The Ninth Circuit Court of Appeals affirmed summary judgment in favor of Philadelphia Indemnity Insurance Company (“Philadelphia”) regarding its denial of coverage to Oak Park Unified School District (“Oak Park”) based on a “design defect” exclusion in its policy, holding the denial was not in bad faith even though the Ninth Circuit had previously found the defect exclusion was ambiguous.ⁱ

Background

The coverage dispute arose from an accident on May 11, 2014 at an Oak Park soccer field where the plaintiff in the underlying action Darrell Arendts sustained serious injuries when he fell down a steep embankment while chasing an errant soccer ball.ⁱⁱ Mr. Arendts was a spectator watching his granddaughter play at the Oak Park field.ⁱⁱⁱ Mr. Arendts alleged the steep embankment behind the soccer field without fencing or warnings and obscured by tall grass was a “hidden trap.”^iv Oak Park was an additional insured on a Philadelphia policy issued to United States Club Soccer (“USCS”).^v Philadelphia denied Oak Park’s tender for defense and additional insured coverage relying on a coverage exclusion in the policy for bodily injury arising out of design defects.^vi

The district court granted Philadelphia’s prior summary judgment motion finding the defect exclusion barred any potential for coverage, thereby also preventing the duty to defend from triggering.^vii The district court reasoned Arendts’ complaint allegations the embankment lacked any “fencing, guards, barriers or warning” clearly fell within the design defect exclusion.^viii The Ninth Circuit reversed, determining the policy terms in the defect exclusion were ambiguous, construing them in favor of the insured Oak Park to find a potential for coverage existed and Philadelphia had a duty to defend Oak Park.^ix

After Philadelphia picked up and paid for Oak Park’s legal defense, the only remaining issues were Oak Park’s bad faith and punitive damage claims based on the original denial. Philadelphia renewed its summary judgment motion on these issues, claiming it acting reasonably in denying Oak Park’s claims based on its interpretation of the defect exclusion.^x The District Court agreed, granting Philadelphia’s second motion for summary judgment. The court held the coverage denial was not in bad faith because Philadelphia reasonably interpreted the defect exclusion based on the fact any potential liability in the Arendts’ lawsuit would require a legal conclusion a dangerous condition existed on the Oak Park premises and therefore would fall within the defect exclusion.^xi The district court also found there was no basis for punitive damages. Oak Park appealed to the Ninth Circuit.

Analysis

On Oak Park’s appeal, the Ninth Circuit reviewed the District Court’s grant of summary judgment de novo. The first issue addressed by the Ninth Circuit was whether the District Court improperly relied on cases which interpreted the term “design defect” consistent with Philadelphia’s interpretation. The Ninth Circuit found it was within the district court’s purview to do so.^xii According to the Ninth Circuit, “Under well-settled California law, a court’s subsequent analysis of a policy exclusion can serve as evidence an insurer acted reasonably when it interpreted the policy similarly.” The Ninth Circuit cited a California Court of Appeal decision which reasoned “if…the coverage issue turns upon analysis of a legal point—and assuming the governing law has not changed in the interim—the fact that a court had interpreted that law in the same manner as did the insurer, whether before or after, is certainly probative of the reasonableness, if not necessarily the ultimate correctness, of its position.”^xiii

The second issue raised by Oak Park’s appeal was whether Philadelphia conducted an adequate investigation before denying coverage.^xiv The Ninth Circuit reasoned there was no relevant correlation between the adequacy of the investigation and the reasonableness of Philadelphia’s interpretation of the policy exclusion: “[E]ven if the evidence permits an inference that Philadelphia conducted an inadequate investigation, it would be insufficient to overcome summary judgment here.”^xv Citing two California cases, the Ninth Circuit explained the test for deciding whether a denial is reasonable is an objective one, the insurer’s subjective state of mind is immaterial.^xvi

The third and final issue raised on appeal was whether the district court ignored the law of the case doctrine based on the prior appeal in this case.^xvii The Ninth Circuit explained for the law of the case doctrine to apply, the issue must have been decided either explicitly or by necessary implication in the previous disposition.^xviii The Ninth Circuit explained the first appeal was limited to whether the duty to defend was not triggered because the defect exclusion eliminated the possibility of coverage.^xix In reversing the summary judgment, the Ninth Circuit explained it construed the terms of the exclusion narrowly in favor of the insured and found certain terms were ambiguous.^xx However, the Ninth Circuit did not address whether Philadelphia’s contrary interpretation was reasonable and nothing in the district court’s disposition memorandum suggested Philadelphia “’ignored’ any ‘factual issues’ in its investigation or denial as Oak Park asserts, or that it otherwise acted unreasonably.”^xxi

As for punitive damages, the Ninth Circuit affirmed because the punitive damage claim was derivative of the bad faith claim, and because there was no bad faith, there necessarily was no basis for punitive damages. ^xxii

Takeaway

The Ninth Circuit’s holding reinforces California’s objectively reasonable standard for evaluating an insurer’s actions based on its interpretation of policy language. Here, the fact the Ninth Circuit had previously found the defect exclusion to be ambiguous did not mean Philadelphia’s coverage denial based on its objectively reasonable interpretation of the exclusion was tantamount to bad faith. Furthermore, the fact Philadelphia’s investigation of the claim may or may not have been inadequate did not mean its ultimate decision to deny the claim constituted bad faith, because the decision was based on an objectively reasonable interpretation of the defect exclusion.

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