BRIAN WHITE et al., Plaintiffs and Respondents, v. WESTERN TITLE INSURANCE COMPANY, Defendant and Appellant, 40 Cal. 3d 870

Opinion BROUSSARD, J. Plaintiffs Brian and Helen White filed suit against defendant Western Title Insurance Company for breach of contract, negligence, and breach of implied covenants of good faith and fair dealing. A jury found for plaintiffs, awarding damages of $8,400 for breach of contract and negligence, and an additional $20,000 for breach of the covenants of good faith and fair dealing. We affirm the judgment. In 1975, William and Virginia Longhurst owned 84 acres of land on the Russian River in Mendocino County.

The land was divided into two lots, one unimproved, the other improved with a ranchhouse, a barn and adjacent buildings. It contained substantial subsurface water.

On December 29, 1975, the Longhursts executed and delivered an “Easement Deed for Waterline and Well Sites,” conveying to River Estates Mutual Water Corporation an “easement for a right-of-way for the construction and maintenance of a water pipeline and for the drilling of a well or wells within a defined area and an easement to take water, up to 150 [gallons per minute], from any wells within said defined area.” The deed was recorded the following day. In 1978 plaintiffs agreed to purchase the property from the Longhursts.

Plaintiffs, who were unaware of the water easement, requested preliminary title reports from defendant. Each report purported to list all easements, liens and encumbrances of record, but neither mentioned the recorded water easement. Plaintiffs and the Longhursts opened two escrows, one for each lot. Upon close of escrow defendant issued to plaintiffs two standard CLTA title insurance policies, for which plaintiffs paid $1,467.55. Neither policy mentioned the water easement. The title insurance policies provided: “Subject to

Schedule B and the Conditions and Stipulations Hereof, Western Title Insurance Company . . . insures the insured . . . against loss or damage, . . . and costs, attorneys’ fees and expenses . . . incurred by said insured by reason of: “1. Title to the estate or interest described in

Schedule A being vested other than as stated therein; “2. Any defect in or lien or encumbrance on such title; ...” “Schedule B” provided in part that “[t]his policy does not insure against loss or damage . . . which arise[s] by reason of the following: . . . “3. Easements, liens or encumbrances, or claims thereof, which are not shown by the public records. . . . “5. (

a) Unpatented mining claims; (

b) reservations or exceptions in patents or in Acts authorizing the issuance thereof; (

c) water rights, claims or title to water. ” (Italics added.) About six months after the close of escrow, River Estates Mutual Water Corporation notified plaintiffs of its intention to enter their property to implement the easement. Plaintiffs protested, and River Estates filed an action to quiet title to the easement. Plaintiffs notified defendant, who agreed to defend the proceeding. Plaintiffs, however, declined defendant’s offer, preferring representation by an attorney who was then representing them in an unrelated action. River Estates eventually decided not to enforce its easement and dismissed the suit.

Plaintiffs’ appraiser estimated the loss in value of their lots resulting from the potential loss of groundwater at $62,947. Plaintiffs then made a demand on defendant for that sum. Defendant acknowledged its responsibility for loss of value due to the easement (the loss attributable to the occupation of plaintiffs’ land by wells and pipes, and to the water company’s right to enter the property for construction and maintenance).

It maintained, however, that any loss in value attributable to loss of groundwater was excluded by the policy, and since plaintiffs’ claim of loss was based entirely on diminution of groundwater, declined to pay their claim. Plaintiffs filed suit in October of 1979, alleging causes of action for breach of the insurance contract and negligence in the preparation of the preliminary title reports. Defendant moved for

summary judgment; after briefing and argument the motion was denied. Defendant then retained an appraiser, who estimated plaintiffs’ loss at $2,000. Assertedly based on this estimate, defendant in May of 1980 offered to settle the case for $3,000. Defendant did not furnish plaintiffs with a copy of the appraisal, and plaintiffs rejected the offer. In June defendant served a written offer to compromise for $5,000 pursuant to Code of Civil Procedure

section 998. Plaintiffs, having already incurred litigation expenses exceeding this figure, rejected the offer. Plaintiffs then obtained leave of court to amend their complaint to state a cause of action for breach of the covenant of good faith and fair dealing. The trial court separated the issues of liability and damages. The issue of liability under the original complaint was presented to the court without a jury in January of 1981; in August of that year the court rendered an interlocutory judgment finding defendant liable for breach of contract and negligence.

Defendant then furnished plaintiffs with a copy of their appraisal, and filed a new offer to compromise for $15,000. Plaintiffs rejected the offer, and the remaining issues were tried to a jury in February of 1982. The parties first presented evidence of the loss in value to plaintiffs’ property; the jury returned a special verdict fixing the loss at $100 per acre, or a total of $8,400. The court then turned to the cause of action for breach of the covenant of good faith and fair dealing.

