Earlier this month, the California Supreme Court agreed to review Montrose Chemical Corporation’s appeal from a September appellate court ruling that rejected Montrose’s preferred “vertical exhaustion” method of exhausting excess-layer policies in favor of a policy-by-policy review to determine which policies are triggered. The California high court’s grant of Montrose’s petition for review is potentially significant in clarifying the appropriate excess policy exhaustion trigger under California law, not to mention in addressing a significant insurer defense in Montrose’s longstanding coverage dispute over environmental insurance coverage, which has been winding its way through California courts for more than 25 years.

From 1947 to 1982, Montrose manufactured chemicals at a facility in Torrance, California. Operations at this facility were later the subject of a federal lawsuit under the Comprehensive Environmental Response, Compensation, and Liability Act, which alleged that Montrose caused over $100 million in environmental damages to neighboring land, water, and wildlife. During the time period at issue in the CERCLA lawsuit, however, Montrose had purchased many “layers” of commercial general liability coverage, including a primary policy in each policy year and more than 40 layers of excess coverage with aggregate limits in excess of $120 million.

Montrose sought the benefit of those policies and requested a summary adjudication that it could “electively stack” excess policies—i.e., it could access any excess policy issued in any policy year as long as the lower-lying policies for the same policy year had been exhausted (sometimes referred to as “vertical exhaustion”), notwithstanding the fact that the coverage terms and limits of its excess policies vary from year to year. Montrose’s excess insurers opposed the motion for summary adjudication on the grounds that no insurer had a duty to pay until Montrose had “horizontally exhausted” its lower-lying excess policies in all triggered policy years.

In September, the California Court of Appeals disagreed with Montrose’s “elective stacking” principle. While the appellate court did not hold that all policies must be horizontally exhausted at each coverage level and for each year before higher-level policies may be assessed, it did conclude that the sequence in which the policyholder may access the policies must be decided on a policy-by-policy basis, taking into account the relevant provisions of each policy, rather than leaving it up to the policyholder to elect which level policies to exhaust. Montrose appealed, and now the California Supreme Court has agreed to answer the following question:

When continuous property damage occurs during several periods for which an insured purchased multiple layers of excess insurance, does the rule of ‘horizontal exhaustion’ require the insured to exhaust excess insurance at lower levels for all periods before obtaining coverage from higher-level excess insurance in any period?

The grant of review by the California high court sets up a showdown between “vertical exhaustion,” which is favored by policyholders so that they can more easily access excess layers for multi-year exposure; and “horizontal exhaustion,” which is favored by insurers but can create roadblocks for policyholders that had the foresight to buy substantial liability coverage over many years. A broad ruling in favor of either exhaustion method in full is not guaranteed, however, given the lower court’s emphasis on analysis of the terms and conditions in each policy. We will continue to monitor this important case for further developments.