No Insurance Coverage Stinks: South Carolina Court of Appeals Denies Coverage for Sewage Odor Lawsuit

The South Carolina Court of Appeals recently held that a state-run insurance company owed no defense to a county public service district for offensive odors emanating from a sewage valve based on the policy’s pollution exclusion. The decision in S.C. Ins. Reserve Fund v. E. Richland Cty. Pub. Serv., No. 5393, 2016 S.C. App. LEXIS 32 (S.C. Ct. App. Mar. 23, 2016) is significant for insurers since it rejects the notion that odors must be regulated or harmful to be considered pollutants, and instead, following several other jurisdictions, applies the plain language interpretation in finding that foul odors – comprised of irritating and offensive gases – are encompassed by the pollution exclusion.

The facts are straightforward. In 2010, East Richland resident Coley Brown (“Brown”) filed a complaint against the East Richland County Public Service District (“District”) for inverse condemnation, trespass, and negligence in connection with the District’s installation of a sewage force main and air relief valve on Brown’s street that released offensive odors on Brown’s property multiple times per day. The stench ultimately caused Brown to leave the property, and he was unable to find a buyer. The District tendered the complaint to the state-run South Carolina Insurance Reserve Fund (“Fund”), which denied coverage.

The Fund initiated a declaratory judgment action seeking a declaration that it had no duty to defend or indemnify the District in the Brown matter. The Fund denied coverage based on the pollution exclusion, which barred coverage for personal injury or property damage “arising out of the discharge, dispersal, release or escape of smoke, vapors, soot, fumes, acids, alkalis, toxic chemicals, liquids or gases, waste materials or other irritant, contaminants or pollutants into or upon land, the atmosphere or any water course or body of water; but this exclusion does not apply if such discharge, dispersal, release or escape is sudden and accidental[.]” The Fund also denied coverage based on its position that the damages alleged by Brown did not qualify as “property damage” caused by an “occurrence.”

During trial, the District’s executive director and former maintenance superintendent testified that the sewage odor was the result of naturally occurring hydrogen sulfide and methane, that the District was not required by the Department of Health and Environmental Control to control these gases, and that in response to odor complaints, the District employed several novel corrective measures to mask or eliminate the odors.

The trial court found that the policy’s pollution exclusion barred coverage for the inverse condemnation claim. As to the negligence and trespass claims, the court determined that the pollution exclusion’s reference to gases and fumes encompassed the offensive odors delineated in Brown’s complaint. The court also found that the discharge of offensive odors were a part of the District’s ordinary operations such that the pollution exclusion’s “sudden and accidental” exception was inapplicable. Finally, the court found that there was no ambiguity between the policy’s definition of “occurrence” and the pollution exclusion. Consequently, the court determined that the Fund owed no duty to defend or indemnify the District.

On appeal, the District first argued that the pollution exclusion was void because it conflicted with provisions of the South Carolina Tort Claims Act (“Act”), which required the Fund to provide coverage for all risks for which immunity has been waived under the Act. Further, the District argued that because its decision to purchase insurance from the Fund precluded it from purchasing additional insurance from other sources, it was improperly exposed to liability for any excluded risks.

The Appellate Court rejected these arguments, finding that neither the Act nor the Act’s insurance provision expressly stated whether a pollution exclusion was a proper addition to a tort liability policy issued through the Fund. Moreover, because other state regulations mentioned pollution exclusions for general liability policies, the Appellate Court found that the inclusion of such pollution exclusions is strong evidence that the legislature did not intend to preclude the use of such exclusions in policies issued under the Act. Accordingly, the Appellate Court held that the pollution exclusion at issue was valid.

The District next argued that the pollution exclusion was inapplicable because it did not mention offensive odors or explain why such odors should be considered pollution when they are not harmful and not regulated. The Appellate Court rejected these arguments, finding the pollution exclusion applicable because the odors at issue could properly be classified as “fumes” or “gases,” both of which were listed in the exclusion. Giving these words their plain and ordinary dictionary meaning, the Appellate Court found that the word “gas” is defined as “a substance that can be used to produce poisonous, asphyxiating, or irritant atmosphere” and “fume” is defined as “a smoke, vapor, or gas esp[ecially] when irritating or offensive.” Although the District argued that the odors must be harmful in some way to be considered pollutants, the Appellate Court declined to impose such a limitation on the plain language of the policy, finding that the fact that the odors were comprised of irritating and offensive gases satisfied the ordinary meaning of the pollution exclusion’s terminology. The Appellate Court also noted that its decision comported with several other jurisdictions holding that foul odors (e.g., compost facility, animal rendering plant, pig farm manure, and treatment plant) are encompassed by such pollution exclusions.

The District lastly argued that even if the pollution exclusion applied, the exception to the exclusion created coverage because the circumstances surrounding the release of the odors were unique and unexpected. The Appellate Court dismissed this argument, holding that the release of the odors were not accidental and unexpected. Based on the testimony, the Appellate Court found that the District’s knowledge that the pumps would turn on occasionally was sufficient to demonstrate that the releasing of the odors was not only expected, but a necessary, routine and expected function of the system.

California Appeals Court Rules that “Escape” “Other Insurance” Clause Contained in Coverage Portion of Primary CGL Policy Not Enforceable in Equitable Contribution Action

In Certain Underwriters at Lloyds, London v. Arch Specialty Insurance Co., a California appeals court held that an “other insurance” clause in a primary commercial general liability policy would not, as a matter of public policy, allow the insurer to avoid having to share defense costs.

Certain Underwriters at Lloyds, London (“Underwriters”) and Arch Specialty Insurance Company (“Arch”) were both primary insurers of Framecon, Inc. over successive policy years. Framecon was sued by a real estate developer for framing and carpentry work it performed on residential homes in three separate homeowner actions. Framecon tendered the claims to both Underwriters and Arch. Underwriters agreed to defend Framecon, while Arch denied any defense obligation based on the “other insurance” language contained in the insuring agreement and in the conditions section of its policy.

