Are Repair Costs Covered Damages Under a Liability Policy?

Larry P. Schiffer | Squire Patton Boggs | September 27, 2019

Liability policies cover sums an insured becomes legally obligated to pay to a third-party as damages for a loss. Typically, there is no coverage in a liability policy for expenses incurred by the insured to repair damage to the insured’s own property. Additionally, nearly every liability policy has an owned-property exclusion. In a recent case, the 5th Circuit addressed this subject and whether an exception to the owned-property exclusion applied.

In Eagle Water, L.L.C. v. Ash, No. 19-30056 (5th Cir. Sep. 26, 2019) (unpublished), the owner of a sewer system repaired that system following a localized collapse and sought to recover the cost of repair from its liability insurer. The insurer paid for property damage suffered by a homeowner when the sewer system backed up because of the collapse, but rejected the policyholder’s request to cover the cost for repairing the sewer system. As the court noted, without those repairs, there could have been additional backups or sewage spills.

The policy had the usual liability coverage grant providing coverage for “those sums that the Insured becomes legally obligated to pay as damages because of . . . property damage.” The policy also had the usual owned-property exclusion that precluded coverage for damage to property “owned by the Insured.”

After the insurer rejected the claim, the policyholder sued and the insurer moved for summary judgment. The district court granted summary judgment to the insurer reasoning that the repair costs were not covered by the liability insurance policy because those costs were not damages that the policyholder became legally obligated to pay.

In affirming, the circuit court held that the district court correctly determined that the policyholder’s sewer repair costs were not covered by its liability insurance policy. The court stated that when the policyholder paid to repair its sewer system, it was not compensating anyone for loss or injury, so the repair costs were not damages and not covered. Damages, held the court are money claimed by, or ordered to be paid to, a person as compensation for a loss or injury (citations omitted).

The appellate court rejected the policyholder’s argument that an exception to the owned-property exclusion should apply. That judicial exception, said the court, arises in situations where the costs expended are done so to prevent future harm to third parties. The court distinguished the operative case and noted that in that case the repairs were necessary to prevent imminent or immediate harm to third parties because actual damages had occurred. Notably, the court stated that concluding that an owned-property exclusion does not prevent coverage is not the same as concluding that coverage exists. The court concluded that no matter whether the owned-property exclusion applied, the policyholder’s repair costs were not covered by the policy, because those costs were not damages as defined by the liability policy.

Seventh Circuit Holds “Breach of Contract” Exclusion in Professional Liability Policy Renders Coverage Illusory

Jason Taylor | Traub Lieberman Straus & Shrewsberry | October 2, 2019

Most professional liability policies include a “breach of contract” exclusion precluding coverage for claims or damages arising out of breach of contract. How to apply such broad exclusions to claims brought by clients of the insured (or others with whom the insured has contracted) can be difficult because most professional relationships necessarily involve an underlying contract. On the one hand, arguably every claim against an insured professional “arises out of” the contract where but for the contract there would be no relationship between the claimant and insured. That interpretation of the exclusion, however, is seemingly too broad. But, what about claims that could be brought in both contract and tort? Or, does the exclusion limit coverage only to claims brought by third parties with whom the insured has not contract? Just as “breach of contract” exclusions vary, courts are mixed.

In Crum & Forster Specialty Insurance Company v. DVO, Inc., 2019 WL 4594229 (7th Cir. Sept. 23, 2019), the Seventh Circuit addressed whether the E&O coverage of the primary and excess insurance policies issued to DVO cover a state court claim for contract violations in light of the policies’ broad “breach of contract” exclusion. In applying Wisconsin law, the Seventh Circuit found that the language in the “breach of contract” made the exclusion broader than the grant of coverage, and therefore, rendered coverage illusory.

In DVO, Inc., the underlying contract claim was brought by WTE pursuant to Standard Form Agreement under which DVO agreed to design and build an anaerobic digester for WTE to be used to generate electricity from cow manure which would then be sold to the electric power utility. WTE sued DVO for breach of contract alleging that DVO failed to fulfill its design duties, responsibilities, and obligations under the contract in that it did not properly design substantial portions of the structural, mechanical, and operational systems of the digester, resulting in substantial damages to WTE. WTE sought over $2 million in damages and fees.

Crum & Forster initially offered a defense under primary and excess policies providing a combination of commercial general liability, pollution liability, E&O and other coverages. The issue on appeal concerned the E&O coverage, and more specifically, whether the policies’ “breach of contract” exclusion barred coverage. The exclusion precluded coverage for damages and costs “based upon or arising out of: breach of contract, whether express or oral, nor any ‘claim’ for breach of an implied in law or an implied in fact contract[]….” DVO argued that the “breach of contract” exclusion was so broad as to render the E&O professional liability coverage illusory, and therefore, could not be enforced to preclude a duty to defend. The District Court held that the professional liability coverage was not illusory because it would still apply to third party claims, and even if it was, the remedy would be to reform the contract to allow coverage for third party claims against the insured, not to allow coverage for all professional liability claims. The Seventh Circuit reversed.

