Farella Braun + Martel's Shanti Eagle. Farella Braun + Martel’s Shanti Eagle.

On Tuesday, the Supreme Court of California will hear oral argument in the case of Liberty Surplus Insurance v. Ledesma & Meyer Construction, case no. S236765. The court likely will decide whether there can be coverage under a general liability policy for negligent supervision claims, a decision which could have a significant impact on California policyholders across a range of industries. In addition, the court may clarify the definition of “accident” in a broader sense, settling a lower court split over whether the unintended consequences of intentional acts can constitute an “occurrence” under general liability insurance policies.

Ledesma involves an insurance dispute between a contractor, Ledesma & Meyer (L&M), and its insurers, Liberty Surplus Insurance Corp. and Liberty Insurance Underwriters, Inc. (Liberty). One of L&M’s employees, Darold Hecht, was found to have sexually abused a student while working on a construction project at a middle school in San Bernardino, California. The student sued L&M and the school, and ultimately obtained a judgment against L&M for negligent hiring, supervision and retention of Hecht.

Liberty defended L&M under a reservation of rights, but denied a defense to the school as an additional insured under L&M’s policy. Liberty sued L&M and the school in federal court, seeking a declaration that it had no duty to defend or indemnify either in the underlying lawsuit on the ground that there was no “occurrence”—defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions”—under the policy. The district court granted summary judgment in favor of Liberty, finding no duty to defend because: the negligent hiring, retention, and supervision were “antecedent” and “too attenuated” from the injury-causing conduct; and the acts of hiring, supervising, and retaining employees are “intentional” and not accidents. L&M appealed.

After full briefing and oral argument, the U.S. Court of Appeals for the Ninth Circuit decided that the issue involved an unsettled area of California law and certified the following question to the California Supreme Court: “Whether there is an ‘occurrence’ under an employer’s commercial general liability policy when an injured third party brings claims against the employer for the negligent hiring, retention, and supervision of the employee who intentionally injured the third party,” Liberty Surplus Insurance v. Ledesma & Meyer Construction Co. 834 F.3d 998, 1000 (9th Cir. 2016), certified question accepted (Oct. 19, 2016).

The ramifications of this decision may have a major impact on California policyholders. As the Ninth Circuit observedThe certified question is of considerable importance to employers, insurers, and third parties injured by the willful acts of employees. Moreover, we note that the resolution of this question will extend beyond the employment context, affecting many insured entities and persons, and the third parties that are injured by the willful acts of those individuals supervised by the insured.

Liberty contends that the ramifications of the California Supreme Court’s decision are not so widespread. Liberty argues that a ruling in its favor would be based on its “specific policy language” and would not preclude the potential for coverage under other policies or prevent policyholders from purchasing specific coverage for this type of risk. However, obtaining that specialized insurance in the future may be prohibitively expensive for many small businesses. In addition, it fails to take into account that the Liberty commercial general liability (CGL) policy was written on a standard ISO form that is virtually identical to that of thousands of general liability policies purchased by California policyholders for decades. The “trigger” of coverage under CGL policies is when the bodily injury or property damage occurred, not when the lawsuit was filed, and therefore older CGL policies may be required to respond to lawsuits filed today alleging conduct that occurred many years ago. As a result, it is hard to imagine how the California Supreme Court’s decision in Ledesma will not affect the scope of coverage available to many CGL policyholders in California.

If Liberty prevails, negligent hiring, training and retention claims may no longer be covered under the CGL policies in effect at the time of the alleged negligence. In many instances, those policies were purchased based on the reasonable expectation and mutual understanding that negligent supervision claims were covered claims—because in the absence of exclusions, historically insurers have covered them. As a result, if the court adopts Liberty’s proposed narrowing of what constitutes an “accident,” it could create significant uncovered exposure.