Plaintiffs indicated their intention to present evidence of defendant’s conduct, including settlement offers, during the whole course of the litigation. In response to defendant’s objection, the court ruled that such evidence would be admissible only as to events occurring before the interlocutory judgment of August 1981. Plaintiffs’ former attorney then testified to defendant’s settlement offers of $3,000 and $5,000, its failure to provide plaintiffs with a written appraisal to support those offers, and the attorney’s fees paid and incurred in prosecuting the suit.

The jury returned a special verdict finding defendant in breach of the covenant, awarding compensatory damages of $20,000, and denying punitive damages. Defendant appeals from the judgment. 1. Liability Under the Terms of the Insurance Contracts. The insurance policies purport to insure a “fee” interest, free from any defect in title or any lien or encumbrance on title, subject to the exceptions listed in

schedule B of the policies. A fee interest includes appurtenant water rights. (See City of San Diego v. Sloane (1969) 272 Cal.App.2d 663 [77 Cal.Rptr. 620].) Thus the only question is whether coverage under the present case is excluded by

schedule B.

Schedule B contains two parts. Part two lists specific exceptions, generally encumbrances of record discovered by the title company and therefore excluded from coverage under the policy. The easement of River Estates Mutual Water Corporation was not listed in part two. Part one describes nine kinds of title defects excluded generally from coverage. The first four paragraphs describe interests which should have been, but were not, recorded; item 3, for example, excludes coverage of “[ejasements, liens, or encumbrances . . . which are not shown by the public records. ...” The remaining five paragraphs exclude interests of a type which are ordinarily not recorded, including, in paragraph 5, “(

a) Unpatented mining claims; (

b) reservations or exceptions in patents or in Acts authorizing the issuance thereof; (

c) water rights, claims or title to water.” Defendant relies on this last exclusion to avoid coverage in the present case. Construction of the policy, however, is controlled by the well-established rules on

interpretation of insurance agreements. As described most recently in Reserve Insurance Co. v.

Pisciotta (1982) 30 Cal.3d 800, 807-808 [180 Cal.Rptr. 628, 640 P.2d 764]: “ ‘[A]ny ambiguity or uncertainty in an insurance policy is to be resolved against the insurer and ... if semantically permissible, the contract will be given such construction as will fairly achieve its object of providing indemnity for the loss to which the insurance relates.’ The purpose of this canon of construction is to protect the insured’s reasonable expectation of coverage in a situation in which the insurer-draftsman controls the language of the policy.

Its effect differs, depending on whether the language to be construed is found in a clause providing coverage or in one limiting coverage. ‘Whereas coverage clauses are interpreted broadly so as to afford the greatest possible protection to the insured . . . exclusionary clauses are interpreted narrowly against the insurer.’” (Citations omitted.) The Court of Appeal in Jarchow v. Transamerica Title Ins.

Co. (1975) 48 Cal.App.3d 917, 941 [122 Cal.Rptr. 470], reiterated these rules in the title insurance context: “In determining what benefits or duties an insurer owes his insured pursuant to a contract of title insurance, the court may not look to the words of the policy alone, but must also consider the reasonable expectations of the public and the insured as to the type of service which the insurance entity holds itself out as ready to offer. (Barrera v. State Farm Mut. Automobile Ins.

Co., 71 Cal.2d 659, 669 [79 Cal.Rptr. 106, 456 P.2d 764].) Stated in another fashion, the provisions of the policy, ‘ “must be construed so as to give the insured the protection which he reasonably had a right to expect, . . .’” (Original italics.) (Gray v. Zurich Insurance Co., 65 Cal.2d 263, 270, fn. 7 [54 Cal.Rptr. 104, 419 P.2d 168].)” In the present context, these rules require coverage of water rights shown in public records within the scope of an ordinary title search.

The structure of the policy itself creates the impression that coverage is provided for claims of record, while excluded for unrecorded claims. This impression is reinforced by the specific language of the policy. Paragraph 3, by excluding easements, liens, and encumbrances “not shown by public records,” implies inclusion of such interests when recorded.

Paragraph 5, the exclusion of water rights on which defendant relies, joins that exclusion with exclusion of unpatented mining claims and exceptions in patents or authorizing legislation—interests which would not appear in the records ordinarily searched by a title company.* *** Coverage of claims of record also accords with the purpose of the title policies and the reasonable expectations of the insured. This standard CLTA policy is a policy based upon an inspection of records and, unlike more expensive policies, does not involve inspection of the property.

