Appeal from a judgment of the Superior Court of Orange County, W. Michael Hayes, Judge. Reversed with directions. (Super. Ct. No. 00CC04293).
The opinion of the court was delivered by: Sills, P. J.
CERTIFIED FOR PUBLICATION
At first we did not know what to make of this case. There was a $10 million judgment obtained by a nationwide groundwater pumping and control company, against its liability insurer. The compensatory damages -- all of which consisted of the attorney fees and costs incurred to sue the insurer for the $10 million -- were about $1 million.*fn1 What foul deeds had the insurer committed, we wondered, that merited such punishment?
At first the answer seemed simple.
At a meeting in Houston in May 1997, representatives of the insurer had, in order to induce the insured to renew its CGL*fn2 (that is, "third-party" liability) policy, orally promised representatives of the insured that the insurer would cover any "future" liability claims based on the release of sewage, even though the insurer, to that point, had steadfastly maintained that any liability based on sewage releases was excluded under the insurer‟s "total pollution exclusion."*fn3 The Houston meeting had arisen out of the insurer‟s disavowal of any coverage, or potential for coverage, for liability arising out of a certain sewage overflow in Laguna Beach. In particular, the insurer had disclaimed any coverage for the damages to the Laguna Beach home of Dr. and Mrs. Waters about a year and one half before arising out of an allegedly faulty sewer bypass constructed by the insured for a water district.*fn4 (In this opinion we will refer to that sewage backup as the "Waters claim" and the (alleged) promise made by the insurer in Houston as the "Houston Oral Promise."*fn5
When the district on whose behalf the insured had built the bypass settled the Waters claim, the district sued the insured to get its money back. But the insurer refused to defend this latter suit against the insured for about 11 months even though it had promised the insured that it would cover any "future" claims.
Hence, it initially looked to us like this case might indeed warrant punitive damages. After all, coming to us after a jury trial, the ambiguity in the word "future" (could it encompass the district‟s post-May 1997 suit against the insured? -- or, because it originally surfaced in the form of an informal claim by the district sometime earlier, was it a "past" claim?) would have to be construed in favor of the prevailing party -- the insured.
But then we started digging into the voluminous record with the help of able counsel on both sides who provided two rounds of supplemental briefing plus a second oral argument. And it was only after the second oral argument in April of this year that the case finally unfolded itself. The whole theory of liability based upon the Houston Oral Promise turned out to be an illusion that dissolved under scrutiny. Two items in particular made liability based on the Houston Oral Promise untenable:
First, the complaint never actually mentioned the oral promise made in Houston at all. Rather, the complaint was predicated on a straightforward coverage question based not on some oral promise made in Houston in May 1997, but on the written insurance policy as it stood in 1996. Essentially, the complaint said: We, the insured, had a sewage claim against us, and the insurance company denied our request for a defense of that claim because it interpreted the written insurance policy, with its total pollution exclusion, unreasonably.
Second, the complaint was never amended to include any cause of action based on the oral promise made in Houston in May 1997. In fact, before the trial, the insured‟s counsel expressly dropped an attempt to amend the complaint to state a claim based on that promise as a "stand alone" cause of action.
Why? The answer came out in the second oral argument. Rather than expose the merits of the issue to the jury, the insured‟s counsel wanted to rhetorically exploit the promise as a simple "concession" (his word at oral argument) by the insurer that its coverage position had been unreasonable all along.
But absent an amendment to the complaint, the Houston Oral Promise could not serve as a basis for recovery. It is elementary that a party cannot recover on a cause of action not in the complaint. (E.g., Mondran v. Goux (1875) 51 Cal. 151, 153 ["In other words, the cause of action, if any, established by the findings, is wholly different from that averred in the complaint, and is foreign to any issue raised by the proceedings. The rule is well settled that a plaintiff must recover, if at all, upon the cause of action set out in his complaint, and not upon some other which may be developed by the proofs."]; Walker v. Belvedere (1993) 16 Cal.App.4th 1663, 1670 [""It is a fundamental principle of pleading that "a plaintiff must recover, if at all, upon the cause of action set out in the complaint, and not upon some other which may be developed by the proofs."‟"].)
