Sixth Circuit Holds Faulty Workmanship Is Not An Occurrence

In its recent decision in Liberty Mutual Fire Ins. Co. v. Kay & Kay Contracting LLC, 2013 U.S. Dist. LEXIS 23587 (6th Cir. Nov. 19, 2013), the United States Court of Appeals for the Sixth Circuit, applying Kentucky law, had occasion to consider whether a subcontractor’s allegedly faulty preparation of a building pad, and the resulting settling and structural damages to the building constructed on the building pad, constitutes an “occurrence.”

Liberty Mutual issued a CGL insurance policy to Kay & Kay as the named insured and included MW Builders as an additional insured (“the contractors”). Wal-Mart contracted with MW Builders as a general contractor to build a new Wal-Mart store. MW Builders in turn subcontracted with Kay & Kay to perform site preparation work and construct the building pad for the new store. After Kay & Kay completed the building pad and constructed the building, Wal-Mart notified MW Builders that there were cracks in the building’s wall. Wal-Mart demanded that MW Builders remedy these issues and fix the resulting damage. MW Builders in turn demanded that Kay & Kay remedy these issues and indemnify MW Builders from Wal-Mart’s claim. MW Builders and Kay & Kay reached an agreement and executed a new and separate contract under which Kay & Kay agreed to perform the remedial work demanded by Wal-Mart. Meanwhile, Liberty Mutual filed a complaint seeking a declaratory judgment against the contractors alleging that their claims were not covered under the CGL policy, in relevant part, because there was no “occurrence” alleged.

The CGL policy at issue contained the standard coverage language found in a standard Insurance Services Office form.  The policy provided: “This insurance applies to ‘bodily injury’ and ‘property damage’ only if…[t]he ‘bodily injury’ or property damage’ is caused by an ‘occurrence’ that takes place in the ‘coverage territory’… .” The policy defined “occurrence” to mean “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The policy did not define the term “accident.”

The parties filed cross-motions for summary judgment on the limited issue of whether there was an “occurrence” alleged in the claim. After a hearing, the district court denied Liberty Mutual’s motion for summary judgment and granted the contractors’ motion. Liberty Mutual appealed.

Relying on Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W. 3d 69, 73 (Ky. 2010), the court noted that, standing alone, claims of faulty workmanship are not “occurrences” under CGL policies. The contractors argued that the damage was not Kay & Kay’s allegedly defective building pad (the work product itself), but was instead the collateral damage to the building (other property), which was the work of third-party contractors. The Court recognized that in order for there to have been an “occurrence”, there had to have been an “accident.” Following Cincinnati, the court concluded that the plain meaning of the term accident implicated the doctrine of fortuity, and it recognized that fortuity consists of intent and control.

After a careful examination of Cincinnati, the Court held that the facts of the case did not present an “accident” that would trigger coverage as an “occurrence” under the CGL policy issued by Liberty Mutual. The Court emphasized the importance the Cincinnati court put on “control” in analyzing the question of fortuity, and noted that the damages that occurred in this case were within the control of Kay & Kay; Kay & Kay was hired to prevent the settling and resultant structural damage that occurred. “In other words, the possibility of the type of damage in this case was exactly what Kay & Kay was hired to control.” The Court reversed the judgment of the district court and remanded the case with instructions to grant judgment for Liberty Mutual.

Insured’s Settlement Without Consent Bars Coverage Under An OCIP

In its recent decision in Perini/Tompkins Joint Venture v. Ace Am. Ins. Co., 2013 U.S. App. LEXIS 24865 (4^th Cir. Dec. 16, 2013), the United States Court of Appeals for the Fourth Circuit, considering both Maryland and Tennessee law, had occasion to consider whether an insured’s settlement of an underlying construction defect claim, without its insurer’s consent, precluded its right to indemnification.

