You can’t have it both ways
In 2000, Paul Terrell and Rica Tseng purchased a house in San Francisco. They initially lived at the property and obtained a homeowners policy from State Farm General Insurance Company. In 2003 they moved out and began renting the property. At their direction, State Farm canceled and replaced the homeowners policy with a rental dwelling policy in January 2004. In the winter of 2004, Terrell and Tseng discussed moving back to the property and asked State Farm to change their coverage. State Farm canceled the rental dwelling policy in January 2005 and replaced it with a homeowners policy. Terrell and Tseng, however, did not move back into the property. Instead their existing tenants remained in the house until May 2006. When those tenants moved out, Terrell and Tseng signed a lease in June or July 2006 with a new tenant, Pamela Fitzgerald, and her then minor daughter, Mary Fitzgerald.
Eight years later the porch area in front of the property’s front door collapsed. Mary, who was standing on the porch at the time, fell through a hole and sustained injuries. Terrell contacted State Farm to report the collapse of the front porch area and possible injury to one of the tenants. The State Farm claim representative verified that Terrell and Tseng had been renting out the property since 2003 but noted that they did not have a rental dwelling policy. Terrell acknowledged that they should have contacted their State Farm agent but did not do so because they thought their situation was temporary and they would move back to the property.
In April 2014, the Fitzgeralds sued Terrell and Tseng, alleging claims for damages, including bodily injury, arising out of their ownership and maintenance of the house rented to Pamela. The complaint set forth causes of action for negligence, premises liability, breach of the lease agreement, and breach of the implied warranty of habitability, among other claims. The essence of their complaint was that the property “suffered from numerous uninhabitable conditions” that Terrell and Tseng failed to repair, that they “failed to … inspect and maintain the landing throughout their tenancy,” and that they failed to notify the Fitzgeralds of the dangerous condition or otherwise protect them against the risk of harm.
State Farm concluded that the Fitzgeralds’ suit did not seek to recover damages potentially covered by Terrell and Tseng’s homeowners policy. In a letter to the couple denying coverage and declining to provide a defense, State Farm explained that the lawsuit’s claims all arose out of Terrell and Tseng’s rental of the property and “[t]here are no claims for damages that do not arise out of the landlord/tenant relationship as set forth in the lease agreement.”
Terrell and Tseng settled the Fitzgerald lawsuit for $43,000. Their attorney then contacted State Farm to request reconsideration of their denied claim. They asserted that the rental exclusion was itself subject to an exception for “activities which are ordinarily incident to non-business pursuits” and therefore State Farm had wrongfully refused to defend and indemnify them. State Farm reaffirmed its denial of the claim, concluding that the “ordinarily incident” exception did not apply to their circumstances. Over the course of these communications, Terrell and Tseng returned in August 2015 to live in the house.
Terrell and Tseng sued State Farm in May 2016, asserting breach of contract and breach of the implied covenant of good faith and fair dealing. The complaint alleged that State Farm wrongfully failed to conduct a full investigation into their claims and unreasonably denied them defense and indemnity. State Farm moved for summary judgment, arguing that it had no duty to indemnify or defend the couple because the damages sought in the Fitzgerald lawsuit arose solely from excluded business pursuits/rental activity, the “ordinarily incident to non-business pursuits” exception did not apply to restore coverage, and the “insured location” exclusion separately barred coverage because the property did not qualify as Terrell and Tseng’s “residence premises.”
The couple argued in opposition that their property maintenance activities were ordinarily incident to non-business pursuits, that State Farm waived the “insured location” exclusion when it paid their property damage claim, and that material factual disputes existed with respect to State Farm’s bad faith in failing to defend and indemnify.
In June 2017, the court granted State Farm’s summary judgment motion. The court construed the business pursuits/rental exclusion as consisting of two separate exclusions—one applying to “business pursuits” and the other applying to “rental” activities. It concluded that “the exception for ‘activities which are ordinarily incident to non-business pursuits’ does not apply where the rental exclusion bars coverage.” Because the Fitzgerald lawsuit arose out of the rental of the property and was excluded from coverage under the homeowners policy, State Farm owed no duty to defend or indemnify Terrell and Tseng. The couple appealed.
On appeal, the court stated that the couple’s rental of the property to the Fitzgeralds clearly constituted an excluded activity under the policy. According to the court, it could not seriously be argued that the couple’s maintenance of the front porch of the property fell within an exception for “activities which are ordinarily incident to non-business pursuits.” The undisputed facts showed that the couple had been engaged in the business of renting the property consistently for over a decade and were being paid to keep the property in a habitable condition for their existing tenants at the time of the accident. According to the court, the couple tried to construe their homeowners policy as providing coverage for the commercial risks attendant to renting their house as a for-profit venture. If this argument were accepted, it would upend the allocation of risks and costs associated with commercial or personal activities that insurers rely on to keep homeowners premiums lower than those for business enterprises. The court upheld the trial court’s granting of summary judgment with respect to both Terrell and Tseng’s breach of contract and bad faith claims.
Terrell v. State Farm General Insurance Company-California Court of Appeal, First District, Division 1-September 26, 2019-No. A152541.