United States: Federal Court Rules On Consequences Of Insurer’s Alleged Change Of Coverage Position Predicated On Post-Contracting Case Law
Insurance Coverage Case Advisory, Issue 72

In Illinois National Insurance Company v. Nordic PCL Construction, Inc., No. 11-0515, 2013 WL 5739639 (D. Haw. Oct. 22, 2013), the United States District Court for the District of Hawaii, applying Hawaii law, granted summary judgment to commercial liability insurers on their policyholder's bad faith counterclaim and request for punitive damages while reserving for trial counterclaims for negligent misrepresentation and reformation arising out of alleged construction defects at a newly constructed store. Id. at *1.

The policyholder, a general contractor, had purchased comprehensive general liability (CGL) and umbrella insurance policies in 2007, the terms of which provided coverage for "bodily injury" and "property damage" caused by an "occurrence." Id. at *1-2. At the time of contracting, the Ninth Circuit had predicted that, "if the Hawaii Supreme Court examined the matter, it would rule that, for purposes of insurance coverage, construction defects were not 'occurrences.'" Id. at *2 (citing Burlington Ins. Co. v. Oceanic Design & Constr., Inc., 383 F.3d 940, 948 (9th Cir. 2004)). In January 2008, the contractor was notified of alleged defects in the store roof causing water leaks and property damage, and in October 2008 it filed a claim with its insurers. Id. at *1-2. In May 2010, the Hawaii Intermediate Court of Appeals, "not[ing] that authorities were split as to whether defective workmanship was an 'occurrence' for purposes of a CGL policy, . . . adopted the majority position and held that, 'under Hawai'i law, construction defect claims do not constitute an 'occurrence' under a CGL policy.'" Id. at *4 (quoting Group Builders, Inc. v. Admiral Ins. Co., 231 P.3d 67, 73 (Haw. Ct. App. 2010)). Thereafter, "the Insurers took the position that no money would be offered to [the store] . . . in light of [the 2010 decision]," and they sought a declaration that they need not defend or indemnify their policyholder with respect to the construction defect claims. Id. at *1, 4. The policyholder filed counterclaims for bad faith, negligent misrepresentation, reformation, and punitive damages, all predicated on the allegation that the parties had entered the contracts intending coverage for such claims notwithstanding the case law. Id. at *1-3.

The court granted the insurers' motion for summary judgment on the bad faith counterclaim. It first explained that the policyholder was "not arguing . . . that the Insurers . . . acted in bad faith by unreasonably denying insurance coverage in contravention of the express language of the Policies" but rather that they were "liable for having changed their position as to coverage in light of" subsequent case law. Id. at *5. It recognized that the Hawaii Supreme Court had previously held that "a bad faith claim for the mishandling of a claim does not necessarily fail when the insurer demonstrates that no coverage is available under a policy," id. at *7, and also that there "clearly [we]re questions of fact" as to "the scope of coverage that the Insurers intended to provide when they accepted [the policyholder's] premiums, and as to whether, based on Group Builders, the Insurers changed their original coverage interpretation." Id. Nonetheless, the court concluded that the disputed questions of fact were not material and thus did not preclude summary judgment. Id. at *8. It reasoned that, "[g]iven Hawaii law providing that an insurer that denies coverage based on an open question of law does not act in bad faith, an insurer that actually relies on governing law, even if the insurer only belatedly learns of the law, cannot be said to thereby act in bad faith. This is a matter of law." Id. (citation omitted). The policyholder's contention that the insurers allegedly "'evaded the spirit of the bargain'" was misplaced, as the policyholder was "trying to apply a contract principle . . . to a tort claim." Id.; see also id. at *9 ("[R]eliance on governing case law to deny coverage is not bad faith if indeed coverage is unavailable under that case law, even if the reliance constitutes a change in position . . . . Such conduct may form the basis of other claims, but not of a bad faith claim."). Thus, "[e]ven assuming the Insurers believed at the time the Policies were entered into that the Policies' use of 'occurrence' covered property damage caused by subcontractors' defective work, the Insurers did not act in bad faith when they provided [their policyholder] with a defense . . . subject to a reservation of rights and filed this action seeking a declaration that there was no coverage." Id. at *8.

For similar reasons, the court granted summary judgment to the insurers on the punitive damages counterclaim. See id. at *13 (concluding that "the Insurers acted reasonably in challenging the existence of coverage, even assuming the Insurers changed their intent," such that their alleged conduct was not "wilful or wanton").

As to the counterclaim for negligent misrepresentation, however, the court denied summary judgment. First, although the insurers asserted that "they [had] made no false representation" concerning coverage for construction defects, the court reasoned that the policyholder's payment of a premium for "Contractors-Subcontracted Work-In Connection with Construction, Reconstruction, Repair or Erection of Buildings NOC" "raise[d] a question of fact as to whether the Policies covered [or were represented as covering] only damages to third parties caused by subcontractors' defective work," rather than more extensive coverage. Id. at *10 (capitalization omitted). Second, although the insurers argued that the alleged representations had not "relate[d] to a past or existing material fact," id., the court predicted that "the Hawaii Supreme Court would also recognize a negligent misrepresentation claim based on a speaker's present intention to do or not do something in the future, especially when the speaker's intent pertains to matters within the speaker's control." Id. at *11. Third, it rejected the argument that the policyholder was "not justified in believing that the Policies covered [its] subcontractors' defective work" because, as the insurers argued, it "could have easily discovered Burlington and determined that no such coverage existed": "A Ninth Circuit prediction as to how the Hawaii Supreme Court will rule does not preclude reliance on past practices and understandings, especially when insurance companies allegedly continued to provide coverage for such claims and the Insurers may have based their premiums on such coverage." Id. Lastly, responding to the insurers' argument that contributory negligence principles should bar any recovery, the court "predict[ed] that, in the insurance context, when coverage is sought for bodily injury or property damage, the Hawaii Supreme Court will apply . . . comparative negligence principles," such that "negligence might not preclude at least some recovery against the Insurers." Id. at *11-12.

As to the counterclaim for reformation, predicated on the policyholder's allegation that "there was a mutual mistake as to whether the Policies covered claims that both parties believed were covered," id. at *12, the court also denied summary judgment. It reasoned that the policyholder had "introduced evidence demonstrating that insurers in general were covering such claims and suggesting that the Insurers did not initially intend to deny coverage based on Burlington. Additionally, [the policyholder] paid a large premium for 'Contractors-Subcontracted Work-In Connection with Construction, Reconstruction, Repair or Erection of Buildings NOC.'" Id. at *13 (capitalization omitted). Thus, "a reasonable jury could infer that, at the time the Policies were issued, the Insurers meant to cover claims arising out of the defective work of [the policyholder's] subcontractors." Id. Trial was therefore necessary. Id.

The Nordic PCL decision is important because it sheds light on a rapidly developing area of the law, coverage under CGL policies for construction defects, and recognizes the varying consequences for coverage claims when post-contracting changes to the law may not coincide with the expectations of at least one of the parties at the time of contracting.

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