California Fire Insurance Ruling Spurs Policyholder Pushback (1)

A California appeals court ruling that could doom insurance coverage for smoke damage claims is in line for strong pushback from the policyholder bar and will likely end up in a high court showdown.

In an opinion late last week, the California Court of Appeal, Second District, held that “wildfire debris” stemming from a 2019 fire near Los Angeles wasn’t covered because it didn’t constitute physical loss or damage for insurance purposes.

The ruling, a major win for insurers, comes at a time when fire-related damage is top of mind for businesses and homeowners in the LA area, which was ravaged by wildfires last month resulting in property and capital losses estimated as high as $164 billion.

It also lands in the middle of an insurance crisis in the Golden State, as California’s insurance commissioner announced plans Tuesday to impose a $1 billion assessment on private carriers to shore up the FAIR Plan, the state’s insurer of last resort. State Farm and other top insurers in the state are set to pass along those costs to policyholders already reeling from the state appeals court ruling.

In the immediate term, insurers could wield the ruling to limit or deny coverage for all sorts of property insurance claims, as well as business interruption losses stemming from fires.

“I would hope that this would have very limited impact,” said Margaret McDonald, a partner in Reed Smith LLP’s insurance recovery practice. “Unfortunately, I don’t think that’s going to be the case, and insurers are probably going to use this decision as a basis to deny valid claims.”

But the ruling ultimately falls short of providing clarity on whether smoke damage is covered, policyholder attorneys say, and will likely spur a fight over depublication—which deprives a ruling of precedential effect—at the California Supreme Court.

No Bright-Line Rule

In the case at hand, two homeowners sued their carrier—a unit of the Automobile Club of Southern California, the Southern California affiliate of AAA—over coverage for alleged debris damage resulting from the 2019 Saddle Ridge fire, which burned about half a mile from their home.

Upholding a lower trial court, the California appeals court held the insurer owes no coverage because the smoke and ash damage could easily be removed or cleaned from the homeowners’ property, meaning it didn’t cause a direct physical loss.

It’s not clear from the ruling, however, exactly what standard smoke damage claims must meet to be covered by insurers, said Daniel Veroff, an attorney with Merlin Law Group who represents policyholders.

“I don’t think the opinion goes into anywhere near the level of detail that it should to set a bright-line rule that can guide folks,” he said.

Policyholder attorneys were quick to point out that the decision addressed the specific circumstances of the case and may not apply to many other coverage disputes.

“Courts make rulings based on the facts and the cases that are before them,” and this case involved some “messier” factual issues, said Haynes Boone attorney Caroline Hurtado Ford.

For instance, the California appellate court “clearly felt that the insureds in this case were overreaching for additional claim payments from their insurers even after the house already had been cleaned by the owners and the owners even testified there was no remaining smoke damage,” Marc Ladd, a partner with policyholder firm Cohen Ziffer Frenchman & McKenna, said by email.

In addition, the opinion addressed “wildfire debris” constituting soot and ash, but it wasn’t clear if smoke damage in other forms and to other degrees would be affected, policyholder attorneys say.

Many insured parties will likely make the case that the opinion doesn’t apply to their particular claim, Veroff said. Still, he said he is worried for policyholders with pending smoke claims and expects an uptick in denials and disputes.

Federal Ruling

Policyholders may take some hope from a ruling by a California federal district last month denying summary judgment to an insurer over whether it owes coverage to a Napa restaurant for business income allegedly lost from a 2017 fire.

The court held that smoke damage constituted physical loss or damage, but stopped short of a final ruling on business interruption coverage.

A genuine dispute remains as to whether the restaurant and an affiliated cafe paused operations due to smoke damage, Judge Jacqueline Scott Corley of the US District Court for the Northern District of California said in her order.

But a ruling from California’s high court will likely be needed to resolve the lingering questions around smoke damage, especially since insurance is regulated and litigated largely at the state level.

High Court ‘Tidal Wave’

The uncertainty over the California state appellate ruling means there will likely be “a tidal wave of letters” from policyholder-side firms and groups asking the state’s Supreme Court to depublish the decision—and a “proportionate response of insurer oppositions,” Sills Cummis & Gross insurance practice group co-chair Scott Greenspan said.

Requests for depublication must be submitted to the high court within 30 days after the decision is final in the intermediate appeals court. Once a request is filed, other parties then have an additional 10 days to submit their responses.

Depublication would be appropriate in the smoke damage case because the opinion focuses on a unique set of facts that arguably wouldn’t apply to many policyholders, McDonald said. “It doesn’t add anything to the law, so that reason alone should be a basis to depublish it.”

The policyholder bar will likely push for depublication rather than an appeal because of the unfavorable evidentiary record in the case, Greenspan said, but insurers would probably be happy to see an appeal and a high court ruling affirming their win.

“There’s going to be quite a battle between the insurance industry and policyholders over this decision,” Greenspan said.