CA Sup. Ct. / Pollution Allocationshoke2013
“Vertical Exhaustion” of Long-Tail Claims Allowed for Excess Coverage
In a unanimous ruling, the California Supreme Court, applying California law, held “vertical exhaustion” is appropriate when continuous injury occurs over the course of multiple policy periods for which an insured purchased multiple layers of excess insurance. Thus, a policyholder is entitled to access otherwise available coverage under any excess policy once it has exhausted directly underlying excess policies for the same policy period. The rule of “vertical exhaustion” does not affect an insurer’s right to seek reimbursement via equitable contribution from other insurers that also issued policies covering relevant policy periods.
Montrose Chemical Corporation (“Montrose”) manufactured the insecticide dichloro-diphenyl-trichloroethane (DDT) in the Los Angeles area between 1947 and 1982. The United States and the State of California sued Montrose for environmental contamination. Montrose entered into partial consent decrees in which it agreed to pay for the environmental clean-up. It then sought coverage for the millions of dollars that it had spent for the clean-up and for the millions it anticipates in future liability. For each year from 1961 to 1985, Montrose had primary insurance and multiple layers of excess insurance, which collectively would provide coverage sufficient to indemnify Montrose’s anticipated total liability. Montrose and the insurers agree that Montrose’s primary coverage has been exhausted.
Each excess policy provides that Montrose must exhaust the limits of its underlying insurance before there will be coverage under the policy. The excess policies also provide that “other insurance” must be exhausted before the excess policy can be accessed. According to Montrose, it is entitled to coverage under any relevant policy once it has exhausted directly underlying excess policies for the same policy period, i.e. “vertical exhaustion” or “elective stacking.” The insurers on the other hand, argued that Montrose may call on an excess policy only after it has exhausted every lower level excess policy covering the relevant years, i.e. “horizontal exhaustion.”
The parties filed cross motions for summary judgment. The trial court denied Montrose’s motion and held that the excess policies required “horizontal exhaustion” in the context of a multiyear injury. According to the trial court, there is a “’well-established rule that horizontal exhaustion should apply in the absence of policy language specifically describing and limiting the underlying insurance.’” The appellate court affirmed the trial court’s denial of Montrose’s motion and concluded that the plain language of many of the excess policies provided that they “attach not upon exhaustion of lower layer policies within the same policy period, but rather upon exhaustion of all available insurance.”
The California Supreme Court reversed the lower court rulings. In making its decision, the California Supreme Court relied on the policy language and the principles from its previous rulings in the continuous or “long-tail” injury context: “continuous injury trigger of coverage,” “all sums” allocation, and “all-sums-with stacking indemnity principle.” The insurers argued that the “other insurance” clause found in the excess policies requires horizontal exhaustion. According to the California Supreme Court, the insurers’ interpretation was not unreasonable, but it was not the only possible interpretation of the policy language and generally “other insurance” clauses have not been understood as dictating a particular exhaustion rule for policyholders seeking to access successive excess insurance policies in cases of long-tail injury. The California Supreme Court also focused on the fact that the excess policies explicitly state their attachment point, generally by referencing a specific dollar amount of underlying insurance in the same policy period that must be exhausted, and the excess policies regularly reference schedules of underlying insurance, again all for the same policy period. Thus, “the policies are most naturally read to mean that Montrose may access its excess insurance whenever it has exhausted the other directly underlying excess insurance policies that were purchased for the same policy period.” Additionally, “[c]onsideration of the parties’ reasonable expectations favors a rule of vertical exhaustion rather than horizontal exhaustion.”
The California Supreme Court disagreed with the insurers’ argument that “vertical exhaustion” is “totally unfair”: “[T]he critical difference between a rule of vertical exhaustion and horizontal exhaustion thus is not whether a single disfavored excess insurer will be made to carry a disproportionate burden of indemnification, but instead whether the administrative task of spreading the loss among insurers is one that must be borne by the insurer instead of the insured. There is no obvious unfairness to insurers from a rule that requires them to bear this administrative burden.”
The California Supreme Court specifically noted that because the question was not presented, its opinion does not decide when or whether an insured may access excess policies before all primary insurance covering all relevant policy periods have been exhausted. Montrose Chemical Corp. of California v. Superior Court of Los Angeles County, No. S244737 (Cal. Apr. 6, 2020).