Wausau Underwriters v. United Plastics Grou ( 2008 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
Nos. 06-3790, 06-4006
WAUSAU UNDERWRITERS INSURANCE COMPANY,
Plaintiff,
v.
UNITED PLASTICS GROUP, INC. and MICROTHERM, INC.,
Defendants-Appellees.
THE OHIO CASUALTY INSURANCE COMPANY,
Intervenor-Appellant.
____________
Appeals from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 04 C 6543—John W. Darrah, Judge.
____________
ARGUED SEPTEMBER 24, 2007—DECIDED JANUARY 15, 2008
____________
Before POSNER, FLAUM, and WOOD, Circuit Judges.
POSNER, Circuit Judge. This diversity suit over insurance
coverage arises out of a suit filed in a Texas state court
by Microtherm, a manufacturer of water heaters, against
United Plastics Group (UPG). The Texas suit complained
about a component that UPG had sold Microtherm.
Microtherm won that case, obtaining a judgment for
2 Nos. 06-3790, 06-4006
$26.5 million. The Wausau insurance company, UPG’s
primary liability insurer, brought the present suit in the
federal district court in Chicago against UPG for a declara-
tion that its policy doesn’t cover the judgment. Wausau
settled with UPG, but meanwhile Ohio Casualty, UPG’s
excess liability insurer, had intervened in Wausau’s
suit, seeking a similar declaration. After a bench trial—the
principal evidence in which, however, was simply the
record of the Texas case—the district judge ruled that Ohio
Casualty was liable on its excess policy for the damages
assessed by the Texas court, up to the $25 million policy
limit. Other insurers had reimbursed UPG for a total of
$4.8 million, but the judge declined to subtract that
amount from the $26.5 million judgment in determining
Ohio Casualty’s liability to UPG, on the ground that it
was unclear whether any part of the $4.8 million related
to losses covered by Ohio Casualty’s policy. In its present
posture, therefore, the case is UPG versus Ohio Casualty,
with Ohio Casualty the appellant, having lost in the dis-
trict court. The substantive issues (all agree) are gov-
erned by Illinois law.
In an ordinary hot water heater, a tank full of cold
water is heated and the heated water piped to the pre-
mises’ hot water taps. Microtherm, in contrast, makes a
tankless water heater, which it calls the “Seisco.” Cold
water enters the heater at one end, is heated as it passes
through, and comes out the other end as hot water,
which is piped to the hot water taps. The main com-
ponent of the heater is the plastic chamber in which
the water is heated. UPG made the chamber out of a
plastic manufactured by DuPont called Zytel. DuPont
recommended a certain temperature range for molding
Zytel. But UPG used a significantly lower temperature
Nos. 06-3790, 06-4006 3
and as a result the water chambers it made and sold to
Microtherm were defective and caused many of the
water heaters that contained them to fail.
In 2001 Microtherm sold 3,900 water heaters contain-
ing chambers manufactured by UPG. Between the start
of the next year and the trial in Texas of Microtherm’s
suit against UPG, 600 of the water chambers ruptured,
though only 65 to 75 ruptured while Ohio Casualty’s
policy, which expired in September 2002, was in force. The
ruptures caused the heaters to stop working, generally
by shorting the heater’s circuit board. In some instances
the rupture caused the heater to leak, damaging car-
pets or other property on the owner’s premises. The
various mishaps created customer dissatisfaction, lead-
ing, Microtherm complained, to a big fall off in its busi-
ness. The Texas jury issued a special verdict in which
it found that UPG had knowingly misrepresented the
quality of its heaters by failing to disclose that it
had ignored DuPont’s recommendations regarding the
proper temperature range at which to mold the water
chambers. The jury awarded damages equal to the cost
to Microtherm of repairing or replacing the water
heaters, but that cost came to only $1.1 million; most of
the $26.5 million jury award was for lost profits result-
ing from customers’ anger at Microtherm, though there
was also a small award ($330,000) of punitive damages.
The insurance policy that Ohio Casualty sold to UPG is
a standard Comprehensive General Liability policy and
obligates the insurer to indemnify the insured for sums
that the insured “becomes legally obligated to pay
by reason of liability imposed by law . . . because
of . . . ’property damage’ . . . caused by an ‘occurrence’ ”
during the policy period. “Property damage” is defined
4 Nos. 06-3790, 06-4006
in the policy as “physical injury to tangible property,
including all resulting loss of use of that
property . . . or . . . loss of use of tangible property that is
not physically injured.” “Occurrence” is defined as “an
accident, including continuous or repeated exposure
to substantially the same general harmful conditions.”
