Mutual of Enumclaw Insurance Company v. Dan Paulson Construction, Inc.

• Decision Date: 08 May 2006
• Docket Number: No. 55342-9-I.,55342-9-I.
• Citation: 132 Wn. App. 803,134 P.3d 240
• Court: Washington Court of Appeals
• Parties: MUTUAL OF ENUMCLAW INSURANCE COMPANY, Appellant/Cross-Respondent, v. DAN PAULSON CONSTRUCTION, INC., a Washington corporation, Karen and Joseph Martinelli, and the marital Community composed thereof, Respondents/Cross-Appellants.

134 P.3d 240

132 Wn. App. 803

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

No. 55342-9-I.

Court of Appeals of Washington, Division 1.

May 8, 2006.

COPYRIGHT MATERIAL OMITTED

Brent Beecher, James Beecher, Hackett, Beecher & Hart, Seattle, K.C. Webster, Woodinville, for Appellant.

Robert Gould, Brian Waid, Law Offices of Robert B. Gould, Seattle, for Respondent.

BAKER, J.

¶ 1 This case arises from an arbitration claim brought by Joseph and Karen Martinelli against Dan Paulson Construction, Inc. (Paulson) for alleged construction defects in the Martinellis' home. Paulson's commercial liability insurance company, Mutual of Enumclaw (MOE), agreed to defend Paulson under a reservation of rights regarding coverage issues. Before Paulson and the Martinellis commenced arbitration, MOE filed a declaratory judgment action and issued a subpoena duces tecum and interrogatories to the arbitrator seeking information that would help MOE determine which parts of any arbitration award would be insured and which would not. Paulson and the Martinellis subsequently entered into a stipulated arbitration award for $1.3 million, whereby Paulson assigned its coverage and bad faith claims against MOE to the Martinellis in return for a covenant not to execute. MOE then dismissed the first declaratory judgment complaint and filed this declaratory judgment action to determine insurance coverage issues. On cross motions for partial summary judgment, the trial court found that MOE's subpoena duces tecum, interrogatories, and ex parte cover letter to the arbitrator constituted bad faith, but because Paulson had not suffered harm, MOE was not estopped from denying coverage for uninsured claims. Upon reconsideration, the court ruled that attorney fees incurred by Paulson in opposing the subpoena to the arbitrator constituted sufficient harm to estop MOE from denying coverage. The court then ruled that the arbitration award was reasonable, and entered judgment against MOE for the full award with interest at 12 percent, plus attorney fees and expenses. The trial court also ruled that MOE's refusal to pay any portion of the arbitration award pending resolution of coverage issues did not violate the Consumer Protection Act¹. MOE appeals, and the Martinellis cross-appeal.

I.

¶ 2 Paulson contracted to build a home on San Juan Island for the Martinellis in 1998. The final construction price was approximately $1,725,000. Paulson and the Martinellis arbitrated their dispute concerning the construction price. The Martinellis then sued their architects for alleged construction defects, and settled in 2003 for an undisclosed amount.

¶ 3 In August 2002, the Martinellis filed a second arbitration claim against Paulson, also asserting construction defects. MOE assigned defense counsel to represent Paulson under a reservation of rights regarding insurance coverage issues. Thus, there were two separate groups of MOE personnel working on the case: Paulson's assigned defense counsel team, and MOE's insurance coverage analysis team. Paulson also retained private defense counsel.

¶ 4 MOE maintained that some of the claims against Paulson might be barred by certain policy exclusions, and that MOE needed to know what damage was allegedly caused by each entity that performed work on the Martinelli home in order to determine the extent and scope of coverage. Soon after the Martinellis filed their arbitration claim, MOE asked Paulson and the Martinellis to provide information concerning the alleged defects, which they made available to MOE. A year later, in August and September 2003, MOE asked Paulson to provide additional information relevant to the arbitration claims. Paulson's attorney offered some documents "as a courtesy," asserting that MOE did not have a right to them, and that document production should not be construed as a concession that any alleged defect was valid or that the Martinellis' claim established an appropriate segregation of any arbitration award.

¶ 5 In October 2003, counsel for Paulson urged MOE to accept the Martinellis' offer to settle the case for $1 million. The letter noted that Paulson "is personally very troubled that a large arbitration award will ruin his small construction company and cause it to shut its doors," and that accepting the offer would save "enormous costs and expenses." MOE countered with an offer to settle for $550,000, but the Martinellis declined.

