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Environmental Investigations Performed Under Consent Orders with the Government Are Not Covered as Defense Costs, Court Rules

June 21, 2018

A federal court has issued a significant insurance coverage decision at odds with the years-long practice in Washington State of resolving cleanup liability disputes with the government short of trial. One consequence of the ruling—intended or otherwise—is to make litigation between the government and insured parties an unwelcome but sometimes necessary option to cover environmental investigation costs that insurance companies previously more willingly paid.

In Travelers Indemnity Co. v. City of Richland,[1] a judge in the Eastern District of Washington held that an insurer’s duty to defend a policyholder ends when the insured agrees to do work under a consensual administrative order (known as an “Agreed Order”). In simplest terms, the court held that once a party commits in an Agreed Order with a government agency to perform certain work—in this case, the remedial investigation and feasibility study at a contaminated site—there is no longer an adversarial relationship between the parties, and therefore nothing left to “defend.”

The area of insurance law the court addressed in the City of Richland case—the scope of the insurer’s duty to defend—may sound dry as dust, but it is critically important to Washington policyholders who are relying on their insurance to defray cleanup costs. Under the insurance policies at issue, the insurer takes on two distinct duties: (1) the duty to defend the policyholder against liability claims; and (2) the duty to pay the policyholder’s legal liability to a claimant, i.e., settlements, judgments, or, in the environmental context, the cost of conducting the prescribed cleanup (the latter duty is also called the “duty to indemnify”). Under Washington law, the legal standard for triggering the duty to defend is low: any claim against the policyholder that is “conceivably covered” under the policy commences the insurer’s duty to defend. Once that duty is “triggered,” the insurer must pay the costs of defending the policyholder—the fees of the insured’s attorneys and technical consultants—on an ongoing basis, and without regard to any potential coverage defenses the insurer might have (i.e., defenses going to the duty to indemnify, under which the legal standard is much higher). Further, defense costs typically are paid without limitation and independent of the policy’s coverage limits. Thus, a policy written many years ago with modest limits of liability (say, $100,000) may nonetheless allow the insured to avoid paying hundreds of thousands or even millions of dollars in defense costs. Costs falling outside the duty to defend may ultimately prove to be covered under the policy limits as “indemnity,” but the policyholder faces a longer and more uncertain road to recovering indemnity costs as “damages,” and the amount of recoverable damages is limited by the limits of the policy at issue.

Washington’s cleanup program, known as the Model Toxics Control Act (“MTCA”), and to some extent the federal cleanup program under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) are premised on cooperation between the government and regulated parties. Both MTCA and CERCLA make going to court to fight with the government expensive and uncertain. It exposes parties to the risk of penalties, increases the transaction costs for all parties, and leaves decision-making for judges who often lack the technical training to decide complex scientific cases. The state and federal Superfund laws were designed this way—to make the risks of non-compliance severe enough that parties, even parties with an arguable defense to liability, would cooperate, at least through the investigative phase, reserving their battles for a later day, perhaps over the extent of the cleanup remedy.

Precisely because of the way MTCA and the federal Superfund system were constructed, the overwhelming majority of cleanups in Washington and elsewhere are conducted either “voluntarily” or administratively, the latter through Agreed Orders at the state level or Administrative Orders on Consent (“AOCs”) at the federal level. The court system has traditionally gotten involved only if a party refuses to do the work, and the State or the United states is forced to bring an action to compel the work to be performed.

Until recently, the insurance industry signed on to the proposition that the system of voluntary and cooperative cleanups was in its self-interest as well. Insurers routinely paid for consultants to conduct remedial investigations (“RIs”), time-critical removal actions, and, in some cases, feasibility studies (“FSs”) as “defense costs,” including in cases in which the work was being conducted pursuant to an Agreed Order or AOC. For decades, insurers recognized that these tasks were a fundamental part of the policyholder’s defense against the government’s cleanup claims, and that the presence or absence of an Agreed Order or AOC did not change their coverage decision. Further, from the insurers’ perspective it was believed to be better to pay the consultants to do the work as “defense” costs than to pay the lawyers and experts to fight with the government. A lawsuit brought by the government would certainly be considered a cost of defense, and could lead to less favorable outcomes, including penalties assessed against their insureds.

More recently, however, at least some insurers began taking a different position. In Gull Industries, Inc. v. State Farm Fire & Casualty Co.,[2] the Washington State Court of Appeals addressed whether a letter from Ecology to the owner of a contaminated property confirming the existence of contamination exceeding cleanup standards was the equivalent of a “suit” triggering an insurer’s duty to defend the property owner. The appeals court held that it was not, because the letter “did not communicate any explicit or implicit threat of immediate and severe consequences” if the contamination was not addressed.

While it addressed a different factual situation, the City of Richland case follows a similar logic. Without citing Gull Industries, the federal court that decided City of Richland was persuaded that “defense” costs are triggered only where there is something to defend—i.e., “immediate and severe consequences” of non-compliance, or something like it. Because the City of Richland was cooperating with Ecology, by entering into an Agreed Order, rather than litigating with it, or refusing to comply with an order, the court ruled that the City’s insurers no longer had a duty to defend it, at least with regard to the work required by Agreed Order: the costs of performing a RI/FS.

