It’s Not What You Thought You Signed That Counts: Chancery Court Rejects Plaintiffs’ Claims For Breach of Contract Plaintiffs Thought They Had Made

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Remsen Kinne and Alidad Vakili | K&L Gates | July 1, 2019

In Concerned Citizens of the Estates of Fairway Village, et al, v. Fairway Cap, LLC and Fairway Village Construction Inc., C.A. No. 2017-0924-JRS (Del. Ch. March 6, 2019), homeowners resident in Fairway Village, a residential planned community (“Plaintiffs”) claimed that plans and actions taken by one of the community’s developers, defendant Fairway Cap, LLC (“Fairway Cap”), to construct, own and lease townhouse condominiums in the community for use as rental apartments breached contractual provisions of Fairway Village’s governing documents. In its verdict for defendants, the Court of Chancery (the “Court”) rejected those claims, and concluded that Plaintiffs failed to prove a breach of contract and denied Plaintiffs’ motion for summary judgment.

In proceedings prior to trial, the Court granted Plaintiff’s motion for preliminary injunction and enjoined defendants from renting townhouses in the community pending the outcome of the trial. Subsequently, the Court dismissed Plaintiffs’ breach of fiduciary duty and fraud claims, leaving only the breach of contract cause of action for trial.

In its findings the Court indicated that Fairway Cap initially wanted to acquire and develop only certain lots within the Community. The prior owner of the undeveloped lots in the Community defaulted on its loan presenting Fairway Cap with the opportunity to purchase the defaulted loan. By purchasing the defaulted loan, Fairway Cap was able to acquire all the remaining undeveloped lots within the Community. After several years of sluggish sales, Fairway Cap re-evaluated its objectives and decided the best and highest use of the remaining lots would be to build townhouses for use as rental apartments, maintain ownership, and rent them to long-term tenants. Testimony at trial indicated this would result in Fairway Cap owning and leasing more than 76% of the community’s condominium units, in turn potentially increasing financing costs for homeowners purchasing and refinancing units and reducing Fairway Village’s property values.

The decision’s analysis first addressed Plaintiffs’ argument that Fairway Village’s governing documents contain restrictive covenants prohibiting the developer’s plans. Plaintiffs bore the burden of proof, the Court held, to identify contractual restrictions on the use of Fairway Cap’s property and how those restrictions had been breached. The Court noted that in real property-related contract breach claims such as Plaintiffs’, the law facilitates free use of land not otherwise validly restricted.

The Court ruled that Plaintiffs failed to meet their burden of proof because they did not identify any contractual commitment that restricted Fairway Cap from owning and renting units in the Community. The Court found that the governing documents clearly provided that a builder or developer can own units to sell or to rent and that “express references to, or implicit recognition of, an owner’s right to rent its condominium unit for residential purposes through the governing documents are too numerous to cite.” A recital in a peripheral declaration document stating that the developer “will offer Condominium Units for sale to the public”, the Court determined, was not incorporated in the governing documents and at best reflects only a then-present intention of the developer, “not … a promise to refrain from all other permitted uses in perpetuity.”

Next, the Court addressed Plaintiffs’ request for a permanent injunction (i) to prevent the developer from constructing townhouses for use as rental units, and (ii) to require the developer to construct townhouses for sale that conform with those already constructed. The Court held that by failing to prove a breach of contract, Plaintiffs also had not proven any predicate wrong and corresponding right of action as required for the Court to grant an equitable remedy such as a permanent injunction. That remedy may not be invoked, the Court indicated, to prevent the developer from lawfully exercising its contractual rights or from putting its property to a lawful use.

The Court rejected Plaintiffs’ contention that the Court should view the Fairway Village’s governing documents “in a macro sense” through Plaintiffs’ eyes. Instead, the Court stated that Delaware law requires adherence to the objective theory of contracts in interpreting the governing documents, “by ‘standing in the shoes of an objectively reasonable third-party observer’ who is bound to give ordinary meaning to the words used by the parties and to enforce the agreements as written when that meaning can be readily discerned.” The Court did not accept Plaintiffs’ argument that Fairway Cap’s rental plan should be enjoined because it fundamentally alters the community and its governance scheme, leaving the developer in control of Fairway Village’s condominium council, even though homeowners contemplated that control would be turned over to them, in support of which Plaintiffs cited references in the governing documents requiring the developer’s consent to certain amendments. The Court went on to observe that no restriction in the governing documents or in law prohibited Fairway Cap’s ownership of multiple units and resulting voting control. The Court noted that Plaintiffs’ “vague sense” of being treated unfairly is not sufficient to justify granting equitable relief.