The underlying claims against Framecon were eventually settled with both Underwriters and Arch agreeing to indemnify Framecon for damages on a “time on the risk” basis. Underwriters then sued Arch for declaratory relief and equitable contribution for defense costs incurred in the underlying litigation. In cross-motions for summary judgment, Arch argued that its “other insurance” provisions relieved it of any duty to defend. The trial court found in favor of Arch, and relied on a prior California case which held that the placement of the “other insurance” clause in the insuring agreement of the policy, as opposed to in the conditions section, makes it an enforceable exception from coverage for defense costs rather than a disfavored “escape” clause.

On appeal, the Court of Appeal noted that the original purpose of “other insurance” clauses was to prevent multiple recovery by insureds in cases of overlapping policies providing coverage for the same loss, but that public policy disfavored “escape” clauses. The court explained that “escape” clauses are so named because they permit an insurer to make a seemingly ironclad guarantee of coverage, only to withdraw that coverage – and thus “escape” liability – in the presence of other insurance. The Court of Appeal rejected Arch’s argument that its “other insurance” clause was enforceable because it was located in both the insuring agreement and in the conditions section of the policy, and found that the “modern trend” is to distrust “escape” “other insurance” clauses that attempt to shift the burden away from a primary insurer. The court also stated that reliance on location of the “other insurance” clause in the coverage section as determinative “would tend to encourage insurers to jockey for best position in choosing where to locate ‘other insurance’ language, needlessly complicating the drafting of policies, inducing wasteful litigation among insurers, and delaying settlements – all ultimately to the detriment of the insurance-buying public.”

The Court of Appeal concluded that Underwriters was entitled to receive equitable contribution from Arch as the “other insurance” clause contained in Arch policy was not enforceable based on public policy considerations.

Georgia Supreme Court Denies Coverage for Lead-Based Paint Injuries Based on the Pollution Exclusion

In a matter of first impression, the Georgia Supreme Court recently held that personal injury claims arising from lead poisoning due to lead-based paint ingestion were excluded from coverage under an absolute pollution exclusion in a commercial general liability insurance policy covering residential rental property. The decision in Ga. Farm Bureau Mut. Ins. Co. v. Smith, S15G1177, 2016 Ga. LEXIS 245 (Ga. Mar. 21, 2016) is significant for insurers since it expressly rejects the notion that a pollution exclusion clause is limited to traditional environmental pollution.

The facts are straightforward.  Amy Smith (“Smith”), individually and as next friend of her daughter Tyasia Brown (“Brown”), sued her landlord, Bobby Chupp (“Chupp”), for injuries Brown allegedly sustained as a result of ingesting lead from deteriorating lead-based paint at the house Smith rented from Chupp. Georgia Farm Bureau Mutual Insurance Company (“GFB”) insured the house under a CGL policy issued to Chupp. Chupp tendered Smith’s claims to GFB, and the insurer filed a declaratory judgment action against Smith and Chupp seeking a determination that Brown’s injuries were not covered under the policy and that it had no duty do defend Chupp against Smith’s claims.

GFB contended, among other things, that Brown’s injuries from lead poisoning were excepted from coverage by the policy’s pollution exclusion, which defined “Pollution” as “‘[b]odily injury’ or ‘property damage’ arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of ‘pollutants’ . . . .” The policy defined “pollutant” as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”

In granting summary judgment to GFB, the trial court relied on the Georgia Supreme Court’s decision in Reed v. Auto-Owners Ins. Co., 284 Ga. 286 (2008), which addressed the proper construction of an identical pollution exclusion in a CGL policy insuring residential rental property wherein a tenant sued her landlord for carbon monoxide poisoning. Although not explicitly listed in the policy as a pollutant, the Reed Court held that carbon monoxide gas fell within the policy’s definition of a pollutant and concluded that all of the plaintiff’s injuries arising therefrom were excluded from coverage under the pollution exclusion.

On appeal, the Georgia Court of Appeals reversed the trial court’s grant of summary judgment to GFB.  The Court of Appeals observed that the specific issue of whether lead-based paint should be considered a “pollutant” under the pollution exclusion clause was one of first impression in Georgia, and noted that a conflict existed among other jurisdictions on this issue. The Court of Appeals sided with those foreign courts holding that a pollution exclusion similar to the instant one did not bar coverage for injuries arising out of the ingestion or inhalation of lead-based paint. The Court of Appeals rejected the trial court’s interpretation of Reed, finding that while a straightforward reading of the pollution exclusion in Reed compelled the conclusion that carbon monoxide gas was a pollutant, it was unclear whether identical language in the instant policy was expansive enough to unambiguously include lead, lead-based paint or paint as a pollutant.

In its analysis, the Georgia Supreme Court found that GFB’s CGL policy contained an absolute pollution exclusion that precludes recovery for bodily injury or property damage resulting from exposure to any pollutants. Overviewing the genesis and development of the absolute pollution exclusion, the Court highlighted the litany of Georgia decisions, including Reed, that have repeatedly applied such clauses outside the context of traditional environmental pollution. Further, the Court rejected the notion that the pollutant at issue must be explicitly named in the policy to be enforceable.

In reversing the Court of Appeals, the Georgia Supreme Court followed Reed and found that GFB’s CGL policy unambiguously governed the factual scenario. Simply put, the Court of Appeals failed to apply the plain language of the contract. Accordingly, the Georgia Supreme Court held that lead present in paint unambiguously qualifies as a pollutant and that the plain language of the policy’s pollution exclusion excluded Smith’s claims against Chupp from coverage.

*** On March 9, 2016, this author published a related blog article on a recent Vermont Supreme Court decision holding that the plain language interpretation of a pollution exclusion in a homeowner policy barred coverage for property damage to a home rendered uninhabitable by an over-application of a bed bug pesticide.

