Opinions of the United 1994 Decisions States Court of Appeals for the Third Circuit
5-12-1994
Lucker Manufacturing v. The Home Insurance Corp, Inc. Precedential or Non-Precedential:
Docket 94-1347
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Recommended Citation "Lucker Manufacturing v. The Home Insurance Corp, Inc." (1994). 1994 Decisions. Paper 14. http://digitalcommons.law.villanova.edu/thirdcircuit_1994/14
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__________________
No. 93-1414 __________________
LUCKER MANUFACTURING, A UNIT OF AMCLYDE ENGINEERED PRODUCTS, INC.,
Appellant v.
THE HOME INSURANCE COMPANY
Appellee
___________________________________________________
On Appeal From the United States District Court for the Eastern District of Pennsylvania (D.C. Civil No. 92-04271) ____________________________________________________
Argued: October 26, 1993
Before: BECKER, ROTH, and LEWIS, Circuit Judges
(Filed May 12, 1994)
ROBERT E. COUHIG, JR. (Argued) Adams & Reese 4500 One Shell Square New Orleans, LA 70139
THOMAS J. ELLIOTT Elliott, Vanaskie & Riley 925 Harvest Drive Union Meeting Corporation Center #5 Third Floor Blue Bell, PA 19422
Attorneys for Appellant
1 WILLIAM T. SALZER (Argued) CURTIS P. CHEYNEY, III Swartz, Campbell & Detweiler 100 S. Broad Street 16 Land Title Building Philadelphia, PA 19110
Attorneys for Appellee
________________________
OPINION OF THE COURT ________________________
BECKER, Circuit Judge.
This is an appeal from summary judgment granted by the
district court in favor of the defendant, The Home Insurance
Company ("The Home") and against the plaintiff, Lucker
Manufacturing, a Unit of Amclyde Engineered Products, Inc.
("Lucker"), in an insurance coverage dispute arising under the
diversity jurisdiction, 28 U.S.C. § 1332. The appeal raises a
question of interpretation of language that appears in the
industry-wide, standard-form liability insurance policy known as
Comprehensive General Liability Insurance ("CGL"): does the
clause "loss of use of tangible property that has not been
physically injured" cover costs of preventing a defective
component from becoming incorporated into a product that has been
designed but has not yet been manufactured?
The product at issue here is an anchoring system made
by Lucker for the off-shore oil drilling industry and called a
Lateral Mooring System ("LMS"). Because of a defect that Lucker
discovered in a component of the LMS -- castings manufactured by
2 Milwaukee Steel Foundry, a division of Grede Foundries, Inc.
("Grede") -- Lucker was forced to increase the number of safety
precautions in the manufacturing process for the LMS. The
increased precautions ensured that the castings incorporated into
the LMS would not be defective. When Lucker sued Grede for these
costs, The Home, Grede's insurer, asserted that these costs were
not covered by the policy, and refused to defend or indemnify
Grede.
As part of a settlement agreement between Lucker and
Grede, Grede assigned to Lucker any rights that it had against
The Home for its failure to defend or indemnify. Lucker then
sued The Home. The district court granted summary judgment for
The Home because it believed that the additional safety
precautions Lucker had to add to its manufacturing process did
not represent a "loss of use" to Lucker of the LMS or LMS design,
but rather represented a change in its customers' acceptance of
the original LMS and LMS design. Since this injury to Lucker did
not constitute loss of use, the court held that The Home had not
breached its duty to defend or indemnify Grede.
In our view, however, loss of use can and should cover
the added costs of preventing a defective component from being
incorporated into a product, even if those added costs were
incurred because of a change in customer preferences. As we
discuss below, the distinction that the court drew between "loss
of customer acceptance" and loss of use is arbitrary. Liability
for costs incurred because of a change in demand for a product in
the marketplace brought about by the insured's wrongful act seems
3 to be precisely the type of liability that loss of use coverage
was designed to protect against.