Notably, in reaching its verdict for the defendants, the Court pointed out that the “Plaintiffs cannot prevail on their breach of contract claim by proving Defendants breached the contract Plaintiffs thought they had made.”

Ninth Circuit Reverses Grant of Summary Judgment to Insurer For Fortuitous Loss

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Tred R. Eyerly | Insurance Law Hawaii | May 15, 2019

    The Ninth Circuit reversed the district court’s issuance of summary judgment regarding coverage for damages when the insured’s plant had to be shut down due to an accident. Ingenco Holdings, LLC v. Ace American Ins. Co., 2019 U.S. App. LEXIS 10946 (9th Cir. April 15, 2019). 

    Ingenco operated a gas purification plant which converted raw landfill gas into usable natural gas. The final step in the purification process involved the removal of excess nitrogen from the landfill gas. The gas was directed through adsorbent beads, to which nitrogen adhered, contained within pressure vessels.The beads could not withstand the direct pressure of the landfill gas inflow. which, if untreated, could grind the beads down into dust. To reduce the force of the gas flow on the beads, a “diffuser basket” was suspended from the top of each bead-filled pressure vessel. The diffuser basket acted as a shield that prevented the full force of the incoming landfill gas from striking the beads directly. 

    In 2010, metal brackets securing a diffiuser basket broke. This resulted in damage to other components and an eventual shutdown of the entire facility. The plant remained idle for several months as Ingenco investigated alternative nitrogen filtration options and undertook repairs. 

    Ingenco filed a property damage claim with Ace in May 2011. The all-risk policy excluded “faulty or defective material, faulty workmanship, faulty methods of construction . . . unless loss by a peril not otherwise excluded ensues . . .” Ace denied coverage, contending that the losses were not caused by any”external” force, but rather from defects in the diffuser basket. Ace reasoned that without an “external cause” there was no covered loss. Even if there were an external cause, coverage would still be denied under the “defective material,” “wear and tear,” “deterioration,” and other, similar exclusions. 

    Ingenco sued for breach of contract and declaratory relief. The district court granted summary judgment to Ace, agreeing that Ingenco’s losses did not result from an “external cause,” but rather from an inherent problem in the system, which had been designed to withstand the “external” force at issue, i.e., the landfill gas. The “ensuing loss’ exception to the “defective material” exclusion did not apply because there was no covered loss in the first place. Ingenco appealed. 

    The Ninth Circuit noted that the policy did not define the term “external cause.” The proper analysis was on whether the loss was fortuitous. This required looking into whether a particular loss was certain to occur, the parties’ perception of risk at the time of the policy issuance, and whether the loss could reasonably have been foreseen. The issue was not the fortuity of the process gas or some other cause, but rather whether Ingenco’s loss was fortuitous. The court concluded the loss was not inevitable and could not have been reasonably foreseen. Therefore, the loss was fortuitous or, at the very least, there was a triable issue of fact.  

    Therefore, the district court’s grant of summary judgment to Ace on the question of whether Ingenco’s loss was the result of an “external cause” was reversed. The district court failed to consider the role of fortuity in all risks insurance disputes. 

    The court next considered the ensuing loss provision in the exclusion for faulty or defective material, etc. Ingenco argued that, even if the diffuser basket was defectively designed, and even if its failure constituted an uncovered “internal” cause of loss, the “ensuing loss” exception preserved coverage for the post-failure damage to the adsorbent beads throughout the purification system. Ace’s position was that the damage did not result from an “external cause.” The court reasoned that the loss of the adsorbent beads did ensue from some prior, but excluded loss or event, whether it was the stream of gas or the failure of the diffuser shield. There was no specific exclusion regarding the loss of the beads. Therefore, even if the diffuser shield suffered from some inherent defect, the subsequent destruction of the adsorbent beads would be covered under the ensuing loss exception. 

    Consequently, the Ninth Circuit reversed the district court grant of summary judgment against Ingenco and remanded the case to the district court for trial. 

Does Payment of an Appraisal Award Wipe Out Claims Handling Insurance Code Violations?

