The Impaired Property
Exclusion
Caroline B. Newcombe
I.
Introduction
1986 witnessed a change in commercial liability
insurance policies. In that year a
number of exclusions were added. This article deals with the impaired property
exclusion. This exclusion has been
characterized as “too complex,”
“difficult,” and “tricky.”[1] Few people outside the world of commercial
insurance know what the impaired property exclusion means or what it excludes.
The aim of this article is to provide information to students of insurance, and
indeed, to practitioners in the field.
The impaired property exclusion is found in commercial
general liability insurance (“CGL”) policies.
These policies are used extensively throughout the United States.[2] Although each commercial insurer is free to
write its own CGL policy, since 1940 most CGL insurance in the United States
has been written on standardized policy forms developed by a nationwide
industry service organization, known as the ISO (Insurance Services Office,
Inc.).[3] One of the most important insurance policy
forms developed by the ISO is the commercial general liability insurance
policy.[4]
In 1986, the ISO added the impaired
property exclusion to its commercial general liability policy form as exclusion
(m).[5] This was part of a significant revision of
the ISO’s CGL policy form which, among other changes, developed a new “claims
made” policy form,[6] added an
absolute pollution exclusion,[7]
and changed the name from “comprehensive” general liability to “commercial”
general liability policy.[8]
A. The Impaired Property Exclusion
The 1986 ISO form of the impaired
property exclusion which first appeared in commercial general liability
policies as exclusion (m), and which is the subject of this article, provides
that:
This insurance does not apply to: . . . .
(m) “Property damage” to “impaired property” or
property that has not been physically injured, arising out of:
(1) A defect, deficiency, inadequacy, or dangerous condition in
“your product” or “your work,” or
(2) A delay or failure by you or anyone acting on your behalf to perform
a contract or agreement in accordance with its terms.
This exclusion
does not apply to the loss of use of other property arising out of sudden and
accidental physical injury to “your product” or “your work” after it has been
put to its intended use.[9]
B. Nature of the Exclusion
The impaired property exclusion is a
property damage exclusion,[10]
in contrast to a contractual liability exclusion or a pollution exclusion. By incorporating the terms, “your work” and
“your product,” the impaired property exclusion is designed to apply to
contractors (“your work”) and product manufacturers (“your product”). It is
“designed to apply to a large group of insureds.”[11] It has been applied to manufacturers
(impaired property exclusion used to deny coverage for manufacturer of
defective liquid crystal displays that had been incorporated into instrument
panels on agricultural machinery)[12] and contractors (impaired property exclusion
applied to exclude coverage for painter’s faulty workmanship in failing to
prevent chips and dust from contaminating a home)[13]
as well as developers and realty owners.[14]
C. History of the Exclusion
To better understand the exclusion
it is useful to review its history. CGL
policies have undergone seven major revisions since they were first introduced
in 1940. The policies were revised in 1943, 1955, 1966, 1973, 1986, 1990, and
1993.[15] The impaired property exclusion grew out of
two earlier exclusions found in CGL policies; the “loss of use exclusion”[16]
and the “failure to perform exclusion.”[17]
The “failure to perform” exclusion
was first introduced in 1966.[18] This original version contained an exception
that was difficult to understand.[19] In 1973 another version of the exclusion was
introduced and, because it only applied to loss of use of tangible property,
this version of the exclusion became known as the “loss of use” exclusion.[20]
Unlike the 1966 exclusion, the 1973
exclusion contained a significant exception for loss of use of other tangible
property resulting from “sudden and
accidental” physical injury.[21] Although the new exclusion was an
improvement on the 1966 version, the language of the exclusion “led to battles
over what constituted physical and non-physical injury.”[22]
D. Concept of Impaired Property and Definition
Contained in Policy
It was not until 1986 that the concept of impaired
property was introduced into the new CGL policy.[23] In that year, the 1973 loss of use/failure
to perform exclusion was reformulated by the introduction of the concept of
impaired property, and the old exclusion became the new impaired property
exclusion.[24] This new exclusion was broader than the old
1973 exclusion. This is because the
1973 exclusion applied “only to loss
of use of tangible property which has not been physically injured . . .
whereas, the current [impaired property exclusion] applies to property damage
to ‘impaired property’ or to property (not merely its loss of use) that
has not been physically injured.”[25]
1. The Definition
An integral part of the impaired property exclusion is
the definitions contained in the policy.
These definitions are used to clarify coverage and are usually contained
in Section VI or Section V of most CGL policies under the heading
“DEFINITIONS.” Under the 1986 policy
definition section:
5. “Impaired property” means tangible property, other
than your product or your work that cannot be used or is less useful because:
a. It incorporates “your product” or “your work” that is known or
thought to be defective, deficient, inadequate or dangerous; or
b. You have failed to fulfill the terms of a contract or agreement;
if such property can be restored to use by:
a. The repair, replacement, adjustment or removal of “your product”
or “your work;” or
b. Your fulfilling the terms of the contract or
agreement.[26]
One
court has found the language contained in the definition of “impaired property”
to be “unambiguous.”[27]
The concept of impaired property can best be
illustrated by an example. A
manufacturer of rubberized tape sells his product to a maker of water
coolers. The tape is placed on the
water coolers, causing the coolers to “smell like rotting fish” and emit an
odor strong enough “to clear a building.”[28] A Pennsylvania court held that there was “no
doubt” the water coolers were impaired property within the meaning of the
exclusion.[29] The coolers were “‘impaired property’
because they were tangible property, other than [the insured’s] products or
completed work, that were only able to be restored to use by the replacement or
removal of the [insured’s] product [(the tape)] that formed a part of the
coolers.”[30]
Grounded aircraft provide another example of “impaired
property” in the following hypothetical.
A manufacturer of airplane tires sells his tires to TWA, who then mounts
the tires onto its airplanes. The tires
prove to be defective and, as a result, an airworthiness directive is issued by
a government agency grounding all TWA aircraft with the defective tires. The grounded aircraft are an example of impaired
property. The aircraft satisfy the
definition of impaired property because they have not been physically injured
and the aircraft are capable of being restored to use by the repair,
replacement, or removal of the defective tires. Of course, if an airplane with the defective tires crashes before
the defect is discovered, then the aircraft would be “physically injured” and
would no longer fit the definition of “impaired property.”[31]
IBM computers with flawed Intel Pentium chips may
provide another example of “impaired property.” If IBM files a claim against Intel for damages arising from the
recall of the IBM computers with the defective Intel chips, the claim might be
denied by Intel’s CGL carrier on the basis of the impaired property
exclusion. This is because the
computers would not be physically damaged but would be impaired property which
“could be restored simply by replacing the flawed chip.”[32]
Finally, although not making its decision in the
context of a claim involving the impaired property exclusion, one federal
district court refused to accept the argument that a defective disk drive
installed in a computer caused “physical damage” to the computer.[33] The court found instead that “[a] defective
disk drive does not injure a host computer upon incorporation. Instead, the drive only inflicts physical
injury on the computer if it actually damages other parts of the computer.”[34] The finding by a federal district court that
incorporation of a defective part into a computer does not constitute
physical damage to the computer is significant for application of the impaired
property exclusion. This is because it
satisfies a fundamental requirement for the exclusion to apply; namely, the
requirement that for property to be “impaired,” it cannot be physically
injured.[35]
Other examples of “impaired property” are instrument
panels installed in agricultural machinery made less useful because the panels
contained the insured’s defective liquid crystal displays,[36]
police baton holders which could not be used because they incorporated the
insured’s defective mold,[37]
a house constructed by a contractor who failed to install specific
waterproofing material,[38]
and a boiler house inside a power company that had to be shut down after the
insured’s giant fans failed to cool it.[39]
II.
