September 21st Newsletter

In Marquez Knolls Property Owners Association, Inc. v. Executive Risk Indemnity, Inc. 2007 Daily Journal D.A.R 10707, the Second Appellate District of the California Court of Appeal stated:

An endorsement in a liability insurance policy issued to a non-profit property owners association excluded coverage of claims for wrongful acts based on the design or construction of any structure. We conclude the exclusion did not preclude coverage of a lawsuit brought by a member against the association asserting claims of fraud and breach of duty. The member’s claims were not based on the association’s involvement in the design or construction of a structure, but instead were based on the association’s conduct in opining on a dispute that arose between the member and another homeowner after the member constructed a structure blocking the view of the other homeowner. Accordingly, the exclusion from coverage did not apply, and the trial court erred in ordering summary judgment for the insurer.

Marquez Knolls Property Owners Association, Inc. is a non-profit corporation whose members own or reside in homes in the Marquez Knolls area of Pacific Palisades. Membership is voluntary, and all owners and residents are entitled to be members, subject to an annual dues payment. The main activity of the Association is to mediate disputes between its members over the covenants, conditions and restrictions (CC&Rs) on their properties. The CC&Rs include a restriction on the erection of structures that obstruct the view from other lots.

Executive Risk Indemnity, Inc. (insurer) issued the Association a policy of insurance for the period July 11, 2002 to July 11, 2003, specifically a “Not-for-Profit Organization Directors, Officers and Trustees Liability Insurance Policy” (the policy). The Association’s application for the policy stated, in response to a request for a brief description of the Association’s operations, that its “[p]rimary function is [to] encourage compliance with CC&R restrictions in deeds of members of the association, for the benefit of the community.” Among several endorsements to the policy was an exclusion (the “development/construction exclusion”) that provided as follows: [¶] . . . [¶] In consideration of the premium charged, no coverage will be available under this Policy for Claims for Wrongful Acts based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving: [¶] (1) The development, planning or landscaping of any real property (including any landscaping design, site planning and soil, water, environmental or other testing with respect to any such development, planning or landscaping); [¶] (2) The exercise of any development rights with respect to any real property; [¶] (3) Any actual or alleged violation of any federal, state, local or common law rule, law, regulation or ordinance respecting the environment or environmental conservation, in connection with any development, planning or landscaping of real property; or [¶] (4) The design, construction, renovation or rehabilitation of any building, structure or other improvement on any real property.”

On June 10, 2003, during the policy period, Association members Nicholas and Yasuko Valery sued the Association, asserting claims of fraud, breach of fiduciary duty, breach of duty to act in good faith, and other claims. The Valerys’ complaint alleged that in 2001, the Valerys remodeled their property, replacing an attached covered patio area with an enclosed structure. In February 2002, Nicholas Valery contacted the Association for assistance with a dispute raised by a neighboring homeowner, Joan Robertson, who claimed that the Valerys’ construction obstructed views from her property.

Thereafter, the Association informed Robertson she should formally apply to the Association so that it could issue a written determination on her dispute with the Valerys. On July 9, 2002, the Association issued a formal determination. Among other things, the determination stated that the Valerys’ replacement structure violated paragraph 11 of the CC&Rs; called for removal of the structure; and “mandate[d] reinstatement of views alleged to have existed before [the Valerys’] purchase of the [property].”

Robertson then sued the Valerys, alleging they were bound to comply with the Association’s determination and the remedial action dictated by the determination, which was subject to judicial deference. After the Association tendered the defense of the Valerys’ action to Executive Risk, the insurer refused to provide a defense or to indemnify the Association for any damages that might be awarded in the Valery lawsuit, asserting that coverage was excluded under the development/construction exclusion. The Association then filed this lawsuit against the insurer and its broker, Michael Sutton and the M.D. Sutton Insurance Agency (Sutton), asserting causes of action for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief (against the insurer), and for negligence and declaratory relief against Sutton. Sutton cross-complained against the insurer and others.

The insurer moved for summary judgment, asserting that because of the development/construction exclusion, no coverage existed under the policy. The trial court granted the motion, concluding the language of the exclusion was “not ambiguous.” Judgment was entered in the insurer’s favor and against the Association. The Association appealed, and the Court of Appeal reversed.

We respectfully disagree with the trial court’s conclusion that the development/construction exclusion in the policy precludes coverage of the Valerys’ claims against the Association. While the court’s interpretation of the exclusion may appear plausible, further analysis demonstrates the interpretation is mistaken. As will appear in more detail post, the exclusion of claims for wrongful acts based on or arising out the “design, construction, renovation or rehabilitation of any . . . structure or other improvement” necessarily refers to the insured’s “design, construction, renovation or rehabilitation” of a structure, not someone else’s. Any other interpretation of the exclusion would be contrary to principles of contract interpretation requiring language to be construed in the context of the policy as a whole and the circumstances of the case; would result in a policy that is almost entirely illusory; has no support in the cases on which the insurer relies; and would defy common sense.

The court found that the fundamental error in the trial court’s analysis of the policy language was that it omitted the requirement of a connection between the risks the policy insures against – or excludes – and the insured. “The trial court had concluded the Valerys’ claim against the Association arose from the construction of an improvement. But the Valerys constructed the improvement, not the Association. The Valerys’ claims that the Association acted fraudulently and in breach of its fiduciary duty did not arise out of or result from or involve the Association’s ‘design, construction, renovation or rehabilitation’ of a structure. The Association had nothing to do with designing or constructing or renovating or rehabilitating any structure. Its only wrongful acts – as the Valerys’ complaint clearly demonstrates – were entirely confined to its issuance of a written determination and its related activities in connection with a dispute between two of its members. Of course, the dispute between the members (the Valerys and Robertson) was based on and arose from the structure the Valerys constructed on their property. But the Valerys’ claim against the Association arises from the Association’s conduct, not from the Valerys’ conduct.”

----Andrea Lynn Rice