Potomoc Insurance v Huang: One Court's View
of "Legally Obligated" under the CGL Insuring Agreement
June 2002
In this article, Pat Wielinski examines a
recent Kansas case recognizing the validity of the insurability of a contractor's
work to repair property damage before suit
is brought.
by Patrick
J. Wielinski
Cokinos, Bosien &
Young
The insuring agreement of the standard commercial general liability (CGL)
policy states that the insurer will pay those sums that the insured becomes
"legally obligated to pay" as damages because of bodily injury and property
damage to which the insurance applies. At the same time, the insuring agreement
also obligates that insurer to defend "suits" seeking those types of damages
against the insured.
The defense of a "suit"1 implies the
assertion of, or adjudication of, the insured's legal rights and obligations.
Perhaps it is the dual obligation of the insurer, that is to defend "suits," and to pay claims for which the insured
is "legally obligated," which causes confusion in the minds of many when a claim
does not fit within the traditional "suit" scenario.
The Typical Scenario
This scenario was discussed in an earlier article, "Glorifying Form over Substance: "Legally
Obligated' in the CGL Insuring Agreement." Such a scenario arises where
an insured, often a contractor, accidentally causes property damage during the
course of performance of its operations. The claimant is often the owner, that
is, the other party with whom the contractor has contracted to perform its construction
services.
In many instances, a contract obligates the contractor to repair damage to
the work or adjoining property, i.e., "property damage." Alternatively, a contractor
faces potential liability to the owner under common law theories of recovery,
such as negligence in performing its work defectively. In any event, the contractor
undertakes the expense of repair of the property damage, without the necessity
of a lawsuit, or more accurately, to obviate the necessity of a lawsuit to enforce
the contractor's legal obligation to make repairs.
Perhaps it is the fact that the traditional means of establishing a legal
obligation is through judgment after the filing and trial of a "suit," which
causes the confusion over whether an insured's repair of such property damage
involves a legal obligation in the absence of such a "suit." Whatever the reason,
insurers continue to raise the "legally obligated" requirement as a defense
to payment of claims where the contractor essentially "does the right thing"
and repairs unintentionally caused property damage, fully expecting its CGL
insurer to pay for those damages. When the contractor-insured, in repairing
the damage to the project, fulfills its obligation to the owner and at the same
time avoids a lawsuit, the substance of that claim remains repair of property
damage arising out of a covered occurrence.
Potomoc Insurance v Huang
Very few courts have squarely addressed these issues in the context of insurance
coverage for property damage caused by a contractor's defective work or operations.
However, one court recently considered this scenario and, recognizing the realities
of the relationships between the contractor and owner, took a very common sense
and practical approach. As is often the case, when a court undertakes such a
common sense analysis, the result tends to focus on substance and not mere form.
The Facts
The facts of Potomoc Insurance of Illinois v Huang,
2002 W.L. 418008 (D Kan March 1, 2002), may at first seem complex, but they
are fairly typical of the types of CGL claims involving property damage faced
by contractors. The insured, Ray Anderson Company, Inc. ("Anderson"), was a
window distributor who sold windows manufactured by Pella. Windows distributed
by Anderson were installed by a general contractor in the Huang home in Topeka,
Kansas. Anderson assembled the individual window units manufactured by Pella
into composites for installation into the home.
The windows were installed in the summer of 1995, and somewhat later in that
year, the Huangs began complaining of leakage and interior damage. In February
and March of 1996, Anderson repaired and recaulked a number of the windows.
Unfortunately, the leakage and damage to the interior of the home continued,
so that between July of 1996 and early 1997, Anderson installed several replacement
windows upon the demand of the Huangs.
In the face of those efforts, the Huangs filed a lawsuit against Pella and
Anderson in September 1997, alleging that Anderson sold windows that leaked
and that despite attempted repairs and replacement, Anderson had failed to satisfactorily
complete the replacement and repairs. That lawsuit was settled in September
of 1998. The settlement agreement included a release of Anderson for all claims
"resulting from the occurrence" described in the settlement.
All appeared to be fine until a rainstorm in October 1998 in which a number
of the original windows, as well as several of the replacement windows, leaked.
It was determined that the leakage was due to the unusual design of the home
in which the exterior windows were mounted flush with the exterior stucco surface,
rather than being recessed with awnings. In addition, the home had no gutters.
Because of the design, pouring rain would cascade down the exterior of the home,
including the windows. The windows' aluminum cladding could not withstand the
cascading water. When the cascading water worked its way around the cladding,
it caused some of the wood underneath to gradually rot so that the cladding
increasingly loosened. In addition, caulking of the mullions holding individual
units together in the composites was insufficient. Once again, Anderson undertook
repairs.
Nevertheless, in November and December of 1998, the Huangs demanded that
Anderson pay for interim damage caused by the leakage, including sanding and
refinishing their wooden floors, painting their damaged walls, and cleaning
their ducts. Anderson had these repairs completed and sought to recover the
$37,655 in repair costs under its CGL policy. It did not seek to recover the
costs to repair or replace the windows themselves.
Anderson's CGL policy was written by Potomoc Insurance of Illinois. Anderson
initially advised Potomoc of the claim through its insurance agent. A lengthy
exchange of requests for information and responses involving the insurance agent,
Anderson's lawyer, Anderson personnel, and Potomoc followed. Despite these efforts,
Anderson had completed the repairs to the Huang home without Potomoc's consent
or authorization before Potomoc could complete its investigation. Nevertheless,
Potomoc was aware that Anderson was making repairs to the Huang home and that
Anderson was concerned that if it did not undertake the necessary repairs as
soon as possible, the Huangs would file another lawsuit.
