California Adopts Vertical Exhaustion Rule in Environmental Loss Claim

April 7, 2020

On April 6, 2020, the California Supreme Court announced its decision in Montrose Chemical Corporation v. Superior Court, case no. S244737, applying a rule of “vertical exhaustion” as to the triggering of excess policies at differing levels of coverage. Under that rule, contrary to "horizontal exhaustion," the insured may select any excess policy once it has exhausted its other underlying excess policies with lower attachment points, in the same policy period.

In Montrose, the insured was sued for causing continuous environmental damage in the Los Angeles area between 1947 and 1982. For each policy year from 1961 to 1985, Montrose had secured primary insurance and multiple layers of excess insurance during this period. Each excess policy provides that Montrose must exhaust the limits of its underlying insurance coverage before there will be coverage under the policy. Each of the excess policies also provide that “other insurance” must be exhausted before the excess policy can be accessed.

The parties disagreed as to whether these clauses required Montrose to exhaust other insurance coverage from other policy periods. Montrose argued that it is entitled to coverage under any relevant policy once it has exhausted directly underlying excess policies for the same policy period (i.e., "vertical exhaustion.") The excess insurers, by contrast, argued that Montrose may call on an excess policy only after it has exhausted every lower level excess policy covering the relevant years (i.e., "horizontal exhaustion.")

The trial court ruled in favor of the insurers, holding that the excess policies required horizontal exhaustion in the context of this multiyear injury. The court concluded there is a “ ‘well-established rule that horizontal exhaustion should apply in the absence of policy language specifically describing and limiting the underlying insurance.’" The Court of Appeal affirmed, holding that the plain language of the excess policies provide that they “attach not upon exhaustion of lower layer policies within the same policy period, but rather upon exhaustion of all available insurance.”

The California Supreme Court reversed, holding: "Reading the insurance policy language in light of background principles of insurance law, and considering the reasonable expectations of the parties, we agree with Montrose: It is entitled to access otherwise available coverage under any excess policy once it has exhausted directly underlying excess policies for the same policy period." In other words, the policyholder is not required to horizontally exhaust excess insurance at lower levels for all periods triggered before obtaining coverage from higher level excess insurance in any period.

This decision will make it easier for policyholders in long-tail progressive injury claims to access upper level excess policies by lowering the attachment level of those policies. A few words of caution. First, it should be noted that its ruling may not apply where the insured is seeking to trigger first level excess insurance. In Community Redevelopment Agency v. Aetna Casualty & Surety Co. (1996) 50 Cal.App.4th 329, the court held that "[u]nder the principle of horizontal exhaustion, all of the primary policies must exhaust before any excess will have coverage exposure.” The Montrose court indicated that this was not the issue before it, thereby leaving open the possibility that "horizontal exhaustion" remains the rule in a primary vs. excess situation.

Secondly, the Court noted that an insurer called on to provide indemnification under this "vertical exhaustion" rule may, however, seek reimbursement from other insurers that would have been liable to provide coverage under excess policies issued for any period in which the injury occurred.

Please feel free to contact Bryan Weiss if you have any questions about this decision or any coverage matters in general. Our office remains fully operation to assist our clients during this unique period.

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