Fourth Circuit Requires CGL Insurer to Defend Data Breach Class Action

The increasing market for cyber insurance policies combined with the addition of cyber exclusions has cooled litigation over whether a cyber breach triggers coverage under a commercial general liability (CGL) policy and whether a CGL insurer owes a duty to defend litigation arising from a cyber breach. However, the expansion of cyber insurance and integration of cyber exclusions has not the stemmed litigation under older CGL policies, many of which do not include cyber exclusions. Earlier today, the Fourth Circuit Court of Appeals addressed cyber coverage under a traditional CGL policy in Portal Healthcare v. Travelers Indemnity Company, Case No. 14-1944.

Portal arose after plaintiffs filed a putative class action, alleging that Portal negligently failed to secure a server containing confidential records for patients at a hospital, thereby making the records available for anyone to view online without a password. The insured argued that Travelers owed a duty to defend that class action because the medical records company published, and therefore disclosed, confidential information, triggering the personal and advertising injury coverage provision in the CGL policy. Travelers disagreed, arguing that the failure to secure a server is not a publication. Publication, Travelers argued, requires the deliberate step of disseminating the records – which was not alleged.

The Fourth Circuit accepted the insured’s argument, with little explanation or analysis. Commending the district court for limiting its analysis to the complaint and policy, the court concluded that “the class-action complaint ‘at least potentially or arguably’ alleges a ‘publication’ of private medical information by Portal that constitutes conduct covered under the Policies.” The court did not explain why a failure to secure a private server satisfies the plain meaning of the word publication, but instead accepted the conclusion that the possibility of pubic access constitutes publication: “Such conduct, if proven, would have given ‘unreasonable publicity to, and disclose[d] information about, patients’ private lives,’ because any member of the public with an internet connection could have viewed the plaintiffs’ private medical records during the time the records were available online.”

Portal should have limited impact on modern CGL policies because the cyber exclusions therein resolve the question of whether there is a duty to defend cyber breach litigation. However, within the Fourth Circuit, Portal suggests that a CGL insurer should carefully review cyber-related claims. Portal should be limited to the unique facts underlying the claim (in that records were made publicly available), but the Court’s failure to provide a definition of publication leaves the scope of this decision open to discussion.

Wisconsin Supreme Court Rules That Inclusion of Defective Ingredient Does Not Constitute Property Damage

In Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., et al., 2016 Wisc. LEXIS 12 (March 1, 2016), the Wisconsin Supreme Court in a 3-2 decision determined that two insurers had no duty to cover claims related to damages caused by the inclusion of a defective ingredient in a probiotic supplement because the inclusion of the defective ingredient did not damage other property and did not result in loss of use of property.

Brief Factual Background

Wisconsin Pharmacal Co., LLC (“Pharmacal”) manufactured a chewable Daily Probiotic Feminine Supplement which contained various ingredients, including a probiotic bacterial species known as Lactobacillus rhamnosus (LRA). In July of 2008, Pharmacal contracted with Nutritional Manufacturing Services, LLC (“NMS”) to procure LRA and manufacture the tablets. NMS in turn contracted with Nebraska Cultures for the LRA, and Nebraska Cultures then bought the LRA from Jeneil. The problem, of course, was that Jeniel supplied NMS with the wrong bacteria.

NMS manufactured the tablet with the ingredient it believed to be LRA but discovered that it had used a different bacteria known as Lactobacillus acidophilus (LA). In April 2009, after Pharmacal packaged and supplied the supplement to its retailer, Pharmacal learned that the supplement contained LA instead of LRA. As a result, the retailer recalled the supplement and Pharmacal destroyed the tablets containing the defective ingredient. NMS assigned its causes of action against Nebraska Cultures and Jeneil to Pharmacal, which sued Nebraska Cultures and its general liability insurer, Evanston Insurance Co., as well as Jeneil and its general liability insurer, The Netherlands Insurance Co.

Analysis

The insurers filed motions for summary judgment, arguing that they did not owe coverage for the loss. The trial court concluded that the insurers had no duty to defend because the incorporation of a defective probiotic ingredient into the tablets did not constitute “property damage caused by an occurrence” because only the product itself was harmed. The intermediate appellate court reversed, concluding the policies provided coverage. The Wisconsin Supreme Court reversed the appeals court and determined that no coverage existed under the policies.

The Netherland’s CGL policy provided coverage for Jeneil’s losses that the “insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’…caused by an ‘occurrence.’” The policy defined property damage as “a) Physical injury to tangible property, including all resulting loss of use of that property. . . .; or (b) Loss of use of tangible property that is not physically injured.”

Evanston’s CGL policy similarly provided coverage for Nebraska Cultures’ losses arising out of “bodily injury” or “property damage” caused by an “occurrence.” The policy defined “property damage” as “physical injury to or destruction of tangible property including, consequential loss of use thereof; o[r] loss of use of tangible property which has not been physically injured or destroyed.”

No Property Damage

The majority determined that there was no property damage, because combining a defective ingredient with other ingredients and incorporating them into supplement tablets formed an “integrated system,” or unified whole. Therefore, the Court reasoned that the defective ingredient (LA), could not be separated from the other ingredients, and no damage resulted to property other than ingredients of the integrated system.  Because the injury was sustained by the integrated system itself, the resulting damage caused by LA’s inclusion in the tablet did not occur to other property.

The Court additionally noted that the defective ingredient rendered the tablets inadequate for their contracted purpose; however, the mere presence of a defective ingredient did not render them hazardous. For this reason, the Court concluded there was no property damage under the Evanston policy.

No Loss of Use

Similarly, the majority rejected the parties’ argument that the incorporation of a defective ingredient rendered the other ingredients and the supplement tablets totally useless to Pharmacal, thereby constituting property damage due to “loss of use of tangible property that is not physically injured.” The Court reiterated that a “diminution in value, even to the point of worthlessness” was not the same as “loss of use.” The Court rejected the insured’s argument and found that Pharmacal did not actually lose use of the tablets, but rather lost the value of the tablets. Thus, the Court held that there was no property damage due to “loss of use of tangible property that has not been physically injured.”

