INSURANCE-RELATED COURT CASES

COURT DECISIONS

Digested from case reports published in Westlaw, West Publishing Co., St. Paul, MN

Pool collapses and coverage takes a dive

Brian and Glenda Armstrong purchased through their agent, David Nipp, a Farmers Insurance Company of Idaho homeowners insurance policy. The Armstrongs claimed that they asked Nipp prior to purchasing the insurance if they would be covered for their swimming pool, and that Nipp told them they would be covered. Nipp denied that this conversation took place.

In July 2003, the Armstrongs’ above-ground swimming pool collapsed and water, mud, and debris flooded their finished basement. No piping or plumbing connected the pool to the house. The Armstrongs filed a claim under their homeowners policy. Farmers denied the claim, stating that the policy excluded losses to property caused by “water damage.” The Armstrongs filed a lawsuit against Farmers alleging various causes of action. The lower court found in favor of Farmers; the Armstrongs appealed.

The policy defined “water damage,” in part, as “overflow or escape of a body of water.” An exception to the water damage exclusion provided: “We insure for accidental direct physical loss to property…but only if caused by…[s]udden and accidental discharge or overflow of water…from within a household appliance.” The policy did not define the term “household appliance.” The lower court had found that the term “household appliance” was neither ambiguous nor commonly understood to include within its meaning the Armstrongs’ above-ground swimming pool. It therefore found that the exclusion exception did not apply.

On appeal, the Armstrongs argued that the term “household appliance” unambiguously included within its meaning an above-ground swimming pool, and that even if the term “household appliance” was found to be ambiguous, a reasonable person would understand it to include within its meaning an above-ground swimming pool. The Supreme Court of Idaho disagreed. In reaching its decision, the court analyzed various dictionary definitions of “household appliance” and noted that “household appliance”...“as used in everyday life refers to devices such as toasters, electric can openers, food processors, et cetera.” The court noted that all of these items are used to perform a “specific active function” such as “toasting, cutting, and chopping.”

The Armstrongs argued that the pool had a “specific function” of aquatic exercise and recreation and that it therefore fit within the dictionary definition of “appliance.” The court commended them for their creative argument but did not find it convincing. The court concluded that a pool is unambiguously not within the meaning of the term “household appliance” because it does not perform a “specific active function” like the other items it listed. Because the swimming pool was not considered to be a “household appliance,” the exception to the water damage exclusion did not apply. Therefore there was no coverage under the policy.

The decision of the lower court in favor of the insurer was affirmed.

Armstrong vs. Farmers Insurance Company of Idaho-No. 34250-Supreme Court of Idaho-April 2, 2009-205 Pacific Reporter 3d 1203.

Home owners dispute third-party exclusion

In about the year 2000, Bernard and Gail Freedman hired a contractor to remodel a bathroom in their home. While hanging new drywall, the contractor drove a nail through a pipe. The nail in the pipe apparently caused no leak at the time and went unnoticed until August 2005, when corrosion around the nail caused a leak and extensive water and mold damage.

The Freedmans had a State Farm Insurance Company homeowners policy that provided coverage for “all risks” except those specifically excepted or excluded. Paragraph 2 of the policy excluded losses related to “wear, tear, marring, scratching, deterioration, inherent vice, latent defect or mechanical breakdown, corrosion, electrolysis or rust.” Paragraph 4 of the policy excluded loss due to “Water Damage, meaning…continuous or repeated seepage or leakage of water or steam from a…plumbing system.” Paragraph 5 of the policy excluded losses due to third-party negligence.

The Freedmans submitted a claim under their homeowners policy for damage caused by the leak, including mold. When State Farm denied their claim, the Freedmans sued the insurer for breach of contract, breach of the implied covenant of good faith and fair dealing, and negligence. The lower court found in favor of State Farm. The Freedmans appealed.

On appeal, the Freedmans argued that the contractor’s negligence was the “efficient proximate cause” of their loss, i.e., the “predominant” or “most important” cause of the loss. They argued that when third-party negligence is the “efficient proximate cause” of a loss, it is a covered peril under the language of the policy. The Court of Appeal, Second District, Division 1, California, disagreed. According to the court, the third-party negligence provisions of the Freedmans’ policy excluded third parties’ negligent conduct and defective workmanship whenever they interacted with an excluded peril such as water damage. According to the court, these were permissible exclusions under California law.

The Freedmans also argued that the exclusion for continuous or repeated seepage or leakage of water was not enforceable. First, they argued that the provision was ambiguous because it did not say how long a leak must last in order to be “continuous.” The court was not convinced by this argument. According to the court, the hole through which the water leaked was very small, and the damage was extensive; thus, the leak must have lasted a sufficiently long time to cause such damage.

