Subrogation, Insurance Code Section 11580, and the Craziness We Call Insurance Law

Garret Murai | California Construction Law Blog | May 9, 2019

Public domain

If you want to geek out on insurance law the next case is for you. The Insurance Company of the State of Pennsylvania v. American Safety Indemnity Company, 2nd District Court of Appeals, Case No. B283684 (March 1, 2019), is an interesting case involving Insurance Code Section 11580, which in essence provides that if a  judgment is entered against an insured (and there is coverage for that insured) the insured may sue the insurance company to pay for the judgment.

However, in this case, the party doing the suing was the insurer of a general contractor that had a judgment entered against it, and the party being sued was the insurer of subcontractor, on subrogation basis.

Interesting stuff, if you’re into these kinds of things.

The Insurance Company of the State of Pennsylvania Case

Unlike Alexandre Dumas’ The Count of Monte Cristo with requires a flow chart to understand the relationships between its more than 38 characters, we thought it might be helpful to sort out the characters upfront so that you can understand the story that follows:

  • Amir and Brenda Moghadam: Homeowners who bought a home built by New Millennium Homes LLC (NMH) and later sued NMH for construction defects obtaining an award in arbitration against NMH of approximately $1.2 million.
  • New Millennium Homes: Builder of Amir and Brenda Moghadam’s home that sued its subcontractor Camarillo Engineering, Inc. (Camarillo) for the damages sought by the Moghadams in their arbitration and obtained a default judgment against Camarillo of approximately $1.5 million.
  • Camarillo Engineering: The mass grading, compacting and finish grading subcontractor hired by NMH that was supposed to have named NMH as an additional insured under its commercial general liability policy, but didn’t.
  • The Insurance Company of the State of Pennsylvania (ICSP): NMH’s excess liability insurer and the one who ultimately had to pay the Moghadams.
  • American Safety Indemnity Company (ASIC): Camarillo’s commercial general liability insurer who refused to indemnify Camarillo against NMH’s default judgment against Camarillo.


The scene takes place in lovely Calabasas, California. Amir and Brenda Moghadam purchase the house of their dreams from NMH. It’s a sprawling estate of more than 15,000 square feet on over an acre of land. A rather largish man could live quite comfortably, and subsist quite nicely I’m sure, in one of the pantries.

They buy furniture. They decorate. They magically transform what was once just a house into a “home.” But happily ever after it wasn’t to be. They begin noticing “drywall and stucco cracks, separation and cracking of interior tiles, and lifting of exterior flagstones.” An ensuing geotechnical investigation reveals that there is “differential fill settlement, as well as expansive soil activity” and that “an inadequate design and construction of the post-tension slab foundation system are exacerbating the distress.” A construction engineer hired to conduct an investigation shakes his head, shrugs his shoulders and tells the Moghadams that their house would be better torn down and rebuilt. The Moghadams sue.

Chapter 1 – NMH Sues Camarillo

Upon being sued by the Moghadams, NMH, pursuant to its subcontract with Camarillo, tenders defense of the Moghadams’ claim to Camarillo’s commercial general liability insurer ASIC. After several unsuccessful attempts, ASIC informs NMH that Camarillo did not name NMH as an additional insured under its policy issued to Camarillo.

Desperate, NMH sues Camarillo for contractual and equitable indemnity, contribution and related causes of action. It is all for naught. Camarillo fails to respond to NMH’s complaint, and a default is entered against Camarillo.

Chapter 2 – The Insurance Company of the State of Pennsylvania (“ICSP”) Sues ASIC

Meanwhile, the Moghadams proceed to arbitration against NMH, winning a judgment of nearly $1.2 million against NMH. In turn, based on the judgment awarded to the Moghadams, NHM obtains a default judgment against Camarillo of more than $1.5 million. But without a defendant able to pay, it’s ICSP that is on the hook to pay the Moghadams.

ICSP later files suit against ASIC, alleging causes of action for declaratory relief, subrogation, breach of contract, and recovery under Insurance Code section 11580, on the ground that it is entitled to recover the amount of the default judgment entered against Camarillo from ASIC.

