West Bend Mutual Ins v. Arbor Homes ( 2013 )

  •                              In the
    United States Court of Appeals
                   For the Seventh Circuit
    No. 12-2274
                Appeal from the United States District Court
         for the Southern District of Indiana, Indianapolis Division.
         No. 1:09-cv-832-TAB-TWP—Tim A. Baker, Magistrate Judge.
       A RGUED S EPTEMBER 28, 2012—D ECIDED JANUARY 8, 2013
     Before P OSNER, R OVNER and SYKES, Circuit Judges.
      R OVNER, Circuit Judge. A plumber hired by homebuilder
    Arbor Homes, LLC, (“Arbor”) made one of the biggest
    mistakes a plumber can make: he forgot to connect the
    home’s drainage system to the city’s sewer. The question
    here is whether Arbor or the plumber’s insurer is liable
    for the resulting damages to the newly built home. Al-
    though Arbor behaved very admirably in addressing the
    problem for the new homeowners, it failed to protect
    2                                             No. 12-2274
    its own interests, and we must affirm the judgment in
    favor of the insurer.
      Arbor builds single-family homes in central Indiana.
    In 2005, Arbor contracted with Willmez Plumbing Inc.
    (“Willmez”) for plumbing services in connection with
    the construction of new homes. The contract required
    Willmez to obtain insurance:
        Contractor [Willmez] shall take out, carry, and main-
        tain the following insurance to protect Contractor
        and Owner [Arbor] . . .
           (b) Comprehensive General Liability insurance
           to protect against bodily injury and property
           damage in an amount of not less than $1,000,000
           per Occurrence;
           (d) Umbrella Liability Insurance in an amount
           of not less than $1,000,000.
    R. 80, at 9. The contract also required that the insurance
    policies name Arbor as an additional insured. Any sub-
    contractors hired by Willmez were bound to the same
    contract terms as Willmez.
      In 2006, Arbor issued three purchase orders to Willmez
    to serve as Arbor’s plumbing subcontractor for the con-
    struction of a new home. The plumbing work included
    underslab plumbing, plumbing rough-in, and plumbing
    finish work on the house. Willmez, in turn, subcontracted
    No. 12-2274                                           3
    the work to Oscar Alarcon, d/b/a A & M Plumbing Com-
    pany. Plumbing work began on the home in December
    2006 and was ostensibly completed in February 2007.
    Homebuyers Kurt and Joy Lorch closed on their purchase
    of the house on March 8, 2007 and moved in shortly
      The Lorches soon noticed a foul odor emanating from
    the lower part of the house. The smell grew worse over
    time and the Lorches began to feel ill. Unfortunately,
    A & M Plumbing had failed to connect the home’s
    plumbing to the main sewer line, and raw sewage was
    being discharged into the crawl space of the home. The
    Lorches complained to Arbor, and on April 1, 2007, Arbor
    confirmed that the plumbing had not been properly
    installed. At Arbor’s request, Willmez connected the
    main sewer line. On April 2, Arbor engaged ACT En-
    vironmental Services, Inc. (“ACT”) to assess the damage.
    ACT tested the home and developed a plan to remove
    the sewage and decontaminate the home. Arbor then
    hired a number of contractors to fulfill ACT’s recom-
    mendations. The required clean-up was comprehensive
    and costly. The crawl space was excavated to a
    depth of twelve inches and then restored with clean
    materials. Everything from the furniture and insulation
    to the ductwork required decontamination because of
    the extensive spread of dangerous bacteria and mold
    from the discharge of raw sewage into the home. In the
    end, Arbor paid more than $65,000 for cleaning, repairs
    and follow-up testing for the home.
      Not surprisingly, the Lorches, who had purchased a
    brand new home, were unwilling to accept a brand new
    4                                            No. 12-2274
    home that had been filled with sewage and then
    cleaned. On April 18, 2007, they sent a letter to Arbor
    demanding, among other things, that Arbor buy the
    home from them and build them a new home. In April
    and May 2007, Arbor and Willmez discussed possible
    resolutions of the Lorches’ claims. Arbor told Willmez
    to place its insurer, West Bend, on notice of the
    Lorches’ claims. On May 4, 2007, Arbor also sent a letter
    to Willmez memorializing the parties’ understanding of
    a settlement with the Lorches, and Willmez’s responsi-
    bilities. In that letter, Arbor requested that Willmez
    or West Bend contact Arbor immediately if Willmez or
    the insurer needed any additional information re-
    garding the settlement. Willmez later told Arbor that
    it forwarded this letter to West Bend.
