Insurance Recovery Law - Jun 2014 #2

by Manatt, Phelps & Phillips, LLP

In This Issue:

  • Nevada Supreme Court Holds That Absolute Pollution Exclusion Does Not Bar Coverage for Carbon Monoxide Poisoning Suit
  • Eleventh Circuit Holds That Insurer Adequately Reserved Its Rights
  • Defense May Be Required for Pollution Claims – Even Without a Lawsuit or Regulatory Action – Washington Court Holds
  • Insurers Must Demonstrate Applicability of Pollution Exclusion in Wrongful Death Suit, Says Texas Court

Nevada Supreme Court Holds That Absolute Pollution Exclusion Does Not Bar Coverage for Carbon Monoxide Poisoning Suit

Why it matters
In answering certified questions from the Ninth Circuit, Nevada joined numerous other jurisdictions in holding that standard-form “absolute” pollution exclusions are ambiguous as to releases of non-traditional indoor pollutants – in this case carbon monoxide. Reasoning that the standard-form pollution exclusion lends itself to more than one reasonable interpretation in this respect, the Nevada Supreme Court held that the insurer “must plainly state that the exclusion is not limited to traditional environmental pollution” if it intends to exclude coverage for non-traditional indoor pollution.

Detailed Discussion
Four people died from carbon monoxide poisoning while sleeping in a room above a pool heater at Casino West Motel in Nevada. Casino West sought coverage from its insurer, Century Surety, which denied based on the absolute pollution exclusion and the indoor air quality exclusion.

Century then filed a declaratory judgment action in Nevada federal court. The district court denied Century’s motion for summary judgment and Century appealed. Finding that Nevada law did not clearly address the scope of these exclusions, the Ninth Circuit certified two questions to the Nevada Supreme Court.

The first was whether the absolute pollution exclusion in Casino West’s policy barred coverage for the carbon monoxide-related deaths. The exclusion precluded coverage for “‘[b]odily injury’ or ‘property damage’ arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of ‘pollutants.’” “Pollutant” was defined as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, and waste.” The exclusion was subject to an exception for building heaters.

The second was whether the indoor air quality exclusion precludes coverage. Under this exclusion, coverage was unavailable for “‘[b]odily injury,’ ‘property damage,’ or ‘personal and advertising injury’ arising out of, caused by, or alleging to be contributed to in any way by any toxic, hazardous, noxious, irritating, pathogenic or allergen qualities or characteristics of indoor air regardless of cause.”

As to the first question, Century took the position that carbon monoxide constituted a “pollutant” under the absolute pollution exclusion, and the building heater exception demonstrated that the exclusion was meant to apply to both indoor and outdoor pollution.

Conversely, Casino West argued that the exclusion applied only to traditional environmental pollution because it contained terms of art typically applied in that context. Moreover, the fact that the parties disagreed about the provision’s meaning provided further support its ambiguity.

The Nevada Supreme Court agreed with Casino West. “As drafted here, the absolute pollution exclusion permits multiple reasonable interpretations of coverage,” the Court opined, finding language to support both Century’s and Casino West’s interpretations. “Taken at face value, the policy’s definition of a pollutant is broad enough that it could be read to include terms such as soap, shampoo, rubbing alcohol, and bleach insofar as these items are capable of reasonably being classified as contaminants or irritants.”

The potential for such absurd results was contrary to any reasonable policyholder’s expectations, the Court held. Moreover, the building heater exception could be read as a clarification rather than an expansion of the exclusion’s scope.

“In light of the exclusion’s ambiguity, we must interpret it to effectuate Casino West’s reasonable expectations,” the Court held. “To demonstrate that the absolute pollution exclusion applies to non-traditional indoor pollutants, an insurer must plainly state that the exclusion is not limited to traditional environmental pollution.”

Turning to the second question regarding the indoor air quality exclusion, the Court reached a similar conclusion. “As with the pollution exclusion, the indoor air quality provision is drafted so broadly that, if no limitations are applied to it, its applicability could stretch well beyond a reasonable policyholder’s expectations and lead to absurd results,” the Court opined.

