Damage From Defective Product Was “Expected” Despite Negligence Allegations.   

Illinois district court Judge Elaine E. Bucklo, applying Illinois law, found the mere inclusion of a negligence theory in an underlying complaint could not satisfy a policy’s occurrence requirement where there were no allegations of an unforeseen or accidental event that produced property damage.  Thus, while the court found the insured’s defective product caused property damage, the insurer had no duty to defend or indemnify because there was no alleged occurrence.

The underlying lawsuit stemmed from Chicago Flameproof and Wood Specialties Corporation’s (“Chicago Flameproof”) sale of lumber to JL Schwieters Construction, Inc. and JL Schwieters Building, Inc. (collectively, “JLS”).   JLS contracted to provide labor and material for the framing and paneling of four building projects that required the use of fire-retardant-treated (“FRT”) lumber that met International Building Code (“IBC”) requirements to be used for the exterior walls of each building.  JLS contracted with Chicago Flameproof to purchase a particular brand of IBC compliant FRT lumber, D-Blaze lumber.  Unbeknownst to JLS, instead of the D-Blaze brand, Chicago Flameproof delivered its in-house FlameTech brand, which despite being marked as FRT lumber, was not IBC compliant.   JLS used the non-compliant lumber in all four building projects.  When the building developer discovered the lumber was non-compliant, JLS was instructed to remove and replace it with approved RFT lumber.  JLS sued Chicago Flameproof, alleging, among other things, negligent or fraudulent misrepresentation regarding the type of lumber that it was providing, leading to significant costs and expenses for JLS, including damage to the exterior walls, wiring, and insulation of the buildings due to the removal process.

Chicago Flameproof tendered the defense of the lawsuit to its commercial general liability insurer, Lexington Insurance Company (“Lexington”).  Lexington sought a declaratory judgment that it had no duty to defend or indemnify because, according to Lexington, the claims against Chicago Flameproof did not involve property damage, were not the result of an occurrence, and were otherwise excluded by the policy’s business risk exclusions.  Chicago Flameproof filed a counterclaim seeking a declaratory judgment that Lexington has a duty to defend in the same federal lawsuit as well as two other lawsuits pending in Minnesota state court.  The parties filed cross-motions for summary judgment.

Under the policy, Lexington had a duty to defend Chicago Flameproof against any suit alleging “property damage” resulting from an “occurrence.”  The policy defined property damage to include “physical injury to tangible property.”  Under Illinois law, the cost of repairing and replacing an insured’s defective product or work generally does not constitute property damage.  However, coverage is not foreclosed where there are actual allegations of physical alternations to property other than the insured’s product.  The court held property damage was alleged in the underlying complaints because they alleged other building materials were physically injured or altered in the removal process.

The policy defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”  Under Illinois law, the term “accident” means “an unforeseen occurrence, usually of an untoward or disastrous character or an undesigned, sudden, or unexpected event of an inflictive or unfortunate character.”  An injury is expected if the injury “should have been reasonably anticipated by the insured.”   According to the court, although one claim against Chicago Flameproof was couched in negligence terminology, the core of JLS’s complaint was that Chicago Flameproof engaged in deliberate conduct—shipping of the wrong lumber and the concealment of that fact—that caused the alleged property damage.  Even if Chicago Flameproof did not intend the damages to the other building materials, Chicago Flameproof could have or should have reasonably anticipated that such injuries could result from supplying non-complaint lumber to JLS.  Thus, because the underlying complaints did not allege an occurrence there was no potential for coverage under the policies and the duty to defend and indemnify was not triggered.  Lexington Ins. Co. v. Chicago Flameproof & Wood Specialties Corp., NO. 17-CV-3513 (N.D. Ill. Aug. 10, 2018).