Court Reminds Insurer that the Mere Possibility Of Coverage at the Time of Tender Triggers a Duty to Defend in a Defect Action

Jatin Patel | Newmeyer Dillion

It has long been the law in California that an insurer’s duty to defend is broader than the duty to indemnify and that the mere possibility of coverage triggers a duty to defend.   Nevertheless, insurers still periodically ignore this clear principle and attempt to narrow the scope of the duty to defend.  Recently, a Federal District Court issued a reminder to a wayward insurer.

In Pacific Bay Masonry, Inc., v. Navigators Specialty Insurance Company, (N.D. Cal., Sept. 16, 2021, No. C 20-07376 WHA, 2021 WL 4221747 (“Pacific”)), the Court was asked to assess whether a tender of defense by a concrete masonry subcontractor to its insurer for a construction defect action required a defense.   Pacific Bay Masonry, Inc. (“PBM”) installed concrete masonry units (also known as “CMUs”) at a new retail shopping center in Oakland, California.  The subsequent owner of the retail center filed suit against the general contractor for alleged construction defects, including “efflorescence of roof deck at CMU wall” and “improper waterproofing and flashing of the CMU block wall.”   The general contractor filed a cross-complaint against PBM.

PBM tendered the defense of the case to Navigators Specialty Insurance Company (“Navigators”) along with copies of a preliminary defect list, a description of defects, interrogatory responses and an expert witness damage analysis.  Navigators denied coverage and a duty to defend citing to the work product exclusion of the policy.  PBM asked Navigators to reconsider.  Navigators held firm on its denial. Two years later, PBM filed suit.

In the litigation, PBM sought summary judgment on the duty to defend.  Navigators argued that the work product exclusion applies if the alleged defect damages are minimally causally linked to the insured’s work (here, the CMUs).  Navigators further explained that it denied coverage to PBM on the basis that PBM’s work was defective and had not yet caused any physical injury to tangible property.

The Court disagreed with Navigators on both counts, finding that:  (1) the bare possibility that an external source is responsible for the subcontractor’s work being damaged triggers an insurer’s duty to defend despite standard work product exclusions; (2) this bare possibility is to be considered in a duty to defend analysis from the facts the insurer knows or becomes aware of at time of underlying lawsuit or time of tender; (3) disputed facts must be considered in the duty to defend analysis; and (4) the insurer has a duty to defend until the insurer can definitively show that the insured’s work is the sole defective source.

The Court reasoned that a bare possibility of coverage can arise when the work of multiple subcontractors overlaps to an extent that it is unclear as to which subcontractor’s defective work led to the property damage.

The lesson for builders and contractors is that even though the duty to defend is extremely broad, and insurers clearly know this, they will still wrongfully deny tenders of defense in construction defect actions.  This case is another in a long line of cases that policyholders can use to obtain a defense of a construction defect lawsuit if there is a mere possibility of coverage.

Court Reminds Insurer that the Mere Possibility Of Coverage at the Time of Tender Triggers a Duty to Defend in a Defect Action

Jatin Patel | Newmeyer Dillion

It has long been the law in California that an insurer’s duty to defend is broader than the duty to indemnify and that the mere possibility of coverage triggers a duty to defend.   Nevertheless, insurers still periodically ignore this clear principle and attempt to narrow the scope of the duty to defend.  Recently, a Federal District Court issued a reminder to a wayward insurer.

In Pacific Bay Masonry, Inc., v. Navigators Specialty Insurance Company, (N.D. Cal., Sept. 16, 2021, No. C 20-07376 WHA, 2021 WL 4221747 (“Pacific”)), the Court was asked to assess whether a tender of defense by a concrete masonry subcontractor to its insurer for a construction defect action required a defense.   Pacific Bay Masonry, Inc. (“PBM”) installed concrete masonry units (also known as “CMUs”) at a new retail shopping center in Oakland, California.  The subsequent owner of the retail center filed suit against the general contractor for alleged construction defects, including “efflorescence of roof deck at CMU wall” and “improper waterproofing and flashing of the CMU block wall.”   The general contractor filed a cross-complaint against PBM.

