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

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.
 

MOE responded with a declaratory judgment action arguing, among other things, that no indemnity obligation existed because, as a result of the statute of limitations, the insured was not “legally obligated” to pay anything. Id. at 6. Following a judgment for the insured, the Court of Appeals reversed, holding that in the absence of any showing of bad faith, the insurer “should be allowed to litigate to finality whether the statute of limitations had run on the underlying claims.” Id. at 7. The Supreme Court disagreed, reasoning that MOE already had a sufficient opportunity to be heard on the statute of limitations defense in the underlying case through an unsuccessful motion for summary judgment, the settlement negotiations and the reasonableness hearing. Id. at 12. The Court wrote that “[w]hen an insurer had an opportunity to be involved in a settlement fixing its insured’s liability, and that settlement is judged reasonable by a judge, then it is appropriate to use the fact of the settlement to establish liability and the amount of the settlement as the presumptive damage award for purposes of coverage.” Id. at 16. The Court held that, regardless of whether or not an insurer acts in good faith, the insurer “is not entitled to litigate factual questions that were resolved in the liability case by judgment or arm’s length settlement.” Id. at 18.

However, that determination did not resolve the extent of MOE’s indemnity obligation because the policy only covered “property damage” as defined and limited by the policy. As the Court correctly noted, “the coverage issue is different from the global damages issue.” Id. at 25. MOE argued that since the majority of the siding was not damaged, it should not be responsible for the cost to remove and replace the siding. Id. at 21. The Court rejected this argument, reasoning that “[r]emoving and repairing the siding is simply part of the cost of repairing the damage to the interior walls.” Id. at 22. Similarly, the Court rejected MOE’s argument that it should not be responsible for the cost of replacing siding because such costs fell within the “impaired property” and “your work” exclusions, concluding that “if the siding must be removed to repair damage” to other components of the building “then there is coverage for the cost of the removal and replacement of the siding.” Id. at 27. On the other hand, the Court found that the record was insufficient to determine the total amount of “property damage” covered by the policy because the settlement could have included amounts attributable to the diminution in value of the entire development “even if there had been no actual property damage to a particular wall.” Id. at 26. In other words, the Court could not tell whether the trial court’s ruling in the coverage action was based on an actual coverage determination or, rather, “merely” upon “the findings of the liability judge that the settlement was reasonable.” Id. at 26. Accordingly, the Court remanded for a closer examination of what damage had actually occurred.

This insurance coverage dispute arose out of dumping activity by Richard Towns between 1972 and 1987. Towns operated a waste hauling business. Over time, he culled some of the debris from his business and used it to fill in a steep embankment at his house. Some of the debris was also used to fill in a swimming hole in front of the property.

Towns sold his home in 1987. Thereafter, the new owners, concerned about the fill, contacted the Vermont Attorney General’s Office which ultimately issued an order to Towns directing him to engage an environmental consultant and clean up the property.

Towns initially sought coverage for the state’s claim from Vermont Mutual, which had insured him after he sold the property in 1987. Ultimately, the Vermont Supreme Court affirmed a lower court’s ruling that the Vermont Mutual policy did not cover the loss. Towns v. Northern Security Ins. Co., 726 A.2d 65, 67 (Vt. 1999).

Thereafter, Towns sued Northern Security, which had insured him between 1983 and 1987. Northern Security disputed its claimed obligations, citing the “business pursuits” exclusion in its homeowners’ policy and contending that the loss in question had “manifested” after its policies had expired. These arguments were for the most part rejected by a state trial court in a 2007 opinion although the court declared that Northern Security was only liable for its “time on the risk” (25%) as its coverage had only been in effect for four of the sixteen years that Towns had lived there.

On appeal, the Vermont Supreme Court agreed with the trial court that the “business pursuits” exclusion did not apply. Although the debris had been generated in the course of the insured’s business, the court held that what was relevant was the dumping activity, which is subject to the non-business exception to the exclusion. This point was contested by Chief Justice Greiber, who argued in a dissenting opinion that the sheer amount and duration of the fill activity was clearly integral to the insured’s waste hauling business.

The Supreme Court also rejected Northern Security’s reliance on the “own property” exclusion. In keeping with the approach followed by most courts, the court held that groundwater contamination was a public resource and not the insured’s “own property.” The court also rejected Northern Security’s argument that because the groundwater contamination was below state action levels, it did not satisfy the policy’s requirement of “property damage.”

The court suggested, however, that the exclusion might yet apply to any costs that were solely related to the insured’s property, as distinguished from the cost of preventing third-party property damage.

The court also rejected Northern’s argument that a manifestation trigger was appropriate, declaring instead that it would follow the majority rule which applies a continuous trigger to claims of this sort where the disposal activity and resulting damage was ongoing over a period of years.
On the other hand, the Supreme Court also sustained the lower court’s decision to limit the insurer’s obligation to that portion of defense and indemnity during its “time on the risk.” The court noted that a “time on the risk” method offers several policy advantages including spreading the risk to the maximum number of carriers, providing a ready means of identifying each insurer’s liability through a relatively simple calculation and avoiding the necessity for subsequent indemnification actions between or among insurers. In cases of this sort, the court held that as the policy was self-insured, it was fair and reasonable to require the insured to bear responsibility for that portion of total defense and indemnity for which he or she chose to assume the risk.

Vermont is an unusual state within which to litigate environmental coverage issues. Unlike states in southern New England, Vermont lacks the type of heavy industry that have historically generated significant numbers of environmental claims in the past. On the other hand, insurers for the most part have been denied the opportunity to include pollution exclusions by reason of regulations followed by Vermont regulators since the early 1970s. Even so, there has been a relative dearth of clear appellate case law construing the availability of insurance coverage for such claims.

The Towns opinion may ultimately be particularly important in two respects.  First, it reenforces the growing consensus in the Northeast and New England that "all sums" has no place in insurance jurisprudence.   Although the Massachusetts SJC has a proud tradition of forging its own path without regard for the views of sister states, it is less likely to view "time on the risk" as a made up argument by insurers where allocation has been approved by the Supreme Courts of Connecticut, New Hampshire, New Jersey, New York and now Vermont.

Second, this is the rare case (Security in Connecticut being another), where a court has explicitly applied  allocation principles to the duty to defend.  As many of these cases (e.g.  ConEd, EnergyNorth) have arisen in the context of excess policies, the focus of most cases has been on insurer's claimed indemnity duties.  Towns rightly affirms that the same analysis applies to the scope of an insurer's duty to pay or reimburse defense costs.