Introduction

Standard ISO exclusion

Failure to supply case

Varying endorsements can be problematic

Public entities are prime candidates for these exclusions

Umbrella and excess liability policy exclusions

No relationship to products/completed operations

Errors and omissions-type policies

Introduction

 Water districts, water companies, gas dealers or distributors, electric light companies or power cooperatives, fuel oil distributor, municipalities that provide utility services, and other entities that supply similar services to the public and business sector may have something in common. When they purchase commercial general liability insurance, they are likely to find their policies subject to a failure to supply exclusion. This exclusion, of which there are many examples, is used with primary and excess liability policies, and attempts to generally serve two purposes.

 The first purpose is to exclude damages and costs arising out of an entity's business decision to intentionally withhold (in whole or in part) an adequate quantity of its product for use or consumption by others. An example is when a utility voluntarily cuts back the amount of power generated in order to conserve usage for some legitimate reason. As a result, a manufacturer, for example, may be unable to utilize all of its production facilities and, thus, might sustain a monetary loss representing loss of use of machinery and resulting loss of business income.

 The second purpose behind the failure to supply exclusion is to assure coverage (by exception to the exclusion) for failure to supply stemming from sudden and accidental injury to tangible property owned or used by the entity (supplier) in question. For example, if the reason a water company must reduce the supply of product to users is because of the destruction of one of its pumps by fire, resulting liability should be covered by the policy.

 An actual case in point that illustrates the intent of this exclusion is Hall v. City of Youngstown, 239 N.E.2d 57 (Ohio 1968). In that case, firefighters were hampered in their efforts to extinguish a fire because a hydrant belonging to the municipal water company would not function. As a result of a failure to supply water to the hydrant, an individual lost his life in a fire. A subsequent investigation revealed that the failure of the hydrant to operate was due to the water district's negligence in not maintaining the hydrant in good working condition. The municipality was held liable for that death. (Note that the ruling was effectively superseded by the subsequent enactment of R.C. Chapter 2744, the Ohio Political Subdivision Tort Liability Act.)

 In the Hall case, the failure to supply exclusion would have applied, because the cause of this loss was a business risk assumed by the municipality. Such risks, generally speaking, are not insurable because they are under the control of the entity that is in the best position to determine how to avoid or at least reduce them. Insurers feel that covering such exposures might eliminate any incentive on the part of suppliers to exercise the high degree of caution and supervision they would otherwise perform if they knew there were no insurance application.

Standard ISO Exclusion

 It was in 1986 that the Insurance Services Office introduced, for the first time, with its commercial general liability revisions, its own version of the failure to supply exclusion. This endorsement is similar in intent to some endorsements that had been in existence for a number of years preceding the standard ISO endorsement. Titled "Exclusion—Failure to Supply", CG 22 50, this exclusion serves two purposes. The first is to exclude bodily injury or property damage arising out of the failure of any insured to adequately supply gas, oil, water, electricity or steam (and biofuel as of the April 2013 edition). However, by exception to this exclusion, as mentioned above, coverage continues to apply if the failure to supply results from the sudden and accidental injury to tangible property owned or used by any insured to procure, produce, process or transmit the gas, oil, water, electricity or steam (and, as revised, biofuel).

 When this exclusionary endorsement was introduced, one of the questions it generated was whether reference to "sudden and accidental" would result in the same temporal versus nontemporal dispute that was encountered with the sudden and accidental exception to the pollution exclusion (as first introduced with general liability policies in 1970). Briefly, insurers confronted with pollution claims maintained that reference to "sudden and accidental" is temporal in nature (i.e., these descriptive words related to how quickly the discharge, dispersal, release or escape of pollutants must be if there were to be coverage by exception to the exclusion). On the other hand, most insureds confronted with pollution claims have maintained that "sudden and accidental," as used in the context of the pollution exclusion, was nontemporal in meaning (i.e., the phrase means unexpected and unintended without limitation as to time). Although there have been disputes over the failure to supply exclusion, it appears, currently at least, that the issue over the sudden and accidental phraseology is not a problem.

