Insurer’s Duty To Defend: How Explicit Must The Underlying Allegations Be?
October, 2010
Introduction
An insurer's duty to defend in Illinois and most other states turns on whether the facts alleged in the underlying complaint against the insured fall within, or potentially within, coverage under the insurance policy. See, e.g., Valley Forge Ins. Co. v. Swiderski Electronics, Inc., 223 Ill. 2d 352, 363, 860 N.E.2d 307, 314 (2006). It is not unusual, however, for the allegations of the underlying complaint to be unclear with respect to just what damages are being sought by the underlying plaintiff. When the allegations do not explicitly invoke coverage, but also do not necessarily foreclose the possibility of coverage, does the insurer still have a duty to defend? The Seventh Circuit Court of Appeals recently responded in the negative in applying Illinois coverage law to allegations brought against an insured manufacturer and seller of allegedly defective products. Amerisure Mutual Ins. Co. v. Microplastics, Inc., 2010 WL 3619785 (7th Cir. Sept. 20, 2010).
Facts
Microplastics, the insured, manufactured insert molding components, or plastic pieces, used in the manufacture of other mechanical devices. It began selling various of its components to Valeo Security Systems for use in automobile door latch assemblies that Valeo sold to automobile manufacturers. The relationship between Microplastics and Valeo was governed by purchase orders that included quality specifications and prices.
By early 2005, Valeo complained that some of Microplastics' products were defective. In August of 2006, Valeo sent a demand letter asserting a breach of the specifications in the purchase orders, terminating the relationship for cause, and advising that Valeo would take an offset against amounts Valeo owed Microplastics in the amount of $1.3 million.
Microplastics subsequently filed suit against Valeo for breach of contract. In response, Valeo filed a counterclaim, in Count I of which it sought a setoff and damages for economic losses incurred as a result of Microplastics' breaches. Count I alleged, among other things, that one of Valeo's customers "charged Valeo for its costs associated with the defects," and that Microplastics "is liable to Valeo for the costs charged to Valeo associated with the defects."
Microplastics notified its liability insurer, Amerisure, of the counterclaim. Amerisure provided coverage to Microplastics under a series of CGL policies that required Amerisure to pay Microplastics' damages to third parties as the result of "property damage" caused by an "occurrence." In response to the tender Amerisure issued a denial letter and brought this coverage action seeking a declaration that it had no duty to defend. While the coverage action was pending, Microplastics and Valeo reached a settlement.
Upon cross motions for summary judgment in the coverage action, the district court found that the Valeo counterclaim did not trigger a duty to defend, and granted judgment in favor of Amerisure and against Microplastics. Microplastics brought this appeal.
Analysis
In an opinion by Judge David Hamilton, the Seventh Circuit affirmed. The Court observed that, under Illinois law, the duty of an insurer to defend is typically determined by comparing the factual allegations of the underlying complaint - in this case, the counterclaim - to the language of the insurance policy.
The Court further noted, however, that allegations of defective workmanship in the insured's own products do not allege "property damage" under the standard CGL policy, which are intended to protect the insured from liability for damage to the property of others. Such policies do not pay the costs associated with repairing or replacing the insured's defective work and products, which are regarded as pure economic losses.
The problem here, said the Court, lay in the application of these rules to the vague allegations in Valeo's counterclaim. Microplastics argued that nothing in those allegations foreclosed the theoretical possibility that Valeo's customer charged back costs resulting from potentially covered damage to property beyond the defective products.
Relying on Santa's Best Craft, LLC v. St. Paul Fire and Marine Ins. Co., 611 F.3d 339 (7th Cir. 2010), and similar language in other cases, Microplastics further contended that the theoretical possibility was enough to trigger the duty to defend. In Santa's Best, the Seventh Circuit, relying on Illinois law, observed that if the facts alleged fell within "or potentially within, the policy's coverage, the insurer's duty to defend arises."
Microplastics advanced its argument still further by hypothesizing situations which, if alleged or true, would bring the costs charged back to Valeo within the scope of covered "property damage." It speculated, for example, that the costs charged back might be referring to damage to the personal property of consumers who bought cars, and whose trunk lids might have opened spontaneously because of the defects, causing property in the trunks to spill onto the roadways.
According to the Seventh Circuit, however, this interpretation went too far. While the duty to defend is broad, it is not unlimited. The Court noted Illinois case law stating that "it is the actual complaint, not some hypothetical version, that must be considered."
The Court also found instructive the case of Diamond State Ins. Co. v. Chester-Jensen Co., Inc., 243 Ill. App. 3d 471, 611 N.E.2d 1083 (1st Dist. 1993). In that case the underlying plaintiff sought damages from an HVAC system installer for defects in the system. The court found there was no coverage for the property damage alleged because, among other reasons, there were "no express allegations of physical injury to property, rather only allegations that [insured]'s thermal units failed to perform their anticipated function."
Like the underlying complaint in Diamond State, the Court here found that the Valeo counterclaim did not expressly allege physical injury to or loss of use of tangible property other than the property sold to Valeo by Microplastics. This was so even though the possibility of covered property damage was fully consistent with losses suffered through contract failure.
The Seventh Circuit did express concern about the fact that requiring an express factual allegation of covered damage could leave the insured at the mercy of the drafting whims of plaintiffs' attorneys. However, Illinois case law has dealt with this concern by drawing a distinction between allegations of legal theories and allegations of fact. The duty to defend is controlled by the factual allegations rather than the legal theory alleged. Thus a duty to defend may arise even if the legal theories are beyond coverage, so long as the facts alleged are within coverage. Here the factual allegations of the counterclaim were not within coverage.
Consequently, the Court affirmed summary judgment in favor of Amerisure.
Learning Points:
- The case does not purport to alter - and indeed the Court explicitly acknowledged - that any doubts or ambiguities with respect to the duty to defend should be resolved in favor of the insured.
- The case nevertheless recognizes limits on the insured's ability to invoke coverage where the complaint's allegations themselves do not trigger coverage, and the only basis for coverage is the insured's speculation and conjecture as to what the underlying plaintiff might be trying to recover.
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