FEBRUARY 23, 2005 Pennsylvania, the Fourth Circuit and Oregon Rule for Insurers on Construction Defect Issues Plus: New York Rules All Insureds Must Provide Separate Notice and Defense Costs Are Allocated On A Pro-Rata Basis Construction Defects No Occurrence In Pennsylvania Meridian/State Farm Auto Insurance Company v. Franklin, No. 04-573, 2004 U.S. Dist. LEXIS 25759 (E.D. Pa. December 23, 2004). In Meridian, the insurer issued a general liability policy to the insured, John Franklin. The insured was sued by homeowners who alleged that the insured s design for their residence was defective and breached their contract. The underlying complaint alleged that the insured breached his obligation to use professional skills to design the homeowners residence, including, the insured s failure to supervise the construction and/or implementation of the design adequately, and, as a result of the design defects, the residence was not completed until two years after the original completion date. Moreover, the claimants alleged that there was profuse leaking in one of the rooms, water damage and corrosion to electrical components and main electrical panels caused by a failure to design adequate water proofing for the exterior landing, water damage to interior walls caused by improper design of copper roof joints and seams over a conservatory, continual water leakage from the pool, and flooding of the basement due to improper design of the basement drainage system. Upon knowledge of the alleged defects, the claimants hired several licensed professional and independent contractors and consultants to review, evaluate and correct the alleged defects. The insured later tendered the claim to its insurer, State Farm. State Farm issued a reservation of rights letter and filed this declaratory judgment action in federal court seeking a judgment that it had no duty to defend the insured in the underlying action. The court applied the gist of the action doctrine and held that the basis for Franklin s potential liability is poor design and that this basis cannot be an occurrence because it asserts what is essentially a breach of contract claim, not a claim of negligence. Meridian/State Farm Auto Insurance Company, 2004 U.S. Dist. LEXIS at *12. The court stated
that if the breach of duties imposed by the contract is the gist of the action, the insurer s duty to defend is not triggered. Meridian/State Farm Auto Insurance Company, 2004 U.S. Dist. LEXIS at *13. The court ultimately granted the insurer s motion for summary judgment and held that the gist of the [underlying] action was for breach of contract and therefore, there was no accident, and thus no occurrence, covered by the [State Farm insurance contract]. Moreover, the court stated that the insured s duties to the [claimants] arose from contractual duties, and the fact that [the insured], as an individual, was not a party to that contract is immaterial. Fourth Circuit Rules Construction Defects And Lost Revenue No Occurrence Hotel Roanoke Conference Center Commission v. The Cincinnati Insurance Company, No. 04-1344, 2004 U.S. App. LEXIS 211 (4th Cir. January 6, 2005). Plaintiff-insured Hotel Roanoke Conference Center Commission ( Commission ) commenced an action against The Cincinnati Insurance Company ( Cincinnati ) to recover funds that the Commission paid to Hotel Roanoke ( Hotel ) in connection with the underlying tort litigation. The underlying action arose from an agreement between the Commission and Hotel. The Commission and Hotel entered into a Deed of Easement, which granted the Hotel an appurtenant easement, exclusive use of rights, and non-exclusive use rights in various areas of the Conference Center. During construction, contractors for the Commission used steel slag as a fill material beneath the Conference Center s foundation. Several years after the construction, the slag hydrated and caused the foundation to crack. The Commission was forced to remove the slag and during the repairs, the Conference Center was forced to close, as were 60 guest bedrooms and a restaurant located in the Hotel. Consequently, the Hotel lost significant revenues from canceled bookings. The Commission agreed to pay the Hotel $678,591 in exchange for a release from liability, and the Commission in turn commenced a coverage action against Cincinnati Insurance Company seeking reimbursement. The Virginia District Court in Hotel Roanoke held that when an insured defectively performs a contract and the defective performance only damages the insured s work or product, the resulting contractual liability is expected for purpose of a commercial general liability insurance policy and therefore excluded from coverage. The District Court noted that when an insured is liable because its product or construction work is substandard or nonconforming -- as opposed to where it causes personal injury or damage to other property -- it is expected from the standpoint of the insured and therefore not covered by a commercial general liability policy. The Fourth Circuit affirmed the District Court s decision and stated that the Commission s liability to the Hotel arose out of the Commission s breach of the Deed of Easements and were thus uncovered damages expected from the standpoint of the insured. The Commission breached the Deed of Easements when it undertook repairs to the conference center in a manner which caused the Hotel lost revenues and other expenses. Hotel Roanoke, 2004 U.S. App. LEXIS at *6-8. 2 of 5