No Occurrence

The policies defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Although it was undisputed that Jeneil’s provision of the defective ingredient was accidental, the Court was not persuaded that the “accidental provision” of a defective ingredient, standing alone, satisfied the Netherlands policy’s definition of occurrence. Under Wisconsin’s American Girl case, the negligent conduct is not the occurrence, but it can cause an “occurrence,” which in turn causes property damage. Here, the provision of the defective ingredient did not cause an occurrence that led to property damage. In other words, the defective ingredient did not cause other property to malfunction or a third party to get sick, so the provision of the defective ingredient alone was not an occurrence.

The Court applied California law to the Evanston policy and followed a line of cases finding that deliberate conduct cannot be an occurrence even if the insured did not intend to cause the injury. So although Jeneil’s provision of a defective ingredient may have been negligent, Jeneil deliberately supplied the ingredient to Nebraska Cultures and intended the ingredient to be incorporated into the tablets. Given the deliberate nature of these actions, the Court found that the provision of a defective ingredient cannot be said to constitute an “occurrence” under California law.

In a dissenting opinion, Justice Shirley S. Abrahamson she disagreed with the majority opinion’s “unwise and unprecedented” application of the integrated system rule, which originates in the economic loss doctrine, to the interpretation of insurance policies. Justice Abrahamson, who was joined in the dissent by Justice Ann Walsh Bradley, compared the application of the economic loss doctrine to the alien creature in the classic science fiction film “The Blob,” noting the doctrine was often incoherent. Justice Abrahamson criticized the majority’s decision for infusing the economic loss doctrine, a tort principle, into insurance policy interpretation. Justice Abrahamson feared that the majority’s approach departed from a reviewing Court’s normal duty of strictly interpreting the plain language of the subject insurance policy.

This decision is available here.

Alaska Supreme Court Rules that Insurer Have No Right to Reimbursement of Defense Fees and Costs

For many years, the prevailing view of Alaska law was that an insurer could obtain reimbursement of defense costs from an insured if it specifically reserved the right to seek reimbursement and subsequently obtained a determination of no coverage. This understanding was based on Unionamerica Inc. Co., Ltd. v. General Star Indem. Co., 2005 WL 757386 (D. Alaska 2005), in which the Alaska federal district court predicted that the Alaska Supreme Court would allow insurers to recover defense costs. It turns out, however, that the district court’s prediction was incorrect.

In Attorneys Liability Protection Society, Inc. v. Ingaldson Fitzgerald, P.C., No. 7095 (March 25, 2016), the Alaska Supreme Court ruled that a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending under a reservation of rights is unenforceable, even if (1) the insurer explicitly reserves the right to seek reimbursement in its offer to provide a defense by an independent counsel, (2) the insured accepts the defense subject to the reservation of rights, and (3) the claims are subsequently determined to be excluded from coverage under the policy.

Attorneys Liability Protection Society, Inc. (“ALPS”) issued a malpractice insurance policy to Ingaldson & Fitzgerald, P.C. (“IF”) from April 29, 2007 to April 29, 2008. The policy contained a provision that entitled ALPS to seek reimbursement for amounts paid by ALPS in defending non-covered claims.

During the policy period, IF reported to ALPS a lawsuit against it alleging, among other things, restitution, disgorgement, and conversion for recovery of a retainer that had been paid to IF. ALPS accepted IF’s tender but reserved rights because the policy excluded coverage for claims arising from conversion or fee disputes. ALPS retained independent counsel to defend IF and paid all defense costs in full, as required by AS 21.96.100.

In the underlying case, summary judgment was rendered against IF on claims of restitution, disgorgement and conversion, all of which were specifically excluded under the malpractice policy. Thereafter, ALPS commenced a declaratory judgment action against IF and moved for partial summary judgment on the reimbursement of defense costs issue. In denying the motion, the district court declined to follow the Unionamerica case and held that Alaska law prohibits the inclusion of a right to reimbursement in insurance policies under AS 21.89.100(d), which states, in part, that in providing independent counsel, an insurer “shall be responsible only for the fees and costs to defend those allegations for which the insurer either reserves its position as to coverage or accepts coverage.”

ALPS appealed to the Ninth Circuit Court of Appeals. The Ninth Circuit noted that while AS 21.96.100(d) requires the insurer to pay defense costs if it either covers the claims against its insured or defends pursuant to a reservation of rights, the statute is not clear as to whether the insurer can later seek reimbursement of fees assumed under a reservation of rights under these circumstances. Therefore, the Ninth Circuit certified two questions to the Alaska Supreme Court:

  1. Does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) the claims are later determined to be excluded from coverage under the policy?
  2. If the answer to Question 1 is “Yes,” does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) it is later determined that the duty to defend never arose under the policy because there was no possibility of coverage?

In answering both questions with “YES,” the Alaska Supreme Court ruled that AS 21.96.100 renders any defense costs reimbursement provisions in insurance policies unenforceable.

The Alaska Supreme Court first acknowledged that under Alaska case law, an insured has a right to demand an unconditional defense. To meet this right, the insurer has three options: (1) affirm the policy and defend unconditionally; (2) repudiate the policy and withdraw from the defense; or (3) offer its insured the right to retain independent counsel to conduct the defense and agree to pay all the necessary costs of that defense. CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113 (1993); Continental Ins. Co. v. Bayless & Roberts, Inc., 608 P.2d 281 (1980). The Court continued that AS 21.96.100 is the codification of such requirements.

In examining the statutory text, the Alaska Supreme Court noted that the subsections (a) through (d) focus on the mandatory requirement that insurers pay for the cost of independent counsel. The Court noted that the statute clearly allocates to the insurer the responsibility to pay the fees and costs when an insurer provides independent counsel to the insured. Therefore, any effort to shift such expenses to an insured would violate the allocation that the statute requires and would be invalid. In short, there is nothing in AS 21.96.100 that permits reimbursement, so the Court concluded that the statutory scheme prohibits reimbursement. The Court held that “reimbursement is prohibited, and because there is no evidence of contrary legislative purpose or intent, we conclude that the statute prohibits reimbursement provisions.”