PBM tendered the defense of the case to Navigators Specialty Insurance Company (“Navigators”) along with copies of a preliminary defect list, a description of defects, interrogatory responses and an expert witness damage analysis.  Navigators denied coverage and a duty to defend citing to the work product exclusion of the policy.  PBM asked Navigators to reconsider.  Navigators held firm on its denial. Two years later, PBM filed suit.

In the litigation, PBM sought summary judgment on the duty to defend.  Navigators argued that the work product exclusion applies if the alleged defect damages are minimally causally linked to the insured’s work (here, the CMUs).  Navigators further explained that it denied coverage to PBM on the basis that PBM’s work was defective and had not yet caused any physical injury to tangible property.

The Court disagreed with Navigators on both counts, finding that:  (1) the bare possibility that an external source is responsible for the subcontractor’s work being damaged triggers an insurer’s duty to defend despite standard work product exclusions; (2) this bare possibility is to be considered in a duty to defend analysis from the facts the insurer knows or becomes aware of at time of underlying lawsuit or time of tender; (3) disputed facts must be considered in the duty to defend analysis; and (4) the insurer has a duty to defend until the insurer can definitively show that the insured’s work is the sole defective source.

The Court reasoned that a bare possibility of coverage can arise when the work of multiple subcontractors overlaps to an extent that it is unclear as to which subcontractor’s defective work led to the property damage.

The lesson for builders and contractors is that even though the duty to defend is extremely broad, and insurers clearly know this, they will still wrongfully deny tenders of defense in construction defect actions.  This case is another in a long line of cases that policyholders can use to obtain a defense of a construction defect lawsuit if there is a mere possibility of coverage.

No Allocation for Defense Costs Incurred in Lawsuit Comprised of Covered and Uncovered “Claims”

Emily Hart | Wiley Rein

The U.S. District Court for the Northern District of California, applying California law, has held that, under a duty to defend policy, an insurer was required to pay defense costs incurred in a lawsuit where the lawsuit contained both covered and uncovered “claims.” Stem, Inc. v. Scottsdale Ins. Co., 2021 WL 3271265 (N.D. Cal. July 30, 2021). 

The insured, a technology company, sought coverage under its directors and officers policy for a shareholder lawsuit (“2017 Lawsuit”) based on a 2013 stock financing round (“2013 Stock Financing”) and a 2017 loan to the company by a member of the board of directors (“2017 Loan”).  The court concluded that the interrelated wrongful act exclusion barred coverage for the 2013 Stock Financing “Claim,” but that coverage was available for the 2017 Loan “Claim” because it did not relate back to an earlier dispute.

The insured then moved for partial summary judgment on the measure of damages. The insured argued that, pursuant to the insurer’s duty to defend, the insurer was required to cover all defense costs incurred in the 2017 Lawsuit, even though the lawsuit contained both covered and uncovered “claims.” The insurer argued that the court should apply the policy’s allocation provision to cover only defense costs related to the 2017 Loan.

The court held that the insurer was required to cover defense costs incurred for the entire 2017 Lawsuit. The court reasoned that, even if an allocation provision applies where there is a duty to defend, in the instant matter, there was not “undeniable evidence of the allocability of specific expenses because the 2017 [L]awsuit is ongoing” and the insured had “taken steps to defend against the [2017 Loan Claim]” for which the insurer’s “proposed allocation does not account.”

Federal Court: Insurer Breaches Duty to Defend By Insisting it Owes Only a “Defense-Follows-Indemnity” Share of Defense Costs

Sarah Odia and Scott Thomas | Payne & Fears

In an insurance recovery case being handled by Payne & Fears partners Scott Thomas and Sarah Odia, an Arizona federal court, applying Nevada law, recently held that NGM Insurance Company breached its duty to defend its additional-insured homebuilder by refusing to pay more than a proportionate share of the builder’s defense costs based on what NGM called a “defense-follows-indemnity” formula.

The court rejected NGM’s argument that its duty to defend required it to pay only a small fraction of the builder’s defense costs proportionate to its named insured’s relatively small role in the homeowners’ overall damages; the court correctly applied Nevada law to the effect that if an insurer has a duty to defend any part of a lawsuit, it has a duty to defend the entire lawsuit. This ruling puts to rest the ill-conceived notion that under Nevada law, insurers defending developers and homebuilders as additional insureds under policies issued to subcontractors can get away with anything less than fully defending their additional insureds.

