California Supreme Court Ruling Will Allow Policyholders Easier Access to Excess Insurance
- April 8, 2020
- Paladin Law Group® LLP
- 0 Comments
By Brian Paget
Earlier this week, the California Supreme Court finally settled an important insurance law issue that had engendered conflicting decisions among the state’s lower courts. On Monday, April 6, 2020, in Montrose Chemical Corp. v. Superior Court, No. S244737 (Montrose III), the California Supreme Court adopted the rule of “vertical exhaustion” advocated by policyholders, over the rule of “horizontal exhaustion” advanced by insurers. Briefly, the Court held that, to access otherwise available coverage under any excess insurance policy, policyholders need only exhaust the directly underlying excess policies for the same period (vertical exhaustion); they are not required to exhaust every lower level excess policy covering every policy period for which they had insurance (horizontal exhaustion). This is a big win for California policyholders and many of Paladin Law Group’s clients.
Montrose Chemical Corporation (Montrose) was sued for causing continuous environmental damage in the Los Angeles area between 1947 and 1982 and subsequently entered into partial consent decrees to resolve various claims. Montrose then sought to tap its liability insurance to cover amounts it owes in connection with those claims. For each policy year from 1961 to 1985, Montrose had secured primary insurance and multiple levels of excess insurance. The case decided Monday, Montrose III, concerned the sequence in which Montrose may access the excess insurance policies covering this period.
The Parties’ Contentions
Montrose argued for a rule of vertical exhaustion: that it should be entitled to coverage under any excess policy once it exhausts the directly underlying excess policies for the same policy period. Montrose’s insurers, by contrast, argued for a rule of horizontal exhaustion: that, because of the “other insurance” clauses in the policies, Montrose may call on an excess policy only after it has exhausted every lower level excess policy across the entire period for which it has insurance, 1961 to 1985.
Montrose and its insurers had filed cross-motions for summary adjudication in the trial court on the vertical versus horizontal exhaustion issue. The trial court denied Montrose’s motion and granted the insurer’s motion, holding that the excess policies required horizontal exhaustion. Montrose filed a petition for a writ of mandate, which the Court of Appeal summarily denied. The California Supreme Court granted Montrose’s petition for review and transferred the case to the Court of Appeal with instructions to issue an order to show cause why the relief Montrose sought should not be granted. The Court of Appeal generally affirmed the trial court’s ruling. (Montrose Chemical Corp. v. Superior Court (2017) 14 Cal.App.5th 1306, 1321, 1338 (Montrose II).) Shortly after the Court of Appeal’s decision, another Court of Appeal disagreed with its reasoning, holding that vertical exhaustion was appropriate. (State of California v. Continental Ins. Co. (2017) 15 Cal.App.5th 1017.) The California Supreme Court granted review in the Montrose case to resolve the conflict and “determine whether vertical exhaustion or horizontal exhaustion is required when continuous injury occurs over the course of multiple policy periods for which an insured purchased multiple layers of excess insurance.”
To understand the Court’s analysis of this issue, it is helpful to understand several background insurance law principles specific to continuous or “long-tail” injuries where damage occurs over multiple policy periods.
First, “an insurer on the risk when continuous or progressively deteriorating damage or injury first manifests itself remains obligated to indemnify the insured for the entirety of the ensuing damage or injury,” up to the policy’s limit. “There is no requirement that . . . the conditions giving rise to the damage or injury . . . themselves occur within the policy period in order for potential liability coverage to arise.” Therefore, “bodily injury and property damage which is continuous or progressively deteriorating throughout several policy periods is potentially covered by all policies in effect during those periods.” This principle is known as the “continuous injury trigger of coverage.” (Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645, 686, 689 (Montrose I).)
Next, an insurer’s obligation to pay is “triggered if specified harm is caused by an included occurrence, so long as at least some such harm results within the policy period.” “It extends to all specified harm caused by an included occurrence, even if some such harm results beyond the policy period.” This is the “all sums” rule. (Aerojet-General Corp. v. Transport Indemnity Co. (1997) 17 Cal.4th 38, 56–57.) This “all sums” rule means that “insurers [a]re responsible for defending the insured for all claims that involved the triggering damage” in a continuous injury case; “as long as the policyholder is insured at some point during the continuing damage period, the insurers’ indemnity obligations persist until the loss is complete, or terminates.” (State of California v. Continental Ins. Co. (2012) 55 Cal.4th 186, 197 (Continental).) The “all sums” rule is necessary because “[i]t is often ‘virtually impossible’ for an insured to prove what specific damage occurred during each of the multiple consecutive policy periods in a progressive property damage case.” “If such evidence were required, an insured who had procured insurance coverage for each year during which a long-tail injury occurred likely would be unable to recover.” (Id. at p. 196.) The “all sums” approach “best reflects the insurers’ indemnity obligations under the respective policies, the insured’s expectations, and the true character of the damages that flow from a long-tail injury.” (Id. at p. 200.)
