MARGLEN INDUSTRIES INC v. AETNA CASUALTY AND SURETY COMPANY

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Court of Appeal, Fourth District, Division 1, California.

MARGLEN INDUSTRIES, INC., Plaintiff and Appellant, v. The AETNA CASUALTY AND SURETY COMPANY, Defendant and Respondent.

No. D013841

Decided: March 09, 1992

Gray, Cary, Ames & Frye, Marcelle E. Mihaila and Gail Armist Greene, San Diego, for plaintiff and appellant. Sedgwick, Detert, Moran & Arnold, Alan J. Freisleben and John E. Feeley, Irvine, for defendant and respondent.

This insurance coverage dispute presents an interesting question concerning the extent of an insurer's duty to defend and indemnify:  At the time that the insured tenders its defense of an underlying action to the insurer, does the insured or the insurer bear the burden of showing that an exception to an otherwise applicable exclusionary clause in the subject policy applies to the facts of the case, so that there is a potential for coverage by the policy, and accordingly a duty to defend on the part of the insurer?   In this action on bad faith insurance theories brought by the insured, plaintiff and appellant Marglen Industries, Inc. (Marglen), against defendant and respondent Aetna Casualty and Surety Company (Aetna), Marglen contends that its comprehensive general liability policy affords it coverage for property damage in the form of loss of use of premises in which its product, carpeting, was installed, when the carpeting faded and the premises (apartment buildings) could not be rented for some time.   The trial court disagreed, granting first Aetna's motion for summary adjudication on the coverage issue, and later Aetna's motion for summary judgment on the complaint.  (Code Civ.Proc., § 437c, subds. (c), (f).)

As we will explain, our de novo review of the policy provisions persuades us that the trial court correctly interpreted the insuring clause and the exclusionary clauses of the policy, properly finding there was no coverage and accordingly no duty to defend and indemnify on the part of Aetna.   We affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

Marglen is a carpet manufacturer located in Georgia.   It sells its carpet to sales agents, who then sell the carpets to developers, builders, or consumers.   Marglen carpet was installed in various apartment complexes in the Southern California area.   Seven apartment complex owners sued Marglen in seven separate lawsuits when the carpet began to fade prematurely sometime after installation.   These seven actions (the underlying actions) were filed between April 1988 and March 1990.1  Various legal theories were alleged against Marglen, all seeking damages for the replacement of the carpet or for the difference in value between the carpet as warranted and the carpet in its defective condition.   In four of the actions, the apartment owners sought to recover for rents lost when the apartments sat vacant because of the condition of the carpet.   Two actions alleged breach of contract theories against Marglen.  (Continental American Properties, Inc. and Comer Development Company, Inc.;   see fn. 1, ante.)   In two of the actions, Marglen was not sued as a defendant, but was brought into the action by way of cross-complaints for breach of contract, indemnity, or declaratory relief.  (Village Property Management, Inc. v. A–1 Apartment Supply, and Eugene J. Polley, Jr. et al. v. ABCO House of Fine Carpets.)   Four of the actions alleged products liability theories against Marglen, including breach of express or implied warranties, strict liability, and negligence.  (E.g., Moss Street Limited v. Marglen and Nobel Court Ltd.)   Two of those four actions also alleged miscellaneous tort theories such as negligent misrepresentation, and intentional and negligent interference with business advantage.  (Comer Development, Lakeridge Associates.)

Approximately one year after the first actions against Marglen were filed, Marglen tendered its defense of the underlying actions to Aetna, its comprehensive liability insurer.   Aetna's two liability policies (nos. 011GL627413CCS;  011GL703736CCS) insured Marglen for the period between September 1, 1985, through September 1, 1987.   Each of the one-year policies contained the following standard insuring agreement:

“The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies, caused by an occurrence, and the company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent.”

Aetna denied coverage, stating in its denial letter:

“As it has been represented to [Aetna], all the Complaints and Cross–Complaints are arising out of an alleged defective product.   These pieces of defective carpeting were all in place in apartment complexes in the Southern California area.   The Complaints are alleging a loss of income due to the defective carpet and their inability to rent the particular apartments.”

Aetna relied on exclusion (m) in the policy forms as showing that a loss of use to tangible property was not covered when it is connected to the failure of the insured's product.   Additionally, exclusion (n) was said to preclude coverage for the product itself.   The denial letter stated that Aetna's decision was based on the information Aetna presently had available to it, and added that if additional information relevant to the coverage and duty to defend question was supplied, Aetna would reconsider its position.2

Although Marglen protested, relying solely on the policy terms, Aetna continued to refuse to defend the underlying actions.   Marglen did so on its own behalf, settling six and taking one to trial.

