Association responsible for insurance, but is condo unitowner's policy valueless?

The woman bought a "condominium owners" insurance policy. Withrespect to coverage for real property, it stated in part: "We willcover items of real property pertaining directly to your residentpremises which are your insurance responsibility as expressed orimplied under the governing rules of the condominium."

In March 2002, the insured submitted a claim, seeking coveragefor water damage to the interior of her condominium unit thatresulted from a water leak in a neighboring unit. The carrierdenied the claim, stating that the homeowners association wasresponsible for obtaining insurance for the claimed loss. The womansued the insurer for breach of contract, breach of the impliedcovenant of good faith and fair dealing, and fraud.

At a hearing before the trial court, the woman's counselclarified that she initially made a claim for the water damage tothe homeowners association's insurer but that it denied the claim,based on its assertion that its policy "doesn't cover floods." Herlawyer stated that the woman could amend the complaint to reflectthese facts. The trial court, however, did not allow thisamendment.

The trial court ultimately concluded that even if the woman wereallowed to amend her complaint, it would not state a basis forrecovery, because the homeowners association's regulationsunambiguously placed sole responsibility for insuring her unit'sinterior structures on the association itself. Accordingly, thecourt sustained the insurer's demurrer (a plea in response to anallegation that admits its truth but also asserts that it is notsufficient as a cause of action). The woman appealed.

The appeals court said it would review the case de novo (as iffor the first time), thus exercising its own judgment about whetherthe woman's complaint stated a cause of action.

Two sections of the condominium's CC&Rs addressed the matterof insurance for real property and improvements. They read in partas follows:

"Section 8.2: Fire and Extended Coverage Insurance. TheAssociation also shall obtain and maintain a master or blanketpolicy of fire insurance for the full insurable value of all of theimprovements within the Development. The form, content, and term ofthe policy and its endorsements and the issuing company must besatisfactory to all institutional first mortgagees."

"Section 8.3: Individual Fire Insurance Limited. Except asprovided in this Section, no Owner can separately insure his Unitor any part of it against loss by fire or other casualty covered byany insurance carrier under Section 8.2. If any Owner violates thisprovision, such Owner will be liable for any diminution ininsurance proceeds otherwise payable.... Any Owner can, however,insure his personal property against loss. In addition, anyimprovements made by an Owner within his Unit may be separatelyinsured by the Owner, but the insurance is to be limited to thetype and nature of coverage commonly known as tenant'simprovements. All such insurance that is individually carried mustcontain a waiver of subrogation rights by the carrier as to otherOwners, the Association and Declarant."

The court observed that both the insurer and the insuredrecognized that the primary purpose of these provisions was toavoid double coverage. "If both the master and individual policycover the same loss, the unit owner may be compelled to pay twicefor the same insurance-once through homeowners association dues andthen again through individual policy premiums. Additionally, doublecoverage can lead to disputes over control of proceeds and to therisk of subrogation disputes, the court noted.

Because the carrier incorporated the homeowners associationrules into its policy, the appeals court said that it was necessaryto "not only determine the meaning of the words contained in thefour corners of the insurance policy, but also to determine themeaning of the language used in the CC&Rs.... Unless therelevant language in these two documents is clear and unambiguouslyestablishes that (the insured's) claim is not covered, the demurrershould have been overruled."

The insurer argued there was no coverage under its policybecause it could be triggered only by real-property damage that wasthe woman's responsibility to insure. But under the CC&Rs, theresponsibility for insuring this property was solely the homeownersassociation's, the insurer said. The court, however, declined toconclude that the only reasonable interpretation of the policy'scoverage for real property was that it had "no potential value to acondominium owner."

The question, the appeals court said, was whether the insuredalleged-or could amend her complaint to allege-that she had theimplied responsibility under Sec. 8.3 to insure the property thatwas damaged.

The insured first argued that the interior structure of thecondominium constituted an "improvement" within the meaning of Sec.8.3. The appeals court, however, held that her interpretation was"unsupported by the plain language of the insurance policy and the(homeowners association's) CC&Rs." Sec. 8.2, the court noted,made the homeowners association responsible for obtaining fireinsurance, extended coverage, and a special form endorsement for"all of the improvements within the Development." However, Sec. 8.3then makes an exception for "improvements made by an Owner," thecourt said, but limits the word "improvements" to those additions"commonly known as tenant's improvements." This more limiteddefinition is further qualified by the statement in Sec. 8.3 thatthose "improvements" must have been added "by an Owner." Thisinterpretation, the court observed, also was consistent with aprovision of (the insurer's) policy stating that covered realproperty includes "fixtures...installations or additions...onlywhen situated within that portion of the premises used exclusivelyby you and made or acquired at your expense." The insured did notallege damage to improvements "made or acquired at (her) ownexpense," the court said, only that the water had damaged a portionof the premises that she used exclusively.

The court also rejected the insured's argument that since theCC&Rs imposed responsibility on individual owners to repair andmaintain the interior surfaces of their units, they also madeindividual owners responsible for insuring these interiorstructures. There was nothing in the CC&R's, the court said,that "equates maintenance responsibility with insurance coverageresponsibility."

The appeals court found, however, that the insured met herburden to show "a reasonable probability she could amend heroriginal complaint to show damages to 'improvements' under Section8.3." In her appellate brief, she clarified that the water damagerequired her to repaint walls and replace carpet pads. The courtheld that paint and/or a carpet pad could conceivably constitutethe type of improvement commonly known as a "tenant's improvement"within the meaning of Sec. 8.3. Moreover, based on the insured'scounsel's comments at oral argument, it appeared reasonablyprobable that the insured could allege that these real propertyitems were added to the unit by a condominium owner and thus "madeor acquired at (the insured's) expense" within the meaning of theapplicable insuring clause.

The insured also argued the trial court erred in sustaining thedemurrer because the alleged damages were not covered under thehomeowners association's insurance policy. That made them herresponsibility, she said, and thus covered by her policy. Theappeals court said that "because the insured never alleged the lackof Homeowners Association insurance coverage or even mentioned theHomeowners Association's policy in her complaint, these facts werenot before the trial court and thus the court could not haveoverruled the demurrer on this basis." The appeals court agreedthat the insured should have been allowed to amend her complaint toinclude these allegations. With these amendments, the complaintwould state an actionable claim at the pleading stage, the courtsaid.

The appeals court ruled that if the insured could amend hercomplaint, the litigation could proceed beyond the pleading stage.That would permit the parties to present any extrinsic evidencerelevant to resolving the ambiguities in the policy and then enablethe trial court to apply settled insurance construction rules todetermine the meaning of the insurance clause and any applicableexclusions. This would have to be done before the fraud andbad-faith claims against the insurer could be resolved. The appealscourt sent the case back to the trial court with an order to vacateits order sustaining the insurer's demurrer and to enter a neworder sustaining the insurer's demurrer but allowing the insured toamend her complaint.

Palacin vs. Allstate Insurance Co., No. D042813 (Cal.App.Dist.4 06/22/ 2004) 2004.CA.0005487 (www.versuslaw.com).

Readers may fax Don Renau at (502) 897-1533. His e-mail addressis [email protected].