No Coverage to Builder for Beetle-Infested Logs

Larry P. Schiffer | Squire Patton Boggs

Nearly all construction jobs require that the contractor purchase insurance. Commercial general liability insurance (“CGL”) is often what is purchased. CGL policies also typically have an exclusion for property damage to “your work.” In a recent case, the Ninth Circuit Court of Appeals addressed this exclusion in a case of damage caused by beetle-infested logs used to build a log home. What would Abe Lincoln say?

In Northland Casualty Co. v. Mulroy, No. 19-35085 (9th Cir. Dec. 27, 2019) (Not for Publication), the appellate court affirmed the district court’s grant of summary judgment in favor of the insurance company and against the policyholder (actually the property owner as assignee of the contractor’s rights after settlement) based on the exclusion for property damage to “your work.” The coverage dispute started after a property owner contracted with a builder to build a log home and renovate a guest log home. The contractor purchased logs from a log broker, but did not treat the logs for insects. Several years later, the owner noticed signs of a beetle infestation (powderpost beetles), which caused substantial damage to both homes.

The owner asserted a claim against the builder and the builder tendered the claim to its insurer. The insurer notified the builder that the CGL insurance policy did not cover the damages. The owner sued the builder in state court and, without the insurance company’s consent, the owner and builder settled. The builder assigned all rights under the CGL insurance policy to the owner.

The insurance company brought a coverage action and the parties moved for summary judgment. The district court granted summary judgment to the insurance company.

In affirming the district court, the appellate court held that the district court correctly applied the exclusion because there was property damage to the builder’s work. By failing to treat the logs, the builder installed untreated, beetle-infested logs. According the court, the damage arose from those acts, even if the damage also arose partly because the log supplier selected beetle-infested longs.

The exclusion barred coverage for “`property damage’ to `your work’ arising out of it or any part of it and included in the `products-completed operations hazard.” It “does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a sub-contractor.” The court held that the subcontractor exemption did not apply because under any reasonable interpretation of the term, the log supplier was merely a materials supplier and not a subcontractor.

Finally, the court rejected the “reasonable expectations” doctrine argument, holding that the policy clearly excluded coverage and no other factor suggested that the policyholder reasonably expected coverage. As simply put by the court, “[c]overage is unavailable in this case only because the damages were to the work itself (rather than to a bystander), the project had been completed, and the log supplier was not a subcontractor.

Welcome to the Hall of Shame(rs)

Dennis Jay | Insurance Fraud News

Insurance fraud is an $80 billion a year industrial enterprise, churning out stolen insurance cash with the collective financial force of an overheated solar flare.

Say hello to the newest avatars of avarice, the freshly chosen members of the Insurance Fraud Hall of Shame … the No-Class of 2019.

The shamers are the year’s nine biggest moral pathogens and were dishonored by the Coalition Against Insurance Fraud.

Some shamers think big; their crime rings stole millions with steely audacity and bloated excess. Others are wobbly knuckleheads; their ethical DNA is missing genome coding for common sense. All shamers are convicted, yoked with lifetime criminal records.

These Tyrannosaurus Wrecks play a valuable deterrent role. They add a human face to the stolen insurance dollars. Their crimes call public attention to a brazen theft that many consumers view as a harmless prank. The shamers thus remind us that insurance fraud is a costly drain on all Americans.

Perhaps most important, the convicted shamers are a warning that highly trained fraud fighters are imposing their will. Their deterrent message: The risk isn’t worth the reward. Resistance is futile.

Fire flimflam. Wealthy socialite Claire Risoldi strafed her insurer with $20 million of swollen claims for ruined home possessions after her mansion mysteriously caught fire near Philadelphia.

Risoldi’s bling often wasn’t lost or didn’t exist — or she simply puffed up claims because she thought it was easy to get away with. Risoldi mostly invented $10 million worth of jewelry — blaming brave firefighters for stealing her rocks.

Then came an inflated $950,000 for hand-painted wall and ceiling murals that cost Risoldi a fraction of that amount. Not to mention, hundreds of thousands for draperies supposedly infused with crystals.

Insurance money flew into her bank accounts. Enough to buy more homes, six Ferraris, two Rolls Royces, a Cobra and other vehicles for her and her family members. Then came the final overdue bill: two years in prison thanks to the state attorney general’s effective courtroom pursuit.

