District Court Holds California’s 10- Year State of Repose Effectively Bars General Liability Coverage For Construction Defect Claims

By on October 11, 2016
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On September 27, 2016 the U.S. District Court for the Northern District of California issued its opinion in Swiss Re International Se, et al. v. Comac Investments, Inc., et al., effectively closing the door on ISO form general liability coverage for construction defect claims that are subject to California’s 10-year statute of repose. 2016 U.S. Dist. LEXIS 132793 (N.D. Cal. Sept. 27, 2016).

California Code of Civil Procedure §337.15 provides that latent construction defect claims are subject to a 10-year statue of repose, which commences upon substantial completion of the construction. The statue of repose is not subject to equitable tolling and the only exception to the statue of repose is provided in subsection (f), which allows for “actions based on willful misconduct or fraudulent concealment” See Lantzy v. Centex Homes, 31 Cal.4th 363, 367 (2003); Cal. Code. Civ. Proc. §337.15(f).

In Comac, the plaintiff homeowner’s association sued the insured builder, Comac, in connection with alleged construction defects at a residential project. The Plaintiffs, however, filed suit more than 10 years after the project’s completion. Nonetheless, the Plaintiffs alleged that Comac’s responsible managing officer observed the defective workmanship, did not correct the defects in order to avoid additional costs, and in some cases “directed [the] condition be covered up….” Seeking to skirt California’s 10-year statue of repose, Plaintiffs alleged that Comac’s actions “amount[ed] to reckless disregard and/or willful misconduct as defined by [C.C.P.] §337.15(f).”

Each of Comac’s insurance policies required that property damage be caused by an “occurrence,” which was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Rejecting the plaintiffs’ argument that Comac did not intend any injury, the court held the homeowners’ allegations of willful misconduct could not, by definition, be an “accident.” In so holding, the court noted that the claims against Comac were limited to claims that “Comac’s deliberate acts caused the property damage” and did not include any alleged intervening, unexpected causes. Central to the court’s analysis were the allegations that “any contractor who chose not to remedy [the defects] would be doing so with actual or constructive knowledge that injury was a probable result” and “any knowledgeable construction supervisor who chose not to direct the contractor to remedy the condition would have done so with actual or constructive knowledge that injury was a probable result.”

The court harmonized the term “willful” under Cal. Code. Civ. Proc. §337.15(f) and Cal. Ins. Code §533, finding both encompassed conduct where a reasonable person under the same or similar circumstances would be aware of the highly dangerous character of his or her conduct and that neither necessarily required an actual intent to injure. Thus, the court found that Comac’s alleged willful misconduct was also subject to the policies’ “expected or intended” exclusions and California Insurance Code §533.

Filed under California Insurance Code, Commercial General Liability, Construction Defect

New Jersey Supreme Court Latest to Weigh In on Insurance Coverage for Faulty Workmanship

By on August 15, 2016
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Perhaps unsurprisingly to those who enjoy following the trajectory of CGL coverage for faulty workmanship around the country, New Jersey recently joined those states which recognize faulty workmanship as an “occurrence” – at least in certain circumstances.

In Cypress Point, the New Jersey Supreme Court faced the question of “whether rain water damage caused by a subcontractor’s faulty workmanship constitutes ‘property damage’ and an ‘occurrence’” under a property developer’s CGL policy. Cypress Point Condominium Association, Inc. v. Adria Towers, LLC, et.al, (A-13/14-15) (076348) (N.J. Aug. 4, 2016).  In Cypress Point, condo owners complained of roof leaks and water intrusion at window jambs and sills, as well as water damage to the common areas and interior structures of the buildings in the new condominium development. The condo association sued the developers, alleging faulty workmanship and consequential damages including damage to steel supports, exterior and interior sheathing, and sheetrock and insulation in both condo units and common areas. The developers’ insurer denied coverage and ultimately two of the developers’ insurers were brought into the case to determine whether the policies should provide defense and indemnity to the developers.

The Court distinguished prior cases on this issue, Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979) and Firemen’s Insurance Co. of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (App. Div. 2006), primarily by focusing on the fact that both dealt with the 1973 ISO form, not the 1986 ISO form at issue in this case. The Court particularly focused on the fact that, in the 1986 ISO form, there is an exception to the “Your Work” exclusion which allows coverage for faulty workmanship where it is performed by a subcontractor.

