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LOS ANGELES-General liability insurers in California now must defend policyholders against cleanup orders by governmental environmental agencies.

In partially overturning a lower court's December 1995 ruling, a California appellate court on July 3 unanimously found that a pollution cleanup order by a state or federal environmental regulatory agency is equivalent to a lawsuit. As a result, a potentially responsible party is entitled to a defense from its comprehensive general liability insurers against such orders.

The policyholder's insurers in the case argued cleanup orders are comparable to claims, not suits. Under CGL policies, claims do not trigger insurers' duty to defend policyholders.

While CGL policies typically distinguish between suits and claims, they do not define those terms. As a result, courts nationwide have been at odds over whether a cleanup order is equivalent to a lawsuit.

Although the California appellate court's decision is not groundbreaking, it is important for policyholders in California and in other states where courts have not ruled on the issue, policyholder attorneys said.

"For environmental coverage in California, it's significant because it's the first reported decision on this issue," said policyholder attorney Barry J. Shotts, who represents the policyholder in the California appellate court case.

And, now that California, a leading state in insurance and environmental law, "has weighed in on the issue, it carries quite a bit of weight in other states, I think," said Mr. Shotts, a partner with Latham & Watkins in San Diego.

"You don't want to have a decision where you have a state taking a formal administrative position against a policyholder and the policyholder being left without a defense because of some fiction by an insurance company attorney" that a cleanup order is not a legal action by the government against a policyholder, said policyholder attorney Robert M. Horkovich, a partner with Anderson Kill & Olick P.C. in New York. Mr. Horkovich was not involved in the case.

An insurer attorney said the decision unfairly burdens insurers.

"This is a decision which tortures the definition of the word 'suit' to reach results which the court wants," said Bernard London, who was not involved in the case.

"Rather than look up the word 'suit' in Webster's Dictionary and afford it its logical common-sense meaning, the court undertakes an extremely lengthy analysis which concludes that a PRP (letter) is indeed a suit," said Mr. London, of London Fischer in New York. "This court's reasoning rewrites the insurance contract and forces a cost not underwritten and for which no premium was paid to the insurer."

In the case, pesticide and fertilizer wholesaler Foster-Gardner Inc. of Coachella, Calif., has incurred hundreds of thousands of dollars in defense costs since 1992, according to Mr. Shotts. That is when California's Environmental Protection Agency ordered the company to investigate and remediate pollution at its Coachella site.

The company is seeking a defense from the insurers that wrote its CGL insurance from 1970 until 1986. Those insurers, which Latham & Watkins estimates wrote a total of at least $5.5 million dollars of limits, are National Union Fire Insurance Co. of Pittsburgh, Pa., a subsidiary of American International Group Inc.; Fremont Indemnity Co., a subsidiary of Fremont General Corp.; Pacific Indemnity Co., a subsidiary of Chubb Corp.; and Ranger Insurance Co., a subsidiary of Fairfax Financial Holdings Ltd.

The insurers' attorneys at Sinnott, Dito, Moura & Puebla in Los Angeles did not return calls.

Including the California appellate court ruling, courts in at least 15 states have determined that a pollution cleanup order amounts to a lawsuit, according to court papers and attorneys.

The 2nd U.S. Circuit Court of Appeals, interpreting New York law, also has ruled such actions are the equivalent of lawsuits. A New York state court reached the same finding.

Courts in at least seven states and the 6th Circuit, which interpreted Michigan law, have sided with insurers on the issue. However, the Michigan Supreme Court later rejected the notion that cleanup orders are not lawsuits. It sided with policyholders in 1994.

In the California appellate court's 3-0 decision, written by Justice John Zebrowski, the court examined many of those rulings-including dissenting opinions-at length.

Justice Zebrowski summed up that the rulings can be categorized in three ways.

Courts that have rejected the notion that cleanup orders are lawsuits have adopted the "literal meaning" approach. Those courts find that cleanup orders and related pre-lawsuit proceedings do not trigger a duty to defend because they are not literally suits in court.

Those courts generally also have found remediation costs are not covered damages under CGL policies.

Other courts have adopted a "functional approach" in determining that cleanup orders and proceedings that precede remediation lawsuits are equivalent to lawsuits. Those courts have found that the term "suits" in CGL policies is unclear and that the legal procedures created by environmental protection statutes have functional attributes and ultimate consequences of lawsuits.

Those courts also have determined that cleanup costs are covered damages under CGL policies.

Still other courts have taken a hybrid approach. Some have determined that the earliest notification from environmental agencies is not tantamount to a suit, though subsequent cleanup orders are. Other courts have found that even the earliest notifications are equivalent to suits.

In adopting the so-called "functional approach," the appellate court cited several factors, including:

The lack of definitions for "suit" and "claim" in CGL policies. Therefore, the term "suit" must be construed to mean what the policyholder reasonably could have expected, Justice Zebrowski wrote.

The California Supreme Court's unanimous 1990 decision to adopt the "functional approach" in determining that cleanup costs are covered damages under CGL policies. "There is no principled basis on which a non-technical functional analysis could properly control the 'damages' issue in (the 1990 Supreme Court case), while a strictly technical and literal analysis controlled the 'suit' issue," Justice Zebrowski wrote.

The nature and irrevocable consequences of California's environmental cleanup statute, which take place before a traditional lawsuit is filed in court, lie "somewhere between a traditional lawsuit in a court and a traditional claim," Justice Zebrowski wrote. The 1990 California Supreme Court decision "teaches" the appellate court that such an ambiguity-produced by the combination of unclear policy language and "new schemes for remediating pollution"-must be "construed against the insurer," the judge wrote.

Even with its court victory in hand, Foster-Gardner still must clear another legal hurdle before it can recover the legal costs it says it has incurred in defending against the cleanup order.

The appellate court upheld the lower court's decision to reject the company's summary judgment motion to compel its insurers to reimburse it for its defense costs. The appellate court ruled that Foster-Gardner has not provided a detailed accounting of those costs. The company's insurers argue that at least some of those costs are not defense-related, said Mr. Shotts, Foster-Gardner's attorney.

But, Mr. Shotts said all of Foster-Gardner's costs were defense-related, because they were incurred in, among other things, responding to demands for information, raising available defenses, searching for other PRPs, trying to convince Cal-EPA it was not responsible and preparing a pollution remediation plan.

The court included those activities in the defense cost standards it outlined in both published and unpublished portions of the decision, Mr. Shotts said.

Foster-Gardner Inc. vs. National Union Fire Insurance Co. of Pittsburgh Pa., et al., California Court of Appeal; No. B099340