Illinois Supreme Court Affirms School District Must Pay for Emergency Construction

Kelly K. Koss | Barnes & Thornburg

Public construction projects in Illinois can be fraught with legal loopholes and “gotchas” that can take hard earned money out of the pockets of construction workers. Back in December, we wrote about the cautionary tale of Proviso East High School. In that case, the school district attempted to avoid making any payments over and above insurance proceeds for $7.3 million of emergency construction work that was performed to repair a high school following a fire loss. 

The construction contracts at issue were signed by the school superintendent and the board received regular updates on the work. There were no objections to the price or the quality of the work when it was performed. But the school district then refused to pay on the ground that the contracts were void from the beginning because the school board did not follow the bidding-and-approval process required by the Illinois School Code. In the school district’s view, this was the construction company’s problem because the contractor had the responsibility in the first instance to make sure that the people it was dealing with had proper authorization before proceeding. 

The trial court agreed with the school district and dismissed the case on the ground that the construction contract was void. The trial court also held that the contractor could not recover based on a contract implied by law (quantum meruit). The appellate court reversed, finding that the affected contractors could sue based on a contract implied by law for the value of the work. 

The Illinois Supreme Court’s decision affirms the appellate court’s decision. The Supreme Court first held that the school board did not act beyond its statutory authority when it entered into the contracts. The decision observed that a Financial Oversight Panel (FOP) was managing the school district’s finances at the time the construction contracts were entered into, and the FOP had the authority to regulate the procedure for entering into contracts – not the school board. In addition, the school code provides that its “enumeration of powers is not exclusive,” and also specifically exempts the expenditure of funds for emergencies from the normal bidding process where the expenditure is approved by three-quarters of the board. 

The Supreme Court then concluded:

“While the actions taken by the Board in handling the emergency repair and restoration work at Proviso East may not have comported with the procedures set forth in the School Code, hiring a contractor to do such work, as the Board did here, is unquestionably among the types of action Illinois school boards are authorized to undertake. The contractor, Restore, performed its obligations in good faith, and the Board willingly accepted the benefits of Restore’s efforts without question or complaint.”

The decision also holds that the contractor was entitled under the circumstances to recover the value of its work based on a contract implied by law. According to the Court:

“Illinois courts have similarly recognized that the failure of a governmental unit to comply with the required methods for awarding contracts is not fatal to a plaintiff’s right to recover based on principles of quasi-contract or contract implied in law. The essence of a cause of action based upon a contract implied in law is the defendant’s failure to make equitable payment for a benefit that it voluntarily accepted from the plaintiff. Even where a governmental unit has not complied with its policies and procedures for awarding contracts, recovery may be had against it if the plaintiff can show that it furnished valuable goods or services, which the defendant received under circumstances that would make it unjust to retain without paying a reasonable sum in compensation.”

Finally, the Supreme Court concluded that any problem with the formation of the contracts was caused by the school board’s own “misconduct,” and that fundamental principles of Illinois law will not permit a party to seek to take advantage of its own wrongdoing: 

“A fundamental precept of Illinois law is that no one shall be permitted to take advantage of his own wrong. Allowing the Board to escape responsibility for paying what it owes based on its own misconduct would directly contravene this core principle and reward school districts for failing to adhere to the law. That is not a precedent we should set, particularly where, as here, the school board has had such difficulty managing its own financial affairs that it has been forced to operate with State oversight for more than a decade.”

Although the Illinois Supreme Court has made it clear it will not allow a public entity to hide behind contracting technicalities to escape payment for work performed under an improperly formed agreement, contractors should still act with caution. Contractors that are contemplating contracting with a public entity should consult an attorney to navigate the complex bidding requirements for such work. 