Both ICSP and ASIC file competing motions for summary judgment. After the dust settles, ICSP rises as the victor. But, as is the case with every story about litigation, the vanquished is always given a second chance to prevail, by way of an appeal.

Chapter 3- The Court of Appeal Decision

On appeal, ASIC made four arguments:

  1. ICSP is barred from recovering under Insurance Code Section 11580 because NMH’s default judgment against Camarillo is void since it didn’t include a specific claim for damages

ASIC’s first argument on appeal was that ICSP’s claim under Insurance Code Section 11580 was barred. Section 11580 provides in pertinent part that “whenever judgment is secured against the insured . . . in an action based upon bodily injury, death or property damage, then an action may be brought against the insurer on the policy and subject to its terms and limitations, by such judgment creditor to recover on the judgment.”

However, Civil Code Section 580 provides that relief granted to a plaintiff in a default judgment “cannot exceed that demanded in the complaint” and any such judgment is void.

ASIC’s argument was that because NMH’s complaint against Camarillo did not specify a dollar amount it was seeking from Camarillo, NMH’s default judgment against Camarillo in the amount of $1.5 million was void. Of course, practically, it could not specify an amount, since NMH did not know if or in what amount a judgment would be entered against it in the arbitration filed by the Moghadams against NMH. Further, ASIC argued, since NMH’s default judgment was void, ICSP as NMH’s insurer did not have a judgment by which it could recover against ASIC under Insurance Code Section 11580.

The Court of Appeals, focusing on whether ASIC had notice of its potential liability, noted that while NMH did not specify a dollar amount it was seeking from Camarillo, NMH did attach a copy of the Moghadams arbitration claim, which sought to recover at least “$2,347,592” in damages. Thus, held the court, the allegations contained in the Moghadam’s arbitration claim “were more than adequate to put Camarillo on ‘formal notice’ of the ‘maximum judgment that may be asserted against [it],’ as required by due process.”

2. ICSP is barred from recovering under Insurance Code Section 11580 because the Moghadam’s judgment against NMH was not based upon property damage, and therefore, was not a covered claim under the insurance policy issued by ASIC

In the arbitration between the Moghadams and NMH the arbitrator awarded the Moghadams $1.2 million measured by the diminution in value of their home as a result of the soil conditions.

ASIC’s second argument was that because the Moghadams were awarded $1.2 million as measured by the diminution in value of their home, the judgment was not “based upon . . .  property damage.” Because Insurance Code Section 11580 limits recovery “subject to [the] terms and limitations” of the defending insurer’s policy, ICSP was not entitled to recovery against ASIC, since only property damage (as well as personal injury) were covered under its policy.

The Court of Appeals disagreed.

First, held the court, “NMH’s action against Camarillo for indemnity was plainly “based upon . . . property damage.”

Second, the court held that “the fact that the arbitrator measured the damages by diminution of value, rather than by the cost of repair, changes nothing. In statutory actions for construction defects, the homeowner’s ‘right to the reasonable value of repairing any nonconformity is limited to the repair costs, or the diminution in current value of the home caused by the nonconformist, whichever is less.”

Third, addressing the difference between the Moghadam’s judgment against NMH ($1.2 million) and NMH’s judgment  against Camarillo ($1.5 million), which reflected NMH’s attorney’s fees in its action against Camarillo, the court explained that “the statute on its face does not require every element of the damages in that judgment to be property damage; it requires the judgment to be ‘in an action based upon . . . property damage.’”

3. ICSP is barred from recovering under Insurance Code Section 11580 because the Moghadam’s failed to show when their property was damaged and ASIC’s policy only covers property damage occurring at the time the policy was in effect

ASIC’s third argument was that the Moghadam’s failed to show when their property was damaged, and because ASIC’s policy only covers property damage occurring at the time the policy was in effect, ICSP was barred from recovering under Insurance Code Section 11580.

