Failure to Fulfill Warranty Prevents Policy from Attaching to Risk

An Assignment of a Bad Faith Claim is Worthless if there is no Coverage

Insurance policies include conditions precedent and warranties to protect the insurer against being compelled to indemnify an insured for risks the insurer had no intent or desire to insure. Litigants seek assignments from tortfeasors against insurance companies to obtain punitive damages in addition to a judgment. This only works, however, if counsel reads and understands the policy that will be the subject of their suit.

In Debra Gray et al. V. American Safety Indemnity Company, B289323, Court of Appeal of the State of California Second Appellate District Division Four (December 3, 2018) Plaintiffs Debra Gray and numerous other former tenants of an apartment building successfully sued the owner for multiple serious habitability violations. They did so as part of a settlement with the owner, which included an assignment of the building owner’s claim for bad faith and breach of contract against the owner’s insurer—American Safety Indemnity Co. (ASIC)—after ASIC refused to defend and cover those claims.

FACTUAL BACKGROUND

On February 14, 2013, plaintiffs asserted claims for habitability against New Hampshire, including breach of the warranty of habitability, breach of the covenant of quiet enjoyment, negligence, and related claims based on the conditions of the property. Plaintiffs alleged that the premises were infested by vermin and cockroaches, lacked security, had broken windows and doors that were off their hinges, lacked adequate water supply, heat, proper sewage disposal, and the smoke detectors were either missing or inoperable, and was generally unsanitary and in poor repair. (Habitability Action.)

New Hampshire was insured by ASIC. ASIC refused to defend New Hampshire.

A settlement agreement (Agreement) entered into between plaintiffs and New Hampshire on April 30, 2014, provided for the release of New Hampshire from plaintiffs’ claims and assignment of New Hampshire’s claims against its insurer to plaintiffs, based upon certain terms and conditions including a release of New Hampshire. After a trial by reference  the judge ruled in favor of plaintiffs and issued a judgment for $1.3 million against New Hampshire. A corrected judgment was entered that specified numerous deficiencies in the property, including “lack of smoke detectors, or smoke detectors that were inoperable.”

Plaintiffs sued ASIC alleging claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief. Plaintiffs asserted that ASIC had refused to defend New Hampshire in the Habitability Action, and refused to provide coverage.

ASIC successfully demurred to the second amended complaint. ASIC argued that plaintiffs failed to satisfy a condition precedent, precluding coverage. ASIC relied on the insurance policy’s language regarding the “Protective Safeguard Promissory Warranty.” The language of this warranty provided that “the insured shall maintain in complete working order all equipment and services pertaining to the operation of the described protective safeguard. . . . [¶] Smoke Detectors in all units/living spaces. [¶] Breach of any warranty(s) shall render coverage provided by this policy null and void.”

ASIC argued the complaint and first amended complaint in the habitability action alleged a “lack of smoke detectors, or smoke detectors that are inoperable.” ASIC requested judicial notice of tenants’ complaints regarding the property and citations from the Los Angeles Department of Housing, which stated that the property lacked operating smoke detectors.

Plaintiffs claimed substantial compliance with the warranty. Plaintiffs also asserted compliance with the smoke detector requirement should be equitably excused because the missing or unrepaired smoke detectors constituted a technical forfeiture.

DISCUSSION

Plaintiffs assert that their position in the two actions regarding the condition precedent (the smoke detectors) is not inconsistent, and in any event, factual issues regarding substantial compliance, waiver, and equitable excuse preclude demurrer.

NEW HAMPSHIRE’S FAILURE TO SATISFY THE CONDITION PRECEDENT PRECLUDES COVERAGE UNDER THE POLICY.

The Protective Safeguard Promissory Warranty is a Condition Precedent to Coverage Under the Policy.

A condition precedent refers to an act, condition, or event that must occur before the insurance contract becomes effective or binding on the parties. Conditions precedent in insurance policies neither confer nor exclude coverage for a particular risk, but impose certain duties on the insured in order to obtain the coverage provided by the policy. The existence of a condition precedent depends on the intent of the parties as set forth in the insurance contract.

