Supreme Court rules that losses pleaded as contract damages may be covered under liability policies

In recent years, general liability and professional liability insurers have increasingly been refusing to defend or indemnify lawsuits brought by trustors against trustees and lenders alleging wrongful eviction or wrongful foreclosure. Insurers have been arguing that such claims are not covered under liability policies because such policies do not cover breach of contract actions. The insurers contend that because the eviction or foreclosure is related to a trustee's sale under the terms of a promissory note or deed of trust, such actions sound in contract, not tort, and are not covered.

The California Supreme Court has now addressed the issue of whether lawsuits which may arise out of a contract between the plaintiff and defendant but could be brought in tort are covered under a liability policy. The California Trustee's Association joined other trade organizations in filing an amicus brief before the California Supreme Court in the recently decided case of Vandenberg v. Superior Court (Centennial Insurance Company). The California Supreme Court held that an insurer may owe a duty to cover a lawsuit which is pleaded as a breach of contract action, where it could just as easily have been plead as a tort claim.

The Vandenberg case involved a suit by a landlord against his tenants for contaminating his property by failing to maintain leaking underground oil storage tanks. The tenants tendered the suit to their general liability carriers. The underlying claim was arbitrated. The arbitrator awarded $4 million in favor of the landlord, finding that the tenants breached their lease by contaminating the property. The award was confirmed by the Superior Court.

The insurers refused to pay the judgment contending that their policies did not cover breach of contract damages citing a long line of prior cases holding that the phrase "legally obligated to pay as damages" contained in a liability policy meant that their policies covered only tort claims.

In the subsequent bad faith action, the trial court granted the insurers' motions for summary judgment holding, among other things, that the arbitration award was for contractual damages and thus was not covered. The Court of Appeal reversed. The Supreme Court granted review.

The Supreme Court held that the arbitration award may be covered even though the award was entered on a breach of contract theory. The court analyzed prior case law holding that the phrase "legally obligated to pay as damages" meant that insurance policies cover only tort claims. The Supreme Court held that this line of cases resulted from a misreading of the Ritchie v. Anchor Casualty Co. case which involved policy language making the distinction between liability imposed "by law or by written contract".

The Supreme Court noted that a reasonable layperson would not understand that the phrase "legally obligated to pay as damages" would cover claims only plead in tort and exclude claims plead on a theory of breach of contract. The Court also noted such an interpretation would be unfair, as some claims may be plead either in tort or contract. Coverage is not determined based upon how the plaintiff chooses to plead his or her claim. Instead, coverage is determined "on the nature of the risk and the injury".

The Vandenberg case has now done away with nearly fifteen earlier Court of Appeal and federal court cases in which insurance companies have been citing for the proposition that any lawsuit tenuously related to a contract between the parties is never covered under a liability policy. It is important to keep this case in mind the next time you tender a case to your insurance carrier.