The Contract

By Alice Wolfson & David Lilienstein


The following are some issues which frequently arise when litigation insurance bad faith cases. This includes claims denials, coverage issues, duty to defend, duty to indemnify, and ERISA preemption law. This primer focuses on insurer conduct that may qualify as bad faith claims handling.

Because statutes change and decisional law on any topic evolves, and because decisions are often subject to multiple interpretations, the reader is cautioned not to rely on the principles set forth without undertaking additional research.

The authors gratefully acknowledge the assistance of Jill Schlichtmann, Esq., and Amy Bach, Esq.

[A] The Contract

  1. Q: What general rules of construction apply to the interpretation of insurance policies?
    A: a.The language of an insurance policy is to govern its interpretation if the language is clear and explicit. (Civil Code section 1638; Bank of the West v. Superior Court (1992) 2 Cal.4th 1254, 10 Cal.Rptr.2d 538.)

    1. Any ambiguity or uncertainty in a policy will be resolved against the insurer and in favor of the policy holder. (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 54 Cal.Rptr. 104; Delgado v. Heritage Life Ins. Co. (1984) 157 Cal.App.3d 262, 203 Cal.Rptr. 672.)

    2. Insurance contracts are to be interpreted to effectuate the “objectively reasonable expectations of the insured.” (AIU Ins. Co. V. Superior Court (1990) 51 Cal.3d 807, 822, 274 Cal.Rptr. 820.)

    3. Insurance industry publications are particularly persuasive as interpretive aids in determining coverage on behalf of the insured. (Prudential-LMI Commercial Ins. Co. v. Reliance Ins. Co. (1994) 22 Cal.App.4th 1508, 27 Cal.Rptr.2d 841.)

    4. Indemnity in case of loss should be effectuated rather than defeated. (Insurance Company of North America v. Electronic Purification Co. (1967) 67 Cal.2d 679, 63 Cal.Rptr. 382.)

    5. Words used in an insurance policy are to be interpreted according to the plain meaning which a layperson would ordinarily attach to them, not as they might be analyzed by an attorney or an insurance expert. (Delgado v. Heritage Life Ins. Co., supra, 157 Cal.App.3d 262, 272; Jones v. Crown Life Ins. Co. (1978) 86 Cal.App.3d 630, 638, 150 Cal.Rptr. 375; Crane v. State Farm Fire & Cas. Co. (1971) 5 Cal.3d 112, 115, 95 Cal.Rptr. 513, 514.)

    6. Exclusions must be in clear and unambiguous language and will be narrowly construed. (Ins. Code section 11580.1(c); California State Auto Association Inter-Insurance Bureau v. Warwick (1976) 17 Cal.3d 190, 130 Cal.Rptr. 520; State Farm Mut. Auto. Ins. Co. v. Jacober (1973) 10 Cal.3d 193, 110 Cal.Rptr. 1; Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800, 180 Cal.Rptr. 628.) An exclusionary clause that is not conspicuous will be strictly construed against the insurer. (Merrill & Seeley, Inc. v. Admiral Ins. Co. (1990) 225 Cal.App. 3d 624, 630, 275 Cal.Rptr. 280.)

    7. Policies are read as a whole with each clause lending meaning to others. (Titan Corp. v. Aetna Casualty & Surety Co. (1994) 22 Cal.App. 4th 457, 27 Cal.Rptr. 2d 476.)

  2. Q: Is an insurer required to advise claimants of contractual rights under their policy?
    A: In many situations, yes. Where an insured’s lack of knowledge may potentially result in the loss of benefits or forfeiture of rights, an insurer is required to bring to the insured’s attention any relevant information to enable the insured to take action to secure rights afforded by the policy. (Sarchett v. Blue Shield of California (1987) 43 Cal.3d 1, 233 Cal.Rptr. 76.)

  3. Q: Does an insurance agent have a duty to advise a policyholder on the sufficiency of his/her coverage limits?
    A: .The agent’s general duty of care does not include advising a policyholder on the adequacy of his/her limits. (Jones. v. Grewe (1987) 189 Cal.App. 3d 950, 234 Cal.Rptr. 717.) However, where agents assume additional duties by agreement, or hold themselves out as having specific expertise, a special duty may arise. (Kurtz, Richards, Wilson & Co. v. Insurance Communicators Marketing Corp. (1993) 12 Cal.App.4th 1249, 16 Cal.Rptr.2d 259.) Negligent misrepresentation may lie against an agent whose assurances of proper coverage turn out to be false. (Clement v. Smith (1993) 16 Cal.App.4th 39, 19 Cal.Rptr.2d 676.)

  4. Q: Can an insured reasonably rely upon an insurance agent’s representations regarding coverage?
    A: An insured cannot intentionally remain ignorant as to the terms of his/her policy, but need not independently verify the accuracy of representations made by the agent regarding relevant policy provisions. (Clement v. Smith, supra, 16 Cal.App.4th 39.) If the insured can prove justifiable reliance, an agent may be liable for intentional or negligent misrepresentation. (Eddy v. Sharp (1988) 199 Cal.App.3d 858, 245 Cal.Rptr. 211; Hadland v. NN Inventors Life Ins. Co. (1994) 24 Cal.App.4th 1958, 30 Cal.Rptr.2d 88, rev. denied.)

  5. Q: Notwithstanding provisions of the policy itself, what are the restrictions on an insurer’s right to cancel?
    A: A cancellation must meet the requirements of Insurance Code section 677 which provides that all notices of cancellation must be in writing, and must specify the reason for the cancellation. Insurance Code section 675 et seq. contain additional cancellation requirements applicable to certain types of policies. A cancellation that does not comply with statutory requirements is ineffective. (Lee v. Industrial Indemnity Co. (1986) 177 Cal.App.3d 921, 223 Cal.Rptr. 254.)

