Business Decision Voided Insurance Coverage

Claims are made against you regarding concerns with your work, so you decide to "fix" the problem as a business decision to maintain good will and avoid further issues. Sounds like a good business decision, doesn't it? Well, not if you think the underlying issue could be subject to insurance coverage. In a recent decision of first impression construing Virginia insurance coverage law, Judge Smith of the U.S. District Court for the Eastern District of Virginia concluded recently in Builders Mutual Insur. Co. v. Dragas Management Corp., Civil Action No. 2:09cv185 that the mere threat of litigation is itself insufficient to support a "legal obligation" so as to trigger a carrier's obligation to pay money damages.

The context of that decision was the property developer's decision to replace "Chinese drywall" after receiving numerous complaints by homeowners. Judge Smith sided with what she concluded was the majority of courts who have concluded that in order for an insured to be "legally obligated" there must have been either a final judgment or a settlement as the result of a suit. She then concluded that the demands made upon the developer were legally insufficient to trigger such legal obligation because doing so would improperly expand the carrier's obligation beyond the contractual coverage. She therefore held that the developer "volunteered" the remediation and could not recover for it from its carrier, concluding that "Demands under the guise or potential of a legal right are not sufficient to create a legal obligation to pay by the insured, and the sums expended in response to such demands do not constitute 'damages' under the insurance policies at issue."

So what is a developer or contractor to do? This case at least concludes that if you decide to "do the right thing" or try and "get ahead of the curve" regarding mere threats of litigation, you clearly do so at your own risk with respect to coverage for what you spend doing that. This case dictates consultation with your carrier before you make that type of decision, or you likely will have been concluded to have waived coverage; at least if you case ends up before Judge Smith, until such time as the Virginia Supreme Court or a higher Federal Court addresses the issue differently. The downside of this decision is that it discourages pre-suit settlement, and the result may well be increased litigation. But if you think you may have coverage at that point, voluntary remediation should only be used when you in fact are willing to pay for the remediation at your own cost.

To the cynical, this case reflects the adage that "no good deed goes unpunished." To me, its further shows the importance of involving everyone available from your business teams before making this type of major business decision, including your insurance agent and your attorney, when it comes to questions of building defects, potential coverage and the pros and cons of your various available courses of action.