In this case, the United States District Court in Pennsylvania had to decide whether the insured's claim that a regular use exclusion in an auto policy could not be enforced because of the insured's reasonable expectations of coverage was valid. This case is Costello v. Government Employees Insurance Company, 2010 WL 1254273 (M.D.Pa.).

This case dealt with underinsured motorist insurance coverage and insurer bad faith issues, with the insurer, GEICO, making a motion for judgment on the pleadings. The facts are as follows. Costello was employed as an auditor with the state government and was operating a vehicle owned by the state and was acting in the course of employment when he was rear-ended by a car driven by Cox. The accident caused Costello serious, permanent, and disabling injuries.

Prior to the accident, Costello had purchased auto insurance with GEICO under a policy that included underinsured motorist (UIM) coverage in the amount of $100,000, stacked coverage for two vehicles. After the accident, Costello advised GEICO of an underinsured motorist claim. The insurer declined any UIM coverage due to the regular use exclusion. The insurer then filed this motion for judgment.

The U.S. District Court noted that the purpose of the regular use exclusion in an auto policy was to give coverage to the insured while engaged in the only infrequent or merely casual use of an auto other than the one described in the policy, but not to cover him with respect to his use of another auto that he frequently uses or has the opportunity to do so. The court also found that regular use exclusions that limit UIM coverage have been upheld as valid under Pennsylvania law. In addition, the court found that the exclusion did not violate the public interest.

The court said that the test for regular use does not consider how often a vehicle was actually used, but rather whether the vehicle was regularly available for use by the insured. And, determining whether a vehicle was available for an insured's regular use was a fact-intensive inquiry. The facts showed that Costello used a state owned vehicle 94.61 percent of the days he worked, and that his use of such a vehicle was not infrequent or casual. In fact, Costello had regular access to a state vehicle. Accordingly, the court decided that the regular use exclusion clearly applied in this instance and GEICO was entitled to a determination that UIM coverage for Costello was excluded.

Costello argued that the exclusion should not be enforced because he reasonably expected UIM coverage. In support of this argument, Costello supplied an affidavit showing that he increased UIM coverage from $30,000 to $200,000 and did not sign any type of rejection waiver. Moreover, Costello said that during the time he was an insured with GEICO, the insurer never explained to him that UIM coverage would be denied if he were injured while driving a state owned vehicle. In answer to this, the court said that it must look at the totality of the circumstances and factual evidence in determining what expectations are reasonable, and unfortunately for the insured, the court went on, at this stage of the litigation, adjudication of the reasonable expectations doctrine is premature. The court said that, other than Costello's affidavit, there is no evidence concerning the communications between Costello and GEICO or its agent regarding use of an employer provided car, or whether the GEICO agent knew that Costello expected UIM coverage when using such a vehicle. If the agent knew that Costello regularly used a government owned vehicle and assured him that there would be coverage under those circumstances, it is arguable that this created a reasonable expectation that the insured would be covered while operating the vehicle and that this expectation would prevail over the regular use exclusion. However, since there was no factual record of this, the court decided that it could not rule on the applicability of the reasonable expectations doctrine.

As for the bad faith claim against the insurer, the court said that since the regular use exclusion is applicable to this situation, there is no basis to find that GEICO acted in bad faith. The court found that GEICO acted reasonably in requesting and obtaining information relevant to the regular use exclusion, and that it performed a reasonable investigation into whether or not the regular use exclusion applied. The court said that no reasonable jury could find under a clear and convincing evidence standard that the actions of the insurer amounted to reckless disregard in this instance, so the bad faith claim against GEICO was dismissed.

In sum, the court granted the insurer's motion for judgment on the pleadings in part, dismissed the bad faith claim, and ruled that the adjudication of the reasonable expectations claim is premature at this point in time.

Editor's Note: The U.S. District Court did a commendable job in this case in discussing the reasonable expectations doctrine as opposed to the regular use exclusion. The reasonable expectations doctrine holds that the objectively reasonable expectations of insureds regarding the terms of an insurance policy will be honored even though a study of the policy provisions would have negated those expectations. And, as the court noted, the regular use exclusion has been upheld as a valid exclusion. When it comes to a conflict between the two, the finding of facts as opposed to findings of law will determine the outcome and that is the course taken by this court.

Other Insurance Clauses and the Duty to Defend

The Court of Appeals of New York had to settle a dispute between two insurers over the question of respective responsibility for the cost of defending a mutual insured. This case is Fieldston Property Owners Association v. Hermitage Insurance Company, 2011 WL 649812 (N.Y.). Note that this decision is uncorrected at this time and subject to revision before publication in the New York Reports.

