Covered and Uncovered Claims — When Allocation Is Required

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

Plaintiffs usually don’t bring claims based on the defendant’s insurance coverage. So it is not unusual for an insurer and policyholder to have a dispute about what claims are covered and what claims are not covered under the insurance policy and, if there are covered and uncovered claims, how to allocate the covered claims to the insurance policy. When the allocation question arises between a policyholder and an excess insurer, where the excess insurer did not control the underlying defense, the situation becomes more complicated. The Eighth Circuit Court of Appeals recently addressed this issue.

In RUSI Indemnity Co. v. New Horizon Kids Quest, Inc., No. 17-3567 (8th Cir. Aug. 12, 2019), the policyholder had commercial general liability and excess liability policies issued by one carrier and a second excess liability policy issued by a second carrier (the “excess carrier”). The underlying claim alleged negligent employee training and supervision resulting in a physical and sexual assault at a childcare facility operated by the policyholder (the alleged perpetrator was an older child also at the facility). The excess policy had a Sexual Abuse or Molestation Exclusion (so did the primary policy, but the primary insurer defended under a reservation of rights and ultimately never adjudicated that issue).

After two trials, the jury rendered a verdict and did not make any findings concerning whether there was sexual abuse as well as physical assault (the policyholder admitted liability for negligent supervision). The jury’s award reached the excess carrier’s limits and the excess carrier refused to pay that part of the award (the primary carrier paid its full primary and excess policy limits and the policyholder paid the remaining amount of the judgment, which it sought back from the excess carrier).

The excess carrier commenced a declaratory judgment action claiming that the exclusion barred coverage for the part of the award that reached the excess carrier’s policy. The district court granted summary judgment to the policyholder, but the circuit court reversed and remanded.

The basis for the reversal and remand was the court’s holding, under Minnesota law, that an excess insurer that did not control the underlying defense must be afforded the opportunity to prove in a subsequent coverage action that the jury award included damages for uncovered as well as covered claims. The court went on to say that if the excess carrier sustains that burden, the district court must then allocate the award between covered and uncovered claims.

Here, said the court, the jury was not asked to find whether the victim suffered sexual as well as physical assault and the award was not allocated between those two claims. While the excess carrier had the right to participate in the defense of the underlying claim to which the insurance may apply, it had no duty to defend unless the underlying limits were exhausted. Although the court found that it was undisputed that physical assault claims were covered under the excess policy, the excess carrier asserted that it had no duty to pay the policyholder because a substantial portion of the jury award–“perhaps all of it in excess of the amounts paid by” the primary carrier– was based on claims of sexual assault that were barred by the exclusion.

The court concluded that two issues had to be resolved on remand. First, whether the jury award included damages for sexual assault that fell within the exclusion, and, if so, what portion of the total award must be allocated to that uncovered claim. Under Minnesota law, held the court, the excess carrier had the right to try to prove in a post-award coverage action that the award was based at least in part on an uncovered claim and the failure to allocate the award between covered and uncovered claims. Because whether the underlying claimant proved an uncovered claim was a coverage issue that was not necessary or essential for the jury to determine, it, said the court, was an issue the excess carrier was entitled to litigate in a post-award coverage action.

The circuit court held that if the excess carrier establishes that the claimant proved an uncovered sexual assault claim as well as a covered physical assault claim, then the district court must address the final coverage issue of how to allocate the total award. The circuit court left it to the district court to determine in the first instance who has the burden to prove allocation should the excess carrier carry its burden on the uncovered claim issue.

Endorsement Excludes Replacement of Undamaged Property with Matching Materials

Tred R. Eyerly | Insurance Law Hawaii | June 26, 2019

    The court approved the insurer’s endorsement which stated the insured would not pay for undamaged property in order to match damaged property. Noonan v. Am. Family Mut. Ins. Co., 2019 U.S. App. LEXIS 15545 (May 24, 2019).

