Liability Insurance Coverage for Breach of Contract Damages - February 2007 - Tort and Insurance Law
| Publication year | 2007 |
| Pages | 39 |
2007, February, Pg. 39. Liability Insurance Coverage for Breach of Contract Damages - February 2007 - Tort and Insurance Law
February 2007
Vol. 36, No. 2 [Page 39]
Tort and Insurance Law
Liability Insurance Coverage for Breach of Contract Damages
by Ronald M. Sandgrund, Leslie A. Tuft
Tort and Insurance Law articles provide information concerning current tort law issues and insurance issues addressed by practitioners representing either plaintiffs or defendants in tort cases. They also address issues of insurance coverage, regulation, and bad faith.
Article Editor:
William P. Godsman of the Law Office of William Godsman, Denver - (303) 455-6900,wgodsman@qwest.net
This month's article was written by Ronald M. Sandgrund, Denver, a principal with Vanatta, Sullan, Sandgrund, Sullan & Smith, P.C. - (303) 779-0077, and Leslie A. Tuft, Denver, an associate with Vanatta, Sullan, Sandgrund, Sullan & Smith, P.C. - (303) 779-0077. The firm has represented both insurers and policyholders in coverage and bad faith disputes. The firm also handles construction defect disputes on behalf of homeowners and homeowners associations.
This article explores whether breach of contract damages can trigger liability insurance coverage. Although courts historically have been reluctant to find such coverage, recent trends reflect a greater willingness to find coverage for breach of contract damages under proper circumstances.
Many accept as hornbook law the proposition that liability insurance covers tort, not contract, liabilities. Recent cases question the continuing viability of this assumption. This article surveys case law regarding liability insurance coverage for purely contractual obligations, and discusses the analysis likely to be used by Colorado courts in addressing this insurance coverage issue. Finally, practical considerations for policyholders and claimants are discussed.
Historical Judicial Hostility
Many judicial decisions echo the general rule that liability insurance indemnifies against "liability sounding in tort, not in contract."(fn1) Some such decisions rely on policy language providing that coverage applies when the insured is "legally obligated to pay damages" to another, as well as the conclusion that "legally obligated to pay as damages" means liability arising ex delicto (from a tort) and not ex contractu (from a contract).(fn2)
Other cases rely on a policy's use of the term "accident" to define a covered "occurrence," holding that an "accident" refers to a fortuitous loss with resulting liability, but not liability "voluntarily assumed" pursuant to contract.(fn3) These decisions typically note, as one court put it:
[T]he important difference between contract and tort actions is that the latter lie from the breach of duties imposed as a matter of social policy while the former lie for the breach of duties imposed by mutual consensus, [and that extending coverage to contract liabilities presents the danger of] making the insurer a sort of silent business partner [with the insured, creating an] expansion of the scope of the insurer's liability . . . without corresponding compensation.(fn4)
Liability policies also typically contain an express "contractual liability" exclusion, which is discussed more fully below.(fn5) Many courts rely on this exclusion to find no coverage for contractual liabilities.(fn6)
Difficulties arise, however, even in jurisdictions that attempt to clearly demarcate coverage between tort and contract liabilities, because some liabilities may sound both in tort and contract. For example, implied warranty liability may arise pursuant to statute (such as a state's commercial code), or pursuant to public policy (such as implied warranties attendant to the sale of new homes). Thus, in Colorado, a seller or manufacturer may be liable for accidental property damage or bodily injury arising from a product defect that constitutes a breach of Colorado's implied warranties arising from the sale of goods.(fn7) Such liability may extend to damage to a consumer product itself.(fn8) Similarly, a new home builder-vendor may be liable for accidental property damage or bodily injury arising from its breach of Colorado's implied warranties. Such implied warranty liability cuts across traditional tort and contract boundaries, because it involves actual physical injury to a consumer's person or property and not merely loss of the benefit of a bargain.(fn9)
Recently, several courts, including the California, Wisconsin, and North Dakota Supreme Courts, have begun to question whether (if the underlying conduct and resulting injury is the same) the form of action chosen by the plaintiff should dictate whether coverage exists.(fn10) These same courts have found that the "contractual liability" exclusion is more limited in scope than argued by the insurance industry.(fn11) These cases are discussed in more detail in the section entitled "Emerging Judicial Views."