That left the breach of the written contract (the insurance policy) which was, after all, the actual basis for the jury‟s punitive damage assessment. But that assessment turned out to be the result of an error of law in a motion in limine in favor of the insured. Specifically, the trial court had ruled, in an in limine motion, that, as a matter of law based on the written contract and totally independent of the Houston Oral Promise, the insurer had breached the contract unreasonably so as to expose the insurer to tort, and maybe even punitive damages.
However, that theory would not hold up either. The ruling on the in limine motion (as we explain in probably too much detail below) was clear error, as shown by this court‟s opinion in Morris v. Paul Revere Life Ins. Co. (2003) 109 Cal.App.4th 966, a case which turns out to be directly on point. The trial court erroneously thought that because the case law was "unsettled" when the insurer first turned down the claim, that unsettledness created a potential for a covered claim. Morris, however, explained that if an insurance company‟s denial of coverage is reasonable, as shown by substantial case law in favor of its position, there can be no bad faith even though the insurance company‟s position is later rejected by our state Supreme Court.
Exactly that had happened in the case before us. Back in the late 1990‟s, at the time this insurer denied a request for a defense, there was ample case law and policy language to support the insurer‟s position. On top of that, this insurer changed its mind in favor of the insured more than six months before the California Supreme Court settled the question of correctness of the insurer‟s original position in MacKinnon v. Truck Ins. Exchange (2003) 31 Cal.4th 635.
And finally, there was the matter of damages for the insurer‟s initial and incorrect denial of coverage. It turned out, there weren‟t any. As to contract damages, the insurer had, long prior to the MacKinnon case, (a) settled all the litigation against the insured and (b) paid all the insured‟s attorney fees incurred in that litigation. As to tort damages, the insured‟s claims for attorney fees foundered on the reasonableness of the insurer‟s initial and incorrect denial. Because the denial was reasonable, no tort damages were available, including attorney fees -- often called "Brandt fees." (See Brandt v. Superior Court (1985) 37 Cal.3d 813; Cassim v. Allstate Insurance Company (2004) 33 Cal.4th 780, 808 ["without a tort judgment, there could be no Brandt fees"].)
We therefore reverse the approximately $11 million judgment, with directions to enter a judgment in favor of the insurer.*fn6
Because this is a bad faith case, perspective is best attained if the story is told in a timeline fashion. In particular, noting the time that specific events occurred is important here because it shows that:
(a) the insurer denied the requested defense long before the MacKinnon case came down;
(b) the insurer actually changed its mind and provided a defense relatively quickly after it had first denied it, and did so before the Supreme Court handed down the MacKinnon decision;
(c) the insurer changed its mind with sufficient speed that the insured never really paid anything in defense costs. Those costs were picked up by the insurer before the insured was ever billed for them.
Also, because this is a bad faith case, we quote the precise and full language of a number of important documents, so readers can easily see the "source materials" which reveal how the parties were dealing with each other.*fn7
A. Events Prior to Litigation
B. Events after the Litigation Began
A. The Basic Three-Part Paradigm For Analyzing Bad Faith Cases
B. The Reasonableness (or Lack Thereof) of the Insurer‟s Denial of a Defense to the Waters Claim
1. A Primer on the Potentiality Rule
2. The Question of an Objective Standard
4. "Congeries of Cerebrates": Why MacKinnon and Morris Show The Insurer‟s Decision Here Was Reasonable
5. The Insured‟s Attempt to Distinguish Morris Is Not Persuasive
a. Reasonability Is the Test in Both First and Third Party Cases
b. A Third-Party Insurer Has the Right to Make a Reasonable Coverage Decision Even if It "Benefits Its Own Interests"
1. The Failure to Amend the Complaint to Include a Cause of Action Based on the Houston Oral Promise Precludes Any Recovery Based on that Promise
2. The Reservation of Rights Issue
3. Miscellaneous Brandt Fee Issue
IV. CONCLUSION AND DISPOSITION
A. Events Prior to Litigation
1. November 1995-February 1996: The insured‟s work and the origin of the Waters claim
In early November 1995, Griffin Dewatering (usually referred to in this opinion as "the insured," sometimes as "Griffin"*fn8 ) agreed to fix a 75-foot manhole feeding into the main sewer line for the South Coast Water District (usually referred to as "the district").*fn9
The insured worked on the job sometime between November 1995 and February 1996. On February 6 and February 21, sewage backed up into the Laguna Beach home of Dr. and Mrs. Ron Waters, obviously resulting in extensive damage.