In ruling that reimbursement provisions are unenforceable, the Alaska Supreme Court declined to follow the California case of Buss v. Superior Court, 939 P.2d 766 (1997). First, the Court noted that the California statute does not contain language similar to that in AS 21.96.100(d). Second, the California statute actually provides a section on reimbursement, which states that “[t]his subdivision does not invalidate other different or additional policy provisions pertaining to attorney’s fees or providing for methods of settlement of disputes concerning those fees.”

The Court further noted that the legislative history supports its conclusion that the statute allocates responsibility to pay for independent counsel to the insurer when the insurer defends under a reservation of rights. Finally, the Court acknowledged that even though the Division of Insurance had approved the policies containing the reimbursement provision, the Division’s past practice is not dispositive. More importantly, however, the Division had disavowed its past practice in its amicus brief with a more “considered interpretation” that “under AS 21.96.100, if an insurer has a duty to defend and elects to reserve its rights on an issue, it is obligated to provide and pay for independent counsel.”

So insurers beware – reimbursement of defense costs provisions are prohibited and unenforceable in Alaska.

Exterminating Coverage Under a Pes[t]y Pollution Exclusion: Vermont Supreme Court Denies Coverage for Pesticide Contamination

The Vermont Supreme Court recently held that the plain language interpretation of a pollution exclusion in a homeowner policy barred coverage for property damage to a home rendered uninhabitable by an over-application of a bed bug pesticide. The decision in Whitney v. Vt. Mut. Ins. Co., 2015 VT 140 (2015) is significant for insurance carriers because it restates the principle that pollution exclusions are not limited to traditional environmental pollution.

The facts are straightforward. A pest control company sprayed plaintiffs’ home, “corner to corner” and “wall to wall” with the pesticide chlorpyrifos to eradicate bed bugs. Notably, and very much relevant to the court’s analysis of the pollution exclusion, chlorpyrifos is not labelled for residential use and the spraying of the plaintiffs’ home with chlorpyrifos violated federal and state law. The homeowners complained to a state agency that the amount of chemicals sprayed in their home, which included walls and surfaces visibly dripping with the pesticide, was grossly excessive. After testing confirmed elevated pesticide levels, the plaintiffs were evacuated from the home for safety reasons.

Shortly after the testing was performed, the plaintiffs filed a claim with the defendant-insurer. Coverage A of the policy insured against a “physical loss to property.” Among the exclusions to coverage in Coverage A was a pollution exclusion, which stated that the policy did not insure loss caused by:

Discharge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself caused by a Peril Insured Against under Coverage C of this policy. Pollutants means any solid, liquid, gaseous, or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

The defendant-insurer denied the plaintiffs’ claim under the absolute pollution exclusion. Plaintiffs thereafter filed suit seeking a declaratory judgment that the losses incurred by the spraying of chlorpyrifos within their home were covered by the homeowners policy. On cross motions for summary judgment, the trial court ruled in plaintiffs’ favor, reasoning that the terms “pollution” and “discharge, dispersal, release, and escape” were ambiguous and therefore must be construed in favor of coverage. The trial court relied on the California Supreme Court decision of McKinnon v. Truck Ins. Exchange, 31 Cal. 4th 635 (Cal. 2003), which held that pollution exclusion clauses are generally ambiguous and therefore apply only to traditional environmental contamination.

On appeal, the issue was whether the pollution exclusion barred coverage for the loss of their home due to the spraying of chlorpyrifos inside the dwelling. The court began its analysis by relying on its then recently filed Cincinnati decision, wherein it enforced an unambiguous pollution exclusion in a commercial general liability policy. In Cincinnati, the court reviewed the evolution of the pollution exclusion clauses in the insurance industry and discussed the leading cases construing those clauses. The court considered two divergent lines of cases construing these clauses. In one, following the California Supreme Court in MacKinnon, courts have construed pollution exclusions very narrowly, concluding that they are inherently ambiguous, and that the purpose of the exclusions was to address liability arising from traditional environmental pollution, and not ordinary acts of negligence involving harmful substances. In the other, courts have concluded that by their plain language, pollution exclusion clauses exclude all injuries caused by pollutants.

The court stated that the “main lesson of Cincinnati . . . is that pollution exclusions are not presumed, as a class, to be ambiguous or to be limited in their application to traditional environmental pollution. They should be construed in the same as any other insurance contract provisions” to ascertain and carry out the parties’ intentions by looking at the plain language of the policy. Examining the policy language, the Vermont Supreme Court determined that the pollution exclusion excluded coverage for the pesticide contamination insofar as the spraying of chlorpyrifos constituted a “discharge, dispersal, seepage, immigration, release, or escape” of the pesticide.

The key issue was whether chlorpyrifos qualified as a “contaminant” or “irritant” to fall within the definition of “pollutant.”  The court quickly answered the question, relying on the undisputed facts that chlorpyrifos may be toxic to humans, can cause nausea, dizziness, confusion, and at very high exposures, respiratory paralysis and death, and is banned for residential use. The pesticide applicator’s use of chlorpyrifos in plaintiffs’ home violated EPA regulations, and federal and state law. The concentration levels in the plaintiffs’ home were consistently higher than EPA action levels, thereby preventing plaintiffs from inhabiting their house. Accordingly, the court concluded, in reversing the trial court, that the terms “irritant,” “contaminant,” and “pollutant” plainly and unambiguously encompassed the chlorpyrifos sprayed “corner to corner” and “wall to wall” throughout the plaintiffs’ home.

