The insured had made repairs near a sewer line for a water district. Sewage from the sewer line backed up into a house owned by a couple, the Waters, and caused extensive damage. The Waters presented a claim to the water district, but never filed suit.
Upon notice, the insurer advised the insured of its denial of coverage for the claim based on the policy’s “total” pollution exclusion. The insured met with insurer representatives to discuss the insurer’s coverage position regarding the Waters’ claim and the renewal of the policy. At trial, the insured contended that at that meeting, the insurer representatives made oral promises to cover the Waters’ claim, should a suit ever be filed, as an inducement to renew the policy. The insurer representatives later testified that at the time the oral promises were made, the denial of the Waters’ claim could not be altered, but that “similar-type claims in the future” would be covered.
Two years later, the water district settled the Waters’ claim for $417,000. The water district then sought reimbursement from the insured, and ultimately sued the insured. Upon tender, the insurer denied coverage. The insured tendered to its excess insurer, which did agree to defend and agreed to have defense counsel bill the insured, though the excess insurer agreed to fund the defense.
Six months after the primary insurer's denial, the insured sued for bad faith. The complaint did not mention the oral promises that the insurer allegedly made. Five months later, the insurer agreed to defend the insured and settled the water district’s suit against the insured. The insurer withdrew any right to reimbursement and offered to pay the insured’s fees incurred in the bad faith suit in exchange for a dismissal. The insured rejected the offer and pressed on with the bad faith suit, including seeking punitive damages.
Over the next year and a half, while the bad faith suit was still ongoing, the California Court of Appeal issued two decisions that supported the insurer’s denial based on the total pollution exclusion. The insurer sought summary judgment based on the decisions, but while the motion was pending, the California Supreme Court reversed one of the Court of Appeal’s decisions, holding that the “absolute” pollution exclusion applied only to traditional widespread environmental pollution. Thus, the insurer’s motion was denied. The insurer then unilaterally withdrew any right to seek reimbursement from the insured.
At trial, the jury awarded $10 million in punitive damages against the insurer. The insured also received an award of $1 million in fees pursuant to Brandt v. Superior Court, 37 Cal.3d 813 (1985). The insurer appealed.
In determining whether the insurer committed bad faith in denying coverage, the Court of Appeal concluded that the insurer had a duty to defend but that the breach was “objectively reasonable.” Examining the history and reasoning behind the case law on the “absolute” pollution exclusion, the Court determined that the insurer’s original denial was reasonable, as the insurer would have prevailed if the literal language of the “total” pollution exclusion had been applied. The Court added that “the mere existence of a legal dispute does not create a potential for coverage . . . ."
The Court rejected any recovery based on the insurer’s oral promises of covering future claims because the insured’s complaint failed to allege a cause of action based on the oral promises. The Court further noted that the insured never paid for defense or settlement and did not incur any liability. The Court held that the insured could not recover tort damages, including Brandt fees, as the insurer acted reasonably in denying coverage under the policy.