After observing that courts across the country were trending toward faulty workmanship as an “occurrence” (although not discussing neighboring Pennsylvania’s fairly recent decisions), the Court turned to the definitions of “property damage” and “occurrence” in the policies at issue. The Court determined that (1) the consequential damages fell within the policies’ definition of “property damage” and (2) that ‘accident’ encompasses unintended and unexpected harms caused by negligently performed work, and thus the consequential water damage was an “occurrence.” Having determined the loss fell within the coverage grant of the policies, the Court then considered the “Your Work” exclusion and its subcontractor exception and determined that, as the work was clearly performed by a subcontractor, this was still a covered loss.

Importantly, while this case addresses a common situation of the property developer’s CGL coverage, it is not necessarily universally applicable to all contexts in which a faulty workmanship claim may arise. It remains to be seen whether New Jersey courts will apply this holding broadly or more narrowly, i.e. whether faulty workmanship be an “occurrence” in the absence of consequential damage, or where no subcontractor was involved.

Filed under Commercial General Liability, Construction Defect

Insurance Companies Held Liable As Real Parties In Interest After Unsuccessfully Prosecuting Action Under Assigned Contract With Attorneys’ Fees Provision

By and on May 11, 2016
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In Hearn Pacific Corporation v. Second Generation Roofing, Inc. 2016 Cal. App. LEXIS 354 (May 2, 2016), the California Court of Appeal, First Appellate District, reversed an order denying a subcontractor’s motion to add two insurance companies as judgment debtors in an action after the insurers unsuccessfully prosecuted a contractual indemnity claim based upon an assignment of rights under a contract which included an attorneys’ fees provision.

The Court of Appeal determined that the trial court had abused its discretion in refusing to add North American Specialty Insurance Company (“North American”) and RSUI Group, Inc. (“RSUI”) as judgment debtors in a lawsuit under California Code of Civil Procedure section 368.5. The appellate court held that the insurers’ ability to prosecute the action in the insured transferee’s name under the statute did not insulate them from exposure as real parties in interest. The appellate court similarly found that North American and RSUI should be added as judgment debtors even though they only received a partial assignment of rights from their insured.

The Court of Appeal also rejected the trial court’s finding that Insurance Code section 11580 prevented the subcontractor from suing North American and RSUI. Although Insurance Code section 11580 provided certain litigants with a means to sue third-party insurers for policy benefits, the appellate court found that there was no language in the statute which indicated that it provided an exclusive remedy against insurers who had prosecuted assigned rights under a contract. In so ruling, the Court of Appeal partially rejected the Ninth Circuit’s decision in Fireman’s Fund Ins. Co. v. City of Lodi, California (9th Cir. 2002) 302 F.3d 928 which broadly interpreted the statute.

Filed under Commercial General Liability

Colorado Supreme Court Rejects Notice-Prejudice Rule for “No Voluntary Payments” Provision in CGL Policy

By on April 25, 2016
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In Travelers Property Casualty Co. v. Stresscon Corp., ___ P.3d ___, 2016 CO 22 (Colo. No. 13SC815, April 25, 2016), the Colorado Supreme Court reversed the Colorado Court of Appeals’ decision which held that the notice-prejudice rule—which requires an insurer to show prejudice as a result of a policyholder’s delay in giving notice of a claim in order to deny coverage for the claim—does not apply to the “no voluntary payments” provision in a Comprehensive General Liability (CGL) insurance policy.

In a 4-3 decision, the court held that the notice-prejudice rule, which it first applied to first-party insurance policies in Clementi v. Nationwide Mutual Fire Insurance Co., 16 P.3d 223 (Colo. 2001), and later extended to third-party occurrence-based policies in Friedland v. Travelers Indemnity Co., 105 P.3d 639 (Colo. 2005), does not apply when the policyholder makes voluntary payments in settlement of a claim in contravention of a policy’s “no voluntary pay­ments” provision. The insured, Stresscon, was a concrete subcontractor that was sued by the general contractor over an accident caused by a crane operator who was Stresscon’s sub­contractor. Stresscon entered into a settlement agreement with the general contractor without having contacted its liability insurer, Travelers. Stresscon settled the accident-related claim, along with other unrelated and concededly uncovered claims against Stresscon, without differentiation as to amount, and then sued Travelers for coverage of the settlement and for bad faith under the common law and Colo. Rev. Stat. § 10-3-1116. Stresscon prevailed at trial and was awarded damage for breach of contract and bad faith.