Business Risks
The impaired property exclusion is one of a class of
exclusions found in general liability policies known collectively as the
“business risk” exclusions.[40] Business risk exclusions are designed to
prohibit insureds from recovering funds to correct deficiencies caused by their
own inadequate performance.[41] These exclusions are placed in commercial
general liability policies to make clear that the coverage is not intended as a
guarantee of the insured’s work,[42]
nor is it intended to provide for the replacement of the insured’s product.[43]
“Business risks” mean those risks that are predictable
and normal consequences of doing business.[44] The reasoning behind excluding business
risks from coverage is that the insured can control these predictable risks.[45] Risks that the insured can control
should not be the subject of insurance.[46]
Business risk exclusions were first included in CGL
policies in 1966.[47] These exclusions have been recognized as a
valid limitation on commercial liability insurance coverage.[48] The exclusions reflect the underlying
principle that the risk and cost of correcting poor workmanship or repairing a
defective product is a commercial risk which should not be passed on to an
insurance company.[49] Instead of being absorbed by the insurer,
business risks should be absorbed as a “cost of doing business” by the insured[50]
as normal, predictable, and expected consequences of doing business.[51]
The facts in Dorchester Mutual Fire Insurance Co.
v. First Kostas Corp.[52]
provide an excellent example of a business risk scenario expressly excluded
from coverage by the impaired property exclusion. The case involved a painting
contractor who entered into a contract to paint the outside of a house. After the job was completed, the homeowners
sued the painter claiming that lead paint chips and dust had contaminated the
inside of their house. The painter’s
general liability insurance company denied coverage. Relying on the impaired property exclusion and the principles
underlying all business risk exclusions, the court ruled in favor of the
insurance company. The court found that
it was an expected incident of doing business as a painter that paint chips and
dust might contaminate the surrounding area.
The court went on to hold that the allegations in the case “encompass a
scenario expressly excluded from coverage.”[53] Specifically, the court found that:
In the paint trade, scraping and sanding away old
paint -- which commonly contains lead -- is de rigueur. The possibility that chips and dust may
contaminate the surroundings is clearly a normal, foreseeable, and expected
incident of doing business. This
risk can and should be reduced to manageable proportions by prophylactic
measures (such as drop cloths and closed windows and doors) and careful
cleanup, but the possibility cannot be completely foreclosed because of the
nature of the business. This is
a classic business risk scenario, the cost of which is properly
reflected in the price of the painting service.[54]
In short, like other business risk exclusions, the
impaired property exclusion embodies the principle that, as a general matter,
the insured should be responsible for his own defective work or product.
The boundary between business risks which are not
insurable and insurable risks is explained by the New Jersey Supreme Court in
the frequently-cited case of Weedo v. Stone-E-Brick, Inc.[55] There, a masonry contractor sought coverage
under a comprehensive general liability policy for the cost of correcting his
faulty workmanship after the stucco he had applied cracked. In justifying its decision to deny coverage,
the court noted that:
[t]he insured contractor can take pains to control the
quality of the goods and services supplied. At the same time he undertakes the
risk that he may fail in this endeavor and thereby incur contractual liability
whether express or implied. The
consequence of not performing well is part of every business venture; the
replacement or repair of faulty goods and works is a business expense, to be
borne by the insured-contractor in order to satisfy customers.[56]
III.
Principles Underlying the
Impaired Property Exclusion
To better understand the impaired property exclusion,
it is helpful to examine the three principles that underlie it. The first principle is that a general
liability policy is not a performance bond.
The second principle involves recognition of the concept of
fortuity. The third is that the
coverage afforded by a general liability insurance policy is for tort
liability, not for contractual liability.
These three principles will be discussed below.
A. General Liability Policy is Not a Performance
Bond
The impaired property exclusion and the other business
risk exclusions have as their foundation, “the principle that general
liability policies are not intended to serve as performance bonds.”[57] Put another way, a CGL policy cannot be used
as a bond securing the insured’s performance under a contract.
Situations involving the impaired property exclusion
usually arise in cases of faulty construction or the defective design or manufacture
of a product. Far from serving as a performance bond, the impaired property and
other business risk exclusions make clear that they are designed to enforce the
principle that, as a general matter, liability insurance is not designed
to serve “as a warranty or guarantee of the insured’s product”[58]
and that business risk exclusions “protect insurers from contractors’ attempts
to recover funds to correct deficiencies caused by the contractors’
questionable performance.”[59]
B. Fortuity
The second principle underlying the impaired property
exclusion and the other business risk exclusions is the concept of
fortuity. The principle of fortuity is
“central to the notion of what constitutes insurance”[60]
and is “basic to insurance law.”[61] Insurance does not provide coverage for
losses that are certain or expected to occur. Instead, insurance is designed to protect against unknown
events.[62]
An insured’s failure of workmanship, or breach of
contract, with no consequential damage inflicted upon a third party, is hardly
enough to satisfy the fortuity element upon which insurance is based. In other words, “[t]he fortuity implied by
reference to accident or exposure is not what is commonly meant by a failure of
workmanship.”[63] Nor is the requirement of fortuity satisfied
by ordinary wear and tear. Under all
insurance policies, for a claim to be covered, the loss must involve a
fortuitous event; “losses occasioned by ordinary circumstances or wear and tear
are not covered.”[64]
In short, it is not the function of liability
insurance to protect against losses in which the element of fortuity is absent
– that is, losses that are almost certain to occur. Injuries caused deliberately “or by what might be described as
‘errors or omissions’ of the insured as opposed to well-defined accidents, and
legal injuries of a purely economic or commercial nature, are not the subject
of general liability insurance, and in some cases may not be the proper subject
of insurance at all.”[65]
C. General Liability Policies Protect Against Tort,
Not Contract Liability
The third principle which underlies CGL policies in
general, and the impaired property exclusion in particular, is that commercial
general liability policies are primarily designed to provide insurance against
risks grounded in tort, not contract.[66] Specifically, liability policies are not
intended to insure ordinary contract failure, but rather to protect the insured
in the event his product injures a person or causes damage to other property.[67] The difference between tort and contract
rests on the protection of different interests. Contract law protects the
contracting parties expectation interests.[68] Tort law, on the other hand, is designed to
protect society’s interest in being free from an unreasonable risk of harm.[69]
Clearly then, commercial general
liability insurance should not be, nor is it “intended to protect the insured
against contractual liability.”[70] Instead, the purpose of liability insurance
is to protect the insured from tort liability caused by negligence to third
parties.[71] Relying on an often-cited law review
article, the Wisconsin Supreme Court explains the difference between tort and
contract in the context of insurance coverage:
The insured, as a source of goods or services, may be
liable as a matter of contract law to make good on products or work which is
defective or otherwise unsuitable because it is lacking in some capacity. This may even extend to an obligation to
completely replace or rebuild the deficient product or work. This liability, however, is not what the
coverages in question are designed to protect against. The coverage is for tort liability for
physical damages to others and not for contractual liability of the insured for
economic loss because the product or completed work is not that for which the
damaged person bargained.[72]
IV.
Application of the Impaired
Property Exclusion
No single satisfactory test has been formulated to
determine when the impaired property exclusion will apply to deny coverage for
a specific claim.[73] Nevertheless, the following factors should
be considered in deciding whether the impaired property exclusion applies to a specific
claim. These seven factors are
presented in the following questions, which should be asked by any policy
holder or insurance company when confronted with a claim involving the impaired
property exclusion:
1.
Is the injured property
“capable of being restored to use” by the repair of the insured’s work or
replacement of the insured’s defective product?
2.
Does the insured’s
activity satisfy the “your work” or “your product” definition contained in the
policy?
3.
Is the underlying claim
based on physical injury or loss of use?
4.
Is the underlying claim
based on physical injury to “other property?”
5.
