from a single occurrence with damage occurring from 1984 to 1995. After the claim was settled, the insurers contended that the insured had to exhaust the retained limit of $250,000 for five consecutive policy periods. The court rejected this argument holding that the insured only had to pay the retained limit in one policy period in order to obtain the $2,000,000 policy limit for a single policy period.

Possible Limitations on Additional Insured Benefits

The decision in Reliance National Indemnity v. General Star Indemnity Co. (1999) 72 Cal.App.4th 1063 involved a dispute between Reliance, which issued a primary policy to its insured, and General, who issued an excess policy naming the same insured as an additional insured under that excess policy. Reliance contended that the insurance naming the insured as an additional insured was primary to its policy in light of an indemnity clause in an underlying contract running in favor of the insured. The court found that Reliance's primary policy responded to the claim before the General Star excess policy. Although it is uncertain whether the court would have reached the same decision if the plaintiff had been an insured and not an insurance company seeking equitable contribution, insureds seeking additional insured benefits should specify that all such insurance is primary to its own insurance even when the additional insured benefits are provided with a combination of a primary policy and excess policies.

Limitations on Bad Faith Liability

The California Supreme Court ruled in PPG Industries, Inc. v. Transamerica Insurance Company (1999) 21 Cal.4th 28 that an insurer's bad faith liability for its unreasonable failure to settle a claim within policy limits does not include punitive damages awarded against the insured at trial.

In another recent decision, the California Supreme Court also held in Cates Construction, Inc. v. Talbot Partners (1999) 21 Cal.4th 28 that a surety issuing a construction bond is not an insurance company and therefore cannot be held liable for bad faith tort damages in California.

Indemnity Obligation Requires Finding of Fault

The court in Heppler v. J.M. Peters Co. (1999) 73 Cal.App.4th 1265 examined an indemnity agreement between a developer and its subcontractors. The court found that although the agreement could be categorized as a Type I indemnity agreement, it still required a finding of some fault by the subcontractors. In reaching this conclusion, the court strictly construed the indemnity clause against the indemnitor (the developer) and it relied upon other contract provisions that required the subcontractors to "adhere to a non- negligent standard of care in the performance of their work."