Failure to Supply Case

 Claims involving failure to supply products and services that lead to litigation are relatively uncommon, probably due in part at least to loss control measures implemented by entities supplying the products involved. This does not mean that claims are nonexistent because they still do occur. In fact, one case that involved a failure to supply exclusion that referred to the "sudden and accidental" exception is Washington Energy Company v. Century Surety Company, 407 F. Supp. 2d 680 (U.S. Dist. Ct., W.D. PA. 2005). Although not a basis for denying coverage, the failure to supply exclusion was considered to be of some significance nonetheless. Briefly, Washington Energy supplied natural gas to Columbia Gas of Pennsylvania (Columbia). A part of Washington Energy's mechanical equipment used to transmit natural gas ruptured without warning. As a result of the rupture, air infiltrated Washington Energy's natural gas transmission line, as well as Columbia's main transmission line, which was connected to Washington Energy's line and the service lines of approximately 1,400 Columbia customers. The root cause of the crack was either corrosion or a manufacturing defect.

 As a result of the equipment failure, Columbia suffered a complete loss of use of the Columbia line due to the dangerous condition created by the air that infiltrated the Columbia line. This required Columbia to cease using its line and to take action to restore the line to use, including flushing its lines and those of its customers. Columbia then submitted a claim to Washington Energy for full payment of its loss. Washington Energy submitted the Columbia claim to its insurer, Century Insurance Company, which issued a reservation of rights letter indicating that the claim did not arise from property damage, as defined in its policy; Century also indicated that coverage might be precluded by certain exclusions.

 After the court concluded that both the impaired property and the products recall (sistership) exclusions were ambiguous, it turned to the failure to supply exclusion, which it said was significant because it specifically addressed the type of business in which Washington Energy was engaged. In other words, this exclusion provided some indication as to the intended coverage for Washington Energy's business, as opposed to the generic language in the main body of the policy which applied to all insureds without regard to their particular line of business.

 The court found the exclusion to be inapplicable in this instance since, based on its language, the exclusion appeared to be meant to apply in a breach of contract or warranty situation. The failure to supply exclusion, the court explained, was not applicable in this case, because there was no evidence in the record that the damages claimed by Columbia were based on a failure by Washington Energy to adequately supply gas to Columbia, or that Washington Energy breached a contract or warranty with Columbia. Rather, the evidence revealed that these losses consisted of consequential damages incurred as a result of the loss of use of Columbia's transmission lines, and those of its customers. Perhaps even more importantly, said the court, was Century's abandonment of this exclusion as a basis for denying coverage. By doing so, the court added, Century could not credibly argue that the claims brought by Columbia were based on breach of contract or warranty.

Also significant about the failure to supply exclusion, the court added, was the exception to this exclusion. Although the exception never came into play because Century abandoned its reliance on the failure to supply exclusion to deny coverage, the court said that the exception did inform the court as to Century's intended coverage under the policy with specific regard to Washington Energy's business of supplying natural gas. In essence, the exception provided that coverage existed under the policy when the failure to supply resulted from sudden and accidental injury to tangible property owned or used by the insured to process or transmit natural gas. Arguably, the court added, it appeared that if the failure to supply exclusion actually applied in this case, coverage would not have been precluded, because the interruption of the gas supply to Columbia and its customers resulted from sudden and accidental injury to Washington Energy's transmission equipment. Thus, the court concluded, the language in the exception to the failure to supply exclusion evidenced an intent to provide coverage when a sudden and accidental mechanical failure occurred in the insured's transmission equipment, and reinforced the court's conclusion that coverage actually existed under the policy for the losses. For all of the foregoing reasons, the court held that coverage applied for the losses claimed.