ASIC issued several policies to Camarillo. However, the policy at issue contained language stating that, while ASIC was covering property damage “‘Property damage’ . . . which commenced prior to the effective date of this insurance will be deemed to have happened in its entirety prior to, and not during, the term of the insurance.” In other words, the policy would only be triggered if property damage “first occurred” during the policy period.

ASIC’s argument was that the Moghadams had not shown when the property damage first occurred, and therefore, unless the Moghadams showed that property damage first occurred during the policy term, there was no coverage.

The Court of Appeal disagreed, holding that it is a “settled rule” that “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.” In other words, while the Court didn’t expressly say it in so many words, ASIC’s policy was contrary to public policy.

4. ICSP is barred from recovering under Insurance Code Section 11580 because Camarillo didn’t satisfy its self-insured retention

ASIC’s fourth and final argument was that Camarillo didn’t satisfy it’s self-insured retention, which ranged from $15,000 to $50,000, depending on the type of claim, ASIC further stated that because the payment of self-insured retention was a condition precedent of coverage, no coverage existed and no claim could be made by ICSP under Insurance Code Section 11580. I’ve got to hand it to ASIC’s attorneys for creativity.

The Court of Appeals again disagreed, but this time, didn’t need to rely on a public policy argument. The policy language in question specifically stated that no coverage would be provided if ASIC requested that Camarillo pay its self-insured retention and Camillo failed to do so. There was no evidence, explained the Court, that ASIC ever requested that Camillo pay its self-insured retention. Thus, held the Court, ASIC’s reliance on the language as a defense to ICSP’s claim under Insurance Code Section 15580 was moot.

ASIC made other additional arguments as well, but because they weren’t raised during the underlying summary judgment motion,  the Court held that these arguments were “not before the court.”


The Insurance Company of State of Pennsylvania case is an interesting one, involving a statute I wasn’t intimately familiar with, and some creative defenses. When I asked my colleague Gary Barrera, an insurance attorney at the firm, he said, “Well, we could see the foreshadowing of that ending a mile away!” The moral of the story?  I’m glad I’m not an insurance claims attorney.

A Good-Faith Attempt to Limit Unwarranted Bad-Faith Liability in Georgia

Bryan Lutz, Tiffany Powers, and Kyle Wallace | Alston & Bird | March 21, 2019

A victory for insurers in Georgia’s Supreme Court clarifies state law on liability for failing to settle a claim. Our Insurance Litigation & Regulatory Team offers three key holdings that will limit an insurer’s potential exposure.

  • The injured party must present a valid offer
  • Whether a claimant has made a valid offer to settle is a legal question
  • Insurers may exhaust the policy limits by settling one of multiple claims

In a recent victory for insurers by Alston & Bird’s insurance team before the Georgia Supreme Court, the court issued an opinion in First Acceptance Insurance Co. of Georgia v. Hughes clarifying longstanding (and much debated) Georgia law governing an insurer’s liability for failing to settle a claim within the policy limits. The court held that a claimant’s ambiguous demand letter did not create a duty for the insurer to settle a claim, shedding light on three key aspects of Georgia law:

  • Insurers have no duty to settle a claim until they receive a valid offer to settle.
  • Demand letters are construed by the court with the principles of general contract construction, with ambiguous terms to be construed against the drafter.
  • Insurers have no duty to settle one of multiple claims when there is no time-limited demand and the claimant has expressed a willingness to engage in a joint settlement conference.

Georgia Law on Liability for Bad-Faith Failure to Settle Claims Against an Insured

The Georgia Supreme Court recently stepped in to clarify Georgia’s law governing an insurer’s liability for failing to settle a claim within the policy limits. Decades ago, the Georgia Supreme Court announced a rule in Southern General Insurance Co. v. Holtthat if an insurer acts in bad faith by refusing to settle a claim for an amount within the policy limits, it may be liable for the full amount of any judgment against the insured. The reason for the rule was simple: to encourage insurers to settle to avoid liability to their insured for judgment amounts exceeding the insurance coverage rather than take a chance at a trial where the insurer will face the same policy-limits maximum exposure but will possibly save money if the insured is found not liable.

