Every once in a while, a court teaches us by judicial decision an entire chapter of insurance law lessons we can carry with us, secure in the knowledge that we can reason our way to the right result in insurance coverage disputes. Such a court opinion was filed March 30, 2018 by the US District Court for the Eastern District of Pennsylvania, applying Pennsylvania law. The case is State Farm Fire & Cas. Co. v. DTL Mechanical. It is reported at 2018 U.S. Dist. LEXIS 54953. It reminds us that commercial liability insurance is typically limited to defending against, or paying, damages from lawsuits against policyholders for property damage, bodily injury or personal and advertising injury, caused by an “occurrence”— an accident.
The facts of this State Farm case were certainly not unusual – which makes its teachings so useful, especially in resolving insurance coverage issues typically encountered in construction projects. Scott and Maria Evans engaged Bianco Contractors, Inc. (Bianco) to build an addition to their residence. Bianco, in turn, subcontracted with DTL Mechanical, LLC (DTL) to install a heating, ventilation and air conditioning (HVAC) system in the home addition. Numerous problems plagued the project, including the HVAC system, forcing the Evanses to replace what they alleged was a defectively designed and installed HVAC system. The property owners brought suit against Bianco in Pennsylvania state court, and Bianco sued DTL, alleging that the HVAC subcontractor was at fault in installing an improperly designed, sized and vented new HVAC system.
Bianco contended in the owners’ lawsuit that under the subcontract, DTL had assumed responsibility for installing a new HVAC system in the Evanses’ addition. The Evanses alleged that DTL’s work had failed to comply with pertinent building codes and DTL had breached implied warranties that the new HVAC system would comply with industry standards and be fit for ordinary usage. Bianco contended that the damages sustained by the Evanses were caused by DTL’s negligent performance of its installation work.
During the construction work, DTL was insured by a State Farm Business Owners liability insurance policy providing that State Farm would pay those sums Bianco became legally obligated to pay as damages because of bodily injury, property damage or personal and advertising injury caused by an “occurrence,” which the policy defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” (Emphasis added.)
The policy defined “property damage” as meaning “[p]hysical injury to tangible property, including all resulting loss of use of that property,” or “[l]oss of use of tangible property that is not physically injured or destroyed, provided such loss of use is caused by physical injury to or destruction of other tangible property.”
State Farm refused to defend or indemnify DTL in the state court lawsuit, because, the insurer said, the HVAC installation work, alleged by the Evanses and Bianco to have been negligently performed by DTL, did not constitute an “occurrence,” as defined by the policy.
Eventually, the Evanses, Bianco and DTL settled the state court litigation, with DTL assigning to the Evanses all of DTL’s rights of action under the State Farm liability policy based on the subcontractor’s right to a defense and/or indemnification, and any bad faith claims arising from State Farm’s refusal to indemnify and/or defend DTL in that lawsuit.
Still later State Farm brought suit in federal court against DTL and the Evanses for declaratory relief (the basis of federal court jurisdiction is unclear) and then moved for a summary judgment declaring that it did not owe DTL a defense or indemnification in the homeowners’ litigation against Bianco and DTL.
Procedurally, the court said, a summary judgment should be granted to State Farm if there is no genuine issue of material fact separating the parties, and, viewing the facts most favorably to the other parties, State Farm is entitled to judgment as a matter of law. A genuine issue of material fact exists if a reasonable jury could return a verdict for the nonmoving parties.
The homeowners asked the court to determine that they were entitled to recover as damages the cost of defending and indemnifying DTL for damages based on State Farm’s legal duties as a liability insurer for DTL in the litigation commenced by the Evanses. The court recited the general rule that the duty of a liability policy insurer to defend its policyholder is broader than the duty to indemnify it (see, e.g., California Practice Guide: Insurance Litigation (2016 Update), ¶ 7:501), so it necessarily follows that the insurer will not have a duty to indemnify its insured for a judgment in an action for which it was not required to provide it with a defense.
Accordingly, a typical first step in analyzing coverage is to assess whether the insurer has a duty to defend its policyholder. This is done by comparing the charging allegations of the complaint against the insured to the terms of the grant of coverage found in the policy of insurance. In this process, factual allegations of the complaint are taken as true and liberally construed in favor of the insured. The duty to defend is present if the allegations of the complaint could potentially fall within the coverage wording of the policy. In evaluating the policy duty to defend, the court must focus on factual allegations in the complaint, not the causes of action against the policyholder. In order to determine whether the duty to defend is triggered, the court held, a court must first examine the language of the insurance policy to determine the scope of coverage. Next, the court must analyze the complaint against the policyholder to determine if the claims asserted by the plaintiff potentially fall within the scope of the policy’s coverage.
The court concerned itself with a discussion of whether property damage caused by faulty workmanship qualifies as an “occurrence,” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The court, citing a decision of the Supreme Court of Pennsylvania, agreed that property damage caused by faulty workmanship is not an “occurrence”, because an “accident” requires a degree of fortuity not covered by faulty workmanship. Relying on the same case, the court in the new decision said that this type of policy does not cover “contractual liability of the insured because the product or completed work is not that for which the damaged person bargained.” Accordingly, an insurer has no duty to defend an insured against a lawsuit alleging only “property damage” resulting from poor workmanship. And this is true, moreover, even when faulty workmanship is cast as a negligence claim, is based upon a failure to follow industry standards or is couched as a breach of warranty.
Another coverage touchstone regarding liability insurance coverage analysis is that damages that are a reasonably foreseeable result of faulty workmanship are not covered. Put another way in the new case, there is no coverage under a liability insurance policy covering property damage where the only allegation of property damage involved damage to the completed construction work (here the HVAC system) itself, requiring its removal and replacement. The Pennsylvania Supreme Court decision the court relied on clarified that the risk intended to be insured against is the possibility of damage to property other than to the completed work itself – yet another touchstone in coverage analysis.
The court distinguished a decision where the court found coverage for a claim arising from an “occurrence” because, among other reasons, the plaintiffs asserted faulty workmanship claims for bodily injury. In the newly reported decision, on the other hand, the claims arose from DTL’s alleged faulty workmanship and the “foreseeable consequences of that workmanship” – replacing the HVAC system. Another decision distinguished in the current case completes the picture of coverage by involving claims against an industrial fan designer and manufacturer, where a fan failed due to design defects. The court concluded that the claims were an “occurrence” within the meaning of the policy, because they involved a product that actively malfunctioned, which could give rise to an “accident.”
Cleaning up the “campsite,” State Farm also moved for summary judgment on 13 counterclaims asserted against the insurer by the Evanses after they settled with the contractor and HVAC subcontractor and received an assignment from DTL of its claims against State Farm. The court held that, because all of the counterclaims other than one alleging insurer “bad faith” against State Farm fell outside the scope of the assignment of DTL’s rights of action against State Farm.
Finally, since the only counterclaim the Evanses owned and have standing to pursue as the real party in interest, is the one for “bad faith,” and the court already found that State Farm had no duty to defend or indemnify DTL for its faulty workmanship. It follows that DTL had no viable claim for bad faith –in its hands or in those of the Evanses.