Finally, because the limits of any one policy may be insufficient to cover the entire liability resulting from a continuous injury, the insured may seek indemnification from every policy that covered a portion of the loss, up to the full limits of each policy. (Continental, at p. 200.) This “all-sums-with-stacking indemnity” principle properly incorporates the Montrose I “continuous injury trigger of coverage” rule and the Aerojet “all sums” rule, and “effectively stacks the insurance coverage from different policy periods to form one giant ‘uber-policy’ with a coverage limit equal to the sum of all purchased insurance policies.” (Id. at p. 201.) “[T]his approach treats all the triggered insurance as though it were purchased in one policy period” and recognizes “the uniquely progressive nature of long-tail injuries that cause progressive damage throughout multiple policy periods” giving “the insured . . . immediate access to the insurance it purchased.” (Ibid.)
The Court’s Analysis
Having adopted an “all-sums-with-stacking” approach to insurance coverage of long-tail injuries, the California Supreme Court was presented in Montrose III with a follow-on question: In what order may an insured access excess policies from different policy periods to cover liability arising from long-tail injuries?
The Court was tasked with deciding between two proposed approaches by which excess insurance policies might be stacked after the primary insurance has been exhausted to cover liability in a way that “treats all the triggered insurance as though it were purchased within one policy period.” Under the insurers’ proposed rule of “horizontal exhaustion,” the insured would have to exhaust all of its lower layer excess coverage across all relevant policy periods before accessing any of its higher layer coverage. Under Montrose’s proposed rule of “vertical exhaustion,” in contrast, an insured would be permitted to access any higher layer excess policy once it has exhausted the directly underlying excess policy covering the same period.
The parties’ dispute centered on the meaning of the “other insurance” clauses in the excess insurance policies. Those clauses provided that each policy was excess to other insurance available to the insured, whether or not the other insurance was specifically listed in the policy’s schedule of underlying insurance. The insurers argued that these clauses call for a rule of horizontal exhaustion because they restrict indemnification from any excess policy until the insured has exhausted all other available insurance—which, in a case of long-tail injury, means every policy with a lower attachment point from every policy period triggered by the continuous injury.
The California Supreme Court held that the “other insurance” clauses do not clearly specify whether a rule of horizontal or vertical exhaustion applies. Read in isolation, the “other insurance” clauses might plausibly be read to perform the function the insurers ascribe to them. But read in conjunction with the actual language of other provisions in the policies, and in light of their historical role of governing allocation between overlapping concurrent policies, the insurers’ reading becomes less likely. Rather, the policies are most naturally read to mean that Montrose may access its excess insurance whenever it has exhausted the other directly underlying excess insurance policies that were purchased for the same policy period. And to the extent the policy language is ambiguous, such ambiguities are resolved to protect the reasonable expectations of the insured, which, in this case, favored a rule of vertical exhaustion rather than horizontal exhaustion.
The Court also pointed out that, “because the exclusions, terms, and conditions may vary from one policy to another, a rule of horizontal exhaustion would create significant practical obstacles to securing indemnification” and “would effectively increase the attachment point—thereby undermining the policyholder’s reasonable expectation that coverage would be triggered upon the exhaustion of the amount listed as the policy’s stated attachment point.” “Objectively speaking, the parties could not have intended to require the insured to surmount all these hurdles before the insured may access the excess insurance it has paid for.”
Finally, the Court rejected the insurers’ contention that the insurers claim that vertical exhaustion is “totally unfair” to them because “decades’ worth of environmental damage [could] fall on the shoulders of disfavored insurers who happened to provide excess insurance . . . during that single unlucky year or two.” The Court noted that “nothing about the rule of vertical exhaustion requires a single insurer to shoulder the burden of indemnification alone.” “[I]nsurers may seek contribution from other excess insurers also liable to the insured. The exhaustion rule does not alter the usual rules of equitable contribution between insurers.”
The California Supreme Court thus concluded that “California law permits Montrose to seek indemnification under any excess policy once Montrose has exhausted the underlying excess policies in the same policy period. Montrose is not required to exhaust excess insurance at lower levels for all periods triggered by continuous injury before obtaining coverage from higher level excess insurance in any period.” Accordingly, the Court reversed the judgment of the Court of Appeal.