In late February 1996, the Waters submitted a claim form to the district. The claim form submitted by the Waters said that the "sewer line under construction by South Coast Water District backed up causing massive flow of raw sewerage [sic] into ground floor of our home on two occasions."
The Waters, however, never sued, and never would sue, on their claim.
2. March-April 1996: The insurer is requested to cover a claim not yet reduced to a lawsuit, and denies the request
In March 1996, (about March 8) the insurer*fn10 received notice of the Waters claim. It is not clear from the record precisely from whom the notice first came -- from the district or from the insured -- though it is clear that at least the insured had brought the matter to the insurer‟s attention in March 1996.
The next month, in April 1996, the insurer denied the claim in a letter dated April 11.*fn11 The insured‟s broker immediately disputed the conclusion in a letter sent on April 15, 1996.
3. May 1996-May 1997: the Waters claim is still a possible suit against the insured, and a bone of contention between the insurer and the insured
There is not much in the record about events in the May 1996 through May 1997 time period, except that the policy had come up for renewal in early February 1997 and the earlier denial of coverage for the Waters claim was clearly a sore spot for the insured.
4. May 1997: The Houston Meeting
In May 1997, there was a meeting between representatives of the insurer (including members of its environmental claims unit) and the insured (including its president, its in-house attorney, and its insurance broker) in Houston. This is the origin of the Houston Oral Promise mentioned above. The insured was unhappy with the denial of the Waters claim, and the insurer was apparently eager to retain the insured‟s business.
There is no dispute that there was some sort of oral promise made at the May 1997 meeting, but there is a dispute as to the precise nature of the promise. According to one of the insurer‟s underwriters who was at the meeting (as he would later testify at trial*fn12 ), the promise was that the insurer would consider sewage claims under a reservation of rights "and in many instances" make payments as a "business consideration." This same underwriter would also later testify that by the time of the Houston meeting, the decision on the Waters claim could not be altered but "similar-type claims" would be covered in the future.
In contrast to the resolute quality of the insurer‟s decision that there was no coverage at all for the Waters claim as described by one of the insurer‟s underwriters, the insured‟s president would later testify that he asked the same underwriter "if anything comes from South Coast are we covered, and the answer was yes." The insured‟s in-house attorney also testified that he "understood" the underwriter to be promising that "if the Waters claim suddenly had come back to life" that the insurer would "pay" it. And the insured‟s broker testified that he understood Griffin would be receiving something in writing to confirm Northern‟s new coverage position. (There is no dispute that nothing was ever received afterwards except a change in the pollution exclusion in the renewed policy to remove the phrase "in whole or in part" from the pollution exclusion.)
5. May 1997-May 1999: The district settles the Waters claim on its own and begins to think about looking to the insured for reimbursement
Around May 1999, the district paid the Waters nearly $417,000 to settle their claim against the district for the sewage backup. Now the district wanted to recoup that money from the insured.*fn13
6. Late September 1999-October 1999: The district sues the insured, the insured wants coverage from the insurer, the insurer denies the request
In September 1999, the district sued both the insured and the insurer*fn14 to recoup its expenditures to settle the Waters claim. The insured was served with the suit "within a day or two" of September 29, 1999, and, in a letter dated October 1, 1999, the insured‟s broker enclosed the lawsuit brought by the district against the insured (as well as the insurer itself), requesting coverage (presumably a defense or settlement, since no judgment had been entered against the insured at that point).*fn15
A representative of the insurer telephoned with a "verbal response," to the effect that there would be no coverage for the suit. The insurer did not think a written response was necessary because there had been three prior denials.
As it turned out, though, the insured was never out-of-pocket for any defense costs during the pendency of the suit. The insured had an excess insurance policy with another insurance company (AIG -- yes, that AIG), and AIG agreed to hire a defense firm to defend the insured against the district and "invoice" the bills to the insured. Essentially the excess insurer would be fronting money for the defense. The insured‟s in-house counsel would later admit on cross-examination that the district‟s case against it was settled (as we shall soon ...