In the trial court and Colorado Court of Appeals, Travelers argued that Stresscon was not entitled to coverage due to its violation of the policy’s “no voluntary payments” clause by settling with the general contractor without notifying Travelers of the loss or payment, and without seeking Travelers’ permission for or approval of the settlement. Both lower courts rejected Travelers’ argument, with the Court of Appeals holding that the notice-prejudice rule of Friedland applies to “consent to settle” and “no volun­tary payments” clauses and requires the insurer to prove that it suffered prejudice as a result of the insured’s voluntary settlement of a claim without the insurer’s notice or consent. The Court of Appeals concluded that “forfeiting insurance benefits when the insurer has not suffered any prej­udice would be a disproportionate penalty and provide the insurer a windfall based on a technical violation of the policy.” Stresscon Corp. v. Travelers Property Casualty Co., 2013 COA 131, ¶ 45 (Colo. App. Nos. 11CA1239 & 11CA1582, Sept. 12, 2013).

The Colorado Supreme Court disagreed with the Court of Appeals, finding that the justifications for the notice-prejudice rule in Clementi and Friedland did not extend to the “no voluntary payments” provision. First, the court noted that neither Clementi nor Friedland dealt with or addressed a “no voluntary payments” provision, such that there was no precedent for extending the notice-prejudice rule to “no voluntary payments” provisions: “Whatever the state of the law in this jurisdiction may have been with regard to the no-voluntary-payments provision in Friedland, or the one at issue before us today, it was neither addressed nor directly impacted by our decision to extend our notice-prejudice rule in Friedland.”

Next, the court “did not find our justification for adopting a notice-prejudice rule in Clementi and Friedland to apply with the same force to the enforcement of agreements not to incur costs or obligations on behalf of an insurer without the insurer’s consent.” Citing “the freedom to contract,” which the court observed “is especially important in the insurance industry, where the terms of a policy distribute risk and define the very product that is bargained for,” the court determined that the “no voluntary payments” provision “far from amounting to a mere technicality imposed upon an insured in an adhesion contract, was a fundamental term defining the limits or extent of coverage.” This is because the “no voluntary payments” clause “clearly excluded from coverage any payments voluntarily made or obligations voluntarily assumed by the insured without consent, for anything other than first aid. The insurance policy emphatically stated that any such obligations or payments would be made or assumed at the insured’s own cost rather than by the insurer.”

Accordingly, the court concluded, unlike the notice requirements in Clementi and Friedland, which place an affirmative duty on the insured to give timely notice of a claim in order to invoke coverage, “the no-voluntary-payments clause in this case does not purport to impose a duty on the insured to do anything, whether for the purpose of assisting in the insurer’s investigation or defense of a claim, or otherwise.” “Nor does it impose a duty on the insured to refrain from doing something the doing of which would violate the terms of the contract and call for an appropriate remedy,” the court explained, inasmuch as “voluntarily making a payment, assuming an obligation, or incurring an expense necessarily entails affirmative, and voluntary, action on the part of the insured.” Instead, the court held, “the no-voluntary-payments clause of the contract at issue here actually goes to the scope of the policy’s coverage.” As the court explained, the “no voluntary payments” clause means that coverage does not extend to payments made by the policyholder without the insurer’s consent:

Rather than a provision purporting to bar an insured from voluntarily making payments or incurring expense without the consent of the insurer, for the breach of which the insurer would be absolved of compliance with its obligations under the policy, the no-voluntary-payments provision makes clear that coverage under the policy does not extend to indemnification for such payments or expenses in the first place, and instead, the no-voluntary-payments clause merely specifies that as uncovered expenses they will not be borne by the insurer.

Thus, the court concluded, “While there will virtually always be room for debate about the contours of any particular no-voluntary-payments clause, whether the insured acts out of ignorance of the coverage or by design, in an attempt to deprive the insurer of its contractually-granted choice to provide a defense or settle the claim, or for some other reason altogether, the enforcement of such a provision according to its terms can hardly be characterized as ‘reap[ing] a windfall’ by invoking a technicality to deny coverage.”

Because the lower courts erred in applying the notice-prejudice rule to Stresscon’s violation of the “no voluntary payments” provision in Travelers’ policy, the Colorado Supreme Court reversed the denial of Travelers’ directed verdict motion and remanded with directions to vacate the jury verdict (including the verdict on Stresscon’s bad faith claims) and to direct a verdict instead for Travelers.

Filed under Commercial General Liability, Late Notice, Voluntary Payments

California Appeals Court Rules that “Escape” “Other Insurance” Clause Contained in Coverage Portion of Primary CGL Policy Not Enforceable in Equitable Contribution Action

By and on April 15, 2016
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In Certain Underwriters at Lloyds, London v. Arch Specialty Insurance Co., a California appeals court held that an “other insurance” clause in a primary commercial general liability policy would not, as a matter of public policy, allow the insurer to avoid having to share defense costs.

