Stopping insurance cases in their tracks

In 1993, the California Supreme Court rendered its landmark decision in Montrose Chemical Corp. v. Superior Court, 6 Cal. 4th 287 (1993). Montrose involved a dispute between a manufacturer and its insurers over insurance for a lawsuit seeking to recover for damage to natural resources over many years. The Supreme Court reaffirmed the longstanding rule regarding the breadth of an insurer’s duty to defend. It confirmed that an insurer has a duty to defend if there is “a bare ‘potential’ or ‘possibility’ of coverage” and that the defense duty “is a continuing one, arising on tender of defense and lasting until the underlying lawsuit is concluded ..., or until it has been shown that there is no potential for coverage.”

However, Montrose was an important decision not only with respect to the duty to defend, but also with respect to when an insurance coverage lawsuit can proceed. Although the insured had instituted the lawsuit against its insurers, the court recognized that insurers cannot prejudice an insured by proceeding with a coverage action is conducted. The court held: “To eliminate the risk of inconsistent factual determinations that could prejudice the insured, a stay of the declaratory relief action pending resolution of the third party suit is appropriate when the coverage question turns on facts to be litigated in the underlying action.”

The court offered as an example the situation “when the third party seeks damages on account of the insured’s negligence, and the insurer seeks to avoid providing a defense by arguing that its insured harmed the third party by intentional conduct.” “[T]he potential that the insured’s proof will prejudice its insured in the underlying litigation is obvious. This is a classic situation in which the declaratory relief action should be stayed.”

The court provided one caveat to this rule: “[W]hen the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment.”

A California Court of Appeal has just issued a decision revisiting these principles. In Riddell, Inc. v. Superior Court, 2017 DJDAR 8152 (Aug.23, 2017), Riddell had sued its insurers seeking coverage for lawsuits filed by numerous former professional football players alleging injuries from their use of Riddell football helmets. The insurers sought discovery regarding prior claims against Riddell, which model of Riddell helmet each of the underlying plaintiffs used, and the dates of use. Riddell moved for a protective order staying this discovery. The trial court denied the motion for protective order. Riddell filed a petition for a writ of mandate.

The Court of Appeal agreed with Riddell. The court noted that the discovery at issue “is straightforwardly related to factual issues affecting Riddell’s liability in the third party actions.” The court emphasized that “[i]f the factual issues to be resolved in the declaratory relief action overlap with issues to be resolved in the underlying litigation, the trial court must stay the declaratory relief action” (quoting Great American Insurance Co. v. Superior Court, 178 Cal. App. 4th 221, 235 (2009)). If, however, there is no such factual overlap and the coverage action can be resolved on legal issues or factual issues unrelated to issues in the underlying action, then “the question is whether to stay the declaratory relief action as a matter entrusted to the trial court’s discretion.”

The court further held that these principles “apply not only to a request for a stay of the declaratory relief action, but also to a request for ‘a stay of all discovery in the declaratory relief action which is logically related to issues affecting [the insured’s] liability in the underlying action’” (quoting Haskell, Inc. v. Superior Court, 33 Cal. App. 4th 963, 980 (1995)).

The Riddell court also pointed out that discovery in the coverage action that is “logically related” to issues affecting liability in the underlying action poses a “risk of prejudice” because “the insured may be collaterally estopped from relitigating any adverse factual findings in the third party action, notwithstanding that any fact found in the insured’s favor could not be used to its advantage” (quoting Montrose Chemical Corp. v. Superior Court, 25 Cal. App. 4th 902, 910 (1994)).

The Riddell court also explained that “the insured will inevitably be prejudiced by having to pay the costs of discovery in the declaratory relief action that would, if it had taken place in the underlying action, have been paid for by any insurers with a duty to defend.”

Therefore, the court held that “an insurer cannot, over the insured’s objection, use a declaratory relief action as a forum to litigate factual issues affecting the insured’s liability” in the underlying action. It emphasized that an insurer “cannot use the discovery process in the declaratory relief to investigate or develop [facts that might negate its duty to defend] if they are logically related to issues affecting the insured’s liability.” As the court further held, “that factual investigation and development must take place in the underlying litigation, where any insurer with a duty to defend should be paying for the insured’s defense, including discovery costs.”

In so holding, the court rejected a slew of arguments raised by the insurers. For example, the court held that even if the insurers intended “merely to obtain information related to erosion or exhaustion of policy limits, self-insurance, captive insurance, and other coverage issues that are unrelated to liability in the third party actions,” asking Riddell to “identify various prior claims” in which its captive insurer was involved and requesting all documents relating to those claims are not “logically unrelated to issues affecting liability in the third party actions.”

More importantly, the court rejected the insurers’ argument that a stay of discovery is not required unless “the insured will suffer prejudice if forced to respond to that discovery.” As the court explained, “if discovery in the declaratory relief action is logically related to issues affecting liability in the underlying action, then ‘such discovery should be stayed pending resolution of the liability claims asserted against [the insured] in the underlying action unless the court finds that a confidentiality order will be sufficient to protect [the insured’s] interests.’” (quoting Haskell). It emphasized that there need not be a finding of prejudice, but noted that Riddell would be severely prejudiced because of ‘the collateral estoppel problem or the shifting of defense costs from insurers who have a duty to defend (in the third party actions) to Ridell (in the coverage action).”

The court stressed that there was no balance required between the prejudice that the insured would suffer from the discovery and that the insurers would suffer from being precluded from discovery. “[I]f there are overlapping factual disputes, then a stay is mandatory. ... Similarly, if discovery in the declaratory relief action is logically related to issues affecting liability in the underlying action, then the discovery must be stayed unless a confidentiality order would adequately protect the insured’s interests.”

Finally, the court held that a confidentiality order in the coverage action would not suffice. “[I]f Riddell is compelled to respond to this discovery in the coverage action rather than in the third party actions, then Riddell rather than any insurers with a duty to defend will be forced to bear the costs of collecting and producing all of this evidence. No confidentiality order can solve either of these problems.” It also noted that the federal court hearing the underlying action “is not bound by a state court confidentiality order in the coverage action.” And, it concluded that Riddell summarized the situation well: “[N]o confidentiality order, no matter how broad, can protect Riddell from the prejudice caused by having to build the underlying plaintiffs’ case for them, bear investigation and discovery costs that should be borne by the Insurers ..., and risk collateral estoppel.”

Thus, putting it simply, the insurer may be “stuck” defending its insured through the conclusion of the underlying lawsuit, while its effort to terminate its defense duty is put on hold during that period. As the Riddell court reaffirmed, the alleged prejudice that an insurer suffers in such a circumstance does not allow it to proceed when the coverage action and/or discovery therein is logically related to issues affecting liability in the underlying lawsuit.