Hartford Fire Insur v. St. Paul Surplus ( 2002 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 01-1946
Hartford Fire Insurance Company,
Plaintiff-Appellant,
v.
St. Paul Surplus Lines Insurance Company,
Defendant-Appellee.
Appeal from the United States District Court
for the Northern District of Indiana, South Bend Division.
No. 98 C 584--Allen Sharp, Judge.
Argued September 10, 2001--Decided February 6, 2002
Before Posner, Kanne, and Evans, Circuit
Judges.
Posner, Circuit Judge. This diversity
suit, governed all agree by California
law, involves a dispute between two
insurance companies over the scope and
applicability of the form of insurance
known as a "vendor’s endorsement." A
manufacturer will often add to its
products liability insurance an
endorsement extending coverage to
distributors of its product who may be
sued for breach of warranty or for strict
products liability should the product
turn out to be defective or unreasonably
dangerous and cause an injury. "When a
manufacturer produces a product which
contains a defect in design or one caused
by faulty workmanship and it is sold to a
distributor who in turn sells it to a
retailer, the latter two links in the
chain to the ultimate consumer ordinarily
are merely conduits in the stream of
commerce which ends at the ultimate
consumer. The manufacturing or design
defect, as to which they had no creative
role, was in existence when each of them
received the product and each is merely a
nonculpable accessory in the eventual
sale. Nevertheless, each, in that role,
is strictly liable to the injured
ultimate user. . . . The nonculpable
distributor or retailer is not, however,
without remedy and has ’an action over
against the manufacturer who should bear
the primary responsibility for putting
the defective products in the stream of
trade.’ . . . Since, in the ordinary
case, the liability trail eventually
leads back to the manufacturer, and
consequently to his insurer, it is a
matter of common sense and fair dealing
that the coverage of the manufacturer
should be extended to the distributor and
the insurance of the distributor in turn
cover the retailer." American White Cross
Laboratories, Inc. v. Continental Ins.
Co., 495 A.2d 152, 155-56 (N.J. App.
1985) (citations omitted); see also
Hartford Accident & Indemnity Co. v.
Bennett, 651 So. 2d 806, 808 (Fla. App.
1995); Dominick’s Finer Foods, Inc. v.
American Manufacturers Mutual Ins. Co.,
516 N.E.2d 544, 546 (Ill. App. 1987);
Peter J. Kalis, Thomas M. Reiter, & James
R. Segerdahl, Policyholder’s Guide to the
Law of Insurance Coverage sec.
19.06[B][4][a], pp. 19-37 to 19-38
(1997). We don’t think "fair dealing" has
much to do with anything, but one can
perceive the economic logic of this form
of insurance easily enough; it allows the
insurer to coordinate the defense of
multiple suits arising out of the same
injury and spares the distributor the
expense of hiring a lawyer to defend
against a suit arising out of a design or
manufacturing defect with which the
distributor had nothing to do.
Wendy Como suffered a stroke on August
31, 1995. Claiming that it had been
caused by a diet pill she had been
taking, "Trim Easy," manufactured by Nion
Laboratories and distributed by Team Up
International, she sued both companies.
Team Up was not just a distributor,
however; it had supplied Nion with the
formula for Trim Easy and it had also
designed the contents of the label,
including the warnings, and provided
printed labels to Nion, which placed them
on the bottles of the pill. Como’s suit
included a charge that the labels had
failed to warn adequately of the risks
created by the product. The suit was
settled for a sum exceeding $1 million
(the exact amount is unclear from the
record), paid by the Hartford insurance
company, the insurer of Team Up.
Hartford’s policy was excess, meaning
that Hartford would be responsible only
for those losses that exceeded the caps
on Team Up’s other insurance policies.
St. Paul, the defendant, had written a
primary policy of liability insurance for
Weider Nutrition Group, which had
acquired Nion. That policy contained a
vendor’s endorsement, and Hartford
brought this suit to obtain a declaration
that Team Up was covered by the
endorsement and so St. Paul, as Team Up’s
primary insurer by virtue of the
endorsement, should bear the expense of
the settlement of Como’s suit up to St.