    After hail and wind damaged part of the roof in the insureds’ home, American Family inspected the roof and determined that it had suffered $12,000 in damage. The insureds disputed this amount and demanded an appraisal to provide a binding estimate of the amount of loss. American Family asked the appraisers to divide their estimate into two categories – one for replacing damaged shingles and another for replacing undamaged shingles that would not match those needed to replace the damaged ones. The appraisers did not do so. They instead found that replacing the entire roof would cost $141,000 and noted there was a matching issue because alternative products did not match the current shingles on the roof.

    Of the $141,000 needed to replace the entire roof, American Family estimated that $87,232.98 was due to the costs of matching. The insureds sued. The district court remanded the case to the appraisers to clarify the award by differentiating the costs attributable to the actual roof damage from those attributable to shingle matching. The appraisers clarified the award and reported that actual damages were $66,619, meaning that $74,381 was attributable to matching. American Family then paid the actual damages, less the deductible, but refused to pay the rest. 

    An endorsement stated that American Family would “not pay to repair or replace undamaged property due to mismatch between undamaged material and new materials used to repair or replace damaged material.” The district court denied American Family’s motion for summary judgment. The court found that the endorsement did not apply to the policy because the endorsement did not say it applied to a prior endorsement which deleted and replaced the portion of the policy titled “Loss Value Determination.” 

    The Eighth Circuit reversed and found that the matching exclusion did apply. The first page of the policy explicitly said that the endorsement applied and a copy of the endorsement was physically attached to the policy. 

The Seventh Circuit Court of Appeals Weighs In On “Matching”

Edward Eshoo | Property Insurance Coverage Law Blog | August 10, 2019

Last year in one of my blogposts, I wrote about Windridge of Naperville Condominium Association v. Philadelphia Indemnity Insurance Company,1 and the issue whether appraisal is appropriate to resolve a dispute over the cost of repairing physically undamaged siding of townhome buildings to remedy a mismatch with repaired damaged siding. There, a federal district court in Illinois denied the Association’s motion to compel appraisal on the “matching” issue, reasoning it was a question of coverage, not loss amount, and thus inappropriate for appraisal. This coverage issue was subsequently resolved in favor of the Association, the district court concluding that Philadelphia must replace or pay to replace the siding on all four of the townhome buildings’ elevations if no siding is available that matches the undamaged siding on the north and east elevations, as claimed by the Association.2

Philadelphia appealed the district court’s entry of summary judgment in favor of Windridge. The Seventh Circuit Court of Appeals recently affirmed the ruling, rejecting Philadelphia’s argument that because only the south and west elevations suffered “direct physical loss to covered property” within the meaning of the policy’s coverage grant, it need only replace the siding on those elevations.3

With respect to the phrase “direct physical loss,” the Seventh Circuit applied a common sense meaning: physical damage to tangible property causing an alteration in appearance, shape, color, or in other material dimension, which is what occurred to the siding. As to the term “covered property,” the Seventh Circuit concluded that the unit of covered property to consider under the policy (each panel of siding vs. the building as a whole) was ambiguous, meaning that the Association’s reading of the policy prevailed.

One point the Seventh Circuit made clear though was that it was deciding the case on the policy language at hand, including the valuation and loss payment provisions in the Philadelphia policy. That is why the only case it found instructive was National Presbyterian Church, Inc. v. GuideOne Mutual Insurance Company,4 in which a federal district court in the District of Columbia ordered GuideOne to pay to replace all of a church’s exterior limestone panels, including those that were undamaged by a 2011 earthquake, to ensure that all of the panels matched in color and weathering.5 While the coverage grant, valuation, and loss payment provisions in the Philadelphia policy supported the conclusion that Philadelphia must pay to return the buildings to their pre-storm status (matching siding on all sides),6 the Seventh Circuit stated that matching may not be appropriate in situations involving limited damage, such as one mismatched shingle on a roof.

