The efficient proximate cause rule is one of the more confusing analyses that an insurance company must undertake when investigating certain coverage issues under first party insurance policies. And until now, the efficient proximate cause rule has only been applied to first party insurance policies in Washington. But that has now changed with the Washington Supreme Court’s decision in Xia, et al. v. ProBuilders Specialty Insurance Company, et al., Case No. 92436-8 (April 27, 2017). In Xia, the Washington Supreme Court not only ruled that an insurer must consider the efficient proximate cause rule in determining its duty to defend under a CGL policy, but that ProBuilders acted in bad faith by failing to do so, despite no prior precedent for application of the rule in a CGL coverage analysis.
In Xia, the claimant purchased a new home constructed by Issaquah Highlands 48 LLC (“Issaquah”), which was insured under a CGL policy issued by ProBuilders. The claimant fell ill soon after moving in due to inhalation of carbon monoxide, caused by improper installation of an exhaust vent.
The claimant notified Issaquah about the issue, and Issaquah notified ProBuilders. ProBuilders denied coverage under the pollution exclusion and a townhouse exclusion. The claimant filed a lawsuit, which Issaquah then settled by a stipulated judgment of $2 million with a covenant not to execute and an assignment of rights against ProBuilders. The claimant filed a declaratory judgment action against ProBuilders for breach of contract, bad faith, violation of the Consumer Protection Act and the Insurance Fair Conduct Act.
At the trial court level, ProBuilders won summary judgment on the townhouse exclusion. Division One of the Washington Court of Appeals reversed in part, finding that the pollution exclusion applied, but not the townhouse exclusion.
The Washington Supreme Court accepted review to determine whether the pollution exclusion applied to relieve ProBuilders of its duty to defend. The Court held that even though ProBuilders did not err in determining that the plain language of its pollution exclusion applied to the release of carbon monoxide into Xia’s home, “under the ‘eight corners rule’ of reviewing the complaint and the insurance policy, ProBuilders should have noted that a potential issue of efficient proximate cause existed,” as Xia alleged negligence in her original complaint, i.e. failure to properly install venting for the hot water heater and failure to properly discover the disconnected venting.
Ultimately, the Court concluded that the efficient proximate cause of the claimant’s loss was a covered peril – the negligent installation of a hot water heater. Even though ProBuilders correctly applied the language of its pollution exclusion to the release of carbon monoxide into the house, the Court ruled that ProBuilders breached its duty to defend as it failed to consider an alleged covered occurrence that was the efficient proximate cause of the loss. The Court granted judgment as a matter of law to the claimant with regard to her breach of contract and bad faith claims.
The application of the efficient proximate cause rule to CGL policies in Washington is troublesome for insurers. The Washington courts have long held in cases involving first party policies that under the efficient proximate cause rule, “[i]f the initial event, the “efficient proximate cause,’ is a covered peril, then there is coverage under the policy regardless whether subsequent events within the chain, which may be causes-in-fact of the loss, are excluded by the policy.” Key Tronic Corp., Inc. v. Aetna (CIGNA) Fire Underwriters Insurance Co., 124 Wn.2d 618, 881 P.2d 210 (1994). Also, the efficient proximate cause rule applies only “when two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss.” Vision One, LLC v. Philadelphia Indemnity Insurance Co., 174 Wn.2d 501, 276 P.3d 300 (2012).
In Xia, the Court noted that like any other covered peril under a general liability policy, an act of negligence may be the efficient proximate cause of a particular loss. “Having received valuable premiums for protection against harm caused by negligence, an insurer may not avoid liability merely because an excluded peril resulted from the initial covered peril.” Xia at *14. The Court stated:
…it is clear that a polluting occurrence happened when the hot water heater spewed forth toxic levels of carbon monoxide into Xia’s home. However, by applying the efficient proximate cause rule, it becomes equally clear that the ProBuilders policy provided coverage for this loss. The polluting occurrence here happened only after an initial covered occurrence, which was the negligent installation of a hot water heater that typically does not pollute when used as intended.
Xia at *17.
Justice Madsen took issue with the majority decision in a dissenting opinion, specifically with respect to a finding of bad faith when no other case prior to this decision had ever applied the efficient proximate cause rule to CGL policies. Justice Madsen also disagreed with the majority in extending the application of the efficient proximate cause rule to CGL policies when this Court specifically declined to do so in the earlier case of Quadrant Corp. v. American States Insurance Co., 154 Wn.2d 165, 110 P.3d 733 (2005).
The State of Washington unfortunately has been historically unkind to insurers on the duty to defend, and the Xia decision only further cements that reputation.