New Illinois Supreme Court Trigger Rule for CGL Personal Injury “Offenses” Could Have Costly Consequences for Policyholders

Michael S. Levine and Kevin V. Small | Hunton Andrews Kurth

The Illinois Supreme Court’s recent decision in Sanders v. Illinois Union Insurance Co., 2019 IL 124565 (2019), announced the standard for triggering general liability coverage for malicious prosecution claims under Illinois law.  In its decision, the court construed what appears to be a policy ambiguity against the policyholder in spite of the longstanding rule of contra proferentem, limiting coverage to policies in place at the time of the wrongful prosecution, and not the policies in effect when the final element of the tort of malicious prosecution occurred (i.e. the exoneration of the plaintiff).  The net result of the court’s ruling for policyholders susceptible to such claims is that coverage for jury verdicts for malicious prosecution – awarded in today’s dollars – is limited to the coverage procured at the time of the wrongful prosecution, which may (as in this case) be decades old.  Such a scenario can have costly consequences for policyholders given that the limits procured decades ago are often inadequate due to the ever-increasing awards by juries as well as inflation.  Moreover, it may be difficult to locate the legacy policies and the insurers that issued such policies may no longer be solvent or even exist.  A copy of the decision can be found here.

The Sanders case arose out of the wrongful conviction of Rodell Sanders in 1994 by the City of Chicago Heights (the “City”).  Mr. Sanders sought recompense for, among other things, malicious prosecution through a federal civil rights action against the City.  In September 2016, Mr. Sanders obtained a consent judgment for $15 Million; however, at the time of the wrongful conviction, seventeen years earlier, the City’s only applicable insurance policy provided just $3 million in coverage.  The City contributed another $2 million towards the judgment and, in exchange for Mr. Sanders’s agreement not to seek the $10 million balance from the City, assigned its rights under the policies for the 2012 to 2014 period.

The City’s primary insurer from 2012 to 2014 was Illinois Union Insurance Company (“Illinois Union”).  Starr Indemnity & Liability Company was the follow form umbrella carrier.  The Illinois Union policy provided coverage for Personal Injury arising from an Occurrence during the policy period.  Personal Injury was defined to include “one or more of the following offenses … [f]alse arrest, false imprisonment, wrongful detention or malicious prosecution ….”  (Emphasis added.)

In the coverage dispute, the court observed that the central issue concerned whether the “offense of malicious prosecution” occurred during the insurers’ policy period, which hinged on the interpretation of the undefined term “offense.”  Sanders asserted that the offense took place upon the satisfaction of the final element of the tort claim for malicious prosecution – the exoneration of the plaintiff.  The insurers argued that the focus should be on the requisite act and injury, which occurred at the time of the wrongful conviction, rather than the accrual of a completed cause of action.

The court noted that the parties each proffered competing dictionary definitions of the word “offense.”  According to Black’s Law Dictionary (10th ed. 2014), offered by Sanders, an “offense” means a “violation of the law; a crime, often a minor one.”  Comparatively, the insurers cited Merriam-Webster’s Online Dictionary, which provides that “the term is primarily used to mean something that outrages the moral or physical senses.”  Based on these definitions alone, the term “offense” appears susceptible to two reasonable interpretations and, thus, is ambiguous, entitling the policyholder to the interpretation that favors coverage pursuant to the rule of contra proferentem.

Nonetheless, the court concluded “that the word offense in the insurance policy refers to the wrongful conduct underlying the malicious prosecution.”  The court stated that its ruling was based on “the meaning of the word offense and the contractual requirement that the offense must both happen and take place during the policy period” and that a “malicious prosecution neither happens nor takes place upon exoneration.”  The court further noted that the fact that the policy was an occurrence-based policy weighed heavily in its decision because such a policy “reflects the intent to insure only for the insured’s acts or omissions that happen during a policy period.”  The court stated:

If we were to deem exoneration the trigger for coverage of a malicious prosecution insurance claim, liability could be shifted to a policy period in which none of the acts or omissions giving rise to the claim occurred.  That would violate the intent of the parties to an occurrence-based policy.

The court added that “the language of the policy does not require that the elements of the tort be satisfied” and that it “cannot read into it the requirements of a tort claim for malicious prosecution.”  The court did not discuss the fact that the policy language did not preclude such a reading or how the rule of contra proferentem applied in the context at issue.