The court also rejected NGM’s argument that the builder “failed to mitigate” its damages by not trying to shift NGM’s defense burden to other defending insurers. Instead, the court held that the builder is entitled to recover from NGM all of the builder’s reasonable defense costs and any consequential damages resulting from NGM’s breach – potentially including its litigation expenses in the recovery action.

The case is Centex Homes et al. v. NGM Insurance Co., case number 2:19-cv-01392, in the U.S. District Court for the District of Arizona (July 9, 2021 Order, ECF No. 195).

Eastern District of Pennsylvania Confirms Carrier Owes No Duty to Defend Against Claims for Faulty Workmanship

Anthony L. Miscioscia and Marianne Bradley | White and Williams

On March 17, 2021, the Eastern District of Pennsylvania issued its decision in Estate Chimney & Fireplace v. IFG Companies & Burlington Insurance Company, 2021 U.S. Dist. LEXIS 50360 (E.D. Pa. March 17, 2021), finding that an insurance carrier had no duty to defend its insured where the allegations in the underlying litigation involved claims of faulty workmanship.

Estates Chimney & Fireplace, LLC (Estates Chimney) had performed inspections and replaced chase covers for a number of chimneys in a condominium complex. Chase covers are pieces of metal, which are placed over chimneys in order to keep out environmental elements. Several condominium owners sued Estates Chimney, alleging that Estates Chimney had improperly installed, then improperly replaced, their chimney caps, which caused their chimneys to cease working properly. As a result, the underlying plaintiffs allegedly incurred costs to repair or replace the chimney caps and chimneys.

Estates Chimney sought coverage from its carrier, who denied coverage based upon its determination that the claims in the underlying lawsuits arose out of faulty workmanship, which did not result in damage to the property of a third party. Estates Chimney filed a declaratory judgment action, seeking a declaration that it was entitled to coverage under the policy. Both parties moved for summary judgment, and the Eastern District ruled in favor of the carrier.

In reaching its decision, the court declined to consider the insured’s expert’s opinion, explaining that – under Pennsylvania law – courts “must decide coverage issues based on the four corners of the complaint against the insured, not the opinion of an expert, even if that expert opined that Estates Chimney did quality work that complied with all laws and regulations. This is a coverage dispute, the outcome of which cannot be decided by extrinsic evidence that addresses the merits of the underlying claims.” Id. at *17.

Having determined that its consideration was limited solely to the four corners of the underlying complaints, the court concluded that all of the underlying plaintiffs’ claims were for faulty workmanship, which do not present the degree of fortuity required for there to be a covered “occurrence,” defined in part as an “accident.” Id. at *17 (citing Kvaerner Metals Division of Kvaerner U.S., Inc. v. Commercial Union Insurance Co., 908 A.2d 888 (Pa. 2006).

The court further rejected the insured’s argument that – because some of the underlying plaintiffs may have sought consequential damages – the allegations in the underlying complaint constituted an “occurrence.” Id. Rather, the court explained that “the holding in Kvaerner has been extended to the foreseeable results of the insured’s faulty workmanship.” Id. Thus, because it was foreseeable that faulty workmanship when capping chimneys could lead to damage to the chimney itself, rendering the fireplace unusable, “there is no insurance coverage.” Id. at *16.

Finally, the court declined to find a covered “occurrence” based upon the insured’s argument that the underlying lawsuits involve “specific allegations of negligence.” Relying upon well-established Pennsylvania law, the Eastern District explained that it is the factual allegations, not the legal terminology used in the complaint, which determines whether a duty to defend arises. Id. at *18 (citing Nationwide Mutual Insurance Company v. CPB International, Inc., 562 F.3d 591, 598-99 (3d Cir. 2009)). Thus, faulty workmanship – even when cast as a negligence claim – does not constitute a fortuitous event. Id. (citing Westfield Insurance Company v. Bellevue Holding Company, 856 F. Supp. 2d 683, 694 (E.D. Pa. 2012).