Certain Underwriters at Lloyds, London (“Underwriters”) and Arch Specialty Insurance Company (“Arch”) were both primary insurers of Framecon, Inc. over successive policy years. Framecon was sued by a real estate developer for framing and carpentry work it performed on residential homes in three separate homeowner actions. Framecon tendered the claims to both Underwriters and Arch. Underwriters agreed to defend Framecon, while Arch denied any defense obligation based on the “other insurance” language contained in the insuring agreement and in the conditions section of its policy.

The underlying claims against Framecon were eventually settled with both Underwriters and Arch agreeing to indemnify Framecon for damages on a “time on the risk” basis. Underwriters then sued Arch for declaratory relief and equitable contribution for defense costs incurred in the underlying litigation. In cross-motions for summary judgment, Arch argued that its “other insurance” provisions relieved it of any duty to defend. The trial court found in favor of Arch, and relied on a prior California case which held that the placement of the “other insurance” clause in the insuring agreement of the policy, as opposed to in the conditions section, makes it an enforceable exception from coverage for defense costs rather than a disfavored “escape” clause.

On appeal, the Court of Appeal noted that the original purpose of “other insurance” clauses was to prevent multiple recovery by insureds in cases of overlapping policies providing coverage for the same loss, but that public policy disfavored “escape” clauses. The court explained that “escape” clauses are so named because they permit an insurer to make a seemingly ironclad guarantee of coverage, only to withdraw that coverage – and thus “escape” liability – in the presence of other insurance. The Court of Appeal rejected Arch’s argument that its “other insurance” clause was enforceable because it was located in both the insuring agreement and in the conditions section of the policy, and found that the “modern trend” is to distrust “escape” “other insurance” clauses that attempt to shift the burden away from a primary insurer. The court also stated that reliance on location of the “other insurance” clause in the coverage section as determinative “would tend to encourage insurers to jockey for best position in choosing where to locate ‘other insurance’ language, needlessly complicating the drafting of policies, inducing wasteful litigation among insurers, and delaying settlements – all ultimately to the detriment of the insurance-buying public.”

The Court of Appeal concluded that Underwriters was entitled to receive equitable contribution from Arch as the “other insurance” clause contained in Arch policy was not enforceable based on public policy considerations.

Filed under Commercial General Liability, Contribution, Duty to Defend, Other Insurance

Georgia Supreme Court Denies Coverage for Lead-Based Paint Injuries Based on the Pollution Exclusion

By on April 12, 2016
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In a matter of first impression, the Georgia Supreme Court recently held that personal injury claims arising from lead poisoning due to lead-based paint ingestion were excluded from coverage under an absolute pollution exclusion in a commercial general liability insurance policy covering residential rental property. The decision in Ga. Farm Bureau Mut. Ins. Co. v. Smith, S15G1177, 2016 Ga. LEXIS 245 (Ga. Mar. 21, 2016) is significant for insurers since it expressly rejects the notion that a pollution exclusion clause is limited to traditional environmental pollution.

The facts are straightforward.  Amy Smith (“Smith”), individually and as next friend of her daughter Tyasia Brown (“Brown”), sued her landlord, Bobby Chupp (“Chupp”), for injuries Brown allegedly sustained as a result of ingesting lead from deteriorating lead-based paint at the house Smith rented from Chupp. Georgia Farm Bureau Mutual Insurance Company (“GFB”) insured the house under a CGL policy issued to Chupp. Chupp tendered Smith’s claims to GFB, and the insurer filed a declaratory judgment action against Smith and Chupp seeking a determination that Brown’s injuries were not covered under the policy and that it had no duty do defend Chupp against Smith’s claims.

GFB contended, among other things, that Brown’s injuries from lead poisoning were excepted from coverage by the policy’s pollution exclusion, which defined “Pollution” as “‘[b]odily injury’ or ‘property damage’ arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of ‘pollutants’ . . . .” The policy defined “pollutant” as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”

In granting summary judgment to GFB, the trial court relied on the Georgia Supreme Court’s decision in Reed v. Auto-Owners Ins. Co., 284 Ga. 286 (2008), which addressed the proper construction of an identical pollution exclusion in a CGL policy insuring residential rental property wherein a tenant sued her landlord for carbon monoxide poisoning. Although not explicitly listed in the policy as a pollutant, the Reed Court held that carbon monoxide gas fell within the policy’s definition of a pollutant and concluded that all of the plaintiff’s injuries arising therefrom were excluded from coverage under the pollution exclusion.