Perini/Tompkins Joint Venture (“PTJV”) qualified as a named insured under a primary and excess layer owner controlled insurance program (“OCIP”) issued by ACE American Insurance Company with respect to the construction of a $900 million hotel and convention center in Oxon Hill, Maryland.  A collapse of the hotel’s atrium during the construction process resulted in significant property delays.  Following completion of the project, PTJV sued the owner on various theories for approximately $80 million in unpaid work, and the owner brought a separate suit against PTJV based on various theories of negligence in connection with its construction management activities.  The owner’s sought damages in the amount of $65 million.  PTJV did not notify ACE of the countersuit, but later settled the litigation.  Pursuant to the settlement, the owner paid PTJV approximately $42 million and PTJV credited $26 million back to the owner.

Some six months after the settlement, PTJV demanded that ACE pay the $26 million shortfall.  ACE issued a reservation of rights on several grounds, including breach of the policies’ prohibition on settlements without ACE’s consent.  Specifically, the policies contained clauses stating that “No 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.”  In the ensuing coverage litigation, the United States District Court for the District of Maryland granted summary judgment in ACE’s favor on the issue of voluntary payment. 

On appeal, PTJV noted that under Maryland law (which it argued governed the policies), Section 19-110 of the Maryland Code states that an insurer’s disclaimer of coverage based on an insured’s breach of a cooperation clause or notice clause will not be permitted unless the insured can demonstrate actual prejudice.  PTJV argued that ACE’s disclaimer of coverage based on a voluntary payment was tantamount to a disclaimer based on late notice, and that as such, ACE was required to demonstrate actual prejudice.  ACE, on the other hand, argued that its disclaimer of coverage was not based on untimely notice, but instead based on breach of the policies’ voluntary payment clause.  ACE argued that it would be unfair to require it to demonstrate prejudice, since having been shut out of the settlement negotiations, it would be “placed in the impossible situation of having to prove a negative.”

The Fourth Circuit agreed that "[t]he central issue in this appeal is whether the insured . . . can unilaterally settle a construction defect case . . . , present the settlement to its liability insurer as a fait accompli, and obtain indemnification despite its blatant breach of clear and unambiguous policy provisions.”  Looking to a Maryland state appellate court decision on the issue in Phillips Way, Inc. v. American Equity Insurance Co., 795 A.2d 216 (Md. Ct. Spec. App. 2002), the court concluded that Section 19-110 of the Maryland Code did not control the issue, and that ACE was not statutorily required to demonstrate prejudice in order to succeed on its motion for summary judgment.

The court also entertained PTJV’s alternative argument that prejudice must be demonstrated as a matter of common law.  In analyzing the question, the court looked to Maryland law, which is where the underlying events took place, and to Tennessee law, which is where the project owner resided and where the policies were issued.   The court found no precedent under Maryland law for the proposition that an insurer is required to demonstrate prejudice when an insured breaches a voluntary payment clause.  The court nevertheless observed that even if prejudice was a consideration, ACE was necessarily prejudiced by not having been afforded an opportunity to participate in the settlement discussions and by having been deprived of its opportunity to investigate, defend, control or settle the underlying suit.  Looking to Tennessee law, the court found no controlling authority from Tennessee’s Supreme Court on the issue, but nevertheless predicted based on lower court decisions that prejudice would not be a consideration, at least for settlements entered into prior to first notice to the insurer.

Wisconsin Appellate Court Holds Manure Not a Pollutant

In its recent decision in Wilson Mutual Ins. Co. v. Falk, 2013 Wisc. App. LEXIS 1031 (Wis. App. Dec. 11, 2013), the Court of Appeals for Wisconsin had occasion to consider whether cow manure generated at a dairy farm constitutes a pollutant for the purpose of a pollution exclusion.

Wilson Mutual issued a farmowners policy to Jane and Robert Falks, insuring their dairy farm operations.  The policy’s liability part contained an exclusion applicable to “losses resulting from the "discharge, dispersal, seepage, migration, release, or escape of  'pollutants' into or upon land, water, or air" as well as for "any loss, cost, or expense arising out of any … claim or suit by or on behalf of any governmental authority relating to testing for, … cleaning up, removing, … or in any way responding to or assessing the effects of ‘pollutants.’” The term “pollutant” was defined in the policy as “any solid, liquid, gaseous … irritant or contaminant, including … waste. Waste includes materials to be recycled, reclaimed, or reconditioned, as well as disposed of.”