Paul’s policy limit of $1 million.
All this is quite a tangle, so let us
recapitulate. St. Paul insured Weider,
which acquired the manufacturer of the
pills, Nion. Hartford insured Team Up,
Nion’s distributor. Both policies were in
force when Como was injured. If by virtue
of the vendor’s endorsement in St. Paul’s
policy, that policy also covered Team Up,
so that Team Up was insured by both
Hartford and St. Paul, then Hartford, as
the excess insurer, is entitled to lay
off a chunk of the settlement that it
paid Como on St. Paul, the primary
insurer. The district court, however,
held that the vendor’s endorsement did
not cover Team Up, and granted summary
judgment for St. Paul.
As we noted at the outset, the purpose
of a vendor’s endorsement is to protect
the vendor (i.e., dealer or other
distributor) against the expense of being
dragged as an additional defendant into a
lawsuit arising from a defect in a
product that it distributes. It makes
sense for the manufacturer to buy the
insurance, as he has a better sense of
the risk that there will be suits
complaining about defects in his
products. This assumes, however, that the
vendor’s role in the distribution of the
product is passive. The manufacturer
would be unlikely to insure the vendor
against defects introduced by the vendor
himself, SDR Co. v. Federal Ins. Co., 242
Cal. Rptr. 534, 538 (Cal. App. 1987);
American White Cross Laboratories, Inc.
v. Continental Ins. Co., supra, 495 A.2d
at 156-57, the risk of those defects
being better known to the vendor than to
the manufacturer. The vendor’s
endorsement even contains an express
exception for cases in which a claim of
products liability is based on the
labeling or relabeling of the product by
the vendor, for example because he has
omitted a warning without which the
product poses an unreasonable danger to
the consumer. Id. at 157; Lee R. Russ &
Thomas F. Segalla, 9 Couch on Insurance
sec. 130:10 (3d ed. Supp. 2000).
Beyond that, the vendor’s endorsement is
inapplicable if the vendor, whether by
participating in the creation of the
product or by altering or repairing it,
may be responsible for the alleged defect
out of which the products liability suit
arises. That at least is the majority
view, see, e.g., Mitchell v. Stop & Shop
Companies, Inc., 672 N.E.2d 544, 545-46
(Mass. App. 1996); Senco of Florida, Inc.
v. Continental Casualty Co., 440 So. 2d
625, 626 (Fla. App. 1983), but, more
important, it is the view of California,
SDR Co. v. Federal Ins. Co., supra, 242
Cal. Rptr. at 538, and it is California
law that governs the substantive issues
in this diversity suit. Some cases, such
as Pep Boys v. Cigna Indemnity Ins. Co.,
692 A.2d 546, 547-48, 550, 552 (N.J. App.
1997), and Sportmart, Inc. v. Daisy
Manufacturing Co., 645 N.E.2d 360, 362-64
(Ill. App. 1994), hold that the vendor’s
endorsement is applicable if the vendor,
rather than introducing a defect or
relabeling in a way that conceals a
danger, is merely negligent as to whom he
sells to (for example, selling to
children a product intended for adults
and dangerous to children), but this is a
distinction without a difference.
The majority view is not based on the
language of the vendor’s endorsement,
which does not define "vendor," or on the
ordinary meaning of the word, which does
not distinguish between active and
passive vendors, but on the improbability
of supposing that the manufacturer’s
insurer intends to protect others against
the risks that the others create. A
further consideration is that vendor’s
endorsement policies are cheap add-ons to
products liability policies, American
White Cross Laboratories, Inc. v.
Continental Ins. Co., supra, 495 A.2d at
156, and their cheapness makes the most
sense if they’re limited to the case in
which the vendor, being completely
passive in relation to the harm giving
rise to liability rather than the active
author of the harm, would be entitled to
indemnity from the manufacturer in the
event that he (the vendor) was sued and
held liable and made to pay damages. For
in such a case the vendor’s endorsement
would be unlikely to impose a big loss on
the insurance company even if the vendor
was hit with a damages judgment.
