Indemnity Obligations of Insurers in a California Construction Defect Case

In Community Redevelopment Agency v. Aetna Casualty & Surety Co. (1996) 50 Cal.App.4th 329, the court considered the indemnity obligations of primary and excess insurers in the context of a complex construction defect case.

The insured was a developer who filled a redevelopment area on which it constructed residential housing developments.

The fills and building pads were defectively designed and engineered, causing excessive subsidence and damage to the developments between 1977 and 1986. (Id. at pp. 333-334.)

Between 1982 and 1986, the developer had purchased primary insurance policies from United Pacific Insurance Company and State Farm Fire and Casualty Insurance Company, each worth $1 million; for policy year 1985 through 1986, it had also purchased a $5 million excess policy from Scottsdale Insurance Company. The excess policy provided that Scottsdale would be liable for the developer's ultimate net loss in excess of its "underlying limit," defined as an amount " 'equal to the Limits of Liability indicated beside the underlying insurance listed in the Schedule of Underlying Insurance ... plus the applicable limits of any other underlying insurance collectible by the Insured.' " (Id. at p. 335.)

In litigation between the insurers, the primary insurers contended that Scottsdale was obligated by the terms of its policy to provide coverage once the 1985 through 1986 primary policy was exhausted. Scottsdale contended that it need not provide coverage until the primary policies for all years were exhausted. (Community Redevelopment, supra, 50 Cal.App.4th at p. 336.)

The Court of Appeal held that Scottsdale's policy was excess to all primary policies, and thus that Scottsdale need not indemnify the developer until all primary policies had been exhausted. (Community Redevelopment, supra, 50 Cal.App.4th at pp. 337-342.)

It explained:

"There is no dispute that Scottsdale's $5 million coverage was purchased as excess to the $1 million primary policy issued by State Farm. However, the express provisions of the policy further provide that Scottsdale's liability was also excess to 'the applicable limits of any other underlying insurance collectible by the insured parties.' ... The policy also provided that the insurance afforded by the policy 'shall be excess insurance over any other valid and collectible insurance available to the insured parties whether or not described in the Schedule of Underlying Insurance' (which schedule listed State Farm's $1 million policy)." (Id. at p. 338.)

This policy language, the court said, "could hardly be more clear" that Scottsdale's exposure was excess to all other primary coverage available to the insured. (Id. at pp. 338-339.)

Its conclusion, the court said, was consistent with the principle of "horizontal exhaustion"--the notion that "all primary insurance must be exhausted before a secondary insurer will have exposure ... ." (Community Redevelopment, supra, 50 Cal.App.4th at p. 339.)

It noted that horizontal exhaustion raised particular problems in cases of continuous loss, because "in such cases, primary liability insurers may have exposure to defend (and perhaps indemnify) claims arising before or after the effective dates of such policies. As a result of the Supreme Court's conclusion that a continuing or progressively deteriorating condition which causes damage or injury throughout more than one policy period will potentially be covered by all policies in effect during those periods (Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645 at pp. 686-687), the 'horizontal exhaustion' versus 'vertical exhaustion' issue will become an increasingly common one to be resolved. As we find to be the case here, primary policies may have defense and coverage obligations which make them underlying insurance to excess policies which were effective in entirely different time periods and which may not have expressly described such primary policies as underlying insurance." (Community Redevelopment, supra, 50 Cal.App.4th at p. 340.)

The court concluded:

"Absent a provision in the excess policy specifically describing and limiting the underlying insurance, a horizontal exhaustion rule should be applied in continuous loss cases because it is most consistent with the principles enunciated in Montrose. In other words, all of the primary policies in force during the period of continuous loss will be deemed primary policies to each of the excess policies covering that same period. Under the principle of horizontal exhaustion, all of the primary policies must exhaust before any excess will have coverage exposure." (Community Redevelopment, supra, 50 Cal.App.4th at p. 340.)

Thus, "Scottsdale's responsibility to respond was not triggered by State Farm's exhaustion; not until exhaustion of all primary policies, including United's, would Scottsdale have had any duty to provide a defense to the insureds." (Ibid.)