So, is Illinois a “matching” state? With respect to any case filed in an Illinois federal district court under the ISO Commercial Property Building and Personal Property Coverage Form, I would submit yes, as long as matching is sought for something other than “limited” damage as the Seventh Circuit discussed in its opinion. As far as Illinois state courts, the answer likely will depend on the court considering the issue, as Illinois state courts are not bound to follow federal district court opinions, including Seventh Circuit opinions, as they are considered persuasive authority and not precedential authority.7
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1 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., No. 16-3860, 2017 WL 372308 (N.D. Ill. Jan 26, 2017).
2 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., No. 16-3860, 2018 WL 1784140 (N.D. Ill. April 13, 2018).
3 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., 2019 WL 3720876 (7th Cir. August 7, 2019).
4 Nat’l Presbyterian Church, Inc. v. GuideOne Mut. Ins. Co., 82 F. Supp. 3d 55 (D. D.C. 2015).
5 The policy at issue in both Windridge of Naperville Condominium Association and Nat’l Presbyterian Church, Inc. was a slightly modified version of the ISO Building and Personal Property Coverage Form (CP 00 10).
6 Philadelphia’s counsel conceded at oral argument that matching siding was not available.
7 Bridgeview Health Care Center, Ltd. v. State Farm Fire & Cas. Co., 10 N.E.3d 902 (Ill. 2014).c

When is a Mistake an ‘Accident’?

Jason R. Potter | Claims Magazine | June 2019

Commercial General Liability (CGL) policies, like all insurance products, are intended to protect the insured from unexpected claims or suits by third parties. A CGL policy covers bodily injury, property, personal and advertising liability, products and completed operations and fire liability unless they are excluded by a specific endorsement. CGL coverage can provide important protections to a business owner for a variety of losses, but they are most ubiquitous in the construction setting.

Perhaps no issue is as litigated and disputed within the CGL context as whether faulty construction work comes within a typical CGL policy’s initial grant of coverage. Pundits, professors and law professionals have all offered starkly differing views, but recent cases appear to be coalescing in favor of coverage, albeit for a specifically delineated subset of damages. This article will briefly summarize the positions and arguments in favor and in opposition to such coverage and offer a glimpse of what the future may hold. This article is limited to analyzing the CGL’s initial grant of coverage and does not delve into how, if at all, the policy’s 20 or so exclusions would affect that grant. The case for CGL coverage CGL insurance was first developed in 1941 as a way to purchase separately insured risks in one, unified policy. The Insurance Services Office, Inc. last modified the current standard form CGL policy in 1986. Its initial grant of coverage provides: “We will pay those sums that the insured becomes obligated to pay as damages because of ‘bodily injury’ or ‘property damages’ to which this insurance applies.” It clarifies that “This insurance applies to ‘bodily injury’ and ‘property damage’ only if: 1. The ‘property damage’ is caused by an ‘occurrence’ that takes place in the ‘coverage territory’

The case for CGL coverage

CGL insurance was first developed in 1941 as a way to purchase separately insured risks in one, unified policy. The Insurance Services Office, Inc. last modified the current standard form CGL policy in 1986. Its initial grant of coverage provides: “We will pay those sums that the insured becomes obligated to pay as damages because of ‘bodily injury’ or ‘property damages’ to which this insurance applies.” It clarifies that “This insurance applies to ‘bodily injury’ and ‘property damage’ only if: 1. The ‘property damage’ is caused by an ‘occurrence’ that takes place in the ‘coverage territory’ 2. The ‘bodily injury’ or ‘property damage’ occurs during the policy period.” It defines “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The term “accident,” however, is undefined. That lack of definition bears responsibility for much of the current dispute.

Consider the following example. A university contracted with a general contractor (GC) to build a new hotel on its campus. GC has a CGL policy. GC subcontracted most of the work to subcontractors. After construction was complete, the university discovered extensive water damage from hidden leaks, as well as other structural problems, all of which, it contended, arose from defective workmanship. The repair cost was estimated at $6 million.

The university sued the GC for the defective construction, and the GC turned to its CGL carrier for a defense of the case and indemnity for any judgment rendered against it. The CGL carrier argued there was no coverage because no accident (and thus no occurrence) had taken place. The court agreed with the insurer, leaving the GC with the $6 million repair bill.