Marglen then brought this complaint on bad faith insurance theories for breach of contract, breach of the covenant of good faith and fair dealing, breach of fiduciary duty, and declaratory relief, alleging the refusal to defend and indemnify (based on the exclusion for loss of use damage to property caused by failure of the product) was wrongful.   Cross-motions for summary adjudication of issues were consolidated for hearing on the coverage issues.   Aetna's motion sought a determination it had no duty to defend Marglen in any of the underlying actions.   Aetna argued the liability policies did not cover claims based on breach of contract, as alleged in several of the underlying actions, and claimed the underlying actions did not seek “property damage” within the meaning of the policies.   Aetna further contended that even if there otherwise were coverage, three exclusions in the policies apply to preclude that coverage.3

On its part, Marglen contended that as a matter of law Aetna had a duty to defend and indemnify the alleged covered damages.   Marglen pointed out that each underlying action either expressly included, or could be amended to include, tort claims, which are normally insurable under liability policies.   Although Marglen did not seek coverage for damage to the carpeting itself or for any physical damage that the carpeting caused to the premises, it did seek a ruling it was entitled to coverage for the lost rental value of the apartments, since each underlying action either actually or potentially included claims for lost rent.   Marglen argued such loss of use of the apartments should be considered “property damage” within the meaning of the policies.4

Although neither Marglen's opposition to Aetna's motion nor Marglen's own motion for summary adjudication had made a claim that a “sudden and accidental” physical injury justified a finding of coverage within the meaning of the exception to exclusion (m), Marglen submitted in its reply papers in support of its own motion a new theory that the lost rents were a covered occurrence because they resulted from severe carpet fading caused by ozone oxidation.   According to a declaration by Marglen's expert chemist, J. Woodson Mader, this oxidation occurs when ozone, an air pollutant, contacts carpet dye.   Mader stated ozone oxidation can cause serious carpet fading in a matter of minutes or hours.   The rate of oxidation is greatly accelerated by the presence of high levels of moisture in the atmosphere.   According to Mader's declaration, ozone fading can occur quite unexpectedly and, due to the undeveloped state of research in this area, no warranty for ozone colorfastness now exists in the carpet industry, nor has the government formulated a standard.   Mader's declaration concluded:

“From my 20 years experience in the carpet industry, I would not characterize the ozone oxidation that occurred in these cases as a typical business risk.   To the contrary, ozone damage occurs infrequently, unexpectedly and in limited parts of the country.   Unfortunately, due to its air quality and humidity, San Diego and Los Angeles are subject to this kind of problem.”

After hearing argument on the cross-motions for summary adjudication, the trial court granted Aetna's motion.   The court first opined that the allegations of torts in the underlying actions arose out of a contractual basis, which was a failure of Marglen's product.   The court found that the damages alleged were so connected to the failure of the carpeting that exclusions (m) and A(3) applied.   The court then declined to find that the lost rents damages alleged were covered by the policies because there was no destruction or damage to the other property because of the failure of the carpeting.   Finally, the court noted there was just an interruption in the enjoyment of the apartment premises, and that such loss of use did not constitute property damage under the policy.   Marglen's own motion for summary adjudication was accordingly denied.

Aetna thereafter successfully moved for summary judgment on Marglen's complaint.   Judgment was entered in Aetna's favor, and Marglen timely appealed.

DISCUSSION

 Our review of the insurance policy interpretation question presented is de novo.  “ ‘[T]he construction of the instant policy is one of law, because it is based upon the terms of the insurance contract.   Accordingly, we are not bound by the trial court's interpretation of the policy, and it is our duty to make the final determination in accordance with the applicable principles of law.  [Citations.]’ ”  (Economy Lumber Co. v. Insurance Co. of North America (1984) 157 Cal.App.3d 641, 645, 204 Cal.Rptr. 135.)   In construing the policy, we must follow the general rule that uncertainties are resolved in favor of the insured and the policy provisions are interpreted according to the layman's reasonable expectations.  (Ibid.)  However, determination of whether an insured's expectation of coverage is reasonable is a question of law.  (Dyer v. Northbrook Property & Casualty Ins. Co. (1989) 210 Cal.App.3d 1540, 1549, 259 Cal.Rptr. 298.)

 Moreover, since this is a bad faith insurance case, a determination that there was no contractual basis for liability under the policy is fatal to bad faith theories which claim that the denial of a defense and indemnification was wrongful.  (Coe v. Farmers New World Life Ins. Co. (1989) 209 Cal.App.3d 600, 608, 257 Cal.Rptr. 411.)

It is often stated that the duty to defend under an insurance policy is much broader than the duty to indemnify.  (CNA Casualty of California v. Seaboard Surety Co. (1986) 176 Cal.App.3d 598, 605, 222 Cal.Rptr. 276.)

