7th Circuit Holds Insured’s Voluntary Payments Barred Coverage

In its recent decision in West Bend Mut. Ins. Co. v. Arbor Homes LLC, 2013 U.S. App. LEXIS 428 (7^th Cir. Jan. 8, 2013), the United States Court of Appeals for the Seventh Circuit, applying Indiana law, addressed whether an insured’s settlement of a claim, prior to giving notice to its insurer, precluded its right to coverage under a general liability policy.

The underlying claim in Arbor Homes arose out of the negligent construction of a new home in Indiana. Arbor Homes, the developer of the home, hired a plumbing contractor that failed to connect the drainage pipes in the claimants’ home to the sewer system.  As a consequence, when the home was occupied and put to use, raw sewage was discharged directly into the home’s crawlspace.  This resulted in noxious odors that ultimately caused the homeowners to become ill.  Upon receiving a complaint from the homeowners, Arbor took immediate action.  Within a week, it had the sewer connection fixed, and it undertook comprehensive efforts to decontaminate the home at a cost in excess of $65,000.  The homeowners, however, were not satisfied with these efforts and demanded a new home.   Arbor consulted with the plumbing contractor and proposed a settlement whereby the two would repurchase the home, build a new home for the claimants, and pay for all costs associated with moving the claimants into the new home. 

After outlining the settlement plan, Arbor sent a letter to the contractor memorializing the settlement.  The letter specifically advised the contractor to place its general liability carrier, West Bend, on notice of the proposed settlement and to inquire as to whether West Bend required any further information regarding the settlement.  Not hearing any immediate objections from West Bend, or from the contractor, Arbor agreed to the settlement with the underlying claimants. Arbor later brought suit against the plumbing contractor, and sent a courtesy copy of the complaint to West Bend, claiming that as an additional insured under the contractor’s policy, it was entitled to payment of the amount it sought in its suit.  West Bend denied coverage, and later commenced a declaratory judgment action against both Arbor and its own insured.  West Bend contended, among other things, that it did not become aware of its own insured’s agreement to fund a portion of the settlement, and in fact, did not learn of the terms of the settlement until long after it had been consummated.  Thus, West Bend sought a declaration that its insured and Arbor violated the policy’s voluntary payments provision which stated that “[n]o insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.”

The Seventh Circuit commended Arbor for its admirable conduct in responding to the complaint in a diligent and comprehensive fashion.  The court nevertheless concluded that Arbor’s actions did, in fact, violate the policy’s voluntary payment provision, which it noted serves a vital function to insurers.  As the court explained, “West Bend must have the opportunity to protect itself and its insured by investigating any incident that may lead to a claim under the policy, and by participating in any resulting litigation or settlement discussions.”  Arbor’s conduct, observed the court, deprived West Bend of these protections and therefore negated its right to coverage.   In so concluding, the court rejected Arbor’s argument that its non-compliance should be excused under the circumstances since it relied on the contractor to communicate the settlement with West Bend, and it presumed West Bend’s silence to be consent.  In fact, the contractor failed to communicate this information to West Bend.  Under the circumstances, explained the court, Arbor acted at its own peril by relying on a third-party and by acting without West Bend’s express authorization to enter into the settlement.

The court also rejected Arbor’s argument that the voluntary payment provision was the functional equivalent of a notice provision, and that as such, West Bend should be required to demonstrate that Arbor’s conduct resulted in prejudice.  The court observed that the voluntary payments provision was not a notice provision per se, but instead a consent provision, and thus subject to different considerations that did not include prejudice.  As the court explained:

The voluntary payment provision relieves West Bend of the obligation to pay not because the insured provided late notice but because West Bend did not consent to any voluntary payments or obligations assumed by Arbor or [the contractor] … Although Arbor's quick and decisive aid to the Lorches was laudable, the failure of Arbor … to obtain West Bend's consent to the settlement relieves the insurer of any obligation to pay for the damages caused by the plumber's negligence.