AUGUST 2005 Fourth Circuit Decision Holds that Under Virginia Law Faulty Workmanship Does Not Constitute an "Occurrence" Travelers Indem. Co. of America v. Miller Building Corp., 2005 U.S. App. LEXIS 14780 (4th Cir. VA, July 20, 2005) The Fourth Circuit, in Travelers Indem. Co. of America v. Miller Building Corp., held on July 20, 2005, that, under Virginia law, faulty workmanship does not constitute an "occurrence." In so holding, the Fourth Circuit resolved a conflict between the district courts in Virginia with respect to coverage for construction defect claims. The insured general contractor, Miller, sought coverage from Travelers for damages to the project caused by a subcontractor. The subcontractor allegedly selected and used defective fill material. The material expanded, resulting in damage to buildings on the property. Overturning the Eastern District of Virginia s determination that Travelers was obligated to indemnify the builder for alleged construction defects, the Fourth Circuit followed the reasoning of the Western District of Virginia in Hotel Roanoke Conf. Ctr. Comm'n v. Cincinnati Ins. Co., 303 F. Supp. 2d 784 (W.D.Va. 2004) that a general liability policy is not a performance bond. The Fourth Circuit expressly rejected the argument that the "subcontractor" exception to the your work exclusion created coverage, stating: The subcontractor exception merely rendered the your work exclusion inapplicable; it did not itself provide coverage. While this case is decided under Virginia law, the court expressly followed the Supreme Court of South Carolina s decision in L-J, Inc. v. Bituminous Fire and Marine Insurance Company, No. 25854, 2004 S.C. LEXIS 190 (S.C. August 9, 2004).
California Supreme Court Affirms Insurer s Right to Reimbursement for Non-Covered Defense Costs Scottsdale Insurance Company v. MV Transportation, 2005 Cal. LEXIS 8147 (Cal. July 25, 2005) The insurer, Scottsdale, agreed to defend the insured in an action subject to a reservation of rights to seek reimbursement for defense costs pursuant to the prior California Supreme Court decision of Buss v. Superior Court, 16 Cal. 4th 35 (1997). Scottsdale then filed an action for declaratory relief that it owed no defense and was entitled to reimbursement for defense costs it had paid. In the coverage litigation, the Court of Appeal concluded that the complaint did not create a potential for coverage, but it denied Scottsdale s reimbursement claim on the ground that Scottsdale s duty to defend was extinguished only from the time the court determined there was no coverage -- it did not apply retroactively to create a right to reimbursement. In a unanimous decision, the California Supreme Court reversed the Court of Appeal s decision, and found instead that an insurer is entitled to reimbursement for defense costs incurred in defending a claim that was never covered, as long as the insurer properly reserved its right to such reimbursement. The Court rejected the insured s argument that Buss applied only to mixed actions involving claims that are both covered and not covered by insurance, and held instead, that under Buss, an insurer is entitled to seek reimbursement of defense costs in an action in which there never was a potential for coverage or a duty to defend. California Appellate Court Rejects Theory That Would Create Unlimited Per Occurrence Limits Garamendi v. Mission Insurance Company, 2005 Cal. App. LEXIS 1102 (Cal. App. 2d Dist., July 18, 2005) The insured, Industrial Trucking Service Corp., settled contamination claims involving the disposal of waste at two adjacent parcels. Mission Insurance provided second-layer excess insurance that was excess of $1.5 million in underlying insurance. The insured filed a claim with the California Insurance Commissioner for the insolvent Mission Insurance Company s portion of the settlement. The Insurance Commissioner took the position that the claim involved two separate occurrences and that Mission s liability did not attach until $1.5 million had been paid for each occurrence. The California Court of Appeals found that the number of occurrences issue was irrelevant, as the scope of Mission s coverage was determined by whether the underlying insurance had an applicable annual aggregate limit. The Mission policy provided that: It is expressly agreed that liability shall attach to the Company only after the Underlying Umbrella insurers have paid or have been held liable to pay the full amount of their respective ultimate net loss liability as follows... [$1 million primary] ultimate net loss in respect of each occurrence but [$1 million] in the aggregate for each annual period during the currency of this Policy, separately in respect of Products Liability and in respect of [Occupational Liability]. The Insurance Commissioner took the position that this language created an annual aggregate limit only for products liability 2 of 6