Slip-and-fall stumbles. Street people and other down-and-outers were recruited to pretend they tripped on the sidewalks of New York in a $32 million strafing of insurers by a slip-and-fall ring.

Peter Kalkanis recruited hundreds of destitute people who needed spare cash. He coached them on how to fake injuries after tumbling on uneven or cracked pavement. Backs, knees or shoulders were badly hurt, Kalkanis’ troops told insurers. He forced some people to have life-altering — and unneeded — spinal fusions and other surgeries to inflate their claims even more.

Doctors on his payroll did bogus medical exams, and colluding attorneys pressured insurers in order to extract large settlements. Kalkanis awaits sentencing.

Singed scam. A roaring home arson fire began as a faulty $500,000 insurance theft. It ended with the arsonist heat-wrapped in searing flames, staggering from the burning home to die in Scranton, Pa.

Diomedes Ceballos hired his younger brother, Aurelio Ceballos DeLeon, to torch his home. Yet Aurelio knew nothing about fire. He lit gasoline with a lighter and was promptly engulfed by fire.

Aurelio lurched outside on fire; his clothes nearly all singed off. Somehow, Aurelio staggered to his apartment. A friend found him there, dying. Still, Aurelio wouldn’t call 911. His addled brain worried more about the police discovering the arson than about saving his own life. Aurelio died the next day.

Part of a firefighter’s arm was nearly torn off while combating the flames.

Diomedes bought his home for $86,000 and insured it for a $500,000 bonanza. His only windfall was a state jail term, up to 20 years.

For other non-construction related fraud cases continue reading this article.

Indemnify is a Funny Word Carrying Historical Baggage—Be Aware and Use with Care

Glenn West | Weil, Gotshal & Manges

Despite the proliferation of R&W insurance as the sole recourse for buyers with respect to sellers’ breach of representations and warranties, an indemnification remedy against sellers (subject to a cap) continues to find its way into many private company acquisition agreements.  Indemnification, as a concept, originated in the context of one party to a contract agreeing to ensure that the counterparty was held harmless against claims by third parties for which the indemnifying party had agreed to be responsible.  In other words, indemnification was not a concept that ordinarily applied as a means of ensuring that a non-breaching party was compensated by the breaching party for direct losses the non-breaching party sustained by virtue of the breaching party’s breach of contract.  Indeed, absent an exclusive remedy provision, a non-breaching party is entitled to damages under the common law for a breaching party’s failure to abide by the terms of the contract irrespective of whether that contract contains an indemnification clause.  Nevertheless, indemnification provisions in most acquisition agreements today purport to cover losses sustained by a non-breaching party, whether those losses arise directly from the breach or arise as a result of a third party claim.  But the historical fact that indemnification was not normally associated with direct (or first party) claims continues to cause courts some confusion and requires care by deal lawyers to avoid misunderstandings and unintended results.

The dictionary definition of “indemnify” includes both “secur[ing] against hurt, loss, or damages,” as well as “compensat[ing] for incurred hurt, loss, or damage.”  Nonetheless, cases across the country have suggested that there is a presumption that the term “indemnify” only applies to losses arising from third party claims, not losses incurred directly by a party as a result of a counterparty’s default under a contract.[1] While most of these cases do not involve the indemnification provisions contained in private company acquisition agreements, and are focused on whether the indemnification provision allows recovery for attorneys’ fees related to direct claims between the parties,[2] it is not clear that they can be completely discounted on that basis. 

To overcome the general presumption that an indemnification provision only covers third party claims, it is important to state in clear and unequivocal terms that the indemnification provision applies to both direct and third party claims.  Language that simply provides that the breaching party shall indemnify the non-breaching party for losses sustained by the non-breaching party, as a result of the breaching party’s breach of representations, warranties or covenants set forth in the agreement, may be deemed insufficient to clearly cover first party (or direct) claims, as opposed to be presumed to only apply to third party claims.  While we have addressed this issue before in a series of posts to Weil’s Global Private Equity blog,[3] some recent Delaware cases have suggested that a reminder of these principles may be in order.