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J. Ryan Fowler | Property Insurance Coverage Law Blog | July 5, 2019

The Texas Supreme Court recently answered the question above in two cases with different results depending on what type of insurance code violations the insured is alleging. The court addressed Texas Insurance Code chapter 542 violations (often called prompt payment of claims) in Barbara Technologies Corporation v. State Farm Lloyds.1

In Barbara Technologies, the court held that an insured may proceed on a claim under Chapter 542 even after the insurance company invokes the policy appraisal provision and ultimately pays the appraisal award.

However, on the same day, the Texas Supreme Court addressed violations of Chapter 541 of the Texas Insurance Code (often called bad faith claims practices) in Ortiz v. State Farm Lloyds.2 In Ortiz, the court held that an insurance company’s payment of an appraisal award bars the insured’s breach of contract claim and the insured’s common law and statutory bad faith claims to the extent that the only actual damages sought are lost policy benefits.

Both cases involved the insurance company invoking appraisal during litigation and ultimately paying the appraisal award after it was issued. Reading the two cases together highlights the differences in Insurance Code violations and what claims are still viable after appraisal. To simplify, the court held that:

  1. An insured’s breach of the insurance contract claim is barred;
  2. An insured’s common law bad faith claims are barred when the insured is only seeking policy benefits;
  3. An insured’s Chapter 541 claims are barred when the insured is only seeking policy benefits; and
  4. An insured’s Chapter 542 claims remain viable.

The court made it clear however to prosecute Chapter 542 violations and ultimately recover damages under the statute the insured must still carry the burden of proof and establish that it is entitled to the prompt payment of damages. The court rejected the insured’s argument that when an insurer pays an appraisal award, it accepts liability on a claim and pays policy benefits as actual damages that it is strictly liable for statutory penalties under the prompt payment of claims act.3

Ultimately the court has attempted to clarify the law as it relates to the payment of appraisal awards and Texas Insurance Code violations. If you have a question relating to an insurance claim that has been through the appraisal process contact an experienced insurance attorney.
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1 Barbara Technologies Corporation v. State Farm Lloyds, No. 17-0604 (Tex. June 28, 2019).
2 Ortiz v. State Farm Lloyds, No. 17-1048 (Tex. June 28, 2019).
3 Barbara Technologies.

Another Reason to Always Respond (or Hensel Phelps Wins One!)

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Christopher G. Hill | Construction Law Musings | June 18, 2019

Here at Construction Law Musings, Hensel Phelps Construction Co. is best known as the company that got whipsawed between indemnity rules and the lack of a statute of limitations for state agencies.  However a recent case out of the Federal District Court for the Eastern District of Virginia gave them a win and illustrates, once again, that failing to appear or respond is never a good option.

In Hensel Phelps Construction Co. v. Perdomo Industrial LLC, the Alexandria, VA federal court looked at an arbitration award entered for Hensel Phelps and against Perdomo under the Federal Arbitration Act.  The facts of the case showed that Perdomo “double dipped” into the deep end of refusal or failure to respond.  First of all, the contract required arbitration and any award was enforceable in any state or federal court having jurisdiction.  Based upon this language, Hensel Phelps filed a demand for arbitration with the American Arbitration Association against Perdomo and its surety, AAA sent notice to both Perdomo and Surety, and. . . neither responded or appeared at what was ultimately 8 days of hearings.  After hearing Hensel Phelp’s evidence and the total lack of defenses from Perdomo and Surety, the panel issued an award in favor of Hensel Phelps, finding Perdomo LLC in default and holding Perdomo LLC and Allied World jointly and severally liable in the amount of $2,958,209.71 and Perdomo LLC individually liable in the amount of $7,917,666.30 plus interest.

Hensel Phelps filed the action with the Alexandria court to confirm the arbitration award and after proper service of the petition Perdomo once again failed to respond.  Not only that, Perdomo failed to appear at the hearing on the inevitable default judgment motion filed by Hensel Phelps.  After finding that it had jurisdiction over the matter due to both the law and the contract, the Court held a default judgment was proper and that Hensel Phelps was entitled to the full award.  In doing so, theCourt held that Perdomo did not request modification of the award in the proper time and that Hensel Phelps had petitioned the Court in a timely manner under the Federal Arbitration Act.  In short, Hensel Phelps didn’t even have to work that hard because there were no defenses presented either by pleading or at the hearing (no one having appeared).