Colorado Law
Many Colorado cases have held, based on particular facts or policy language before them, that the policy at issue did not cover an insured's liability for a purely contractual obligation.(fn12) A discussion of several of these cases follows.
The A.D. Irwin Case
A.D. Irwin Investments, Inc. v. Great American Insurance Co.(fn13) arose from claims that the faulty design and installation of a commercial air conditioning system caused various losses, including: the cost to replace the inadequate system and make accompanying ceiling repairs; the expense of wrapping pipes to prevent further ceiling damage from condensation; ceiling redecoration expenses; and wall repair expenses due to vibrations. The insured's liability insurance policy provided coverage "for all sums that [the insured] might become legally obligated to pay as damages because of injury to or destruction of property, including loss of use, which was caused by accident."(fn14)
The insured appealed the trial court's finding that the damage was not the result of an "accident." The Colorado Supreme Court held:
damage which occurs and reoccurs over a continued period of time from the gradual accumulation of condensate or from the functioning or removal of inadequately powered and improperly installed motors is not the result of an accident.(fn15)
The court concluded that the case presented "a breach of contract," and that the insurer, by its liability insurance policy, did not "become a guarantor of perfect performance."(fn16) Because A.D. Irwin concerned a policy form that did not contain the broader term "occurrence" typically found in today's policies, its continuing vitality is unclear.
The Gerrity Co. Case
The plaintiff-insureds in Gerrity Co. v. CIGNA Property & Casualty Insurance Co.(fn17) had a liability policy covering bodily injury and property damage arising out of "an occurrence." The insureds sued their insurer for refusing to defend a lawsuit that sought to impose liability on the insureds under a continuing guaranty given to secure the performance of a contactor who walked off a government job, which resulted in various sureties paying to finish the work. The policy excluded coverage for contractual liability in a non-standard exclusion, stating: "This insurance does not apply: (a) To liability by the insured under any contract or agreement except in incidental contracts."(fn18) The Colorado Court of Appeals found no coverage, because the underlying complaint did not allege that any contractual liability arose from an "incidental contract." In response to the plaintiffs' claim that the underlying complaint's negligence allegations triggered the insurer's duty to defend, the court held:
all the allegations of negligence, if proven, would amount to nothing more than a breach of contract; they do not, and cannot, allege a separate tort claim. As such, the policy exclusion applies, and [insurer] properly denied a defense.(fn19)
The Hottenstein Case
In Union Insurance Co. v. Hottenstein,(fn20) the Colorado Court of Appeals analyzed coverage under the current Commercial General Liability (CGL) insurance policy form(fn21) for an arbitration award of $67,250 on a breach of contract claim, and $9,915 on a negligent construction claim arising from a renovation contractor walking off the job before completion. The court noted that the policy contained the undefined term "accident," which prior case law had construed to mean an unanticipated or unusual result flowing from a commonplace cause.(fn22) The court observed that "[a] breach of contract is not generally an accident that constitutes a covered occurrence."(fn23)
The Hottenstein court also analyzed the insured's contention that coverage existed under the policy's exception to the "contractual liability" exclusion, which exception restored coverage for "insured contracts," a defined term. The court found that the contract at issue was not an insured contract within the meaning of the policy, but noted that if a construction contract falls within the exception to the contractual liability exclusion, indemnity might be allowed for property damage resulting from the contractor's breach of its express warranties.(fn24) This statement, albeit dicta, suggests that the court conceived of some circumstances where breach of contract liability might arise from a covered "occurrence." The court also rebuffed the insured's suggestion that it "recharacterize" her contract damages as negligence damages, particularly where there was no evidence that the damage extended "beyond the scope of the contractor's work."(fn25)
Hottenstein's holding centers on the distinction between damages flowing from a breach of contract unrelated to any actual property damage or loss of use, such as a simple failure to build in accordance with the applicable...
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