Moe v. Dan Paulson Const., Inc.

• Citation: 169 P.3d 1,161 Wn.2d 903
• Decision Date: 11 October 2007
• Docket Number: No. 79027-2.,79027-2.
• Court: United States State Supreme Court of Washington
• Parties: MUTUAL OF ENUMCLAW INSURANCE COMPANY, Respondent/Cross-Petitioner, v. DAN PAULSON CONSTRUCTION, INC., a Washington corporation, Karen and Joseph Martinelli, and the marital community composed thereof, Petitioners/Cross-Respondents.

169 P.3d 1

161 Wn.2d 903

MUTUAL OF ENUMCLAW INSURANCE COMPANY, Respondent/Cross-Petitioner, v. DAN PAULSON CONSTRUCTION, INC., a Washington corporation, Karen and Joseph Martinelli, and the marital community composed thereof, Petitioners/Cross-Respondents.

No. 79027-2.

Supreme Court of Washington, En Banc.

Argued June 14, 2007.

Decided October 11, 2007.

Robert B. Gould, Attorney at Law, Brian J. Waid, Law Office of Robert B. Gould, Seattle, WA, for Petitioners.

Brent William Beecher, James Morton Beecher, Law Offices of Hackett, Beecher, & Hart, Seattle, WA, K.C. Webster, Attorney at Law, Woodinville, WA, for Respondents.

Stewart Andrew Estes, Keating Bucklin & McCormack, Joseph D. Hampton, Daniel L. Syhre, Betts, Patterson & Mines, P.S., Russell Charles Love, Thorsrud Cane & Paulich, David Michael Jacobi, Wilson Smith Cochran Dickerson, Seattle, Amicus Curiae on behalf of Washington Defense Trial Lawyers.

Bryan Patrick Harnetiaux, Gary Neil Bloom, Harbaugh & Bloom, P.S., Spokane, Amicus Curiae on behalf of Washington State Trial Lawyers Association Foundation.

Julie M. Sund, Andrew C. Cook, Building Industry Association of Washington, Olympia, Amicus Curiae on behalf of Building Industry Association of Washington.

FAIRHURST, J.

¶ 1 Respondent/cross-petitioner Mutual of Enumclaw Insurance Company (MOE) defended its insured, petitioner/cross-respondent Dan Paulson Construction, Inc. (DPCI), against construction defect claims brought by petitioners/cross-respondents Karen and Joseph Martinelli (Martinellis). Shortly before the arbitration hearing on those claims, MOE subpoenaed the arbitrator, explaining in two ex parte letters to the arbitrator that it needed information to resolve its coverage dispute with DPCI. During the hearing, DPCI and the Martinellis reached a settlement, the terms of which included assignment of DPCI's claims against MOE to the Martinellis and the Martinellis' covenant not to execute the resulting judgment against DPCI.

¶ 2 MOE brought this declaratory judgment action against DPCI and the Martinellis to resolve its coverage issues, and the Martinellis cross-complained. The Martinellis now seek review of the Court of Appeals decision reversing summary judgment in their favor on their insurance bad faith claim against MOE. We hold that MOE's subpoena and ex parte communications to the arbitrator constituted bad faith, that MOE did not rebut the resulting presumption of harm to DPCI, and that MOE has not raised a genuine issue of material fact with respect to whether the settlement amount is reasonable.

I. FACTUAL AND PROCEDURAL HISTORY

Background

¶ 3 In February 1998, the Martinellis contracted with DPCI to build their new home in Friday Harbor, San Juan County.¹ In August 2002, the Martinellis initiated arbitration proceedings against DPCI (Martinellis/DPCI arbitration) with the American Arbitration Association (AAA), alleging construction defects. The amount recoverable through the arbitration proceeding was initially limited to $1 million and then later increased to $2 million.

¶ 4 DPCI maintained a comprehensive general liability insurance policy with MOE. DPCI tendered defense in the arbitration proceeding to MOE, which informed DPCI that it would defend under a reservation of rights. Consequently, MOE provided DPCI with assigned defense counsel² and simultaneously, through its coverage group (hereinafter MOE), investigated the extent to which the Martinellis' claims against DPCI were covered or excluded by DPCI's policy.

¶ 5 DPCI's policy excluded coverage for DPCI's work, but provided coverage for work performed for DPCI by subcontractors. Therefore, to ascertain which of the Martinellis' claims, if any, were covered, MOE sought to determine which entities performed what work on the Martinellis' home, what construction defects resulted from each entity's work, and the cost to repair each defect. Both DPCI and the Martinellis "cooperated" with MOE's requests for information and documentation, "providing all that MOE requested." Clerk's Papers (CP) at 649 (San Juan County Superior Ct. letter op. (Aug. 19, 2004)) (hereinafter letter op.).

¶ 6 Ultimately, in October 2003, MOE authorized settlement authority of up to $550,000. The Martinellis offered to settle for $1 million, an amount within the limits of DPCI's policy. Both DPCI's assigned defense counsel and DPCI's private counsel recommended that MOE accept the Martinellis' offer. A settlement was not reached before arbitration.