 Varying Endorsements can be Problematic

 Sometimes there is an advantage in using standard endorsements. Insurers sometimes find this out after something happens, such as in the case of Elizabethtown Water Company v. Hartford Casualty Insurance Company and Centennial Insurance Company, 998 F. Supp. 447 (U.S. Dist. Ct., D. N.J., 1998). Developers in the underlying action filed a complaint against Elizabeth Water Company (Water Company) alleging that the developers purchased a large tract of land for development because the Water Company represented that it would and could supply adequate water to the future development. As it turned out, the Water Company was said to have failed to supply water for all of the houses until a couple of years later, even though the water mains were completed sometime earlier, and despite the Water Company's ability to provide water to all of the houses and lots.

 The developers claimed that the Water Company's failure to provide water caused them to lose numerous sales and adversely affected their reputation. As a result, they sought damages for injury to their business reputation, and for their carrying costs, i.e., property taxes, mortgage payments, auction expenses, promotional expenses, and IRS expenses. The developers also claimed lost sales.

 The insurers of the Water Company were Centennial and the Hartford Casualty Companies. Centennial provided CGL and umbrella liability policies for two years, whereas the Hartford provided a CGL policy for the two years following the period when coverage was provided by the Centennial Insurance Company. Centennial denied coverage because the complaint did not allege bodily injury or property damage caused by an occurrence, as defined in the policy, and did not allege advertising injury, personal injury, or property damage liability caused by an occurrence, as defined in the umbrella policy. The Hartford also denied coverage because the allegations and circumstances surrounding the case did not comport with its policy definitions of occurrence or property damage.

 After the underlying case had settled, the Water Company informed both insurers to that effect and that the Water Company would pay the developers $1.75 million. The release stated that this amount was being paid because of the Water Company's potential liability to the developers on the negligence count. Centennial Insurance Company promptly responded that it was disclaiming the coverage. Centennial also sent the Water Company a letter supplementing its prior disclaimers and dealing with its failure to supply water endorsement.

 Both insurers denied coverage for essentially the same reasons even though their respective failure to supply endorsements read differently. In fact, the court stated that Centennial's and Hartford's definitions of property damage and occurrence were substantially similar such that they would be viewed as one and the same. Both definitions of property damage included loss of use of tangible property, which was not physically injured or destroyed, provided the loss was caused by an occurrence. Both definitions, furthermore, defined occurrence as an accident. Although there were slight differences in the respective definitions, the court found the differences to be insignificant.

 The insurers argued, however, that the circumstances and facts surrounding the developers' claims did not constitute loss of use, i.e., the second definition of property damage. The Water Company contended that it was its negligence that was the occurrence that caused the developers to suffer a loss of use of their real property, i.e., the opportunity to develop the property for sale. The Water Company added that the definitions of property damage and occurrence were patently ambiguous because they conflicted with state law and reasonable expectations. As it turned out, the court found that the developers did sustain a lost use of their property, but decided to leave up to the jury the issue of whether an occurrence had happened. The lost use of property was held not to be covered under the Hartford policy because of an exclusion that precluded coverage for loss of use of property arising out of the failure of any insured to perform a contract or agreement according to its terms. (Interestingly, the standard ISO definition of impaired property includes this wording about failure to perform a contract or agreement. Apparently, the Centennial policy did not include this wording or it might have been overlooked.)

 The next issue dealt with the failure to supply endorsements. The endorsement applying to the Centennial CGL policy read as follows: It is agreed that this policy does not apply to personal injury or bodily injury arising out of the interruption or [impairment] of electrical, gas or water service. Property damage shall not include damage arising out of inability of the insured to supply gas and/or electricity or water in quantities sufficient to meet the demands of the insured's customers unless such liability shall be the result of a sudden or unforeseen occurrence resulting from physical damage to tangible property and which is not related to a shortage of gas, electricity, water, distributional or generating capacity, or fluctuation in the level of demand of the insured's customers. Centennial's umbrella liability policy also included a failure to supply endorsement that stated that the policy "did not apply to personal injury, bodily injury or property damage arising out of the interruption or impairment of electrical, gas, or water service."