For instance, in the case of a hypothetical fire inside the motel, the insurer’s reading would exclude coverage for injuries resulting from a guest’s inhalation of smoke but would cover any burn injuries caused by the same fire. “Such potentially absurd results illustrate the need for some limitations on the exclusion’s applicability,” the Court concluded.

To read the opinion in Century Surety Co. v. Casino West, Inc., click here.

Eleventh Circuit Holds That Insurer Adequately Reserved Its Rights

Why it matters
Policyholders should not assume that an insurer has failed to preserve coverage defenses by failing to identify them specifically in a reservation of rights letter, at least where Georgia law applies. In evaluating whether an insurer made a proper reservation of rights, the Eleventh Circuit recently concluded in an unpublished opinion that the appropriate standard is one of “adequacy.” Reservation of rights letters do not have to identify “each and every potential basis for contesting coverage” as long as they adequately inform the insured that the insurer does not waive its coverage defenses, the court held.

Detailed Discussion
Wellons manufactures and installs capital equipment for the forest product industry. Wellons entered into agreements with Langboard, a manufacturer of wood products used in home construction and flooring, for design and installation of an energy system.

Wellons maintained primary and excess commercial general liability coverage with Lexington. During the construction of the energy system, part of the system collapsed and caused extensive property damage. Langboard sued Wellons in 2005 for losses emanating from the collapse. Wellons provided Lexington with notice of the suit, and Lexington defended it.

Lexington sent two reservation of rights letters to Wellons in connection with the claim. The first was when the lawsuit was first filed in 2005, in which Lexington stated that “this letter is not to be construed as a waiver of any of the terms, conditions, or provisions of the Lexington Insurance Company policy, or of any right or policy defense now or hereafter available to the Lexington Insurance Company.” The second was in 2007, in which Lexington stated that: “there may be additional policy conditions that may also preclude coverage and this should not be construed as a waiver of other terms and conditions that may apply.”

The Wellons energy system later developed leaks, which were repaired by a third party. When the system failed again even after the repairs, Langboard demanded that Wellons replace the system. Wellons tendered the claim for replacement to Lexington, which issued a preliminary response stating that “there may be a coverage question and we are investigating this matter under a reservation of rights.” Lexington’s letter also quoted provisions from its policy, including exclusions for “Damage to Property,” “Damage to Your Product,” and “Damage to Your Work,” as well as the requirement that “property damage” be caused by an “occurrence.”

In 2007 Langboard sued Wellons again, asserting that the energy system never worked as intended. Lexington defended the second Langboard lawsuit under a reservation of rights, noting that its prior reservation of rights letters were “in the same mode” and “the issues addressed in each of the letters are still applicable.” After discovery in the second suit was complete, Lexington denied coverage, stating that, under the facts as developed, the alleged loss did not meet the definition of “occurrence” or “property damage” under the policy.

A jury subsequently awarded Langboard nearly $8.5 million in damages. Wellons then sued Lexington, seeking a declaration that Lexington was required to provide indemnification for the jury verdict because it did not adequately reserve, and therefore waived, its coverage defenses related to “occurrence” and “property damage.”

Interpreting Georgia law, the Eleventh Circuit concluded that “a reservation of rights need not specify each and every potential basis for contesting coverage, as long as the reservation fairly informs the insured that, notwithstanding the defense of the insured, the insurer does not waive its coverage defenses.” Insurers are not required to delineate specific policy provisions, the court opined, because certain coverage defenses may be unknown until discovery has been completed and the insurer has completed its investigation.

Turning to the facts of the case, the court found that Lexington’s reservation of rights was adequate. When Langboard filed its second lawsuit, Lexington informed Wellons that the issues addressed in the prior reservation of rights letters were still applicable. According to the court, these letters satisfied the requirements of an effective reservation: “While the April 2007 letter quoted large portions of the policy, it also provided detailed analysis as to why specific provisions and exclusions may apply,” the court opined, and was a “far cry from an insurer cutting and pasting the entire insurance policy into a letter, with no explanation or analysis.”