Anderson's "Legal Obligation"
A declaratory judgment was filed to determine Potomoc's coverage obligations
and in that action, Potomoc raised the defense that Anderson was not "legally
obligated" to pay for the repairs to the Huang home which resulted from the
defective installation of the aluminum cladding. The court viewed the issue
as whether the insured's decision to proactively settle a claim rather than
awaiting a lawsuit amounted to a "legal obligation," the fulfillment of which
gave rise to damages payable under its CGL policy.
The court's analysis of the policy language as to an insurer's obligation
to pay claims for which the insured is legally obligated, even in the absence
of a third-party lawsuit, is worth quoting at length:
This case presents unique circumstances insofar as the court has been
unable to locate another Kansas case in which the insured proactively settled
a third-party claim before the third party even filed a lawsuit. However,
neither Kansas case law, nor the CGL policy in this case, requires that
a third-party lawsuit be brought against the insured as a condition precedent
to the insurer's obligation to pay. In fact, the CGL policy expressly contemplates
coverage outside of the context of a lawsuit. It defines "suit" in terms
of civil litigation and alternative dispute resolution procedures. However,
it requires Ray Anderson to notify Potomac in writing "[i]f a claim is made or 'suit'
is brought"; thus, it distinguishes between a "claim" and a "suit." It requires
Ray Anderson to send Potomac "copies of demands, notices, summonses or legal
papers received in connection with the claim or 'suit'"; in this sentence,
"demands" corresponds to the term "claim" and "summonses or legal papers"
corresponds to the term "suit." It requires Ray Anderson to cooperate in
the investigation or settlement of the claim or defense against the 'suit.'" Further, the CGL policy imposes on Potomac
the duty to defend "against any 'suit.'" Yet, despite extensive use of the
term "suit" throughout the CGL policy, it nevertheless states that Potomac
"will pay those sums that the insured becomes legally obligated to pay";
this provision of the policy does not impose the filing of a third-party
lawsuit against the insured as a condition precedent to Potomac's obligation
to pay a claim.
Having concluded that the filing of a third-party lawsuit or a judgment was
not necessary to fix an insured's legal obligation, the court undertook a traditional
analysis of whether the performance of the repairs was reasonable in light of
the circumstances. In doing so, it likened the performance of those repairs
to a settlement of the claim, applying the body of case law that allows an insured
to recover the amount of a settlement from its liability insurer upon proof
that the settlement was reasonable in amount and made in good faith. It then
went on to apply various factors from Kansas case law to determine the reasonableness
and good faith nature of the "repair settlement," as follows:
- Amount of Damages. $37,655 was reasonable
in light of the $1 million value of the Huang home.
- Merits of Liability Theory. The Huangs
would have likely prevailed against Anderson on a negligence theory since
the evidence demonstrated that Anderson's deficient caulking, to some degree,
caused the window leaks.
- Merits of Defense Theory. The court reviewed
the settlement agreement and rejected Potomoc's argument that the settlement
of the initial lawsuit released Anderson from liability for future leaks.
It also rejected Potomoc's argument that the 2-year statute of limitations
had run for the Huangs to file a lawsuit so that there would be no way that
a suit could be pursued against Anderson. The court found that it was likely
that a lawsuit would have been filed within the limitations period had Anderson
not undertaken its proactive repair measures.
- Anderson's Relative Fault. Evidence indicated
that liability would have been apportioned between Anderson and Pella.
- Risks and Expenses of Continued Litigation. The amount of attorneys and experts fees in the event of continued litigation
made settlement reasonable.
- Anderson's Ability to Pay. Anderson was
solvent and the Huangs would have proceeded against Anderson regardless
of its CGL coverage.
The court concluded that Anderson had met its initial burden of proving that
it acted reasonably and in good faith. Potomoc, in an attempt to show that Anderson
acted in bad faith, argued that Anderson paid for the repairs to the Huang's
home not because it believed it was liable, but rather because it was a good
business decision to do so. The court rejected this argument stating that, "a
good business decision is not necessarily inconsistent with a legal obligation."
The court was unwilling to infer that Anderson had acted unreasonably or
in bad faith simply because it also may have been motivated by business concerns.
Even though Anderson may have made a business decision to appease its dissatisfied
customers, it was also likely motivated, to some degree, by its legitimate fear
that another lawsuit was imminent if it failed to make the requested repairs.
The court, therefore, concluded that Anderson was "legally obligated to pay"
for the repairs because it acted reasonably and in good faith in making them.
Therefore, it was entitled to reimbursement from Potomoc, absent any other defenses
to coverage.2
Lessons?
The reasoning of a case like Potomoc Insurance v
Huang provides some comfort to insureds that a legal obligation can be
established through other means besides a suit or judgment and that reasonableness
of conduct can prevail. Nevertheless, in the event an insured contemplates recovery
of costs incurred in repairing property damage to a project from its CGL insurer,
it is well advised to control those costs, keep a record of them, and allow
the insurer to be involved in the process should it so desire. At least in this
case, the insured was not forced to sit on its hands and wait to be sued in
order to trigger CGL coverage.
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