Does the claim against
the insured seek recovery merely for “economic loss?”
6.
Is the underlying claim
against the insured based on breach of contract?
7.
Did the loss arise out
of “sudden and accidental” injury to
the insured’s product or to his work?
1. Capable of Being Restored to Use
Central to determining whether the impaired property
exclusion will apply is the requirement that the injured property, other than
the insured’s product or work, “can be
restored to use by . . . [t]he repair, replacement, adjustment or removal of
[the] product.”[74] Injured property that cannot be restored to
use is not “impaired,” and the exclusion will not apply.
For example, in Federated Mutual Insurance Co. v.
Grapevine Excavation Inc.,[75]
the insured was hired to perform excavation and compaction work in connection
with the construction of a parking lot.
Six months after the parking lot was completed, it was discovered that
the “fill” material installed by the insured was not in accordance with the
general contractor’s specifications and had caused damage to the parking lot’s
asphalt paving. The court determined
that the impaired property exclusion did not apply because the paving
could not be “restored to use” simply by removing the insured’s underlying
defective fill. Specifically, the court
found that the impaired property exclusion was inapplicable because:
[T]here has been no suggestion that the damage to the
surface of the parking lot can be restored by “the repair, replacement
adjustment or removal of” [the insured’s] underlying work. . . . Indeed it is
inconceivable that any remedial or supplemental work could be done to [the
insured’s] portion of the project, all of which lies underneath the surface,
without removing and destroying the paving subcontractor’s work. . . .
Consequently, we conclude that the impaired property exclusion is inapplicable.[76]
Another court refused to apply the impaired property
exclusion after determining that it was “fanciful to suppose” that contaminated
food products (nut clusters used in a
General Mills cereal) could be “restored to use” by removing wood splinters.[77] Remarkably, in a strained effort to satisfy
the “restored to use” requirement of the impaired property exclusion, the
insurer argued that syrup-congealed cereal nut clusters could be “restored to
use” simply by removal of the splinters.[78] In refusing to apply the impaired property
exclusion to the loss the court found that:
[The insurer] has presented no evidence that the
contaminated products manufactured from the diced almonds could be “restored to
use” by removal of the wood splinters. Indeed, it is fanciful to suppose that
the nut clusters composed of congealed syrups and diced nuts or the boxed
cereal product containing the nut clusters could be somehow deconstructed to
remove the injurious splinters and then recombined for their original use.[79]
Finally, it is important to note that for the
exclusion to apply, the product at issue need not actually have been restored
to use, simply that the product could have been restored to use. For example, in Wisconsin Label Corp v.
Northbrook Property & Casualty Insurance Co.,[80] an insured manufacturer of labels sought
coverage for mislabeling 350,000 packages of a feminine hygiene product. The insured’s mislabeling caused the product
to be sold by the retailer, Wal-Mart, at $1.16 per package, rather than the
actual price of $2.47 per package.
Wal-Mart insisted that the insured reimburse it for lost profits caused
by the undercharging and for the cost of relabeling the remaining packages. The court began by observing that “[n]o
physical damage occurred in this case.
The products were improperly labeled, but both the products themselves
and the packaging remained physically undamaged at all times. The lack of physical damage is demonstrated
by the fact that the products were sold to customers with the improper
labeling.”[81] Although the court relied on other grounds
to deny coverage, nevertheless it made the following observation:
In addition, the circuit court concluded that even if
Wisconsin Label’s losses were due to “property damage,” the impaired property
exclusion precluded any coverage. The
[lower] court explained that the packages were “impaired property” under the
Policy definition because they could be restored to use by repair or
replacement of the labels. Wisconsin Label argued that the packages that
were sold at the wrong price were not “impaired property” because they could no
longer be repaired or replaced. The
[lower] court rejected this argument, because the definition of “impaired
property” requires only that the products “can be restored to use,” not that
they actually be restored to use. Since
the products could have been restored to full use by replacement of the labels
before they were sold, they were impaired property.[82]
2. Exclusion will not apply if it is not the insured’s
“work”
Closely related to the “restored to use” factor is the
“your work” factor. By its express terms, the impaired property exclusion
denies coverage for claims arising out of a “defect, deficiency, inadequacy or
dangerous condition in ‘your product’ or ‘your work.’”[83] The corresponding definitions of “your
product” and “your work” contained in the 1986 policy state that:
14. “Your product” means:
a. Any goods or products,
other than real property, manufactured, sold, handled or distributed or
disposed of by: (1) You; (2) Others trading under your name; or (3) A person or
organization whose business or assets you have acquired; and
b. Containers (other than
vehicles), materials, parts or equipment furnished in connection with such
goods or products.
“Your Product” includes
warranties or representations made at any time with respect to the fitness,
quality, durability or performance of any of the items included in a. or b.
above. “Your product” does not include
vending machines or other property rented to or located for the use of others
but not sold.”
15. “Your work” means:
a. Work or operations performed by you or on your
behalf; and
b. Materials, parts or
equipment furnished in connection with such work or operations.
“Your work” includes
warranties or representations made at the time with respect to the fitness,
quality, durability or performance of any of the items included in a. or b.
above.[84]
Thus,
the exclusion only applies to impaired property that can be restored by repair
of “your work.” If the “work” being restored is not that of the insured, then
the impaired property exclusion will not apply.[85]
In Esicorp, Inc. v. Liberty Mutual Insurance Co.[86]
a general contractor purchased steel pipe sections for a construction
project. The pipes were welded together
by a welder. The general contractor
hired the insured to inspect and approve the welder’s pipe welds before the
pipe was shipped to the construction site. When the pipe arrived on the site, the contractor discovered that
some of the pipe welds were defective and had to be repaired. The contractor sued the insured, claiming
that the insured’s negligent testing and approval of the defective pipe welds
caused him to incur damages and costs in excess of $3 million dollars.
The insured tendered the defense of the claim to his
CGL insurance carrier. The insurance
company declared that the losses alleged in the complaint were excluded under
the policy’s impaired property exclusion.
The Eighth Circuit agreed with the district court and found that the
exclusion for impaired property that can be “restored to use” by the repair of
“your work” did not apply. This was because
the insured’s “work” was the testing of pipe welds, not the welding itself. It would be impossible to restore the
defective pipes simply by further testing.
The court summarized:
Briefly stated, [the insurer] relied upon the
exclusion for “property damage to your work”. . . and the exclusion for “impaired property” that can be restored
by repair of “your work.” As the district court noted, [the insured’s] “work”
was the testing of the shop welds, not the welding itself. Even if pipe
sections containing defective shop welds were “impaired property,” they could
not be restored simply by further testing.[87]
For purposes of the impaired property exclusion, “your
work” or “your product” can include statements about the product.[88] In St. Paul Fire & Marine Insurance
Co. v. Futura Coatings, the court found the insured’s “work” to include not
only the products it supplied (in this case a sealant for concrete basins that
failed), but also “statements made by [the insured] concerning the fitness,
quality, durability, or performance of the products.”[89] Even “negligent advice” can fall within the
ambit of “completed work” or “your work” under an impaired property exception.[90]
As demonstrated above, critical to the issue of the
application of the impaired property exclusion is defining the work or product
of the insured. Once that has been determined, the issue then becomes whether
the claim against the insured is directly related to the cost of repairing or
replacing that “work” or that “product.”
3. No physical injury
By its express terms, the impaired property exclusion
only excludes damage to property that has not been physically injured.[91] If a claim for damages is based on actual
physical injury to the property of others, then the impaired property exclusion
will not apply. For example, in
Gaylord Chemical Corp. v. Propump, Inc.,[92]
the purchaser of a pump brought a claim against the seller and the
manufacturer, alleging that the pump’s performance was less than its
represented design capacity. The court
made the following observation regarding the application of the impaired
property exclusion:
We note first that the “impaired property” exclusion
only excludes damage to property that has not been physically injured or
for which the claimed damages are only
for loss of use of that property.
