On August 31, 2017, the Second Appellate District of the California Court of Appeal adopted the horizontal exhaustion method of allocating responsibility between excess and underlying insurance for long-tail claims that trigger multiple policy periods. In Montrose Chemical Corporation v. Superior Court, B272387 (Cal. App. 2nd Dist. Aug. 31, 2017), the court held that where a loss triggers policies across multiple policy periods, a policyholder must demonstrate exhaustion of all triggered underlying policies before any excess policy will be called upon to pay a claim, unless the excess policy has specific language that would require a different result. In reaching this decision, the court rejected the policyholder’s arguments in favor of vertical exhaustion, which only requires exhaustion of underlying policies in concurrent coverage periods without requiring exhaustion of policies covering different periods.

Montrose was a dispute regarding coverage for environmental liabilities arising from Montrose’s manufacture of DDT at a Torrance, California facility over the course of several decades. In 1990, the United States and the State of California filed suit against Montrose alleging that the Torrance facility caused environmental contamination for which Montrose was liable under CERCLA. Montrose entered into partial consent decrees with the government, resulting in damages in excess of $100 million.

Montrose filed suit seeking coverage for these liabilities pursuant to primary and excess insurance policies covering Montrose for the period between 1960 and 1986. During the pendency of the litigation, the California Supreme Court adopted the “all-sums with stacking” allocation rule in State of California v. Continental Insurance Company, 55 Cal.4th 186 (Cal. 2012). This rule provides that where a long-tail liability, common in instances of ongoing environmental pollution, triggers policies across multiple policy terms, the insured may “stack” the coverage limits of all triggered policies “to form one giant ‘uber-policy.’” The Supreme Court did not, however, decide the manner in which the liabilities would be allocated between excess and underlying insurers.

Following the Continental decision, Montrose amended its complaint seeking a declaration that vertical exhaustion applied to the all-sums with stacking rule, such that Montrose could access an excess policy as soon as the underlying policies in a given excess policy’s coverage period were exhausted. Montrose and its insurers filed cross-motions for summary judgment on this issue. Relying on the “other insurance” provisions in the policies, the trial court adopted the horizontal exhaustion rule and held that before the policyholder could access any excess policy, the policyholder would be required to establish exhaustion of every triggered underlying policy without regard to the coverage term.

Montrose sought relief from the Court of Appeal by filing a petition for a writ of mandate, which the Court of Appeal summarily denied. However, the California Supreme Court granted review and transferred the matter to the Court of Appeal with directions to issue an order to show cause why the requested relief should not be granted. Ultimately the Court of Appeal affirmed the trial court’s decision, in part. The court framed the issue as “not whether an insured can access policies written for different policy years (it can), but the order or sequence in which it may or must do so.” Relying on the specific language of the excess policies it considered, the court adopted the horizontal exhaustion rule and held that “many of the policies attach not upon exhaustion of lower layer policies within the same policy period, but rather upon exhaustion of all available insurance.” In reaching this decision, the court pointed to the “other insurance” clauses in the excess policies, which provide that the policies are excess of “other collectible insurance,” as well as provisions limiting the excess insurers’ liability to loss in excess of “any underlying insurance.” Importantly, however, the court rejected a bright-line rule mandating horizontal exhaustion in all cases, and instead held that exhaustion will be governed by the language in each excess policy. The court further explained: “Specifically, we do not hold that policies must be horizontally exhausted at each coverage level and for each year before higher-level policies may be accessed. Instead, we conclude that the sequence in which policies may be accessed must be decided on a policy-by-policy basis, taking into account the relevant provisions of each policy.”

The Montrose decision, while following the recent Continental decision and finding that “their conclusion that (at least some of) the policies before us are excess to lower-lying policies written in both the same and other years is consistent with the conclusion of Community Redevelopment,”¹ still appears irreconcilable with the earlier decision from the Sixth District of the California Court of Appeal in Associated International Insurance v. St. Paul Fire & Marine Insurance, 269 Cal.Rptr. 485 (Cal. App. 6th Dist. 1990). In that case, the court rejected the “other insurance” argument adopted by the Montrose court, and ordered an excess insurer to provide coverage after the exhaustion only of the primary policy in the same coverage term because “[t]he term ‘other insurance’ . . . must be interpreted to refer only to other insurance within the policy period for which [the excess insurer] has agreed to provide coverage.” Id. at 488.

Moreover, although not mentioned by the Montrose court, just last year the New York Court of Appeals adopted vertical exhaustion, holding that the rule is “conceptually consistent with an all sums allocation” – the same allocation rule adopted by the California Supreme Court in Continental. In re Matter of Viking Pump, Inc., 27 N.Y.3d 244, 255 (N.Y. 2016); see also Westport Ins. Corp. v. Appleton Papers Inc., 787 N.W.2d 894, 919 (Wisc. Ct. App. 2010); J.H. France v. Allstate Ins. Co., 626 A.2d 502, 509 (Pa. 1993); Cadet Mfg. Co. v Am. Ins. Co., 391 F. Supp. 2d 884, 892 (W.D. Wash 2005); Dayton Indep. Sch. Dist. v. Nat’l Gypsum Co., 682 F. Supp. 1403, 1411 (E.D. Tex. 1988), rev’d on other grounds, 896 F.2d 865 (5th Cir. 1990). The Viking Pump court went on to reject the “other insurance” argument on which the Montrose decision was based. Id. at 226. The court explained that other insurance clauses only apply to policies covering the same coverage period and “have nothing to do with . . . situations involving successive – as opposed to concurrent – insurance policies.” Id. at 226.

Given the conflicting approaches to exhaustion, both within California and with courts in other jurisdictions, the California Supreme Court may decide to hear this case, assuming the insured files a Petition for Review, particularly given the fact that the Court previously directed the Court of Appeal to decide the case after the Court of Appeal denied an earlier write petition. Interested policyholders should consider submitting amicus briefs to the Supreme Court to support the policyholder’s efforts to have this decision overturned. However, so long as the case remains on the books, policyholders seeking to avoid a horizontal exhaustion rule should closely analyze the specific terms of their excess insurance policies to determine whether those policies include language limiting the scope of “underlying insurance” to specific policies or policy terms.

One potential issue with the decision is that it may impair the ability of policyholders to settle with their primary and lower-level excess carriers for amounts less than the full limits of the applicable policies, for fear that excess insurers will claim that such settlements do not constitute full “exhaustion.” Policyholders and their counsel should be mindful of this in formulating their settlement strategies.

An important note: even if a dispute arises out of underlying liabilities in California, the policies may be interpreted under another jurisdiction’s laws. Those laws may be more favorable to the policyholder.

1. Community Redevelopment Agency v. Aetna Casualty & Surety Co. (1996) 50 Cal.App.4th 329. The court cites other earlier case law regarding horizontal exhaustion in support of its decision, including Padilla Construction Co. v. Transportation Ins. Co. 150 Cal.App.4th 984 (Cal. App. 2007), and Olympic Ins. Co. v. Employers Surplus Lines Ins. Co. 126 Cal.App.3d 593, 600 (Cal. App. 1981).

Client Alert 2017-208