“An insurer's duty to defend must be analyzed and determined on the basis of any potential liability arising from facts available to the insurer from the complaint or other sources available to it at the time of the tender of defense.   If the insurer is obliged to take up the defense of its insured, it must do so as soon as possible, both to protect the interests of the insured, and to limit its own exposure to loss.   Unlike the duty to indemnify, which is only determined after liability is finally established, the duty to defend must be assessed at the outset of the case.  (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 275–277 [54 Cal.Rptr. 104, 419 P.2d 168] [citations].)”  (CNA Casualty of California, supra, 176 Cal.App.3d 598, 605, 222 Cal.Rptr. 276.)

 In assessing the validity of an insurer's decision not to provide a defense, “courts do not examine only the pleaded word but the potential liability created by the suit.”  (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 276, 54 Cal.Rptr. 104, 419 P.2d 168.)   The pleadings in the underlying actions should be construed together with the language of the policy to determine the insurer's obligation.  (Bonfils v. Pacific Auto. Ins. Co. (1958) 165 Cal.App.2d 152, 331 P.2d 766;  7C Appleman, Insurance Law and Practice (rev. ed. 1979) § 4683, p. 50.)   In construing the pleadings, attention must be paid to the underlying facts alleged, rather than the legal theories predicated thereon, because the pleadings “are malleable, changeable and amendable.”  (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at p. 276, 54 Cal.Rptr. 104, 419 P.2d 168.) 5

 The pleadings in the underlying actions whose defense Marglen tendered to Aetna revealed numerous different theories, based both in tort and in contract.   It is the general rule that liability insurance policies cover tort, but not contract liability.  (Fireman's Fund Ins. Co. v. City of Turlock (1985) 170 Cal.App.3d 988, 995, 216 Cal.Rptr. 796.)   A fair reading of the underlying complaints reveals that they were primarily premised upon theories of product liability, including a contractual theory of implied warranty.   Of course, products liability theories had their genesis in the law of strict liability in tort.  (Greenman v. Yuba Power Products, Inc. (1963) 59 Cal.2d 57, 63, 27 Cal.Rptr. 697, 377 P.2d 897;  see 6 Witkin, Summary of Cal.Law (9th ed. 1988) Torts, § 1242, pp. 676–678.)   This fact, and the fact that four of the underlying actions included tort theories, required Aetna as a reasonable insurer to make its determination on whether to provide a defense and indemnification with an awareness that it was exposed to potential liability for indemnification on tort theories.

However, the underlying allegation of tort theories was not the only factor which Aetna had to keep in mind.   The nature of all these underlying allegations (that Marglen should be subject to products liability for its defective carpet) served to put Aetna on notice that its specific policy exclusions concerning products liability and warranty might apply.   In making its determination whether potential liability under the policy existed, Aetna was entitled to take its policy exclusions into account in deciding whether to provide a defense and indemnification.

 “Ordinarily an insurer cannot be called upon to defend a suit against the insured where the petition or complaint upon its face alleges a state of facts excluded from the policy.   The court is not at liberty to ignore the plain meaning of policy language and impose on an insurer a duty to defend that was unambiguously excluded.”  (7C Appleman, op. cit. supra, § 4685.01, pp. 124–126, fns. omitted.)   However, to excuse the duty to defend, the pleading of the underlying action must unambiguously exclude coverage under the policy.  (Id. at § 4684.01, p. 98;  see State Farm Mut. Auto. Ins. Co. v. Cummings (1971) 21 Cal.App.3d 441, 98 Cal.Rptr. 320.)   Thus, if the duty to defend is not considered to be absolute and if the courts are ever to be able to find an insurer may justifiably decline to defend, the rule must obtain that an insurer's determination there is no potential liability for an underlying action under the insurance policy may be based upon its conclusion that liability is unambiguously excluded under the policy.

Before addressing the dispositive issue in this case, the applicability of exclusion (m) and its exception under these facts (see part II, post ),6 we first find it necessary to address the issue of the appropriate allocation of the burden of persuasion (or the burden of producing evidence) at the time that the insurer's decision on whether to accept a tendered defense must be made.   This issue arises since an insurer's duty to defend under a policy is not absolute, arising only where there is a potential for coverage under the policy.   What is the scope of an insured's duties to supply sufficient facts for the insurer to make an informed decision on the potential for coverage?