Therefore, any damages based on actual physical injury to [the pump
purchaser’s] plant, equipment, or other property would not be excluded under this
provision.[93]
4. Exclusion will not apply with injury to other
property
The impaired property exclusion will not apply to a
claim based on injury to “other property.”[94] In this context, the term “other property”
means property other than the insured’s work or product. If the complaint alleges damages arising
from injury to other property instead of injury to the insured’s product, then
the impaired property exclusion will not apply.[95]
The rule that the impaired property exclusion cannot
be applied if the claim arises from injury to “other property” is another
example of the different treatment accorded a claim based on breach of
contract, versus a claim for recovery in tort.
A general liability policy is not designed to protect the insured
against ordinary contract failures arising from damage to his own
product as previously discussed, “but rather to protect the insured in the
event the insured’s product causes damage to other property or persons.”[96]
5. No recovery for economic loss
The impaired property exclusion prohibits recovery for
economic loss and is included in a policy to prevent the insured from claiming
economic losses resulting from the insured’s work or work product.[97] If the complaint against the insured fails
to allege injury to other property and merely alleges economic loss resulting
from injury to the product itself, the impaired property exclusion will apply,
and there will be no coverage for the claim.[98]
“Economic losses are ‘disappointed economic
expectations’ . . . .”[99] Lost profits are a form of economic loss.[100] Other examples of economic losses are costs
of replacement and repair, and “diminution in the value of the product because
it is inferior in quality and does not work for the general purposes for which
it was manufactured and sold,” as well as damages for “consequent loss of
profits . . . without any claim of personal injury or damage to other
property.”[101] Technical building code violations that do
not result in damage to a structure or a building are another form of economic
loss.[102]
The case of Transcontinental Insurance Co. v. Ice
Systems of America, Inc.[103]
illustrates the application of the impaired property exclusion to deny coverage
for a claim based on damages for economic loss. This case arose out of a claim for lost profits after an ice
hockey game was cancelled because the portable ice rink the insured provided
failed to freeze properly. The promoter of the ice hockey game sued the insured.
The court found that the claimant was seeking to
recover “for what appear to be purely economic damages resulting from the
cancellation of the hockey game.”[104] The court went on to hold that since this
claim for economic loss fell squarely within the impaired property exclusion,
there was no coverage, and the insurance company was not obligated to defend or
indemnify the insured.[105]
6. Contract versus tort
If the damages sought in the underlying claim can be
characterized as contractual damages arising from promises made by the insured,
then these damages will be excluded from coverage under the impaired property
exclusion.
The purpose of insurance is to provide coverage for
the insured’s tort liability to others and not for contractual liability.[106]
Contract law protects disappointed contractual expectations,[107]
which is not an interest that tort law protects.[108]
Disappointed contractual expectations are also not an interest that insurance
ordinarily protects.
The vastly different consequences of whether a claim
sounds in tort or in contract for purposes of application of the impaired
property exclusion is seen in Glens Falls Insurance Co. v. Donmac Golf
Shaping Co.[109]
In that case the allegations of the complaint filed against the insured
determined whether the impaired property exclusion applied.[110] In Glens Falls, a contractor was
asked by a developer to construct a golf course. When the golf course was completed, it was determined that the
course was constructed on federally protected wetlands without obtaining the
necessary permits in violation of federal law.
As a consequence, the developer was required to undertake restoration
and preservation of certain areas on the golf course and to restore an offsite
wetland area.[111]
The court began its opinion by examining the
allegations of the developer’s complaint against the insured contractor, finding
that:
(1)
The failure of the
insured contractor to identify the wetlands and to comply with federal
regulations in the construction of the golf course was set forth as both a
breach of contract claim and a tort claim.[112]
(2)
The amount of money
sought by the developer as a result of the alleged acts and of the contractor
far exceeded the full contract price of $1.2 million paid to the contractor.[113]
(3)
The complaint was based
on the assumption that not only did the contractor breach his contract with the
developer by failing to construct the project in accordance with
specifications, but that the contractor committed a tort when he “negligently
built part of the project on federally protected wetlands.”[114]
(4)
In his prayer for
relief, the developer sought to recover
the expense of restoring the
damaged wetlands, purchasing and restoring an offsite wetland area, and the
resulting diminution of value in the
fair market price of the project.[115]
After reviewing the type of damages sought by the
developer, the court concluded that these were tort damages which did not arise
exclusively from the costs of repairing or replacing the insured’s own work.
If the alleged damages had been directly related to correcting
or repairing the insured’s deficient work, then they could easily have been
characterized as contractual damages calculated to “make good” the promises
made by the insured to the developer.[116]
These damages would easily have been excluded from coverage under the impaired
property exclusion, and there would have been no coverage for the claim. Instead, because they were tort damages, the
impaired property exclusion and the other business risk exclusions were “not
applicable to the type of tort damages sought.”[117] Specifically, the court found that in
contrast to cases where the damages sought by various plaintiffs against an
insured were all directly related to correcting their deficient work or
repairing their defective product,
the damages sought by the developer against [the
insured] are not directly related to the cost of repairing and replacing
deficiencies in [the insured’s] work on the project---and therefore excluded
from the CGL coverage as business risks---but rather are claims beyond the
scope of the contractual expectations for additional tort damages caused by the
alleged deficiencies in [the insured’s] performance.[118]
Finally, artful pleading cannot change an excluded
contract claim into a covered tort claim.
For example, in Unifoil Corp. v. CNA Insurance Cos., in an effort
get around the principle that the purpose of liability insurance is to provide
insurance against tort based claims and not contract based claims, one clever
insured argued that the claim he was seeking coverage for was really a claim
for negligent manufacture, rather than a breach of warranty claim.[119] In upholding the denial of coverage based on
the impaired property exclusion, the court found:
[E]ven if these actions were performed negligently,
they still are . . . intimately connected with the sale and the asserted breach
of plaintiff’s warranties concerning the goods . . . . On the facts before us,
we have no more than a warranty claim made against plaintiff by a customer who
suffered economic damages allegedly due to the failure of plaintiff’s product
to perform as specified.[120]
7. Sudden and accidental exception to impaired
property exclusion
The impaired property exclusion contains a significant
exception that renders the exclusion inapplicable if the loss of use of other
property is caused by “sudden and accidental” damage to the insured’s work or
to his product. Specifically, contained
in the impaired property exclusion is the following exception: “This exclusion does not apply to the loss
of use of other property arising out of sudden and accidental physical injury
to ‘your product’ or ‘your work’ after it has been put to its intended use.”[121]
Courts refer to this exception as the “sudden and
accidental” exception.[122]
It provides that the impaired property exclusion will eliminate coverage unless
the loss of use of other property was caused by “sudden and accidental” injury to the insured’s product or to his
work.
In order for the “sudden and accidental” exception to
apply, thus defeating the impaired property exclusion, two requirements must be
met. First, the insured’s work or product must have been put to its intended
use.[123] Second, the word “sudden” in the exclusion
has a temporal aspect. It does not mean
“unexpected,” but means that for the “sudden and accidental” exception to
apply, the damage must occur immediately or suddenly, and not over a period of
time.[124]
The case of St. Paul Fire & Marine Insurance
Co. v. Futura Coatings, Inc.[125]
provides an example of a court refusing to apply the “sudden and accidental”
exception after it found that the impaired property exclusion precluded
coverage for a large claim. The claim involved the insured manufacturer of a
sealant for concrete basins. The Connecticut
Light and Power Company had applied the sealant to its concrete basins, which
it used to hold untreated wastewater.