Doctrine of Superior Equities Does Not Bar Assignment of Claim against Insurance Broker

In a recent decision from the Fifth District Court of Appeal, the court held that a negligence cause of action against an insurance broker could be assigned to a third party, including the insurer of an injured party. In AMCO Insurance Company v. All Solutions Insurance Agency, LLC, 16 C.D.O.S. 1521, two separate lawsuits were filed against Amarjit Singh (“Singh”) in connection with a fire caused by Singh’s negligence. Hideo Ogawa and Myong Echols (collectively, “Ogawa”) owned a restaurant that was damaged by the fire. David Saari (“Saari”) owned commercial property that was damaged by the fire. AMCO Insurance Company (“AMCO”) was the commercial property insurer for Saari and paid $371,326 to Saari for damages caused by the fire. AMCO then brought a subrogation action against Singh. Ogawa also brought suit against Singh for losses caused by the fire. Singh tendered the claims to his insurance company but the claims were denied because there was no policy in effect on the date of the fire as a result of the negligence of Singh’s insurance broker, All Solutions Insurance Agency, Inc. (“All Solutions”). Subsequently, Singh entered into stipulated judgments with AMCO and Ogawa and assigned his claims against All Solutions to AMCO and Ogawa.

AMCO and Ogawa as assignees of Singh filed suit against All Solutions. The trial court granted summary judgment to All Solutions holding that Singh’s claim for broker negligence against All Solutions was not assignable. In addition, the trial court held that AMCO and Ogawa’s claims were precluded by the rule of superior equities.

The Court of Appeal noted that the general rule in California favors the assignability of tort causes of action. However, there are exceptions for causes of action for wrongs done to the person, the reputation or feelings of the injured party. Other exceptions include legal malpractice based upon the highly personal and confidential relationship between an attorney and client. All Solutions argued that the same reasons for prohibiting assignment of legal malpractice claims were equally applicable to insurance malpractice claims. However, the Court of Appeal rejected this argument stating that the communications between an insurance broker and client are not privileged or confidential and because of the standardized nature of insurance policies, the product delivered by the insurance broker to the client is not highly unique or personal.

The Court of Appeal also held that AMCO and Ogawa’s claims were not barred by equitable subrogation principles or the doctrine of superior equities. Equitable subrogation refers to the transfer of rights against a third party that arises in equity and occurs only by operation of law because a party (i.e., the subrogee) has paid a loss of another (i.e., the subrogor). The most common equitable subrogation action is one brought by an insurer against a wrongdoer who caused the loss paid by the insurer. In these instances, the doctrine of superior equities has developed based on the idea that an insurer who has been compensated (by receipt of premiums) for issuing a policy should not be allowed to shift the very loss contemplated by the policy to an innocent party. An insurer pursuing a claim for equitable subrogation must demonstrate that it is not attempting to shift the loss to an innocent party. California does not recognize a difference between equitable subrogation and conventional (i.e. contractual subrogation). Accordingly, even a contractual assignment to an insurer from its insured is subject to the doctrine of superior equities. All Solutions contended that the doctrine of superior equities limited the contractual assignments because it was Singh, and not All Solutions, who caused the fire.

With regards to Ogawa, the Court of Appeal held that the doctrine of superior equities did not apply because Ogawa was not a surety (i.e., an insurer). The Court of Appeal also found that AMCO was not subject to the doctrine of superior equities because it did not have a subrogee-subrogor (i.e., insurer-insured) relationship with Singh who had caused the fire. Rather, AMCO insured Saari who had been damaged by Singh. The doctrine of superior equities would have precluded the contractual assignment to AMCO if AMCO had insured Singh. However, AMCO’s insured was Saari and AMCO pursued its equitable subrogation claim against Singh for payments AMCO made to Saari. Accordingly, the doctrine of superior equities did not apply.

Finally, the Court of Appeal held that even if the doctrine of superior equities did apply, All Solutions had not demonstrated through material facts that its equitable position was equal or superior to AMCO. The Court of Appeal criticized the separate statement of undisputed material facts that All Solutions had submitted in support of summary judgment. No facts were introduced demonstrating how the fire losses would have been allocated if All Solutions had obtained the proper insurance for Singh. As a result, the Court of Appeal was unable to determine how the unobtained coverage would have related to coverage provided by AMCO. Accordingly, All Solutions did not demonstrate that its equitable position was equal or superior to AMCO’s equitable position. The Court of Appeal reversed the trial court granting All Solutions’ motions for summary judgment.

Click here for the opinion.

This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority in California state courts.

Florida’s Approach to the Assignability of Post-Loss Benefits

Background

In Bioscience West, Inc. v. Gulfstream Prop. & Cas. Ins. Co., No. 2D14-3946, 2016 WL 455723 (Fla. 2d DCA Feb. 5, 2016), the Second District Court of Appeal affirmed the rule in Florida that insureds may, without the insurer’s consent, assign post-loss benefits of an insurance policy to a third party, whether or not the insurance policy contractually prohibits assignment of the policy.

The facts are simple enough: The insured, Elaine Gattus, purchased homeowner’s insurance from Gulfstream Property and Casualty Insurance Company. After executing the policy, Gattus’ property suffered water damage. She then engaged plaintiff Bioscience West to perform “emergency water and removal construction services.” Rather than directly compensating Bioscience West for its services, Gattus assigned the contractor her benefits due under the policy without Gulfstream’s knowledge or consent.

Gulfstream denied coverage, leading Bioscience West to file suit for breach of contract. Gulfstream successfully moved for summary judgment. The circuit court noted the policy’s express language prohibiting the insured from transferring “this policy” to a third party without Gulfstream’s written consent. Bioscience West appealed to the Second District Court of Appeal.

On appeal, Bioscience West’s principle contention was that although the entire policy cannot be assigned absent Gulfstream’s consent, there is no such prohibition for the assignment of a “benefit derived from the policy” once it has accrued. The appellate court agreed with Bioscience West’s position that notwithstanding the policy’s valid prohibition on assignment of the entire policy, the policy as written did not have the effect of prohibiting the post-loss assignment of the right to receive benefits under the policy. In so doing, the court drew the distinction between assignment of the entire policy versus a right thereunder.

