Property Insurance Held Not To Be Equivalent of ‘Reserve’

By Don R. Sampen, published, Chicago Daily Law Bulletin, November 7, 2023

The 1st District Appellate Court recently held that a directors and officers insurer for a condominium association had a duty to defend claims that association directors and their agents failed to obtain adequate insurance coverage for a fire destroying the association’s building. The duty was imposed despite a policy exclusion relating to the failure to maintain adequate reserves.

The case is Truck Insurance Exchange v. Ulman, 2023 IL App (1st) 220804 (Oct. 20). The insurer, Truck, was represented by Lewis Brisbois Bisgaard & Smith LLP of Chicago. Honigman LLP of Chicago and Franklin Greenswag Channon & Capilla LLC of Northfield represented the insured defendants and unit holders.
In 2018, a fire destroyed the Landings, a condominium building in Des Plaines. The estimate to rebuild came to $8.3 million. The policy limit under the Landings Condominium Association’s property coverage issued by Truck, however, was only about $6 million.

As a result, in 2020 Landings unit owners filed a complaint against the association, three directors and property manager personnel. They claimed the defendants failed to obtain adequate insurance in violation of the Illinois Condominium Act and the condo association declaration. Claims also were included for breach of fiduciary duty, misrepresentation and mismanagement of the reconstruction process.

The Truck policy issued to the association included general liability and D&O coverage. In response to a tender of the underlying claims, Truck filed the instant action seeking a declaration it owed no duty to defend. It acknowledged that all the underlying defendants qualified as insureds, but contended that three exclusions barred coverage.

Specifically, it relied on exclusions under the D&O portion of the policy (a) for bodily injury and property damage, (b) relating to a failure of an insured to establish or maintain adequate reserves or levy adequate assessments for repair, and (c) for claims brought by or on behalf of an insured organization.

On cross-motions for judgment on the pleadings, the trial court found that the exclusion for failure to maintain adequate reserves applied. It reasoned that the failure to maintain enough insurance and the failure to maintain enough cash reserves were “functionally equivalent,” and it therefore granted Truck’s motion for judgment. The defendants appealed.

Analysis

In an opinion by Justice Michael B. Hyman, the 1st District reversed. He initially disposed of the exclusion for bodily injury and property damage. He agreed with the trial court that, while the underlying complaint alleged property damage, it did not allege that the insured defendants were responsible for such damage.

Thus, even though the condominium liability section of the Truck policy covered claims against insureds for property damage, the condominium general liability section was not triggered, and the exclusion in the D&O portion of the policy for bodily injury and property damage had no application.

Hyman disagreed with the trial court, however, regarding application of the exclusion for an insured’s failure to maintain adequate reserves or levy adequate assessments. He observed that the policy did not define a “reserve” and that dictionary definitions did not equate that term to insurance coverage.

Likewise, the Illinois Condominium Act, in defining “reserves” as sums maintained for specified purposes, makes no reference to insurance or insurance coverage. Based on these considerations, Hyman wrote the trial court erred in finding insurance to constitute the “functional equivalent” of cash reserves for purposes of the policy exclusion.

He further noted the underlying complaint was not limited to reserves but also alleged the defendants’ failure to obtain competitive bids and keep adequate records under the Condominium Act. Since those types of allegations could themselves result in liability, they provided an additional reason why the exclusion for reserves and assessments did not apply.

As for the exclusion for claims brought by or on behalf of an insured — i.e., the insured vs. insured exclusion — the issue was whether the underlying insured defendants had colluded with the underlying plaintiff unit holders to bring the claims against the insureds to obtain insurance coverage. Regarding this issue, Hyman agreed with the trial court that fact issues existed, thereby precluding judgment on the pleadings.

The 1st District therefore reversed the trial court and held in favor of the insureds regarding inapplicability of the reserves and assessments exclusion, and otherwise affirmed.

Key Point
For purposes of an exclusion to coverage for an insured’s failure to establish or maintain adequate reserves or assessments, an alleged failure to maintain adequate property insurance does not trigger the exclusion’s application.