A recent decision from the California Court of Appeal demonstrates how insurance policy interpretation should be done, in a case interpreting certain CGL policy exclusions for the first time in the state. Though the precise language at issue was new to the court, the decision should come as no surprise to those expecting courts to faithfully apply well-established rules of insurance policy interpretation.
On September 8, 2017, the Fourth Appellate District of the California Court of Appeal issued its decision in Global Modular, Inc. v. Kadena Pacific, Inc., Case No. E063551. The case involved a modular construction project that Kadena Pacific, Inc. was to complete for the U.S. Department of Veterans Affairs. Kadena contracted with Global Modular, Inc. to deliver modular units for use in the project. At Kadena’s request, Global delivered the units without roofs to accommodate warranty and cost concerns. This meant that only plywood substrates and plastic tarps protected the units from the elements. Subsequent heavy rains resulted in water damage to the units, for which Global was responsible under its contract with Kadena.
In the resulting litigation between Kadena and Global’s insurer, the insurer claimed that the damage fell within two policy exclusions. The first excluded coverage for the particular part of real property on which any contractor or subcontractor was performing operations. The second excluded coverage for damage to a part of any property that resulted from the insured’s improper work on that part.
The court gave the exclusions a narrow reading and concluded that neither applied. Focusing heavily on each word of the policy’s text, the court found that the first exclusion applied only to damage occurring during active construction work and not, as the insurer argued, to damage occurring at any point before completion of the construction project. Because the water damage occurred while work had temporarily stopped during heavy rain, the court found the first exclusion to be inapplicable. Turning to the second exclusion, the court found that it applied only to damage caused to the discrete object or property that was the subject of improper work. While the court acknowledged that the second exclusion might apply to the inadequately protective substrate, it concluded that it did not reach the non-defective parts of the unit, such as the drywall, insulation, and carpentry damaged in the rain.
The takeaway from the court’s decision is a familiar one: the unambiguous text of a policy controls its coverage. However, three other aspects of the ruling warrant attention. First, the court allowed Kadena to recover not only the cost to remediate the water damage, but also delay costs incurred during that remediation. The policy obligated the insurer to pay the amount its insured became liable to pay “because of property damage.” Since the delays were the consequence of the water damage, the court found the delay costs to be within the scope of recoverable damages.
Second, there is a traditional rule that courts resolve a policy’s ambiguities against the insurer and in favor of the insured. The insurer argued that Kadena should not get the benefit of this rule because Global, not Kadena, was the policyholder, and was not a party to the lawsuit. Nevertheless, the court ruled that it was the objectively reasonable meaning of the policy language that controls the analysis, not what the third party subjectively understood. Thus, California courts should construe ambiguous policy language against the insurance company, and in favor of coverage, even when the party seeking coverage is not the original insured.
Also of importance is the court’s discussion of the “business risk” doctrine. This doctrine reflects the view that the purpose of a CGL policy is ordinarily to cover the risk of damage to third-party property, and not to insure contractors against the risks posed by their own inadequate workmanship. It is oftentimes argued that if an insurer were to bear that risk, it would eliminate the incentive for the contractor to perform its best work. Though the court recognized this general policy, its decision against the insurer in this case makes clear that the actual language of the insurance policy controls its interpretation, not general principles as to what insurance policies should or should not cover. Courts should resolve ambiguities in favor of coverage, even if the result might run counter to a general principle, such as the “business risk” doctrine.
The lesson to insurers continues to be that clarity in insurance language is critical, and California courts will continue to hold the line in enforcing rules of construction that protect policyholders from imprecise policy drafting.
Client Alert 2017-220