After the basins were coated with the sealant, they cracked, peeled, and
eventually failed completely. During application of the sealant, the concrete
basins developed pinholes known as “gassing.”[126]
When the court held that any claims were barred by the
impaired property exclusion, the insured manufacturer argued that the “sudden
and accidental” exception applied. The
court found the insured’s contention to be “without merit”[127]
because the cracking did not occur suddenly and because the “gassing” of the
sealant did not occur after the product was “put to its intended use,” but well
beforehand, during application.[128] Specifically, the court found that,
[the insured’s] argument that
the “sudden and accidental” exception to the “impaired property” exclusion
applies is without merit. The policy
provides that [the insurance company] will not apply the “impaired property”
exclusion “to damages that result from the loss of use of other property not
physically damaged that’s caused by sudden and accidental physical damage to
your products or completed work after they’ve been put to their intended
use.” Here, the alleged cracking and
peeling of the [insured’s] coating was not sudden and accidental, but became
apparent only as time passed after application. The “gassing” that occurred
during application also does not fall within this exception because it occurred
before the product was put to its intended use. Indeed, none of the
allegations in the complaint in the underlying action fall within the ambit of
the “sudden and accidental” exception. [129]
In short, Futura Coatings held that if the
insured’s product or work has not yet been “put to its intended use,” or if the
damage occurred “only as time passed,” rather than immediately or suddenly,
then the sudden and accidental exception will not apply.[130]
As explained in the first part of this article, one of
the principles underlying the impaired property exclusion is that general liability insurance is not
intended to provide coverage for the business risks of the insured. But where the cause of a loss is not faulty
workmanship, but rather accidental injury, then the exception is justified.[131]
The root notion, again is to exclude damages due to
actions, or failures of workmanship, that are within the insured’s
control. Similarly, the lack of faulty
workmanship justifies the exception to [the impaired property] exclusion “m” in
the case where other property is damaged because of “accidental” injury to the
insured’s work.[132]
V.
Public Policy Reasons To
Support the Impaired Property Exclusion
There are several public policy reasons supporting the
impaired property exclusion. First, it
is sound public policy to discourage defective products and shoddy
workmanship. For example, if an insured
that defectively manufactured a product was permitted to recover from its
insurer for the loss of anticipated profits under the theory that this
constituted “property damage,” then the result would be to:
transform a general liability policy into a guarantee
or contractual performance bond. In that event, the insured would not be
discouraged from defective workmanship since he or she would recover from the
insurer even if the diminution in value to the project arose solely due [to]
the defectiveness of its own work. [133]
Another public policy justification for the
enforcement of the business risk exclusions is the issue of control. Particularly with respect to contractors, it
is frequently the insured and the insured alone who can control the quality of
his work. One federal district court
noted that coverage for an insured’s incorrect work should be excluded to
“protect the insurer from ‘attempts to recover funds to correct deficiencies
caused by the contractors’ questionable performance’.”[134]
Justification for this type of exclusion is the belief that it is the insured
not the insurance company who has control over the quality of the services the
insured supplies.[135] Put another way, an insured contractor,
has a contractual business risk that he may be liable
to the owner resulting from failure to properly complete the building project
itself in a manner so as to not cause damage to it. This risk is one the general contractor
effectively controls and one which the insurer does not assume because it has
no effective control over those risks and cannot establish predictable and
affordable insurance rates.”[136]
VI.
conclusion
The purpose of this article has been
to analyze a business risk exclusion found in a particular and specialized type
of commercial insurance contract known as a CGL policy. The typical purchaser of such a policy is a
commercial enterprise, not an individual.[137] Such a purchaser is no doubt aware that
insurance coverage is not provided for all property damage, but only for the
type of coverage provided for in the policy.
The qualifying phrase, “to which this insurance applies” contained in
most CGL policies, underscores that fact,[138]
and the enforcement of the business risk exclusions make that clear. As one court stated, “(t)he limitations on
coverage are set forth in the exclusion clauses of the policy, whose function
it is to restrict and shape the coverage otherwise afforded.”[139]
Finally, even though a claim may be
subject to the impaired property exclusion, or to another business risk
exclusion, the exclusion may be waived by improper pleading.[140] In most jurisdictions if an insured files an
action against his insurer and the insurance company wants to rely on a
business risk exclusion to limit coverage, the insurance company cannot rely
merely on declination letters to preserve its defense. Instead, the company must raise any business
risk exclusion as an affirmative defense or the insurer may find that reliance
on the exclusion has been waived. As
stated by one appellate court:
This court holds that an insurance policy exclusion is
an affirmative defense that must be pled or may be waived. It was an error of law to conclude the
declination letters of [the insurer] sufficed to raise the policy exclusions in
lieu of pleading the policy language as an affirmative defense. In light of the conclusion that the
‘business risk’ exclusions must be pled as an affirmative defense, the case is
remanded to the trial court. Whether or
not [the insurance company] may amend its answer on remand to include the
“business risk” exclusions is a matter for the trial court to determine. . .[141]
ENDNOTES
[1] See Michael J. Brady, The Impaired Property Exclusion: Finding a Path Through the Morass, 63 Def. Couns. J. 380, 382 (1996) (citations omitted).
[2] Controlled Blasting, Inc. v. Ranger Ins. Co., 484 S.E.2d 47, 49 (Ga. Ct. App. 1997) (citation omitted).
[3] See Reliance Nat’l Ins. Co. v. Hatfield, 228 F.3d 909, 911 (8th Cir. 2000); Wis. Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 607 N.W.2d 276, 283 n.3 (Wis. 2000). The Insurance Services Office, Inc. consists of approximately 1,500 domestic property and casualty insurers and agents. See About ISO, at http://www.iso.com/docs/about.htm (last visited Dec. 12, 2001). The “ISO develops standard policy forms and files or lodges them with each State’s insurance regulators; most CGL insurance written in the United States is written on these forms.” Hartford Fire Ins.Co. v. Cal., 509 U.S. 764, 772 (1993).
[4] See Rowland H. Long, The Law of Liability Insurance § 10.03 [2], 10-12 (1997).
[5] See Brady, supra note 1, at 381; See also Delta Fiberglass Structures, Inc. v. United States Fidelity & Guar. Co., 2000 U.S. App. LEXIS 27382 at*4 (10th Cir. Nov. 2, 2000).
[6] See 1 Eric Mills Holmes & Mark S. Rhodes, Appleman on Insurance § 1.15, 66-67 (2d ed. 1996). “Claims made” and “occurrence” are two of the forms that an insurance policy can take. A claims made policy “insures against claims that are made during the policy period . . . .” Id. at 66. “In the occurrence policy, the peril insured is the “occurrence” itself. Once the occurrence takes place, coverage attaches even though the claim may not be made for sometime thereafter.” Am. Cas. Co. v. Continisio 17 F.3d 62, 68 (3d Cir. 1994). Unlike occurrence policies, claims made policies were developed to limit an insurance company’s liability “to a fixed period of time.” LaValley v. Va. Sur. Co., 85 F. Supp. 2d 740, 744 (N.D. Ohio 2000) (citation omitted).
[7] Earlier versions of the pollution exclusion contained a “sudden and accidental” exception that opened the door to coverage for environmental claims where none was intended. As one federal district court stated, the new 1986 “pollution exclusion is just what it purports to be - absolute . . . .” Alcolac, Inc. v. Cal. Union Ins. Co., 716 F. Supp. 1546, 1549 (D. Md. 1989).
[8] See James T. Hendrick & James P. Wiezel, The New
Commercial Liability Forms - An Introduction and Critique, 36 Fed’n Ins. & Corp. Couns. Q. 319,
320 (1986). The use of the adjective,
“comprehensive” did not mean that the policies were designed to cover all
risks. Liability policies were never
meant to be “all risk” policies. See
Standard Fire Ins. Co. v. O’Donley & Assocs., Inc., 972 S.W.2d 1, 6 (Tenn.
