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

At issue in Citation Ins. Co. v. Mary Blake Newman, No. 10-P-0331 (Mass. App. Ct. August 18, 2011) was a dispute between the owners of adjacent units at a small Cambridge condominium. Mary Blake Newman objected to her neighbor’s through-wall air conditioner which projected into a yard area to which Newman held an exclusive easement as a common area under the condo’s by-laws. Newman complained to her neighbor that his air conditioner intruded into the yard and emitted excessive noise, hot air and vibrations. 

After Hanratty ignored Newman’s complaints, she resorted to self help by sealing the air conditioner with duct tape to make it unusable. Hanratty responded by filing a pro se complaint against Newman seeking to restrain her from interfering with his air emissions and requiring her to stay ten yards away from him and his family. Newman counterclaimed for nuisance, trespass and defamation and sought an order requiring that the air conditioner be removed. 

Hanratty tendered the defense of this counterclaim to his homeowner’s insurer (Citation Insurance), which agreed to defend him subject to a reservation of rights. Citation then filed an action for declaratory relief seeking a declaration that it was not required to provide coverage for these claims. Hanratty counterclaimed alleging bad faith and asserting that Citation had failed to pay a reasonable hourly rate for his chosen defense counsel.  While the coverage litigation was still pending, the feuding Cambridge neighbors reached agreement whereby Hanratty agreed to remove the offending air conditioner and exchanged his counterclaim against Citation to his contentious neighbor Newman. 

In June 2009, a trial judge granted summary judgment to Citation. Newman appealed and on August 18, 2011, the Appeals Court of Massachusetts ruled that Newman’s counterclaim set forth a potential claim for both “property damage” triggering the insurer’s duty to defend. 

On the crucial issue of whether an easement is “tangible property,” the court held that what is important is not the nature of the insured’s right in a particular piece of property but the nature of the property in which the right is held. Accordingly, the fact that Newman merely had a right to use the back yard and did not actually own it did not change the fact that the yard itself was, in the Court’s view “tangible property.” In light of Newman’s allegations that her use of the yard had been infringed by the offending air conditioner, the Court held that such claims triggered the policy’s “property damage” coverage as involving a loss of use of tangible property.

In a footnote, the Appeals Court distinguished the California Supreme Court’s opinion in Kazi v. State Farm Fire & Cas. Co., 24 Cal. 4th 871 (2001) as involving a different set of facts (Kazi involved a dispute with respect to an implied non-exclusive easement as opposed to the existing express easement possessed by Newman) and was declared by the Court, in any event, to be an unreliable precedent that it need not follow. 

The Appeals Court ruled, moreover, that coverage was independently triggered by allegations in an affidavit that Newman had filed claiming that the noisy air conditioner had affected her use of the interior space in her condominium unit:  “When the air conditioner is operating, I can hear it in my unit. I can feel its vibrations through the floor when I’m on my balcony. When its running, it interferes with conversations in my room, especially if I leave my outside door open for cross-ventilation purposes. In fact, its so noisy that I can’t leave my windows open and door open. . . .” The Court of Appeals declared, without a trace of irony, that this evidence clearly supported a finding that she was claiming for loss of use of tangible property.

There are a number of problems with Citation. First, the Court did not discuss the extent to which an affidavit not referenced in the underlying complaint could trigger a duty to defend. Although Massachusetts has recently evidenced a broader standard with respect to whether insurers are limited to the allegations in the “four corners” of the complaint, it is far from clear that an affidavit is the type of “fact” that an insurer is required to consider.

More to the point, the court’s analysis with respect to the back yard obscured the fact that the back yard itself did not suffer any injury. Rather, it was the insured’s intangible right that was impaired. One might just as easily argue that my recent losses in the stock market involve a loss of use of tangible property since the subject matter of those claims involve tangible objects (stocks, bonds and dollar bills).

The ruling is all the more surprising in that it was authored by Justice Cynthia Cohen who, before going on the bench, was one of Boston’s leading insurer coverage attorneys.

Shilo had contracted with Maryland Casualty’s insured, Grant, to install various granite components in its hotel, including granite panel tub surrounds. Shilo determined the granite tub surrounds were poorly installed, and filed a complaint in arbitration against Grant alleging claims for breach of contract and negligence for faulty work. In a Memorandum of Decision, the arbitrator found that much of Grant’s work was defective and faulty, and that, as a result, water intrusion had occurred behind the granite tub surrounds in many rooms. The arbitrator also found that there was little evidence of the extent of water intrusion damage behind the granite. The arbitrator awarded Shilo damages against Grant for the cost to remove improperly installed granite panels and to install new granite tub surrounds, and Shilo’s mitigation cost to hire another contractor to make the panels watertight. Notably, the arbitrator awarded no damages for wall board, or framing or any components behind the panels.

Shilo then filed a Writ of Garnishment against Grant, noticing Maryland Casualty as garnishee, to recover the judgment entered against Grant in state court. Maryland Casualty removed the garnishment action to federal court. Shilo’s claim for coverage for property damage under the policy was based upon its contention that, during the policy period, Grant negligently installed granite that allowed water to intrude into the tub surrounds. In denying Shilo’s summary judgment motion and granting Maryland Casualty’s cross-motion for summary judgment, the District Court focused on the policy’s exclusion for property damage to “[t]hat particular part of any property that must be restored, repaired, or replaced because ‘your work’ was incorrectly performed on it” (emphasis in opinion), and ruled that the arbitration award of damages to remove and replace defectively installed granite tub surrounds was excluded from coverage.

On Shilo’s appeal, the Ninth Circuit’s focus was on whether there was evidence in the record supporting Shilo’s contention that “property damage” had taken place during the policy period.  Noting evidence that the rooms had not been used until after the policy period, and noting that Shilo had presented no evidence that “property damage” had taken place during the policy period, the Ninth Circuit affirmed the District Court’s grant of summary judgment for Maryland Casualty. In doing so, the Ninth Circuit made clear that, under Oregon law, coverage is triggered by the occurrence of property damage, defined in the Maryland Casualty policy as physical injury to tangible property, even if the damage is not discovered until later.  St. Paul Fire & Marine Ins. Co. v. McCormick & Baxter Creosoting Co., 324 Or 184, 923 P.2d 1200, 1211 (1996).  Addressing Shilo’s contention that “property damage” takes place at the moment a defective product is installed, the Ninth Circuit emphasized that McCormick does not hold that “mere installation of a defective product, without resulting physical injury to property during the policy period, triggers coverage.” Also, the Ninth Circuit notably did not address Shilo’s contention that the policy provided coverage for the cost to remove and replace the insured’s defective work in order to see if there was any actual physical injury to materials behind the insured’s work.

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.