The court reasoned that [b]ecause the Commission thoroughly considered its actions with respect to repairing the Conference Center and recognized that such repairs would cost the Hotel revenue losses, the Commission s breach of the Deed of Easements cannot be considered an accident or an occurrence covered by the CGL policy. Hotel Roanoke, 2004 U.S. App. LEXIS at *7. Oregon Supreme Court Applies State Statute To Bar Coverage Through A.I. Agreements On January 27, 2005 the Supreme Court of Oregon in Walsh Construction Co. v. Mutual of Enumclaw, 338 Ore. 1 (2005), held that Or. Rev. Stet. 30.140 applied not only to direct indemnity agreements between parties to construction contracts, but likewise to additional insurance agreements where one party was obligated to secure insurance for losses arising from the others fault. ORS 30.140(1) provides: Except to the extent provided under subsection (2) of this section, any provision in a construction agreement that requires a person or that person s surety or insured to indemnify another against liability for damage arising out of death or bodily injury to persons or damaged property caused in whole or in part by the negligence of the indemnitee is void. In Walsh, general contractor Walsh Construction Company ( Walsh ) entered into a subcontractor agreement with subcontractor Rust Drywall, Inc. ( Rust ) to perform work on a project. The agreement between the general contractor and subcontractor required Rust to procure insurance coverage naming Walsh as an additional insured on its policy. The subcontractor s policy, which was issued by Mutual of Enumclaw ( Enumclaw ), already contained a blanket additional insured endorsement that automatically extended the coverage required by the subcontract. During the course of the work conducted on the project, an employee of Rust was injured. When the employee issued a claim against Walsh, the general contractor tendered the claim to Enumclaw. Enumclaw denied coverage for the claim, stating that the additional insured provision of the subcontract between Rust and Walsh violated ORS 30.140. Specifically, Enumclaw argued that, because the additional insured position of the subcontract was void under ORS 30.140, Walsh was not a legally cognizable additional insured and, therefore, was not entitled to defense or indemnity from Enumclaw. Walsh argued that the statute applied only to an agreement to indemnify and that an agreement to procure insurance to something different. The focus of Walsh s argument was that the subcontract required only that Rust procure insurance for Walsh s benefit the term indemnity connotes unlimited liability exposure, whereas insurance limits the insurer s liability to the amount of coverage purchased. Enumclaw countered that Walsh s argument overlooks the fact that the statute does not simply invalidate the requirement that one person has to indemnify another. Rather the statute also invalidates any requirement that the person s insurer indemnify another. The court agreed with Enumclaw, stating that the text of ORS. 30.140, and historic evolution, 3 of 5
strongly suggests that the statute prohibits not only direct indemnity agreements between parties to a construction agreements but also additional insurance arrangements by which one party is obligated to secure insurance for losses arising in whole or in part from the other s fault. The New York Supreme Court Held That All Insureds Must Provide Separate Notice Ocean Partners, LLC v. North River Insurance Company, No. 0605267/01, 2004 N.Y. Misc. LEXIS 2947 (Sup. Ct., New York County November 4, 2004). In Ocean Partners, LLC, plaintiff Ocean Partners, LLC ( Ocean Partners ) owned part of a building which caught fire on the morning of November 18, 1999. The building was insured by defendant North River Insurance Company ( North River ). SL Green Realty Corporation ( SL Green ) was the first named insured on the insurance contract issued by North River. Ocean Partners was listed as an insured. SL Green was the property manager as well as the tenant of the building. Several hours after the fire occurred, Dennis Egan, who was employed by SL Green, phoned Kassole Company, Inc., SL Green s insurance broker ( Kassole ), to report the fire. The property loss notice form listed SL Green as the insured on the claim and described the damage as water damage to bldg in approx 8 tenants spaces due to water pressure to extinguish fire. Ocean Partners, 2004 N.Y. Misc. LEXIS at *2. The form did not mention Ocean Partners. SL Green was the only