The Seventh Circuit began its analysis with familiar tenants of Wisconsin insurance law. First, a determination of whether the exclusion applies must focus on the incident that allegedly gave rise to the coverage, not the theory of liability. See e.g., 1325 North Van BurenLLC v. T-3 Group, Ltd. (noting that claims of negligence in the failure to provide competent professional services could raise both tort and contract claims). Therefore, according to the Court, even a claim that purports to be a tort claim can be excluded under the “breach of contract” exclusion if it arises out of that contract.

Second, the Seventh Circuit reiterated that the “arising out of” language, even in an exclusion, is broadly construed. The phrase is broad, general, and comprehensive, and it is ordinarily understood to mean “originating from, growing out of, or flowing from.” Therefore, under Wisconsin law, “the term ‘arising out of’ is interpreted broadly to reach any conduct that has at least some causal relationship between the injury and the event not covered, which sweeps in third-party claims as well when so related.” DVO, Inc., 2019 WL 4594229 at *8.

In DVO, Inc., the underlying state court complaint alleged that DVO was contracted to design and construct the anaerobic digester and, because of its faulty design, damages were incurred. As such, the complaint alleged a claim that arose out of the contract, and therefore, fell within the exclusion language. According to the Seventh Circuit, the “event not covered” in the policy was itself quite expansive, explicitly applying “breach of contract” to all contracts whether express or oral, and even including contracts implied in law or fact. The Seventh Circuit rejected the District Court’s attempt to distinguish between direct claims between contracting parties based on the contract, and third-party claims based on the insured’s failure to exercise reasonable professional care where the claimant has no contractual relationship with the insured. While the Seventh Circuit conceded that more tailored language may support the District Court’s reasoning, the “breach of contract” exclusion at issue was extremely broad: it included claims “based upon or arising out of” the contract, thus including a class of claims more expansive than those based solely upon the contract. Given that broad language, the exclusion would include even the claims of third parties. As to those third parties, the claims of professional negligence against DVO fell within the “breach of contract” exclusion because they necessarily “arose out of” the express, oral, or implied contract under which DVO rendered professional services on the project.

Based on the above analysis, the Seventh Circuit reasoned that the “breach of contract” exclusion rendered the professional liability coverage in the E&O policy illusory. In the insurance context, “[i]llusory policy language defines coverage in a manner that coverage will never actually be triggered.” Id. *6. While the Seventh Circuit recognized that if the purported coverage in a policy proves to be illusory a court may reform the policy to meet the insured’s reasonable expectation of coverage, the Court disagreed with the District Court’s attempt to reform the contract. The District Court reasoned that even if the coverage was illusory, the remedy would be reform the contract to allow coverage for third party claims (and not those brought directly by parties with whom the insured contracted). The Seventh Circuit, however, held that the District Court’s focus on the hypothetical third-party action was misplaced. Rather, the focus should be on the “reasonable expectation” of coverage of the insured in securing the policy. Although the Seventh Circuit’s analysis of hypothetical third-party claims under the “breach of contract” exclusion might foreshadow the likely outcome in this case, ultimately the Seventh Circuit declined making a determination on the reasonable expectations of the insured and remanded the case back to the District Court to consider.

PA Superior Court Provides Clarification on Definition of CGL “Occurrence” When Property Damage Is Caused by Faulty Building Conditions

Anthony L. Miscioscia and Konrad R. Krebs | White and Williams | July 25, 2019

The standard for an “occurrence” under a commercial general liability (CGL) insurance policy has been addressed on several occasions by Pennsylvania courts when an insured has allegedly performed faulty workmanship on a construction project. Specifically, in Pennsylvania, a claim for damages arising from an insured’s performance of faulty workmanship pursuant to a construction contract, where the only damage is to property supplied by the insured or worked on by the insured, does not constitute an “occurrence” under the standard commercial general liability insurance policy definition. But what about the circumstance when the insured has failed to perform contractual duties where the claim is for property damage to property not supplied by the insured or unrelated to the service the insured contracted to provide? The Pennsylvania Superior Court recently addressed this question in Pennsylvania Manufacturers Indemnity Co. v. Pottstown Industrial Complex LP, No. 3489 EDA 2018, 2019 Pa. Super. 223, 2019 Pa. Super. LEXIS 729* (Pa. Super. 2019).