For example, in a recent Delaware Superior Court decision, Sarn Energy LLC v. Tatra Defence Vehicle A.S., C.A. No.: N17C-06-355 EMD CCLD, 2019 WL 6525256 (Del. Super. October 31, 2019),  a party’s claims for attorney’s fees and costs incurred in pursuing its claim for damages against the breaching party were denied despite the existence of the following indemnification clause in Section 11 of the Agreement:

11. Indemnification. Parties shall defend, indemnify and hold harmless each other and its officers, directors, employees, agents, parent, subsidiaries and other affiliates, from and against any and all damages, costs, liability, and expense whatsoever (including attorneys’ fees and related disbursements) incurred by reason of (a) any failure by Parties to perform any covenant or agreement of the Parties set forth herein; (b) injury to or death of any person or any damage to or loss of property which is due to the negligence and/or willful acts of the Parties; or (c) any breach by Parties of any representation, warranty, covenant or agreement under this Agreement. (emphasis added)

Notwithstanding Section 11’s seeming breadth, the court held that: “Section 11 is a standard indemnity provision that applies to third party actions not to first party claims like the one asserted here by [plaintiff].” And, as such, it did not otherwise qualify as a valid fee shifting clause that overrode the American Rule which “provides that litigants generally are responsible for their own litigation costs.”

Similarly, in a granted motion for re-argument in Winshall v. Viacom International, Inc., C.A. No.: N15C-06-137 EMD CCLD, 2019 WL 5787989 (Del. Super. November 6, 2019), the court held that the following indemnification clause in Section 8.6 of the Merger Agreement only applied to third party claims, not to first party claims:

a) Indemnification. Subject to the limitations set forth in this Article VIII, from and after the Effective Time, each of Parent [Viacom] and MergerCo, jointly and severally, shall indemnify, defend and hold harmless each Merger Consideration Recipient [Mr. Winshall and the other Harmonix Shareholders] against any and all Losses actually incurred or suffered by any such Merger Consideration Recipient as a result of:
(i) the breach of any representation or warranty of Parent or MergerCo set forth in this Agreement or in any Ancillary Document; and
(ii) the breach of any covenant or agreement of Parent or MergerCo contained in this Agreement or in any Ancillary Document.

Losses were defined in the Merger Agreement as follows:

any and all losses, liabilities, damages, claims, awards, judgments, diminution in value, Taxes, fees, costs and expenses (including reasonable attorneys’ fees and expenses, expenses of investigation, defense, prosecution and settlement of claims (including any claims under Article VIII hereof), court costs or enforcement of the provisions of this Agreement) suffered or incurred by such Person, plus any interest that may accrue on the foregoing.

According to the court, the absence of explicit language covering the reimbursement of attorneys’ fees for directly enforcing the breaching party’s obligations (i.e., first party claims), which were the only claims asserted, meant that the indemnification clause was limited to third party claims.  Hmmmm.

But, in Collab9. LLC v. En Pointe Technologies Sales, LLC, C.A. NO. N16C-12-032 MMJ CCLD, C.A. NO. N19C-02-141 MMJ CCLD, 2019 WL 4454412 (Del. Super. September 17, 2019), the court was able to conclude that the indemnification provision covered both direct and third party claims (this case did not, however, involve a dispute over the recovery of attorney’s fees).  After noting that typically “indemnification [only] comes into play when one party to a contract agrees to indemnify a second party to the contract for liability resulting from third-party claims against the second party,” the court note that the Asset Purchase Agreement “states that Seller indemnification may apply ‘whether or not involving a third party claim’ resulting from ‘any breach or inaccuracy of a representation or warranty….’” The court further noted additional language that made clear that indemnification was available for both direct and third party claims. 

The good news is that most private company acquisition agreements cover this issue explicitly and make clear that despite the historical limitations placed on the word “indemnify,” both direct and third party claims are intended to be covered by the indemnification regime.  Moreover, the indemnification provisions in many private company acquisition agreements use terms more expansive than simply “indemnify, defend and hold harmless,”[4] which are terms more traditionally related to third party claims.  But many ancillary agreements do not explicitly cover this issue or use the more expansive terms. 