In early 2011, the Falks began using manure generated by their cattle for crop fertilizer.  Their fertilizer plan was prepared by an agronomist and approved by their local county’s land and water conservation division.  Several months later, however, the Wisconsin Department of Natural Resources notified the Falks that manure runoff from their farm contaminated a local aquifer and polluted their neighbors’ wells.  These neighbors asserted claims against the Falks, who in turn sought coverage under their policy.  Wilson Mutual disclaimed coverage for the claims on the basis of its policy’s pollution exclusion.  In the ensuing coverage litigation, the trial court granted summary judgment in Wilson Mutual’s favor, concluding that cow manure constitutes waste for the purpose of the exclusion, and that the exclusion, therefore, barred coverage for the underlying claims.

On appeal, Wisconsin’s Court of Appeals agreed that manure came within the plain terms of the policy definition of “pollutant,” since manure “is certainly gaseous, often liquid, solid in winter, and can be both an irritant and a contaminant.”  (Emphasis in original.)  This, however, did not end the court’s inquiry, as it noted that in Peace v. Northwestern Nat'l Ins. Co., 596 N.W.2d 429 (1999), Wisconsin’s Supreme Court articulated a standard requiring a more exacting analysis of what constitutes a “pollutant,” since “there is virtually no substance or chemical in existence that would not irritate or damage some person or property.”  The Peace court reasoned that “the reach of the pollution exclusion clause thus must be circumscribed by reasonableness, lest everyday incidents be characterized as pollution and the contractual promise of coverage be reduced to a dead letter.”  In other words, determining whether a substance qualifies as a pollutant for the purpose of the exclusion must be viewed in terms of the understanding of a “reasonable person in the position of the insured.”

Looking to the holdings in Peace and its progeny, the court noted diverging results as to what substances qualify as pollutants.  For instance, Wisconsin courts have held that carbon monoxide released indoors is not a pollutant, whereas lead paint chips are properly considered a pollutant.  Further, in a 2012 decision, the Wisconsin Supreme Court held that bat guano would reasonably be considered a pollutant by a homeowner.  With these decisions in mind, the court reasoned that a dairy farmer likely would not cow consider manure to be a pollutant, explaining:

Manure is a matter of perspective; while an average person may consider cow manure to be "waste," a farmer sees manure as liquid gold. Manure in normal, customary use by a farmer is not an irritant or a contaminant, it is a nutrient that feeds the farmer's fields that in turn feeds the cows so as to produce quality grade milk. Manure in the hands of a dairy farmer is not a "waste" product; it is a natural fertilizer. While bat guano is "waste" to a homeowner, and lead paint chips are universally understood by apartment building owners to be dangerous and pollutants, manure is beneficial to a dairy farmer. Manure, by act of nature, has always been universally present on dairy farms and, if utilized in normal farming operations, is not dangerous

In reaching its holding that manure is not a pollutant and that the exclusion was inapplicable, the court noted that Wilson Mutual acknowledged the value of manure to the Falks, since the policy insured several pieces of equipment used in the manure fertilizer process; namely, the farm’s manure tank, the manure pump, manure spreaders and two manure tankers.  The court observed that by taking premium for this risk, Wilson Mutual expressed an understanding that manure spreading was a part of the Falks’ operations.  As such, explained the court, Wilson Mutual “cannot now seriously contend that paying claims related to the Falks' manure spreading is ‘a risk it did not contemplate and for which it did not receive a premium.’”

Florida Court Allows Rescission of a Professional Liability Policy

In its recent decision in Zurich American Ins. Co. v. Diamond Title of Sarasota, Inc., 2013 U.S. Dist. LEXIS 170981 (M.D. Fla. Dec. 4, 2013), the United States District Court for the Middle District of Florida had occasion to consider whether an insured’s guilty plea can be used as the basis for rescission of a professional liability policy.

Zurich insured Diamond Title under a title agent’s errors and omissions policy issued in 2007.  The owner/operator of Diamond Title was later indicted on several counts of mortgage fraud, conspiracy, bank fraud, wire fraud, and making false statements in connection with a loan application.  She later pled guilty to two counts, including conspiring to make materially false statements to banks and that she committed several acts of wire fraud.  Her plea agreement stated that the conspiracy ran from 2002 through 2008, the purpose of which was “to obtain loans secured by mortgages from FDIC-Insured banks and mortgage lending businesses.” 