Hermitage issued a commercial general liability (CGL) policy to Fieldston for the period July 5, 2000 to July 5, 2001. The other insurance clause in this policy declared that if other valid and collectible insurance was available to the insured for a covered loss, the Hermitage insurance was usually primary, but if other insurance was also primary, the coverage would be shared. Federal Insurance Company issued a directors and officers (D&O) liability policy to Fieldston for the period February 13, 1999 to February 13, 2002. This policy had an other insurance clause and that one stated that if any loss arising from a claim made against the insured was covered by any other valid policy, the D&O policy would apply but only to the extent that the amount of loss is in excess of the amount of such other insurance.

The insured, Fieldston, was sued by Chapel Farm which alleged several causes of action against the insured, including injurious falsehood. Hermitage demanded that Federal acknowledge its coverage obligations for defense, but Federal refused; Hermitage then proceeded to defend Fieldston under a full reservation of rights. This resulted in two declaratory judgment actions being filed by the insurers, with both of them seeking to establish the respective defense costs responsibilities. The trial court sided with Federal, concluding that the other insurance clause in the respective policies rendered Hermitage the primary and Federal the excess insurer as to defense costs. The appellate division reversed this decision and an appeal was then made to the Court of Appeals.

The Court of Appeals noted that in resolving insurance disputes, it first looked to the language of the applicable policies. In this instance, the court found that Federal's D&O policy provided that its coverage is excess where any loss arising from any claim made against the insured is insured under any other valid policy; also, loss was defined in the D&O policy to include defense costs. The Hermitage policy clearly applied to at least one of the causes of action against Fieldston. Therefore, under the terms of the D&O policy, there does exist other insurance that would cover the loss arising from the defense of the underlying actions. This meant that Hermitage had an obligation to defend the insured without contribution from Federal.

The court acknowledged that if the terms of the policies were drafted using different language, it might hold differently, but it had no power to rewrite contracts in this instance. The order of the appellate division was reversed and the judgment of the trial court was reinstated.

Editor's Note: This decision by the Court of Appeals of New York shows the importance of clear and definitive policy language, and this within the context of the other insurance clause. The clause in the D&O policy clearly stated that if “any” loss from “any” claim made against the insured is covered under any other valid policy, the D&O policy coverage is excess. Moreover, the D&O policy included defense costs in its definition of loss. Since the Hermitage policy did apply to at least one of the claims against the insured (and both insurers agreed on this point), the court had no problem in deciding that Hermitage was primary for defense and indemnity.

Note also that the court acknowledged that the result reached by the Appellate Division had a much more equitable appeal, but the policies' language did not support such a position.

Coverage under General Contractor's CGL Form for Faulty Work of Subcontractor

The Supreme Court of Indiana was presented with this issue: whether a standard commercial general liability (CGL) policy covers an insured contractor for the faulty workmanship of its subcontractor. This case is Sheehan Construction Company v. Continental Casualty Company, 935 N.E.2d 160 (2010).

Continental Casualty Company filed a declaratory judgment action to determine its obligation to its insured, Sheehan Construction Company. This was due to an underlying lawsuit filed against Sheehan by the Alig family who alleged faulty workmanship in the building of the Alig house. The Aligs alleged leaking windows, fungus growth on the house's siding, decayed OSB sheathing, deteriorating and decaying floor joists and water damage to the interior of the house. Sheehan had hired a subcontractor to actually build the house.

Sheehan requested coverage from its insurer, Continental, and the insurer agreed under a reservation of rights. The underlying case soon evolved into a class action lawsuit and was ordered into mediation. Continental participated in the mediation and a settlement resulted in the amount of $2.8 million. Continental then filed this declaratory judgment action.

The trial court determined that there was no property damage other than to the structural components of the homes themselves, that there was, therefore, no occurrence and no property damage under the terms of the policy, and then granted summary judgment to Continental. The court of appeals affirmed the ruling and the case went before the Indiana Supreme Court.

The Supreme Court discussed the varying decisions from around the country on the subject of CGL coverage for faulty workmanship. It found that there appeared to be two different rationales for the proposition that faulty workmanship is not covered under the CGL form.

On the one hand, the finding has been justified on public policy grounds; namely, the cost to repair and replace the damages caused by faulty workmanship is a business risk not covered under a general liability policy. The court, however, decided that it did not see the business risk rule as an initial bar to coverage, but rather as potentially excluding certain events from coverage under the “your work” exclusion where the policy is found to initially grant coverage.