Pottstown Industrial Complex arose out of an underlying dispute between a landlord and a commercial tenant who had leased space to store its product inventory. The tenant alleged that the landlord was responsible under the lease for keeping the roof “in serviceable condition in repair.” Notwithstanding this responsibility, the tenant alleged that the landlord failed to properly maintain and repair the roof, resulting in leaks and flooding during four separate rainstorms, destroying over $700,000 in inventory. The tenant specifically alleged that the floods were caused by poor caulking of the roof, gaps and separations in the roofing membrane, undersized drain openings, and accumulated debris and clogged drains.

The insurer filed a declaratory judgment action, seeking a determination that there was no coverage under a commercial general liability policy issued to the landlord. Following a motion for judgment on the pleadings, the trial court entered an order in favor of the insurer, holding that allegations of inadequate roof repairs were claims for faulty workmanship and were not covered under Kvaerner Metals Division of Kvaerner U.S., Inc. v. Commercial Union Insurance Co., 908 A.2d 888 (Pa. 2006) and Millers Capital Insurance Co. v. Gambone Brothers Development Co., 941 A.2d 706 (Pa. Super. 2007).

In its opinion, the Superior Court reversed the decision of the trial court, holding that the tenant had alleged a covered “occurrence” under the commercial general liability policy.[1] The Superior Court noted that Kvaerner and Gambone only precluded the finding of an “occurrence” where a claim is for damage to property supplied by the insured, where the only property damage is the product or property that the insured supplied or on which it worked, or where the damages sought are for the insured’s failure to deliver the product or perform the service it contracted to provide. The Superior Court distinguished Pottstown Industrial Complex from Kvaerner and Gambone on the grounds that those cases only alleged damage to the property that the insured had worked on or supplied, while the Pottstown Industrial Complex underlying plaintiffs sought to recover for damage to their own property, stored on the ground of the insured’s facility, rather than damage to the insured’s faulty roof. The Superior Court held that this interpretation of the term “occurrence” was consistent with Kvaerner’s rationale that the term “occurrence” was not to be construed to “convert [a commercial and general liability policy] into a performance bond,” but rather, to provide insurance for the risk of “damage the insured causes to another person’s property.”

[1] “Occurrence” is defined as “an accident”

Is Faulty Workmanship an “Occurrence” Under a CGL Policy?

Larry P. Schiffer | Squire Patton Boggs | September 16, 2019

Manufacturers often face multiple lawsuits when their products fail to perform as expected. Sometimes, the cause of the product’s failure is the faulty workmanship of a component manufacturer. When that is the case, the product manufacturer will seek damages from the component manufacturer for the underlying product defect claims. The component manufacturer will then turn to its insurance carriers to cover it for the dispute with the product manufacturer. In a recent case, the Third Circuit Court of Appeals addressed claims by a window component manufacturer against its insurance carriers after the insurance carriers disclaimed coverage for a settlement between the component manufacturer and the product manufacturer.

In Sapa Extrusions, Inc. v. Liberty Mutual Insurance Co., No. 18-2206 (3rd Cir. Sep. 13, 2019), the district court granted summary judgment to the insurance carriers, finding that the product defect claims were not covered under the various CGL policies. The circuit court affirmed in part and vacated in part. The court held that “recovery turns on the language of the specific insurance policies at issue” under Pennsylvania law.

The court first discussed how Pennsylvania law required the strict application of the “four-corners” rule and that if the court determines that there is no duty to defend, then there is no duty to indemnify. The court also discussed in detail how Pennsylvania law requires courts to interpret insurance policies. Here, the court focused on the definition of “occurrence” found in the 28 applicable insurance policies. The court organized the policies into three groups: (a) the “Accident Definition”; (b) the “Expected/Intended Definition”; and (c) the “Injurious Exposure Definition.” The details of this analysis are in the opinion. The basis for the division was the differences in the occurrence wording.

The first definition, which covered 19 of the policies, focused on the term “occurrence” being defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Under Pennsylvania law, this definition required fortuity and “faulty workmanship” did not come within that definition. Thus, held the court, the factual allegations of the product manufacturer’s complaint did not amount to an occurrence that could trigger coverage. The allegations of faulty workmanship, said the court, did not amount to an unforeseeable, fortuitous event. Thus, the court affirmed the grant of summary judgment for those 19 policies.

The court vacated the judgment and remanded the remaining 9 policies back to the district court to consider the implications of the latter two occurrence definitions. The differences in the definitions, held the court, were unique and the district court should have considered those policies separately. The court declined to interpret these 9 policies other than to say that the additional language was not mere surplusage and may be considered ambiguous under Pennsylvania law.

