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June 21, 2024

California Supreme Court Continues Move Toward Vertical Exhaustion

Until recent years, California case law supported the position that, in continuous loss cases, all applicable primary liability insurance policies had to exhaust before any excess insurance policies could be triggered – a rule known as horizontal exhaustion. Community Redevelopment Agency v. Aetna Casualty & Surety Co., 50 Cal.App.4th 329, 339 (1996)(“Community”)(“It is settled under California law that an excess or secondary policy does not cover a loss, nor does any duty to defend the insured arise, until all of the primary insurance has been exhausted.”); Stonewall Ins. Co. v. City of Palos Verdes Estates, 46 Cal.App.4th 1810, 1852-1853 (1996)(“Stonewall”); Padilla Construction Co., Inc. v. Transportation Ins. Co. 150 Cal.App.4th 984, 986-87 (2007)(“Padilla”)(“California’s rule of ‘horizontal exhaustion’ in liability insurance law requires all primary insurance to be exhausted before an excess insurer must ‘drop down’ to defend an insured...”).

However, the California Supreme Court had not weighed in on the issue until its decision in Montrose Chemical Corp. of California v. Superior Court, 9 Cal.5th 215 (2020)(“Montrose III”). Montrose III involved higher tier excess insurers arguing – based on horizontal exhaustion – that all lower tier excess carriers had to exhaust their limits before the higher tiers were triggered. The Court rejected this argument and instead applied a rule of vertical exhaustion, holding that California law permits the insured “to seek indemnification under any excess policy once [the insured] has exhausted the underlying excess policies in the same policy period. [The insured] is not required to exhaust excess insurance at lower levels for all periods triggered by continuous injury before obtaining coverage from higher level excess insurance in any period." Id. at 238. Montrose III did not, however, reach the question of whether horizontal exhaustion still applied to all applicable primary policies before any excess policy could be triggered.

Subsequently, the appellate courts split on the remaining question. In SantaFe Braun, Inc. v. Ins. Co. of North America, 52 Cal.App.5th 19 (2020)(“SantaFe”), an appellate court applied the ruling in Montrose III to apply vertical exhaustion with respect to both primary policies and excess policies. The court in SantaFe explicitly held that the prior cases applying horizontal exhaustion (Community, Stonewall and Padilla) were wrongly decided in light of the decision in Montrose III. However, in Truck Ins. Exch. v. Kaiser Cement, 2022 WL 71771 (2022), another appellate court reached the opposite conclusion, holding that differences between the nature of primary and excess policies required that the horizontal exhaustion rule be applied to all primary policies before any excess policy could be triggered. The SantaFe case was not appealed to the California Supreme Court, but the Truck case was. 

Notably, the Truck decision relates to a contribution action filed by Truck Insurance Exchange against various other carriers with respect to coverage for asbestos claims. Kaiser Cement manufactured products containing asbestos from 1944 through the 1970s. Eventually, Kaiser faced claims from more than 24,000 claimants related to asbestos. All of the primary policies issued to Kaiser from 1947 onward included aggregate limits, except for a single primary policy issued by Truck for the 1974-1975 policy period, which had a $500,000 per occurrence limit. At the time of the Truck decision, all of Kaiser’s other primary policies had exhausted, leaving only the 1974/75 Truck policy to respond to every asbestos claim. Truck argued that the excess carriers over all of the other exhausted policies should have to contribute to the cost of these asbestos claims, arguing for vertical exhaustion. Although this was a contribution claim, Kaiser was also a party and joined with the excess carriers to argue for horizontal exhaustion.

On June 17, 2024, the Supreme Court issued its decision in Truck Ins. Exch. v. Kaiser Cement, Case No. S273179, 2004 WL 3016941 (June 17, 2024)(“Truck”). The Court rejected the appellate court’s application of horizontal exhaustion and held that “first-level excess policies are most reasonably construed as requiring only vertical exhaustion” of primary policies. Id. at *2. The Court supported the ruling in the SantaFe case and expressly disapproved of “Community Redevelopment’s conclusion that standardized ‘other insurance’ provisions appearing in first-level excess policies compel a rule of horizontal exhaustion.” Id. at *18. The Court also expressly rejected the reasoning in Stonewall and Padilla regarding horizontal exhaustion. Id.

The Court held that an insured has the right to seek funding from excess policies above exhausted primary policies regardless of whether or not primary policies in other years have exhausted their limits. However, in this case, the insured was not the plaintiff, instead Truck filed the suit to seek contribution from the excess carriers. Because the appellate court had based its ruling against Truck solely on the horizontal exhaustion rule that the Supreme Court rejected, and the appellate court had not evaluated the equitable arguments for and against Truck’s indemnity and contribution claim against the excess carriers, the Supreme Court remanded the case to allow the lower courts to evaluate the equitable arguments related to Truck’s contribution claim. Therefore, the Supreme Court left open the issue of whether its vertical exhaustion rule applies in a dispute between insurers for equitable contribution.  

Although the Court has left open a slim possibility that horizontal exhaustion may still be applicable to inter-insurer disputes, it seems doubtful this position will survive further scrutiny from the Supreme Court. The Court is trending away from horizontal exhaustion and toward a rule of vertical exhaustion. While California was solidly a horizontal exhaustion jurisdiction from at least 1996 when the Community and Stonewall decisions came down, the decisions in Montrose III and now in Kaiser Cement show that California has reversed course and is now solidly a vertical exhaustion jurisdiction. 

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