I

 The “fundamental principle that all ambiguities in an insurance policy are construed against the insurer-draftsman” (State Farm Mut. Auto. Ins. Co. v. Partridge (1973) 10 Cal.3d 94, 102, 109 Cal.Rptr. 811, 514 P.2d 123) has led to two different canons of construction which we must apply here:  coverage clauses are interpreted broadly so as to afford the greatest possible protection to an insured;  and exclusionary clauses are interpreted narrowly against the insurer.  (Id. at pp. 101–102, 109 Cal.Rptr. 811, 514 P.2d 123.)   Where an initial coverage question arises, “It is hornbook law that the insured must demonstrate that the claimed loss is comprehended by the policy's general coverage provisions.   See 19 G. Couch, Couch on Insurance 2d § 79.315, at 255 (M. Rhodes rev. ed. 1983);  [citation.]   If the insured shoulders this burden, then the insurer must come forth with proof that a policy exclusion applies.  [Citation.]”  (New Castle County v. Hartford Acc. and Indem. Co. (3d Cir.1991) 933 F.2d 1162, 1181, original italics.)

The rules regarding the construction of exclusionary clauses are also well established:

“ ‘[A]n insurer cannot escape its basic duty to insure by means of an exclusionary clause that is unclear.   As we have declared time and again, “any exception to the performance of the basic underlying obligation must be so stated as clearly to apprise the insured of its effect” [citation];  thus, “the burden rests upon the insurer to phrase exceptions and exclusions in clear and unmistakable language.”  [Citation.]’  [Citation.]”  (Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800, 808, 180 Cal.Rptr. 628, 640 P.2d 764.)

 Generally speaking, exclusionary clauses subtract from coverage, rather than grant it.  (Sturla, Inc. v. Fireman's Fund Ins. Co. (1984) 67 Haw. 203, 684 P.2d 960, 965.)   However, where an exclusionary clause in a policy contains an exception, such an exception to an exclusion is somewhat analogous to a coverage provision, since it sets forth the conditions under which coverage will be afforded despite the exclusion made.  (National Union Fire Ins. Co. v. Lynette C. (1991) 228 Cal.App.3d 1073, 1082, 279 Cal.Rptr. 394.)

On the subject of the proper interpretation of an exception to an exclusion (or an exception to an exception), a treatise writer has set forth the two possible rules which could be used:

“In many instances, a policy exception is itself subject to exceptions or limitations.   When this is the case, the insurer in proving that the loss comes within the exception must also proceed further to show that the exception or limitation to the exception does not preclude the application of the exception․  [¶] There is, however, authority that when a policy contains an exception within an exception, the insurer need not negative the internal exception;  rather, the plaintiff must show that the exception from the exemption from liability applies.”  (19 Couch on Insurance (2d ed. 1983) § 79.385, p. 338, fn. omitted.)

Federal cases are split on the issue of which rule should be followed in interpreting exceptions to exclusions.   In New Castle County v. Hartford Acc. and Indem. Co., supra, 933 F.2d 1162, 1181–1182, the Court of Appeals was faced with the question of what Delaware law would be on the issue of which party has the burden of proof concerning the application of an exception to an exclusion.   The Court of Appeal predicted that since the exception is part of an exclusionary clause, the insurer should carry the burden to show not only that the exclusion applied, but also that the exception to the exclusion did not supply coverage to the insured.  (Accord, A. Johnson & Co., Inc. v. Aetna Cas. and Sur. Co. (1st Cir.1991) 933 F.2d 66, 75–76, fn. 14;  U.S. Fidelity & Guar. v. Morrison Grain Co. (D.Kan.1990) 734 F.Supp. 437, 443;  see Upjohn Co. v. Aetna Cas. and Sur. Co. (W.D.Mich.1990) 768 F.Supp. 1186, 1201.)

An opposite result was reached by a district court in Fireman's Fund Ins. Companies v. Ex–Cell–O Corp. (E.D.Mich.1988) 702 F.Supp. 1317, 1328–1329.   Finding that the insured had the burden of proof that an exception to an exclusion applied, the court stated that several factors had to be considered in allocating the burden of proof:  “[A]n estimate of the probabilities, fairness, and special policy considerations.”  (Id. at p. 1328.)   The court found it was fair to place upon the insured the burden of showing that a more unusual event had occurred and to supply information pertaining to its own activities.  (Accord, Northern Ins. Co. v. Aardvark Associates (3d Cir.1991) 942 F.2d 189, 194–195;  Fischer & Porter Co. v. Liberty Mut. Ins. Co. (E.D.Pa.1986) 656 F.Supp. 132, 140.)

Although, as noted above, Aetna was required to make a decision on Marglen's tender of defense of the underlying action at a time before this litigation was filed, we find the general rules concerning the allocation of the burden of producing evidence and the burden of proof to be instructive by analogy.  (Evid.Code, §§ 550, 500.)  “Except as otherwise provided by law, a party has the burden of proof as to each fact the existence or nonexistence of which is essential to the claim for relief or defense that he is asserting.”  (Evid.Code, § 500.)   For reasons of policy or convenience, however, the burden of proof can be allocated “in a manner different from that which would normally be expected from the requirement of pleading.”  (1 Witkin, Cal.Evidence (3d ed. 1986) Burden of Proof and Presumptions, § 136, p. 119.)   The Law Revision Commission Comment to Evidence Code section 500 states:

“In determining whether the normal allocation of the burden of proof should be altered, the courts consider a number of factors:  the knowledge of the parties concerning the particular fact, the availability of the evidence to the parties, the most desirable result in terms of public policy in the absence of proof of the particular fact, and the probability of the existence or nonexistence of the fact.”  (Also see Zuckerman v. Underwriters at Lloyd's (1954) 42 Cal.2d 460, 475 [267 P.2d 777] where it was held proper to instruct that a plaintiff had the burden to prove that the death of its insured occurred through a covered cause.)

