The Federal Ins. Co. v. Steadfast Ins. Co, et al decision last week from the Second District Court of Appeal for the State of California provided helpful clarification for insurers regarding the scope of coverage under the “personal injury” coverage part of a general liability policy by finding that insurers had no duty to defend a complaint for federal housing discrimination against California apartment owners.

The underlying suit filed by the United States Department of Justice (“DOJ”) under the Fair Housing Act alleged that the defendants, (the “Sterling Defendants” aka Beverly Hills Properties) managed approximately 119 apartment buildings comprising over 5,000 apartments in Los Angeles County, and that they discriminated against non-Korean tenants and prospective tenants at buildings in the Koreatown area of Los Angeles. The DOJ presented evidence that Sterling Defendants’ employees prepared internal reports that identified the race of tenants at properties the defendants purchased in Koreatown. Additionally, the Sterling Defendants reportedly made statements to employees at Koreatown buildings indicating that African-Americans and Hispanics were not desirable tenants. The DOJ also presented expert analysis in court filings showing that the Sterling Defendants rented to far fewer Hispanics and African-Americans in Koreatown which than would be expected based on income and other demographic characteristics.

The underlying case was settled for $2.75 million, which, as of November 2009, was the largest payment ever obtained by the DOJ for an apartment discrimination case. The Sterling Defendants had primary insurance coverage with Steadfast and Liberty, and excess coverage with Federal Insurance Company. Steadfast paid over $5 million in defense costs and $1 million towards the settlement. Federal paid over $300,000 in defense costs. Steadfast sought reimbursement from Federal on the basis that Steadfast had no duty to defend as it did, and that Federal did have that obligation, but largely failed to pay for a defense. Steadfast also sought contribution from Liberty as a co-primary insurer if Steadfast did have an obligation to defend.

Federal not only denied Steadfast’s contention that it had a duty to defend, but it also sought reimbursement of defense costs from Steadfast on the basis that as an excess insurer, it had no duty to the insured until the Steadfast and Liberty policies were exhausted.

Both Steadfast’ s and Liberty’s policies defined “personal injury” to include “wrongful eviction, wrongful entry, and the invasion of the right of private occupancy.” However, Federal’s policies expressly provided coverage -- on an excess basis -- and defined “personal injury” as including, “discrimination, harassment or segregation based on a person’s age, color, national origin, race, religion, or sex.”

Accordingly, the key issue was whether the discrimination claims were potentially covered under the primary policies. Federal asserted that the discrimination claims were potentially covered under the Steadfast’ s and Liberty’s primary policies because of the DOJ’s contentions that the Sterling Defendants created a hostile environment for some of the tenants that amounted to a claim of constructive eviction, thus falling under the coverages for wrongful eviction, wrongful entry, and invasion of the right of private occupancy.

The Appellate Court agreed with Steadfast and Liberty, reasoning that the claims in the DOJ action were for violations of the Fair Housing Act. It was irrelevant that the discriminatory conduct alleged in the underlying action could give rise to some other covered claim. The court held that just because, “a nonparty alleged victim of housing discrimination could have brought a separate common law action against the Sterling defendants based on the factual allegations in the Sterling action complaint might have been covered under the Steadfast and Liberty policies does not establish potential coverage under those policies for the Fair Housing Act discrimination allegations . . . [brought by the DOJ].

Because the complaint was not potentially covered, Steadfast, which paid over $6 million towards the defense and settlement, was entitled to reimbursement from Federal, whose excess policy dropped down to primary. Liberty, which had not defended, had no duty to do so.

This case provides important clarification to insurers seeking to determine the breadth of their obligations to defend or indemnify an insured for a discrimination complaint asserting conduct that could give rise to covered claims, but which nevertheless are not covered in that action.

[Note: Although this is a published opinion, as of this writing, this opinion is not final and is still subject to modification, or review by the California Supreme Court.]