In the 27 years following Holt, however, the rule has been weaponized. Plaintiffs’ attorneys have recognized that when the person at fault in a catastrophic accident may be rendered insolvent by a massive judgment, the insurer is often the only possible source to collect from. In these instances, plaintiffs’ attorneys have every incentive to break through the contractual limits of the insurance policy and to seek collection of the entire judgment from the insurer. Holt provided an inlet with its bright-line rule. As a result, rather than promoting settlement, the Holt rule has often been used as a trap to ensnare unwary insurers through the use of strategic “set-up” demands to create bad-faith liability even when the claimant never truly intends to settle their claim for an amount within the policy limits. Set-up tactics have included demand letters that require hand delivery of settlement payments within an unrealistic timeframe and vague and confusing demands that may not fully release all claims. These tactics have become so widespread that plaintiffs’ attorneys have actually created continuing legal education seminars to instruct on their use.

The Georgia Supreme Court’s Opinion in Hughes

Although the Georgia legislature took action to curb the abusive tactic of sending time-limited demands,[1] the Georgia Supreme Court recognized in Hughes that the law governing bad-faith liability needed further reform. In Hughes, the insured caused a car accident that seriously injured multiple parties and resulted in the insured’s death. The insurer, recognizing the $50,000 policy limit would quickly be exhausted, attempted to schedule a joint settlement conference with all injured parties. One of the injured parties (on her own behalf and her minor child’s) sent two letters to the insurer on the same day: (1) a letter expressing interest in a joint settlement conference and alternatively offering a limited release that would carve out claims for uninsured motorist coverage upon payment of the policy limits and receipt of coverage information; and (2) a letter requesting coverage information within 30 days.

After 41 days, the attorney “withdrew” the offer, filed suit, and the claimants at issue were awarded a judgment of $5.3 million against the insured’s estate. The estate then filed suit against the insurer for the full amount of the judgment. The trial court granted the insurer’s motion for summary judgment, finding that the insurer could not have reasonably known that all of the injured parties’ claims could have been settled within the policy limits. The Georgia Court of Appeals reversed, relying on a rigid application of Holt, finding that a jury could find that a demand had been made with a “purported 30-day time limit” and that the insurer failed to settle the two claims at issue within that timeframe. The Georgia Supreme Court reversed the court of appeals, finding that there was no “time-limited” demand for settlement and that the insurer could not be liable for bad-faith failure to settle when the claimant unilaterally withdrew a pending offer that had no express time limit. 

Georgia’s highest court in Hughes made three key holdings that work to further limit an insurer’s potential exposure from the use of set-up demands:

An insurer’s duty to settle does not arise until the injured party presents a valid offer.

The court in Hughes held that insurers cannot be liable for excess judgments if the claimant never presented a valid offer to settle a claim within the insured’s policy limits. Before Hughes, courts had openly questioned whether under Georgia law an insurer could be liable for bad-faith failure to settle even without an express offer to settle for the policy limits. Many plaintiffs argued that an insurer had an obligation to initiate settlement discussions or make an offer even if the claimant had not. However, the court in Hughes recognized that such a rule would encourage after-the-fact testimony that a claimant would have settled every time a judgment is entered that exceeds the policy limit. 

By holding that a claimant must first present a valid offer to settle within the policy limits, the court has provided insurers with a powerful defense to set-up demands that are vague, contradictory, or fail to settle the entire claim. In those instances, insurers can argue that there was no valid offer to “accept” that would avoid future liability for the insured.

Whether a claimant has made a valid offer to settle is a legal question decided by the court according to the general rules of contract construction.

The court also struck at the heart of set-up demands that provide vague, confusing, or contradictory terms by holding that courts must construe the validity of an offer as a matter of law, resorting to a jury only if ambiguity remains after applying the rules of contract construction. Ambiguous demand letters are construed against the drafter—in this instance, the claimant. Before Hughes, plaintiffs often sought to avoid summary judgment (and to appeal to sympathetic jurors) by arguing that the interpretation or intent of a demand letter was a fact question that was appropriately resolved at trial and by arguing that agreements are generally construed in favor of the insured or claimant.