On appeal, the Georgia Court of Appeals reversed the trial court’s grant of summary judgment to GFB.  The Court of Appeals observed that the specific issue of whether lead-based paint should be considered a “pollutant” under the pollution exclusion clause was one of first impression in Georgia, and noted that a conflict existed among other jurisdictions on this issue. The Court of Appeals sided with those foreign courts holding that a pollution exclusion similar to the instant one did not bar coverage for injuries arising out of the ingestion or inhalation of lead-based paint. The Court of Appeals rejected the trial court’s interpretation of Reed, finding that while a straightforward reading of the pollution exclusion in Reed compelled the conclusion that carbon monoxide gas was a pollutant, it was unclear whether identical language in the instant policy was expansive enough to unambiguously include lead, lead-based paint or paint as a pollutant.

In its analysis, the Georgia Supreme Court found that GFB’s CGL policy contained an absolute pollution exclusion that precludes recovery for bodily injury or property damage resulting from exposure to any pollutants. Overviewing the genesis and development of the absolute pollution exclusion, the Court highlighted the litany of Georgia decisions, including Reed, that have repeatedly applied such clauses outside the context of traditional environmental pollution. Further, the Court rejected the notion that the pollutant at issue must be explicitly named in the policy to be enforceable.

In reversing the Court of Appeals, the Georgia Supreme Court followed Reed and found that GFB’s CGL policy unambiguously governed the factual scenario. Simply put, the Court of Appeals failed to apply the plain language of the contract. Accordingly, the Georgia Supreme Court held that lead present in paint unambiguously qualifies as a pollutant and that the plain language of the policy’s pollution exclusion excluded Smith’s claims against Chupp from coverage.

*** On March 9, 2016, this author published a related blog article on a recent Vermont Supreme Court decision holding that the plain language interpretation of a pollution exclusion in a homeowner policy barred coverage for property damage to a home rendered uninhabitable by an over-application of a bed bug pesticide.

Filed under Commercial General Liability, Pollution Exclusion

Fourth Circuit Requires CGL Insurer to Defend Data Breach Class Action

By on April 11, 2016
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The increasing market for cyber insurance policies combined with the addition of cyber exclusions has cooled litigation over whether a cyber breach triggers coverage under a commercial general liability (CGL) policy and whether a CGL insurer owes a duty to defend litigation arising from a cyber breach. However, the expansion of cyber insurance and integration of cyber exclusions has not the stemmed litigation under older CGL policies, many of which do not include cyber exclusions. Earlier today, the Fourth Circuit Court of Appeals addressed cyber coverage under a traditional CGL policy in Portal Healthcare v. Travelers Indemnity Company, Case No. 14-1944.

Portal arose after plaintiffs filed a putative class action, alleging that Portal negligently failed to secure a server containing confidential records for patients at a hospital, thereby making the records available for anyone to view online without a password. The insured argued that Travelers owed a duty to defend that class action because the medical records company published, and therefore disclosed, confidential information, triggering the personal and advertising injury coverage provision in the CGL policy. Travelers disagreed, arguing that the failure to secure a server is not a publication. Publication, Travelers argued, requires the deliberate step of disseminating the records – which was not alleged.

The Fourth Circuit accepted the insured’s argument, with little explanation or analysis. Commending the district court for limiting its analysis to the complaint and policy, the court concluded that “the class-action complaint ‘at least potentially or arguably’ alleges a ‘publication’ of private medical information by Portal that constitutes conduct covered under the Policies.” The court did not explain why a failure to secure a private server satisfies the plain meaning of the word publication, but instead accepted the conclusion that the possibility of pubic access constitutes publication: “Such conduct, if proven, would have given ‘unreasonable publicity to, and disclose[d] information about, patients’ private lives,’ because any member of the public with an internet connection could have viewed the plaintiffs’ private medical records during the time the records were available online.”

Portal should have limited impact on modern CGL policies because the cyber exclusions therein resolve the question of whether there is a duty to defend cyber breach litigation. However, within the Fourth Circuit, Portal suggests that a CGL insurer should carefully review cyber-related claims. Portal should be limited to the unique facts underlying the claim (in that records were made publicly available), but the Court’s failure to provide a definition of publication leaves the scope of this decision open to discussion.

Filed under Commercial General Liability, Cyberinsurance, Data Breach

Wisconsin Supreme Court Rules That Inclusion of Defective Ingredient Does Not Constitute Property Damage

By and on April 7, 2016
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In Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., et al., 2016 Wisc. LEXIS 12 (March 1, 2016), the Wisconsin Supreme Court in a 3-2 decision determined that two insurers had no duty to cover claims related to damages caused by the inclusion of a defective ingredient in a probiotic supplement because the inclusion of the defective ingredient did not damage other property and did not result in loss of use of property.