The purchaser of such a policy could not reasonably expect coverage against unrecorded claims, but he could reasonably expect that the title company had competently searched the records, disclosed all interests of record it discovered and agreed to protect him against any undisclosed interests. Nothing in the policy makes it clear that there may be interests of record undisclosed by the policy yet excluded from coverage.

We conclude that the title insurance policies here in question, construed to carry out their purpose of protecting against undisclosed recorded interests, provide coverage for water rights which appear of record within the scope of the ordinary title search. The trial court reached the same conclusion, but by a different route. It reasoned that the water rights here at issue are inseparable from the recorded easement permitting River Estates Mutual Water Corporation to construct and maintain wells and pipelines.

No provision of the policies excluded such easement, and defendant from the beginning has acknowledged liability for any loss in value attributable to the easement. The loss of water rights, the trial court concluded, is a loss attributable to the easement. We raise no objection to this line of reasoning, but prefer to rest our holding upon the broader ground that a purchaser of a title policy could reasonably expect protection against recorded water rights even if they were not connected to an easement for wells or pipes. 2. Liability for Negligence.

Plaintiffs’ cause of action for negligence rests on long-established principles concerning the duties of a title insurer. As explained in Jarchow v. Transamerica Title Ins. Co., supra, 48 Cal.App.3d 917, 938-939: “When a title insurer presents a buyer with both a preliminary title report and a policy of title insurance, two distinct responsibilities are assumed.

In rendering the first service, the insurer serves as an abstractor of title—and must list all matters of public record regarding the subject property in its preliminary report. [Citations.] The duty imposed upon an abstractor of title is a rigorous one: ‘An abstractor of title is hired because of his professional skill, and when searching the public records on behalf of a client he must use the degree of care commensurate with that professional skill. . . . [T]he abstractor must report all matters which could affect his client’s interests and which are readily discoverable from those public records ordinarily examined when a reasonably diligent title search is made. ’ [Citations.] Similarly, a title insurer is liable for his negligent failure to list recorded encumbrances in preliminary title reports. [Citations.]” These principles find support in the numerous cases cited in Jarchow, and also in the more recent decision of Wilkinson v.

Rives (1981) 116 Cal.App.3d 641, 650 [172 Cal.Rptr. 254], where the court said that “[w]hen a title insurer furnishes a preliminary title report to a prospective buyer, the insurer serves as an abstractor of title and has a duty to list all matters of public record regarding the subject property in its preliminary report.” It is undisputed that the preliminary title report failed to list the recorded easement of River Estates Mutual Water Corporation. The failure of a title company to note an encumbrance of record is prima facie negligent. Defendant has made no attempt to rebut this inference of negligence.

Defendant relies instead on the language of the preliminary title reports and on the enactment of Insurance Code

section 12340.11. Each report states that it “is issued solely for the purpose of facilitating the issuance of a policy of title insurance and no liability is assumed thereby.” This statement, however, appears in the report itself, not in a contract under which defendant agreed to prepare that report. Moreover, even if we viewed the title report as a contract, the quoted provision would be ineffective to relieve defendant of liability for negligence.

A title company is engaged in a business affected with the public interest and cannot, by an adhesory contract, exculpate itself from liability for negligence. (Akin v. Business Title Corp. (1968) 264 Cal.App.2d 153 [70 Cal.Rptr. 287].) Insurance Code

section 12340.11, effective January 1, 1982, provides: “‘Preliminary report’, ‘commitment’, or ‘binder’ are reports furnished in connection with an application for title insurance and are offers to issue a title policy subject to the stated exceptions set forth in the reports and such other matters as may be incorporated by reference therein. The reports are not abstracts of title, nor are any of the rights, duties or responsibilities applicable to the preparation and issuance of an abstract of title applicable to the issuance of any report.

Any such report shall not be construed as, nor constitute, a representation as to the condition of title to real property, but shall constitute a statement of the terms and conditions upon which the issuer is willing to issue its title policy, if such offer is accepted.” .Whatever the effect of this statute upon preliminary title reports prepared after January 1, 1982, it has no effect upon the present case. “ ‘It is a general rule of construction . . . that, unless the intention to make it retrospective clearly appears from the act itself, a statute will not be construed to have that effect.’” (Western Pioneer Ins.