Ct. App. 1998). “The CGL is not, and
was never conceived to be, an ‘all-risk’ liability policy.” George H. Tinker, Comprehensive General
Liability Insurance - Perspective and Overview, 25 Fed’n Ins. Couns. Q. 217, 220 (1975). Instead, a comprehensive general liability
policy was named for two reasons.
First, it contained one “comprehensive” insuring
agreement covering all hazards within the scope of the insuring agreement that
were not otherwise excluded. This was in contrast to the “schedule” liability
policies of that day, which keyed coverage to separate insuring
agreement relating to specific hazards.
The new form was “comprehensive,” too, in that it provided automatic
coverage for new locations and business activities of the named insured arising
after policy inception.
Long, supra note 4, at 10-12, 10-13 (citations omitted).
[9] Donald S. Malecki & Arthur L. Flitner, Commercial
General Liability: Claims Made and Occurrence Forms, 193 app. B (5th ed.
1994). The 1986 form of the impaired
property exclusion is identical to the 1993 form of the exclusion except that a
title has been added to the top of the form.
Thus, the first paragraph of the 1993 version of the exclusion appears
with the following title in bold face:
m. Damage to Impaired Property or
Property Not Physically Injured
Id. at 250 app. E.
[10] Long, supra note 4, § 10.05[8] at 10-76.
[11] Hendrick & Wiezel, supra note 8, at 356.
[12] See Hamlin Inc. v. Hartford Acc. & Indem. Co., 86 F.3d 93, 96 (7th Cir. 1996).
[13] See Dorchester Mut. Fire Ins. Co. v. First Kostas Corp., 731 N.E.2d 569, 572 (Mass. App. Ct. 2000).
[14] See Hendrick & Wiezel, supra note 8, at 356.
[15] See Tinker, supra note 8, at 221. See generally Malecki & Flitner, supra note 9, at 181-261, app. B, C, E.
[16] Sentry Ins. Co. v. S & L Home Heating Co., 414 N.E.2d 1218, 1220 (Ill. 1980).
[17] Fritz K. Huszagh & Michael T. Hepburn, Insurance Coverage of Product Liability, Prod. Liab. Prac., §10.31, LEXIS, Secondary Legal Publications Group File.
[18] Malecki & Flitner, supra note 9, at 56.
[19] Id. at 56-57.
[20] The
1973 language of the new “loss of
use” exclusion excluded coverage for:
(m) to loss of use of tangible property which has not been physically injured or
destroyed resulting from
(1) delay in or lack
of performance by or on behalf
of the named insured or any contract or agreement, or
(2)
the failure of the named insured’s products or work performed by or on behalf
of the named insured to meet the level of performance, quality, fitness or durability
warranted or represented by the named insured; but this exclusion does not
apply to loss of use of other tangible property resulting from the sudden and
accidental physical injury to or destruction of the named insured’s products or
work performed by or on behalf of the named insured after such products or work
have been put to use by any person or organization other than an insured;
Malecki & Flitner, supra note 9, at 174 app. A.
[21] See supra note 20, last paragraph of text.
[22] Brady, supra note 1, at 381. After the introduction of the 1973 version of the exclusion, courts began to refer to the 1973 exclusion as either the “loss of use” exclusion or the “failure to perform” exclusion. For example, in United States Fire Ins. Co. v. Good Humor Corp., 496 N.W. 2d 730 (Wis. Ct. App. 1993), the court calls the 1973 exclusion the “failure to perform” exclusion. Id. at 739. Yet in Marglen Industries, Inc. v. Aetna Casualty & Surety Co., 5 Cal. Rptr. 2d 659 (Ct. App.1992), the same 1973 exclusion is referred to as the “loss of use” exclusion. Id. at 662.
[23] See Brady, supra note 1, at 381.
[24] Id. The new CGL form also incorporated the new concept of “impaired property” into exclusion (n), popularly known as the “sistership exclusion.”
[25] Malecki & Flitner, supra note 9, at 57.
[26] Id. at 199, 200.
[27] Island Lathing & Plastering, Inc. v. Travelers Indem. Co., 161 F. Supp. 2d 278, 289 (S.D.N.Y. 2001).
[28] St. Paul Fire & Marine Ins. Co. v. Bergquist Co., 28 Pa. D. & C.4th 141, 143 (Pa. Common Pleas Ct. 1996).
[29] Id. at 148.
[30] Id.
[31] At the same time the impaired property exclusion appeared, the definition of “impaired property” was also incorporated into another business risk exclusion known as the “product recall” or “sistership” exclusion. See Maleki & Flitner, supra note 9, at 198 (policy section (n)(3)). This airplane hypothetical is drawn from the historic origin of the “sistership” exclusion that arose “following an aircraft crash after which the airplane’s ‘sister ships’ were grounded and recalled to correct a common defect.” Hi-Port, Inc. v. Am. Int’l Specialty Lines Ins. Co., 22 F. Supp. 2d 596, 600 (S.D. Tex. 1997).
[32] Donald R. Ballman, Comment, Software Tort: Evaluating Software Harm by Duty of Function and Form, 3 Conn. Ins. L.J. 417, 442 n.88 (1996) (citation omitted); see also Joseph G. Manta & Christine N. Schultz, Y2K: Liability and Coverage Issues, 18 Temp. Envtl. L. & Tech. J. 27, 45 (1999), which found the impaired property exclusion to be “especially relevant for manufacturers of software and embedded chips. In the Y2K context, courts may similarly find that although computer systems and/or pieces of equipment are impaired by containing non-compliant date sensitive material, they are not damaged by containing such a feature. Thus, the impaired property exclusion should similarly bar coverage in those instances.”
[33] See Seagate Tech., Inc. v. St. Paul Fire & Marine Ins. Co., 11 F. Supp. 2d 1150, 1155 (N.D. Cal. 1998).
[34] Id. The same court also held that damages to the computer components caused by repair efforts cannot create coverage. Specifically, the court found that “damage arising from these repair efforts cannot create coverage where none exists.” Id. at 1155 n.4.
[35] See infra notes 93-95 and accompanying text for a discussion of the physical injury requirement.
[36] See Hamlin Inc. v. Hartford Accid. & Indem. Co., 86 F.3d 93, 95 (7th Cir. 1996).
[37] See Armament Sys. & Procedures, Inc. v. Federated Mut. Ins. Co., No. 97-1595, 1998 Wis. App. LEXIS 542, at *6 (Apr. 29, 1998) (unpublished).
[38] See Brosnahan Builders, Inc. v. Harleysville Mut. Ins. Co., 137 F. Supp. 2d 517, 528 (D. Del. 2001).
[39] See
Hartzell Indus., Inc. v. Federal Ins. Co., 168 F. Supp. 2d 789, 795 (S.D. Ohio
2001). This case nicely illustrates the difference between the definition
of impaired property, the impaired property exclusion, and the exception
to the exclusion. The boiler house
in the case was located inside the Allegheny Power Company (hereinafter
“Allegheny”). The insured had supplied Allegheny with seven roof fans to cool
its boiler house. When the propellers
on one of the fans disintegrated, the power company shut down the entire
facility. After a lawsuit was filed, one
of the issues became the application of the impaired property exclusion. The
court ruled first that “Allegheny’s boiler house fit[] squarely within the definition
of ‘impaired property.’” Id. at 799 (emphasis added).
The court also found that the shut down fit within the
impaired property exclusion.
“Although its facility was not physically injured, Allegheny experienced
property damage (i.e., a partial loss of use of its boiler house) arising from
an alleged defect, deficiency, inadequacy or dangerous condition in [the
insured’s] fan which disintegrated in November, 1994.”
Id.