      Hearing nothing from West Bend, Arbor assumed the
    insurer had no objections to the settlement. On June 6,
    2007, Arbor signed a settlement agreement with the
    Lorches that provided the homebuyers with a complete
    remedy. Among other things, Arbor agreed to buy the
    tainted home from the Lorches, build another new
    home for them (using a different plumbing contractor),
    pay for all of the closing costs and moving expenses
    related to the new home, and compensate the Lorches
    for any increase in their mortgage rate on the purchase
    of the second home.
      Arbor then filed suit against Willmez in state court,
    alleging negligence, breach of contract, breach of the
    settlement agreement, slander of title, and constructive
    fraud. On October 12, 2007, Arbor’s lawyer sent a copy
    No. 12-2274                                                5
    of the complaint to West Bend, noting that Arbor was an
    additional insured on the relevant insurance policies
    and asking West Bend to discuss the resolution of the
    dispute. West Bend denied any liability under the insur-
    ance policies in the state court proceedings, and ulti-
    mately filed a declaratory judgment suit in federal
    court against both Willmez and Arbor.1 In federal court,
    West Bend sought a declaration that it had no duty
    under the insurance policies to defend and indemnify
    Arbor against the Lorches’ claims and the settlement
    agreement. West Bend was not aware of any problem
    with the Lorches’ home until May 4, 2007, and did not
    learn of Willmez’s agreement to cover a large part of the
    damages until October 2007, when it received a copy of
    Arbor’s lawsuit against Willmez. The insurer was not
    aware of the terms of the settlement with the Lorches
    until April 2008.
      West Bend denied coverage for Arbor under a number
    of different theories. Initially, West Bend insisted that
    Arbor was not an “additional insured” under the poli-
    cies. West Bend later acknowledged that this position
    was factually incorrect and conceded that Arbor should
    have been treated as an additional insured under its
    policies with Willmez. West Bend also denied cov-
      West Bend sought declarations related to Willmez that are
    not part of this appeal. Willmez failed to appear and defend
    against West Bend’s declaratory judgment action, and
    West Bend ultimately obtained a default judgment against
    Willmez. We will address only the claim that relates to Arbor
    because only that claim is on appeal.
    6                                                 No. 12-2274
    erage under three provisions of the insurance contracts:
    the fungi and bacteria exclusion, the voluntary payment
    provision, and the completed-operations provision. The
    district court granted summary judgment to West Bend,
    finding that the insurer was relieved of any duty to
    defend or indemnify Arbor under the fungi and bacteria
    exclusion as well as the voluntary payments provision.
    Arbor appeals.
      On appeal, Arbor contends that a provision excluding
    coverage for damages caused by fungi and mold in a
    commercial general liability policy issued to a plumber
    renders the coverage illusory. Arbor also maintains
    that coverage may not be denied under the voluntary
    payments provision because West Bend denied for years
    that Arbor was an additional insured, and thus West
    Bend would not have participated in settlement discus-
    sions even if it had been given the opportunity to do so.
    Finally, Arbor argues that the completed-operations
    exclusion should not apply where the plumbing work
    was never “completed” as promised.
      A district court sitting in diversity must apply the
    choice of law principles of the forum state (in this case
    Indiana) to determine which state’s substantive law
    governs the proceeding. Tanner v. Jupiter Realty Corp., 
    433 F.3d 913
    , 915 (7th Cir. 2006); French v. Beatrice Foods Co.,
    854 F.2d 964
    , 966 (7th Cir. 1988) (citing Klaxon Co. v. Stentor
    Electric Mfg. Co., 
    313 U.S. 487
    , 496 (1941)). The parties
    agree that the insurance contract for the Indiana con-
    No. 12-2274                                              7
    struction project at issue in this diversity action is gov-
    erned by Indiana law. See Dunn v. Meridian Mutual Ins.