But the fact that the Lucker complaint adequately
alleged a loss of use (and gets by summary judgment on that
issue) does not end the inquiry because, under the CGL policy,
the loss of use must have been to "tangible property." When The
Home withdrew coverage, it knew that the LMS itself had not
physically existed at the time Grede's casting failed but was
only in the design stage. Lucker contends, however, that its LMS
design, which did exist, was tangible property within the meaning
of the policy. We disagree because under current Wisconsin and
Pennsylvania law, a system design like that of the LMS is not
tangible property as that term is used in the standard form CGL
policy. Since an insurer has no duty to defend or indemnify
claims that fall outside the coverage of the policy, The Home had
no duty to defend or indemnify Grede. Consequently, we will
affirm the judgment of the district court.
I. FACTS AND PROCEDURAL HISTORY
In 1989, Lucker contracted with Shell Oil Company to
design and manufacture the LMS. An LMS is, in essence, a huge
permanent anchor. It is fixed to the ocean floor and holds in
place ships, oil platforms, and other large structures floating
on the surface. Among its components are "castings," large metal
objects that attach to the ocean floor and hold the cables
connected to the ship or platform. Lucker purchased a number of
these castings from a foundry in Milwaukee owned by Grede. Before
4 putting these castings into the LMS, Lucker decided to test their
strength, and it arranged an "equipment load test" at Lehigh
University. Confident that the test would impress its customer,
Lucker invited a Shell representative to watch. The test,
however, was a disaster. To everyone's horror, a casting
involved in the test suffered a catastrophic failure. Had it
been incorporated into the LMS and put into operation, Shell's
ships and platforms would have floated off to sea. So Shell told
Lucker that, although it still wanted the LMS, Lucker had to
maintain tighter control over the production and testing of the
steel for the castings. Lucker complied at a cost of $600,000.
At the time of the failure of the castings, the LMS was
only in the design phase and had not yet been built. After it
completed the LMS, Lucker sued Grede on both tort and contract
theories for the cost of compliance with Shell's instructions. It
is undisputed that the castings were defective and that the
defect was Grede's fault. Grede had a CGL policy with The Home
which insured it against any "property damage" Grede would be
legally obligated to pay Lucker. Although Lucker never claimed
that the LMS was physically injured, physical injury was not a
prerequisite of coverage. According to the terms of the policy,
"property damage" included "[l]oss of use of tangible property
that is not physically injured." Such a provision typically
covers an interruption of income that is caused by a wrongful act
not accompanied by physical injury.
The Home conditionally defended Grede during the early
part of the lawsuit under a reservation of rights. But when the
5 district court held that the tort claims sought purely economic
losses which are not recoverable under Pennsylvania law and that
Lucker could pursue its contract but not its tort claims, the
Home withdrew its defense of Grede and disclaimed all liability
under the policy. In a letter to Grede, The Home claimed that
contract-based economic damages were not loss of use of tangible
property and that there was no basis for coverage. In addition,
The Home took the position that the losses were excluded by the
"business risk," "failure to perform," and "sistership"
exclusions in the policy.0
The dispute between Lucker and Grede eventually went to
trial, and Lucker won a jury award of approximately $500,000.0 A
few months later, Lucker and Grede settled the lawsuit: Grede
paid Lucker $600,000 and assigned to Lucker its rights against
The Home to recover for defense costs and indemnification under
the policy. Standing in Grede's shoes, Lucker sued The Home
claiming that The Home was in breach of both its duty to defend
and to indemnify Grede, and that its breach was in bad faith.
Both The Home and Lucker moved for summary judgment, agreeing
that there were no factual disputes.
The district court granted summary judgment for The
Home. Lucker Mfg., Unit of Amclyde Engineered Prods., Inc. v.
0 The business risk exclusion excludes from coverage damage to the castings; the failure to perform exclusion excludes from coverage non-physical injury to other property arising from a breach of contract unless the damage comes from a sudden and accidental injury; the sistership exclusion excludes from coverage the costs of inspection, repair, or replacement of the castings. 0 Whether the jury correctly found Grede liable for the costs Lucker incurred due to Shell's demands is not before us.
