Padilla Construction Company v. Transportation Insurance Company
(2007) ___ Cal.App.4th ____, 07 C.D.O.S. 5330

Excess Insurer Not Required To "Drop Down" And Defend Underlying Action Prior To Exhaustion Of Primary Policy and Self-Insured Retention Irrespective of Potentially Uncovered Continuous Loss Occurring Prior to Defending Policy

The California Court of Appeal for the Fourth District affirmed the trial court and held that an excess insurer does not have a duty to drop down and defend in an underlying action prior to exhaustion of the defending insurer's primary policy. The court also held that an excess insurer with an "other insurance" clause, irrespective of whether it includes a specific reference to self-insurance, has no duty to drop down until the self-insured retention ("SIR") is exhausted.

Padilla Construction Company ("Padilla") was named as a cross-defendant in a continuous damage construction defect suit filed in June 2002. In 1995, Padilla performed stucco work on certain property owned by plaintiffs and the suit alleged defects related to Padilla's work.

Padilla had four successive primary liability policies from January 1995 until March 1, 2003. The initial primary coverage was issued by Transcontinental Insurance ("Transcontinental") and provided two years of coverage. Reliance Insurance and Legion Indemnity issued two subsequent policies and became insolvent prior to the underlying construction defect suit. The last primary policies were issued by Steadfast Insurance ("Steadfast") and also provided two years of coverage. Padilla also obtained two yearly commercial umbrella policies from Transportation Insurance ("Transportation") providing umbrella coverage during the Transcontinental policy period.

Padilla initially tendered the underlying claim solely to Transcontinental due to the existence of a $25,000 SIR contained in the Steadfast primary policy. However, the Transcontinental policy exhausted in December 2003 due, in part, to the payment of numerous other claims against Padilla. Padilla elected not to trigger the Steadfast policy and instead elected to tender defense and indemnity to Transportation, its sole umbrella insurer. Transportation declined the tender on the ground that the Steadfast policies had not yet exhausted. Padilla assumed its own defense and reached a settlement in 2005. The settlement was funded in part by Steadfast.

In subsequent coverage litigation between Padilla and Transportation, Padilla argued Transportation had a duty to drop down and defend Padilla once the underlying Transcontinental policy limits were exhausted. According to Padilla, since the underlying case involved continuing property damage from 1995 to 2002 and the Steadfast policy did not cover liability for property damage outside its policy period (March 1, 2001 to March 1, 2003), there was some damage for which Padilla was being sued that was not potentially covered by the Steadfast policy. Since there was no coverage for this damage, the Transportation umbrella policy was obligated to drop down and defend the underlying suit.

The trial court disagreed and ruled that since there was still primary coverage available to Padilla, Transportation was not obligated to provide a defense.

The appellate court affirmed the trial court's decision. The court first held that an excess insurer does not have a duty to drop down and defend an underlying action where primary coverage still exists, even if there are gaps in the primary coverage during the alleged continuous property damage. The court relied upon the decisions of Buss v. Superior Court (1997) 16 Cal.4th 35 and Aerojet-General Corp. v. Transport Indemnity Co. (1997) 17 Cal.4th 38.

In Buss, the California Supreme Court held an insurer must defend an entire action when there is at least one claim that is potentially covered. Buss, 16 Cal.4th at 49. In Aerojet, the California Supreme Court held that one insurer's duty to defend extended to underlying action where damage putatively occurred during some other insurer's policy period. Although the Aerojet Court framed its rule as to an insurer's duty to defend an action alleging continuous damage extending beyond its policy period in terms of time forward, the Padilla appellate court extended the Aerojet holding to apply even to underlying actions where the continuous property damage happens before the policy period. In extending Aerojet to apply to prior property damage, court relied upon prior appellate decisions rejecting the notion of restricting an insurer's defense obligation to just an amount pro rated based on the insurer's time on the risk. See Haskel, Inc. v. Superior Court (1995) 33 Cal.App.4th; State of California v. Pacific Indemnity Co. (1998) 63 Cal.App.4th 1535. An insurer is obligated to defend an insured entirely and may seek contribution from other insurers on risk.

In sum, by extending the Aerojet holding to apply to property damage occurring prior to inception of a primary policy, the court held Steadfast was obligated to defend Padilla against all claims even though the prior property damage was not covered under the Steadfast policy.

Next, the court examined what it termed the "more difficult problem" concerning the application of the Transportation policy's "other insurance" clause. The "other insurance" clause operated to make the Transportation policy excess over any unexhausted primary policies otherwise providing coverage to the insured, regardless of whether they are listed on the umbrella carrier's schedule of underlying insurance. This clause did not reference an underlying SIR. As the court noted, no court had yet held that an excess insurer with an "other insurance" clause that does not include a specific reference to self-insurance has no duty to drop down until the SIR is exhausted.

The court acknowledged that self-insurance is not "insurance" and the "other insurance" clause in the Transportation policy operates, by its terms, only when there is "other insurance." Further, from Padilla's standpoint, Steadfast was not responsible for anything until the $25,000 SIR was reached, such that the insured really had no "insurance" from Steadfast. Therefore, Transportation's "other insurance" clause could not operate to make it excess of the Steadfast policy as to the $25,000 SIR.

However, the court held Transportation was not obligated to drop down and defend Padilla until the SIR was exhausted even though the "other insurance" clause did not reference the SIR. The court noted that the SIR cannot be meaningfully separated from the Steadfast policy, as this defeats the reasonable expectations of all parties, including the insured, and "obliterates the distinction between primary and excess insurance." To hold otherwise would present the anomaly of requiring an earlier excess insurer to drop down and defend a claim "beneath" the coverage of a later primary policy. Further, the court noted the substantial disparity in premiums charged under the Steadfast primary policy and the Transportation umbrella policy was reflective of the parties expectations as to the obligations of each insurer.

The court also relied upon the terms and conditions of the Steadfast policy in support of its conclusion the SIR was part of the Steadfast policy and not "beneath" the policy as a period of "non-insurance." The Steadfast policy stated it was a primary policy and would interact with other policies as a primary policy. Further, the SIR endorsement was, by its terms, a modification of what would otherwise be covered under the primary policy. Thus, the Steadfast policy did not simply spring to life at the $25,000 level of loss. Similarly, Steadfast retained the right to step in and settle litigation within the retention amount. According to the court, if Padilla wanted to go without any insurance, it could have "gone bare" and not purchased any, primary or otherwise. Under this scenario, such a claim would potentially be covered by excess insurance.

In sum, the court held the Supreme Court's statement in Aerojet that an "excess insurer" does not have a duty to defend an insured until "primary insurance" in the form of an SIR is exhausted applies even if the excess insurer's "other insurance" clause does not contain a direct reference to self insurance.

This opinion is not final. It may be depublished, modified on rehearing, or review could be granted. This events would render this decision unavailable for use as legal authority.

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