On April 27, the Washington Supreme Court created a significant new wrinkle in how courts will approach liability insurance disputes involving policy exclusions. In Xia v. ProBuilders Specialty Insurance Co. RRG, the Court applied the “efficient proximate cause” rule to a third-party liability case for the first time, a move that may effectively render most policy exclusions unenforceable. The Court further held that the insurer’s failure to anticipate this new approach to evaluation of the coverage question in denying coverage constituted bad faith.

The facts of the case are not unusual. Xia purchased a new home built by contractor Issaquah Highlands. She fell ill shortly after moving in. When a Puget Sound Energy service technician was called to the home months later, he discovered that the exhaust vent for a hot water heater had been improperly installed, with the result that carbon monoxide was being pumped directly into Xia’s home.

Xia sued the builder, but the builder’s insurer (ProBuilders) refused coverage, based in part on the policy’s pollution exclusion. Xia and the builder settled, and the builder assigned its coverage claims to Xia. In the coverage litigation the Washington Court of Appeals found that ProBuilders was entitled to summary judgment, based on the pollution exclusion.

In reversing the court of appeals, the supreme court acknowledged that the carbon monoxide that had harmed Xia was a “pollutant” under the policy. In a surprise move, however, the Court nonetheless held that ProBuilders owed coverage, because the “efficient proximate cause” of Xia’s harm—in other words, the most direct cause in the chain of causation leading to injury—was not the pollutant, but the negligent installation of the exhaust vent before she purchased the home. Relying on the “occurrence” language of the policy, the Court implied that it will enforce exclusions such as the pollution exclusion when the excluded cause is the only cause or the first in a series of causes leading to harm, but not when the chain of events begins with a covered negligent act.

No Washington court had ever before applied the “efficient proximate cause” rule outside first-party (property) coverage cases. But the Court asserted that doing so was not a novel or unexpected extension of the law because the “efficient proximate cause” rule had never been limited to specific types of insurance. The Court therefore found that ProBuilders’ refusal to defend was bad faith. In essence, the Court ruled that ProBuilders had an obligation to consider not only liability cases involving the pollution exclusion, but also facially unrelated insurance cases, and evaluated the potential applicability of the “efficient proximate” cause rule.

Despite the Court’s characterization of its holding, Xia is clearly a departure from the way that exclusions have been analyzed before under Washington law (or under Oregon law—see our coverage of a recent ruling from an Oregon court enforcing the pollution exclusion in nearly identical circumstances). In practice, Xia appears to dramatically narrow the effectiveness of many common exclusions in the Commercial General Liability form. Because most harm from a pollutant begins with an initial negligent act, and because it is likely infeasible for insurers to write into their policies specific exclusions for every conceivable act of negligence that could result in pollutant-related harm, insurers may now be hamstrung in their ability to deny coverage based on the pollution exclusion or other exclusions that operate in a similar way.

Xia is likely to amplify the current trend in Washington of insurers’ accepting defense under a reservation of rights when there is any question whether a claim is covered, and then filing suit for a declaration of their obligations from the court. Indeed, some carrier-side commentators are advising their clients that in virtually every case it will now be necessary to accept a tender of defense and seek relief from the court, because it will be so difficult to determine at the outset what the “efficient proximate cause” of any damage or injury was, and because under Xia and Washington bad-faith law generally the consequences of “guessing wrong” are so severe. Furthermore, although the Xia Court speculated that insurers could rewrite their policies to avoid these results, the Court effectively nullified an anti-concurrent-causation clause in the ProBuilders policy, making it difficult to imagine how insurers could contract around the new standard.

Xia is certain to change how coverage lawyers approach many liability coverage disputes. Its impact will have to be carefully followed, so please check back on this blog often for further updates.