CITY OF PALO ALTO v. PACIFIC INDEMNITY CO (1986)

This is an appeal from a summary judgment entered in favor of defendant Pacific Indemnity Co. and against the City of Palo Alto.   The decision was based squarely on a ruling that plaintiff's claim was barred by the statute of limitations.

Unless indicated otherwise, the following evidence before the trial court was uncontradicted.

In August of 1972, the City adopted Ordinance 2654 which changed the zoning of large areas of land from agricultural-residential to open space.   Much controversy was engendered, as affected property owners claimed that the zoning took property without any compensation because development was precluded.

On December 18, 1972, Donald Eldridge filed a complaint against City seeking $4 million.   The pleading was headed “Complaint in Inverse Condemnation.”   The first and third causes of action were based on article I, section 14 of the Constitution of the State of California (the condemnation section), the only difference between the two causes being that the first referred to a “taking” and the third to a “damaging.”   The second cause of action purported to rely on the Fifth and Fourteenth Amendments of the Constitution of the United States and charged a deprivation of property without due process of law and a taking of private property for public use without just compensation.

On October 18, 1976, an amended complaint was filed which dropped the third cause of action.

On December 5, 1978, plaintiff filed an amendment to the first amended complaint which asserted that the acts previously set forth also constituted a violation of the federal Civil Rights Act (42 U.S.C., §§ 1981 and 1983).

At all times here relevant, City was covered by a policy of liability insurance issued by Pacific Indemnity.   That policy contained an express exclusion in the following words:  “This policy does not apply:  ․ (f) to liability arising under Article I, Section 14 of the Constitution of California.”   Except for a short period of time between September 1974 and July 1975, coverage for inverse condemnation was simply not available in the market.   There is highly probative evidence in the record that City knew at all times, indeed asserted in correspondence, that its liability policy did not cover damages for inverse condemnation and that such insurance could not be purchased.   It is not clear whether that evidence is entirely uncontradicted, but for reasons which will be explained later, the point is irrelevant.

On January 2, 1973, City in writing tendered to Pacific Indemnity the defense of the Eldridge action and requested indemnification.   The very next day, the insurer rejected the tender, stating “We have made a thorough review of this complaint and in view of the fact that it is based entirely on inverse condemnation, we do not see that we have any alternative but to refuse to accept the defense of this case.   The denial of a defense is based on the fact that liability arising under article I, section 14 of the Constitution of California is specifically excluded by exclusion G in the public entity special comprehensive liability policy held by the City of Palo Alto.”

After the first amended complaint and the amendment to first amended complaint were filed in 1976 and 1978 respectively, the City tendered their defense to Pacific Indemnity and requested indemnification.   Both tenders and requests were rejected.

Sometime in the summer of 1980, the Eldridge litigation was settled by City paying the sum of $10,000.   The lawsuit was dismissed on September 30, 1980.

This action by City against Pacific Indemnity was commenced on January 20, 1980 and alleged that City had incurred $10,000 in damages to settle the Eldridge litigation as well as more than $500,000 in attorneys' fees and other defense costs.   There was also a prayer for punitive damages.   Defendant's answer raised the statute of limitations as an affirmative defense.

In due course reciprocal motions for summary judgment were filed, that of Pacific Indemnity resting solely on the statute of limitations.   The parties are agreed that this action is governed by Code of Civil Procedure section 337.1, the four year statute.   The trial court granted the defense motion and therefore did not deem it necessary to address the City's.

 In the summary judgment proceedings below and in its briefs here, City devoted much effort to establishing that the documents submitted by Pacific Indemnity in support of its motion did not rule out all possible merit to the complaint.   City does not seem to understand that there can be twenty-five issues with hotly controverted facts, none of which can defeat summary judgment if the evidence is uncontradicted that the claim is barred.  (Frazier, Dame, Doherty, Parrish & Hanawalt v. Boccardo, Blum, Lull, Niland, Teerlink & Bell (1977) 70 Cal.App.3d 331, 338, 138 Cal.Rptr. 670.)

Most strongly stressed is the contention that the City had reasonably expected to be covered.   But the learned trial judge went plaintiff one better.   In his detailed order granting summary judgment he stated:  “For purposes of this motion, we assume without deciding that Pacific breached its duty to defend under its policy of insurance.”