The court in Hughes clarified that demand letters are to be construed against the injured party, and that if its terms are “too indefinite for a court to [ ] determine, there can be no assent thereto” and the offer is not valid. Applying this basic rule of contract interpretation, the court held as a matter of law that there was no time-limited demand when a claimant mailed two separate letters—one expressing a willingness to attend a joint settlement conference or, in the alternative, to settle the claims if insurance information was provided, and the other requesting insurance information within 30 days. In light of Hughes, insurers will have a powerful defense when faced with vague, confusing, or contradictory demand letters.

Insurers may exhaust the policy limits by settling one of multiple claims, but need not do so absent a time-limited demand.

Finally, the court addressed the situation insurers face when there are multiple claimants involved. It has long been the rule that an insurer may settle one claim that exhausts the policy limits without incurring liability for excess judgments resulting from litigation by the non-settling claimants. However, Hughes clarifies that an insurer has no obligation to settle one of multiple claims for the full policy limits, absent a time-limited demand.

However, Hughes should not be seen as limiting an insurer’s potential liability in the face of a valid time-limited demand—even in the context of multiple claimants. The court noted that in Hughes, the two claimants at issue “expressed their interest in attending a settlement conference with the other claimants.” Consequently, the insurer’s failure to settle with the two individual claimants was “reasonable as an ordinarily prudent insurer could not be expected to anticipate that, having specified no deadline for the acceptance of their offer, [the claimants] would abruptly withdraw their offer and refuse to participate in the settlement conference.”

[1]  Effective July 1, 2013, Georgia enacted a law that provided insurers with a minimum of 30 days to respond to a time-limited demand and clarified that an insurer’s request for clarification of an offer letter will not be deemed a rejection and counteroffer. O.C.G.A. § 9-11-67.1(a)(1), (d).

Broken Water Main Damage: Flood or Not Flood Under Homeowner’s Insurance Policy?

Paul LaSalle | Property Insurance Coverage Law Blog | May 9, 2019

In a recent court opinion,1 the New Jersey Appellate Division interpreted a homeowner’s insurance policy’s water damage exclusion and determined whether damage from a broken municipal water main under a public street was covered under the policy. In that case, a homeowner brought an action against his insurer for breach of contract after the insurer disclaimed coverage on the basis that damage to his real and personal property resulting from a broken water main was excluded under the policy as flood, surface and ground water intrusion.

The homeowner’s insurance policy at issue in that case provided all risk coverage for damage to the dwelling and other structures and named peril coverage for damage to personal property. The insurance policy’s form excluded losses caused by water damage, which was modified in reach by a “Water Back-Up and Sump Pump Discharge or Overflow” endorsement. The water damage exclusion included: “(1) Flood, surface water, waves …[the] overflow of any body of water … including storm surge” (Exclusion 1); and “(3) Water below the surface of the ground, including water which exerts pressure on, or seeps, leaks or flows through a building … or other structure” (Exclusion 3).

The insurance company claimed that Exclusion 1 applied because the water that caused the damage to the homeowner’s home was a “flood or surface water.” The insurance company also claimed that Exclusion 3 applied because below-ground water “exerted pressure on, … seeped, leaked or flowed through a building, sidewalk … driveway…or other structure.” The court disagreed.

The court initially noted that the insurance policy did not exclude all losses resulting from water, and that unless the kind of water that caused the damage to the homeowner’s dwelling satisfied one of the identified forms of water, the water damage exclusion did not apply. With respect to “flood” as defined in Exclusion 1, the court ruled that flood does not clearly encompass water released from a broken water main. In ruling so, the court noted that the insurance company’s Notice Regarding Flood Damage Coverage (which the insurance company invoked to define flood because the term was undefined by the water exclusion) provided that a “flood” “is a general and temporary condition of partial or complete inundation of normally dry areas.” Therefore, even if it was assumed that the homeowner’s driveway, a “normally dry land area,” was partially or completely inundated because of the broken water main, and that inundation caused damage to the dwelling, the condition was not a “general” one, i.e., a water condition that was “not limited in scope, area, or application.” In other words, in order for the water condition to be considered a flood, it must affect a wide area and precludes the isolated water condition that specifically damaged the homeowner’s property.