“Accident” is not defined, but its meaning is illuminated
by the exclusion in the policy of coverage for liability based
on harms that are “expected or intended from the stand-
point of the insured.”
Property was damaged as a result of the defective
manufacture of the water chambers. For example, the
water chambers themselves were damaged when they
ruptured. But damages resulting from physical damage
to the insured’s own property are expressly excluded
from coverage. Ohio Casualty Ins. Co. v. Bazzi Constuction
Co., 815 F.2d 1146, 1148-49 (7th Cir. 1987) (Illinois law);
Hamilton Die Cast, Inc. v. United States Fidelity & Guaranty
Co., 508 F.2d 417, 419-20 (7th Cir. 1975) (same); Jeffrey W.
Stempel, Stempel on Insurance Contracts § 14.13, p. 213 (3d
ed. 2006). The circuit boards, however, were also damaged
by some of the ruptures, and they were Microtherm’s
property rather than UPG’s. And sometimes the rupture
of the water chamber caused the heater to leak onto and
damage the property of the heater’s owner, and that was
not UPG’s property either.
Even the water chambers were not its property after
it sold the heaters containing them to Microtherm. But
that is not the test of coverage; the test is whether the
damaged property was the property of the insured when
the defect on which the insured’s liability was based came
into being. Travelers Ins. Co. v. Penda Corp., 974 F.2d 823,
830-31 (7th Cir. 1992) (Illinois law); Stempel, supra, § 14.13,
pp. 202, 218-19.
Nos. 06-3790, 06-4006 5
UPG manufactured only the water chamber. The rest of
the heater was therefore other property; and so we have
the following possible causal chains between the manu-
facturing defect and the business losses that were the
main component of the Texas jury’s verdict: (1) defect—
ruptured water chamber—broken heater because the circuit
board shorted—business losses as customers learn about
the defective heaters and turn away from Microtherm; (2)
defect—ruptured water chamber—broken heater because
the circuit board shorted—damage to other property of the
owner—business losses when, as before, disgusted custom-
ers turn away from Microtherm. In either situation the
question is whether “because of property damage” in the
Comprehensive General Liability policy makes the insur-
ance company the insurer of those business losses.
As in tort law, e.g., McPherson v. Schlemmer, 749 P.2d 51
(Mont. 1988); Public Service Co. of Indiana, Inc. v. Bath Iron
Works Corp., 773 F.2d 783 (7th Cir. 1985); 1 Dan B. Dobbs,
Law on Remedies §§ 3.3(4), pp. 302-03; 5.15(1), p. 874 (2d ed.
1993), so in liability-insurance law, once there is damage
to property the victim can recover the nonproperty,
including business, losses resulting from that damage and
not just the diminution in the value of the property. E.g.,
Imperial Casualty & Indemnity Co. v. High Concrete Structures,
Inc., 858 F.2d 128, 135-36 (3d Cir. 1988); American Home
Assurance Co. v. Libbey-Owens-Ford Co., 786 F.2d 22, 26 (1st
Cir. 1986); Aetna Casualty & Surety Co. v. General Time Corp.,
704 F.2d 80, 83 (2d Cir 1983); Allan D. Windt, Insurance
Claims and Disputes, § 11.1, pp. 17-83 (5th ed. 2007);
Stempel, supra, § 14.04, p. 35. Ohio Casualty argues that
Illinois insurance law is different, citing Travelers Ins. Co. v.
Eljer Mfg., Inc., 757 N.E.2d 481 (Ill. 2001). But the question
in that case was not liability for consequential damages;
6 Nos. 06-3790, 06-4006
it was whether physical damage within the meaning of
the policy had occurred when a defective plumbing
system was installed, or not until later, when the system
broke and caused damage; the court held it was the latter.
A much better case for Ohio Casualty is Viking Con-
struction Management, Inc. v. Liberty Mutual Ins. Co., 831
N.E.2d 1 (Ill. App. 2005). Viking contracted to manage
the construction of a school for a town. Through the
negligence of a subcontractor of Viking’s, a wall at the con-
struction site collapsed, causing property damage. The
town sued Viking for breach of contract, seeking dam-
ages just for the cost of repairing the damage, and Viking
sought indemnity from Liberty Mutual. The court held
that the damages were not “because of” property damage
within the meaning of the General Comprehensive Liability
policy. All that the town had sought in its suit against
Viking was the cost of replacing the defective wall,
which the court equated to a defective product supplied
by Viking. The town was not seeking recovery for a loss
caused by damage to other property caused by the
wall’s collapse.
