Whether Pre-Tender Environmental Response Costs Are Voluntary Payments: Is There a Prejudice Requirement?

Are Cleanup Expenses Voluntary?

Where an insured cleans up a site without obtaining authority from its insurer, and then requests reimbursement of its cleanup expenses from the insurer, are those cleanup expenses excluded by the commercial general liability policy's voluntary payments exclusion? The exclusion typically states the following.

No insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.

A 1982 decision from a Michigan appellate court, Coil Anodizers, Inc. v. Wolverine Ins. Co., ¹ articulated the purpose of voluntary payments exclusions:

[Voluntary payments] clauses are usually found in liability insurance policies giving the insurer the right to defend and settle any claim made against its insured and prohibiting the insured from voluntarily settling any claims without the insurer's consent. The purpose of such clauses is to prevent collusion between the claimant and the insured and to give the insurer control over settlement negotiations.

Danger of Increased Damages

In this instance, the insured's incurrence of costs is a response to a threat of a penalty, not a judicial order. In the absence of a judicial order, is there a legal obligation for an insured to conduct a cleanup, and are cleanup costs "voluntary payments"? One factor to consider is the possibility that an insured's refusal to respond to an agency's request to remediate a site could result in an increase of damages. An insured's expeditious remedial action, by contrast, may curtail damages and ultimately reduce an insurer's damages. The Supreme Court of Washington, in a 1996 decision, Olds-Olympic v. Commercial Union Ins., ² stated the following.

Even voluntary costs have been found to be damages within the meaning of a CGL policy, particularly where the voluntary cleanup of groundwater prevented much greater damage and the court wished to encourage quick remedial action. ³

Insurers claim that pollution remediation costs incurred in response to threats of penalties constitute voluntary expenses, and thus are excluded from coverage by the voluntary payments exclusion. A Massachusetts appellate court in a 1999 decision, Atlas Tack Corp. v. Liberty Mutual Ins. Co., ⁴ held that pre-tender response costs incurred as a result of an agency's threat to impose civil penalties did not render such costs involuntary payments. In that case, an insured's business operations resulted in a pollution discharge from lagoons constructed at the insured's premises. The Massachusetts Department of Environmental Quality Engineering informed the insured that the contents of the lagoon were hazardous and advised the insured to hire a licensed professional engineer to remediate the situation. The agency subsequently filed an action against the insured, and shortly thereafter both parties entered into an agreement as to the remediation of the site. The insurer was not notified of this agreement until after the fact.

Prejudice to Insurer

The Atlas decision further held that coverage for the policy's voluntary payments exclusion was not dependent upon a showing of prejudice to the insurer by such payments. Citing the Massachusetts Supreme Court decision, Augat, Inc. v. Liberty Mut. Ins. Co., ⁵ the decision held that the voluntary payments exclusion provided "the insurer an opportunity to protect its interests" ⁶ and, without such protection, an insurer's role would be reduced to "writing a check." ⁷

The Fifth Circuit Court of Appeals, in the LaFarge Corp. v. Hartford Cas. Ins. Co. ⁸ decision, stated in a footnote "prejudice is only a factor when the insurer is seeking to avoid all coverage for failure to comply with the notice provisions of the policy." ⁹ In that decision, the court held that defense costs incurred by the insured prior to the date LaFarge tendered the amended petition to its insurer were beyond the scope of coverage.

In Augat, Inc. v. Liberty Mut. Ins. Co., the insured operated a manufacturing facility where it electroplated mechanical devices by placing them in tanks of chemicals. The plant had a water treatment system to purify wastewater generated by the electroplating process before the water was released into the municipal sewer system. An inspection by the Massachusetts Department of Environmental Quality Engineering revealed that the water treatment system had failed, allowing contaminated water into the sewer system and the ground at the site.

The state drafted a complaint seeking damages against the insured. According to the insured, the state environmental agency indicated that unless the insured agreed to remediate the site, the agency would clean up the site and, pursuant to state statutes, seek to recover three times the amount of the costs of the cleanup from the insured. In response, the insured entered into a "consent order" with the agency, agreeing to remediate the site, and the order was entered with the court.

Five days after the agreement was entered in court, the insured first advised its insurer of the claim against it. Two and a half years later, the insured first informed its insurer of the agreement it entered into with the state agency. The insured requested reimbursement in an amount in excess of $1 million and an additional $3.8 million in anticipated future expenses from its insurer. Citing the policy's voluntary payment exclusion, the insurer denied the claim.

Massachusetts' highest court held that the insured's assumption of damages through its agreement with the state agency was voluntary. The court interpreted "voluntary" to be an unambiguous term, defined as "an act of choice." The court did not dispute that the insured had an obligation to clean up the contaminated site. However, entering into the remediation agreement was voluntary:

We conclude that the decision was "voluntary," however, because [the insured] had an alternative—it had the right to demand that [the insurer] defend the claim and assume the obligation to pay for the cleanup. Nevertheless, [the insured] failed to exercise this right. Thus, while [the insured's] decision obviously was not "voluntary" in the sense of "spontaneous" or entirely free from outside influence, it was "voluntary" in the sense of "by an act of choice." ¹⁰

No Prejudice, No "Voluntary" Payment

The opposite conclusion was reached in Governmental Interinsurance Ex. v. City of Angola, ¹¹ a decision by the United States District Court for the Northern District of Indiana. That case arose out of a pollution discharge from an underground storage tank owned by the City of Angola. After removing the underground storage tank, the City investigated the extent of damage, and then remediated the site. Following the cleanup, the City requested that it be indemnified by its insurer for its expenses. The insurer claimed that because the City investigated and remediated the site "on its own initiative," the policy's voluntary payment exclusion applied, and thus, it would not pay for the cleanup expenses. The City responded that its costs were involuntary because of the Indiana Department of Environmental Management's threat of substantial monetary penalties if the City failed to clean up the site.