Diamond Title was named as a defendant in an underlying suit relating to its duties as an escrow agent involving the purchase of distressed residential properties.  The suit alleged that Diamond Title negligently released money without prior authorization.  Zurich, in turn, sought rescission of the policy on the basis of material misrepresentations made in the insurance application.  Among other things, the application asked:

Does the Applicant or any prospective Insured know of any circumstances, acts, errors or omissions that could result in a professional liability claim against the Applicant? If "Yes", you must complete the attached claims addendum for each circumstance.

Zurich contended that at the time Diamond Title’s owner completed the application in 2007, and answered “No” in response, she was knowingly committing mortgage fraud and that she confirmed as much in her later plea agreement.   As such, Zurich maintained that Diamond Title should have answered “Yes” in response to the question.  The underlying claimant (named as a party to the rescission action), however, argued that Diamond Title’s response was truthful, since while at the time it was aware that it was committing criminal misconduct, it could not necessarily foresee civil liability for its actions.  In this connection, the claimant pointed out that the question inquired into acts that could result in professional liability claims, not criminal acts that would not come within the policy’s coverage in the first instance.   

Noting that the misconduct described in the plea agreement came within the policy’s definition of professional services, the court rejected the attempt to distinguish criminal misconduct from conduct that could give rise to a professional liability claim, explaining:

… the Court disagrees with the Defendant's assertion that criminal acts cannot result in claims for professional liability. A single act can be a basis for both professional and criminal liability. The Policy makes clear that it does not cover liability for criminal acts, even if they are properly characterized as professional liabilities. Rotolo [the owner of Diamond Title] was not relieved of her duty in the application to report acts that could result in a professional liability claim simply because the Policy may not have covered those acts. The Court concludes that Diamond Title's answer to question 21 of the Policy application, that it did not know of any circumstances that could result in a professional liability claim, was a misrepresentation.

The court further reasoned that the misrepresentation was material to the risk.  While the underlying claimant argued that Zurich failed to point to any underwriting guidelines applicable to the facts, the court relied on common sense reasoning that the insured’s failure to disclose a criminal conspiracy was material.  As the court explained:

The Court does not need an underwriter or guidelines to appreciate how not knowing Rotolo and her employee had been committing mortgage fraud in excess of five years left Zurich unable to adequately estimate the nature of risk in issuing the Policy. … As previously discussed, many of these acts could have resulted in claims against the Policy. An objective insurer may not have issued a policy at all. Certainly a policy would not have been issued under the same terms and pricing knowing that Diamond Title was engaged in an ongoing scheme to commit mortgage fraud.

Missouri Court Holds Underlying Fuel Tank Release Not Progressive Injury

In its recent decision in Stoddard Equipment Co., Inc. v. American Safety Indemnity Co., 2013 U.S. Dist. LEIS 170701 (W.D. Mo. Dec. 4, 2013), the United States District Court for the Western District of Missouri had occasion to consider whether property damage occurred during the policy period of a pollution liability policy.

American Safety’s insured, Stoddard, was named as a defendant in an underlying suit for its alleged negligent installation of a gas pipeline running from a storage tank to a marina where the gasoline was dispensed.  Stoddard completed the work in early October 2009.  The underlying plaintiff alleged that during the evening of September 2, 2011, the entire contents of its tank leaked into the surrounding soils and waters.  Plaintiff alleged that Stoddard’s negligent installation of the pipe in 2009 is what caused the release in 2011.

Stoddard sought coverage under various policies for the underlying suit, including a contractors’ pollution liability policy issued by American Safety for the period November 3, 2008 to November 3, 2009.  The policy’s insuring agreement provided coverage for property damage, but only to the extent the property damage occurred during the policy period.  American Safety denied coverage to Stoddard on the basis that the property damage, i.e., the damage caused by the release of the storage tank’s contents, happened in its entirety nearly two years after the expiration of its policy.  Stoddard nevertheless maintained that because the pipe was negligently installed during the time the American Safety policy was in effect, the property damage should be considered progressive in nature, spanning several policy periods.

