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.
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 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
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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1 The term "suit" is defined in the policy to include arbitration and other alternative dispute resolution proceedings as well as traditional lawsuits.
2 As to other coverage defenses, the court held that the damage constituted an occurrence and that property damage exclusions, including Exclusions j(6), k, l and m did not apply. It also rejected Potomoc's reliance on the cooperation and voluntary payment conditions in light of its finding that Potomoc was not prejudiced by Anderson's conduct.