It was on these grounds that the Court was able to dispose of the primary issue on appeal, but it nonetheless went on to explain that even if there was language in the policy restricting such an assignment, such language would be of no moment because “Florida case law yields deep rooted support for the conclusion that post-loss assignments do not require an insurer’s consent.”

Other Districts

Relying on the 1918 Florida Supreme Court case W. Fla. Grocery Co. v. Teutona Fire Ins. Co., 77 So. 209 (1918),the First, Second, Third, Fourth, and Fifth districts all follow the rule forwarded by Bioscience West that, although an insurance provider may contractually prohibit or limit outright assignment of an entire insurance policy, post-loss insurance claims are freely assignable, whether or not the insurer consents. Federal courts in Florida have also adopted without exception and alteration the Florida Supreme Court and the five districts’ approach to post-loss assignments of benefits derived from an insurance policy.

Analysis & Implications

At first blush, the assignment of post-loss rights may seem as though it is all pain and no gain for insurers, when there may, in fact, be some benefit. For example, in a case where a plumbing leak, if not swiftly repaired, would lead to substantial damage, the ability to assign a claim could encourage insureds to take prompt action to repair, thereby mitigating damages. In this regard, the Second District concluded that “it is imprudent to place insured parties of the untenable position of waiting for the insurance company to assess damages any time a loss occurs” and that the exigencies of the situation typically render the “unexpected loss event [ ] a time-sensitive procedure” aided by the flexibility afforded under post-loss assignments.

There is, however, a caveat to such post-loss assignments in cases where coverage for a particular incident is disputed. When coverage is disputed, such assignments are inherently prone to the risk that insurers may be sued by assignees of post-loss benefits for breaching the insurance policy when, in reality, there may be no coverage for the loss in the first place. As was the case in Bioscience, the assignor-insured and assignee-contractor executed a general release, thereby precluding an action by the assignee against the assignor for the fees of its work, and will likely contain a waiver of the assignee-contractor’s right to pursue payment via a mechanic’s lien on the repaired property. Thus, even if a claim is clearly beyond the scope of a policy’s coverage, such assignees have an incentive to institute litigation to collect under the policy, even in doubtful circumstances. Meanwhile, the insured is provided with the potential windfall of cost-free repairs for property damage that otherwise would have not been covered under the policy. Rather than venture into a thicket of weighing competing interests, the court in conclusion explained that it is “mindful that there are competing policy considerations here” but declined to address them as such “considerations are for the legislature to decide, not our court.”

Hello, Kitty! Can You Smell That Smell? It’s a Covered Loss!

*Republished with permission of the Insurance Coverage Law Bulletin and Connecticut Law Tribune.

The New Hampshire Supreme Court’s recent decision in Mellin v. N. Sec. Ins. Co., 115 A.3d 799, 2015 N.H. LEXIS 32 (N.H. 2015), is getting some attention, and not just because it’s fun to talk about cat pee. The case sets a very important precedent regarding the definition of the term “physical loss” and the construction of pollution exclusions in New Hampshire property insurance policies. It is a decision that is likely going to create uncertainty and increased risk for insurers going forward. The scent-illuminating subject matter is just an added bonus.

1-26The facts started out simply enough. The plaintiffs owned a condominium unit, and their downstairs neighbor had two feline cohabitants. The plaintiffs leased their unit to a tenant in 2009 and 2010, and that tenant was the first person to notice that something didn’t smell right. In November 2010, the tenant decided that he would rather find a new place to live than continue to put up with the noxious odors emanating from below. Undeterred, the plaintiffs moved in themselves and promptly filed an insurance claim under their homeowner’s policy. That claim was denied.

In a continued attempt to take control of the odiferous situation, the plaintiffs contacted the local building and health inspector. After examining the unit, the inspector advised, by way of a letter dated Dec. 22, 2010, that the plaintiffs had “a health problem existing,” and the odor was such that they needed “to move out of the apartment temporarily and have a company terminate the odor.” Unfortunately, remediation efforts were no match for the persistent and pervasive smell of cat urine. The plaintiffs apparently steeled themselves, presumably invested in some scented candles or at least a large can of air freshener, and moved back into the condo until Feb. 1, 2011. At that point, the plaintiffs sold the unit after determining that they could no longer lease it to tenants. Unsurprisingly, they asserted that “the sale price for the unit was significantly less than that for a comparable condominium in the area which was unaffected by cat urine odor.”

In light of this loss and the denial of their claim by the homeowner’s insurer, Northern Security Insurance Company, Inc. (“Northern Security”), the plaintiffs ultimately brought suit, seeking a declaration that they were entitled to coverage for a “direct physical loss” to the unit, namely odor from cat urine. Northern Security moved for summary judgment on the grounds that the smell did not constitute a “physical loss,” and that the claim was barred by the policy’s pollution exclusion.

The trial court ruled in the insurer’s favor, and the plaintiffs appealed. The Supreme Court of New Hampshire began by reciting familiar principles of insurance contract construction: terms shall be accorded their plain meaning; the burden of proof rests with the insurer in a declaratory judgment action; and ambiguities must be construed in favor of coverage.

Are Noxious Odors a ‘Physical Loss’?

The first issue on appeal was whether the trial court erred in holding that the term “physical loss” required a “tangible physical alteration” of the unit, and that the continuous and noxious wafting of cat urine odor did not constitute such a tangible ­physical ­alteration. In addressing this issue, the court noted that the term “physical loss” was undefined in the plaintiffs’ policy, and cited the sixth edition of the Shorter Oxford English Dictionary for the definition of “physical”: “[o]f or pertaining to matter, or the world as perceived by the senses; material as [opposed] to mental or spiritual.” Based on that definition, the court concluded that the term “physical loss” need not be read to include only tangible changes to the property that can be seen or touched, but can also encompass changes that are perceived by the sense of smell.