“Most importantly,” the court added, the 2005 and 2007 letters “both contained nonwaiver clauses that specifically reserved Lexington’s right to assert additional coverage defenses.” In addition, “Wellons implicitly consented not only to a defense under a reservation of rights, but also to the terms of the reservation, including the nonwaiver clause contained in the. . . letters. Under Georgia law, these nonwaiver clauses were sufficient to protect Lexington’s rights and avoid estoppel.”

Wellons contended that the letters addressing each of the lawsuits involved different issues. The court disagreed, noting that the issues were not as discrete as Wellons contended. Thus the court concluded the earlier letters, coupled with the subsequent reservation, fairly informed Wellons of Lexington’s coverage position and precluded waiver.

To read the decision in Wellons, Inc. v. Lexington Insurance Co., click here.

Defense May Be Required for Pollution Claims – Even Without a Lawsuit or Regulatory Action – Washington Court Holds

Why it matters
Policyholders facing strict liability for environmental cleanup often face denials of coverage for defense costs because regulatory enforcement typically is not in the form of a traditional lawsuit. A Washington appellate court recently joined numerous other courts nationwide in holding that strict interpretation of “suit” in a standard defense provision is not appropriate in the context of environmental cleanup claims. Rather, “suit” includes “administrative enforcement acts that are the functional equivalent of a suit.” The court noted that an explicit or implicit threat of “immediate and severe consequences” as a result of pollution may pass the functional equivalency test. However, “potential liability alone, without any adversarial or coercive action by an administrative agency,” would not.

Detailed Discussion
Gull Industries owned gas stations throughout the state of Washington, including one located in Sedro-Woolley. The lessees of the station obtained insurance coverage from State Farm. In 1984 Gull investigated the station’s underground storage tank and discovered a continuous release of hydrocarbons. The company then began a voluntary remediation.

In 2005 Gull notified the Washington State Department of Ecology (“DOE”) that a release of petroleum product had occurred at the Sedro-Woolley station. The DOE responded with a letter acknowledging the notification. Gull then tendered claims for defense and indemnification for the cleanup costs to State Farm, which denied the tender.

Gull eventually filed suit against State Farm and five other insurers based on similar situations at other stations. The insurers moved for partial summary judgment, arguing that they had no duty to defend even though Gull was facing strict liability for cleanup costs under the state’s Model Toxics Control Act.

The State Farm policy provided coverage for “any suit against the Insured seeking damages payable under the terms of this policy.” The policy did not define “suit.” State Farm argued that this term should be construed strictly to include only traditional lawsuits. Gull, on the other hand, argued that, consistent with Washington precedent in the duty-to-indemnify context, the duty to defend should be triggered by its strict liability for cleanup regardless of whether any lawsuit or formal regulatory action had been initiated against it.

The court acknowledged that other courts across the country have reached three different results when considering whether environmental administrative actions that fall short of actual lawsuits constitute a “suit” that triggers the insurer’s duty to defend. One group of courts – in California, Illinois, Maine, New York, and the Eighth U.S. Circuit Court of Appeals (interpreting Missouri law) – has applied a narrow construction of “suit” and required that a formal complaint be filed against the insured in a court of law to trigger the duty to defend.

Taking a broader view of “suit,” a second group of courts in California, Minnesota, New Hampshire, North Carolina, Vermont, and the Second U.S. Circuit Court of Appeals holds that the issuance of a potentially responsible party letter triggers the duty to defend because such letters are the functional equivalent of a suit.

The third group of courts have adopted an “it depends” perspective, holding that the coerciveness of the specific regulatory action taken by the government dictates whether or not coverage is triggered. This group includes courts in California, Indiana, Massachusetts, Ohio, and the First U.S. Circuit Court of Appeals.

Joining the third group, the Washington appellate court opined that “more than an invitation” to initiate cleanup is required to trigger an insurer’s duty to defend in the environmental liability context. “We conclude that the term ‘suit’ is ambiguous in this context and does not require that a summons and complaint be filed or served or that an administrative action be commenced,” the court wrote. “Rather, under a functional equivalent standard, the duty to defend is triggered if a government agency communicates an explicit or implicit threat of immediate and severe consequences by reason of the contamination.”