The court commented that its definition of a flood was consistent with the view of other jurisdictions that have found that a flood “connotes a great inundation or deluge affecting a broad area, and not the kind of localized water damage that a water-main break causes.” The court further provided this line of thought is clearly connected to the position that “the principal defining characteristic of a flood is not that it is a natural phenomenon – it may arise from human actions – but that it involves the overflow of a body of water”—and a water main is not a body of water.

With respect to the insurance company’s claim that the broken water main damage was excluded as “surface water” in Exclusion 1, the court concluded that the term “surface water” was ambiguous.2 Nevertheless, the court found the water main break’s water did not qualify as surface water under both definitions of the term. Therefore, water from a water main break is not, unambiguously, surface water.

Moreover, the court rejected the insurance company’s claim that Exclusion 3 prevented the homeowner’s recovery because the water that damaged the home was no longer “below the surface of the ground” when it reached the property; it was above ground. The court found that by its plain meaning, Exclusion 3 does not address damage caused by above-ground water. Furthermore, water below the surface of a public street adjoining an insured’s property is neither mentioned, nor implied by Exclusion 3.

Finally, it bears noting that while the court reversed the trial court’s determination that the broken water main damage was barred by the water damage exclusion, the court affirmed the trial court’s order that the insured had not established that his personal property claim satisfied a named peril. While the court commented that the only named peril that would appear to apply would be coverage for personal property by the “accidental discharge or overflow of water…,” and that provision does not extend if the discharge occurred off the “residence premises,” the court would leave the coverage determination to the trial court because the provision had not been addressed by the parties.
1 Sosa v. Massachusetts Bay Ins. Co., No. A-5349-16T3, 2019 WL 1780983 (N.J. Super. Ct. App. Div. Apr. 24, 2019).
2 The insurance policy did not define “surface water” and the court found there were two competing but plausible meanings of the term. Surface water has been defined by the New Jersey Administrative Code to possess a permanent nature, akin to a body of water (such as water in lakes, ponds, streams, etc.). Alternatively, a prior opinion of a New Jersey court found surface waters “are those which fall on the land from the skies or arise in springs” and embrace waters derived from falling rain and melting snow, whether on the ground or on the roofs of buildings thereon.

Insurance Policy’s Promise to Advance Claims Expense for Covered Claims Does Not Create a Duty to Defend

Christopher Kendrick and Valerie Moore | Haight Brown & Bonesteel | May 7, 2019

In United Farm Workers of America v. Hudson Insurance Company, (E.D. Cal.) 2019 WL 1517568, the United Farm Workers of America union (UFW) sued Hudson Insurance Company for breach of contract and bad faith arising out of a former employee’s wrongful termination and wage and hour lawsuit.

Hudson provided UFW with Labor Professional Liability Insurance that included employment practices liability coverage. Hudson reserved its rights and agreed to pay an allocated share of the defense costs, citing the terms of its policy. UFW and Hudson agreed to a 50-50 allocation and, defending itself, UFW moved to compel arbitration of the employee lawsuit pursuant to its collective bargaining agreement. However, the trial court found that the only claim subject to arbitration was the employee’s wrongful termination claim, which Hudson contended eliminated the sole covered cause of action.

The employee’s complaint was amended to include class action allegations for the statutory wage and hour claims and the case proceeded to trial, resulting in an adverse judgment of $1.2 million. Hudson paid UFW for the allocated share of the defense costs incurred through the dismissal of the sole covered claim, and disclaimed any obligation for the wage and hour award.