  6. Q: Beyond the possible effect of specific policy provisions, what are the principal restrictions on an insurer’s right to non-renew or effect a reduction in coverage in a policy?
    A: The non-renewal of a property and/or liability policy, (excluding auto and worker’s compensation policies) is governed by Insurance Code section 678. A notice of non-renewal or reduction in coverage must be sent to the policyholder at least 45 days before expiration of the policy. If an insurer fails to provide such notice, the prior policy, with no changes in coverage, will remain in effect. If the insurer later complies with the notice provision, the prior policy will remain in effect for 45 days from delivery or mailing of the notice.

  7. Q: If an insurance policy contains provisions that are extremely one-sided or unfair, what remedies are available?
    A: If the court, as a matter of law, finds the contract or any clause of the contract to have been unconscionable at the time it was made, the court may refuse to enforce the contract; enforce the remainder of the contract without the unconscionable clause; or limit the application of any unconscionable clause to avoid an unconscionable result. The basic test is whether the clauses involved are so one-sided as to be unconscionable under the circumstances existing at the time of the making of the contract, given the general background and the needs of the particular case. (Civil Code section 1670.5; Truta v. Avis Rent-A-Car System, Inc. (1987) 193 Cal.App.3d 802, 238 Cal.Rptr. 806.)

  8. Q: If two or more policies cover a loss, what remedies are available to the respective insurers?
    A: Generally, each can seek contribution from the other. This is true even if the two carriers are not co-insurers and the insured risks are not identical (e.g.: an errors and omissions policy and a comprehensive general liability (“CGL”) policy). (State Farm Fire & Casualty Co. v. Cooperative of American Physicians, Inc. (1984) 163 Cal.App.3d 199, 209 Cal.Rptr. 251; Troost v. Estate of DeBoer (1984) 155 Cal.App.3d 289, 202 Cal.Rptr. 47.) For primary and excess carrier obligations, see Hartford Accident & Indemnity Co. V. Superior Court (1994) 23 Cal.App.4th 1774, 29 Cal.Rptr.2d 32 and Iolab Corp. v. Seaboard Surety Co. (9th Cir. 1994) 15 F.3d 1500.

  9. Q: In a dispute between two property insurers regarding continuous, progressive and deteriorating damage to covered property which began during policy period #1 but continued until policy #2 was in effect, who is liable?
    A: In the absence of enforceable policy language to the contrary, the insurer providing coverage when the damage is first manifest may be liable for all continuing damage even if it “occurs” after the policy period expires. (Snapp v. State Farm Fire & Cas. Co. (1962) 206 Cal.App.2d 827, 24 Cal.Rptr. 44.) Where two insurers’ policies cover successive periods, each insurer can be held jointly and severally liable for the loss. (California Union Ins. Co. v. Landmark Ins. Co. (1983) 145 Cal.App.3d 462, 193 Cal.Rptr. 461.) Note: substantial analytical differences exist between first and third party cases in the area. (Garvey v. State Farm Fire & Casualty Co. (1989) 48 Cal.3d 395, 257 Cal.Rptr. 292; Prudential-LMI Commercial v. Superior Court (1990) 51 Cal.3d 674, 274 Cal.Rptr. 387.)

  10. Q: Can coverage “evaporate” in the presence of “other insurance” clauses?
    A: Public policy disfavors “escape” clauses in insurance policies, whereby coverage purports to “evaporate” in the presence of other insurance. This may also apply to “excess-only” clauses, by which carriers seek exculpation whenever the loss falls within another carrier’s policy limit. When two “excess-only” other-insurance clauses collide, courts will force both carriers to pro-rate, in derogation of the policy language; this rule is based on the fact that if both of the other-insurance clauses were given effect according to their terms, the insured would have no coverage. (CSE Ins. Group v. Northbrook Property & Casualty Co. (1994) 23 Cal.App.4th 1839, 29 Cal.Rptr.2d 120.)

  11. Q: Can a CGL policy providing standard “advertising liability” coverage provide a defense and/or indemnity for remotely related advertised activities?
    A: Not usually. The test for coverage is whether there is a causal connection between the advertising activities and the “advertising injury.” (Bank of the West v. Superior Court, supra, 2 Cal.4th 1254.)

  12. Q: What are an insured’s remedies where an insurer has used advertising and solicitation materials that are unfair or deceptive as to the coverage that was actually provided?
    A: Insurance Code sections 790.03(a) and (b) prevent insurers from engaging in such conduct.

    Although there is probably no private right of action in a first party case, these code sections establish standards of conduct for the insurance industry. Violation of these code sections may constitute evidence of bad faith.

  13. Q: Who bears the burden of proving an excluded risk or condition subsequent which negates an insurer’s liability . . . the insured or the insurer?
    A: The insurer. (State Farm Mut. Auto Ins. Co. v. Partridge (1973) 10 Cal.3d 94, 109 Cal.Rptr. 811; Maffei v. Northern Ins. Co. of New York (9th Cir. 1993) 12 F.3d 892.)

  14. Q: What happens when a loss is caused by a combination of a covered and an excluded risk?
    A: Coverage will probably be a question of fact. (Howell v. State Farm Fire and Casualty Co. (1990) 218 Cal.App.3d 1446, 267 Cal.Rptr. 708.) The loss should be covered if the covered risk was the triggering or “efficient proximate cause” of the loss. (Garvey v. State Farm Fire & Casualty Co., supra, 48 Cal.3d 395, 402.) The loss is not covered if the covered risk was only a remote cause of the loss, or if the excluded risk was the efficient proximate cause of the loss.