Brief Factual Background

Wisconsin Pharmacal Co., LLC (“Pharmacal”) manufactured a chewable Daily Probiotic Feminine Supplement which contained various ingredients, including a probiotic bacterial species known as Lactobacillus rhamnosus (LRA). In July of 2008, Pharmacal contracted with Nutritional Manufacturing Services, LLC (“NMS”) to procure LRA and manufacture the tablets. NMS in turn contracted with Nebraska Cultures for the LRA, and Nebraska Cultures then bought the LRA from Jeneil. The problem, of course, was that Jeniel supplied NMS with the wrong bacteria.

NMS manufactured the tablet with the ingredient it believed to be LRA but discovered that it had used a different bacteria known as Lactobacillus acidophilus (LA). In April 2009, after Pharmacal packaged and supplied the supplement to its retailer, Pharmacal learned that the supplement contained LA instead of LRA. As a result, the retailer recalled the supplement and Pharmacal destroyed the tablets containing the defective ingredient. NMS assigned its causes of action against Nebraska Cultures and Jeneil to Pharmacal, which sued Nebraska Cultures and its general liability insurer, Evanston Insurance Co., as well as Jeneil and its general liability insurer, The Netherlands Insurance Co.

Analysis

The insurers filed motions for summary judgment, arguing that they did not owe coverage for the loss. The trial court concluded that the insurers had no duty to defend because the incorporation of a defective probiotic ingredient into the tablets did not constitute “property damage caused by an occurrence” because only the product itself was harmed. The intermediate appellate court reversed, concluding the policies provided coverage. The Wisconsin Supreme Court reversed the appeals court and determined that no coverage existed under the policies.

The Netherland’s CGL policy provided coverage for Jeneil’s losses that the “insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’…caused by an ‘occurrence.’” The policy defined property damage as “a) Physical injury to tangible property, including all resulting loss of use of that property. . . .; or (b) Loss of use of tangible property that is not physically injured.”

Evanston’s CGL policy similarly provided coverage for Nebraska Cultures’ losses arising out of “bodily injury” or “property damage” caused by an “occurrence.” The policy defined “property damage” as “physical injury to or destruction of tangible property including, consequential loss of use thereof; o[r] loss of use of tangible property which has not been physically injured or destroyed.”

No Property Damage

The majority determined that there was no property damage, because combining a defective ingredient with other ingredients and incorporating them into supplement tablets formed an “integrated system,” or unified whole. Therefore, the Court reasoned that the defective ingredient (LA), could not be separated from the other ingredients, and no damage resulted to property other than ingredients of the integrated system.  Because the injury was sustained by the integrated system itself, the resulting damage caused by LA’s inclusion in the tablet did not occur to other property.

The Court additionally noted that the defective ingredient rendered the tablets inadequate for their contracted purpose; however, the mere presence of a defective ingredient did not render them hazardous. For this reason, the Court concluded there was no property damage under the Evanston policy.

No Loss of Use

Similarly, the majority rejected the parties’ argument that the incorporation of a defective ingredient rendered the other ingredients and the supplement tablets totally useless to Pharmacal, thereby constituting property damage due to “loss of use of tangible property that is not physically injured.” The Court reiterated that a “diminution in value, even to the point of worthlessness” was not the same as “loss of use.” The Court rejected the insured’s argument and found that Pharmacal did not actually lose use of the tablets, but rather lost the value of the tablets. Thus, the Court held that there was no property damage due to “loss of use of tangible property that has not been physically injured.”

No Occurrence

The policies defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Although it was undisputed that Jeneil’s provision of the defective ingredient was accidental, the Court was not persuaded that the “accidental provision” of a defective ingredient, standing alone, satisfied the Netherlands policy’s definition of occurrence. Under Wisconsin’s American Girl case, the negligent conduct is not the occurrence, but it can cause an “occurrence,” which in turn causes property damage. Here, the provision of the defective ingredient did not cause an occurrence that led to property damage. In other words, the defective ingredient did not cause other property to malfunction or a third party to get sick, so the provision of the defective ingredient alone was not an occurrence.

The Court applied California law to the Evanston policy and followed a line of cases finding that deliberate conduct cannot be an occurrence even if the insured did not intend to cause the injury. So although Jeneil’s provision of a defective ingredient may have been negligent, Jeneil deliberately supplied the ingredient to Nebraska Cultures and intended the ingredient to be incorporated into the tablets. Given the deliberate nature of these actions, the Court found that the provision of a defective ingredient cannot be said to constitute an “occurrence” under California law.