Hudson retained Haight, Brown & Bonesteel to defend the company against the subsequent bad faith lawsuit brought by the UFW, which alleged that Hudson wrongfully failed to defend or indemnify the union for the employees’ lawsuit. Besides the $1.2 million wage and hour award, UFW claimed in excess of $800,000 incurred defending itself as damages.

UFW and Hudson brought cross-motions for summary judgment, with UFW seeking summary adjudication on the duty to defend. UFW argued that Hudson had a duty to defend the entirety of the employee lawsuit based on the mere potential for coverage, which was not extinguished by the partial grant of UFW’s motion to compel arbitration. (Citing Gray v. Zurich Ins. Co. (1966) 65 Cal.2d 263; Montrose Chem. Corp. v. Super. Ct. (1993) 6 Cal. 4th 287; and Buss v. Super. Ct. (1997) 16 Cal.4th 35.) UFW argued that Hudson’s failure to do so amounted to a bad faith breach of contract, exposing Hudson to the full amount of the defense costs, the resulting judgment, UFW’s own attorney’s fees for suing Hudson under Brandt v. Super. Ct. (1985) 37 Cal.3d 813, and other damages.

Hudson’s cross-motion for summary judgment asserted that there was no duty to defend under the terms of its policy, which expressly stated that UFW had the duty to defend. Under the policy, Hudson was only obligated to advance defense expenses for covered claims, subject to an allocation based on the respective liabilities and further subject to reimbursement in the event of an uncovered result, none of which translated into a duty to defend. (Citing Jeff Tracy, Inc. v. United States Spec. Ins. Co. (C.D. Cal. 2009) 636 F.Supp.2d. 995; and Petersen v. Columbia Casualty Company (C.D. Cal.) 2012 WL 5316352.) Further, although the employee’s original claim for wrongful termination was a covered claim under the Hudson policy’s definition of Wrongful Employment Practices, Hudson argued that none of the statutory wage and hour claims that remained after wrongful termination was ordered to arbitration came within the policy’s Wrongful Acts, Wrongful Offenses or Wrongful Employment Practices coverages. (Citing California Dairies v. RSUI Indem. Co. (E.D. Cal. 2009) 617 F.Supp.2d 1023.)

Consequently, Hudson contended that its payment after the entry of judgment, limited to an allocated share of the defense expense, and its disclaimer of coverage for the wage and hour award, were entirely proper and not in breach of the contract. In addition, Hudson uncovered the existence of misrepresentations in UFW’s application for the insurance during discovery, which Hudson argued voided the policy. (Citing Imperial Cas. Co. v. Sogomonian (1988) 198 Cal.App.3d 169; and Thompson v. Occidental Life (1973) 9 Cal.3d 904.) Without coverage or a breach of contract, Hudson argued that there could be no bad faith.

The district court agreed with Hudson, denying UFW’s motion for summary adjudication on the duty to defend and granting Hudson’s cross-motion for summary judgment. The court found that there was no duty to defend under the terms of the policy, which imposed the duty to defend on the insured and not the insurer. The court agreed that Hudson’s obligation was limited to payment for the cost of defending claims actually covered by the policy, and the award for wage and hour violations did not come within any of the policy’s coverages. Additionally, the court found that UFW made material misrepresentations in its application for insurance, holding that the contract was void. Because there was no coverage there was no breach of contract, and the cause of action for breach of the implied covenant of good faith and fair dealing had to fail as well, entitling Hudson to summary judgment.

This document is intended to provide you with information about insurance law related developments.The contents of this document are not intended to provide specific legal advice. If you have questions about the contents of this alert, please contact the authors. This communication may be considered advertising in some jurisdictions.

