In Montrose, the Court of Appeal 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. Montrose Chemical argued that vertical exhaustion should apply in light of the California Supreme Court’s decision endorsing all sums allocation in State of California v. Continental Insurance Company, 55 Cal.4th 186 (Cal. 2012). In other words, Montrose Chemical sought a ruling that to trigger an excess policy, the policyholder need only demonstrate exhaustion of underlying coverage in the same policy period. The Court of Appeal rejected Montrose Chemical’s argument. The court held that the “other insurance” provisions in the policies required the policyholder to exhaust coverage horizontally, meaning that before any excess policy could be triggered, the policyholder would need to prove exhaustion of every triggered underlying policy without regard to the coverage term.

Less than two months after the Montrose decision was rendered, the Fourth District Court of Appeal rejected an insurer’s request to apply a horizontal exhaustion rule. See California v. Continental: Horizontal Exhaustion the Rule in California? Not So Fast. In State of California v. The Continental Insurance Company, 15 Cal.App.5th 1017 (App. 4th Dist. 2017), the Court of Appeal relied on California Supreme Court precedent to conclude that “other insurance clauses are intended to apply in contribution actions between insurers, not in coverage litigation between insurer and insured.” Id. at 1032 (citing Dart Indus. v. Commercial Union, 28 Cal. 4th 1059 (Cal. 2002)). Accordingly, the court held that vertical exhaustion applied, and the policyholder could access excess coverage as soon as the underlying limits for that particular coverage period were exhausted. The court rejected Montrose, noting that “to the extent that the court’s reasoning is irreconcilable with ours, we disagree with it.” Id. at 1036 n.5.

The Continental decision is squarely in line with longstanding California precedent limiting the application of other insurance clauses to contribution actions between insurers. See Dart, 28 Cal. 4th 1059; Assoc. Int’l Ins. v. St. Paul Fire & Marine Ins., 269 Cal.Rptr. 485, 488 (App. 6th Dist. 1990) (“The 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.”). Moreover, the decision is consistent with other jurisdictions that have concluded that vertical exhaustion is “conceptually consistent with an all sums allocation.” 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 n.23 (E.D. Tex. 1988), rev’d on other grounds, 896 F.2d 865 (5th Cir. 1990).

Until the Supreme Court of California resolves this dispute, the Court of Appeal’s decision in Continental and the Supreme Court’s decision to review Montrose provide strong ammunition for policyholders seeking to avoid horizontal exhaustion. Policyholders should also continue to closely scrutinize their policies to determine whether the policies include language limiting the scope of underlying insurance, and should consider whether the policies could be interpreted under the laws of a jurisdiction that more clearly provides for vertical exhaustion.

Client Alert 2017-300