Turning to case law, the court first recognized that some jurisdictions, like Michigan, have adopted a definition of “physical loss” that is, in fact, restricted to “tangible” changes. In support of its conclusion, however, the court went on to note “a substantial body of case law in which a variety of contaminating conditions, including odors, have been held to constitute a physical loss to property.” Here, the court cited cases from several jurisdictions that, in its view, support a more liberal interpretation of “physical loss.” Among those cases, the court cited decisions from Connecticut (asbestos and lead contamination was physical loss), New Jersey (ammonia release), and Colorado (gasoline vapors).

While the insurer urged the court to follow its own prior definition of the term “physical injury,” the court refused because the case relied upon by Northern Security, Webster v. Acadia Insurance Company, 156 N.H. 317 (2007), turned on the interpretation of the term “property damage” contained in Coverage E, pertaining to personal liability. While the Mellins’ homeowner’s policy contained that same definition, the personal liability coverage part of that policy was not at issue. Simply put, the Mellins’ claim was one for first-party, not third-party, coverage, and was thus distinguishable from Webster.

In ultimately rejecting the trial court’s holding that “physical loss” required “tangible changes,” the New Hampshire Supreme Court articulated the standard that “physical loss” ­requires only a “distinct and demonstrable alteration to the unit” not limited to structural changes and including changes perceived by smell. Interestingly, the trial court’s holding gave effect to the “physical” component of the term “physical loss” by including an ostensible synonym — “tangible” — in its standard of interpretation, while the court did not. Rather than deciding the coverage issue however, the court instead remanded the case to the trial court to apply the newly articulated standard for “physical loss.”

Is the Noxious Odor of Cat Urine Excluded By the ‘Pollution’ Exclusion?

The court next considered the issue of whether the policy’s pollution exclusion would allow Northern Security to relieve itself of its coverage obligation. The operative exclusion disclaimed coverage for “pollutants,” which were defined, in pertinent part, as: “any … irritant or contaminant, including … vapor … [and] fumes.” You may have read that definition, looked at the legal standard above that states that terms must be accorded their plain meaning, and assumed that this second issue would be easily resolved in the insurer’s favor. If so, you would be wrong.

The court began by stating that this definition did not render the term “pollutant” unambiguous. The terms “irritant” and “contaminant” were impugned as “virtually boundless, for there is no substance or chemical in existence that would not irritate or damage some person or property.” As such the definitional phrase “any … irritant or contaminant” was held to be too broad to meaningfully define “pollutant.” Further, the court was persuaded that because other courts have construed similarly worded pollution exclusions in different ways, this meant that the exclusion was ambiguous.

Curiously, nowhere in the court’s analysis did it consider the Oxford definition of the word “fumes”: “Gas, smoke or vapor that smells strongly or is dangerous to inhale; a pungent odor of a particular thing or substance.” It would appear that the latter portion of this definition would end the inquiry, since the smell of cat urine is quite plainly “a pungent odor of a particular thing or substance.” Yet, the court did not engage in this analysis.

Instead, the court held that the policy’s invocation of “vapor” and “fumes,” among other terms, “brings to mind products or byproducts of industrial production that may cause environmental pollution or contamination.” As such, the court held that a reasonable policyholder would not expect these terms to exclude damage resulting from everyday activities gone awry. The court concluded its analysis by construing the ambiguous term “pollutants” in favor of coverage, and holding that the exclusion did not serve to preclude coverage.

In a stinging dissent, Justice Robert J. Lynn harshly criticized the majority’s holding that the pollution exclusion did not apply. Justice Lynn reasoned that “[t]he cat urine at issue in this case fits squarely within the plain and ordinary meaning of contaminant, and is thus a pollutant as defined in the pollution exclusion clause.” He pointed out that the breadth of the exclusion does not mean that it eluded definition and was rendered ambiguous, and further urged that it is ambiguity, not over-breadth, that provides the court with a license to look beyond the plain meaning of the policy. He went so far as to call the majority’s approach “dubious” in following a case that was focused on the historical genesis of environmental pollution exclusions rather than focusing on the plain meanings of the terms at issue. Justice Lynn pointed out that “when a policy’s meaning and intent are clear, it is not the prerogative of the courts to create ambiguities where none exist or rewrite the contract in attempting to avoid harsh results.” He concluded by stating that if the pollution exclusion was overly broad, the remedy must be provided by the open market or the legislature, and not through “creative judicial construction of clear policy language.”

Looking Ahead

All kittens aside, the Mellin decision is bound to leave a physical mark on first-party coverage suits involving “property damage” claims. New Hampshire insurers are going to have a hard time figuring out what isn’t covered as a “physical loss.” The new standard that any “distinct and demonstrable alteration of the unit” could constitute a “physical loss” exposes insurers to endless possibilities of property damage. Since the irremediable stench of cat urine emanating from an adjacent property can satisfy this standard, there is no telling what other odors may satisfy the standard as well. The smell of garbage, sewage, fertilizer, or farm animals kept at a nearby property could potentially trigger coverage, not just for homeowners, but for businesses as well. Likewise, a restaurant moving into the neighborhood and filling the air with the fragrance of faraway spices and fry-a-lator oil might be a covered loss, not otherwise excluded by the pollution exclusion. Looking beyond smells, it stands to reason that an increase or decrease in the amount of sunlight an insured property receives could cause a “distinct and demonstrable change.” Now that there is no requirement of a “tangible” loss, the barn door seems to be wide open for new and creative claims.

Second, it is not clear what language insurers could include in their policies, short of adding increasingly specific language, which would persuasively exclude claims of this type. On its face, it would seem that an exclusion referring to “fumes” would serve to exclude a claim based on urine smells. Yet this is obviously not the case, at least in New Hampshire, and potentially not in any state recognizing the reasonable expectation of the insured over the plain language of the policy. For insureds, on the other hand, it may be viewed as the cat’s whiskers — at least until premiums catch up to the risk.

Conclusion

In sum, the facts of the Mellin case may seem trivial, but the holding is significant as it has far-ranging repercussions for property insurance in New Hampshire and beyond.