California Supreme Court Dumps Excess Insurers’ Horizontal Exhaustion Argument

As recounted by the Court, the Montrose coverage dispute has lasted decades and produced prior published decisions, including Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287) and Montrose Chemical Corp. v. Superior Court (2017) 14 Cal.App.5th 1306, 1321, 1338 (Montrose II). In the new Montrose III decision, the Court granted review to determine whether vertical exhaustion or horizontal exhaustion is required when continuous injury occurs over the course of multiple policy periods for which an insured purchased multiple layers of excess insurance.

The Court summarized the rules of insurance applicable to what are typically long-tail environmental insurance claims as follows:

• “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,” up to the policy’s limit. (Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645, 686, italics added (Montrose I).)
• “There is no requirement that . . . the conditions giving rise to the damage or injury . . . themselves occur within the policy period in order for potential liability coverage to arise.”
• “bodily injury and property damage which is continuous or progressively deteriorating throughout several policy periods is potentially covered by all policies in effect during those periods.” ( at p. 689.) (The “continuous injury trigger of coverage” rule.)
• “insurers [a]re responsible for defending the insured for all claims that involved the triggering damage” in a continuous injury case; “as long as the policyholder is insured at some point during the continuing damage period, the insurers’ indemnity obligations persist until the loss is complete, or terminates.” (State of California v. Continental Ins. Co., 55 Cal.4th at p. 197. (The “all sums” rule.)
• The insured may seek indemnification from every policy that covered a portion of the loss, up to the full limits of each policy. State of California v. Continental Ins. Co. (2012) 55 Cal.4th 186, 200. (“All sums with stacking.”)

Considering these precedents, the Court addressed the following question: In what order may an insured access excess policies from different policy periods to cover liability arising from long-tail injuries? The Court explained a hypothetical where a policyholder purchased three layers of coverage for each of three years. The insurers argued that the policyholder is obligated to exhaust each layer for all three years before seeking coverage at the next layer.

Interpreting the language of the policies in question, the Court concluded that the excess policies could fairly be read to require exhaustion only of directly underlying insurance. Accordingly, under the Court’s example of three layers of coverage over three years, the policyholder can elect to access all layers of coverage in a selected year, and it has no obligation to exhaust layer by layer across many years of coverage.

Why is this important? From a practical standpoint, there are many reasons why a policyholder would want to seek coverage in a single year. Policy language varies from insurer to insurer and over time, meaning that a policyholder may elect to choose years with more favorable policy language. Some insurers are more inclined to settle, while others prefer to fight their policyholders to the bitter end rather than pay claims. And the horizontal exhaustion rule argued by the excess insurers would require the policyholder to litigate many more potentially inconsistent policy forms in order to access purchased excess coverage.

There are two issues the Court did not reach. First, Travelers argued that in order to access excess insurance, the policyholder must actually exhaust lower levels of coverage by claim payment, and not just have liabilities that exceed those lower layers. Second, Travelers sought to escape California law on a choice of law analysis disregarding the location of the underlying claim in favor of the law of principal place of business of the insured at the time the policies were purchased. The Court concluded that these two questions were not properly before it because they were not reached by the lower court. On remand, it will not be surprising to see Travelers and other insurers continue with the strategy of spending all their effort to avoid coverage instead of paying claims.

The Court allowed that an excess insurer who has paid under the vertical exhaustion rule may seek contribution from insurers who issued policies in other years. And the Court pointed out that for the future, parties to insurance contracts are free to establish different exhaustion rules by writing their policies differently.

Montrose and other environmental insurance lawsuits have been pending in the California courts for decades because insurers have been fighting to the Supreme Court rather than paying claims. Perhaps Montrose III will persuade some of those insurers that it is time to pay their policyholders.