Co. v. Estate of Taira (1982) 136 Cal.App.3d 174, 180-181 [185 Cal.Rptr. 887]; see Balen v. Peralta Junior College Dist. (1974) 11 Cal.3d 821, 830 [114 Cal.Rptr. 589, 523 P.2d 629]; Battle v. Kessler (1983) 149 Cal.App.3d 853, 858 [197 Cal.Rptr. 170]; Carr v. State of California (1976) 58 Cal.App.3d 139, 147 [129 Cal.Rptr. 730].) This rule is particularly applicable to a statute which diminishes or extinguishes an existing cause of action. (Cf. Robinson v. Pediatrics Affiliates Medical Group, Inc. (1979) 98 Cal.App.3d 907 [159 Cal.Rptr. 791].) Nothing in the language or legislative history of

section 12340.11 suggests an intention to apply that statute to a preliminary title report procured prior to its effective date. Defendant finally argues that the trial court refused to permit it to introduce evidence of plaintiffs’ contributory negligence. Defendant offered only to prove that plaintiffs by diligent investigation could have discovered the water easement. Since plaintiffs had no duty to investigate, but were entitled to rely on the preliminary title report, such evidence is insufficient to show contributory negligence. (See J. H. Trisdale Inc. v. Shasta etc.

Title Co. (1956) 146 Cal.App.2d 831, 839 [304 P.2d 832].) Defendant did not offer to prove that plaintiffs had actual knowledge of the easement. 3. Liability for Breach of the Covenant of Good Faith and Fair Dealing. A covenant of good faith and fair dealing is implied in every insurance contract (Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 575 [108 Cal.Rptr. 480, 510 P.2d 1032]), including title insurance contracts (Jarchow v. Transamerica Title Ins. Co., supra, 48 Cal.App.3d 917, 940; see Kapelus v. United Title Guaranty Co. (1971) 15 Cal.App.3d 648, 653 [93 Cal.Rptr. 278]).

The jury found defendant breached the covenant, and awarded compensatory damages of $20,000. Defendant argues on appeal that the court erred in admitting, as evidence of breach, settlement offers and other matters occurring after commencement of litigation. It also asserts that no substantial evidence supports the jury’s verdict. Defendant first contends that all evidence relating to events after plaintiffs filed suit should have been excluded on the ground that, once suit has been filed, the insurer stands in an adversary position to the insured and no longer owes a duty of good faith and fair dealing.

The issue is one of first impression. The parties review the numerous cases which discuss first-party good faith litigation: plaintiffs point out that none of the cases suggest that the insurer’s duty of good faith terminates when suit is filed; defendant points out that all involve acts which in fact occurred before litigation commenced. But neither can point to any case which has considered the issue raised here, and we have discovered none. We believe, however, that the issue can be resolved as a matter of principle.

It is clear that the contractual relationship between insurer and the insured does not terminate with commencement of litigation. In an automobile liability policy, for example, even if the insurer and insured were engaged in litigation concerning coverage of one accident, if the insured were involved in another accident within the policy terms and coverage he would certainly be protected.

In the present setting, if some third party today were to assert title to plaintiff’s land—or if River Estates Mutual Water Corporation were to reassert its right to a pipeline easement—there is no doubt that defendant would be obliged to provide a defense and possible indemnity. And it is not unusual for an insurance company to provide policy benefits, such as the defense of litigation, while itself instituting suit to determine whether and to what extent it must provide those benefits.

It could not reasonably be argued under such circumstances either that the insurer no longer owes any contractual duties to the insured, or that it need not perform those duties fairly and in good faith. Defendant’s argument is less unreasonable in a case in which the insured filed suit (obviously the insurer could not be permitted to terminate its own obligations by initiating litigation), and the issue is limited to the insurer’s duty of good faith and fair dealing in regard to the specific subject matter of the suit.

But even here a sharp distinction between conduct before and after suit was filed would be undesirable. Defendant’s proposed rule would encourage insurers to induce the early filing of suits, and to delay serious investigation and negotiation until after suit was filed when its conduct would be unencumbered by any duty to deal fairly and in good faith.

Defendant responds that such delay would itself be a breach of the implied covenant, but the incentive would remain, especially since the insured would find it difficult to prove the prelitigation conduct unreasonable if it could not present evidence of the postlitigation conduct by way of contrast. The policy of encouraging prompt investigation and payment of insurance claims would be undermined by defendant’s proposed rule. Defendant argues that imposing a duty of good faith after litigation has begun will make it difficult for the insurer to defend the suit.

It claims that investigation of the factual circumstances would be hampered by an obligation to reveal to the insured any material facts it discovers favorable to his claim, and that the attorney who prepares the case for trial could not conduct the trial because he would be a critical witness to the insurer’s good faith during the pretrial period. Neither of these concerns, however, justify a distinction between the period before suit is filed and the period after it is filed.

Certainly the insurer should have investigated the factual basis of the claim before suit is filed, and may well have utilized counsel to evaluate that claim. The issue of contractual liability can be tried separately, and prior to the trial on the good faith claim, as was done in the present case. In any event, what constitutes good faith and fair dealing depends on the circumstances of each case, including the stage of the proceedings and the posture of the parties.