The court’s ruling could be problematic for Illinois policyholders seeking “personal injury” coverage under standard form policy wording.  With respect to claims like Sanders’s, the National Registry of Exonerations, which compiles statistics concerning exonerations from wrongful convictions, states that exonerations have grown tremendously since 1989, the first year of the database.  Similarly, jury awards have also generally risen year over year.  These conditions, combined with the tendency of policyholders of yesteryear to procure less coverage than policyholders of today and the uncertainties of even locating or obtaining coverage under legacy policies, creates a perfect storm that could leave the policyholder on the hook for a significant portion of an award for malicious prosecution.  This is especially notable considering that, in light of the Sanders decision, plaintiffs will likely not accept a consent judgment and assignment of rights to pursue coverage from the insurers on the risk at the time of exoneration.

Supplying Wrong Construction Materials Resulting in Rip-and-Tear Damage Not an “Occurrence,” 7th Circuit Holds

Timothy Carroll and Anthony Miscioscia | White and Williams

The construction contract calls for International Building Code-compliant lumber. The insured doesn’t supply that. What the insured does supply gets installed but then ripped out and replaced, causing damage to the surrounding property into which the lumber was integrated. Such circumstances — not uncommon in the construction industry — do not constitute an “occurrence” under Illinois law, according to the U.S. Court of Appeals for the Seventh Circuit in an opinion published yesterday. Lexington Insurance Company v. Chicago Flameproof & Wood Specialties Corporation, No. 19-1062, 2020 U.S. App. LEXIS 6006 (7th Cir. Feb. 27, 2020).

The insured in Chicago Flameproof was an Illinois-based “distributor of commercial building materials, including fire retardant and treated lumber (‘FRT lumber’).” A residential and commercial contractor contracted with the insured for “a particular brand of FRT lumber, D-Blaze lumber, for use in the four projects.” Despite the insured’s alleged knowledge that the lumber was being purchased to comply with International Building Code (IBC) standards adopted in Minnesota, the site of the construction projects, the insured allegedly “made a ‘unilateral decision’ to instead deliver its in-house FlameTech brand lumber, which purportedly was not IBC-compliant FRT lumber, and “thereby ‘did not meet the IBC definition of FRT lumber’ and therefore ‘was not actually FRT lumber.’” Not aware of using the wrong lumber, the contractor installed it but, after later discovering it, was instructed to remove it and replace it with IBC-certified FRT lumber. Doing so resulted in damage to the “surrounding materials into which the lumber had been integrated.” The insured was sued for breach of contract, breach of warranties, negligent misrepresentation, and on other related causes of action.

The insurer in Chicago Flameproof filed suit, seeking a declaration that it did not owe a duty to defend the insured in the underlying suit. Entering judgment for the insurer, the Illinois federal district court held that if, as alleged, the insured “knowingly supplied non-IBC-compliant lumber and concealed that it did so, . . . then the property damage that allegedly resulted from tearing out that non-compliant lumber cannot be said to have been caused by an accident.” On appeal, the Seventh Circuit Court of Appeals affirmed that holding, concluding the underlying suit did not allege an “occurrence,” defined in the policy as “an accident.”

Under Illinois law, the Court observed, an accident is “an unforeseen occurrence, usually of an untoward or disastrous character or an undesigned sudden or unexpected event of an inflictive or unfortunate character,” and that if damage “ ‘is the rational and probable consequence of the act or, stated differently, the natural and ordinary consequence of the act,’ then the act ‘is not an accident.’ ” The Court of Appeals also observed that “[f]aulty workmanship may constitute an occurrence if it results in damages that exceed the scope of the insured’s work product,” or “where the insured ‘was unaware of the defective nature’ of its component until after it was incorporated into a finished product.”

Concluding that the underlying suit did not allege an “occurrence,” as so defined, the Court reasoned that “[t]here was nothing regarding the natural and ordinary consequences of supplying uncertified lumber for projects that require certified lumber that was unknown or hidden to [the insured] at the time it shipped the uncertified lumber.” The rip-and-tear damage alleged, therefore, “was the natural and ordinary result of [the insured’s] deliberate decision to supply, and conceal that it had supplied, uncertified lumber,” and thus not an “occurrence.”