 The Hartford policy, unlike the policy of Centennial, contained a water utilities limitation endorsement that stated: It is agreed that the insurance does not apply to property damage arising out of the inability of the insured to supply water in quantities of pressure sufficient to meet the demands of the insured's customers, unless such inability is the result of an occurrence not related to a shortage of water or distributional capacity nor fluctuation in the level of demand of insured's customers.

 Hartford maintained that its water utilities limitation endorsement should be treated the same as Centennial's because the intent and meaning of the endorsements were the same. The court, however, disagreed, because the difference in word choice was significant. Centennial's exception to the failure to supply water exclusion of its CGL policy, the court explained, was limited to occurrences resulting from physical damage to tangible property. The exception, therefore, did not include property damage that was a loss of use of property. This insurer's umbrella policy's exclusion, furthermore, was said not to contain any exceptions, and flatly excluded coverage related to property damage from the interruption or impairment of water service.

 The court was said to have been inclined to grant Centennial's motion for summary judgment based on the plain language of its failure to supply water exclusions (CGL and Umbrella), but refrained from doing, because the Water Company created an issue of material fact on whether Centennial's exclusions were ambiguous. What had happened was that a Centennial employee who was handling this claim wrote in her computer that, as a result of a conference with her superior and claim manager, they agreed that a disclaimer was in order but that the failure to supply endorsement was not applicable. On the previous day, however, this claims person had written that she believed that Centennial should have disclaimed coverage because of the failure to supply endorsement. These contradictions therefore made the endorsements ambiguous.

 Hartford's water utilities limitation endorsement, on the other hand, permitted coverage where the damage arose out of an occurrence, defined to mean an accident. The problem here was that a jury question existed as to whether there was an occurrence in this case, as the Water Company had maintained. The Hartford endorsement, therefore, was held to be ambiguous. The Water Company also argued that the phrase "interruption or impairment" of water service in the Hartford umbrella liability policy was ambiguous because it did not indicate whether the exclusion applied to a situation where no water supply system was in place. In essence, the Water Company believed it was the jury's charge to decide whether interruption or impairment included the delaying of the initial supply of water. On this point, the court agreed with the Water Company that interruption or impairment was ambiguous, as applied to the facts of this case, and that this also was a question for the jury to decided; that is, whether the parties intended interruption or impairment to cover the situation in this case.

 In the final analysis, the court granted Hartford's motion for summary judgment, based on the insurer's exclusion which precluded coverage for "property damage to . . . property that has not been physically injured, arising out of . . . failure by any insured. . . to perform a contract or agreement in accordance with its terms." This exclusion, the court said, barred coverage of the Water Company's liability, because the developers' damages were the lost use of their property, i.e., property that has not be physically injured, and because the Water Company did not fulfill its agreement. The court recognized that the Water Company based its settlement with the developers on an asserted negligence claim, but to have permitted the Water Company to use negligence to frustrate the plain and unambiguous language of the exclusion, the court explained, would yield to form rather than substance. The exclusion, according to the court, was intended to preclude situations like this and, therefore, ruled in favor of the Hartford. Centennial, which did not have a similar exclusion, was allowed to continue its arguments for another day.

 Public Entities are Prime Candidates for these Endorsements

 It stands to reason that, considering the number of different services that public entities, such as cities, towns and counties, can provide, the liability policies issued to them will likely have a failure to supply exclusion of some kind. One such case, for example, where a village was subject to one of these endorsements is Scottsdale Indemnity Co., et al, v. Village of Crestwood, 784 F. Supp. 2d 988 (U.S. Dist. Ct., N.D. Ill. 2011). As it turned out, the issue was pollution and it became unnecessary for the insurer to deny coverage under the failure to supply exclusion. As a matter of interest, however, this exclusion precluded coverage for "bodily injury or property damage arising out of the failure of any insured to adequately supply gas, oil, water, electricity or steam." The endorsement apparently did not contain an exception such as the one offered by ISO.