Before deciding which of the two lines in the split of authority on the burden of proof regarding an exception to exclusion is more persuasive here, we consider the merits of Marglen's claim that exclusion (m) and its exception do not preclude coverage for the claimed loss of use property damage here.

II

We first reiterate what this case is not about:  Marglen does not seek insurance coverage for the costs of replacing its defective product, nor does it assert that the defective carpet caused physical damage to other tangible property (e.g., on forcible removal), such as the apartments in which it was installed.7  Instead, Marglen's claim to coverage is based on a contention that the time period in which the apartment owners were unable to rent the property because of the defective carpet represents “property damage” as defined in the policy, because there was a “loss of use of tangible property which has not been physically injured or destroyed provided such loss of use is caused by an occurrence during the policy period[.]” 8

Turning then to the policy definition of occurrence as “an accident, including continuous or repeated exposure to conditions, which results in ․ property damage neither expected nor intended from the standpoint of the insured [,]” Marglen argues its reply papers filed in support of its motion for summary adjudication demonstrate, through the declaration of chemical expert J. Woodson Mader, that the ozone oxidation which occurred constituted an accident or occurrence within the meaning of the policy.

 To analyze the merits of this claim of coverage for loss of use of tangible property, we first dispose of Marglen's threshold argument that exclusion (m) is aimed only at breach of warranty claims, rather than the “actual and potential tort claims alleged in the underlying actions here.”   As discussed above, at the early stage of deciding whether to accept Marglen's tender of defense, Aetna was entitled to analyze the facts pled in the underlying actions as setting forth primarily products liability claims and, accordingly, to consider its exclusions applicable to such claims in making its decision on whether to supply a defense.   The presence in the underlying actions of causes of action for negligence, negligent misrepresentation, and intentional and negligent interference with prospective business advantage did not impose an unconditional duty on Aetna to defend Marglen against the underlying suits.   It is the facts pled, rather than the theories alleged, which determine the duty to defend.  (Gray v. Zurich Insurance Co., supra, 65 Cal.2d at pp. 275–277, 54 Cal.Rptr. 104, 419 P.2d 168.)

In Marglen's backup position, it agrees that exclusion (m) would ordinarily exclude coverage for loss of use of tangible property which was not physically injured or destroyed (i.e., the apartment buildings), resulting from the failure of Marglen's products to meet the level of performance warranted by Marglen.   However, Marglen goes on to argue that the exclusion does not come into play because of the terms of its exception:

“[T]his exclusion does not apply to loss of use of other tangible property resulting from the sudden and accidental physical injury to or destruction of the named insured's products ․ after such products have been put to use by any person or organization other than an insured[.]”

This case hinges on the interpretation of this exception:  Whether the fading of the carpet constitutes a “sudden and accidental physical injury to or destruction of” the installed carpet, because of Marglen's contention (newly raised at the reply stage of the motions for summary adjudication in the bad faith action) that a sudden phenomenon of ozone oxidation created the damage complained of in the underlying actions.9

Marglen's claim to coverage under the policy requires it to show that the apartment premises became unusable resulting from “the sudden and accidental physical injury to or destruction of” the installed carpeting.   The meaning of the term “accidental” as used in the exception to exclusion (m) is given some illumination by the policy definition of occurrence, which means “an accident, including continuous or repeated exposure to conditions, which results in ․ property damage neither expected nor intended from the standpoint of the insured.”   However, the terms of the exception, a “sudden and accidental physical injury to or destruction of” the carpeting, must be interpreted as a whole.

In Economy Lumber Co. v. Insurance Co. of North America, supra, 157 Cal.App.3d 641, 647–648, 204 Cal.Rptr. 135, the “occurrence” definition of a liability policy was interpreted to cover the application of defective siding to houses that were being constructed, on the theory that the damage to the houses caused by the application of the defective siding was unexpected before the defects were discovered, and resulted in a loss of value of the property.   However, that analysis does not help us much here, because Marglen is not contending that the use of its carpeting caused physical damage to the apartment buildings, as was the case in Economy Lumber, where the defective siding admittedly caused property damage when applied to the houses that were being built.   Marglen's claims here are confined to loss of use of the apartment premises;  there was no similar loss of use property damage claim asserted in Economy Lumber.   There is also no reason here to follow the distinction drawn by the court in Economy Lumber between insureds who are suppliers of products as opposed to contractors;  the comprehensive liability policy issued here drew no such distinction.