Illinois Appellate Court Clarifies What Is and Is Not an “Occurrence” in the Construction Defect Context

Marianne Bradley and Anthony Miscioscia | White and Williams LLP

On December 31, 2019, the First District Illinois Appellate Court issued its decision in Owners Insurance Company v. Precision Painting & Decorating Corporation, clarifying what does and does not constitute “property damage” caused by an “occurrence” in the construction defect context. 2019 IL App. (1st) 190926-U, 2019 Ill. App. Unpub. Lexis 2425.

The underlying case involved allegations of negligence, consumer fraud and breach of contract. In particular, the underlying homeowner claimants alleged that Precision Painting & Decorating Corporation (Precision), whom the homeowners had hired to perform certain exterior paintwork at their home, failed to conform to U.S. Environmental Protection Agency (EPA) regulations with respect to the presence of lead-based paint. In its contract, Precision had agreed to take special care with respect to containing lead dust while working on the homeowners’ property. Despite having agreed to do so, Precision (allegedly) took almost no precautions, resulting in significant contamination to the interior of the home.

Owners Insurance Company (Owners) had issued Precision a CGL policy, providing coverage for “property damage” caused by an “occurrence,” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”

Precision tendered its defense to Owners. Owners filed a DJ Action arguing that it owed no duty to defend as the homeowners had failed to allege any “property damage” caused by an “occurrence.” Specifically, Owners argued that, under Illinois law, damages resulting from an insured’s breach of contract are not recoverable under a CGL policy.

The trial court agreed, finding that no “accident” or “occurrence” was alleged. The trial court observed that the homeowners’ contract with Precision had specifically provided for various EPA-required precautions with respect to the use of lead-based paint. The trial court concluded that Precision’s failure to implement those precautions was not an “accident,” which in the trial court’s view, referred to something “unforeseen or untoward or disastrous.” Instead, the trial court characterized Precision’s conduct as nothing more than a foreseeable breach of contract.

Precision appealed, and the Appellate Court reversed and remanded. The Appellate Court found that the trial court’s focus on foreseeability was misplaced. It observed that: “[i]nstead of focusing on the foreseeability of the event itself (the release of lead-based particles), or even generally the damages (lead contamination),” Illinois case law instructs courts “to focus on what, specifically, was damaged, and whether the remediation of that damage fits within the general purpose of a CGL policy.” Id. at *12 (emphasis added). The Appellate Court emphasized that: “when the underlying lawsuit against the insured contractor alleges damages beyond repair and replacement, and beyond damage to other parts of the same project over which that contractor was responsible, those additional damages are deemed to be the result of an ‘accident.’” Id. at *14.

The Appellate Court was careful to contrast these so-called “beyond” damages with damages arising out of faulty workmanship, alone. It reiterated that it is well-settled under Illinois law that “there is no occurrence when a [contractor’s] defective workmanship necessitates removing and repairing work.” Id. at *14. This is true even when a contractor’s faulty workmanship results in consequential damages to any other part of the project for which the contractor has responsibility, as it remains part of the contractor’s work product. However, where damages extend beyond the scope of a contractor’s work product, the court concluded that those damages are more properly classified as unforeseeable accidents, and thus “occurrences.”

The Appellate Court found that Precision’s “work product” was limited to the exterior of plaintiffs’ house. Thus, any damage to the interior of the home, as well as to the surrounding land, was outside the scope of Precision’s project. Because plaintiffs had alleged damages “beyond repair and replacement, and beyond damage to other parts of the same project over which [Precision] was responsible,” plaintiffs had satisfactorily alleged “property damage” caused by an “occurrence.” The Appellate Court reversed and remanded in accordance with those findings.

Bad Faith Damages Against Surplus Line Insurers Might Not Be Capped in Illinois

Paul Walker-Bright | Neal, Gerber & Eisenberg | November 15, 2019

I recently had occasion to read through the Illinois Surplus Line Law in detail when I noticed something interesting:  surplus lines insurance companies may not be subject to the cap on bad faith damages usually applied to claims against insurers in Illinois. Allow me to explain.

In Illinois there is a statute, 215 ILCS 5/155 (“Section 155”), that governs bad faith claims against insurers. It states that:

In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts:

(a)  60% of the amount which the court or jury finds such party is entitled to recover against the company, exclusive of all costs;

(b)  $60,000;

(c)  the excess of the amount which the court or jury finds such party is entitled to recover, exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the claim prior to the action.