Second, the Freedmans argued that the exclusion applied only to “normal deterioration of the plumbing system,” not to leaks “caused by some force other than deterioration.” The court rejected this argument as well. The policy excluded “coverage for any loss which is caused by [continuous or repeated seepage or leakage of water from a plumbing system], regardless of whether the event occurs suddenly or gradually, involves isolated or widespread damage, [or] arises from natural or external forces[.]” According to the court, the policy language expressly provided that leaks were excluded, regardless of whether they were caused by natural forces or external forces.

Finally, the Freedmans argued that because their policy included an endorsement relating to mold, it followed that their mold damage was covered. The court disagreed with this argument as well. The mold identified in the endorsement was very specifically defined, and the Freedmans’ mold did not qualify. Because the Freedmans did not identify a covered peril that was otherwise not excluded from coverage, the mold was not covered.

The decision of the lower court in favor of State Farm was affirmed.

Freedman vs. State Farm Insurance Company-No. B202617-Court of Appeal, Second District, Division 1, California-May 5, 2009-173 California Appellate 4th 957.

Insurers deny consultant’s E&O claim

In 2003, Lifeline Health Group (“Lifeline”) hired Energy Insurance Agency, a consultant in the insurance field, to find a company to administer health insurance to its employees. Energy recommended Consumer Health Solutions (CHS), and Lifeline accepted this recommendation, paying CHS over $1.8 million in premiums. But CHS failed to pay the Lifeline employees’ claims because, as was later discovered, a CHS principal had commingled the funds and ultimately taken the money for his own use. This misconduct rendered CHS insolvent.

As a consultant, Energy had purchased an errors and omissions policy from Westport Insurance Corp. and a professional liability insurance policy from Employers Reinsurance Corp. Each of these policies contained exclusions, such that coverage would not be provided for insolvency or commingling. For example, the policies state:

“This policy does not apply to…claims for… the commingling or use of clients’ funds…This policy does not apply to…any claim arising out of or in connection with the financial inability to pay, insolvency, receivership, bankruptcy or liquidation of any insurance company, any reinsurer, any pool, syndicate, association or other combination formed for the purpose of providing insurance or reinsurance.”

Certain Lifeline employees sued Lifeline, and Lifeline brought a third-party complaint against Energy, claiming that Lifeline had chosen CHS because of Energy’s negligence. Energy submitted a claim to its insurers (Westport and Employers), seeking legal defense. The insurers provided the defense under a reservation of rights and filed a separate action seeking a declaratory judgment that their policies did not cover Energy because the underlying claim involved commingling and insolvency.

Energy countered that, while its policies excluded coverage for its own commingling or its own insolvency, it was not Energy that had commingled any funds and become insolvent. Rather, Lifeline had sued Energy for its negligence, a claim that the insurance policies certainly covered.

The district court considered the policy language and the parties’ arguments and agreed with Energy. The policies, the district court found, excluded coverage for claims against the insured’s insolvency or commingling, but did not exclude claims for the insured’s negligence in which the harm happened to be caused by a third party’s insolvency or commingling.

Moreover, the district court found that, even if this reading was incorrect, it was surely a plausible reading, and policy language susceptible to two or more plausible readings is ambiguous and is to be construed against the drafters (Westport and Employers) and in favor of the insured (Energy), that is, in favor of coverage. Westport and Employers appealed.

On appeal, the U.S. Court of Appeals for the Sixth Circuit stated that, pursuant to a Kentucky Supreme Court ruling in a similar case, it was obliged to read the exclusion clauses in the Westport and Employers policies as excluding coverage only if the recommending party (i.e., Energy) did something to cause or contribute to the recommended insurer’s (i.e., CHS’s) insolvency.

It was undisputed, the appeals court noted, that Energy did nothing of the sort. Moreover, the court added, it would have been a relatively simple matter for Westport and Employers to have written their limitations expressly to exclude CHS’s inability to pay, regardless of a wrongful act by Energy; however, the insurers did not do so.

Finally, the court noted that Kentucky, like the majority of jurisdictions, has adopted the rule that “if there is any allegation in the complaint which potentially, possibly or might come within the coverages of the policy, then the insurance company has a duty to defend.” Further, “[t]he duty to defend continues to the point of establishing that liability upon which plaintiff was relying was in fact not covered by the policy and not merely that it might not be.”

Here, the court noted, the complaint alleges that Energy was negligent, a claim that, at the very least, potentially would come within the coverage of the policy.

The judgment of the district court was affirmed.

Westport Ins. Corp. vs. Energy Financial Services, LLC. U.S. Court of Appeals, 6th Circuit. March 24, 2009.