Interpreting contracts to make economic
sense is a method of contract
interpretation that we have commended in
other cases. PMC, Inc. v. Sherwin-
Williams Co., 151 F.3d 610, 615 (7th Cir.
1998); Rhone-Poulenc Inc. v.
International Ins. Co., 71 F.3d 1299,
1303 (7th Cir. 1995) (an insurance case);
In re Kazmierczak, 24 F.3d 1020, 1022
(7th Cir. 1994); In re Stoecker, 5 F.3d
1022, 1029-30 (7th Cir. 1993). It rests
on the commonsensical observation that
people usually don’t pay a price for a
good or service that is wildly in excess
of its market value, or sell a good or
service (here insurance) for a price
hugely less than its market value, which
would be the case if the cheap vendor’s
endorsement bought the kind of coverage
that Hartford contends it buys. That is
just a presumption, but it has not been
rebutted. Both because Team Up,
Hartford’s insured, was not a passive
vendor, and because the underlying
products liability suit arises in part
from label content furnished by Team Up
to the manufacturer, Nion, and thus comes
within the express exemption, Team Up
does not have coverage under the vendor’s
endorsement in Weider’s policy.
There is an alternative route to this
conclusion. The pill or pills that Wendy
Como took that caused her stroke were
sold by Nion before its assets became
assets of Weider, and the vendor’s
endorsement on which Hartford relies is
contained in an insurance policy that St.
Paul sold Weider, not Nion. Como had been
taking Trim Easy right up to the time of
the stroke in August 1995, but she had
obtained the pills at retail rather than
from the manufacturer. We do not know
exactly when the pills left Nion’s
premises. But we know that Weider
acquired Nion’s assets pursuant to an
asset acquisition agreement that became
effective on June 1, 1995; and Hartford
conceded during discovery that the
particular assets that injured Como,
namely the Trim Easy pills that she took,
had by that date been sold by Nion to
Team Up (for remember that Team Up was
the vendor of Trim Easy) and so were no
longer assets of Nion and did not pass in
the sale.
It is conceivable that Weider agreed to
insure vendors of Nion’s product rather
than just vendors of its own products. At
least the possibility is not excluded by
the language of the policy, which
provides coverage for vendors of products
manufactured either by Weider or by
"others whose business or assets you’ve
acquired." But it is implausible that
this language was intended to extend
coverage to products that might have been
manufactured many years before Weider
acquired the manufacturer. St. Paul would
have been unlikely to buy such a pig in
a poke. Oliver Machinery Co. v. United
States Fidelity & Guaranty Co., 232 Cal.
Rptr. 691, 694-96 (Cal. App. 1986). More
likely the language is intended merely to
cover Weider for postacquisition sales of
acquired assets.
Against this conclusion Hartford points
to the method of calculating the premium
for the vendor’s endorsement in Weider’s
policy. The premium is based in the first
instance on an estimate of the vendor’s
sales of the manufacturer’s product
during the period in which the policy is
in force, which was October 1, 1994, to
December 1, 1995; but at the end of that
period the premium is adjusted for the
actual sales during the period. This
means that sales made by Team Up
(assuming, contrary to our first holding,
that Team Up was covered by the vendor’s
endorsement) as early as October 1, 1994
(and we’ll assume for the sake of
argument that the pills taken by Wendy
Como were sold by Nion after that date,
as they may have been, for we know only
that they were sold before June 1, 1995),
could be used to adjust the premium due
to St. Paul. So Weider may actually have
paid St. Paul a premium based in part on
the sale by Nion of the very pills that
caused Como’s stroke.
We don’t think Hartford is reading the
premium-adjustment provision aright,
however. The vendor’s endorsement in St.
Paul’s policy is for the benefit of
Weider’s vendors, and Team Up did not
become a Weider vendor until Weider
acquired Nion’s assets, which was after
Nion sold the pills that Como took. The
purpose of the premium adjustment is to
recompute the premium for actual coverage
on the basis of experience during the
period of coverage; it is not to expand
coverage. Cooper Companies v.
Transcontinental Ins. Co., 37 Cal. Rptr.
2d 508, 516 (Cal. App. 1995).
Affirmed.