 That assumption was undoubtedly correct.   Ever since the pivotal case of Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 54 Cal.Rptr. 104, 419 P.2d 168 was handed down, an insurer's duty to defend is much broader than its duty to indemnify.   The duty must be determined on the basis of any potential liability arising from facts apparent to the insurer from the complaint or other sources accessible to it at the time of the tender of defense.   Indeed the duty to defend is so broad that as long as the complaint contains language creating the potential of liability under the policy, the carrier must defend even though it has independent knowledge of facts not in the pleadings that establish absence of coverage.  (Id. at p. 275–277, 54 Cal.Rptr. 104, 419 P.2d 168;  CNA Casualty of California v. Seaboard Surety Co. (1986) 176 Cal.App.3d 598, 605–606, 222 Cal.Rptr. 276.)

 We note that while the first and third causes of action of Eldridge's original complaint were bottomed on article I, section 14 of the California Constitution, a claim expressly excluded from coverage under the policy, the second cause of action purportedly is based on federal constitutional grounds.   It hardly requires citation of authority that all doubt in the meaning and scope of exclusions must be resolved against the insurance company.   (Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800, 808, 180 Cal.Rptr. 628, 640 P.2d 764.)   We note further that the policy here involved expressly required “ ․ the company to ․ defend ․ any suit against the insured claiming such damages, even if such suit is groundless, false or fraudulent.”   Thus, a defense must be afforded even if the alleged cause of action under the United States Constitution is frivolous.  (Gray v. Zurich Ins. Co., supra, 65 Cal.2d 263, 273, 54 Cal.Rptr. 104, 419 P.2d 168;  CNA Casualty of California v. Seaboard Surety Co., supra, 176 Cal.App.3d 598, 606, 222 Cal.Rptr. 276;  Remmer v. Glens Falls Indem. Co. (1956) 140 Cal.App.2d 84, 90, 295 P.2d 19.)

As it is impossible to frame a more categorical rejection of a duty to undertake a defense than is contained in Pacific Indemnity's letter of January 3, 1973, as City admitted receipt of that letter and then waited more than eight years before commencing suit, this case poses a naked issue of law:  when does the statute of limitations commence running against an insured whose insurance carrier breaches its fiduciary duty to defend?

There are two lines of authority in California.   The first is represented by Oil Base, Inc. v. Continental Cas. Co. (1969) 271 Cal.App.2d 378, 76 Cal.Rptr. 594.   There, the insured brought an action against its insurance carrier to recoup litigation costs six and a half years after the insurance company had refused to defend against a third party's suit.   The action was commenced shortly after the insured had obtained a defense judgment.   In rejecting the argument that the action was barred by the statute of limitations, the court stated:  “[¶ ] In our opinion, the statute of limitations does not apply.   The duty of the insurer to defend is a continuing duty․  [¶ ] Continental had a continuing duty to defend, which it could have assumed at any time, before final judgment.   Although Continental refused acceptance of the complaint and summons served on appellant, it could have indicated its willingness to appear and defend at any time before trial, during trial, or at any stage before final judgment.   Until Baritina's action was terminated by final judgment, Continental had a duty which it could elect to assume.   Continental's duty having been a continuous one, appellant could elect to wait until a final judgment had been entered and the duty to defend had ceased.”  (Id. at p. 389–390, 76 Cal.Rptr. 594.)  Oil Base was followed by the United States Court of Appeals for the Ninth Circuit in Tibbs v. Great American Ins. Co. (1985) 755 F.2d 1370, 1375–1376.

Central Bank v. Transamerica Title Ins. Co. (1978) 85 Cal.App.3d 859, 149 Cal.Rptr. 822 promulgates a different rule.   There, a third party had agreed to subordinate his deed of trust to that of insured on certain conditions.   Claiming that those conditions had been breached, third party sued insured for, among other things, restoration of his superior security position.   Defendant was the title insurance company for insured and owed a contractual duty to defend.   The carrier categorically denied liability and refused the tender of defense, and the insured waited more than two years (the statute of limitations applicable to title insurance) before commencing suit.   The trial court sustained a demurrer without leave to amend on the ground that the action was barred and the court of appeal affirmed.   Rejecting the contention that the cause of action against the carrier did not accrue until judgment was entered in the underlying lawsuit, the court held that the statute began to run when the tender of defense was rejected and the insured suffered appreciable harm.¹

Both parties cite a number of other cases, none of which adds much illumination except for the following dictum in Bollinger v. National Fire Ins. Co. (1944) 25 Cal.2d 399 at p. 404, 154 P.2d 399:  “If an insurance company unconditionally denies liability, it would serve no purpose to require the insured to delay suit further․  The rule is therefore settled in this court, as in the federal and most state courts, that an unconditional denial of liability by the insurer after the insured has incurred loss and made claim under the policy gives rise to an immediate right of action․  The desirability of the rule is apparent, for if a waiting period were necessary notwithstanding the election of the insurer to deny liability, it would become a trap for the unwary, and would encourage dilatory tactics as in the present case.”