Two out-of-state cases have interpreted similar liability policies in very similar fact situations.   In Sturla, Inc. v. Fireman's Fund Ins. Co., supra, 684 P.2d 960, an insured vendor of carpeting that had faded (allegedly due to atmospheric conditions), who was covered under the manufacturer's policy by virtue of a vendor's endorsement, sought a defense from its liability insurer to underlying actions which sought against the vendor, manufacturer and installer of the carpeting the cost of replacing the defective product, along with consequential damages (possibly including lost rents) and interest.   The Hawaiian Supreme Court interpreted an identical exclusion (m) and its exception, along with other exclusions, as preventing the insured from having an objectively reasonable expectation of protection against claims that the product it sold was “ ‘not that for which the damaged person bargained.’ ”   (Id. at p. 964.)   The court found the liability insurer had no duty to defend the underlying actions.   However, the court did not discuss the operation of the exception to exclusion (m), since there was apparently no creative claim made there that the carpet fading due to the atmospheric conditions was a “sudden and accidental” occurrence.

In Commercial Union Ins. Co. v. R.H. Barto Co. (Fla.App.1983) 440 So.2d 383, the court found a liability insurance policy did not provide coverage to an insured, Barto, for loss of rents incurred by the owners of an office building who had hired Barto to install air conditioning equipment which continually malfunctioned even after repair and replacement.   The court first found that the claimed damage fell within exclusion (m), because it involved loss of use of tangible property that was not physically injured or destroyed, due to the failure of the insured's products to meet the level of performance warranted;  the court further concluded the exception to the exclusion did not require coverage to be extended.   In the court's “considered opinion,” the allegations that the air conditioning equipment frequently broke down and had to be replaced did not measure up to the policy requirement that “sudden and accidental physical injury ․ or destruction” take place in order for the exception to apply.  (Id. at p. 388.)   Further, with regard to the insured's contention that the evidence showed at least one occasion of a sudden interruption in service, the court noted that the insurer's determination on whether to supply a defense must be made in consideration of whether the allegations of the underlying action brought the claim within the provisions of the insurance policy:

“It does not suffice to say that later on in the proceeding the evidence showed that the injured party really did have a claim against the insured which was covered by the insured's policy.   As stated in 7C Appleman, Insurance Law and Practice, § 4683.01 at pg. 63:  [¶] ‘The determination in regard to the duty to defend is made at the time suit is brought and not after it is reduced to judgment.’ ”  (Id. at p. 388.)

Accordingly, the court in Barto found the insurer to be justified in declining to defend the action.

All this authority provides useful and instructive guidelines on the scope of coverage of this liability insurance policy.   However, we are required to keep in mind the procedural context of this case in deciding whether the trial court correctly concluded Aetna did not show bad faith as an insurer in declining to accept Marglen's tender of its defense in the underlying actions.   Even assuming that Marglen's expert's declaration represents the state of the art in chemical analysis of carpeting defects, the fact remains that at the time Marglen tendered its defense, Aetna was not shown to have had access to that specialized information (which was only supplied to the court at the reply stage of the motions for summary adjudication in the bad faith action).   Instead, when Marglen tendered its defense, Aetna had available to it the information provided by the pleadings in the underlying actions, as well as what was available through its own reasonably diligent investigation.   In assessing whether there was a potential for liability under the policy, due to the operation of exclusion (m) and its exception, it should be assumed that Aetna, as an insurer, did not profess the same expertise in the carpeting business as did its insured.

In deciding whether Aetna was derelict in its duty to its insured when it made its decision not to defend the underlying actions, based on its determination there was no potential for its liability to indemnify, we find it instructive to review the factors cited by the Law Revision Commission in its comment to Evidence Code section 500, regarding the allocation of the burden of proof:  The knowledge of the parties concerning a particular fact, the availability of the evidence to the parties, the most desirable result in terms of public policy in the absence of proof of a particular fact, and the probability of the existence or non-existence of the fact.   Because of the insured's presumably greater degree of experience and expertise in dealing with its product, all the factors mentioned above (except public policy, which is neutral) weigh in favor of imposing a duty on the insured to make available to its insurer information showing that seemingly applicable exclusions may not in fact apply.

