Seventh Circuit Affirms Cost of Capital Improvements Not Covered Under GL Policy

In its recent decision, Continental Cas. Co. v. Sycamore Springs Homeowners Association, 2011 U.S. App. LEXIS 15005 (July 22, 2011), the United States Court of Appeals for the Seventh Circuit, applying Indiana law, had occasion to consider whether an underlying suit demanding that the insured undertake measures to prevent future “property damage” triggered coverage under a general liability policy.

The insured, Courtyard Homes, was the developer of a residential subdivision constructed in a flood plain in Indianapolis, Indiana.  In fact, both Courtyards Homes, and the homeowners’ association, Sycamore Springs, knew of the flood risks associated with the area.  Courtyard Homes addressed this risk by constructing various flood-protection elements such as levees and retention ponds.  It was alleged, however, that Courtyard Homes overdeveloped the property, placing too much strain on these preventative measures, and that as a result, they failed during an extended period of heavy rains.

Sycamore Springs later sued Courtyard Homes, but not for damage resulting from the flooding.  Rather, Sycamore Springs sought relief in the form of requiring Courtyard Homes to construct improved measures to reduce the chances of future flooding.  Courtyard Homes’ carrier, Continental, denied coverage primarily on the basis that “any loss was the expected result of a deliberate reduction in the subdivision's ability to deal with heavy rain or a rising river” and thus did not allege "property damage" arising out of an occurrence.  In the ensuing coverage action, the district court did not reach the issue of whether the underlying suit alleged an occurrence.  Rather, the court found in favor of Continental on the basis that the suit did not allege loss arising out of “property damage,” but instead sought  to prevent future “property damage.”  Costs associated with preventing future, hypothetical “property damage,” held the court, did not fall within the policy’s coverage. 

On appeal, the Seventh Circuit affirmed the lower court’s decision, and in doing so, rejected the insured’s argument that costs of capital improvements can qualify for coverage under a liability policy.  The court reasoned that the moral hazards involved would prevent general liability insurers from writing such coverage:

Protected by a policy covering the costs of improvements, a builder would produce a substandard project and demand that the insurer finish the job; builder and buyers could split the savings. Insurers, recognizing this incentive, would raise the price of their policies so high that no builder planning to do the job right would find the offer attractive. The result would be the collapse of the insurance market. No one would gain, and honest builders would lose because insurance would no longer be available. That's why Continental's policy does not cover the expense of improving the subdivision's flood defenses.

Thus, held the Seventh Circuit, because the underlying suit did not involve any amounts that could be considered covered “property damage,” the lower court’s ruling was proper.  The Seventh Circuit nevertheless considered and rejected Continental’s argument that the underlying matter did not allege an “occurrence,” explaining that the unintended and unanticipated consequence of an intentional choice (i.e., constructing a housing development in a flood zone without proper precautions) can be an accident for the purpose of a liability policy.  Notwithstanding, a general liability policy provides coverage only for “property damage” resulting from such an accident, not for costs associated with preventing future “property damage.”