In a dissenting opinion, Justice Shirley S. Abrahamson she disagreed with the majority opinion’s “unwise and unprecedented” application of the integrated system rule, which originates in the economic loss doctrine, to the interpretation of insurance policies. Justice Abrahamson, who was joined in the dissent by Justice Ann Walsh Bradley, compared the application of the economic loss doctrine to the alien creature in the classic science fiction film “The Blob,” noting the doctrine was often incoherent. Justice Abrahamson criticized the majority’s decision for infusing the economic loss doctrine, a tort principle, into insurance policy interpretation. Justice Abrahamson feared that the majority’s approach departed from a reviewing Court’s normal duty of strictly interpreting the plain language of the subject insurance policy.

This decision is available here.

Filed under Commercial General Liability, Food Contamination, Loss of Use, Property Damage

Liquor Liability Exclusion Bars Coverage for the Four Loko Bodily Injury Lawsuits

By and on December 29, 2015
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In Phusion Projects, Inc. v. Selective Ins. Co., No. 1-15-0172, 2015 Ill. App. LEXIS 942 (Ill. App. Dec. 18, 2015), the manufacturers of the alcoholic beverage “Four Loko” (collectively “Phusion”) filed a declaratory judgment action seeking a declaration that their commercial liability insurer was required to defend and indemnify Phusion in six underlying bodily injury claims. Selective claimed it was not required to defend Phusion because of the policy’s liquor liability exclusion. The trial court agreed and dismissed Phusion’s complaint. Phusion appealed, and the Appellate Court affirmed the underlying decision.

Four Loko is a fruit-flavored malt beverage which contains 12% alcohol by volume, as well as taurine and guarana. During the relevant time period, Four Loko also contained 135 milligrams of caffeine. The underlying suits alleged that the plaintiffs’ injuries were caused by either their own or another individual’s consumption of Four Loko and subsequent intoxication, mainly due to the inclusion of the stimulants in the Four Loko product.

The CGL policy excluded coverage for “bodily injury…for which any insured may be held liable by reason of (1) causing or contributing to the intoxication of any person.” The exclusion applied only where the insured was “in the business of manufacturing, distributing, selling, serving, or furnishing alcoholic beverages.”

In its initial motion to dismiss the declaratory judgment action, Selective relied on the policy’s liquor liability exclusion. Selective cited to a Federal District Court opinion excluding coverage for Phusion based on an identical liquor liability exclusion. Netherlands Insurance Co. v. Phusion Projects, Inc., 2012 WL 123921 (N.D. Ill. Jan 17, 2012). Phusion argued the underlying lawsuits were not based on liquor liability, but were based on “stimulant liability,” pointing to the allegations that Phusion was liable for adulterating its Four Loko products with caffeine, guarana, and taurine. Phusion pointed to the underlying plaintiffs’ claims that the addition of these stimulants desensitized consumers of Four Loko to the symptoms of intoxication, and caused them to act recklessly. In its reply, Selective relied on the Seventh Circuit’s holding in Netherlands, which recognized that “the presence of energy stimulants in a [sic] alcoholic drink has no legal effect on the applicability of a liquor liability exclusion.” The trial court held the terms of the insurance policy and liquor liability exclusion made it “clear that coverage is excluded when there are claim[s] that an individual sustained bodily injury caused by intoxication,” and therefore Selective had no duty to defend or indemnify Phusion for the lawsuits.

On appeal, Phusion argued that the exclusion did not apply to manufacturers, but rather only to “those in the liquor business to preserve host liquor liability coverage.” Phusion relied on cases establishing that the voluntary consumption of alcohol is the proximate cause of an injury rather than the manufacture of the beverages. The Appellate Court rejected this argument as relevant only to Phusion’s liability in the underlying suits, and not Selective’s duty to defend or indemnify Phusion in those suits. The court instead followed the Seventh Circuit’s interpretation of the exclusion in Netherlands, finding the plain and ordinary meaning of the exclusion applied to “claims of bodily injury…where Phusion may be held liable because it either caused or contributed to the intoxication of any person,” an exclusion which applied specifically to those in the business of manufacturing alcoholic beverages.