 Since exceptions to exclusions are in some sense analogous to coverage provisions (National Union Fire Ins. Co. v. Lynette C., supra, 228 Cal.App.3d 1073, 279 Cal.Rptr. 394), it seems reasonable to require the insured, as part of its claim that the policy covers the claimed loss, to place the insurer on notice of facts supporting its claim that an exception to the exclusion applies, thus entitling it to coverage.   Requiring an insurer to negative the possible applicability of an exception to an exclusion, at the stage of deciding on the duty to defend, seems to require the insurer to possess specialized knowledge about the insured's circumstances which it could not otherwise be expected to have.   Thus, at least to the extent of analyzing the propriety of an insurer's decision not to provide a defense to its insured, we believe that the line of cases allocating the burden to the insured to demonstrate the applicability of an exception to an exclusion is correct.   (See, e.g., Fireman's Fund Ins. Companies v. Ex–Cell–O Corp., supra, 702 F.Supp. 1317, 1328–1329;  Fischer & Porter Co. v. Liberty Mut. Ins. Co., supra, 656 F.Supp. 132, 140;  Northern Ins. Co. v. Aardvark Associates, supra, 942 F.2d 189, 194–195.)

 Our conclusion on this issue of the burden of persuasion at the time of the tender of defense leads to several related findings.   First, Aetna's determination that the face of the policy showed the applicability of its products exclusions to the underlying actions justified its decision not to offer a defense to Marglen.   Marglen's effort to show its theory that a “sudden and accidental” event took place which caused the property damage complained of came too late in the dealings between the parties (i.e., at the motions stage of the bad faith action) to place Aetna on notice that it had a realistic potential liability to indemnify under the policy.10

 Moreover, even if we were to hold that the insurer should bear the burden of showing that the exception to the exclusion did not apply to these facts, we would conclude that, for purposes of a preliminary coverage determination, Aetna was entitled to evaluate the allegations in the underlying actions (that Marglen's carpeting had faded sometime after it was installed) as not demonstrating a “sudden and accidental physical injury to or destruction of” Marglen's product.   Aetna had reasonable grounds to characterize the fading carpet as a defective product, rather than to attribute the fading to the occurrence of some sudden and accidental event.   There were no allegations in the underlying actions that the carpeting had failed to withstand ordinary indoor conditions to which carpeting is normally subject.   The trial court was therefore justified in concluding that the showing made on the cross-motions for summary adjudication did not disclose the existence of any triable issue of fact concerning the allegations by Marglen that Aetna's conduct in declining to provide a defense constituted bad faith by the insurer.   The court's ruling on the motions for summary adjudication and summary judgment was correct as a matter of law.

DISPOSITION

Judgment is affirmed.

FOOTNOTES

1.   The underlying actions are:  Moss Street Limited v. Marglen Industries, Inc., et al. (Super.Ct. San Diego County, 1988, No. 605040);  Village Property Management, Inc. v. A–1 Apartment Supply (Super.Ct. Orange County, 1988, No. 54–86–04);  Eugene J. Polley, Jr., et al. v. ABCO House of Fine Carpets (Mun.Ct. San Diego County, 1988, No. 79853);  Continental American Properties, Ltd. v. Marglen Industries, et al. (Super.Ct. San Diego County, 1988, No. 597680);  Comer Development Company, Inc. v. Sumerset Carpet Mills Inc. et al. (Super.Ct. Orange County, 1988, No. 55–00–12);  Lakeridge Associates et al. v. Marglen Industries, Inc. (Super.Ct. Los Angeles, 1990, No. 0755625);  and Nobel Court Ltd. (Fairfield Development) v. Marglen Industries, Inc. (Super.Ct. San Diego, 1989, No. 613383).

2.   At the time of the hearing on the motions for summary adjudication (June 1990), five of the underlying actions had already been settled.

3.   These three exclusions ((n), (A)(3), and (m)) may be characterized as “business risk” exclusions.  (Weedo v. Stone–E–Brick, Inc. (1979) 81 N.J. 233, 239, 405 A.2d 788, 791.)   Briefly, exclusion (n) excludes coverage for property damage to an insured's product arising out of the product;  exclusion (A)(3) excludes property damage to “work performed” by an insured.   Exclusion (m), the dispositive provision in this case, a “loss of use” exclusion, states in full:  “[This insurance does not apply] to loss of use of tangible property which has not been physically injured or destroyed resulting from [¶] (1) a delay in or lack of performance by or on behalf of the named insured of any contract or agreement, or [¶] (2) the failure of the named insured's products or work performed by or on behalf of the named insured to meet the level of performance, quality, fitness or durability warranted or represented by the named insured;  but this exclusion does not apply to loss of use of other tangible property resulting from the sudden and accidental physical injury to or destruction of the named insured's products or work performed by or on behalf of the named insured after such products or work have been put to use by any person or organization other than an insured[.]”  (Italics added.)

