The California Supreme Court Has Agreed To Consider Whether The Rule Of “Horizontal Exhaustion” Applies In The Context Of Environmental Damage Claims

On November 29, 2017, the California Supreme Court agreed to review Montrose Chemical Corp. v. Superior Court, 14 Cal.App.5th 1306 (App. 2nd Dist. 2017), an environmental damages matter, where the Court of Appeal, Second Appellate District ruled on the insurers’ declaration that “[a]ll underlying policy limits across the years of continuing damage must be exhausted by payment of covered claims before any of the Insurers’ excess policies ha[s] a duty to pay covered claims.”  In particular, the California Supreme Court will consider the following issue:  When continuous property damage occurs during several periods for which an insured purchased multiple layers of excess insurance, does the rule of “horizontal exhaustion” require the insured to exhaust excess insurance at lower levels for all periods before obtaining coverage from higher level excess insurance in any period?

In Montrose Chemical Corp., the Second District Court of Appeal rejected the insured’s “elective stacking” approach, specifically concluding that Montrose was “not entitled to a declaration that it may access any of the more than 115 excess policies at issue so long as its liabilities are sufficient to exhaust the underlying policies for the same policy year.”  Therefore, the Court rejected an outright vertical exhaustion approach.  However, the Second District Court of Appeal also noted that California law requires that insurance contracts must be interpreted according to their specific terms, and that there was tremendous variation among the terms of the excess policies at issue.  Further, although the parties stipulated as to some of the language of the relevant policies, they had not provided copies of the policies themselves. Accordingly, it was impossible for the Court to interpret the policy “language in context, with regard to its intended function in the policy.”  Based on this fact, the Court also rejected the trial court’s conclusion that all excess policies must be horizontally exhausted.  Instead, the Court declined to adopt a single exhaustion scheme across Montrose’s entire coverage portfolio, and directed that each policy be interpreted according to its terms.

It is hopeful that the decision of the California Supreme Court will provide further clarity as to the application of the horizontal and vertical theories of allocation among primary and excess policies under California law, potentially setting ground rules for when and how an insured can obtain coverage for long-tail claims, sometimes spanning many decades.