City of Richland had to do with the Horn Rapids Landfill, a municipal landfill. In March 2016, Ecology notified the City of that it was a potentially liable person (“PLP”) under MTCA at the landfill. The City notified Ecology that it accepted its status as a PLP.

The City thereafter tendered Ecology’s claim to Travelers and demanded that Travelers provide a defense and indemnity under the City’s policies. After a period of dispute, Travelers eventually agreed to pay the City’s defense costs from the date of Ecology’s PLP letter until the date that the City executed an Agreed Order with Ecology. The Agreed Order, which the City provided to Travelers in draft form, required the City to conduct an RI/FS at the site. After the Agreed Order was final, Travelers announced that it had satisfied its obligations to pay the City’s defense costs with respect to the defense of the Agreed Order. Any work under the Agreed Order, according to Travelers, was not “defense” in nature, and was instead “damages,” which should be characterized as “indemnity” for insurance purposes.

Travelers sued the City, seeking a declaration that the insurer had no defense or indemnity obligation with respect to the landfill. However, Travelers’ motion for summary judgment was limited to its claim that any investigatory costs that the City incurred under the Agreed Order were damages (i.e., costs potentially recoverable as indemnity, not defense, under the City’s insurance policies). The City brought a cross-motion for summary judgment, arguing that Travelers’ duty to defend was not terminated by the Agreed Order.

The court started by reaffirming some basic principles of Washington environmental coverage law, including that coverage is provided when PLPs engage in cleanups in the cooperation of environmental agencies, and that a settlement agreement with an environmental agency, which resolves a party’s liability, means that cleanup costs are damages for insurance coverage purposes. The court also referred to a 2010 decision from the eastern district, Teck Metals, Ltd., v. Certain Underwriters at Lloyd’s,[3] holding that a settlement agreement between a liable party and the Environmental Protection Agency (“EPA”) requiring the liable party to conduct an RI/FS obligated the insurers to pay such costs as damages. That decision had concluded, according to the court, that RI/FS costs in that case did not “represent investigation costs incurred in defense of a claim.”

The court acknowledged that an Agreed Order, under Washington law, is not a settlement agreement, which the City’s Agreed Order made clear. However, according to the court, “the Agreed Order settled the questions of whether [the City] would perform the RI/FS.” For this reason, relying on the Teck decision, the court found that “the costs of performing the RI/FS are damages, rather than defense costs.” The court therefore granted summary judgment in favor of Travelers, holding that such costs were “damages” and characterized as indemnity under the applicable policies.

The court acknowledged, however, the ample Washington State case law holding that the duty to defend continues “until the suit it is defending is resolved by settlement or judgment,” and that “the RI/FS is but one step of the many necessary to address such legal and environmental quagmires.” The court therefore held that, although “the Agreed Order resolved [the City’s] liability to perform the RI/FS,” the City nonetheless “faces future liability related to the cleanup of the” landfill. As a result, according the court, Travelers “has a duty to continue to defend [the City] while liability is being determined,” because the City “faces future liability for hazardous substances cleanup under” MTCA. The court granted summary judgment in favor of the City with respect to Travelers’ ongoing duty to defend, but excluded from that duty the obligation to pay the City’s RI/FS costs.

The decision is consequential, even if limited only to RI/FS costs, because those costs routinely approach or exceed $1 million per site. For a small city like Richland, already struggling to meet public needs, the costs of funding an investigation into a City landfill can mean not being able to provide other basic services.

Implications

In Washington, Agreed Orders are often used not only for the RI/FS work at issue in the City of Richland decision, but also for interim actions taken to address “emergency” situations, like open storage of waste drums, or threats to drinking water. Aspects of such work, which can run into the millions of dollars, have historically fallen within the category of “defense costs” under typical CGL policies, which has provided PLPs/insureds with funds to develop data from contaminated sites that is often pivotal to understanding the PLP/insureds’ potential defenses to liability at the site as a whole, before the final remedial action costs have been determined.

Based on the City of Richland decision, a policyholder in Washington State relying on its insurer(s) to pay its defense costs will have to think twice about agreeing to do anything under an Agreed Order or AOC. If the logic of City of Richland is adopted by Travelers and other insurers broadly, any party who does work by agreement with the government will pay those costs upfront, and can only recover them, if at all, if they prevail in proving down the road that their insurer breached their contract—possibly only after an expensive coverage trial, and only if the costs are within their coverage limits.

Brad Marten is a partner with Marten Law PLLC. He can be reached at 206-292-2600. Frank Cordell is a partner with Gordon Tilden Thomas & Cordell, LLC. He can be reached at 206-467-6477.

[1] No. 4:17-CV-5200, Dkt. 27 (E.D. Wash. May 30, 2018).

[2] 181 Wn. App. 463 (2014).

[3] 735 F. Supp. 2d 1260 (E.D. Wash. 2010).

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