California Supreme Court Rules Vertical Stacking Applies, Not Horizontal

On April 6, 2020, the California Supreme Court issued yet another groundbreaking ruling in the case that keeps on giving, Montrose Chemical Corporation of California v. Superior Court.¹

Montrose arises from a massive loss in the Los Angeles area that occurred over several years from 1961 to 1985. The loss led to enough coverage litigation to keep hundreds of lawyers employed for decades. This most recent decision addressed a longstanding open question on the issue of “stacking.” I’ll explain what that means below. This issue is dear to my heart. I fondly recall as a law school student researching “stacking” for a law review article my law school insurance professor was writing. Thanks for the shout-out in the footnote, Professor Leo Martinez! As you already know, I owe my successes to you and a small handful of others.

Stacking is a complicated issue involving numerous terms of art, so I will start with a summary of the decision and then break down the concepts further. If you don’t fully understand the next two sections, keep reading.

The Issue: Horizontal or Vertical Stacking?

Montrose was running a chemical plant in Los Angeles for decades when it discovered a massive environmental loss. The loss occurred over a number of years. Over those years, Montrose was insured under numerous primary and excess insurance policies issued by several different carriers. Montrose knew that its financial loss was so massive it would have to tender to several different insurers. Montrose faced an interesting and strategic decision: Which insurance carriers to tender to.

On the one hand, Montrose could tender the claim to every primary insurer, and if it still had uncovered losses after exhausting all primary policies, it could turn to its excess insurers. This approach is called “horizontal stacking.” The challenge for Montrose, however, was that it would have to fight each and every one of these carriers and deal with challenging coverage provisions in some policies.

On the other hand, Montrose could tender to a select few primary insurers where it had the best chance of getting coverage. After exhausting the limits of those primary policies, Montrose could then tender to the excess insurers for those same policy years. Those excess insurers would then assumedly try to recoup their payments from other primary and excess insureds that Montrose did not tender the claim to. This is called “vertical stacking.”

Montrose chose the latter route, vertical stacking. However, the excess insurers refused to pay, arguing that Montrose had to first tender to and exhaust all primary insurance layers that were effective during the loss, before tendering to any excess insurer—horizontal stacking.

The Decision: Vertical Stacking

The California Supreme Court held that absent any clear policy language to the contrary, Montrose did not have to exhaust all primary policies before tendering to any excess insurers. Instead, the court held that Montrose could make a “targeted tender” to only some primary policies, and then access the excess layers once those selected primary layers were exhausted. Montrose would not have to tender to the other primary insurers and exhaust their limits first. The court held that the excess insurers who paid could then turn to the non-paying primary and excess insurers to seek contribution. The court noted that policy language requiring horizontal stacking could have changed the outcome.

Breaking Down The Concepts

Although I explained the difference between horizontal stacking and vertical stacking above, there are a lot of building block concepts in there that not all readers will be familiar with. After all, it is not common to encounter a loss that occurs over multiple policy years, and many losses are not so significant as to require evaluating primary and excess policies. I explain these all below.

These concepts start with “primary” and “excess” layers of insurance. Insurance is like an onion, it has layers.² An insured needs layers of insurance when no single insurer will take on all the risk themselves. For example, if an insured wants to get a policy with $200 million of limits but no insurer will give more than $50 million of limits, the insured needs to look to the “excess” market to cover the uninsured $150 million. “Excess” insurers provide an additional layer of insurance limits on top of the “primary” policy. Those limits do not come into play on a claim until the insured first “exhausts” (“get paid all”) the limits of the primary layer. Naturally, these policies are much cheaper than their primary counterparts even for the same amount because a loss must be catastrophic to trigger them. Excess policies and excess insurers are unlike their primary counterparts in many ways.

The next concept is that of a loss occurring over multiple policy periods. When a loss occurs in just one policy period, the insured’s choice is simple: tender the claim to the primary insurer and if the loss exhausts the primary layer limits, tender to the excess insurer. But in Montrose’s situation, the loss occurred over multiple policy periods. When a loss occurs over multiple policy periods, there are numerous other legal disputes that can arise, including the “trigger” of coverage and whether the late discovery of the loss prejudices a claim to an older insurer. In this case, Montrose had the choice of tendering to every primary insurer or a subset of them before turning to excess layers. This is known as a “targeted tender.”

Montrose chose a “targeted tender.” Montrose selected the primary insurance policies it believed it had the best chance to recover under and tendered claims. After exhausting those primary layers, Montrose did not tender to other primary insurers. It tendered to the excess insurers who were on the risk the same years as the primary insurers to whom Montrose tendered. This is “vertical stacking.”

The excess insurers whom Montrose targeted argued this was unfair and that Montrose should have to tender to all primary carriers first before tendering to any excess insurers. However, the excess policies at issue did not include terms that Montrose must tender to all primary insurers on the risk before seeking the excess limits. Therefore, the case was about what should happen when such terms are not present.

The decision is interesting from an academic point of view but may not be something one comes across every day. Still, the Montrose case is not over with this latest decision. It will continue giving us case law for years to come.
______________________________
¹ Montrose Chemical Corp. of California v. Superior Court, S244737 (Cal. Apr. 6, 2020).
² Credit: Shrek, who said ogres are like onions, they both have layers.