The United States District Court for the Eastern District of California has concluded that a liability insurer had a duty to defend its insured, a drywall subcontractor, against allegations that the insured installed damp drywall in houses which eventually led to mold in the houses. ( McGranahan v. Insurance Corp. of New York (E.D.Cal. 2008) 544 F.Supp.2d 1052)
Facts
Dunmore Homes, LLC (Dunmore) was the general contractor for a residential subdivision in Ceres, California. In May 2002, Dunmore entered into a subcontract with Jeff Stewart Drywall, Inc. (JSD) for the installation of drywall at the project.
Before JSD installed the drywall at the project, the drywall was stacked inside the houses. During that time frame, fog or rain got into some of the houses and some of the drywall got damp. JSD claimed that it replaced the damp drywall with new drywall and then proceeded to install the drywall in the houses. After installation of the drywall, Dunmore inspected and approved JSD’s work.
Later, mold was identified on some of the drywall in the homes. With Dunmore’s approval, JSD attempted to repair the damage by treating the moldy drywall with bleach. The drywall was then texture coated and painted. Apparently, however, the mold problem persisted or resurfaced. The general contractor, Dunmore, ultimately hired an expert who recommended removing the drywall from the houses; removing and cleaning interior fixtures such as cabinets, tubs and toilets; removing exposed insulation; cleaning the heating and air conditioning ductwork; and removing residual traces of mold from floors, walls and ceilings.
Subsequently, in August 2003, Dunmore initiated arbitration proceedings against JSD, alleging a single claim for breach of contract. JSD tendered the defense of the arbitration proceeding to its general liability insurer, The Insurance Corporation of New York (INSCORP). However, in January 2004, INSCORP denied JSD’s tender of defense.
In March 2004 the arbitration between Dunmore and JSD occurred. The arbitrator found that JSD was aware of a potential mold problem both while the drywall was stacked and after it was installed, and that JSD’s subsequent attempt to bleach to the moldy drywall was “insufficient.” The arbitrator concluded that JSD was liable to Dunmore for approximately $350,000 in damages, plus approximately $50,000 in attorney’s fees. In July 2004, judgment was entered in favor of Dunmore and against JSD.
Eventually, JSD filed for bankruptcy. In April 2006, as part of the bankruptcy proceedings, JSD’s bankruptcy trustee sued INSCORP for breach of contract and bad faith. The bad faith case was then transferred from the bankruptcy court to the federal district court. Thereafter, JSD’s bankruptcy trustee filed a motion for partial summary judgment, and INSCORP filed a cross-motion for summary judgment.
Holding
The federal district court, applying California law, held that INSCORP had a duty to defend JSD against the underlying arbitration proceeding brought by Dunmore. The district court noted that, at the time of JSD’s tender to INSCORP, there was a factual dispute as to whether JSD had intentionally or unintentionally hung damp, moldy drywall in the houses. Since it was possible that JSD had unintentionally hung damp, moldy drywall, it was possible that JSD’s alleged liability arose from an “occurrence,” or “accident.” Further, at the time of JSD’s tender, there was evidence that JSD’s work may have caused property damage to portions of the homes other than drywall itself. Thus, the exclusion for property damage to “that particular part of the property” on which JSD worked did not bar coverage for all the damages sought. Since Dunmore was potentially seeking damages from JSD that were covered by the policy, INSCORP had a duty to defend JSD against Dunmore’s claim.
With respect to the duty to indemnify, the court noted that when an insurer erroneously fails to defend an action against its insured, the insurer is bound by all material findings of fact essential to the underlying judgment against the insured. However, the insurer is not bound by issues not adjudicated in the underlying action and can present defenses that are consistent with the judgment against the insured. Here, the arbitrator in the underlying case did not make any findings regarding (1) whether JSD intentionally installed damp, moldy drywall in the houses or (2) whether any property damage extended beyond the drywall itself. Thus, INSCORP was free to litigate those issues in the bad faith case. However, since there were triable issues of fact regarding the extent to which INSCORP might have a duty to indemnify JSD, neither INSCORP nor JSD’s bankruptcy trustee was entitled to summary judgment on that issue.
Last, with regard to the issue of bad faith , the court rejected INSCORP’s argument that JSD’s bad faith claim against INSCORP was barred by the two-year statute of limitations. The court reasoned that although INSCORP denied JSD’s tender of defense in January 2004, the underlying judgment against JSD was not entered until July 2004. The court held that the two-year statute of limitations on JSD’s bad faith claim was “equitably tolled” until entry of the underlying judgment. Since the judgment in the underlying arbitration proceeding was not entered until July 2004, and since JSD’s bankruptcy trustee filed the bad faith action in April 2006, JSD’s bad faith action against INSCORP was not barred by the two-year statute of limitations.
Comment
At least based on what is in the court’s written opinion, it is somewhat difficult to see how INSCORP did not at least defend JSD in the underlying arbitration proceeding. Given the factual disputes about whether JSD knew it was hanging damp, moldy drywall, and whether property damage extended beyond the drywall to other portions of the houses, it seems clear that Dunmore was potentially seeking covered damages against JSD, thus triggering INSCORP’s duty to defend.