The court held that the City's remediation costs were not voluntary, and thus not excluded from coverage. The court's decision was premised upon its determination that the insurer suffered no prejudice from the insured's actions. There was no evidence that the remediation work performed by the City "would somehow have been conducted differently had [the insurer] been involved in the process earlier." ¹² Thus, whether the insured's costs constituted "voluntary payments" was contingent upon whether an insurer would have incurred the same costs had it conducted the cleanup, rather than the insured. The court acknowledged that the insurer "could have hired contractors on its own to conduct the remediation work and thereby saved some money." ¹³ However, that was an insufficient factor to allow characterizing the payments as "voluntary."

The same analysis was employed in a 1997 decision by the United States District Court of New Jersey, Federal Ins. Co. v. Purex Industries, Inc. ¹⁴ There, the court held that for remediation expenses to constitute "voluntary payments," an insurer must show that the insured was not liable under the provisions of a statute, and thus had no obligation to incur cleanup expenses. The insurers claimed that Purex, by entering into an administrative consent order with the state environmental agency, voluntarily accepted liability for the cleanup of a site. Purex acquired Airwork Corporation and Airwork operated an aircraft engine repair facility at the site. Sampling operations at the facility revealed groundwater and soil contamination. Purex's sale of the stock of Airwork triggered obligations under New Jersey's Environmental Cleanup Responsibility Act. A section of this act required owners and operators of industrial establishments to remediate their facilities as a precondition to the closure, sale, or transfer of their business operations.

Purex entered into the consent order with the state agency, which allowed the sale of Airwork to go forward and set forth a timetable for compliance with the statute. Purex claimed that it incurred $12 million in cleanup expenses at the site. The insurers argued that the $12 million constituted "voluntary payments" because Purex was not an owner or operator of the site and thus not liable under the statute. The insurers alleged that Purex incurred cleanup expenses for the purpose of facilitating the sale of the premises. Purex asserted that it was liable because Airwork was its wholly owned subsidiary and the owner of the site. Purex also asserted that it entered into the consent agreement because "it had a legal obligation to comply with the [state statute] and compliance costs under that statute are mandatory, not voluntary." ¹⁵The Washington Supreme Court, in Olds-Olympic v. Commercial Union Ins., stated that it had reached the same conclusion in Boeing Co. v. Aetna Casualty and Sur. Co.:( ¹⁶

[W]e held costs the insured was required to pay to the State as reimbursement for cleanup under [a state statute] were "damages" the insured was legally obligated to pay within the meaning of a CGL policy. ¹⁷

The court in the Purex decision held that there "was no evidence that the state environmental agency would have allowed Purex to escape liability for remediation costs at the site even if Purex—or its insurer—had challenged Purex's statutory liability under ECRA." ¹⁸ Because of an absence of evidence that Purex was not liable under the statute, the costs incurred by its insured were not "voluntary" costs, and thus there was coverage for the remediation costs.

"Voluntary" as Ambiguous Term

Insureds argue that applicability of the voluntary payments provision should be interpreted in the same way that most courts have interpreted the policy's notice provision. Most jurisdictions hold that where an insured fails to provide timely notice of an occurrence or suit to its insurer, the insurer cannot prevail on a late notice defense unless it suffered prejudice from the delay. Prejudice occurs where an insurer's position worsens as a result of late notice, i.e., a key witness dies, etc. Insureds argue that resistance to an agency's requests and/or demands for site remediation, until liability has been litigated, is to risk penalties and increasing damages.

As stated above, insurers claim that refusing to recognize pre-tender response costs as "voluntary payments" reduces insurers to merely issuing checks. The insured, without consulting its insurer, assesses liability and damages. The insured makes such decisions having no fiscal responsibility. Because insureds request indemnity from insurers, insurers contend that the decision to expend costs to remediate a site should be made by the insurer. The term "voluntary" is unambiguous, and thus the issue of coverage is contingent upon whether the insured incurred costs in the absence of a legal obligation. A legal obligation arises out of a court order, not a consent agreement entered into by insureds with environmental agencies.

This issue has not been decided by many courts. In attempting to determine how a court would decide this issue, one indicator may be whether a court has held that an insured's receipt of correspondence from an environmental agency triggers coverage. Some courts have held that, in the context of pollution occurrences, coverage is triggered even though an action was not yet commenced against an insured. Such courts place a premium on a speedy response to notice of a pollution occurrence. Also, those courts holding that certain policy terms and phrases are ambiguous may interpret "voluntary" in the context of a pollution occurrence. Such an interpretation would allow a court to decide this issue on the basis of whether the insurer sustained prejudice as a result of the pre-tender expenses. Those courts finding that policy terms and phrases are unambiguous may be less receptive to the idea that pre-tender expenses arise out of voluntary actions. No majority rule on this question has as yet been established.