Here, New Hampshire’s policy specified that “BREACH OF ANY WARRANTY(S) SHALL RENDER COVERAGE PROVIDED BY THIS POLICY NULL AND VOID.” New Hampshire failed to satisfy this condition, and as a result ASIC’s obligation to provide coverage under the policy never accrued. (See American Way Cellular, Inc. v. Travelers Property Casualty (2013) 216 Cal.App.4th 1040, 1055 [insured failed to maintain sprinkler system as required by the terms of the endorsement].)

Here, the court only needed to look to the judgment in the habitability action to conclude plaintiffs are estopped from asserting the smoke detectors were in substantial compliance with the warranty condition. The judgment in the habitability action made a finding that “[p]laintiffs allege that during the time they resided at the Property, they became aware of defective and dangerous conditions at the Property, including: . . . [¶] Lack of smoke detectors, or smoke detectors that are inoperable.” The judgment further found, “[p]laintiffs allege that because of the defects such as those listed above [including missing or inoperable smoke detectors], the premises of the Property were rendered uninhabitable and unfit for human occupation.”The factual summary included the allegations concerning the lack of smoke detectors. Plaintiffs was unable to change their position in the proceeding and assert that the smoke detectors were installed and functioning, or at the very least that their condition was in substantial compliance with the condition precedent of the policy.

Similarly, under principles of collateral estoppel, plaintiffs cannot assert that the condition precedent was satisfied. Issue preclusion prohibits the relitigation of issues argued and decided in a prior case, even where the second suit raises different causes of action.  Here, the judgment in the habitability action found nonfunctional or missing smoke detectors, the same issue plaintiffs assert here as the basis for the bad faith complaint. Plaintiffs are bound by that finding.

For a Condition Precedent in a Warranty to Void Coverage, No Nexus to the Loss is Necessary.

Generally, an insured must be in strict compliance with a condition precedent to the right of recovery under a policy. As explained in Wells Fargo & Co. v. Pacific Ins. Co. (1872) 44 Cal. 397, 412, ‘”the very meaning of a warranty is, to preclude all question whether it has been substantially complied with; it must be literally”‘ complied with.

Lack of a nexus to the loss does not vitiate a warranty as a precondition to coverage. “California courts have held the breach of even an immaterial warranty will void a policy ‘where the policy expressly declares that it shall avoid it.’ [Citation.].” (Certain Underwriters at Lloyd’s v. Montford (9th Cir. 1995) 52 F.3d 219, 223.) In Certain Underwriters, the insured obtained a policy on a vessel that contained a “cruising warranty” that specifically excluded Colombian and Nicaraguan waters, and that a breach of the warranty would render the policy “null and void.” The insured sought reimbursement after the vessel disappeared from its berth in Costa Rica. The captain admitted that the vessel had recently cruised in waters near Colombia one month before it disappeared.  The court concluded that no nexus was required.

No Equitable Excusal of Condition.

Finally, plaintiffs argue that because enforcement of the warranty will result in a forfeiture in this instance, they should be equitably excused from compliance with a condition (smoke detectors) that has no relationship to the loss (habitability).

There are no grounds for equitable excusal. There is no evidence that New Hampshire’s compliance with the condition was rendered nearly impossible to perform or that New Hampshire made any effort to honestly comply with the condition before obtaining the insurance.

The failure to have operational equipment does not work a forfeiture but merely prevents the insurer’s obligation under the policy from accruing.

ZALMA OPINION

Warranties are a special type of promise made by the insured that, as a condition precedent, prevents a policy from attaching to a risk of loss. In this case the insured promised to have operational smoke detectors in every unit of the building. The insured, New Hampshire, had failed to maintain the smoke detectors and the trial court in the underlying action ruled against New Hampshire because, among other reasons, failed to protect the tenants with smoke detectors. As a result the insured failed to fulfill the warranty and the policy never attached to the risk of loss.  As a result the assignment the plaintiffs obtained from New Hampshire was worthless because the policy never attached to the risk.


© 2018 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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