Courts that confuse damages arising in "tort" with damages arising in "contract" overlook an important legal principle, as well as misuse the concept of "negligence" in the insurance context. The argument that concludes no coverage exists for breach of contract actions puts the cart before the horse. Recent case law illustrates the problem.
More and more, commercial transactions go bad when the parties' expectations are not met. Can these breach of contract actions be covered by liability insurance? The supreme courts of Oregon and Vermont recently have faced this issue. One case presents facts that triggered coverage; the other does not. In Oak Crest Construction v Austin Mutual Insurance, 320 Or App 620, 998 P2d 1254 (2000), the court found that an accident can arise from a contractual relationship but held no coverage existed under the contractor's policy. In City of Burlington v Association of Gas and Electric Insurance Services, 751 A2d 284 (Vt 2000), the Supreme Court of Vermont held that the policy provided coverage for unexpected harms resulting from a breach of contract.
Background Facts: Oak Crest Construction
Oak Crest, a general contractor, builds custom homes for sale directly to homebuyers. Oak Crest contracted with a subcontractor to paint cabinets and other interior woodwork. After the homeowner took possession, it became apparent the paint had not cured. Oak Crest had to redo the subcontractor's work, stripping and refinishing the cabinets and woodwork at a cost of approximately $10,000. Oak Crest then submitted a claim for the amount to its general liability insurance company, Austin Mutual, claiming that the cost was incurred because of deficiencies in the subcontractor's work. Austin Mutual refused to reimburse the cost.
The Lower Court Decisions
Oak Crest filed an action against Austin Mutual alleging breach of the insurance contract. Oak Crest argued that the "products and completed work" coverage applied to the cost of repairing the deficient painting. The Austin Mutual policy provided coverage for all damage to persons or property arising out of Oak Crest's work if an "occurrence" caused the damage. The policy defined "occurrence" as "an accident." However, the policy did not define "accident." Oak Crest asked the court to define "accident" as an unintended and unexpected occurrence. Applying this proposed definition, Oak Crest claimed that the cost of repairing the paint was an unintended and unexpected result covered by the policy.
Austin Mutual argued that the cost did not arise from an accident, but rather from Oak Crest's failure to meet the requirements of its contract, with the homebuyer to repair or replace defective painting. The trial court granted Austin Mutual's motion for summary judgment. In doing so, the court held that there had been an occurrence but that there was no coverage because Oak Crest's liability for replacing the paint was based in contract and not in tort. Oak Crest appealed. The court of appeals affirmed, but for different reasons, holding that there was no occurrence because the damage was not the result of an accident [905 P2d 848 (Or App 1995)].
Can a Breach of Contract Be an Accident?
The Supreme Court of Oregon reconsidered the question of whether a breach of contract can be an accident. The court reviewed older case authority that held that property damage that results from the failure to meet contractual standards may qualify as being caused by accident if a breach of some duty imposed by law has occurred.1 The Supreme Court found, however, that the record presented no evidence to show that the cost of replacing the paint was the result of a breach of a duty. Rather, the court held that the cost was solely the result of the requirements imposed by Oak Crest's contract with the homebuyer. Thus, the court held that despite the fact that the peeling paint was unintended and unexpected, it was not the result of an accident covered by the policy.
Can a Breach of Contract Result in Unexpected Harm?
The Supreme Court of Vermont also addressed the question of whether a breach of contract can be an accident covered by an insurance policy. The City of Burlington entered into a contract to purchase wood chips from Moffatt. Subsequently, Burlington refused to accept the contracted amount of wood chips. Moffatt brought an action against Burlington alleging breach of contract. Burlington settled the lawsuit. Thereafter, Burlington sought indemnification of the settlement amount from its primary and umbrella insurers. National Union Fire Insurance Co. (NUFI) was primary; Associated Electric and Gas Insurance Co. (AEGIS) was the umbrella. In both cases, the trial court granted summary judgment for the insurer. Both cases reached the Supreme Court of Vermont.
The Supreme Court of Vermont affirmed the NUFI decision (City of Burlington v National Union Fire Ins. Co., 655 A2d 719 (Vt 1994)). The court focused on the language of the policy, which provided coverage for an "occurrence." The policy defined "occurrence" as "an accident" resulting "in bodily injury or property damage neither expected nor intended from the standpoint of the insured." The court stated that because Burlington had intentionally breached its contract with Moffatt, there was no "accident" as defined under the policy. As such, the NUFI policy did not cover the damages allegedly resulting from the breach of contract.