However, the court drew the line at creating a standard of an absolute duty to defend environmental cleanup claims. According to the court, “an agency action must be adversarial or coercive in nature in order to qualify as the functional equivalent of a ‘suit.’”

Unfortunately for Gull, the court found that the single letter from the DOE acknowledging notice that the Sedro-Woolley station was contaminated was insufficient to trigger coverage under this standard. Although the letter advised Gull to “be aware that there are requirements in state law which must be adhered to,” it “did not advise of any consequences that might attach to the failure to adhere to those requirements,” the court opined. “The letter did not present an express or implied threat of immediate and severe consequences by reason of the contamination. Therefore . . . Gull has not met its burden on summary judgment to establish there is the functional equivalent of a ‘suit’ here, triggering the duty to defend.”

To read the decision in Gull Industries, Inc. v. State Farm Fire and Casualty Co., click here.

Insurers Must Demonstrate Applicability of Pollution Exclusion in Wrongful Death Suit, Says Texas Court

Why it matters
A Texas federal district court delivered a mixed ruling to a policyholder seeking defense and indemnity for a wrongful death suit, finding that a pollution exclusion prohibited defense but not indemnity based on conflicting determinations regarding the cause of a worker’s death. In this case, the insurer was unable to demonstrate from available evidence that inhalation of methane gas was the worker’s sole cause of death, and therefore was not entitled to summary judgment. This decision serves as a reminder that the insurer bears the burden of proving the applicability of policy exclusions, and should be strictly held to its burden.

Detailed Discussion
This case involved a sewer construction project. Jacob & Martin, a construction company, contracted with the city of Gordon to design and install a new sewer system for the city. Acadia Insurance Company issued general liability and umbrella liability policies to Jacob & Martin.

During the course of the project, one of the engineers instructed an employee to open a manhole, climb inside it, and remove a plug from the sewer line. When he did, “toxic fumes were released and [the employee] died from asphyxia due to methane gas inhalation,” according to the wrongful death complaint filed by the employee’s family.

Jacob & Martin sought coverage from Acadia, which responded by filing a declaratory judgment action in Texas federal district court seeking to evade its coverage obligations.

Separating Acadia’s defense and indemnity obligations, the court agreed with Acadia that the standard-form pollution exclusion precluded coverage for defense. The underlying complaint specified that the worker died after toxic fumes were released and he inhaled methane gas, the court noted. While Jacob & Martin did not dispute that methane gas constituted a pollutant, it argued that the court should look beyond the complaint to consider the possibility that the worker may have died from a lack of oxygen.

Applying the “eight-corners” rule, the court declined to consider evidence beyond the Acadia policy and complaint because it would require the court to “engage the truth or falsity of . . . facts alleged in the underlying case.” Because the complaint did not allege any cause of death other than methane gas inhalation, the court granted summary judgment to Acadia on its defense obligation.

However, evidence outside the complaint could require Acadia to indemnify Jacob & Martin, the court held. The initial autopsy report and the results of an Occupational Safety and Health Administration (“OSHA”) investigation of the incident stated that the employee died from “asphyxia due to methane gas inhalation” and “asphyxiation due to the inhalation of a toxic vapor.” But the autopsy report was later amended, changing the cause of death to “asphyxia due to oxygen displacement in a confined space.” The updated autopsy report, the court opined, “raises a genuine issue of material fact as to whether [the employee’s] death falls outside the pollution exclusion of plaintiffs’ policies.”

Although the updated report was inconsistent with other evidence – such as the OSHA investigation – the court opined that Acadia had failed to demonstrate that the substance that displaced the oxygen was also a pollutant under its policies. Therefore, Acadia did not meet its burden on summary judgment as to the duty to indemnify, the court concluded.

To read the decision in Acadia Insurance Co. v. Jacob & Martin Ltd., click here.

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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