The takeaway, aside from having an experienced construction attorney on your side?  ALWAYS SHOW UP!  It was bad enough that Perdomo forfieted its right to defend itself at arbitration, but it then gave up what limited avenues of defense to the award that it may have had when it failed to pursue either modification or vacation of the award and then failed to even respond to the petition to confirm or motion for default judgment.  While defenses to the confirmation of a proper arbitration award are limited, at least Perdomo would have been able to put up a fight.

Care, Custody or Control Exclusion Requires Complete and Exclusive Control by Insured Claiming Coverage

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Christopher Kendrick and Valerie Moore | Haight Brown & Bonesteel | June 11, 2019

In McMillin Homes Construction v. Natl. Fire & Marine Ins. Co. (No. D074219, filed 6/5/19) a California appeals court held that a “care, custody or control” exclusion did not bar coverage for defense of a general contractor as an additional insured under a subcontractor’s policy, because the exclusion requires exclusive control, but the facts and allegations posed a possibility of shared control with the subcontractor.

McMillin was the general contractor on a housing project and was added as an additional insured to the roofing subcontractor’s policy pursuant to the construction subcontract. The homeowners sued, including allegations of water intrusion from roof defects. McMillin tendered to the roofing subcontractor’s insurer, which denied a defense based on the CGL exclusion for damage to property within McMillin’s care, custody or control.

In the ensuing bad faith lawsuit, McMillin argued that the exclusion required complete or exclusive care, custody or control by the insured claiming coverage, which was not the case for McMillin. The insurer argued that the exclusion said nothing about complete or exclusive care, custody or control. Further, the intent to exclude coverage for damage to any and all property in McMillin’s care, custody or control, to whatever degree, was demonstrated by the fact that the additional insured endorsement in question was not an ISO CG2010 form, but a CG2009 form, which expressly adds a care, custody or control exclusion to the additional insured coverage not found in the CG2010 form. The argument was that the CG2009 form evidences an intent to conclusively eliminate coverage for property in the additional insured’s care, custody or control. In addition, the insurer argued that this result was also reinforced by its inclusion of an ISO CG2139 endorsement in the roofer’s policy, which eliminated that part of the “insured contract” language of the CGL form, defining an “insured contract” as “[t]hat part of any other contract or agreement pertaining to your business . . . under which you assume the tort liability of another party to pay for ‘bodily injury’ or ‘property damage’ to a third person or organization.” The insurer’s argument was that by having eliminated coverage for contractual indemnity or hold harmless agreements, it had “closed the loop” of eliminating additional insured coverage for construction defect claims.

In a bench trial, the trial court agreed and entered judgment for the insurer. However, the appeals court reversed. The appeals court pointed out that the care, custody or control exclusion had already been judicially construed to require exclusive or complete control. (Citing Home Indem. Co. v. Leo L. Davis, Inc. (1978) 79 Cal.App.3d 863, 872.) And the facts indicated only shared control between the general contractor and its roofing subcontractor.

The McMillin court did not even discuss whether the difference between the CG2009 and the CG2010 forms had any effect, but merely ruled that the care, custody or control exclusion did not apply, presumably meaning either way. According to the court, “[w]here a policy term has been judicially construed, it is not ambiguous. (County of San Diego v. Ace Property & Casualty Ins. Co. (2005) 37 Cal.4th 406, 423.) ‘[T]he judicial construction of the term should be read into the policy unless the parties express a contrary intent.’ (Bartlome v. State Farm (1989) 208 Cal.App.3d 1235, 1239.)” In footnote, the McMillin court also dismissed a distinction in the fact that the CG2009 form uses the words, “over which the insured exercises physical control,” saying that physical control was a possibility under the circumstances.

Disagreeing that the insurer’s interpretation would render additional incurred coverage totally illusory, the McMillin court did say that covering construction defect lawsuits was within McMillin’s reasonable expectations, given that the requirement for procuring the coverage was contained in a construction subcontract.

As to the insurer’s “close the loop” argument regarding elimination of contractual indemnity coverage by way of the modification to the insured contract definition under the CG2139 endorsement, the McMillin court questioned whether that would be a reasonable expectation for McMillin but found it irrelevant regardless, having already concluded that coverage was mandated because of its rejection of the care, custody or control argument. Thus, “[b]ecause the insurer did not prove coverage for the underlying construction defect litigation was impossible, it owed the general contractor a duty to defend the homeowner claim.”

This document is intended to provide you with information about insurance law related developments.The contents of this document are not intended to provide specific legal advice. If you have questions about the contents of this alert, please contact the authors. This communication may be considered advertising in some jurisdictions.