National Insurance Law Forum : Insurance Litigation Lawyer & Attorney : National Insurance Law Forum : Insurance Coverage, Bad Faith Litigation

The HOA claimed its insurer misrepresented the limits of its policy, which fact did not come to the HOA’s attention until after it compromised its claim for property damage from the Northridge earthquake. The settlement agreement between the HOA and its insurer contained many "boilerplate" but necessary provisions including that the parties had disputed claims, were compromising, were buying their peace, and were waiving Civil Code § 1542 so as to assume the risk that there may be additional claims arising out of the same facts. Valuable consideration was received by the HOA.

Upon discovering information that the policy limits were substantially larger than believed at the time of setlement, the HOA went back to the well and when that did not work, sued.  Repeatedly, the HOA indicated it did not intend to rescind the earilier , the settlement funds having already been spent on repairs. Rather, the HOA sought to affirm the settlement and obtain dmaages for fraud. This the court found the insured could not do since to affirm the settlement was to agree to all of its terms including that there had been a release of all claims.

Other equitable arguments were also rejected. This is not a pronouncement that insurers are free to misrepresent policy limits (if that even were the case) but rather that the only way to get out of a settlement agreement with the types of provisions this one contained (which are the usual provisions found in settlement agreements) is to seek to rescind the agreement on the basis of fraud or mistake and tender the consideration given.

The other decision that left the parties where they stood was Essex Ins. Co. v. Richard Heck, MD, 2010 Cal.App.Lexis 1256 (2010). Starting the decision with its pronouncement of "What the heck?!" and its agreement with the trial court that the case was "screwed up," the appellate court went on to find that the insurer, having created the situation, was stuck with it.

Essex

was a messy case. The insurer defended the wrong person in a personal injury case arising out of an injury during construction repairs. The mix up was due to the very similar names of son (insured, owner of the property) and father (not insured, purchaser of the property). Judgment was entered against the father for over $800,000. Essex denied any coverage based on an exclusion in the policy (which was not explained further in this decision). Essex brought a coverage case to try to iron out the problem of who it insured and what it covered, but its motion for summary judgment was denied. Meanwhile the claimant as judgment creditor sued Essex, the son, the father, and defense counsel for bad faith and fraud. Much time and money having been spent without a resolution, Essex settled all the cases for $700,000, obtaining releases from all parties. The settlement agreement did not (as is often the case) specify how much was paid for which claim.

Thereafter – two years later - Essex sought equitable subrogation from the doctor who allegedly in treating the claimant had exacerbated the injuries. The doctor defended against the claim on the basis that Essex waived its claims and failed to prove its claims. Most importantly, there was no proof that the settlement was for the same injuries for which the doctor was allegedly responsible. The settlement agreement displaced the judgment. The settlement agreement was for release of much more than the judgment and did not allocate amounts to the claims released. Extrinsic evidence as to the parties' intentions was inadmissible. Thus, the court concluded the insurer was not entitled to recover from the doctor – the insurer must lie in the bed it made.

In 2000, Boston Financial Data Services ("BFDS") retained Suffolk Construction Corporation as general contractor for a tenant improvement project at its offices in Massachusetts. In undertaking the project, Suffolk subcontracted with BloomSouth for the installation of carpet tile and related materials throughout the building. This work included testing and cleaning the concrete floor. BloomSouth itself subcontracted out the installation to two other companies. One was charged with supplying the carpet and the other with installing it.

After the work was completed, however, BFDS employees began to complain that their offices smelled like a "locker room" and alleged headaches or other ill effects. In an effort to eliminate the source of the odors, one of BloomSouth's subcontractors scraped up the original carpet adhesive and re-carpeted the floor. That effort failed to correct the problem, however, and the problem spread to other areas of the building.

After further voluntary efforts to remediate the problem failed, BFDS ultimately hired other contractors to repair the problem, at a cost of $1,417,500 and brought suit against Suffolk Construction and BloomSouth. The Complaint alleged that 1) BloomSouth was responsible for negligently and defectively providing and installing carpet "resulting in damage to and loss of use of the building, including an alleged unwanted odor which permeated the building," and (2) BloomSouth's negligent and defective work caused Suffolk to spend money in an attempt to eliminate the alleged odor. Money was spent on, among other things, "the installation of carbon air filters to the ventilation system in the building," and "removal of the existing carpet tile and adhesives, bead-blasting of the concrete floor and replacement of the carpet tile and related materials."

The defendants both sought coverage under a CGL policy that Essex had issued to BloomSouth. Essex disclaimed any duty to defend, citing the absence of property damage and the applicability of its “business risk” exclusions. A U.S. District Court in Boston agreed. BloomSouth appealed.

As a preliminary matter, the First Circuit declared that the suit against BloomSouth sought recovery for "property damage."  The First Circuit ruled that the resulting “locker room” smell had resulted in physical injury to tangible property, rejecting the insurer’s contention that “property damage” required tangible injury to the physical structure itself. The court also concluded that “bead blasting” to the concrete floor to eradicate the carpeting had resulted in physical injury to the concrete substrate despite the insurer’s argument that the bead blasting was part of the replacement process for the defective carpet.

Having found “property damage,” the First Circuit further concluded that Essex had failed to establish that these claims were subject to the business risk exclusions in its policy. To begin with, the court declared that its finding of physical injury to tangible property precluded the application of the “impaired property” exclusion apart from the fact that it was not clear that the property in question could be restored to use merely by repairing, replacing, adjusting or removing its product or work.

For similar reasons, the court held that the “your product” exclusion did not apply since there were allegations of property damage beyond the carpeting installed by the insured. The court ruled that the preexisting building structures, including the concrete sub-floor over which the carpet had been installed, were “real property” and thus excluded from the definition of “product” in Exclusion K. The First Circuit declared that the lower court’s conclusion that the sub-floor had become the insured’s product “stretches too far the contours of what an insured might reasonably understand.”

There is much to be concerned about here. Outside the context of asbestos, few courts in the past have found that mere unhealthful conditions inside a building suffice to constitute “property damage” under liability policies.  The pastiche of out of state cases and first party case law relied on by the First Circuit may now yield a road map that insureds will follow to find coverage for “sick building” claims or other cases where there has been a loss of functionality of the plaintiff’s property but not enough to satisfy a “loss of use” requirement.

This idea of "loss of functionality" as property damage is emerging as a synthesis of first and third party insurance law that is now appearing in both types of cases.  For a first party example of what I'm talking about, have a look at the New Jersey Appellate Division's opinion this week in Wakefern v. Liberty Mutual, declaring that food spoilage losses after the 2003 electrical blackout resulted from "physical damage" to the electrical grid even though the grid itself had merely shut down due to a cascade of failures and not due to physical injury to the system itself.  The court ruled that such nuanced distinctions between physical damage and a loss of functionality were beyond the reasonable expectations or understanding of supermarkets that had paid good money for coverage and expected to be reimbused for spoiled lettuce.

The BloomSouth opinion also echoes the growing influence of the “reasonable expectations” doctrine in Massachusetts insurance jurisprudence. It appears that the cumulative weight of a decade’s work of dicta and footnotes has now embedded this principle as an accepted fixture of our case law even in the absence of a single Supreme Judicial Court case that has squarely considered and adopted it as a rule of contract interpretation.