In December 2004 and again in November 2005, the City discovered cracks in welds performed by LB Steel. As a result, the City required Walsh to fix the columns. In February 2008, Walsh and the City entered into a limited settlement agreement in which Walsh agreed to conduct repairs to the columns at its own expense. In November 2008, the City sued Walsh in Illinois state court for breach of contract and contractual indemnity to recover the costs the City incurred to investigate and remediate the defective welds.
In January 2010, Walsh tendered its defense of the City's claims to the insurers under the CGL Policies, based on the fact that, as explained above, Walsh was named as an additional insured as required by the second-tier subcontract. The insurers acknowledged receipt, but they never provided a final coverage decision and never defended Walsh in the City's lawsuit.
Walsh agreed to settle the City's damages claims and then filed its own third-party complaint against LB Steel for breach of contract. The Illinois state court found for Walsh on the breach of contract claim and entered a judgment against LB Steel in excess of $19,000,000. LB Steel then appealed and filed for bankruptcy. On appeal, the Illinois appellate court affirmed Walsh’s judgment against LB Steel. Walsh and LB Steel reached a bankruptcy settlement under which Walsh received payment in excess of $3,000,000 and was allowed an unsecured claim against LB Steel's bankruptcy estate in excess of $24,000,000.
In November 2015, LB Steel’s insurers sued Walsh in the Northern District of Illinois and sought a declaration that (1) the CGL Policies did not cover Walsh’s judgment against LB Steel or the subsequent bankruptcy settlement and (2) they did not have a duty to defend Walsh in the City’s underlying suit against Walsh.
Walsh asserted four counterclaims and sought (1) indemnification under the CGL Policies for the $24,000,000 Walsh was seeking to recover from LB Steel, (2) recovery of the attorneys' fees and costs Walsh incurred in defending the City’s claims, (3) indemnification of the $10,000,000 Walsh paid to the City under the settlement and any additional costs incurred in remediating the defective welds, and (4) sanctions.
The United States District Court granted the insurers' motions for summary judgment and also denied Walsh's request for sanctions. Walsh then appealed to the United States Court of Appeals for the Seventh Circuit.
Analysis
Property Damage
On appeal, Walsh first argued that the district court erred when it determined the CGL Policies did not cover Walsh's damages. The Seventh Circuit emphasized that all three of the CGL Policies only covered “damage to the property of others—not to LB Steel's own property.” Thus, in order to succeed on the coverage question, Walsh would have needed to demonstrate some physical injury to “tangible property beyond the steel elements fabricated by LB Steel.”
Walsh argued that once the welds cracked, (1) the entire canopy became structurally unstable and (2) the structural instability was a physical change to the canopy system that increased the potential for collapse, which was in turn sufficient to trigger coverage. However, the Court rejected this argument as Walsh offered no evidence of the “structural instability” other than the cracked welds themselves and, under Illinois law, an increased potential for future property damage does not itself constitute property damage. The Court explained that, where such damage has yet to manifest, there is no “property damage” that triggers traditional CGL coverages. Furthermore, Walsh took measures to prevent damage to other parts of the canopy system and those costs were not recoverable under the policies.
Similarly, Walsh also argued that their damages were covered by the CGL Policies because the elements manufactured by LB Steel were so intertwined with the canopy structure that damage to the steel columns necessarily meant damage to the canopy as a whole. The Court rejected this argument and explained that when the definition of property damage requires physical injury, economic injury is not sufficient to show property damage. Moreover, Walsh had offered no evidence of physical damage other than the cracked welds themselves. The Court explained that, although Walsh suffered economic losses while retrofitting the defective steel columns, the defects in the columns did not require Walsh to disassemble the entire canopy and completely start over. The Court noted, however, “The outcome may be different if physical abnormalities in the columns required Walsh to disassemble the canopy and start anew, but that was not the case.”
From a policy standpoint, the Court concluded that all of Walsh’s damages were limited to LB Steel's own defective work and to find coverage in this case would mean that manufacturers like LB Steel could perform defective work without consequence, knowing that they could later recover any adverse judgments under their CGL policies.
Duty to Defend
The second argument that Walsh raised on appeal was that the district court erred when it found that the insurers owed no duty to defend them in the City’s underlying suit against Walsh. The Seventh Circuit prefaced their analysis by explaining that courts determine the duty to defend by looking only at the insurance policy and the complaint for which defense is sought. Thus, in order to succeed on the duty to defend question, Walsh needed to show that the City’s claims against them contained allegations that potentially fell within policy coverage. In other words, the City's allegations needed to somehow indicate that there might have or could have been damage to parts of the canopy not supplied by LB Steel because, as explained above, LB Steel's CGL policies only covered damage to the property of others—not to LB Steel's own property.
To this point, Walsh relied on the City's conclusory statement that its damages included costs associated with “repair.” According to Walsh, this language should have been sufficient enough to put the insurers on notice that the defective welds may have caused physical damage to non-LB Steel elements, thereby potentially implicating the CGL Policies and thereby triggering the duty to defend. However, the Court rejected this argument and explained that the City’s complaint made it clear that the “repairs” were made to defective welds themselves and not to other canopy elements. The Court also highlighted that the City’s complaint did not suggest the possibility that LB Steel's defective welds might have caused damage to other parts of the canopy system.
From a policy standpoint, the Court concluded that if it accepted Walsh's theory, an insurer would have a duty to defend any lawsuit where the complaint contains a generalized statement of damages or a conclusory request for relief.
Sanctions
Lastly, Walsh argued that the district court should have imposed sanctions on the insurers pursuant to an Illinois statute (215 Ill. Comp. Stat. 5/155(1)). Sanctions can be imposed when there is “an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable.” The Court explained that it is not unreasonable to litigate a bona fide dispute, and because the insurers’ position prevailed, the dispute was bona fide and sanctions were not warranted.
Concurrence in Part
The concurring opinion agreed with the majority that the defective welds were not, and did not cause, “property damage” under the CGL Polices. However, the opinion dissents as it pertains to the majority’s decision that there was no duty to defend. The dissenting opinion asserted that an insurer can refuse to defend only if the underlying complaint precludes any possibility of coverage under the policy. The dissent posits that the City’s complaint did not preclude any possibility of coverage under the policy, as the complaint’s silence on the issue of damages for elements other than the welds was not an admission that there was no possible physical damage to other elements of the canopy.
Conclusion
Illinois law contemplates that there may be scenarios in which a second-tier subcontractor’s CGL insurers must defend and/or indemnify a general contractor against claims arising from the second-tier subcontractor’s work. This ruling illustrates that both the duty to defend and the duty to indemnify depend on the specific coverage provided by the insurers and the specific types of property damage at issue. In cases where an insurance policy requires damage to property other than the property of the insured in order for coverage to be triggered, a general contract may need to show actual, manifested, physical damage of property other than that of the second-tier subcontractor’s work in order to trigger the insurer’s defense and/or indemnity obligations.