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02.01.2013

They say that no good deed goes unpunished.   A recent decision from the United States Court of Appeals for the Seventh Circuit interpreting the voluntary payment provision of an insurance contract lends credence to this expression, and should encourage businesses to think twice before paying to cover a loss without first understanding insurance policy.  A business that pays to resolve a matter quickly in an effort to avoid a lawsuit and protect its reputation may, in fact, be failing to protect its own interests if it hopes to have the payment covered by its insurance.

In West Bend Mutual Insurance Co. v. Arbor Homes LLC, No. 12-2274, 2013 WL 68995 (7th Cir. Jan. 8, 2013), a commercial general liability insurer, West Bend Mutual Insurance Company  brought suit against a homebuilder, Arbor Homes LLC , seeking a declaration that it had no duty to defend and indemnify Arbor.

Arbor builds single-family homes in central Indiana and had contracted with Willmez Plumbing Inc. for plumbing services in connection with the construction of new homes.  The contract required Willmez to obtain insurance, and further required that the insurance policies name Arbor as an additional insured.  Any subcontractors hired by Willmez were also bound by the same contract terms as Willmez. 

Shortly after the homebuyers, Kurt and Joy Lorch, moved in to their new home, they noticed a foul odor coming from the lower part of the house.  The Lorches soon learned that the plumber, who had been subcontracted by Willmez, failed to connect the home’s drainage system to the city’s sewer.  As a result, raw sewage was being discharged into the crawl space below the home.  The homeowners complained to Arbor, who confirmed that the plumbing had been improperly installed.  Arbor then had the main sewer line connected and hired contractors to remove the sewage and decontaminate the home.  In the end, the clean-up process and repair work cost Arbor more than $65,000.00.

Not surprisingly, the Lorches, who had purchased a brand new home, were unwilling to accept a home that had been filled with sewage and then cleaned, so they demanded that Arbor buy the home from them and build them a new home.  Arbor and Willmez discussed possible resolutions to the demands and ultimately reached a settlement agreement.  Arbor told Willmez to place its insurer, West Bend, on notice of the Lorches’ claims.  Hearing nothing from West Bend, Arbor assumed the insurer had no objections to the settlement negotiated between Arbor, Willmez, and the Lorches.  Thus, Arbor signed a settlement agreement with the Lorches that provided them with the desired remedy.

Subsequently, Arbor filed suit against Willmez in state court, alleging negligence, breach of contract, breach of the settlement agreement, slander of title, and constructive fraud.  Arbor’s lawyer sent a copy of the complaint to West Bend, noting that Arbor was an additional insured on the relevant insurance policies and asking West Bend to discuss resolution of the dispute. West Bend denied any liability under the insurance policies in the state court proceedings and later filed this declaratory judgment suit in federal court.  The district court granted summary judgment to West Bend, finding that it was relieved of any duty to defend or indemnify Arbor, and Arbor appealed.

West Bend denied coverage under three provisions of the insurance contracts, one of them being the voluntary payment provision.  That provision provided that the insured would not, except at its own cost, voluntarily make a payment, assume an obligation, or incur an expense (other than for first aid) without the consent of West Bend.  In short, any insured that settled a claim without West Bend’s knowledge or consent did so at the insured’s own expense.

Notably, neither Arbor nor Willmez obtained West Bend’s consent before settling with the Lorches.  Instead, Arbor relied on Willmez to place the insurer on notice of the Lorches’ claims, negotiated a resolution without actually involving West Bend, and then construed West Bend’s silence as a lack of objection to the settlement.  West Bend knew nothing of the terms of the settlement until after the agreement had been signed and Arbor’s state court lawsuit against Willmez had been filed.

The Court acknowledged that Arbor had behaved admirably in expeditiously resolving the matter for the Lorches, but went on to affirm the lower trial court, holding that West Bend was not obligated to indemnify Arbor for costs incurred under the settlement agreement.  Importantly, Arbor had failed to protect its own interests in two ways: (1) by relying on Willmez to notify West Bend about the incident; and (2) by failing to obtain West Bend’s consent to settlement.

Because Arbor had left West Bend in the dark regarding the Lorches’ claims and the subsequent settlement, the Court determined that Arbor was on the hook for the damage caused by the plumber’s negligence.  The first lesson here is that acting quickly and decisively to settle a dispute or cover a loss may put a business at risk of running afoul of a similar voluntary payment provision.  Although a quick resolution of a claim in the form of a voluntary payment may seem like the best way to preserve a company’s reputation or salvage the customer relationship, without prior notice to the insurer, it could easily lead to the denial of coverage if a voluntary payment provision is at play.  Secondly, since Arbor was purportedly an additional insured on the policy it should have directly reached out to the insurer.  Even if it was not an additional insured, there is nothing that prevented Arbor from directly trying to engage the insurer since protecting Willmez by notifying the insurer could also protect Arbor.  Finally, policyholders should also secure an insurer’s consent to settlement in writing. 

Jaime Wisegarver is an associate in the Litigation Section, where she handles a variety of civil and commercial matters, including insurance recovery litigation and counseling.  For more information, please contact Jaime at (804) 771-5634 or jwisegarver@hf-law.com.

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