Low, Ball & Lynch’s

WEEKLY LAW RESUME

April 20, 2006 Issue  By: Ray Coates

 

Duty to Defend - D&O Policy

 

Oak Park Calabasas Condominium Assn. v. State Farm Fire and Casualty Co.

(February 21, 2006)

 

Court of Appeal, Second District

 

The duty to defend requires a potentiality for coverage under the policy in question. This case points out the importance of examining the underlying claim when analyzing coverage and the duty to defend in the context of a condominium association’s refusal to pay a construction contractor.

 

The Oak Park Calabasas Condominium structures suffered damage in the 1994 Northridge earthquake. Oak Park contracted with a construction company by the name of ECC to repair the structures. A dispute arose during construction, and Oak Park refused to pay the remaining amounts due under the contract. ECC recorded a mechanic’s lien and filed an action against Oak Park and the owners of the condominiums. In this action, cross-complaints were filed by several of the condominium owners against the Association Board, claiming the Board had been negligent in the handling of the construction claims and that it had breached duties to the owners.

 

Oak Park tendered defense of the complaint to State Farm. State Farm denied a defense to Oak Park and its owners for the claims made by the contractor. However, it did accept the defense of Oak Park and the Board of Directors on the cross-complaints.The claims against the individual condominium owners were resolved by summary judgment, and the cross-complaints were dismissed. Trial of the main action against Oak Park resulted in an award for the contractor on the breach of contract claim, and also for fraud, punitive damages, attorneys’ fees and costs.

 

Oak Park sued State Farm for its refusal to defend the complaint. The trial court severed the coverage claim, and after trial, ruled that there was no potential coverage for the action. Judgment was entered for State Farm. Oak Park appealed.

 

The Court of Appeal affirmed. The State Farm policy issued  to the Condominium provided coverage for Business Liability, which covered claims for bodily injury, property damage, and personal injury or advertising injury. In addition, the policy provided Directors and Officers Liability Coverage for “wrongful acts.”  Coverage was provided for negligent acts, errors, omissions, or breach of duty related to management of the Association. The Court quickly disposed of the Business Liability coverage claims as there were no claims for bodily injury or property damage. It focused in on whether there was coverage under the Directors and Officers Liability Coverage.

 

Wrongful acts coverage in a Directors and Officers Liability Policy typically covers negligent breaches of fiduciary duty or violations of Securities law. Interpreting the coverage provided, the Court concluded that it provided coverage for negligent acts, negligent errors, or negligent omissions. Oak Park argued the policy covered any error or omission of the Association. The Court noted that, if Oak Park’s construction of the policy were correct, a condominium association could enter into a contract with a construction contractor and then decide not to pay the bill, shifting the obligation to an insurer. The Court stated that no rational insurer would undertake such an obligation.

 

Furthermore, it would destroy the concept of fortuity, which is the basis of insurance. The contract that Oak Park entered was voluntary. Oak Park’s decision not to pay the bill was voluntary. If Oak Park had coverage for this type of claim, Oak Park could receive the benefit of the construction contract and not pay for its cost, thus shifting the burden to its insurer. Oak Park had received substantial insurance monies from State Farm to pay for the earthquake loss. Oak Park, in essence, was seeking to enrich itself by forcing State Farm to pay twice for the same property loss. The Court refused to allow such a result by affirming the judgment of the trial court.

 

COMMENT

 

This is an interesting case because it is one of the few cases in California to analyze D&O coverage and the extent of such coverage. Furthermore, it shows the importance of analyzing the underlying claim to determine if there is coverage.

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