On the other hand, a competing rationale finds no coverage as a matter of contract interpretation, that is, the fortuity implied by reference to accident or exposure is not what is commonly meant by failure of workmanship. In other words, faulty workmanship is not an occurrence as required for coverage under the terms of the CGL policy. The Supreme Court found that this rationale provided little guidance and was unhelpful to its analysis. Rather, the court decided that faulty workmanship does constitute an accident so long as the resulting damage is an event that occurs without expectation or foresight. The court said that this finding is more consistent with its definition of accident, that is, an unexpected happening without intention or design.

The court said that if the faulty workmanship is unexpected and without intention or design and thus not foreseeable from the viewpoint of the insured, then it is an accident within the meaning of the CGL policy. In this case, the facts showed that the insured, Sheehan, intended and assumed that the work would be completed properly. Sheehan hired a subcontractor to build the homes and had no reason to expect the work to be faulty. And, in connection with this line of thought, the court noted that the CGL policy had an exception to the “your work” exclusion so as to allow coverage for property damage arising out of the work of a subcontractor.

The court said that, by incorporating the subcontractor exception into the “your work” exclusion, the insurance industry specifically contemplated coverage for property damage caused by a subcontractor's defective performance.

The judgment of the trial court and the appeals court was reversed.

Editor's Note: This decision is presented due to the extensive case law that the Indiana Supreme Court noted in its decision. Case law from Arizona, Colorado, Illinois, Iowa, Ohio, Pennsylvania, West Virginia , and other states, is cited. The court also listed quotes from law reviews, Appelman on Insurance, and Couch in helping to make its decision. This ruling from the Indiana Supreme Court makes a powerful argument that a property damage claim based on faulty workmanship can be covered by the CGL form.

It is also interesting to note that the court and FC&S are in agreement that improper or faulty workmanship does constitute an accident as long as the resulting damage is an event that occurs without expectation or foresight on the part of the insured, as for example, the insured mistakenly cutting down trees on the wrong property or demolishing the wrong building.

Another Faulty Workmanship Ruling

The Supreme Court of Georgia has added its opinion to the list of courts' ruling on the coverage of faulty workmanship by the CGL form. This case is American Empire Surplus Lines Insurance Company v. Hathaway Development Company, 2011 WL 768117 ( Ga. ).

Hathaway Development, a general contractor, sued its plumbing subcontractor, Whisnant Contracting Company, for negligent plumbing work at three job sites. Hathaway sought to recover the cost of repairs caused by Whisnant's faulty workmanship; these costs went beyond those required to fix the plumbing mistakes to also include costs associated with water and weather damage to surrounding properties.

Whisnant failed to answer and, after the entry of a default judgment, Hathaway sought payment from Whisnant's insurer, American Empire. The insurer denied the claim, saying that there was no occurrence as defined in the general liability policy. The insurer stated that Whisnant's negligent workmanship could not be deemed an accident. A trial court granted summary judgment to the insurer and the appeals court reversed. The Supreme Court then heard the appeal under a writ of certiorari.

The court noted that it is commonly accepted that, when used in an insurance policy, an “accident” is deemed to be an event happening without any human agency, or if happening through such agency, is unusual and not expected by the person to whom it happens. The court also said that Georgia case law defines an accident as an unexpected happening rather than one occurring through intention or design. And, the court continued, this is in accord with a growing trend of jurisdictions that have considered construction defect claims under CGL policies and interpreted the word “accident” in this manner.

The court ruled that an occurrence can arise where faulty workmanship causes unforeseen or unexpected damage to property. In reaching this holding, the court rejected out of hand the assertion that the acts of Whisnant could not be deemed an occurrence or an accident under the terms of the general liability policy because they were performed intentionally. A deliberate act, performed negligently, is an accident if the effect is not the intended or expected result; that is, the result would have been different had the deliberate act been performed correctly.

The opinion of the appeals court was affirmed.

Editor's Note: The Georgia Supreme Court rules that intentional acts that result in unintentional results can be seen as an occurrence and thus, covered under the terms of the CGL form. This is another example of a court upholding the idea that if the insured intentionally performs a task that leads to unintended consequences, an occurrence can result. As is noted from the previous case from Indiana , this is akin to an insured deliberately tearing down the wrong building or cutting down trees at the wrong location. The insured's actions have to be seen from its viewpoint and even if the job is done correctly and according to specifications, a mistaken result is an accident.