L&M argues that the definition of “accident” easily encompasses negligent hiring, supervision and retention. The court has repeatedly held that “in the context of liability insurance, an accident is an unexpected, unforeseen, or undesigned happening or consequence from either a known or an unknown cause.” Delgado v. Interinsurance Exchange of Automobile Club of Southern California, 47 Cal. 4th 302, 308 (2009) (internal citations and quotations omitted). L&M maintains that this definition is met “as long as the resulting harm from the employer’s deliberate (but negligent) conduct was unexpected or unforeseen.” This is because “the word accident in the coverage clause of a liability policy refers to the conduct of the insured for which liability is sought to be imposed on the  insured.” In this case, that conduct is the insured employer’s negligent hiring, supervision and retention.

Liberty counters that the court must look to the “injury-causing act” to determine whether there has been an accident, not the source of liability to the insured. According to Liberty, “if the cause of the ‘bodily injury’ is not accidental, the ‘insuring agreement’ is not satisfied and coverage is not implicated … even if there are remote, antecedent events that are alleged to have invited the actual cause of the ‘bodily injury.’” Liberty’s position is essentially that there can only be one cause of the injury, and if that cause is intentional, any contributory negligence is “too attenuated” to trigger coverage. L&M counters that its CGL policy covers bodily injury “caused by” an occurrence, which encompasses multiple legal causes, not only the most immediate cause. Conduct that is a proximate cause of the injury for purposes of liability cannot be “too attenuated” to fall within the scope of liability coverage so long as it is a substantial factor in causing the harm.

Lending some additional support for L&M’s argument is the fact that insurers have been increasingly adding exclusions to CGL policies for sexual abuse, assault and battery, or the use of firearms that apply to any claim based on such intentional conduct. Those exclusions generally preclude coverage for claims arising out of or related to specific conduct, even if the insured’s negligence is a contributing factor. In some cases, the exclusions provide exceptions or have carve-backs for the duty to defend. Those exclusions suggest that insurers are capable of eliminating coverage for specific conduct, including derivative claims like negligent supervision, if they choose to. In addition, policyholders point out, there would be no need to have specific exclusions of this type if negligent hiring, retention, and supervision never fell within the insuring agreement to begin with. Absent an exclusion, the argument goes, this kind of exposure is and should be covered under CGL policies.

This case could also have a much larger impact on general liability coverage if the court chooses to address the broader question of whether the unintended and unforeseen consequences of a deliberate act can be an “occurrence,” defined as an “accident.” L&M has requested that the court take this opportunity to rule that unintended and foreseen consequences can be an accident, even if the conduct itself was deliberate, thereby overturning what is currently the majority-view among California Courts of Appeal. If the court finds that unintended consequences of deliberate acts cannot constitute an accident for purposes of a CGL policy, it could eliminate coverage for situations such as that presented in State Farm Fire & Casualty v. Superior Court (“Wright”), 164 Cal. App. 4th 317, 320 (2008), as modified (July 9, 2008), where a boy tried to push another boy into a swimming pool but fell short and caused serious injury. Although most people would understand that to be an accident, other courts have held the opposite under similar facts. See, e.g., State Farm General Insurance v. Frake, 197 Cal. App. 4th 568, 585 (2011).

Importantly, the court need not resolve the greater issue of the split in the California Courts of Appeal in order to decide the limited certified question before it. In fact, in order to reach that secondary question, the court must presume that negligent hiring, supervision and retention are deliberate, intentional acts per se. The district court made that finding without any analysis of the nature of the conduct. However, claims for negligent supervision of employees are generally based on the lack of due care, and do not necessarily involve deliberate or intentional conduct.

Given the narrowly phrased question certified by the Ninth Circuit and the limited scope of the review, the court may opt to take the more conservative approach and restrict its ruling to whether negligent hiring, supervision and retention of an employee who intentionally injures a third party can, in the abstract, constitute an “accident.” If the court limits its ruling to the narrower question, hopefully it will nevertheless provide some guidance to the lower courts as to the proper interpretation of “accident” for purposes of CGL insurance going forward.

Shanti Eagle is a senior associate at Farella Braun + Martel in San Francisco and a member of its insurance recovery practice. She can be reached at seagle@fbm.com, or via the firm’s website, http://www.fbm.com.