WASHINGTON FEDERAL COURT IN COVENANT JUDGMENT CASE REJECTS INSURER’S ARGUMENTS RE: EIFS AND CONTRACTED PERSONS EXCLUSIONS THAT WOULD LEAD TO ABSURD RESULTS
Courts will give insurance policies a practical and reasonable interpretation, and will reject as unreasonable as a matter of law an interpretation leading to an absurd result. Whether an insured breached a notice provision is generally a question of fact. In Capitol Specialty Insurance Corporation v. Zhang, 2012 WL 1252638 (W.D. Wa.)(4/13/12), the owner of an apartment building sued two construction contractors alleging that their work was defective and caused property damage. The contractors entered into a covenant judgment with the apartment building owner, including assigning the contractors’ claims against their insurer (Capitol) to the building owner. Capitol then brought a dec action in federal court against the building owner in which Capitol asserted 6 different arguments, including that, under the applicable policies, (1) the Exterior Insulation and Finish System (EIFS) Exclusion bars coverage; (2) the Contracted Persons Exclusion bars coverage; and (3) the contractors’ breach of the policies’ notice condition bars coverage.
EIFS exclusion: The court noted that EIFS covered less than 5% of the building’s exterior. Capitol argued that the EIFS exclusion bars coverage for damages arising out of any work on the building’s exterior if any portion of the building is clad in EIFS.
The court, citing the principle enunciated in Morgan v. Prudential Ins., 86 Wn.2d 432, 434-35 (1976) that courts give policies practical and reasonable interpretation, not one leading to absurd results, held Capitol’s argument unreasonable as a matter of law.
Contracted Persons Exclusion: The court noted, that the exclusion bars coverage for property damages “sustained by any person who is … [c]ontracted with [the insured] for services.” Capitol argued that the exclusion bars coverage for property damage sustained by any person who had a contract with the contractor, including the building owner. The court rejected Capitol’s argument, noting that a “person who is contracted with the insured for services is the party to the insured’s contract that performs the services for the insured (i.e., the insured’s subcontractors). Thus, the exclusion bars coverage for property damages sustained by an insured’s subcontractors (and the subcontractor’s subcontractors).”
The Court also found that the breadth of the interpretation argued by Capitol, i.e. that the exclusion bars coverage because the building owner had a contract with the contractor, was not reasonable and would lead to an absurd result: “the policy often would not provide coverage because the insured (contractor) typically contracts with the person (owner) that suffered the damage.”
Policies’ Notice Condition: On this issue, the court held that material issues of fact precluded summary judgment. The court noted that in Washington, whether an insured breached a notice provision “is generally a question for the trier of fact, unless … there exists no genuine issue as to any material fact.” Or. Auto. Ins. Co. v. Salzberg, 85 Wn.2d 372, 377 (1975). An insured’s breach of a notice condition relieves the insurer of its coverage duty only if it can prove that the breach “caused actual and substantial prejudice.” Schwindt v. Commonwealth Ins. Co., 140 Wn.2d 348, 357 (2000). The insurer has the affirmative burden of proving the substantial and actual prejudice. Felice v. St. Paul Fire & Marine Ins. Co., 42 Wn.App. 352, 359 (1985). Relevant factors include (1) when the insured discovered its loss; (2) whether the delay left the insurer without an opportunity to defend the insured in an underlying action brought by a third party, or to pursue subrogation claims against other entities; (3) whether the insured destroyed evidence relevant to a policy exclusion; and (4) whether the insured failed to control remediation costs. Schwindt, 140 Wn.2d at 360, n. 7 (citations omitted).