In 1996, the Illinois Supreme Court held that Section 155 pre-empts common law tort claims for breach of the implied duty of good faith and fair dealing against insurers and provides the sole basis for policyholders to recover from insurers for breach of said duty. See Cramer v. Ins. Exch. Agency, 174 Ill.2d 513, 675 N.E.2d 897 (1996). As one can see, Section 155 limits recovery against an insurer to reasonable attorneys’ fees, other costs, and the lesser of the amounts in (a), (b) and (c) above. The effect is to limit the policyholder’s recovery to reasonable attorneys’ fees, costs, and $60,000 or less. No punitive damages or other tort damages, regardless of how egregious the insurer’s conduct was. The Supreme Court in Cramer did state that Section 155 does not pre-empt a tort that has separate and independent elements and is based on something other than an insurer’s failure to pay a claim, but policyholders can find it difficult to meet this test.

Understandably, not everyone is satisfied with this outcome. Don’t get me wrong:  Section 155 was enacted to benefit policyholders, and the fee-shifting aspect does help make lawsuits against insurers more economically feasible. Nevertheless, the feeling remains that the legislature could have gone further.

Enter the Illinois Surplus Line Law, 215 ILCS 5/445. This law governs when and how “surplus line insurance” may be procured for Illinois policyholders. “Surplus line insurance” means:

insurance on a risk:

(A)  of the kinds specified in Classes 2 and 3 of Section 4 of this Code; and

(B)  that is procured from an unauthorized insurer after the insurance producer representing the insured or the surplus line producer is unable, after diligent effort, to procure the insurance from authorized insurers; and

(C)  where Illinois is the home state of the insured, for policies effective, renewed or extended on July 21, 2011 or later and for multiyear policies upon the policy anniversary that falls on or after July 21, 2011; and

(D)  that is located in Illinois, for policies effective prior to July 21, 2011.

215 ILCS 5/445(1) (definition of “surplus line insurance”). Section 4 of the Insurance Code states that Class 2 insurance is “Casualty, Fidelity and Surety” and Class 3 insurance is “Fire and Marine, etc.” 215 ILCS 5/4. These are very broad categories that include accident and health, liability, vehicle, and property insurance. Id. The purpose of the Surplus Line Law “is to make it possible to secure protection against a risk when authorized companies will not provide that protection.” Corday’s Dept. Store, Inc. v. NY Fire & Marine Underwriters, Inc., 442 F.2d 100, 103-04 (7th Cir. 1971). Consequently, surplus lines insurance is fairly common, particularly for unusual or hard to insure risks. For example, flood insurance is often procured through surplus line insurers. https://www.investopedia.com/terms/s/surplus-lines-insurance.asp.

Now for the interesting part. The Surplus Line Law states that:

Surplus line insurance procured under this Section, including insurance procured from a domestic surplus line insurer, is not subject to the provisions of the Illinois Insurance Code other than Sections 123, 123.1, 401, 401.1, 402, 403, 403A, 408, and all of the provisions of Article XXXI to the extent that the provisions of Article XXXI are not inconsistent with the terms of this Act.

215 ILCS 5/445(12). Notice what is missing from the list:  Section 155, which is part of the Insurance Code. If surplus line insurance is “not subject to” Section 155, that statute should not pre-empt common law tort claims for bad faith against surplus line insurers. These insurers have the benefit of not being subject to other parts of the Insurance Code, such as having to issue policies on forms approved by the Department of Insurance. See Cordray’s Dept. Store, 442 F.2d at 104. Therefore, it makes sense that they should not have the benefit of Section 155. This means that policyholders that obtain surplus line insurance may be able to recover more than the limited amounts in Section 155 if they sue their insurers for bad faith, including punitive and other tort damages. See Cramer, 174 Ill.2d at 522-23, 675 N.E.2d at 901-02 (noting that some Illinois courts had held policyholders could recover tort damages, including punitive damages, from insurers that acted in bad faith). In an appropriate case, this could prove to be an unpleasant surprise for an unsuspecting surplus line insurer.