We trust that the jurors will be aware that parties to a lawsuit are adversaries, and will evaluate the insurer’s conduct in relation to that setting. Defendant next contends that the admission of the two settlement offers violated Evidence Code

section 1152. That

section states that “[e]vidence that a person has, in compromise or from humanitarian motives, furnished or offered or promised to furnish money ... to another who has sustained . . . loss or damage, as well as any conduct or statements made in negotiation thereof, is inadmissible to prove his liability for the loss or damage or any part of it.” The Law Revision Commission comment to this

section states that “[t]he rule excluding offers is based on the public policy in favor of the settlement of disputes without litigation. ” The language of this

section does not preclude the introduction of settlement negotiations if offered not to prove liability for the original loss but to prove failure to process the claim fairly and in good faith. This distinction is the basis of the Court of Appeal decision in Fletcher v. Western National Life Ins. Co. (1970) 10 Cal.App.3d 376 [89 Cal.Rptr. 78, 47 A.L.R.3d 286].

In that case, the insurer sent two letters to its insured falsely accusing him of concealing a congenital back defect: the second letter also offered to compromise his claim under a disability policy by permitting him to retain the payments already received. Plaintiff refused the offer, and at trial introduced both letters into evidence. The Court of Appeal commented: “[Defendants’ suggestion] that their letters were improperly admitted into evidence is not meritorious. . . . [T]he applicable code provision (Evid.

Code, § 1152) prohibits the introduction into evidence of an offer to compromise a claim for the purpose of proving liability for that claim. If the letter of October 4, 1966, were considered an offer to compromise, it would be an offer to compromise the claim of liability under the policy. Plaintiff, however, did not offer the letter to prove liability under the policy but, rather, as a part of his proof of the instrumentality of the tort.

Section 1152, therefore, did not preclude its admission.” (10 Cal.App.3d at p. 396.) Defendant argues that both letters at issue in Fletcher were sent before suit was filed, but under our conclusion that the duty of good faith and fair dealing does not disappear with the filing of suit, that distinction is immaterial. Fletcher also rejected the argument that the insurer’s privilege to assert its legal interests would protect communications and settlement offers which were not in good faith. Defendant revives this argument with a twist; it argues that its offers, because made after commencement of litigation, are absolutely privileged under Civil Code

section 47, subdivision 2. No cases apply that privilege in the present context, but defendant relies generally on decisions which have extended the absolute privilege beyond defamation to bar actions for intentional infliction of emotional distress or intentional interference with economic advantage (see Herzog v. “A” Company, Inc. (1982) 138 Cal.App.3d 656, 660 [188 Cal.Rptr. 155] and cases there cited), and argues that liability cannot be based upon a communication in a judicial proceeding. It is obvious, however, that even if liability cannot be founded upon a judicial communication, it can be proved by such a communication—otherwise Evidence Code

section 1152 would be unnecessary, and much of modern discovery valueless. Defendant’s argument, consequently, forces us to draw a careful distinction between a cause of action based squarely on a privileged communication, such as an action for defamation, and one based upon an underlying course of conduct evidenced by the communication. In the present case plaintiffs do not assert that defendant’s communications were defamatory, or done with the intent of causing emotional distress, but instead that they show that defendant was not evaluating and seeking to resolve their claim fairly and in good faith. In our opinion,

section 47, subdivision 2, does not bar admission of the offers for that purpose. Finally, defendant points out that its second offer—the offer of June 1980, to settle the claim for $5,000—was filed as an offer to compromise under Code of Civil Procedure

section

Section 998, subdivision (

b) states that if such an offer “is not accepted prior to trial or within 30 days after it is made, whichever occurs first, it shall be deemed withdrawn, and cannot be given in evidence upon the trial.” Defendant argues that the reasoning of Fletcher v. Western National Life Ins. Co., supra, 10 Cal.App.3d 376—that Evidence Code

section 1152 does not bar introduction of a settlement offer as an instrumentality of the tort—is inapplicable to

section 998. We believe, however, that despite their difference in wording sections 1152 and 998 should receive a parallel construction.

Section 1152 states that offers are inadmissible to prove “liability for the loss or damage,” which we have construed to refer to liability for that loss or damage to be compromised by the offer.

Section 998, subdivision (b), states that an offer cannot be “given in evidence upon the trial.” We think that language refers to the trial upon the liability which the offer proposed to compromise. Thus both sections would serve the same purpose; to bar the introduction into evidence of an offer to compromise a claim for the purpose of proving liability for that claim, but to permit its introduction to prove some other matter at issue. Both defendants’ offers of compromise were submitted before plaintiffs had filed a claim for damages for breach of the covenant of good faith and fair dealing.

