Seventh Circuit Court of Appeals Commentary : In Their Opinion : Lawyer & Attorney Michael E. Rigney : Kelley Drye & Warren Law Firm

UNIVERSAL MORTGAGE CORP. v. WURTTEMBERGISCHE VERSIGHERUNG AG (July 11, 2011)

Ray Hightower worked for Universal Mortgage Corp., a company that originated mortgage loans and sold them to investors. When Universal sold the loans, it warranted that the loans complied with the Federal National Mortgage Corporation standards. For over a year, Hightower took kickbacks from an outside broker in return for ensuring that Universal approved non-compliant loans. Universal sold the loans without knowledge of their non-compliant status. Some of the loans went into default. When those investors realized that Universal had breached its compliance warranty, they exercised their rights to force Universal to repurchase the loans. Universal estimates that its exposure will be $4.5 million. Universal filed a claim under its bankers blanket bond issued by a consortium of Lloyds of London underwriters. The bond indemnified Universal for "[d]irect financial loss" it suffered "by reason of and directly caused by . . . dishonest acts by any Employee." The bond also excluded any loss "resulting from" a loan repurchase from an investor. The underwriters denied the claim. Universal brought suit for breach of contract and bad faith denial of an insurance claim. Judge Stadtmueller (E.D. Wis.) granted a motion to dismiss, concluding that Hightower's fraud did not "directly cause" the loss and that the repurchase exclusion applied. Universal appeals.

In their opinion, Judges Posner, Flaum, and Sykes affirmed. The Court noted that the bond form has been around for decades and that many of its terms have well-established meanings. But two camps have emerged on the proper meaning of "directly cause." One camp has adopted the proximate cause principle from tort law. But this case is governed by Wisconsin law, and Wisconsin has adopted a "direct means direct" definition of "directly cause." Here, Universal's liability is to a third party. Even if its loss from that liability is due to employee misconduct, the employee misconduct did not "directly cause" the loss. The Court rejected Universal’s argument that its loss arose when it initially approved the non-compliant loans. Even if it did, it recovered that loss when it sold the loans to investors. The loss it now seeks to recover is the loss from its obligation to those investors. Alternatively, the Court agreed with the district court that the repurchase exclusion applied and barred coverage.

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ESTATE OF LUSTER v. ALLSTATE INSURANCE CO. (March 23, 2010)

Wavie Luster lived alone in her home in Merrillville, Indiana. In late 2001, she was hospitalized after a fall. Upon her release from the hospital, she immediately moved into an extended-care facility, where she remained until her death in 2006. A fire caused extensive damage to her home a few months after her death. Her personal representative submitted a claim on the estate's behalf to Allstate Insurance Company, which had provided insurance on the home for years. Allstate denied the claim on the basis that her home had been unoccupied for over four years. Notwithstanding the denial, Allstate continued to bill Luster's representative and he continued to pay the premiums for more than two years after the fire. In late 2008, Allstate attempted to cancel the policy retroactive to November of 2001 and returned the premiums for that period. The estate brought suit against Allstate for breach of the insurance contract. The district court granted summary judgment to Allstate. The estate appeals.

