On September 24, 2012, a California appellate court ruled that a housing discrimination claim was not covered by the personal injury definition of a primary policy, but that it was covered by the personal injury definition of the umbrella policy. Therefore, after the underlying dispute was over, the umbrella insurer was ordered to reimburse the primary for over $5.2 million in defense costs and $1 million in indemnity.

The matter Federal Ins. Co. v. Steadfast Ins. Co., California Appellate Case No. B227301, arises from a housing discrimination suit brought by the United States against Sterling, the insured. The underlying action was brought under the Fair Housing Act and alleged that the insured had refused to rent apartments to non-Koreans, refused to rent to African Americans, and provided inferior treatment to non-Koreans by way of oppressive terms of rental agreements. Sterling was insured by a primary policy issued by Steadfast Insurance Company (“Steadfast”) and by an excess/umbrella policy issued by Federal Insurance Company (“Federal”).

The Steadfast primary policy defined “personal injury” to include the following, if done by an owner or landlord: wrongful eviction, wrongful entry or invasion of the right of private occupancy. The Steadfast primary policy did not include reference to “discrimination” in the definition of “personal injury.” Steadfast agreed to defend the underlying action on the theory that the hostile environment the insured allegedly created for its tenants could amount to a constructive eviction, thereby constituting a wrongful eviction, wrongful entry or invasion of the right of private occupancy. Steadfast paid $5.2 million to defend the underlying action and $1 million to settle it. Steadfast then sought a declaratory ruling that the umbrella insurer, Federal was the insurer who should have covered the underlying action, and that it was actually never within the coverage of the Steadfast policy.

The umbrella policy issued by Federal also provided coverage for “personal injury.” However, not only did the umbrella definition of “personal injury” cover wrongful eviction, wrongful entry and invasion of the right of private occupancy, but it also covered “discrimination, harassment or segregation based on a person’s age, color, national origin, race, religion or sex.” Federal initially agreed to participate in the defense of the underlying action and paid $316,000 in doing so. However, Federal then decided that, because the Steadfast primary policy had a duty to defend, Federal’s coverage should not have been implicated. Instead, Federal argued, its coverage was excess to Steadfast’s primary policy, and the excess coverage should not have been triggered until the Steadfast primary policy had exhausted its full limits. Federal then filed a lawsuit against Steadfast to recover the $316,000 that had been paid under the Federal umbrella coverage in defending the underlying case.

The California appellate court began its ruling by noting that a policy like Federal’s which provides both excess and umbrella coverage, is actually to be treated as a policy that provides excess coverage if the claim is covered by underlying insurance, but it is to be treated as primary policy in the event the claim is not covered by the underlying insurance. With this in mind, the court found that the underlying Fair Housing complaint was not within the coverage of the primary policy. The court found that the underlying claimant, the United States, was not technically a tenant and therefore was not able to bring a claim for wrongful eviction, wrongful entry, or violation of the right of private occupancy. Therefore, there was no coverage under the Steadfast policy. On the other hand, the umbrella coverage of the Federal policy specifically provided coverage for discrimination. The court found that discrimination was the “gravamen of the action itself,” and therefore Federal was required to drop down and provide primary coverage for the matter. In other words, Federal was required to reimburse Steadfast for the primary policy’s payment of over $5.4 million in defense and $1 million for the underling settlement payment.

An examination of when an excess or umbrella carrier is required to “drop down” has been the subject of an extensive white paper and presentation that I have recently conducted for clients. Specifically, the topics addressed in that presentation are the following:

1. Duty to Investigate: What types of obligations are courts placing on primary and excess insurers in terms of investigation obligations?
2. Drop down 1: Does an excess insurer have a duty to defend when a primary insurer refuses to defend?
3. Drop down 2: When a primary settles for less than its full limits, does an excess insurer have its excess obligations triggered?
4. Drop down 3: When an excess insurer’s indemnity obligations are triggered, must the excess insurer indemnify the insured’s defense costs?
5. Drop down 4: Does an excess insurer have to drop down and pay post-judgment interest on a huge verdict, even when it was the primary controlling the whole defense?
6. Drop down 5: When does an excess insurer have to pick up orphaned shares of an insolvent primary insurer?
7. Drop down 6: Must an excess insurer drop down to pay defense or indemnity when there are earlier or later primary policies still available?
8. Excess v. Primary: What are an excess insurer’s rights to pursue a primary insurer for bad faith failure to settle?

If you are a client of BatesCarey LLP and are interested in having us conduct such a presentation, or if you have questions about the above-referenced Federal v. Steadfast decision, please do not hesitate to contact us at any time. Adam Fleischer, afleischer@batescarey.com.