Both sought only to compromise plaintiffs’ original contractual and negligence claims. Under our construction of the statutes, those offers were inadmissible to prove liability on plaintiffs’ original causes of action, but were admissible to prove liability for breach of the covenant. That is exactly how matters proceeded: the trial court bifurcated the trial, and admitted the offers into evidence only on the issue of liability for breach of the covenant. Finally, defendant contends that no substantial evidence supports the verdict finding a breach of the covenant of good faith and fair dealing.

However, reading the record most favorably to the judgment below, it reveals that although defendant failed to disclose an easement of record on its preliminary title reports and its title insurance policies, it denied any liability for loss of value in water rights attributable to the easement. When plaintiffs filed suit, defendant responded with a motion for

summary judgment. After losing that motion, defendant was faced with both a ruling of the trial court rejecting its narrow reading of the policy and a unanimous body of case law establishing liability for negligence. Defendant nevertheless offered only nuisance-value settlements, and made no attempt to appraise plaintiffs’ loss until the issue of liability had been tried and decided in plaintiffs’ favor. The entire pattern of conduct shows a clear attempt by defendant to avoid responsibility for its obvious failure to discover and report the recorded easement of River Estates Mutual Water Corporation.

We conclude that the evidence is sufficient to permit the jury to find a breach of the covenant of good faith and fair dealing. 4. Damages for Breach of the Covenant of Good Faith and Fair Dealing. We agree with the Court of Appeal that there is no “merit in the . . . argument that damages for emotional distress were not permitted because that issue was unraised by the pleadings. Such an issue is reasonably, perhaps necessarily, raised by the pleaded issue of an insurer’s bad faith in rejecting settlement of a meritorious claim.

And here we observe that the issue of damages for emotional distress was fully and fairly tried and presented for adjudication, in the superior court.” The remaining question concerns recovery of attorney fees and other litigation expense as an element of damage.

The Court of Appeal held that attorney fees were recoverable under the terms of the title insurance policies, which insure against “costs, attorney’s fees and expenses sustained or incurred by said insured by reason of . . . any lien or encumbrance on . . . title.” Defendant contends that this provision covers only actions against third parties in defense of title, and does not apply to suits against the title insurer itself. (See Jesko v.

American-First Title and Trust Co. (10th Cir. 1979) 603 F.2d 815, 819.) The trial court, however, did not award attorney fees as a separate item of damage under the quoted policy provision, but as an element of the damages for breach of the covenant of good faith and fair dealing. A subsequent decision by this court, Brandt v. Superior Court (1985) 37 Cal.3d 813 [210 Cal.Rptr. 211, 693 P.2d 796], supports the trial court’s position.

We there stated that “ ‘when the insurer’s conduct is unreasonable, a plaintiff is allowed to recover for all detriment proximately resulting from the insurer’s bad faith, which detriment . . . includes those attorney’s fees that were incurred to obtain the policy benefits and that would not have been incurred but for the insurer’s tortious conduct.’” (37 Cal.3d 813, 819.) The same reasoning supports inclusion of witness fees and other litigation expenses as an element of damage. The judgment is affirmed. Bird, C. J., Mosk, J., and Reynoso, J., concurred. GRODIN, J.

I agree with the majority that an insurer’s duty to deal with its insured fairly, and not to withhold payment of claims unreasonably and in bad faith, does not evaporate with the onset of litigation. While breach of the duty gives rise to an action in tort against the insurer, the duty itself is rooted in the covenant of good faith and fair dealing, which is implied in all contracts, and which imposes upon each contracting party to refrain from doing anything which will injure the right of the other to receive the benefits of the agreement. (Egan v. Mutual of Omaha Ins.

Co. (1979) 24 Cal.3d 809, 818 [169 Cal.Rptr. 691, 620 P.2d 141]; Murphy v. Allstate Ins. Co. (1976) 17 Cal.3d 937, 940 [132 Cal.Rptr. 424, 553 P.2d 584]; Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 573-574 [108 Cal.Rptr. 480, 510 P.2d 1032].) There is no reason why this implied covenant should cease to be operative simply because litigation has begun. This is not to say—and I do not understand the majority to be saying—that all of an insurer’s litigation tactics will be subject to scrutiny by a jury on the basis of a bad faith claim.

An insurer must have the right to defend itself in court against claims it believes to be without merit, and the normal rules of litigation should be adequate to protect against abuse.