What is remarkable about this case is that despite the
court’s finding that the boiler house was “impaired property” which appeared to
doom the insured, the court went on to hold that there was coverage for
the claim. This is because the
claim fit within the “sudden and accidental” exception to the exclusion.
The court concluded that:
the exception to the “impaired property” exclusion
applies in the present case. If [the
insured’s] fan simply had failed to work as warranted (for example by failing
to draw sufficient heat from the boiler house), then the impaired property
exclusion would preclude coverage . . . . Given that [the insured’s] fan
propeller suddenly and accidentally disintegrated, however, the resulting loss
of use of the boiler house is covered by virtue of the exception to the
exclusion. Id. at 801 n.20.
See infra notes 125-34 and accompanying text for a discussion of the “sudden and accidental” exception.
[40] “It is
clear that [the impaired property] provision is a form of a business risk
exclusion.” Armament Sys. &
Procedures, Inc., 1998 Wis. App. LEXIS 542, at *5,*6.
The other business risk exclusions are set forth below. While the impaired property exclusion is generally found in CGL policies as exclusion “m,” it may also appear, as it does in the following list of business risk exclusions, as exclusion “n.” For example, one federal district court noted that “[e]xclusions ‘k’ through ‘o’ [in a CGL policy] are commonly referred to as ‘business risk exclusions.’” Brosnahan Builders, Inc., 137 F. Supp. 2d at 527 n.9. The court went on to explain that exclusion (k) “applies to property damage to ‘real property on which you or any contractor or subcontractor working directly or indirectly on your behalf is performing operations, if the property damage arises out of those operations.’” Id. at 527-28 (quoting the policy). Exclusion (l) applies to property damage to “your product,” which does not include real property. Id. at 528. Exclusion (m) excludes from coverage claims arising out of your work and included in the “products-completed operations hazard.” This exclusion does not apply if the defective work was performed by a subcontractor. Id. Exclusion (n) excludes damage to impaired property “or undamaged property that has an inherent defect or is not in accordance with the terms of a contract.” Id. Exclusion (o) is known as the “sistership exclusion,” and it “operates to bar coverage for costs associated with the recall or removal of the product from the marketplace.” Id. at 528-29 (citation omitted).
[41] See Brosnahan Builders, Inc., 137 F. Supp. 2d at 527 n.9.
[42] See Dorchester Mut. Fire Ins. Co. v. First Kostas Corp., 731 N.E.2d 569, 572 (Mass. App. Ct. 2000).
[43] See Controlled Blasting v. Ranger Ins. Co., 484 S.E.2d 47, 49 (Ga. Ct. App. 1997). The purpose of liability insurance coverage is to “provide protection for personal injury or for property damage caused by the completed product, but not for the replacement and repair of that product.” Id. (citation omitted).
[44] See Tinker, supra note 8, at 224.
[45] Id.
[46] As one
commentator noted in an oft-cited article:
“Business risks,” then, are those risks which
management can and should control or reduce to manageable proportions; risks
which management cannot effectively avoid because of the nature of the business
operations; and risks which relate to the repair or replacement of faulty work
or products. These risks are a normal,
foreseeable and expected incident of doing business and should be reflected in
the price of the product or service rather than as a cost of insurance to be
shared by others.
Id.
[47] Standard Fire Ins. Co. v. Chester O’Donley & Assoc., 972 S.W.2d 1, 7 (Tenn. Ct. App. 1998).
[48] See Weedo v. Stone-E-Brick, Inc., 405 A.2d 788, 794 (N.J. 1979).
[49] See Standard Fire Ins., 972 S.W.2d at 7; Business risk exclusions “make clear that these policies do not cover the costs of repairing or replacing the insured’s defective product or faulty work.” Id.; see Tinker, supra note 8, at 224.
[50] See Newark Ins. Co. v. Acupac Packaging, Inc., 746 A.2d 47, 54 (N.J. Super. Ct. App. Div. 2000) (dictum).
[51] See Dorchester Mut. Fire Ins. Co. v. First Kostas Corp., 731 N.E.2d 569, 572 (Mass. App. Ct. 2000). See also Tinker, supra note 8, at 224.
[52] 731 N.E. 2d 569, 571 (Mass. App. Ct. 2000).
[53] Id.
[54] Id. at 572-73 (emphasis added).
[55] 405 A.2d 788 (N.J. 1979).
[56] Id.
at 791 (citations omitted). The court went on to say that,
An illustration of this
fundamental point may serve to mark the boundaries between “business risks” and
occurrences giving rise to insurable liability. When a craftsman applies stucco to an exterior wall of a home in
a faulty manner and discoloration, peeling and chipping result, the
poorly-performed work will perforce have to be replaced . . . . On the other
hand, should the stucco peel and fall from the wall, and thereby cause injury
to the homeowner or his neighbor standing below or to a passing automobile, an
occurrence of harm arises which is the proper subject of risk-sharing as
provided by the type of policy before us in this case.
Id. at 791-92.
[57] Gaylord Chem. Corp v. Propump, Inc., 753 So. 2d 349, 353 n.5 (La. Ct. App. 2000).
[58] Seagate Tech., Inc. v. St. Paul Fire & Marine Ins. Co., 11 F. Supp. 2d 1150, 1155 (N.D. Cal. 1998) (case does not involve impaired property exclusion).
[59] Brosnahan Builders, Inc. v. Harleysville Mut. Ins. Co., 137 F. Supp. 2d 517, 527 n.9 (D. Del. 2001) (citation omitted).
[60] Holmes & Rhodes, supra note 6, § 1.4, at 26. See Barry R. Ostrager & Thomas R. Newman, Handbook on Insurance Coverage Disputes 421-22 (10th ed. 2000) for a list of courts that have “limited insurance coverage, regardless of the language of a particular policy, to fortuitous or accidental events.”
[61] Chu v. Canadian Indem. Co., 274 Cal. Rptr. 20, 25 (Ct. App. 1990).
[62] Cal. Ins. Code § 250 (West 1993).
[63] J.Z.G. Resources, Inc. v. King, 987 F.2d 98, 103 (2d Cir. 1993) (quoting McAllister v. Peerless Ins. Co., 474 A.2d 1033, 1036 (N.H. 1984)).
[64] 43 Am. Jur. 2d Insurance § 683 (1982) (discussing marine policies).
[65] Long, supra note 4, § 10.01 [2] at 10-6.
[66] Calvert Ins. Co. v. Herbert Roofing & Insulation Co., 807 F. Supp. 435, 438 n.1 (E.D. Mich. 1992).
[67] Am. Home Assurance Co. v. Libbey-Owens-Ford Co., 786 F.2d 22, 28 (1st Cir. 1986).
[68] See Casa Clara Condo. Ass’n v. Charley Toppino & Sons, 620 So. 2d 1244, 1246 (Fla. 1993).
[69] Id.
[70] Calvert Ins. Co., 807 F. Supp. at 438 n.1 (E.D. Mich. 1992).
[71] Wis. Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 607 N.W.2d 276, 283 (Wis. 2000).
[72] Id. (citations omitted).
[73] One
court has proposed the following rules for application of the impaired property exclusion which it
refers to as “Exclusion M”:
The first is that if the complaint fails to allege
injury to other property, and merely alleges economic loss resulting from
injury to the product itself, the exclusion is applicable. The second is that if the complaint alleges
or otherwise establishes damage to other property, Exclusion M will not apply.
The third is that Exclusion M does not apply to situations arising from a
sudden and accidental injury to the product which results in economic loss.
Transcontinental Ins. Co. v. Ice Sys. of Am., Inc., 847 F. Supp. 947, 950 (D. Fla. 1994) (citations omitted).
[74] Shade Foods, Inc. v. Innovative Prods. Sales & Mktg., Inc., 93 Cal. Rptr. 2d 364, 377 (Ct. App. 2000).