The court held that the rule it reemphasized in this opinion was simple: “in Pennsylvania, insurance policies must be interpreted and applied in accordance with their plain language and relevant Pennsylvania law.” The remand, said the court, was to give the district court the opportunity to give the latter two categories more consideration based on the difference in the language so as to determine if coverage is triggered.

Does a Mediation Trigger the Duty to Defend Under a CGL Insurance Policy?

Joshua Fruchter | Merge Mediation Group | September 4, 2019

Standardized commercial general liability (CGL) insurance policies impose a “duty to defend” that obligates insurers to defend insureds against “suits” seeking damages for claims potentially covered by the policy. The existence of a duty to defend is determined by the allegations in the “suit” filed against the insured.

Does a mediation qualify as a “suit” under a standardized CGL policy? That question was recently litigated in Illinois state court. See Illinois Tool Works, Inc. v. Ace Specialty Ins. Co., 2019 IL App (1st) No. 18-1945 (August 23, 2019). In that case, the insured manufacturer, ITW, operated a facility at a location (referred to as “AUS-OU”) that was later declared a Superfund site by the United States Environmental Protection Agency (EPA) after the discovery of environmental contamination.

In August 2004, another manufacturer notified ITW that it was negotiating with the EPA concerning the payment of cleanup costs related to the AUS-OU site, and claimed that ITW was partially responsible for those costs because manufacturing activities at ITW’s facility had allegedly released hazardous substances. In response, ITW agreed to share in the expense of remediating the AUS-OU site, and entered into a mediation with the EPA and other manufacturers to allocate cleanup costs. ITW notified its insurers about the mediation, and submitted bills for costs incurred, but the insurers did not reimburse ITW for those costs.

Subsequently, ITW was sued for contribution to cleanup costs for an adjacent site (“Site 36”). The insurers funded ITW’s defense of the Site 36 lawsuit.

After the Site 36 lawsuit settled, ITW filed an action against its insurers seeking a declaratory judgment that the insurers had a duty to defend and indemnify it for claims against it regarding both the Site 36 lawsuit and the AUS-OU mediation. The insurers acknowledged that they had a duty to defend ITW in the Site 36 lawsuit, but argued that the same duty did not apply to the AUS-OU mediation because it was not a “suit” under the policies.

The trial court agreed with the insurers that the AUS-OU mediation did not trigger a duty to defend because it was not a “suit” under the policies.

On appeal, ITW abandoned its argument that the mediation qualified as a “suit” under the policies, and instead maintained that the duty to defend triggered by the Site 36 lawsuit extended to the AUS-OU mediation because the contamination at issue in the Site 36 lawsuit and the AUS-OU mediation arose out of the same allegedly hazardous releases. That argument failed, and the appellate court affirmed.

Why did ITW decide, on appeal, not to press its argument below that the mediation qualified as a “suit” under the policies? The appellate court’s decision indicates that the relevant policies were issued to ITW’s predecessor between 1974 and 1985.

As per an August 2002 article published on the International Risk Management Institute, Inc. (IRMI) website by risk management consultant Craig Stanovich, it was only in 1986 that standardized CGL policies began defining the term “suit” to include (i) arbitration proceedings “in which such damages are claimed and to which the insured must submit or does submit with our consent;” and (ii) “any other alternative dispute resolution proceeding in which such damages are claimed and to which the insured submits with our consent.”

While the definition of “suit” in the new standardized CGL policy does not specifically mention mediation, it seems clear that mediation would qualify as an “alternative dispute resolution proceeding.” Importantly, however, the new definition of “suit” obligates the insured to obtain the insurer’s consent to submit to an ADR proceeding before the insurer becomes obligated to defend the proceeding. Accordingly, assuming a mediation qualifies as a “suit” under the policy, an insured would first need to obtain the insurer’s consent to participate in pre-litigation mediation before the insurer would be obligated to cover mediation costs.

At any rate, given that ITW made its insurers aware of the mediation, and they appeared to have consented (or at least not objected), ITW might have prevailed under the newer definition of “suit” that imposes a duty to fund the costs of an “alternative dispute resolution proceeding” to which the insurer consents.

The importance of obtaining the insurer’s consent to ADR is illustrated by a recent California federal court decision. See Harper Constr. Co., Inc. v. Nat’l Union Fire Ins. Co., 377 F. Supp. 3d 1134 (S.D. Cal. 2019). In Harper, the court held that even if an insured’s interaction with the federal government in a construction dispute under the Contract Disputes Act constituted a form a type of ADR proceeding under the new CGL policy, the duty to defend was not triggered because the insurer had never consented to the proceeding.