Collapse Coverage: Second Circuit Holds That Cracking Walls Do Not Constitute “Collapse”

Dina R. Richman | Property Insurance Law Observer | May 6, 2019

Most homeowners’ policies – and property insurance policies in general – contain a limited coverage extension for “collapse.”  The interpretation of that collapse coverage has been litigated around the country for decades, with different jurisdictions reaching considerably different results.  The latest of these decisions, Valls v. Allstate Insurance Company, No. 17-3495-cv (2d Cir. 2019), comes out of the Second Circuit, deciding the case under Connecticut law.  The case presented a single substantive question: does the “collapse” provision afford coverage for basement walls which had significant cracking but remain standing?  Both the district court (D. Conn.) and the Second Circuit Court of Appeal concluded that it does not.

In Valls, the plaintiffs owned a home in Connecticut which was insured by Allstate.  The Allstate policy excluded “collapse,” but then contained a collapse coverage extension, which provided:

We will cover:

a) the entire collapse of a covered building structure;

b) the entire collapse of part of a covered building structure; and

c) direct physical loss to covered property caused by (a) or (b) above.

For coverage to apply, the collapse of a building structure specified in (a) or (b) above must be a sudden and accidental direct physical loss caused by one or more of the following: . . .

b) hidden decay of the building structure; . . .

f) defective methods or materials used in construction, repair, remodeling or renovation.

Collapse does not include settling, cracking, shrinking, bulging or expansion

The Valls noticed several horizontal and vertical cracks in their basement walls, but the walls remained standing.  The Valls made a claim to Allstate, arguing that the damage should be covered under the collapse provision.  Allstate denied coverage, and the Valls filed suit.  The district court granted Allstate’s motion to dismiss, concluding that the collapse coverage did not apply.  The Valls appealed, and the Second Circuit Court of Appeal affirmed the district court’s decision, finding that mere cracking did not constitute “collapse.”

In reaching this conclusion, the Second Circuit looked at the policy’s requirements that the collapse be “sudden and accidental” and that it be an “entire collapse.”  First, the Court noted that the erosion and cracking of the basement walls had occurred gradually, and therefore was not “sudden and accidental.”  Second, the Court found that even if the cracking had been sudden, it would still not be covered because the damage could not be deemed an “entire collapse.”  Although the Policy did not define “entire collapse,” it expressly excluded “settling, cracking, shrinking, bulging or expansion.”  Accordingly, there was no coverage for the loss.

By determining that cracking is not an “entire collapse,” the Second Circuit joins several other states who have reached similar conclusions.  For instance, in Higgins v. Connecticut Fire Ins.Co., 163 Colo. 292 (1967), the Supreme Court of Colorado held that the cracking and upheaval in a floor could not be considered a “collapse.”  Similarly, in Doheny W. Homeowners Ass’n v. Am. Guar. & Liab. Ins. Co., 60 Cal.App.4th 400 (Cal.Ct.App. 1997), the California Court of Appeal held that although “imminent” collapse may be covered, it does not include mere cracking or settlement.

Other states have reached the opposite conclusion.  In Jenkins v. United States Fire Ins. Co., 185 Kan. 665 (1959), the Kansas Supreme Court held that the “collapse” provision included the “settling, falling, cracking, bulging or breaking of the insured building…in such manner as to materially impair the basis structure or substantial integrity of the building[.]”

In response to cases such as Jenkins insurers began including the limitations in the collapse provision – such as requiring complete collapse and excluding cracking and settling.  Many courts which have addressed the limitations in the collapse provision end up concluding that the provision does not provide coverage for settling and cracking.  See, e.g. Krug v. Milles’ Mut. Ins. Ass’n of Ill., 209 Kan. 111 (1972) (distinguishing Jenkins due to different policy language).  And yet other courts continue to apply a very broad application of “collapse” even with the added limitations.  For instance, in American Concept Ins. Co. v. Jones, 935 F.Supp. 1220 (D. Utah 1996), a district court in Utah held that the term “collapse” was ambiguous, and that settling and cracking could still be “collapse” despite the fact that the policy stated that collapse did not include settling or cracking.

The Second Circuit’s Valls opinion is now part of a sizeable body of case law from around the country interpreting the “collapse” coverage in property insurance policies.  Without a doubt, as the policy language evolves, litigation over the breadth and meaning of “collapse” coverage will also continue.