In their opinion, Judges Posner, Ripple, and Wood reversed and remanded. The Court noted four relevant policy provisions: 1) the insured had an obligation to inform Allstate of any change in the use or occupancy of the premises, 2) the policy continued in effect after the death of the insured until the end of the premium period, 3) there was no coverage for a loss caused by an increase in hazard known to the insured, and 4) there was no coverage for loss caused by vandalism if the property was unoccupied for 30 consecutive days prior to the loss. With respect to notice requirement for a change in occupancy, the Court concluded that the 4+ years in which the house stood empty constituted a change in occupancy, notwithstanding the owner's desire to return. But Luster's failure to notify did not result in a automatic termination of the insurance contract. It was merely a breach, entitling Allstate to certain remedies, which may or may not have included rescission under Indiana law. In any event, Allstate took no action upon learning of the change in occupancy. It continued billing for and receiving the premiums for two years. With respect to the second provision, the Court concluded that the death clause could not revive a policy that had already lapsed -- it merely prevents a coverage lapse upon the death of the insured. It has no application here. The third provision is the provision the district court relied on in granting Allstate summary judgment. The district court ruled that leaving the house unoccupied constituted an increase in hazard as a matter of law. But the Court rejected that conclusion, stating that there is no rule that an unoccupied home for any period of time increases the hazard as a matter of law. Rather, an evidentiary hearing is required for Allstate to prevail on this ground. Finally, with respect to the fourth provision, the Court noted that there was no finding with respect to the cause of the fire. It may well have been caused by vandalism, and, if so, it certainly occurred more than 30 days before the house became unoccupied. The Court concluded that an evidentiary hearing on remand is required to resolve that issue, as well. Before it reversed and remanded, however, the Court had to deal with the estate’s argument that Allstate's waived its right to deny coverage by collecting the premiums for more than two years after learning that the house was unoccupied. The Court rejected the argument. If Allstate was entitled to deny coverage, it was entitled to do so because of the “increase in hazard” or “vandalism” exclusions, not because it had a right to cancel the coverage entirely. Collecting the premiums is not inconsistent with enforcing the exclusions in the policy.

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WESTFIELD INSURANCE COMPANY V. SHEEHAN CONSTRUCTION COMPANY (APRIL 29, 2009)

Several home owners in the same subdivision began to notice water damage in their new homes. Litigation ensued against the general contractor, Sheehan Construction Co. Although the problem was traced to one of Sheehan's subcontractors, Sheehan settled the litigation for nearly $3 million. Sheehan is ensured by Westfield Insurance Co. under a general liability policy. Sheehan brought an action against Westfield for indemnity. The district court granted judgment to Westfield. Sheehan appeals.

In their opinion, Chief Judge Easterbrook and Judges Wood and Williams affirmed. Westfield's policy excluded damage to "your work” if it was included in the "products-completed operations hazard." "Your work" is defined in the policy to include work performed by Sheehan or on its behalf. Although the Court recognized that the standard form policy was changed in 1986 to exclude a subcontractor’s work from the "your work" exclusion, it noted that Sheehan's policy did not contain the newer language. With respect to the "products-completed operations hazard" requirement, the Court also looked to the policy definition and concluded that the term was designed so that it covered accidents that occurred during construction but did not cover poor workmanship in a completed house. The Court concluded that the "your work" exclusion directly addressed the homeowners’ harm at issue and resulted in non-coverage.

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NAUTILUS INSURANCE CO. v. 1452-4 N. MILWAUKEE AVENUE, LLC (April 7, 2009)

1452-4 N. Milwaukee Avenue, LLC ("1452") was the owner of the property at that address in Chicago. 1452 had a comprehensive general liability insurance policy issued by Nautilus Insurance Co. ("Nautilus"). The policy contained an exclusion for property damage arising out of operations performed by contractors or subcontractors. When 1452 was sued by the owner and insurer of the property next door for damages allegedly caused by its contractor’s negligent excavation, 1452 tendered the action to Nautilus. Nautilus brought an action seeking a declaratory judgment that it had no duty to defend or indemnify 1452 in the underlying lawsuit, relying on the exclusion. The court rejected Nautilus' argument and entered a declaration that Nautilus had a duty to defend. Nautilus appeals.

In their opinion, Judges Ripple, Sykes and Tinder reversed and remanded. The Court identified the issue as whether the damages alleged in the underlying complaint fall or potentially fall within the policy’s coverage. The Court noted that the lower court did not apply the contractor exclusion because of an allegation in the complaint that 1452 itself was directly liable because it failed to provide statutorily required notice of excavation to the neighbor. The Court disagreed with the lower court’s analysis. The Court emphasized that the notice claim sought recovery for the same loss as the other claims. Relying on Illinois jurisprudence, the Court concluded that, because the property damage alleged in the complaint falls within the policy exclusion, the alternative theory of relief does not trigger coverage.

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