In this scenario, if the GC is relatively solvent, it will file suit against its subcontractor or subcontractors seeking some or all of those repair costs. If the subcontractor has no insurance coverage and no surety performance bond, the GC and/ or the subcontractors will bear the risk of loss. If, however, the GC and/or the subcontractors has insufficient capital or credit, then some or all of the repair costs will be passed onto the owner. Regardless of who bears that cost, all of the parties are likely to complain that they believe the GC’s CGL carrier should bear such a burden because, for contractors, defective workmanship is by far the largest claim risk they face. In fact, for that reason, they are likely to say that CGL policies are purchased specifically to protect against such risks. Who is right? It will come as no surprise that the answer depends on whom you ask, or, in this case, what court you ask.

Courts’ treatment of CGL coverage for faulty workmanship

Courts throughout the country hold disparate views regarding whether defective construction is an occurrence within the confines of a CGL policy’s initial grant of coverage. By definition, an occurrence must be an accident; thereby raising the question as to whether the failure to properly construct something is an “accident.” As courts have repeatedly demonstrated, the answer to that question is not an easy one.

A minority of jurisdictions holds that defective construction is not an accident. Pointing to the everyday meaning of the term accident, these courts say that construction defects are not unexpected, because, they argue, it is foreseeable that a contractor that does faulty work would cause damages for which it would be obligated to pay the costs of repair. Because an accident must be, by its nature, unexpected, defective construction is no accident.

These jurisdictions often state that if a CGL policy provided coverage for defective workmanship, it would be converted into a warranty or guaranty of the contractor’s performance, which is more properly the province of a surety performance bond, whose sole purpose is to guaranty the contractor’s performance on the construction project. Courts in Ohio, Arkansas, Kentucky, and Pennsylvania adhere to this view and typically deny CGL coverage for construction defects, regardless of the types of damages caused by the defective work.

The majority position says that construction defects may be accidents, and thus occurrences that are eligible for CGL coverage. They are accidental because the contractor performing the work does not intend for the resulting damages to occur. Further, they argue, if CGL policies did not cover construction defects, no contractor would ever purchase them because they would provide no coverage for their single largest category of claim risk – construction defects. These majority -view jurisdictions often look at whether the damages were intended, expected or foreseeable. The focus, therefore, is on whether the results (the damages resulting from the defective work) would have been expected or foreseeable had the contractor performed correctly. If so, then it was not an accident for purposes of the CGL policy; if not, then it was.

Granting coverage for construction defects does not render as insured all such damages, however. Within these majority -view jurisdictions, there is a further split of authority as to whether the CGL policy covers only damages to a third party’s work or whether it also covers the repair and/or replacement cost of the defective work itself.

Most hold that a construction defect may be an occurrence (i.e., an “accident”) but only to the extent that the faulty work damaged property other than the insured’s defective work. These jurisdictions, which include Oregon, Illinois, Iowa, South Carolina, and Nebraska, believe that faulty workmanship itself is not an accident because the damages (the defective work) were within the insured’s control. They further justify their position on policy grounds, believing that the ultimate liability for such defective work should fall on the party that performed it, not the insurance carrier.

Other courts say that there is no basis for distinguishing between damages to the work itself and damages to other property. As the Supreme Court of Florida stated, “the definition of ‘property damage’ in the CGL policies does not differentiate between damage to the [insured] contractor’s work and damage to other property. [W]e reject a definition of occurrence that renders damage to the insured’s own work as a result of a subcontractor’s faulty workmanship expected, but renders damage to property of a third party caused by the same workmanship unexpected.” These jurisdictions, which include Florida, Kansas, Minnesota, Tennessee, Texas, and Wisconsin, find property damage to the work itself, as well as damage to the work of third parties, to be an occurrence that triggers CGL coverage.

What does the future hold?

In 2004, the Supreme Court of Nebraska stated, “the majority of courts have determined that faulty workmanship is not an accident and, therefore, not an occurrence.” [Auto-Owners Insurance Co. v. Home Pride Companies, Inc., 268 Neb. 528 (2004).] Since that case, however, courts in Florida, Kansas, Iowa, New Jersey, Georgia, West Virginia, Montana, Missouri, South Dakota, Tennessee, and South Carolina have reversed that majority, and it appears that a strong consensus has emerged that construction defects are occurrences that come within the initial grant of CGL coverage. The Ohio Supreme Court stemmed the unanimity of these authorities favoring coverage with its 2018 opinion in Ohio Northern University v. Charles Construction Services, Inc., from which the above example was taken.