 Umbrella and Excess Liability Policy Exclusions

 As has been pointed out through discussions of court cases, some insurers use the same failure to supply exclusionary wording as that of the ISO endorsement, whereas other insurers use more restrictive exclusions, particularly with respect to umbrella and excess liability policies and policies written in the excess and surplus lines market.

 It also is not uncommon to find umbrella policies, in particular, that contain broad based exclusions that are not failure to supply provisions. These provisions, instead, preclude coverage for all operations, however related to water and gas utilities, water companies and kindred providers of services. The obvious intent here is to avoid all coverage for these kinds of operations.

 Some umbrella policy insurers utilize limitation endorsements designed for use with public entities that exclude, for example, liability arising out of the complete or partial failure to supply electricity, gas, water or steam. However, sometimes these exclusions apply on a "follow form" basis; that is, the umbrella policy will cover claims to the extent they also are covered by the primary policy. These umbrella policy exclusions relating to service providers also can sometimes be deleted for an additional cost.

 This is not to say that umbrella liability policies categorically exclude all operations relating to service providers, nor is it to say that umbrella insurers do not provide the same kind of coverage exceptions as offered by insurers using the ISO endorsement; there are exceptions. However, caution must be exercised because exclusionary endorsements earmarked for use with these entities can vary. The only common denominator here is that these exclusions encompass only a failure to supply the product, not a defect in the product itself.

 No Relationship to Products/Completed Operations

 It is important to keep in mind that the failure to supply exclusion's primary purpose is to preclude coverage when the allegation involves the failure to supply an adequate quantity of the product in question; the exclusion has nothing to do with the quality of the product. This kind of exclusion, therefore, is not designed nor intended to preclude coverage for an injury caused by a defective product (e.g., water, steam, electricity) supplied by the entity. Products liability insurance is intended to cover the liability of a manufacturer or supplier of a product when the product fails to fulfill its purpose through negligence, breach of warranty or strict liability in tort and results in injury or damage sustained by others. A defect in, and injury arising out of, a product is separate and distinct from the exposure for failure to supply the product. If the insurer desires to exclude coverage for the products exposure, it can do so by issuing a products liability exclusion endorsement.

 Thus, if the supplier of natural gas were to allegedly cause an explosion because of a broken gas main resulting in injury or damage, or if a water company were to be accused of causing some injury due to some problem with the quality of the water, both such claims should be unaffected by the failure to supply exclusion but, instead, should fall under the products liability coverage (or exclusion).

 Relying on the failure to supply exclusion to preclude coverage for a claim properly characterized as arising out of a defect in a product also would most certainly conflict with the coverage designed to be provided for the products hazard, as defined in most general liability and umbrella liability policies. In fact, the policy definition of the named insured's products refers to goods or products manufactured, sold, handled or distributed by the insured, not to the performance of operations relating to the service of providing the product (e.g., oil, gas, steam, electricity or water). To confuse the failure to supply exclusion as being the equivalent of a products liability exclusion would be stretching it. Entities that are normally subject to the failure to supply exclusion may wish to obtain assurances that this kind of an interpretation will not arise.

 Errors and Omission-Type Policies

 Even if an entity's primary and umbrella liability policies were to preclude liability from the failure to supply, water, oil, gas, steam or other products, it is quite possible that the entity may still have protection under its directors and officers or public official liability policies.

 The D&O liability policy, for public and private corporations, and the POL liability policy for municipalities and other governmental agencies vary in coverage. While these policies generally exclude liability stemming from bodily injury and property damage, some of them cover liability from breach of contract, such as the failure to supply a product or service. So, while an entity's general liability insurance program may be subject to a failure to supply exclusion, the entity may still have some form of protection available to it under its D&O policy or its POL liability policy. Much, of course, will depend on the nature of the claim and the provisions of coverage.