[75] 197 F.3d 720 (5th Cir. 1999).
[76] Id. at 728.
[77] See Shade Foods, Inc., 93 Cal. Rptr. 2d at 377.
[78] Id. This case involved an initial claim of over $2.4 million dollars, after General Mills destroyed its entire stock of contaminated cereal, shut down production, and shipped the remaining supply of nut clusters back to the insured.
[79] Id.
[80] 607 N.W.2d 276 (Wis. 2000).
[81] Id. at 284.
[82] Id. at 281 (emphasis added).
[83] Malecki & Flitner, supra note 9, at 193 app. B.
[84] Id. at 201 app. B.
[85] See Esicorp,
Inc. v. Liberty Mut. Ins. Co., 193 F.3d 966, 970 n.2 (8th Cir. 1999). See also Potomac Ins. of Illinois v.
Huang, 2002 U.S. Dist. LEXIS 4710 (D. Kan. March 1, 2002) which involved
application of the impaired property exclusion to an insured window distributor
who installed windows in a home. After
the home leaked, and an action was filed, the court found that,
The Huangs’ home does not satisfy the definition of
“impaired property.” In order to be
regarded as impaired property, it must be “capable of being restored to use” by
either: (a) the repair or replacement
of the windows [the insured’s work/product] . . . the Huangs’ home clearly
could not have been restored to its prior condition simply by repairing or
replacing the windows.
Id. at *43.
[86] Id.
[87] Id.
[88] See St. Paul Fire & Marine Ins. Co. v. Futura Coatings, Inc., 993 F. Supp. 1258, 1263 (D. Minn. 1998).
[89] Id.
[90] Id. (citation omitted).
[91] See Newark Ins. Co. v. Acupac Packaging, Inc., 746 A.2d 47, 51 (N.J. Super. Ct. App. Div. 2000). No doubt to emphasize the “no physical injury” requirement of the exclusion, the 1993 version of the impaired property exclusion is identical to the 1986 version, except that the 1993 version added the following heading to the top of the exclusion in bold face type: “Damage to Impaired Property or Property Not Physically Injured.” Instead of physical injury, the claimed damages are generally for loss of use. Indeed, the earlier version of the impaired property exclusion was even called the “loss of use” exclusion. See Sentry Ins. Co. v. S & L Home Heating Co., 414 N.E.2d 1218, 1220 (Ill. App. Ct. 1980). In Sentry, an insured subcontractor improperly installed ventilation that resulted in the deterioration of a structure’s entire heat and air conditioning system. The insurance company took the position that certain exclusions (including an earlier version of the impaired property exclusion) precluded coverage for the claim. The court disagreed with the insurance company and held instead that the exclusion could not apply “since the clause, by its terms, applies to ‘loss of use of tangible property which has not been physically injured.’” Id. at 1221 (emphasis in original).
[92] 753 So. 2d 349 (La. Ct. App. 2000).
[93] Id. at 355 (emphasis in original).
[94] Transcontinental Ins. Co. v. Ice Sys. of Am., Inc., 847 F. Supp. 947, 950 (D. Fla. 1994).
[95] Id.
[96] Am. Home Assurance Co. v. Libbey-Owens-Ford Co., 786 F.2d 22, 28 (1st Cir. 1986).
[97] See Transcontinental Ins. Co., 847 F. Supp. at 950.
[98] Id.
[99] Casa Clara Condo. Ass’n v. Charley Toppino & Sons, Inc., 620 So. 2d 1244, 1246 (Fla. 1993).
[100] Id.
[101] Id.
[102] Timothy S. Menter & Matthew W. Argue, The Economic Loss Rule & Construction Defect Litigation, 8 Nev. Law. 18, 19 (Sept. 2000).
[103] Transcontinental Ins. Co., 847 F. Supp. at 950.
[104] Id.
[105] Id.
[106] See Wis. Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 607 N.W.2d 276, 283 (Wis. 2000); see also Calvert Ins. Co. v. Herbert Roofing & Insulation Co., 807 F. Supp. 435, 438 n.1 (E.D. Mich. 1992).
[107] Casa Clara Condo. Ass’n v. Charley Toppino & Sons, Inc., 620 So. 2d 1244, 1246 (Fla. 1993).
[108] Id.
[109] 417 S.E.2d 197 (Ga Ct. App. 1992).
[110] Id. at 199.
[111] Id. at 198.
[112] Id. at 201.
[113] Id.
[114] Id. at 200.
[115] Id. at 198.
[116] Id. at 201.
[117] Id. (emphasis added).
[118] Id.
[119] 528 A.2d 47, 51-52 (N.J. Super. Ct. 1987).
[120] Id. at 51, 53.
[121] See Malecki & Flitner, supra note 9.
[122] See St. Paul Fire & Marine Ins. Co. v. Futura Coatings, Inc., 993 F. Supp. 1258, 1264 (D. Minn. 1998); St. Paul Fire & Marine Ins. Co. v. Berquist Co. 28 Pa. D. & C.4th 141, 151 (Pa. Common Pleas Ct. 1996).
[123] See Berquist Co., 28 D. & C. 4th at 152.
[124] See
United Steel Fabricators, Inc., v. Fid. & Guar. Ins. Underwriters,
Inc., 1993 Ohio App. LEXIS 1422, *10
(1993). As explained by one Ohio court
in the context of a case involving the impaired property exclusion,
The [Ohio] Supreme Court interpreted ‘sudden and
accidental’ and held that ‘sudden’ in the exception [in the pollution
exclusion] is not synonymous with the word ‘unexpected’ in the typical
definition of ‘occurrence’; instead, the word has a temporal aspect . . . .”
[Another interpretation] of ‘sudden’ without a temporal aspect, did not allow
‘sudden’ to add anything to the phrase ‘sudden and accidental,’ since
‘accidental’ in its ordinary use means unexpected and unintended, and the two
words then have the same meaning. If
given the same meaning, the word sudden would not serve a purpose in the
phrase.”
Id. (citing Hybud Equip. Corp. v. Sphere Drake Ins. Co., Ltd. , 597 N.E. 2d 1096 (Ohio 1992)). See also, infra text accompanying note 132, in which a federal district court refused to apply the sudden and accidental exception where the loss occurred “only as time passed.”
[125] 993 F. Supp. 1258 (D. Minn. 1998).
[126] Id. at 1260.
[127] Id. at 1264.
[128] Id. at 1263.
[129] Id. at 1264 (emphasis added) (citation omitted).
[130] Id.
[131] See Hendrick & Wiezel, supra note 8, at 363.
[132] Id.
[133] N.H. Ins. Co. v. Vieira, 930 F.2d 696, 701 (9th Cir. 1991) (emphasis added) (alteration in original).
[134] Hi-Port, Inc. v. Am. Int’l Specialty Lines Ins. Co., 22 F. Supp. 2d 596, 599 (S.D. Tex. 1997) (citation omitted).
[135] Id.
[136] Knutson Constr. Co. v. St. Paul Fire & Marine Ins. Co., 396 N.W.2d 229, 234 (Minn. 1986) (emphasis added).
[137] See Holmes & Rhodes, supra note 6, § 1.15, at 65.
[138] See American Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22, 27 (1st Cir. 1986) (citation omitted).
[139] Id. (citation omitted)
[140] See Century Fire Sprinklers, Inc. v. CNA/Trans. Ins. Co. 23 S.W.3d 874 (Mo. App. 2000).
[141] Id.
at 879-80.
(Author’s
bio)
Caroline Bermeo Newcombe (arctic27@aol.com) is a graduate of the University of Virginia School of Law. She practices law in Los Angeles. Ms. Newcombe thanks Richard Newcombe for his support and attorney Charles A. Adamek for his wisdom