¶ 6 MOE requested permission from Paulson and the Martinellis to be allowed to intervene in the upcoming arbitration so that MOE could promptly determine coverage issues, but Paulson and the Martinellis objected. MOE asked to be able to attend the arbitration proceeding as a nonparty observer, but the parties refused. MOE made no further attempts to intervene or appear at the arbitration. Instead, MOE filed a declaratory judgment action against the Martinellis and Paulson seeking information on the claims, but the complaint was not served.

¶ 7 On December 30, 2003, MOE served arbitrator J. Richard Manning with a subpoena duces tecum designed to obtain information that would assist MOE in segregating insured and uninsured elements of the arbitration award, if any. Accompanying the subpoena was a cover letter in which MOE briefly sought to explain why the information requested in the subpoena was necessary to resolve coverage issues. MOE did not send copies to counsel for Paulson or the Martinellis until four days before the arbitration was scheduled to begin. The arbitrator, Paulson, and the Martinellis opposed the subpoena and demanded that it be withdrawn. Over the Martinellis' objections, MOE sent a second letter to the arbitrator abandoning some of the interrogatories, but reiterating its position that the subpoena was appropriate and legal under the circumstances. Paulson incurred unspecified costs for attorney fees and expenses for private counsel to oppose MOE's subpoena to the arbitrator.

¶ 8 The arbitration hearing commenced on January 6, 2004. Paulson was represented by defense counsel assigned by MOE. On January 8, 2004, MOE learned that Paulson and the Martinellis had entered into a stipulation for a lump sum arbitration award at Paulson's request. On January 12, 2004, Paulson and the Martinellis entered into a stipulated arbitration award of $1,300,000. The arbitrator approved the award, and at the request of the parties, found that it was reasonable. Paulson assigned its contract indemnification and bad faith claims against MOE, and the Martinellis entered a covenant not to execute against Paulson. The superior court confirmed the award on February 2, 2004 and found that the award was reasonable, but did not explain the basis for that finding. On February 4, 2004, the Martinellis, as assignees of Paulson, made demand upon MOE to pay any undisputed, insured portions of the damages. MOE acknowledged that some of the claims were covered under the policy, but declined to remit any payments to the Martinellis until it ascertained which portions of the arbitration award were insured and which were not.

¶ 9 In late January 2004, MOE struck its subpoena, dismissed the original declaratory judgment action, and filed a new complaint for declaratory judgment requesting the court to determine which portions of the arbitration award were insured under the MOE/Paulson contract and which were not insured. The parties filed cross motions for partial summary judgment. The trial court initially ruled that MOE's subpoena and cover letter to the arbitrator constituted bad faith, but that MOE was not estopped from denying coverage because MOE had rebutted the presumption of harm. The court further ruled that MOE's failure to settle the case within the policy limits or to pay any portion of the award pending litigation of coverage issues was not bad faith, and that the stipulated award was reasonable. The court deferred ruling on the issue of which party bears the burden of proof regarding the subcontractor exception to an exclusion in the contract. The Martinellis then moved for partial reconsideration on the coverage by estoppel issue, arguing that attorney fees incurred by Paulson in opposing MOE's subpoena constituted sufficient harm to create coverage by estoppel. The court agreed, and entered an order estopping MOE from denying coverage for the entire stipulated award. The court later entered a judgment nunc pro tunc in favor of the Martinellis for $1.3 million plus attorney fees and expenses, with interest. Because issues remain to be litigated, the parties sought and obtained a CR 54(b) order certifying the judgment as final and staying further proceedings pending decision by this court. MOE now appeals and the Martinellis cross-appeal.

II.

¶ 10 This court reviews an order on a motion for summary judgment de novo.² Summary judgment is appropriate "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law."³

¶ 11 MOE contends that sending a subpoena and cover letter to the arbitrator did not constitute bad faith because these actions were not unreasonable, frivolous or unfounded. MOE argues that its insured's actions created an untenable dilemma for MOE of either paying the entire amount of a stipulated, lump sum award or being accused of bad faith if its refusal to immediately do so led to the insured's business failure. The Martinellis argue that the subpoena and cover letters were improper, unnecessary, and prejudicial.

¶ 12 Both insurer and insured are obligated to exercise good faith.⁴ An insurer has an enhanced obligation to its insured when defending under a reservation of...