4.   The policy defines property damage as follows:  “(1) [P]hysical injury to or destruction of tangible property which occurs during the policy period, including the loss of use thereof at any time resulting therefrom, or (2) loss of use of tangible property which has not been physically injured or destroyed provided such loss of use is caused by an occurrence during the policy period[.]”  In turn, occurrence is defined as meaning “an accident, including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured[.]”

5.   A commentator has criticized the broad language of the Gray v. Zurich Insurance Co., supra, 65 Cal.2d 263, 54 Cal.Rptr. 104, 419 P.2d 168, decision concerning the duty to defend, noting that the Supreme Court was “dealing with a situation where the ultimate outcome was known and insured had a judgment against him.   Thus, the court found itself reasoning from a fait accompli and trying to decide ‘what should have been done’ at the outset.   As a result, the case is something of an overkill that is frequently quoted as authority for a variety of points of view.”   (7C Appleman, op. cit. supra, § 4684, at pp. 86–87, fn. omitted.)

6.   Although the trial court based its decision in part on exclusion (A)(3), and Aetna argued the applicability of exclusion (n) as well, the parties agree that the determination of the duty to defend in this bad faith action stands or falls on the interpretation of exclusion (m) and its exception.   Accordingly, we do not find it necessary to discuss the other two exclusions, except as we have indicated above, to the extent that the nature of the underlying actions (products liability claims) put Aetna on notice that its “business risk” exclusions might preclude coverage under the policy for the property damage that was being sought.

7.   These concessions by Marglen are well-founded in case law.   (Geddes and Smith, Inc. v. St. Paul Mercury Indemnity Co. (1959) 51 Cal.2d 558, 565, 334 P.2d 881;  St. Paul Fire & Marine Ins. Co. v. Coss, (1978) 80 Cal.App.3d 888, 892, 145 Cal.Rptr. 836;  Maryland Casualty Co. v. Reeder (1990) 221 Cal.App.3d 961, 967, 270 Cal.Rptr. 719.)   For this reason, as noted in footnote 5, ante, we need not reach the issues argued concerning the applicability of exclusions (n) (the “products exclusion”) and (A)(3) (the “work performed” exclusion).

8.   Although only four of the seven underlying actions specifically alleged claims for lost rent, Marglen argues that the other cases could have made such allegations and thus contained a potential for such damages, and accordingly for insurance coverage.

9.   Because neither St. Paul Fire & Marine Ins. Co. v. Coss, supra, 80 Cal.App.3d 888, 893, 145 Cal.Rptr. 836 nor Economy Lumber Co. v. Insurance Co. of North America, supra, 157 Cal.App.3d 641, 646, 204 Cal.Rptr. 135 discussed the applicability of an exception such as the one to exclusion (m) before us, they are not dispositive authority on the “loss of use” issue presented.

10.   In its petition for rehearing, Marglen has raised for the first time at either the appellate or trial court levels a new contention the Aetna's “continuing duty to defend” (Oil Base Inc. v. Continental Cas. Co. (1969) 271 Cal.App.2d 378, 389, 76 Cal.Rptr. 594) could be invoked by Marglen at any time up until final judgment was entered in the underlying actions, even prospectively after the time of filing of the Mader declaration in reply to Aetna's motion for summary adjudication.   Marglen relies on language in a recent Supreme Court case deciding the applicable statute of limitations rule for a duty to defend claim against a title insurer, Lambert v. Commonwealth Land Title Ins. Co. (1991) 53 Cal.3d 1072, 1077, 282 Cal.Rptr. 445, 811 P.2d 737:  “The duty [to defend] commences upon tender of the defense, and continues until the underlying lawsuit is concluded.”   Marglen also cites Firco, Inc. v. Fireman's Fund Ins. Co. (1959) 173 Cal.App.2d 524, 528, 343 P.2d 311, suggesting that if new facts arose even at the time of trial indicating that a particular claim might be covered by an insurance policy (contrary to the facts leading to an insurer's earlier decision to deny a defense), “ ‘we need not say that the insured might not insist that the insurer take over the defence.’ ”  (Ibid.)The record presented to this court discloses five of the seven underlying actions had already been settled by the time of the hearing on the motions;  the status of the other two actions was not revealed.   Moreover, at the motion stage, the issues concerning Aetna's denial of the defense were presented in terms of a “snapshot” of the knowledge the parties had at the time the defense was denied.   The briefs on appeal took the same approach, also arguing the Mader declaration confirmed there was covered property damage.   While we can conceive of facts in which newly discovered information demonstrating potential coverage under a policy is presented to an insurer in a timely fashion before the resolution of the underlying action, thus requiring serious reconsideration of the insurer's denial of a defense, this is not such a case.   Marglen's attempts to make it into one at either the trial or appellate levels, even if argued in good faith, cannot succeed on this record.

HUFFMAN, Associate Justice.

TODD, Acting P.J., and FROEHLICH, J., concur.

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