With regard to the AEGIS policy, the court focused on the language of the policy, which provided coverage for an "occurrence." Unlike the NUFI policy, however, the AEGIS policy defined "occurrence" as "an accident" or "event" resulting "in bodily injury, personal injury or property damage." The court concluded that because the term "event" is not limited to unexpected and unintentional acts, the policy covered the damages to Moffatt allegedly caused by the intentional breach of contract. Nevertheless, the Supreme Court remanded the case to allow the trial court to construe the language of the policy exclusions [City of Burlington v Assoc. Elec. & Gas Servs., 669 A2d 1181 (Vt 1995).]
On remand, the trial court examined the exclusion denying coverage "to liability of any insured for bodily injury, personal injury or property damage caused intentionally by or at the direction of such insured." The trial court held that this language excluded coverage for intentional injuries but provided coverage for intentional harms. Under this reading, the trial court held that the AEGIS policy covered the costs associated with Moffatt's claims for bodily injury because Burlington did not intentionally cause that harm. However, the trial court concluded that the policy did not cover claims for property damage because under those claims Moffatt sought compensation for uncovered economic losses rather than damage to tangible property. Both parties appealed the decision. Again, the case reached the Supreme Court of Vermont.
The Supreme Court of Vermont held that the AEGIS policy language provided coverage for the costs associated with the claims for bodily injury and property damage. The court noted that while Burlington may have intentionally breached its contract with Moffatt, the breach did not manifest an intent to cause bodily harm or property damage. The court held that merely because Burlington's breach of contract was intentional, it was a "far cry" from finding that the injury was intentional. The court held that Burlington did not intentionally cause the damage sustained by Moffatt—the breach of contract resulted in unexpected harms. Therefore, the policy provided coverage.
The Implication of Oak Crest and Burlington
Courts that confuse damages arising in "tort" with damages arising in "contract" overlook an important legal principle, as well as misuse the concept of "negligence" in the insurance context. The argument concluding that no coverage exists for breach of contract actions puts the cart before the horse.
A "tort" has occurred only when the law finds that a duty of due care exists (apart from the obligation assumed in contract), the duty was breached, the plaintiff was damaged, and the damage was proximately caused by the tortfeasor's conduct. "Negligence" is defined as conduct that is performed without conforming to a standard of care. An "accident" is an undefined term in the policy. However, the courts use a "tort" context when they conclude that an "accident" exists only when the damage results from a breach of some duty imposed by law. Damages caused by the negligent performance of a contract can in certain instances be recoverable in tort or in contract. Therefore, one can "negligently" perform a contract, or a "tortious breach of contract" can exist. Where damages are solely caused by a failure to perform, i.e., where no breach of any duty imposed by the law has occurred, no tort action can be pleaded.
Using Oak Crest as an example, the painting subcontractor has a contractual duty to perform in a workmanlike manner. The subcontractor has a duty, apart from the contract, not to damage the cabinets that he is painting. If the paint does not cure properly and peels, the contractual obligation to perform in a workmanlike manner has been breached. The contract may have been "negligently" performed, but no duty imposed by law has been breached and no accident occurred. On the other hand, if the paint does not cure properly causing solvent to penetrate to the wood cabinet, then the duty not to damage the cabinets has been breached, an accident has occurred, and the damages resulting from the tort, i.e., damage to the cabinets, are covered by the contractor's policy.
Using City of Burlington's facts to illustrate the point, the City's breach of contract may have been an intentional act, but the damages resulted from an accident. The City had a contractual obligation to perform its contract. It was liable in contract for its breach. However, the City had a duty imposed by law (apart from the obligation assumed in contract) not to harm the seller. Because the court found unexpected harm resulted, it found an accident had occurred causing damage covered by the City's policy.
The lesson learned: First, determine what damage has resulted from the complained of conduct. If it is "unexpected harm," then the conclusion follows that a duty imposed by law has been breached and the damage may be covered by insurance. Don't take the opposite route and conclude that a breach of contract cannot constitute an accident.
1 In addition to the other authorities reviewed by the court, see Vandenberg v Superior Court, 982 P2d 229, 88 Cal Rptr 2d 366, decided by the Supreme Court of California on August 30, 1999. Vandenberg sued its liability insurer, USF&G, after USF&G refused to pay a $4 million judgment entered against Vandenberg. The judgment arose from Vandenberg's breach of a lease contract. In deciding the case, the court looked to the language of the policy, which provided coverage for obligations Vandenberg was "legally obligated to pay." The trial court had construed the language to apply only to tort damages and not those arising out of contract. However, the court noted that the policy made no distinction between tort and contract and held that the policy covered contractual obligations if unexpected harm results from the breach of contract. In doing so, the court held that a policy can cover damages arising from a breach of contract.
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