    836 N.E.2d 249
    , 251 (Ind. 2005) (an insurance policy
    is governed by the law of the principal location of
    the insured risk during the term of the policy). We review
    the district court’s grant of summary judgment de novo.
    Norman-Nunnery v. Madison Area Technical Coll., 
    625 F.3d 422
    , 428 (7th Cir. 2010).
      We begin (and end) our analysis with the voluntary
    payments provision of the insurance contract. The con-
    tract assigns several duties to the insured in the event of
    an occurrence that may result in a claim. For example,
    the insured must notify West Bend as soon as practicable
    of any occurrence, and provide details of the incident.
    The insured must also tell West Bend of any claims or
    lawsuits brought against the insured, and cooperate
    with the insurer in the investigation or settlement of
    any claim. Most important for our purposes is the volun-
    tary payments provision that comes at the conclusion
    of the list of obligations for the insured:
       No insured will, except at that insured’s own cost,
       voluntarily make a payment, assume any obligation,
       or incur any expense, other than for first aid, without
       our consent.
    R. 53-2, at 13. The purpose of this reasonable and
    prudent provision is obvious. West Bend must have the
    opportunity to protect itself and its insured by investi-
    gating any incident that may lead to a claim under the
    policy, and by participating in any resulting litigation or
    8                                                    No. 12-2274
    settlement discussions. 2 Any insured that settles a claim
    without West Bend’s knowledge or consent does so at
    the insured’s own expense under the express language
    of this provision. Dreaded, Inc. v. St. Paul Guardian Ins. Co.,
    904 N.E.2d 1267
    , 1271 (Ind. 2009) (a voluntary pay-
    ment provision that clearly prohibits the assumption of
    financial obligation must be given its plain and ordinary
    meaning). See also Travelers Ins. Co. v. Maplehurst Farms,
    953 N.E.2d 1153
    , 1161 (Ind. Ct. App. 2011) (when
    an insured enters into a settlement agreement without
    the insurer’s consent in violation of a voluntary pay-
    ment provision, that obligation cannot be recovered
    from the insurer).
      Yet neither Arbor nor Willmez obtained West Bend’s
    consent before settling. Instead, Arbor relied on Willmez
    to place the insurer on notice and then construed the
    insurer’s subsequent silence as a lack of objection to the
    settlement with the Lorches. Arbor now can produce
    no evidence that West Bend consented to Willmez’s
    settlement with Arbor or Arbor’s settlement with the
       Voluntary payment provisions in insurance contracts also
    guard against the problem of moral hazard. See Amerisure
    Ins. Co. v. National Sur. Corp., 
    695 F.3d 632
    , 635 (7th Cir. 2012)
    (describing a moral hazard as a situation where the party
    taking the risk will not bear the costs of its behavior); Metavante
    Corp. v. Emigrant Sav. Bank, 
    619 F.3d 748
    , 773 (7th Cir. 2010)
    (describing moral hazard as the tendency to take additional
    risks or run up extra costs when another party is financially
    liable). There is no evidence in this case that Arbor unilaterally
    ran up settlement costs.
    No. 12-2274                                                   9
    Lorches. West Bend has produced uncontroverted evi-
    dence that it knew nothing of the damage to the home
    until after Willmez and Arbor agreed on their respective
    liabilities to each other and to the Lorches. And West
    Bend knew nothing of the terms of the settlement agree-
    ment signed with the Lorches until after Arbor’s law-
    suit against Willmez was underway. There is no evi-
    dence that West Bend “consented” to any settlement as
    required by the voluntary payments provision. Although
    Arbor behaved admirably in expeditiously resolving
    the matter for the homeowners, it failed to protect its
    own interests when it relied on Willmez to notify West
    Bend about the incident, and failed to obtain West Bend’s
    consent for any settlement. Having no opportunity to
    participate in the investigation or settlement, West Bend
    is entitled to enforcement of the plain language of the
    contract: Arbor’s settlements with Willmez and with the
    Lorches without the consent of West Bend is at Arbor’s
    own expense. Travelers Ins., 953 N.E.2d at 1161.