But where an insurer has unreasonably and in bad faith withheld payment of benefits due under a policy prior to litigation, and then continues this bad faith conduct after a complaint is filed, there seems to be no compelling reason why the right to recover for that continuing wrong should terminate either because the insurer decides to file a preemptive action for declaratory relief or because the insured, under the compulsion of the insurer’s recalcitrance, decides to file suit himself.

Once it is accepted that the insured’s covenant of good faith and fair dealing does not perish with the onset of litigation, I see no reason—nor do I find any reason suggested in either of the dissenting opinions—why evidence of settlement offers should not be admissible, as relevant, in the same manner as they are admissible prior to litigation, apparently with legislative approval to prove the elements of the tort. (Fletcher v. Western National Life Ins.

Co. (1970) 10 Cal.App.3d 376 [89 Cal.Rptr. 78, 47 A.L.R.3d 286].) What bothers me in this case—and, I take it, our dissenting colleagues as well—is that the two settlement offers which were admitted in evidence support plaintiff’s theory of bad faith only weakly, and a third settlement offer, which might have been helpful to the jury’s evaluation despite its somewhat disparate context, was excluded. Once the trial court decided to admit the first two offers, I believe (unlike the majority) that it should have allowed the defendant to complete the picture.

However, in light of the relatively modest verdict I do not believe there has been such a miscarriage of justice as to require reversal and a new trial. Subject to these reservations, I concur. The parties dispute whether the letter from defendant to plaintiffs on September 13, 1981, constituted a rejection of their claim.

The letter states specifically that “the availability of water on the White property is not a valid consideration in the assessment of a claim under the policies of title insurance.” Then, after criticizing the appraisal for not considering other possible items of loss, it concludes, stating: “This letter should not be interpreted as a rejection of your client’s claim. However, the documentation provided is not sufficient for Western to properly evaluate the claim.

Western will look forward to hearing from you further in this regard.” Plaintiffs understood this letter to reject any claim for loss based upon the taking of groundwater, which seems a reasonable

interpretation of the letter. Under

section 998, if a plaintiff rejects a defendant’s offer and fails to obtain a more favorable judgment, he cannot recover costs, is liable for defendant’s costs from the time of the offer, and in the discretion of the court liable for defendant’s prior costs.

Schedule B, part one, reads in full as follows: “This policy does not insure against loss or damage, nor against costs, attorneys’ fees or expenses, any or all of which arise by reason of the following: “Part One: “1. Taxes or assessments which are not shown as existing liens by the records of any taxing authority that levies taxes or assessments on real property or by the public records. “Proceedings by a public agency which may result in taxes or assessments, or notices of such proceedings, whether or not shown by the records of such agency or by the public records. “2.

Any facts, rights, interests or claims which are not shown by the public records but which could be ascertained by an inspection of the land or by making inquiry of persons in possession thereof. “3. Easements, liens or encumbrances, or claims thereof, which are not shown by the public records. “4. Discrepancies, conflicts in boundary lines, shortage in area, encroachments, or any other facts which a correct survey would disclose, and which are not shown by the public records. “5. (

a) Unpatented mining claims; (

b) reservations or exceptions in patents or in Acts authorizing the issuance thereof; (

c) water rights, claims or title to water. “6. Any right, title, interest, estate or easement in land beyond the lines of the area specifically described or referred to in

Schedule C, or in abutting streets, roads, avenues, alleys, lanes, ways or waterways, but nothing in this paragraph shall modify or limit the extent to which the ordinary right of an abutting owner for access to a physically open street or highway is insured by this policy. “7.

Any law, ordinance or governmental regulation (including but not limited to building and zoning ordinances) restricting or regulating or prohibiting the occupancy, use or enjoyment of the land, or regulating the character, dimensions or location of any improvement now or hereafter erected on the land, or prohibiting a separation in ownership or a reduction in the dimensions or area of the land, or the effect of any violation of any such law, ordinance or governmental regulation. “8.

Rights of eminent domain or governmental rights of police power unless notice of the exercise of such rights appears in the public records. “9. Defects, liens, encumbrances, adverse claims, or other matters (

a) created, suffered, assumed or agreed to by the insured claimant; (

b) not shown by the public records and not otherwise excluded from coverage but known to the insured claimant either at Date of Policy or at the date such claimant acquired an estate or interest insured by this policy or acquired the insured mortgage and not disclosed in writing by the insured claimant to the Company prior to the date such insured claimant became an insured hereunder; (

c) resulting in no loss or damage to the insured claimant; (

d) attaching or created subsequent to Date of Policy; or (

e) resulting in loss or damage which would not have been sustained if the insured claimant had been a purchaser or encumbrancer for value without knowledge. ” “ ‘Under the familiar maxim of expressio unius est exclusio alterius it is well settled that, when a statute expresses certain exceptions to a general rule, other exceptions are necessarily excluded.’” (Kiely Corp. v. Gibson (1964) 231 Cal.App.2d 39, 46 [41 Cal.Rptr. 559]; Collins v.