 Entirely aware of his power under Auto Equity ² to follow whichever line of authority he found more persuasive, the trial judge opted for Central Bank and rejected Oil Base.   We agree with his reasoning.   The facts of this case bear eloquent witness to the preferability of a rule which gives effect to the law's aversion for stale claims by setting a four year limit on the right to bring an action on an insurance policy.   The Eldridge lawsuit was commenced in 1972.   It was settled eight years later while the case was on appeal.   Had it run its course, including the possibility of its acceptance by our Supreme Court, another three years could well have passed.   Under Oil Base, the insured had four years after final judgment to bring suit.   It is therefore not unthinkable that the case would be tried fifteen to twenty years downstream.   This is intolerable.   On the other hand, we discern no prejudice to the insured in setting an ample limitation period after categorical disclaimer of responsibility by the insurance company.

City seeks to distinguish Central Bank on the ground that it involves title insurance rather than ordinary liability coverage.   But that is a distinction without a difference.   There as here the insured was accused of tort.   There as here the insurer contractually undertook an obligation to indemnify his insured and to furnish a defense.   There as here the carrier failed in his duty.

 City makes two additional points.   The first is that the subsequent tenders and their rejection in 1976 and 1978 started the running of new limitation periods.   This would be an interesting and perhaps tenable thesis if the original complaint had alleged only one claim for relief based on a clearly excluded cause such as article I, section 13, if City had made a pro forma tender at that time knowing that there was no coverage, and if the complaint had thereafter been amended to state a claim for which there was insurance at which time a new demand for defense was asserted.   But that is not the scenario here and City never took such a position;  in fact, the complaint makes the opposite contention.   As we previously noted, Pacific Indemnity's repudiation of its obligation was unjustifiable in 1973 under then-existing law;  Eldridge's addition of a new cause of action in 1978 did not give City any rights vis-a-vis Pacific Indemnity which it had not had earlier.   If the 1978 tender could start the running of a new limitation period under the circumstances here obtaining, a party would have it in his sole power to extend the statute indefinitely simply by making further demands.

 Finally, City points to the following provision in the policy:  “14.   No action shall lie against the company ․ until the amount of the insured's obligation to pay shall have been finally determined either by judgment against the insured after actual trial or by written agreement of the insured, the claimant and the company.”   City contends that under this provision it had no duty to sue Pacific Indemnity until after the Eldridge case was finally resolved so that City's claim could not have accrued prior thereto.   Actually, if paragraph 14 is taken literally, City is out of court because neither of the two contingencies specified in that paragraph ever arose.   But no such strained construction is permissible.   The same argument was rejected in Central Bank v. Transamerica Title Ins. Co., supra, 85 Cal.App.3d 859 at p. 869, 149 Cal.Rptr. 822:  “The obvious purpose of paragraph 7 was to prevent the insured from suing respondent while respondent was actively involved in the third party action.   Since respondent denied liability on November 13 and 14, 1973, there was no reason to delay the commencement of an action to determine whether the respondent's claim of nonliability was well taken.   Accordingly, the trial court properly determined that appellants' causes of action were barred by the statute of limitations.”  (Emphasis added.)   The court went on to cite the language from Bollinger previously quoted.

The position contended for by City would have a thoroughly undesirable result.   It would prevent the bringing of a declaratory relief action by an insured against his insurer at a stage of the proceedings when a court could still force the carrier to assume his obligation.   We take judicial notice of the fact that in the face of “no direct action” clauses which are standard in liability policies, such declaratory relief actions are common and entirely appropriate, indeed favored, in response to anticipatory repudiation by insurance companies.   We decline to hinder such actions.

Judgment affirmed.

FOOTNOTES

1.   In the case at bench the complaint alleged that City incurred in excess of $500,000 for attorneys' fees and defense of the Eldridge litigation which lasted from December 18, 1972 to September 30, 1980.   Thus it is clear that City suffered appreciable harm by the time of refusal of tender and certainly long before the running of the statute.   City never contended otherwise.

2.   Auto Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d 450, 20 Cal.Rptr. 321, 369 P.2d 937.

BRAUER, Associate Justice.

AGLIANO, P.J., and SIMMONS, J.,* concur.