¶ 7 By late October 2003, the arbitration hearing had been scheduled, with a start date of January 6, 2004. A few days after scheduling, the parties informed the arbitrator that they had agreed, at DPCI's request, that any award would be a lump sum award. This deviated from the arbitrator's usual practice of providing a detailed, itemized award. MOE did not learn of the lump sum award agreement until after the arbitration hearing had begun.

¶ 8 MOE attempted to participate in the arbitration hearing. However, MOE did not formally move to intervene and did not ask the arbitrator for permission to attend, as allowed by AAA rules.³ Instead, MOE informally requested permission to intervene from DPCI or, in the alternative, to have a MOE coverage representative observe. DPCI denied both requests.

¶ 9 On November 21, 2003, MOE filed a declaratory judgment action against DPCI and the Martinellis in San Juan County Superior Court. The purpose of the action was to resolve coverage issues regarding which of the Martinellis' claims were covered and which were excluded under DPCI's policy. MOE did not serve the complaint on either party. On December 15, 2003, MOE informally notified DPCI of the declaratory judgment action by e-mail. The Martinellis did not learn that MOE had filed the action until late December 2003 or early January 2004. MOE did not perfect this first declaratory judgment action.

The arbitration

¶ 10 On December 30, 2003, MOE issued a subpoena duces tecum to the arbitrator, scheduling the arbitrator's deposition upon written questions after the arbitration was concluded. In addition to making a comprehensive request for documents, the subpoena sought the arbitrator's thoughts regarding the arbitration. With the subpoena, MOE sent the arbitrator an ex parte cover letter explaining its coverage issues with DPCI.

¶ 11 DPCI and the Martinellis received the subpoena on Friday, January 2, 2004, two business days prior to the scheduled start of the arbitration hearing. (They did not receive the cover letter, which MOE sent only to the arbitrator. They first learned of the letter from the arbitrator at the commencement of the hearing.) AAA, the Martinellis, and both DPCI's private counsel and assigned counsel promptly demanded that MOE withdraw the subpoena. When MOE disclosed to the Martinellis its intention to send a second letter to the arbitrator, the Martinellis again protested. However, on day two of the hearing, MOE sent a second letter to the arbitrator and all parties, slightly narrowing the subpoena and reiterating its explanation of its coverage dispute with DPCI. Subsequently, MOE struck the subpoena and dismissed its first declaratory judgment action.⁴

¶ 12 During the sixth day of the hearing, the parties reached a negotiated settlement and entered into a stipulated settlement agreement. The agreement provided (1) a lump sum arbitration award of $1.3 million in favor of the Martinellis against DPCI, (2) assignment of all DPCI's insurance coverage and bad faith claims against MOE to the Martinellis, and (3) a covenant by the Martinellis not to execute the arbitration award/judgment against DPCI. The parties submitted their proposed award to the arbitrator, who found it reasonable and approved it. On February 2, 2004, after proper notice and hearing, the San Juan County Superior Court confirmed the arbitration award and reduced it to judgment.

The instant declaratory judgment action

¶ 13 On January 22, 2004, MOE filed the instant declaratory judgment action against DPCI and the Martinellis, seeking to determine what portions of the arbitration award/judgment were payable by MOE pursuant to DPCI's policy. MOE's claim acknowledged that "[s]ome of the damage claimed against [DPCI] is covered by the [MOE] policy, but much of it is subject to policy exclusions." CP at 2. The Martinellis (as DPCI's assignees) then demanded that MOE pay "those amounts which [MOE] acknowledges are due under its policy," which they identified as at least MOE's final settlement authority of $550,000. CP at 212. After MOE refused, the Martinellis counterclaimed in MOE's declaratory judgment action, alleging the contract and insurance bad faith claims assigned to them by DPCI.

¶ 14 The Martinellis and MOE filed cross-motions for partial summary judgment.⁵ Initially, the trial court held (a) that MOE acted in bad faith when it interfered in the arbitration proceeding, (b) but that MOE had successfully rebutted the presumption of harm, and (c) that MOE had not violated WAC 284-30-330(6) and (7) by failing to pay undisputed property damage amounts. The Martinellis moved for partial reconsideration relative to the presumption of harm, which the trial court granted. The court additionally denied MOE's affirmative defense of fraud or collusion with respect to the reasonableness of the arbitration award/judgment. The court entered judgment nunc pro tunc in the sum of $1.3 million, plus attorney fees, costs, and interest.

¶ 15 The Court of Appeals reversed, holding that MOE had not acted in bad faith when it subpoenaed the arbitrator and sent him ex parte correspondence because MOE "had a reasonable need to know the elements of a potential damage award." Mut. of Enumclaw Ins. Co. v. Dan Paulson Constr., Inc., 132 Wash.App. 803, 813, 134 P.3d 240 (2006) (MOE v. DPCI). It also held that MOE had rebutted the presumption of harm because if coverage by estoppel were imposed, MOE's liability "would grossly...