Prevention Costs Held Not to Constitute Property Damage

By Don R. Sampen, published, Chicago Daily Law Bulletin, April 4, 2023

The U.S. District Court for the Northern District of Illinois recently held that a steel subcontractor’s defective work, causing the general contractor to incur added costs for investigating, designing and implementing repairs, constituted only “economic damages” for which the subcontractor’s insurance policies provided no coverage.

The case is St. Paul Guardian Insurance Co. v. Walsh Construction Co., No. 15 C 10324, 2023 U.S. Dist. Lexis 36690 (March 6). The insurers, St. Paul Guardian Insurance Co., Travelers Property Casualty Co. of America and Charter Oak Fire Insurance Co., were represented by several counsel, including Karbal, Cohen, Economou, Silk & Dunne LLC of Chicago. Goodman Law Group of Chicago and other counsel represented the general contractor seeking coverage as additional insured, Walsh Construction Co.

Walsh contracted with the city of Chicago to build a steel canopy and for related work at O’Hare Airport. Through sub- and sub-subcontracts, LB Steel was retained to supply the steel elements and perform welding for the project. LB Steel’s contract required, among other things, that it indemnify and name Walsh and others as additional insureds on its insurance coverage.

In 2004, the city found cracks in welds for the project, and in 2007, it brought suit for defective design and construction. By 2010 allegations were added against Walsh for contract-related breaches and damages. Walsh eventually reached a settlement with the city and agreed to repair certain defects, including retrofitting steel columns that prevented the canopy from collapsing.

Walsh also filed a third-party complaint against LB Steel for breach of contract and professional negligence. It sought recovery for the settlement it reached with the city and for additional damages for its costs relating to the defective welds, investigation and other repairs.

Moreover, as an additional insured under LB Steel’s policies, Walsh tendered its defense of the city’s lawsuit to LB Steel’s insurers — St. Paul, Travelers and Charter Oak — but they declined to defend.

In 2015, Walsh obtained a judgment against LB Steel, which, after credits and setoffs, came to about $19 million. In the meantime, LB Steel filed for bankruptcy. In 2018, the bankruptcy court approved a settlement between LB Steel and Walsh, giving Walsh access to certain deposited funds and an unsecured claim against the bankrupt estate.

St. Paul brought the instant federal declaratory action against Walsh in 2015, and the other two carriers joined thereafter. In amended pleadings, the insurers sought a determination that their policies provided no coverage for the LB Steel settlement with Walsh and no duty to defend or indemnify Walsh in its litigation with the city. Walsh counterclaimed for breach of the duty to defend and bad faith.

The parties subsequently filed cross-motions for summary judgment.

Analysis

In an opinion by Judge Virginia M. Kendall, the court held in favor of the insurers. She initially addressed whether the policies covered Walsh’s bankruptcy settlement with LB Steel.

She observed that the policies covered “property damage,” which, under Illinois law, meant damage to tangible property causing an alteration in appearance, shape, color or in other material dimension. On the other hand, property damage does not include costs associated with repairing or replacing the insured’s defective work and products, which are regarded as purely economic loss.

Under this reasoning, Kendall regarded Walsh’s costs in repairing and replacing LB Steel’s defective steel parts as constituting purely economic losses and not property damage. This was so despite Walsh’s argument that the canopy built of LB Steel’s defective steel parts underwent detrimental physical changes, for which Walsh incurred costs in retrofitting to prevent its collapse.

Such repairs, in Kendall’s view, were incurred to prevent the canopy from collapsing. The policies, however, were triggered only by the product’s actual failure, not by the potential for failure in the future.

As for Walsh’s professional negligence claim against LB Steel, LB Steel had obtained a summary judgment ruling in the state court litigation that those damages likewise constituted economic losses, for which Walsh was barred from recovery. Walsh was barred from recovery not by any insurance principle but under Illinois’ so-called Moorman doctrine. That doctrine holds that economic losses are not typically recoverable in tort.

In sum, Kendall wrote that the city’s concerns about the canopy’s stability suggested only that LB Steel’s products failed to perform adequately, not that any actual property damage had occurred.

Based on these determinations, Kendall quickly disposed of Walsh’s remaining claims. On the duty-to-defend-and-indemnify counts, she found that the city’s claims against Walsh sounded in contract, did not suggest any property damage resulting from an occurrence, and alleged only economic loss. She further found that no bad faith arose from the insurers’ handling of Walsh’s claim.

The court therefore granted the insurers’ summary judgment motions as to all counts and denied that of Walsh.

Key Point

Liability insurance policies covering “property damage” do not typically cover costs incurred to prevent or avoid property damage, which are more likely regarded as economic losses.