City & Co. of San Francisco (1952) 112 Cal.App.2d 719, 731 [247 P.2d 362].) This canon, based on common patterns of usage and drafting, is equally applicable to the construction of contracts. Water rights may arise by appropriation, prescription, or by virtue of ownership of riparian land. Often such rights do not appear of record, or if recorded do not clearly refer to the property whose title is under investigation, or appear in the recorded chain of title to that property. The same is true of unpatented mining claims and other interests mentioned in paragraph 5. (See 2 Miller & Starr, Current Law of Cal.

Real Estate (1977 ed.) § 12.31.) Defendant argues that plaintiffs did not rely on the title policies, since they were issued only when the sale was consummated. Plaintiffs did rely on the preliminary title report. If, as defendant contends (see

part 2 of this opinion) that report is an offer to insure upon the terms stated, plaintiffs’ reliance on that report is equivalent to reliance upon the policies issued in conformity with the report. Defendant quotes Miller and Starr, who after noting that some water rights are duly recorded in the chain of title, state that “the exclusion in the standard coverage policy is not limited merely to unrecorded rights. The policy apparently also intends to exclude liability arising out of recorded water interests.

Therefore, a subsequent purchaser or encumbrancer is not protected by his title policy against prior interests in water on the property, whether recorded or unrecorded.” (2 Miller & Starr, Current Law of Cal. Real Estate, supra, § 12.31.) It may well be that the policy was intended to exclude recorded water rights, even those in the chain of title which would be discovered during the ordinary search incident to preparation of a standard title policy. Construction of the policy, however, depends not on the intent of the drafter but on the reasonable expectations of the insured. (See Gray v.

Zurich Insurance Co. (1966) 65 Cal.2d 263, 270-271 [54 Cal.Rptr. 104, 419 P.2d 168]; Otter v. General Ins. Co. (1973) 34 Cal.App.3d 940, 950-951 [109 Cal.Rptr. 831].) We distinguish the case of Coleman v. Security Title Ins. Co. (1963) 218 Cal.App.2d 444 [32 Cal.Rptr. 575]. In that case the title insurance policy recited that the property was in the “Beaumont Irrigation District, City of Beaumont”; in fact it was in neither the district nor the city.

The court held coverage was barred by the policy’s exclusion of “water rights. ” But as appears from the opinion, it was unnecessary to reach the question of policy exclusions. The policy protected only against defects in title, and the erroneous recital in no way impaired plaintiffs’ title. Defendant fears that juries will misunderstand the function of various litigation tactics, and in particular that they might mistakenly view a settlement offer as an admission of liability.

The trial court, however, would retain the authority to exclude evidence of settlement offers or other conduct of the insurer if it concluded that in the case before it the prejudicial effect of such evidence would outweigh its probative value. (Evid. Code, § 352.) Civil Code

section 47 provides in relevant part: “A privileged publication or broadcast is one made— “2. In any (1) legislative or (2) judicial proceeding. ...” There is a specific exemption for allegations concerning third parties in a divorce proceeding. If the May offer to settle for $3,000 were admissible, the admission into evidence of the June 1980 offer could not be reversible error. If plaintiffs had not been able to present evidence of any of the postlitigation negotiations, including the May 1980 offer, their proof of defendant’s breach might have been hampered.

But the fact that defendants in June of 1980 made a second offer, $2,000 higher than the first offer, did not add substantially to the case. We believe it unlikely that the exclusion of that second offer would have led to a result more favorable to defendant. (See Cal. Const., art. VI, § 13.) We find no error in the trial court’s exclusion of a $15,000 settlement offer made after the interlocutory judgment of liability in August of 1981.

Once the court had determined liability, defendant’s willingness to make a reasonable settlement offer has little tendency to prove that defendant has been acting fairly and in good faith toward its insured. There is no reason here to address, and I reserve judgment on, the situation where an insurer acts in good faith prior to litigation but engages in bad faith conduct following the onset of litigation. Insurance Code

section 790.03, subdivision (h)(5) establishes as an unfair act an insurer’s knowledge of “Not attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” The statute apparently contemplates that evidence of settlement offers will come in as part of the means of proving a violation of the statutory duty imposed. Although the Legislature has not explicitly addressed the common law tort of breach of the implied duty of good faith and fair dealing, from a policy standpoint there appears to be no difference between the common law duty and the statutory duty imposed by Insurance Code

section 790.03, subdivision (

h) as regards admissibility of settlement offers.