Perhaps we would all do well to heed this observation from a 2012 Delaware Superior Court case attempting to decipher an indemnification provision: 

When the Court considers the indemnity clause here, even if the Court was kind in its description, it would have to guess that it was written by counsel who never litigate, whose days are filled with the excitement of writing contract terms that only they will understand or can reasonably interpret, and who obviously have lost the ability to write in a clear and common-sense manner. While this may be a well-respected and sought-after art form, it does not help the client insure their expectations and demands are understood by all parties. Instead, the Court is left with the challenge of deciphering terms that were perhaps in vogue in the nineteenth century but whose days have clearly passed.[5]

Remember, the word “indemnify” carries historical baggage; be aware and use care. 

Endnotes    (↵ returns to text)

  1. See e.g., TranSched Sys. Ltd. v. Versyss Transit Sols., LLC, 2012 WL 1415466, at *1-*2 (Del. Super. Mar. 29, 2012); Hopper Assoc., Ltd. v. AGS Computers, Inc., 548 N.E.2d 903, 905 (N.Y. 1989); Hot Rods, LLC v. Northrup Grumman Sys. Corp., 272 Cal. App.4th 1166, 1179 (2015); Claybar v. Samson Exploration, LLC, NO. 09–16–00435–CV, 2018 WL 651258, at *3 (Tex. App.—Beaumont Feb. 1, 2018); see also Kenneth A. Adams, A Manual of Style for Contract Drafting §13.416 (4th Ed. 2017).
  2. See Richard L. Levine, Peter Feist and Jessica N. Djilani, Clarifying the “Unmistakable Clarity” Standard in Contractual Indemnification Provisions,  85 U.S.L.W. 1391 (April 13, 2017), reproduced here.  The fact that many of these cases concern the recovery of attorneys’ fees is relevant because of the strong presumption imposed by the “American Rule,” which states that in the absence of a “specific and explicit” provision in a contract or statute requiring a party to pay the attorneys’ fees of the other party, each party is responsible for their own attorneys’ fees.  Indeed, the American Rule’s presumption is so strong that the United States Supreme Court recently held (unanimously) that a statute requiring one party to pay “all expenses of the proceedings” was not sufficiently clear and explicit to rebut the American Rule’s presumption that each party was required to pay their own attorney’s fees.  Peter v. Nantkwest, Inc., No. 18-801, 589 U.S. __ (Dec. 11, 2019, Sotomayor, J.).  Thus, it may be that it is the American Rule’s presumption that is sometimes at work more than the presumption that the word “indemnify” ordinarily only applies to third party claims.
  3. Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 1, Weil’s Global Private Equity Watch, June 9, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 2, Weil’s Global Private Equity Watch, June 14, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 3, Weil’s Global Private Equity Watch, June 23, 2016, available here; Peter Feist & Jessica N. Djilani, Indemnification Provisions: Are Attorneys’ Fees (And Other Expenses) Incurred In Claims Between Contracting Parties Covered? – Part 4, Weil’s Global Private Equity Watch, July 7, 2016, available here.
  4. Such terms may include “pay, compensate, and reimburse for,” in addition to “defend, indemnify, and hold harmless from and against.”
  5. TranSched Sys. Ltd. v. Versyss Transit Sols., LLC, 2012 WL 1415466, at *3 (Del. Super. Mar. 29, 2012).  I suspect contract drafting guru, Ken Adams, would agree with those sentiments.  See  Kenneth A. Adams, A Manual of Style for Contract Drafting, “Introduction,”  xxxvi-xxxvii (4th Ed. 2017).

Crazy New Policy Language? Report It To United Policyholders!

Chip Merlin | Property Insurance Coverage Law Blog

United Policyholders takes action and gets things done for policyholders regarding the insurance gap issue. United Policyholders is tackling the insurance gap coverage problem by providing staff and resources to collect rogue property insurance policy forms being issued by insurance companies, to show examples of how insurers are stepping over each other to silently gain a competitive advantage of lower price with cheap insurance.

One of the biggest complaints from policyholders, contractors, and public adjusters after a loss occurs is that newer policy language issued by many insurers is horrible and does not pay for the loss. United Policyholders is doing something about these concerns.

Insurance companies are filing language to change standard ISO policy language at an increasing rate. These filings are getting by insurance regulators for various reasons. But, these filings by insurers are at the top of the worst anti-policyholder trends—which is accelerating as I write this post. Insurance regulators need to do something now to stop the wrongful conduct.