      Arbor contends that West Bend may not rely on the
    voluntary payments provision to bar coverage because
    West Bend refused to recognize Arbor as an “additional
    insured” from October 2007 through August 2010. Arbor
    argues that notice to West Bend would have been futile
    because West Bend refused to treat it as an insured.3
      Arbor did not raise this futility argument in the district
    court and it is therefore waived. Umezurike v. Holder, 
    610 F.3d 997
    , 1003 (7th Cir. 2010). In any case, Arbor has failed to cite
    any case indicating that futility may negate a voluntary pay-
    10                                              No. 12-2274
    Moreover, Arbor maintains, West Bend suffered no
    prejudice by Arbor’s late notice because West Bend
    would not have participated in settlement negotiations
    even if it had received the requisite notice sooner.
       There are a number of flaws with Arbor’s arguments
    under the facts and under Indiana law. First, the “volun-
    tary payments” provision is not a notice provision, per
    se, but a consent provision. That is, under the clear lan-
    guage of the provision, the insurer must consent to a
    payment, obligation or expense before the insurer is
    liable for that amount. West Bend produced admissible
    evidence that it did not consent to (1) the settlement
    between Arbor and Willmez memorialized in the May 3,
    2007 letter from Arbor to Willmez; or (2) the June 6, 2007
    settlement between Arbor and the Lorches. Arbor has
    produced no evidence that West Bend consented to
    either settlement, and so there are no disputed issues of
    fact regarding West Bend’s lack of consent. Second, as a
    matter of Indiana law, prejudice (or the lack thereof) is
    irrelevant in the enforcement of a voluntary payment
    provision. Travelers Ins., 953 N.E.2d at 1161 (prejudice
    is irrelevant when an insured enters into a settlement
    agreement without the insurer’s consent in violation of
    a voluntary payments provision).
      Finally, Arbor’s reliance on Tri-Etch, Inc. v. Cincinnati
    Ins. Co., 
    909 N.E.2d 997
     (Ind. 2009), is misplaced. Tri-Etch
    ment provision, and we see no reason to recognize an
    exception to the express language of the contract. We will
    therefore not address this argument further.
    No. 12-2274                                            11
    addressed the role of prejudice when the insured gives
    late notice to the insurer. The court first confirmed that
    late notice by the insured gives rise to a rebuttable pre-
    sumption of prejudice to the insurer. 909 N.E.2d at 1005.
    But the court concluded that an insurer’s denial of cover-
    age on other grounds does not, as a matter of law, rebut
    the presumption of prejudice from late notice:
        There is no reason why an insurer should be
        required to forego a notice requirement simply
        because it has other valid defenses to coverage. If
        there is no prejudice to the insurer from lack of
        notice, the absence of prejudice does not arise from
        the insurer’s taking the position that it also has
        other valid defenses to coverage. Rather, it arises
        from the insurer’s taking no action with respect to
        the claim because of its other defenses. Even if an
        insurer consistently denies coverage, timely notice
        gives the insurer an opportunity to investigate
        while evidence is fresh, evaluate the claim, and par-
        ticipate in early settlement. The fact that an
        insurer asserts other coverage defenses does not
        render these opportunities meaningless. It is a fact
        issue whether the other defenses would have
        caused the insurer, if given timely notice, to do
        nothing with respect to the claim.
    Tri-Etch, 909 N.E.2d at 1005.
      According to Arbor, because West Bend denied that
    Arbor was an additional insured, there remains a
    disputed question of fact regarding whether West Bend
    would have behaved differently—whether it would
    12                                            No. 12-2274
    have done nothing—if Arbor (or Willmez) had given
    notice to West Bend in time for the insurer to take part
    in settlement negotiations. But as we noted above, this is
    not a notice case. The voluntary payment provision
    relieves West Bend of the obligation to pay not because
    the insured provided late notice but because West Bend
    did not consent to any voluntary payments or obliga-
    tions assumed by Arbor or Willmez. If anything, Tri-etch
    demonstrates that West Bend did not lose the oppor-
    tunity to assert its rights under the voluntary payments
    provision simply because it denied for a time that Arbor
    was an additional insured. Although Arbor’s quick and
    decisive aid to the Lorches was laudable, the failure
    of Arbor (or Willmez) to obtain West Bend’s consent to
    the settlement relieves the insurer of any obligation to
    pay for the damages caused by the plumber’s negligence.
                                                   A FFIRMED.