Phusion also argued that intoxication was not the “sole and proximate cause” of the injuries asserted in the underlying lawsuits, but that some allegations such as the addition of stimulants to the product fell outside the liquor liability exclusion and were therefore potentially covered by the policy. The court disagreed, finding that Illinois law actually requires an allegation of a proximate cause “wholly independent” from the excluded coverage. The court found that “in order for the underlying lawsuits at issue here to fall within the insurance policy and, thus, outside the liquor liability exclusion, each of the complaints must allege facts that are independent from the event that led to the injury,” requiring that the underlying complaints allege facts “that are independent of ‘causing or contributing to the intoxication of any person.’” Here, it was impossible for anyone to suffer injuries due to the inclusion of stimulants in the product absent consumption of and subsequent intoxication due to Four Loko. It was “[t]he supply of alcohol, regardless of what it is mixed with,” that was “the relevant factor to determine whether an insured caused or contributed to the intoxication of any person.” Quoting the Seventh Circuit, the Court found Phusion’s decision to mix energy stimulants and alcohol “might not have been a very good one,” but did “not amount to tortious conduct that is divorced from the serving of alcohol.” Therefore, the allegations of the underlying complaint fell within the liquor liability exclusion, and Selective had no duty to defend Phusion in the underlying actions.

Courts often struggle with whether to apply policy exclusions in the face of alternative theories of liability in the underlying case, especially when one of those theories arguably falls outside the scope of the exclusion. Here, however, the court appropriately relied on the broad scope of the exclusion and rejected the insured’s efforts to circumvent the exclusion by parsing the allegations of the underlying complaint.

Filed under Appellate, Commercial General Liability, Exclusion

Ninth Circuit Zaps Insured’s Suit Seeking Coverage for Zip Code Claims

By on December 10, 2015
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In Big 5 Sporting Goods Corp. v. Zurich American Ins. Co., et al., Case No. 13-56249 (9th Cir. Dec. 7, 2015), the Ninth Circuit, interpreting California law, held that underlying putative class action lawsuits asserting Song-Beverly Act claims alongside causes of action for invasion of privacy and negligence were not covered and did not trigger a duty to defend under CGL policies issued by Zurich and Hartford. The Ninth Circuit affirmed the decision of the Central District Court Judge Dolly Gee.

The Song-Beverly Act prohibits retailers from requesting and recording personal identification information (e.g., Zip codes) in conjunction with point-of-sale credit card transactions. Big 5 was sued in a series of underlying class action lawsuits asserting causes of action based on alleged violations of the Song-Beverly Act. Some of those complaints also asserted common law and constitutional invasion of privacy claims as well as negligence causes of action.

The policies included “Distribution of Material” exclusions which eliminated coverage for personal and advertising injury arising directly or indirectly out of any act or omission that violates or is alleged to violate any statute that prohibits or limits the sending, transmitting, communicating, distribution, etc., of material or information. Additionally, the Hartford policy included a “Right of Privacy Created by Statute” exclusion which eliminated coverage for personal and advertising injury arising out of the violation of a person’s right of privacy created by statute.

The Ninth Circuit affirmed District Court, holding that these exclusions eliminated coverage and any duty to defend the underlying suits based on the alleged violations of the Song-Beverly Act. The Court determined that the Act was undeniably a statute and that the alleged violations of the Act amounted to acts or omissions that were excluded from coverage.

Significantly, the Ninth Circuit rejected Big 5’s argument that the underlying common law and California constitutional invasion of privacy claims independently triggered a duty to defend. In doing so, the Court determined that in the context of the at-issue garden variety Song-Beverly Act complaints, such invasion of privacy claims “simply do not exist.” The Court further stated:

California does not recognize any common law or constitutional privacy right causes of action for requesting, sending, transmitting, communicating, distributing, or commercially using ZIP Codes. The only possible claim is for statutory penalties, not damages.

As support for this conclusion, the Ninth Circuit recognized that the Song-Beverly Act created a new right to protection in a consumer’s personal identification information that that did not previously exist and that the remedy for violations of the Act were specified statutory penalties. It also relied on the decision in Fogelstrom v. Lamps Plus, Inc. (2011) 195 Cal. App. 4th 986, which concluded that in the context of Song-Beverly class actions, there was no actionable invasion of privacy cause of action as the required element of a serious invasion of privacy or egregious breach of social norms was not present.

The Ninth Circuit further held that the underlying negligence causes of action did not trigger a duty to defend, stating that “[j]ust as a rose by any other name is still a rose, so a ZIP Code case under any other label remains a ZIP Code case.” The Court recognized that under California law, artful drafting and the assertion of superfluous negligence claims does not create a duty to defend where such a duty does not otherwise exist under the facts alleged.

With its decision in Big 5, the Ninth Circuit joins a growing number of Courts from across the country that have held that statutory class action lawsuits do not trigger a duty to defend under CGL policies.

The Ninth Circuit’s decision in Big 5 is not published and its citation is governed by 9th Cir. R. 36-3.

Filed under Commercial General Liability, Electronic Data, Exclusion, Personal and Advertising Injury

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