Despite Ohio Northern, the clear trend favors initial coverage for defective workmanship. And, at least four state legislatures (Colorado, Hawaii, South Carolina, and Arkansas) have enacted statutes that define occurrences in the CGL context to include construction defects. Although such decisions are state-specific, they often rely on policy interpretations from other jurisdictions, a fact which suggests the majority view may continue to grow with support from new jurisdictions that have yet to consider the matter.

What does all this mean for the insurance industry and its insureds? This greater trend toward uniformity in construction defect coverage should provide optimism in the goal toward greater understanding and therefore fewer disputes among all parties (and fewer lawsuits against carriers) regarding the question of CGL coverage of damages arising from

How Specific does a Specific Litigation Exclusion have to be?

Larry P. Schiffer | Squire Patton Boggs | July 9, 2019

Insurance policies often have general exclusions for known losses or prior acts. The reason for this is that most insurance is for fortuitous risks–risks that will take place in the future; not risks that already have taken place. For large policyholders that have ongoing litigation, it is not uncommon for a new carrier to craft a specific exclusion to preclude coverage for an existing claim or set of circumstances that already exists. The First Circuit recently addressed a specific litigation exclusion to determine whether it was broad enough to cover new litigation and investigations arising out of the same investment product.

In USB Financial Services, Inc. of Puerto Rico v. XL Specialty Insurance Co., No. 18-1148, 2019 U.S. App. LEXIS 19946 (1st Cir. Jul. 3, 2019), the First Circuit addressed an appeal by policyholders of a summary judgment order granted to the insurance carriers based on the application of a specific litigation exclusion. The circuit court affirmed.

Basically, there were a series of investigations and lawsuits over a certain financial product sold by the policyholders. The policyholders sought new insurance going forward and the new carriers sought a specific litigation exclusion for the prior investigations and lawsuits. Using a major broker and a well-known policyholder law firm, the policyholders negotiated a new policy along with the specific litigation exclusion. The exclusions was broad and when the policyholder sought to negotiate a narrowing of the exclusion by replacing broad language with more narrow language, the carriers rejected the policyholders’ changes and the policyholders accepted the exclusion.

The exclusion precluded coverage of “any Claim in connection with any proceedings set forth below, or in connection with any Claim based on, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any such proceeding or any fact, circumstance or situation underlying or alleged therein.” New investigations and lawsuits arose concerning the same financial product and the policyholders sought coverage. The carriers disclaimed.

In affirming the grant of summary judgment to the carriers precluding coverage based on the exclusion, the court held that the common and usual meaning of the words of the exclusion were unambiguous and no coverage was available for any claim in any way involving the prior matters or any fact, circumstance or situation underlying or alleged in the prior matters. Moreover, the court found that it was equally clear what the intention of the parties was as demonstrated by the negotiations that preceded the issuance of the insurance policies when the policyholders tried to modify the exclusion and the carriers refused. Thus, held the court, although the language was undoubtedly broad, it was the language the policyholders bargained for during negotiations. The court found that the policyholders were aware that the breadth of the unchanged exclusion and nevertheless agreed to purchase the policies as they read.

The court also rejected the argument that the scope of the exclusion rendered the policies illusory. The court also rejected the argument that the exclusion should be construed in favor of the policyholders noting that those principles seek to protect a weaker party when there is a disparity at the bargaining table. Here, the court found those concerns not to be present because the terms of the exclusion were clear and the parties negotiated the polices at arms-length. The court noted that the policyholders were sophisticated financial players, which engaged a major insurance broker and a major policyholder law firm to negotiate the policy and the specific litigation exclusion. The court concluded that the policyholders could have reasonably expected that they bargained for the plain reading construction that the court gave the exclusion in this case.