Jesse Sipe is a co-founder of the Professional Public Adjusters Association of New Jersey (PPAANJ) and helped make the PPAANJ into the largest public adjuster organization in New Jersey or New York. Unlike some who exclude leaders of other groups, Jesse inclusively invited the legal counsel for the American Association of Public Insurance Adjusters, Holley Soffer, to discuss the insurance gap issue at PPAANJ’s fall meeting. Ms. Soffer did not disappoint.

Holley Soffer’s presentation highlighted the current crisis of policyholders being bamboozled into purchasing “cheap” insurance through language which is non-standard. She noted this is happening at a rate opposite of the slow-moving climate change issues, which make most news headlines. Insurance is not a front-page headline type of issue, despite all of us having to purchase the insurance product.

Soffer noted that Amy Bach and her staff at United Policyholders are collecting and reporting all policy changes to Rutgers University insurance law professor Jay Feinman and his staff at the Center for Risk and Responsibility.

Are you a contractor, policyholder, policyholder attorney, public adjuster, or regulator and want to do your part to help stop this practice? Take this simple step:

Copy the policy form and send it to this email address: Policies@uphelp.org

If it is really bad, send me a copy so I can blog about it!

Be Careful with Good Faith Payments

Christopher G. Hill | Construction Law Musings | November 25, 2019

Sometimes doing the expedient thing and what looks good at the time can come back to bite you.  Just ask 3M Company.

In Faneuil, Inc. v. 3M Co., the Virginia Supreme Court considered a customer services subcontract between Faneuil and 3M relating to a toll collection contract 3M entered into with ERC.  The subcontract had a “pay if paid” clause in it requiring payment to 3M from ERC before ERC was required to pay Faneuil, a written change order provision and a base monthly payment to Faneuil for the services that could be reduced in the event of less than expected toll collections.  Further, the subcontract stated that if either party settled 3rd party claims, that settlement would not bind the other party to the subcontract absent consent or Court order.

Faneuil was then alleged to have been required to provide “Special Services” relating to manual identification of license plates and other information necessary for toll billing due to 3M’s alleged failure to provide adequate imaging services.  Faneuil requested (without written change order) and 3M promised to pay extra for these services.  When 3M was slow to pay for the special services, Faneuil did what you would expect and threatened to stop providing them.  Instead of contesting the right to the work, 3m made sporadic “good faith” payments to induce continued Special Services from Faneuil.  Eventually 3M’s issues caused ERC to stop payments and thus 3M stopped paying Faneuil.  3M then settled the payment claims with ERC and still failed to pay Faneuil.

Faneuil did what any subcontractor in this position would do and sued for 5 categories of damages, including for base payments.  After a bench trial, the Circuit Court dismissed all of the claims by all parties because Faneuil had not obtained a written change order for the Special Services (ignoring the other claims for damages) and that 3M had failed to follow the proper procedures for reducing the monthly payments.  The Virginia Supreme Court reversed.  It held that damages for the Special Services were off the table for a lack of written change order and that 3M’s counterclaims were in fact barred by the subcontract.

While those two holdings are interesting, the Court further went on to say that 1. the settlement between ERC and 3M satisfied the pay if paid requirement, and the reason for the title of this post, 2. 3M was not entitled to the benefit of its good faith payments to induce Faneuil to continue the special services.  The Court held that under Virginia law, these types of non-legally required voluntary payments are not recoverable.  The Court put the holding as follows:

[w]here a person with full knowledge ofthe facts voluntarily pays a demand unjustly made upon him … it will not be considered as paid by compulsion, and the party thus paying is not entitled to recover back the money paid, though he may have protested against the unfounded claim at the time ofpayment made. Where money has been paid under a mistake ofthe facts, or under circumstances of fraud or extortion, or as a necessary means to obtain the possession of goods wrongfully withheld from the party paying the money, an action may be maintained for the money wrongfully exacted. But such action is not maintainable in the naked case of a party making a payment ofa demand rather than resort to litigation. Williams v. Consolvo, 237 Va. 608, 613 (1989)

Thus, despite doing what was seemingly the expedient and correct business action at the time to keep the contracted work moving, 3M was required to pay the full base compensation without credits for its prior good faith payments.

Situations analogous to this occur on the construction site all the time.  Deals are struck to keep the flow of work moving.  Most of the time, these sorts of “on the fly” deals are helpful.  However, before taking such action, remember 3M and consult your local Virginia construction attorney before taking such steps.