and occupational liability claims. The insured argued that this language created three separate annual limits -- one for products liability claims, one for occupational liability claims, and one for all other claims. While the Court of Appeal found that the language in issue was not just ambiguous, but nearly incoherent, it concluded that the insured s interpretation was more reasonable as it comported more squarely with the terms of the underlying insurance and avoided gaps in coverage for nonproducts/occupational liability claims. Moreover, the court noted that the Insurance Commissioner s interpretation would create unlimited per occurrence liability for both insurers. The court remanded the case to the trial court to give the parties an opportunity to address other coverage issues. First Circuit Holds that Reinsurer s Follow the Fortunes Clause Requires Annualization of Policy Limits Commercial Union Ins. Co. v. American Employers Ins. Co., 2005 U.S. App. LEXIS 12705 (1st Cir. Mass., June 27, 2005). W.R. Grace sought coverage from its insurers for numerous environmental contamination claims. Commercial Union issued excess multi-year policies that followed form to the primary policies. The primary policies provided that there was an annual per occurrence limit. The Commercial Union policies contained an occurrence definition that limited liability for continuing property damage to a single per occurrence limit. Commercial Union obtained facultative reinsurance under three multi-year policies issued by Swiss Re. The Swiss Re policies followed the terms of the Commercial Union policies and contained a follow the fortunes provision that made settlements by Commercial Union binding upon Swiss Re. Commercial Union entered into a settlement with W.R. Grace that was premised upon the assumption that Commercial Union would be liable for an annual per occurrence limit. When Commercial Union sought reimbursement from Swiss Re for the settlement, Swiss Re objected that its liability was limited to a single per occurrence limit for each multi-year policy. The District Court agreed on the basis of the language contained in the Commercial Union and Swiss Re policies. On appeal, the First Circuit vacated and remanded the district court s decision. Although it noted that the majority of courts agreed with Swiss Re s position, the follow the fortunes clause required Swiss Re to follow Commercial Union s calculations on liability regardless of whether they were correct, as long as the settlement was reasonable and made in good faith. The court further noted that annualization of limits was not flatly inconsistent with the Commercial Union policy terms since Commercial Union had agreed to follow the terms of the primary insurance, which had annual limits. Lastly, the court found that there was no language in the Swiss Re policy that prohibited annualization of limits. In a companion case, American Employers Insurance Co. v. Swiss Reinsurance America Corp., 2005 U.S. App. LEXIS 12708 (1st Cir. Mass. June 27, 2005), the First Circuit similarly found that Swiss Re s liability was not restricted to a single per occurrence limit for each multi-year policy and 3 of 6
vacated and remanded the district court s decision that American Employers had violated its duty to good faith by settling claims for sites that it had not investigated. Texas Appellate Court Rules on Coverage for Exterior Finish Claims and Holds that Claims Involve Multiple Occurrences Within the Self-Insured Retention Lennar Corporation v. Great American Insurance Company, 2005 Tex. App. LEXIS 4214 (Tex. App. Houston 14th Dist., June 2, 2005) The insured was a developer who was a defendant in lawsuits by homeowners involving defective synthetic stucco. The developer s insurers denied coverage. In the coverage action, the trial court granted the insurers motions for summary judgment and this appeal ensued. The Texas Court of Appeals (Houston Division) court first considered whether defective construction can be an occurrence. It found that Texas law was undecided, but concluded that the defective construction was an occurrence since the resulting damage was not expected or intended by the developer. The court observed that the policy s business risk exclusions would be superfluous if general liability insurance was not intended to cover any construction defect claims. The court further held that costs to repair water damage constituted property damage ; however, costs to replace the stucco as a preventative measure was not property damage. The court also found that overhead, inspection and personnel costs, and attorneys fees were miscellaneous business costs and not property damage. One of the insurers Gerling issued insurance with a self-insured retention of $250,000 per occurrence. Applying a cause analysis, the court concluded that each home constituted a separate occurrence, noting that the insured s liability arose from its construction of the homes, rather than from the manufacture or design of the defective stucco. Since the damages for any single home did not exceed the retention amount, Gerling had no indemnity obligation. The court also held that the business risk exclusions did not bar coverage for damage from water intrusion. The court further ruled that coverage was precluded by the known loss or loss in progress rule to the extent the developer was aware of damage to a home and/or had made repairs to the home prior to the time the policy incepted, but there were issues of fact that precluded granting the insurer s motion for summary judgment on this issue. Lastly, the court rejected the insured s extra-contractual claims. New York High Court Upholds No Prejudice Rule For Late Notice Argo Corporation v. Greater New York, No. 42, 2005 N.Y. LEXIS 770 (N.Y., April 5, 2005). The Court of Appeals New York s high court has confirmed the long-standing rule that an insurer need not show prejudice to bar coverage on the grounds of late notice. The Court s decision acknowledged, however, that the no-prejudice rule was rejected in certain contexts, 4 of 6
