Appeals Court Rules that Vertical and Not Horizontal Exhaustion Applies to Primary and First-Layer Excess Insurance

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In Santa Fe Braun v. Ins. Co. of North America (No. A151428, filed 7/13/20), a California appeals court relied on Montrose Chemical Corp. of California v. Superior Court (2020) 9 Cal.5th 215 (Montrose III), to hold that absent express policy wording to the contrary, horizontal exhaustion of all primary insurance is not required in order to trigger first-layer excess coverage.

Beginning in 1992, Braun was sued for asbestos injuries from refineries it constructed and maintained. Braun had primary coverage and multiple layers of excess coverage for the relevant time period. After defending for years, the primary insurers reached a settlement under which they paid their limits into a trust which would fund the ongoing defense and settlements. Certain of the excess insurers settled and also contributed to the trust.

Braun initiated coverage litigation in 2004, which went to trial and was on appeal when the Supreme Court handed down its Montrose III decision. The Braun trial court had ruled that in order to trigger the first layer excess insurance, Braun had to establish horizontal exhaustion if a policy either “expressly so provides or . . . contains an ‘other insurance clause’ and does not provide for vertical exhaustion of specific policies.” The trial court then proceeded to find that the first level excess policies all required horizontal exhaustion of the underlying primary coverage, and that Braun failed to prove horizontal exhaustion because its evidence was inadmissible hearsay. In a final phase, the Braun trial court then ruled that the upper level excess policies also required horizontal exhaustion, and since Braun failed to even prove exhaustion of the primaries, it could never prove exhaustion of the first layer excess, thereby entering judgment on favor of the excess insurers.

Braun’s appeal had been fully briefed when Montrose III came down, and the appeals court requested supplemental briefing. Based on Montrose III, the Braun court held that horizontal exhaustion was not required for either primary or excess coverage. The Braun court quoted extensively from Montrose III for the proposition that the excess policies were at best ambiguous regarding horizontal exhaustion, and their terms otherwise “strongly suggest that only vertical exhaustion was required.” The Montrose III court had pointed out that if horizontal exhaustion were required, the express attachment point of the excess policy would be exponentially higher than stated. In Montrose III, the court supplied an example that one excess policy would require exhaustion of more than $750 million in underlying coverage, rather than the $30 million expressly specified in the excess policy itself.

In addition, the Montrose III court stated that the excess policies’ schedules of underlying insurance “provide a presumptively complete list of insurance coverage that must be exhausted before the excess policy may be accessed, with the ‘other insurance’ clauses serving as a backstop to prevent double recovery in the rare circumstance where underlying coverage changes after the excess policy is written. [] But under the [excess] insurers’ rule of horizontal exhaustion, these schedules would represent only a fraction—perhaps only a small fraction—of the insurance policies that must be exhausted before a given excess policy may be accessed.”

Montrose III only involved high-level excess-above-excess insurance but the Braun court found that reasoning also dispositive as regards primary and first-layer excess insurance as well: “These first-level excess policies contain comparable language to that interpreted in Montrose III. The ‘other insurance’ clauses are similarly ambiguous and the ‘other aspects of the insurance policies’ including the scheduling of the applicable primary policies and definitions of ultimate net loss suggest ‘the exhaustion requirements were meant to apply to directly underlying insurance and not to insurance purchased for other policy periods.’” (Quoting Montrose III, supra, 9 Cal.5th at p. 233.)

The Braun court rejected the excess insurers’ arguments based on: (1) the nature of primary coverage being “first dollar” coverage; (2) the difference in premiums; and (3) the right to control defense and settlement being vested in the primary insurer. The Braun court stated: “[W]e note that the differences between primary and excess coverage hold true whether vertical or horizontal exhaustion applies. More importantly, the differences provide little justification for construing the policy language interpreted in Montrose III differently simply because primary coverage purchased often many years later for other policy periods remains outstanding.”

The Braun court went on to say that Montrose III effectively abrogated the horizontal exhaustion cases Community Redevelopment Agency v. Aetna Casualty & Surety Co. (1996) 50 Cal.App.4th 329 and Padilla Constr. Co. v. Transportation Ins. Co. (2007) 150 Cal.App.4th 984, stating: “[I]nsofar as Community Redevelopment . . . addresses the relative obligations as between the various insurers, and not the excess insurer’s obligations to the insured, it is distinguishable. While the court in Padilla . . . involved an action by an insured seeking declaratory relief against its excess insurer, the court’s extension of Community Redevelopment can no longer be justified after Montrose III.”

The trial court in Braun had excluded Braun’s evidence of exhaustion, and the excess insurers argued that the ruling would nonetheless preclude a reversal, despite the trial court’s incorrect application of a horizontal exhaustion requirement. But the appeals court held that the exclusionary ruling was negated by its holding that vertical and not horizontal exhaustion applied: “The error in interpretation alone requires remand for the opportunity to present such evidence.”

Finally, the Braun court denied a cross-appeal by the excess insurers on the burden of proof to establish that the claims paid by the primary insurers were correctly allocated to products liability claims rather than premises/operations claims. The trial court ruled, and the appeals court agreed, that Braun could satisfy its initial burden of proof by relying on allocations made by the primary insurers, rather than having to prove the facts supporting those allocations. Once that prima facie showing was made, the burden would be shifted and the excess insurers would have the burden of showing otherwise.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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