The Viking decision, if a sound interpretation of the
CGL policy (and we’re about to see that it is), scotches any
claim that UPG might have to coverage of its liability for
the cost to Microtherm of repairing or replacing any of
the defective water chambers (or any other business
losses resulting from the sale of the defective heaters), as
distinct from the cost of repairing the heaters damaged
by the defective water chambers (or other business losses
resulting from that damage); only the latter cost arose
from damage to property other than the defective product
itself. This conclusion tracks the “economic loss” rule of
tort law, which, with immaterial exceptions, bars the
Nos. 06-3790, 06-4006 7
recovery by means of a tort (including products-liability)
suit of business losses when there is no property damage.
If the defect that gives rise to liability imposes costs,
such as repair costs or loss of customer goodwill, on the
purchaser (Microtherm) without physically damaging
any of his property, the seller of the product (UPG) is not
liable for those costs unless he has agreed by contract to
indemnify them. E.g., Moorman Mfg. Co. v. National Tank
Co., 435 N.E.2d 443 (Ill. 1982); Seely v. White Motor Co., 403
P.2d 145 (Cal. 1965) (Traynor, C.J.); Robins Dry Dock &
Repair Co. v. Flint, 275 U.S. 303, 308-10 (1927) (Holmes, J.);
East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S.
858 (1986). (Compare Consolidated Aluminum Corp. v. C.F.
Bean Corp., 772 F.2d 1217, 1222-24 (5th Cir. 1985), where
recovery of such costs was allowed because there was
also physical damage to the purchaser’s property.)
Otherwise, as Holmes explained in the Robins case, the
extent of the seller’s liability would often depend on his
purchaser’s contractual relations with third parties,
something about which the seller normally would know
little. In Robins the defendant, a dry dock company,
through its negligence damaged a propeller of a boat
that the plaintiffs had chartered, and as a result the plain-
tiffs lost business and sued the dry dock company in tort
for the loss. The Court held the suit barred. The relation to
the famous rule of Hadley v. Baxendale should be plain: in
both cases the consequences of delay were far better
known to the victim of the delay than to the firm that had
caused it. This reason for limiting liability is at least as
persuasive as an aid to interpreting the Comprehensive
General Liability policy, because the insurer is in a poor
position to assess the consequences of a product defect for
the business of the product’s purchasers. The exception for
8 Nos. 06-3790, 06-4006
the case in which the defect injures other property of the
purchasers—the case in which business losses are
recoverable—does not swallow the rule, though only
because such damage is rare.
The Viking decision imports the “economic loss” doctrine
into the interpretation of the CGL policy, and thus
would also bar recovery under the policy if a heater
did not work because the water chamber had broken yet
the break had not shorted the circuit board or caused
physical damage to anything besides the chamber itself.
Suppose that because an auto repair shop replaces a car’s
defective carburetor with a pineapple, the car will not start.
The repair shop’s mistake would make the car seriously
defective, but it would not cause any physical damage to
the car, and so any damages awarded against the shop
would not be covered by its GCL policy. Travelers Ins. Co.
v. Eljer Mfg., Inc., supra, 757 N.E.2d at 813. Not so with re-
spect to damages that the jury awarded Microtherm in
the Texas case because of physical damage that the de-
fective water chambers caused to the heaters or to any
other property. Tort liability for such consequential
damages is limited by the principles of tort causation,
but whatever liability the court imposed in a tort suit
would, as consequential damages from tortiously inflicted
property damage, be within the “because of property
damage” coverage of the Comprehensive General Liability
policy. The fact that Microtherm’s suit against UPG
charged misrepresentation rather than negligent damage
to property is irrelevant; liability-insurance coverage is
based on the facts underlying the liability suit rather than
on the cause of action pleaded in that suit. 9 Couch on
Insurance § 126:3, pp. 126-28 (3d ed., Lee R. Russ & Thomas
F. Segalla eds. 2000).
Nos. 06-3790, 06-4006 9
The foregoing analysis requires that we reverse the
district court. To begin with, only 65 to 75 out of the 600
heaters that had failed by the time the Texas case went to
trial failed during the period in which Ohio Casualty’s
policy was in force. The business losses resulting from
those 65 to 75 failures, out of a total of 3,900 heaters
sold—less than 2 percent—are unlikely to have amounted
to $25 million, the approximate amount awarded by
the Texas jury for business losses resulting from the
defective water chamber. Moreover, only about 80 per-
cent of the water-chamber ruptures shorted the circuit
board; the other 20 percent just caused the water heater
to stop working, and that we know is not property loss.