such as for a SUM claim. But the Court explained that such law did not abrogate the noprejudice rule and should not be extended to cases where the carrier received unreasonably late notice of claim. The facts here [in Argo], where no notice of claim was filed and first notice filed was a notice of law suit, are distinguishable from Brandon where a timely notice of claim was filed, followed by a late notice of law suit. The Court further explained that the fifteen-month delay between Argo s notice of the lawsuit and its tender of the lawsuit to Greater New York was unreasonable as a matter of law. The court stated: The rationale of the no-prejudice rule is clearly applicable to a late notice of lawsuit under a liability insurance policy. A liability insurer, which has a duty to indemnify and often also to defend, requires timely notice of lawsuit in order to be able to take an active, early role in the litigation process and in any settlement discussions and to set adequate reserves. Late notice of lawsuit in the liability insurance context is so likely to be prejudicial to these concerns as to justify the application of the no-prejudice rule. Argo s delay was unreasonable as a matter of law and thus, its failure to timely notify [Greater New York] vitiates the contract. North Carolina Court Rejects Manifestation Trigger For EIFS Claim Harleysville Mutual Ins. Co. v. Berkley Ins. Co. of the Carolinas, 2005 N.C. App. LEXIS 602 (Ct. App. N.C., April 5, 2005). RGS Builders, Inc. ( RGS ) and Mr. and Mrs. K.C. Desai (the Desais ) entered into a contract for RGS to act as general contractor for the construction of their new home. RGS completed the construction in 1994, and the Desais were issued a Certificate of Occupancy on December 15, 1994. In May 1996, the Desais home was inspected. The inspection found that portions of the home contained moisture levels that required further investigation. In May 1997, a supplemental investigation was conducted. The secondary investigation recommended that the Desais take action to seal the penetrations through the stucco system, seal and maintain sill connections of windows and install sealant where the flashing meets the stucco system. The Desais home included an exterior installation finish system ( EIFS ). In a third inspection, conducted on April 6, 2000, the inspectors observed numerous examples of improper installation details of the EIFS cladding and violations of applicable building codes. The inspection report further detailed that the inspectors do not believe the system can be repaired and we recommend that the EIFS synthetic stucco surface be removed and replaced. On May 16, 2000, the Desais filed a complaint against RGS in relation to the defective installation of the EIFS. RGS tendered the lawsuit to its insurers, Harleysville Mutual Insurance Company ( Harleysville ) and Berkley Insurance Company of the Carolinas ( Berkley ). Harleysville insured RGS through May 1, 1997. Berkley insured RGS from that date going forward. Harleysville agreed to provide coverage to RGS in connection with the Desais complaint. Berkley denied coverage. Harleysville defended and eventually settled the Desais claim for the sum of $87,500. Harleysville then commenced a declaratory judgment action against Berkley, seeking contribution for the defense and indemnity costs it incurred in defending RGS. The insurers disagreed on whether Berkley s insurance contract was triggered. 5 of 6
Harleysville argued that the source of the property damage -- the contractor s negligent installation of the EIFS -- was not determined with certainty until May 2000, when the third inspection was conducted. Also, the damage to the Desais home arose from the continual entry of water through the EIFS. Therefore, Harleysville contended, Berkley had a duty to defend since it insured RGS on the date of discovery of the alleged damage. The court concluded that Berkley had no duty to defend. The court reasoned that the first inspection on the Desais residence, in May 1996, evidenced clear property damage that took place prior to the inception of Berkley s insurance contract on May 1, 1997. The court s decision followed the North Carolina Supreme Court s holding in Gaston County Dyeing Machine Co. v. Northfield Ins. Company, 351 N.C. 293 (2000), which held that where the date of the injuryin-fact can be known with certainty, the insurance policy or policies on the risk on that date are triggered. New York Appellate Court Finds No Private Cause of Action For Bad Faith and Consumer Violation Claims Continental Cas. Co. v. Nationwide Indem. Co., 2005 N.Y. App. Div. LEXIS 3390 (1st Dep t, March 31, 2005). New York s Appellate Division, First Department dismissed bad faith and consumer violation claims, holding that the causes of action at best show a private contract dispute over policy coverage and the processing of defendants' claims, not conduct affecting the consuming public at large, and thus do not state a cause of action. The Court also dismissed defendant insurer s counterclaim against plaintiff insurer, finding defendant had no standing to bring the action against defendant insurer absent an unsatisfied judgment against insured contractor, as defendants lack standing to enforce insurance policies to which they were not parties. For more information on these issues or other insurance matters, please contact: in our Boston office, Gregory P. Deschenes at (617) 345-1324 in our New York City office, Aidan M. McCormack at (212) 940-3093 or Michael Murphy at (212) 940-3092. in our San Francisco office, Gregory Schopf at (415) 984-8314 or Ann G. Miller at (415) 984-8236 in our Washington, D.C. office, John C. Hayes, Jr. at (202) 585-8345 or Robert F. Reklaitis at (202) 585-8375 Click here to review prior issues of Insurance Law Alert 6 of 6