Insurance hazards.

Insurance companies and businesses claiming liability insurance coverage for cleaning up toxic waste often approach the matter as economic warfare.

Faced with staggering costs and liabilities that far exceed policy limits, both are finding that the stakes are high and the law far from clear. Whether a company secures coverage of its claim and legal defense costs from its insurance provider can often be the difference between giving employee bonuses or declaring bankruptcy.

Despite the legal controversy, the biggest questions a business may face from its insurance provider revolve around the answers to the simple questions of who, when, where, how and why. The answers will determine whether an insurer will accept or deny coverage.

The Who

The first of these questions is "Who is making the claim?"

Most environmental claims are administrative orders by the federal or state Environmental Protection Agencies or the Regional Water Quality Control Board to investigate and remediate soil contamination. The government agency does not file a "suit" unless the business fails to comply with the administrative order.

Some California insurance companies contend that an administrative notice or claim is not a "suit" and therefore deny coverage. Businesses, on the other hand, assert that an administrative action is the same as a lawsuit because it has the same consequences and ultimate potential liability. They add that if the business fails to respond adequately to an administrative order, the agency may file a suit and simply escalate the damages and costs.

Businesses also may be sued by adjacent property owners or former owners and operators of their site of contribution or cleanup costs. Last, some companies undertake cleanups voluntarily as part of a property transaction. These costs likely will not be recoverable from an insurance carrier.

The When

The second most important question is when the damage occurred. This is a complicated issue because many businesses have owned or operated property for decades and have been issued numerous different comprehensive general liability policies.

Insurance companies argue that the claims should be covered by the policy that is in effect when the damage is discovered. Businesses, on the other hand, argue that the claims should be covered by the policies in existence from the date their property was exposed to the hazardous substance until the damage was actually discovered. This interpretation would extend the number of insurance policies available to cover the loss.

Some courts have decided that damage occurs at the time of exposure and continues until the damage is discovered. The case of Montrose Chemical Company v. Admiral Insurance Company, now before the California Supreme Court, may decide this very issue. A lower court held that policies from the date of exposure until a suit is filed would apply to the loss. The Supreme Court has agreed to review this matter and it may be several years before the Court makes a determination.

The Where

The third most important question is where the damage occurred. Most liability policies exclude coverage for damage to the business's own property and only cover damage to third party property. Insurance companies argue that the actions filed by administrative agencies are excluded from coverage because they relate to cleanup of the business's own property. Businesses refute this by arguing that the cleanup prevents damages to neighboring properties or that the administrative agency is seeking cleanup of the groundwater which is not "owned" by the business.

The How

How and why the damage occurred are important questions in determining if coverage exists. First, if the hazardous discharge was intentional it may not be covered by the liability insurance policy. Insurance providers often deny coverage on the basis that a discharge and the resultant injury were "expected or intended" based upon repeated occurrences of discharges during the insured's operations. Whether something was expected or intended involves a factual dispute. Juries have concluded that contamination occurring in the early 1950's and 1960's was due to a lack of knowledge and, thus, the injury was unintentional. In the 1970's, environmental pollution regulations became more stringent, and ignoring these regulations has been viewed as intentional conduct. In one case, a federal district court jury required an insurance company to cover the inured for some but not all of its cleanup costs.

Comprehensive general liability policies issued today have what is called an "absolute pollution exclusion." For the most part, this condition excludes from coverage various types of environmental damage. Before the mid 1980's, however, comprehensive general liability policies contained what is characterized as a "qualified" pollution exclusion. These types of policies exclude coverage for environmental damage unless the release was "sudden and accidental." The insurer will ask the business to prove that the environmental damage was the result of a "sudden and accidental" event.

Courts throughout the country are split over the meaning of "sudden and accidental." Some have concluded that the terms mean simply "unintended or unexpected," while others have concluded that the terms are unambiguous and mean exactly that, "sudden and accidental." Appeals courts in California will continue to wrestle with this issue for some time.

Alternatives to litigation 

Businesses faced with making claims may be required to sue their insurance carriers or may be brought into court by their insurance carriers to decide whether their policy covers an environmental claim. Both are then faced with the costs of two lawsuits. In the wake of increasing litigation and little guidance by California courts, businesses are seeking alternatives to litigation. In addition to normal avenues of arbitration and mediation, companies and their insurers are turning to creative non-litigation solutions such as the "policy buy-back" and "interim funding agreement."

The "policy buy-back" requires an insurance company to purchase back a policy issued to an insured and rescind the agreement. It is as though the policy never existed. This guarantees the insurance provider that it will not have further liability under the policy and the business receives a lump-sum payment in exchange for the repurchase of the policy. This lump-sum can then be used to assist the business in defending against the environmental claim or order. The advantages of the "policy buy-back" are a quick pool of money and the avoidance of litigation. The major disadvantage is that businesses may face unidentified claims that have yet to be made against it. The "policy buy-back" should only be used after a thorough and comprehensive evaluation of the potential liability and risks involved.

Alternatively, if a business can identify various insurers over several periods, the business may be able to enter into an "interim funding agreement," whereby the insurance providers agree to share the defense costs of the environmental claim. The insurers reserve their right to challenge claims under the insurance policy and the business reserves its right against the insurer as well. The agreement can be spread evenly among the existing identifiable insurers or in difficult cases, the business may help fund the agreement. The parties reserve their right to seek a different arrangement at some future point in time, either upon request of the parties or following resolution of the environmental claim.

The "interim funding agreement" provides the business insured with at least some reimbursement to help fight the, environmental claim and, at the same time, reserves the issues to be resolved at a later date. The two parties, therefore, can avoid litigation of the coverage issues until later.

Insurance companies and businesses will be fighting over coverage of environmental claims for some time to come. The questions of who, what, why, where and when are simple, but the issues they raise are complicated, the stakes high, and the outcome uncertain. The "interim funding agreement" and "policy buy-back" offer new solutions to these ongoing environmental insurance coverage disputes.

Michele E. Flurer is an attorney in the Los Angeles office of the law firm of Baker & McKenzie and is a member of the environmental law sections of the American Bar Association and the State Bar of California.