The deeper problem is that the business losses for which
Microtherm sued might well have occurred even if
no circuit board had ruptured. From the consumer’s
standpoint, the precise mechanism that causes his hot-
water heater to stop working is irrelevant; all he cares
about is that he has no hot water. No doubt if the broken
heater leaks and ruins its owner’s carpet, there is added
fury against Microtherm; but we do not even know how
many of the broken heaters caused such damage. The
question how much of Microtherm’s business losses
were due to the rupture of some 52 to 60 failed water
chambers that damaged a circuit board (80 percent of the
65 to 70 total failures) was not presented to the jury in
Texas because it is an issue related only to insurance
coverage, which was not the subject of the Texas case. But
not all the business-loss damages awarded in that case
could have been due to the 10 percent or fewer ruptures
(52-60 out of 600) that both caused damage to property
(either the circuit board or the owner’s other property,
but as we do not know how many of the ruptures caused
10 Nos. 06-3790, 06-4006
damage to the owners’ other property we are stuck with
our 52-60 estimate) and occurred during the coverage
period.
That incremental damage may have been less than
10 percent of the total damages. Suppose that 500 instead
of 600 heaters had failed; that would still have been a
large fraction of the total sold during the period (3,900),
and as word spread, Microtherm’s image might become
so sullied that the incremental effect on that image, and
hence on Microtherm’s sales and profits, of another 100
failures would have been slight. If it becomes known that
a hotel has bedbugs, Mathias v. Accor Economy Lodging, Inc.,
347 F.3d 672 (7th Cir. 2003), does it matter critically to the
hotel’s future revenues how many of its rooms were
infested? Remember, though, that the 52 to 60 heater
failures in which there was property damage within the
meaning of the policy occurred early in the period covered
by the Texas suit, because Ohio Casualty’s policy expired
in September 2002 and the earliest failures may have been
the ones that did the most damage to Microtherm’s busi-
ness.
But all this is just to say that incremental harm to
Microtherm’s business caused by the handful of heater
failures the liability for which might be within the cov-
erage of the policy was a key issue that the district judge
should have tried, rather than supposing it to have been
resolved by the Texas jury. Cf. Laurie Vasichek, “Liability
Coverage for ‘Damages Because of Property Damage’
Under the Comprehensive General Liability Policy,” 68
Minn. L. Rev. 795, 819 (1984). The jury did not apportion
the business losses incurred by Microtherm between the
policy period in which that handful of failures incurred
and the subsequent period. Its verdict was based on all
Nos. 06-3790, 06-4006 11
600 water-heater failures, most of which occurred after
Ohio Casualty’s policy expired.
Ohio Casualty argues that even business losses result-
ing from physical damage to other property (the circuit
boards and the carpets) are not covered because they
were not due to an accident. The finding by the Texas jury
that UPG’s failure to disclose the risk of rupture was
“knowing” implies, according to Ohio Casualty, that the
ruptures were the consequence of an intentional act
rather than of an accident, which is an unintended act.
Insurers are reluctant to insure against the intentional
infliction of a tortious harm for obvious reasons of moral
hazard (the disincentive that being insured removes to
engage in the conduct insured against). In Sikirica v.
Nationwide Ins. Co., 416 F.3d 214, 227 (3d Cir. 2005), the
insured made deliberately false representations aimed at
inducing purchasers to pay more for the insured’s serv-
ices than the law authorized it to charge, and the court
property held that the harm inflicted on the purchasers by
the fraud was not the result of an accident. In Wood v. Safeco
Ins. Co. of America, 980 S.W.2d 43, 53-54 (Mo. App. 1998), in
contrast, the insured represented to prospective buyers of
his property that it would not flood. It flooded, the pur-
chaser sued, and the court held that the insured was
covered by his CGL policy. Similarly, UPG didn’t want its
water chambers to rupture, or, more to the point, expect
them to. Usually when people cut corners, they think
they’re taking a small risk of causing a harm, not that they
are deliberately inflicting a harm. DuPont had suggested
a temperature range that it knew to be safe. A customer of
DuPont’s, like UPG, might decide to go outside the
range, which would make its product less safe; but it
would be unlikely knowingly to go so far outside the
12 Nos. 06-3790, 06-4006
range as to generate the astronomical failure rate that the
water chambers experienced (600 ÷ 3,900 = 15.4%).
