Real Estate Reporter, Spring 2006
Insurance Coverage 101:
Getting Covered and Getting Paid: What Every Real Estate Litigant Needs to Know About the World of Insurance Coverage
By Lauren J. Katunich
While many liability policies are designed to cover only a specific class of activities or risks (e.g., automobile liability insurance, directors and officers liability insurance, etc.), in the world of construction defect litigation and the like, Commercial General Liability policies ("CGL") are king. Generally speaking, CGL policies provide that the insurer "will pay those sums that the insured becomes legally obligated to pay as damages because of 'bodily injury' or 'property damage' . . . caused by an 'occurrence' . . . during the policy period." Sounds straightforward. Think again.
What is the Insurer "Legally Obligated" to Pay?
The insurer's obligation to pay "those sums that the insured becomes legally obligated to pay" is the subject of much debate and interpretation. This is because most courts hold that the duty to defend an insured from a claim is extremely broad, the duty to indemnify an insured from a claim is not on similarly strong ground. The duty to defend arises where there is some claim which, if the allegations in the plaintiff's complaint are true, would even potentially provide a basis for coverage. That is to say, courts have held that the insurer's duty to defend it excused only in those circumstances where the "third party complaint can by no conceivable theory raise a single issue which could bring it within policy coverage." As such, it logically follows that the duty to defend includes the duty to defend false, fraudulent and groundless claims, as well as allegations of intentional or willful conduct.
The wide-sweeping duty to defend does not necessarily equate to an insurer's obligation to pay the judgment should one ultimately be rendered in the case. Unlike the duty to defend, the duty to indemnify is much more narrow and is triggered by the actual for example, a construction defect case where plaintiff falls through the floor in her brand-new home and is seriously injured. In all likelihood, the foregoing events would constitute both "bodily injury" and "property damage" as required to implicate the terms of the defendant contractor's CGL policy. Plaintiff pleads two causes of action in her complaint. First, plaintiff alleges negligence on the part of the builder. Second, plaintiff alleges that the contractor fraudulently induced her to purchase the home by various false misrepresentations as to the quality of the home. In such a case, once the claim is tendered to the insurer, the insurer is under a duty to defend because, though the fraudulent inducement is not covered, the negligence aspect of the case clearly is covered. If, at the close of trial, the jury finds that there was no negligence (unlikely given the facts, but let's just assume), but that the contractor is guilty of fraud, the insurer is under no duty to indemnify.
There is one caveat that provides a sigh of relief for most contractors facing claims that could conceivably be both tort and/or breach-of-contract. Take the example above where the plaintiff falls through the floor in her home. This time, however, instead of her causes of action for negligence and fraud, plaintiff pleads only a breach-of-contract cause of action. Realistically speaking, plaintiff's negligence cause of action in the first scenario and plaintiff's breach-of-contract cause of action in the second scenario arise from the precise same set of factual circumstances. Nevertheless, for years, courts have reached conflicting opinions as to whether or not CGL policies covered claims of contract as opposed to claims of tort. In 1999, this distinction was finally determined by the California Supreme Court in Vandenberg v. Superior Ct., 12 Cal. 4th 815. There, the court elevated substance over form, rejecting the distinction between breach-of-contract and tort, and instead focused on whether there has been an occurrence resulting in property damage, regardless of the cause of action pled. While the all-important issue of whether contractually mandated costs to repair property damage caused by an occurrence are covered under a CGL policy was not resolved in Vandenberg, the case did, at the very least, provide insureds some protection in the form-versus-substance debate.
At What Point in Time is the Insurer's Legal Obligation to Defend Triggered?
At what point in time an insurer's legal obligation to defend is triggered is often dependent on the precise wording of the policy. While some CGL policies require that the insurer defend "any suit against the insured," others provide that the insurer defend any "claims against the insured." While seemingly a matter of semantics, the distinction between "suit" and "claim" is not without significant legal consequence. Prior to 1998, irrespective of the precise policy language used, most insurers and insureds simply assumed that the obligation to defend arose even prior to the initiation of a formal lawsuit, such as when a demand letter was sent or when the matter went to voluntary pre-litigation mediation. This assumption was forever changed following the California Supreme Court's decision in 1998 in Forster-Gardner, Inc. v. Nat'l Union Fire Ins. Co., 18 Cal. 4th 857. In Forster, the Court held that the word "suit" meant civil litigation commenced by the filing of a complaint in court. Anything short of formal litigation was merely a "claim." Given the policy language at issue in the case, the insurer was under no obligation to defend where formal civil litigation had not been commenced.
In a post-Forster world one may think that most insurers will not defend or indemnify unless a lawsuit has formally been filed (assuming that the policy language uses the "suit" terminology). This is not necessarily the case. In the construction context, even if a formal lawsuit has not been filed, but the contractor is aware of the existence of the claim, it is always prudent to immediately notify the CGL insurer of the loss and give it the opportunity to investigate. If from the demand letter it appears inevitable that a lawsuit will be filed and that there is clear liability, it behooves the insurer to pay the claim up front prior to incurring additional expense. Where the potential plaintiff has not yet filed an action seeking damages against the insured and there is possible exposure, the insured should attempt to persuade its insurer that its damages are legitimate in amount and that the potential plaintiff is looking to the insured for payment. To accomplish this goal, it may be necessary for the insured to persuade the potential plaintiff to make a formal and detailed demand or, although seemingly counterintuitive, convince the potential plaintiff simply to file suit.
In What Time Period Must the "Occurrence" Occur in Order to Trigger the CGL Policy?
The majority of all CGL policies are either "claimsbased" or "occurrence-based." The two very different policy types depend on two distinct periods of time to determine coverage under the policy. As a general rule, claims-based policies cover claims made during the policy period irrespective of when the injury or damage giving rise to the claim occurred. That is to say, even if an injury or damage is sustained during the policy period, but a claim is not made until after the expiration thereof, the insurer is under no obligation to defend or indemnify. Because of the certainty that comes with claims-based policies, most insurers prefer these types of policies and price the policies accordingly. Those who employ the services of a construction contractor do not favor claims-based liability insurance. The reason is that often those who purchase claims-based policies do not purchase the optional supplemental extended reporting period (ERP), more commonly referred to as tail coverage. As a result, once the project is completed, the insurer's duty to defend and/or indemnify ends. If dealing with a contractor without the financial ability to pay, this often means that potential litigants are left holding the bag.
On the other hand, occurrence-based policies do not focus on when the lawsuit was filed or demand letter sent, but rather when the injury "occurred." If the injury occurred during the policy period but a demand was not made until after the policy had expired, the claim would nevertheless be covered. As previously stated, those who employ the services of a contractor are generally wary of claims-based policies and prefer occurrence-based policies. The reason for this preference is clear: often latent construction defects do not show themselves for years and occurrence-based policies provide almost infinite prospective coverage. Although it is often more expensive, contractors are usually advised (and in some cases contractually obligated) to maintain an occurrence-based policy for as many years as necessary to cover the statute of limitations on foreseeable claims.
If you have any questions regarding this bulletin, please contact Barry J. MacNaughton, Esq., Editor of this publication, at 310.281.6342 or bmacnaughton@ecjlaw.com, or Lauren J. Katunich, Esq. at 310.281.6370 or lkatunich@ecjlaw.com. If one of your colleagues would like to be a part of the Real Estate Reporter mailing list, or if you would like to receive copies electronically, please contact Cynthia S. Kaiser at 310.281.6328 or ckaiser@ecjlaw.