entity to inform North River s agent, Kassole, of the fire. SL Green s notice concerned its own claim and not that of Ocean Partners. It was not until sixteen months later until Ocean Partners put North River on notice of the claim. The court was presented with the issue of whether Dennis Egan s call to Kassole was on behalf of Ocean Partners. The court stated that Egan did not mention Ocean Partners and that Egan testified that he had no authority to act on behalf of Ocean Partners. Id. The court stated that [t]here was no reason for North River to assume that Egan was acting on behalf of Ocean Partners and that notice for SL Green s claim cannot, in itself, serve as notice for a claim by Ocean Partners as well. Ocean Partners, 2004 N.Y. Misc. LEXIS at *5. Ultimately, the court concluded that where one named insured notifies its insurer of a potential claim and tangentially mentions that other tenants in its building have sustained damage, it is not realistic to expect the insurer to follow up with every other insured named on the policy to check whether they own the other property in question. Ocean Partners, 2004 N.Y. Misc. LEXIS at *7. Citing Appellate Division cases, the court stated that an insurer is justified in expecting each of its insureds to provide clear, timely notice of any potential claims. Id. New York Federal District Court Applies Pro Rata Allocation To Defense Costs On January 24, 2004, in Consolidated Edison of New York v. Fyn Paint & Lacquer Co., Inc. 2005 U.S. Dist. LEXIS 899, Civil Action No. CV-00-3764 (DGT) (MDG) (E.D.N.Y., January 24, 2005), Honorable David G. Trager of the Eastern District of New York held that a primary insurer is entitled to an allocation of defense costs with co-insurers. 4 of 5
The New York Court of Appeals has long held that an insurer is entitled to an allocation of indemnity costs when multiple policies are triggered. The Court of Appeals has not, however, ruled on the issue of pro rata allocation of defense costs during an ongoing litigation. The Court of Appeals simply stated that when more than one policy is triggered by a claim, pro-rata sharing of defense costs may be ordered, but we perceive no error or unfairness in declining to order such sharing, with the understanding that the insurer may later obtain contribution from other applicable policies. See Continental Casualty Co. v. Rapid- American Corp., 80 N.Y.2d 640, 655 (1993). In Fyn Paint, The Hartford Accident and Indemnity Company ( Hartford ) and Providence Washington Insurance Company ( Providence ) evenly shared the defense costs of insureds Fyn Paint & Lacquer Co., Inc. ( Fyn Paint ) and William Feinstein ( Feinstein ). During the course of the litigation, Hartford and AIG Technical Services ( AIG ) entered into a settlement that allowed each insurer a buy-back of its policies. In doing so, Providence remained the lone insurer providing a defense to insureds Fyn Paint and Feinstein. The court acknowledged that under normal circumstances it would simply require Providence to undertake the full responsibility of the defense of the insureds. Here, however, Providence no longer has the ability to later seek contribution from Hartford and/or AIG in light of the buy-back agreements they entered into with the insureds. Specifically, the court stated that since Providence cannot seek contribution from all of its co-insurers at a later date because the settlement with AIG and Hartford buy-back release them from any duty to defend, the logic behind holding one insurer liable for all defense costs regardless of whether other insurers may have a duty to defend does not hold in this case. The court, therefore, implemented a temporary allocation so as not to prejudice Providence. The court acknowledged the difficulty of determining an accurate percentage of pro rata allocation of defense costs during an ongoing litigation and reserved its right to later modify the precise allocation. This allocation may be altered at a later date once the full liability and defense costs have been determined. For more information on these issues or other insurance matters, please contact: Aidan M. McCormack amccormack@nixonpeabody.com (212) 940-3093 Mark Deckman mdeckman@nixonpeabody.com (516) 832-7635 Mark S. Reich mreich@nixonpeabody.com (516) 832-7581 The foregoing summary is provided by Nixon Peabody for education and informational purposes only. It is not a full analysis of the matter summarized and is not intended and should not be construed as legal advice. This publication may be considered advertising under applicable laws. If you are not currently on our mailing list and would like to receive future publications of Insurance Law Alert or if you would like to unsubscribe from this mailing list, please send your contact information, including your name and e-mail address, to lblaney@nixonpeabody.com with the words Insurance Law Alert in the subject line. Prior publications of Insurance Law Alert are available on our Web site (www.nixonpeabody.com). 5 of 5