On motion to dismiss, the court rejected Stoddard’s argument, distinguishing the gasoline release from matters involving property damage happening over a lengthy period of time, such as at issue in the Missouri Supreme Court case D.R. Sherry Const., Ltd. v. American Fam. Mut. Ins. Co., 316 S.W.3d 899 (Mo. 2010), which involved structural damage to a home over a period of years as a result of an unstable foundation.  The underlying complaint contained no allegation that the pipe installed by Stoddard began leaking prior to November 3, 2009, but instead alleged that the entirety of the leak happened during a one night period in September 2011.  The court further reasoned that no inference could be drawn from the complaint that any hole developed in the pipe prior to the expiration of the American Safety policy.  In reaching its holding, the court cited to the line of Missouri law “that draws a distinction between the occurrence of negligent act during the policy period and the occurrence of physical damage that results from the commission of a negligent act during the policy period.”  While the court agreed that Stoddard’s alleged negligence happened while the American Safety policy was in force, the resulting damage happened in its entirety after the expiration of the policy and thus fell outside of that policy’s scope of coverage.

Kentucky Court Holds Insurer Established Diversity Jurisdiction

In its recent decision in Capitol Specialty Ins. Corp. v. IKO, Inc., 2013 U.S. Dist. LEXIS 167933 (E.D. Ky. Nov. 26, 2013), the United States District Court for the Eastern District of Kentucky had occasion to consider whether an insurer’s declaratory judgment action satisfied the threshold requirements for diversity jurisdiction under 28 U.S.C. § 1332.

Capitol insured IKO, which owned a bar, under a general liability policy.  While the policy was subject to a general limit of liability of $1 million per occurrence, the policy contained an Assault Limitation endorsement setting forth a $25,000 sublimit applicable to loss arising out of assault or battery.  IKO was named as a defendant in an underlying state court lawsuit brought by a patron alleging that she was sexually assaulted by several of the bar’s patrons.  Capitol subsequently brought suit against IKO in federal court, seeking declarations: “(1) that the Assault Limitation ‘is the exclusive liability coverage form applicable to the claims asserted … in the underlying Complaint;’ (2) that Capitol's duty to indemnify IKO in the underlying state action is limited to the Assault Limitation's sub-limit of $25,000; and (3) that Capital has no duty to defend and indemnify IKO upon the exhaustion of the Assault Limitation's sub-limit of $25,000. “

IKO moved to dismiss, contending that Capitol failed to establish diversity jurisdiction under 28 U.S.C. § 1332.  IKO conceded that it and Capitol were not citizens of the same state, but it asserted that the amount in issue did not exceed the $75,000 jurisdictional threshold.  In particular, IKO contended that the object of the coverage action was the policy’s $25,000 sublimit of liability, and that because this amount was less than $75,000, Capitol failed to establish federal court jurisdiction.

In considering the issue, the court observed that the Sixth Circuit had “yet to decide whether the amount in controversy in a declaratory judgment action should be measured by the policy limits or by the value of the underlying claim.”  The court nevertheless drew from its own prior decision in Grange Mutual Casualty Co. v. Safeco Insurance Co., 565 F. Supp. 2d 779 (E.D. Ky. 2008), where it followed the rule applied by other circuit courts that “the policy limits are controlling in a declaratory action . . . as to the validity of the entire contract between the parties, but that when the applicability of an insurance policy to a particular occurrence is the question, the amount in controversy is measured by the value of the underlying claim.” 

While IKO argued that the sole issue in the declaratory judgment action was the validity of the sublimit, the court disagreed, reasoning that the issue was the application of the Assault Limitation endorsement to the underlying loss.  The court therefore concluded that the amount in controversy in the underlying action was the proper consideration for establishing diversity jurisdiction.  As such, and because plaintiff in the underlying lawsuit sought a recovery in excess of $2 million, the court agreed that Capitol successfully established the threshold requirements for diversity jurisdiction and that its lawsuit could proceed in federal court.