• California Court Enforces Allocation Provision in Lieu of “Reasonably Related” Standard
  • November 23, 2011 | Authors: Terrence R. McInnis; Melissa J. Perez; Pamela L. Signorello; Cathy A. Simon
  • Law Firms: Troutman Sanders LLP - Irvine Office ; Troutman Sanders LLP - Washington Office
  • On November 8, 2011, in Endurance American Specialty Co. v. Lance-Kashian & Co., et al., the U.S. District Court for the Eastern District of California held that the allocation provision in a duty to defend policy mandated an allocation of defense costs between insureds and non-insureds. The court upheld the insurer’s allocation of two-thirds of defense costs to a non-insured regardless of the potential “reasonably relatedness” of such costs to the defense of the insureds. This advisory examines that portion of the court’s decision pertaining to allocation.

    The underlying adversary proceeding was brought by the debtor (Gottschalks, Inc.), the sole limited partner of Park 41 Limited Partnership (“Park 41”), against (i) the general partner of Park 41, non-insured River Park Properties III (“RPP III”), (ii) the general partner of RPP III, insured Lance-Kashian & Co. (“Lance-Kashian”), and (iii) two Lance-Kashian individual insureds. The adversary proceeding asserted seven claims against the insureds and non-insured RPP III jointly, and six claims against non-insured RPP III alone.

    The Professional, Management, Employment Practices and Fiduciary Liability Insurance Policy gave Endurance the right and duty to defend any Claim against an Insured. The policy also contained an allocation provision, which provided: “If a Claim made against any Insured includes both covered and uncovered matters or is made against both an Insured and others not insured under this Policy, the Insured and the Company agree that there must be an allocation between insured and uninsured Loss. The Insureds and the Company shall use their best efforts to agree upon a fair and proper allocation between the insured and uninsured Loss. However, the Company shall not seek to allocate with respect to Claim Expenses and shall pay one hundred percent (100%) of Claim Expenses so long as a covered matter remains within the Claim.” (Emphasis added.)

    At the insureds’ insistence, the insureds and RPP III were jointly represented in the underlying action by the same counsel. Relying on the policy’s allocation provision, Endurance allocated one-third of the defense costs to the insureds, and two-thirds to non-insured RPP III on the basis that the underlying complaint attributed to RPP III “the majority, if not all, of any potential liability.” Coverage litigation ultimately ensued, and the insureds and Endurance brought cross-motions for summary judgment on numerous issues, including allocation.

    The insureds raised several arguments against Endurance’s allocation. First, they argued that, under Buss v. Superior Court, Endurance’s unilateral allocation of defense costs between the insureds and RPP III on a forward-going basis was the “functional equivalent of a total denial.” Second, with specific reference to Safeway Stores, Inc. v. National Union Fire Ins. Co. of Pittsburgh, the insureds argued that Endurance must pay all defense costs “reasonably related” to the insureds’ defense, and may allocate to non-covered loss only those defense costs solely attributable to the defense of RPP III. Third, the insureds asserted that the final sentence of the allocation provision (to the effect that the insurer would “not seek to allocate with respect to Claim Expenses and shall pay...100% of Claim Expenses so long as a covered matter remains within the Claim”) applied to claims against insureds and non-insureds, or at a minimum, that the language created an ambiguity in the allocation provision. Finally, the insureds contended that “Claim Expenses” were not limited to defense expenses incurred solely on behalf of the insureds but also included “reasonable fees charged by any lawyer selected by mutual agreement.”

    The court rejected all of the insureds’ arguments, determining that the allocation provision mandated an allocation. On the basis of the allocation language at issue in the policy, the court distinguished prior Ninth Circuit case law applying the “reasonably related” standard. In particular, the court noted that the allocation language here dictated that “there must be an allocation” between insured and uninsured Loss.

    As for the final sentence of the allocation provision, the court determined that “[i]t obligates Endurance to pay 100 percent of Claim Expenses attributable to the insureds. In other words, when an insured and non-insured are subject to the same Claim, Endurance must pay all Claim Expenses for defense of the insured.” Finally, the court noted the parties’ respective obligations, per the terms of the policy, to “use their best efforts to agree upon a fair and proper allocation.” Absent any meaningful challenge from the insureds concerning Endurance’s one-third/two-thirds allocation, particularly where the underlying complaint arguably attributed the majority of any potential liability to RPP III, the court enforced the allocation applied by Endurance.