Illinois Appellate Court Reverses Trial Court Ruling Insurer Owed No Duty to Defend Condo Board Under D&O Coverage: “Reserves” Exclusion Does Not Apply to Condo Owners’ Claims of Underinsurance

By Thushan M. Sabaratnam

In Truck Insurance Exchange v. Ulman, 2023 IL App (1st) 220804, the Illinois Appellate Court, First District, reversed a judgment on the pleadings and declaration an insurer owed no duty to defend a condo association’s directors under the condo policy’s Directors & Officers (“D&O”) coverage, holding the lower court erred in finding an exclusion of claims that directors underfunded “reserves” applied to unit owners’ claims the directors underinsured the condo building before a fire destroyed it in 2018.

Background Facts

A September 16, 2018, fire destroyed the Landings, a condo building containing 35 owner-occupied condominiums in Des Plaines, Illinois. Owners were members of the condo association and elected the association’s board of directors. The directors were responsible for, among other things, procuring insurance for the Landings and hiring the Landings’ property manager, Realty Advisors, Ltd., as well as its president and principal to manage the building.

Before 2017, the directors insured the Landings through an Allstate Insurance policy with coverage up to $8 million. In 2018, the board switched carriers to Truck Insurance Exchange (“Truck”), an insurer under the Farmers Insurance Group umbrella, and reduced the policy limit by $1.5 million to $6.5 million. By the time of the fire in September of 2018, the Landings carried $5.9 million in total coverage.

After the fire destroyed the condo building, the directors used the $5.9 million in insurance proceeds to pay a contractor to rebuild the building—$2.5 million less than the $8.3 million the contractor told the directors was required to fund the project to completion. The contractor ceased work when the insurance proceeds were exhausted, leaving the building uninhabitable.

The condo unit owners ultimately sued the association and its directors for breach of fiduciary duties, fraudulent misrepresentation, and violations of the Condominium Act and Declaration of Condominium, alleging that the directors underinsured the building for less than the full replacement cost of the building and mismanaged the reconstruction process.

Declaratory Action and Cross-Motions for Judgment on the Pleadings

Truck filed suit in state court seeking a declaration it had no duty to defend the directors against unit owners’ claims under its D&O, liability, or umbrella coverage and owed no duty to indemnify for the underlying claims related to the 2018 fire.

Truck and the unit owners filed cross-motions for judgment on the pleadings in their entirety, while the directors filed their motion as to the duty to defend under the D&O coverage only. In Truck’s motion, it admitted that the directors were insureds under the D&O coverage but argued the unit owners’ claims did not give rise to a duty to defend because the claims fell within Exclusions 8(c) (barring claims of failure “to establish or maintain adequate reserves”) and 12 (the “insured vs. insured” exclusion). Additionally, Truck argued there was no duty to defend the directors under the condominium liability coverage, as the unit owners’ underlying claims did not fall within coverage where they did not allege directors caused any “personal injury” or “property damage.”

The trial court granted Truck’s motion and declared the insurer owed no duty to defend the directors under the condominium liability or D&O coverage, finding the underlying claims fell within Exclusion 8(c) and a question of fact existed as to Exclusion 12. The trial court interpreted the policy language used in Exclusion 8(c), specifically whether the exclusion of claims relating to underfunding “reserves” included claims of underinsuring the condo building. The court concluded that claims of underfunding reserves and underinsuring were “functionally equivalent” and entered judgment for the insurer.

The association directors and unit owners appealed, arguing the trial court erred in finding Truck owed no duty to defend under the condominium liability and D&O coverage.

Analysis

The appellate court reversed and remanded for further proceedings.

Because the term “reserves” was not defined in the policy, it must be assigned its ordinary meaning. Outboard Marine Corp. v. Liberty Mutual Insurance Co., 154 Ill. 2d 90, 115 (1992). The Appellate Court discussed the definitions of “reserve” and “reserves” in Merriam-Webster’s Online Dictionary, Black’s Law Dictionary, and the Illinois Condominium Act (765 ILCS 605/2(n)). It noted that Truck acknowledged that there was no precedent in any jurisdiction holding insurance and cash reserves are functionally equivalent as found by the trial court. The First District found that none of the definitions referred to insurance and rejected the lower court’s finding that the underlying claims fell within Exclusion 8(c).

Moreover, even if insurance and “reserves” were functionally equivalent, the trial court’s ruling ignored the owners’ underlying claims against the association directors based on alleged mismanagement of the Landings’ reconstruction. There was no argument or finding below related to any exclusion of these claims based on Exclusion 8(c). Therefore, entry of judgment on the pleadings as to the duty to defend under the D&O coverage was improper.