But Wood was a case of negligent misrepresentation,
while in this case the jury found that UPG’s misrepresenta-
tions were “knowing” and awarded punitive damages,
though modest in amount. There is a difference, how-
ever, between an intentional act and an intentional harm.
The difference is implicit in the key language of the GCL
policy, which is not the definition of an “occurrence” as
an “accident,” since “accident” is not defined, but rather
is the exclusion for harms that are “expected or intended
from the standpoint of the insured.” UPG’s “knowing”
misrepresentation was consistent with its not expecting
any harm—or at least harm of the magnitude that oc-
curred—to result from the misrepresentation. If therefore
it did not intend or expect the harm, it did not forfeit
coverage. United States Fidelity & Guaranty Co. v. Wilkin
Insulation Co., 578 N.E.2d 926, 932 (Ill. 1991); Calvert Ins. Co.
v. Western Ins. Co., 874 F.2d 396, 399 (7th Cir. 1989) (Illinois
law); Park University Enterprises, Inc. v. American Casualty
Co., 442 F.3d 1239, 1245-46 (10th Cir. 2006); Barry R.
Ostrager & Thomas R. Newman, Handbook on Insur-
ance Coverage Disputes § 8.03[b], p. 460 (11th ed. 2002).
What cannot be determined from the jury’s verdict is
how great a risk UPG thought it was taking. Surely it did
not expect 15 percent of the heaters it sold not to work.
What did it expect? Consider Nationwide Ins. Co. v. Board
of Trustees of University of Illinois, 116 F.3d 1154 (7th Cir.
1997). The insured, a college student, set fire to the Astro-
turf in the college football stadium. The fire caused
$600,000 in damages, and naturally the insurance com-
pany refused to pay. The insured, however, “testified that
it was never his intent for the Astroturf to burn; rather,
Nos. 06-3790, 06-4006 13
he and his colleagues thought that the lighter fluid
alone would burn, leaving only a residue of soot on the
portions of the Astroturf to which it had been applied—
spelling out the letters “F-O-O” which would be visible on
television or from the bleachers. In fact, Zavalis [the
insured] recalled, he and his friends had tried the same
thing on a concrete sidewalk earlier, and had caused no
damage (actually, they couldn’t get the lighter fluid even to
ignite); and to Zavalis, the Astroturf itself felt like concrete,
so he thought the results would be equally harmless. Even
after the letters “F-O-O” were ablaze on the field (the
flames reaching from eight to eighteen inches into the air),
the three young men didn’t think they had done any
damage to the playing surface.” Id. at 1156-57 (footnote and
record reference omitted). Unsurprisingly, the insured lost.
When the facts known to a person place him on notice of a
risk, he cannot ignore the facts and plead ignorance of the
risk. AMPAT/Midwest, Inc. v. Illinois Tool Works, Inc., 896
F.2d 1035, 1042 (7th Cir. 1990); SEC v. Jakubowski, 150 F.3d
675, 681 (7th Cir. 1998).
The present case is less extreme, or at least less clear;
and we acknowledged in Nationwide that “the insured
may not ‘expect or intend’ the damage when the actual
result is an injury wholly different in kind from the type
he anticipated would occur; and the magnitude of the
resulting harm is one factor that can be considered in that
assessment.” 116 F.3d at 1156 (citations omitted). Suppose
UPG thought that 0.1 percent of the heaters would fail;
instead 15 percent did. Is the difference in magnitude
enough to show that the harm to the customers that
occurred was “expected”? That is a jury question, but
not a jury question that the Texas jury answered. It is
another question for the trier of fact in this case (a judge,
14 Nos. 06-3790, 06-4006
not a jury, since the parties agreed to a bench trial) to
determine.
We need to discuss one more issue, though only
briefly, and that is Ohio Casualty’s entitlement, should it
be found liable to UPG on the policy for any of the dam-
ages imposed by the Texas court, to an offset by reason
of the settlements that UPG made with its other insurers.
The district judge rightly denied the offset on the ground
that Ohio Casualty had failed to show what if any part
of the settlements should be allocated to the period in
which the policy it had issued to UPG was in force. Most
of the water-chamber ruptures occurred later. We know
from Travelers Ins. Co. v. Eljer Mfg., Inc., supra, that under
Illinois law property damage does not incur when a
defective product is installed, but only when it breaks,
so defects in the water chambers that did not produce
physical damage until after the policy period are not
covered by the policy.
The judgment is reversed and the case remanded to the
district court for a determination of what if any part of the
damages assessed against UPG in the Texas litigation is
covered by the insurance policy.
REVERSED AND REMANDED.
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—1-15-08