6 Home Ins. Co., 818 F. Supp. 821 (E.D. Pa. 1993). The court held
that The Home did not breach its duty to defend Grede because
Lucker's complaint against Grede did not allege damages for "loss
of use" of the LMS or LMS design, or for any other form of
property damage covered by the policy. Id. at 828. It also held
that The Home had no duty to indemnify Lucker because none of
Lucker's damages fell within the policy's coverage. Id.
Additionally, it held that The Home did not act in bad faith. Id.
at 830.
In deciding as it did, the court looked both to the
language of the CGL policy and the language of the complaint
Lucker had filed in its lawsuit against Grede. The CGL policy in
this case provided that The Home: will pay those sums that the insured [Grede] becomes legally obligated to pay because of "bodily injury" or "property damage" to which the insurance applies.
The policy defined "property damage" as
a. Physical injury to tangible property including all resulting loss of use of that property; or
b. Loss of use of tangible property that is not physically injured.
Lucker conceded that there had been no claim in the underlying
action for actual physical injury to property other than the
castings, which (it also conceded) were not covered by the
policy. Instead, it characterized its loss as one for damages
7 resulting from the loss of use of its own tangible property --the
LMS design.0
In fending off the Home's claim that its pleadings were
inadequate, Lucker contended that paragraphs 14-17 of its
complaint potentially stated a claim for loss of use of the
design of the LMS. Paragraph 14 alleged that Shell had imposed
stricter standards for the production and testing of the steel
for the LMS; paragraph 15 alleged that Lucker had lost a
competitive advantage in bidding on Shell projects and had
sustained damage to its reputation; paragraph 16 alleged that had
the castings not failed, the additional tests would not have been
necessary; and paragraph 17 alleged that Lucker had suffered
increased testing costs, increased costs in performing the Shell
contract, lost profits, and lost future profits.
According to the district court, however, paragraphs
14-17 merely averred that "due to the failure of the castings,
[Lucker] could no longer sell the original LMS or LMS design to
Shell because Shell imposed additional requirements; and it was
the cost of complying with these additional requirements that
Lucker sought to recover." 818 F. Supp. at 825 (footnote 0 Lucker actually argued to the district court that it had lost the use of two things: 1) the LMS and 2) the design of the LMS. Because the district court decided there was no loss of use, it assumed that the LMS and LMS design both existed. It appears from the record before us, however, that the LMS itself never existed, but was still in the design stage at the time the castings failed. While the complaint potentially pled that the LMS itself existed, the record indicates that The Home knew these facts when it disclaimed coverage. We believe that since the LMS was no more than a design at the time, Lucker's claims that it lost the use of the LMS and the LMS design actually claim the same thing -- loss of use of the design.
8 omitted). Nowhere did Lucker claim that the LMS as designed
could no longer perform its intended function because of the
defect discovered in the castings. Rather, Lucker acknowledged
that the LMS as originally conceived could still hold floating
objects in place, but argued that its "use" of the LMS design and
the LMS was to sell the LMS to Shell and other customers, and
that when it was forced to change the manufacturing process and
the design, it lost the use of the LMS design. Id. at 827.
The court rejected this argument: There is no indication in the underlying complaint, either by inference or otherwise, that Lucker was ever unable, due to the failure of the castings or otherwise, to offer the original LMS for sale to Shell or to offer use of the original LMS design to other customers. Lucker simply complained that when offered, Shell and perhaps other customers wanted something different because of the failure of the castings. Thus Lucker did not allege a loss of an intended use of the original LMS as merchandise for sale or the original LMS design as a means of producing such merchandise; Lucker alleged a loss of expected customer acceptance of its product and design. And loss of customer acceptance of a product or design is in no way the equivalent of "loss of use" of a product or design under the policy. To equate the two would be to link CGL coverage to the vagaries of customer desire and make insurers of liabilities into guarantors of markets for goods and services. The CGL policy at issue here committed The Home to no such undertaking. The Home contracted to defend and indemnify Grede for damages resulting from the loss of use of tangible property only.
Id. at 828 (footnote omitted).
9 On this basis, the district court granted summary
judgment for The Home on the duty to defend issue. Once it
determined that The Home was not in breach of its duty to defend,
its conclusions on the duty to indemnify and bad faith claims
followed almost as a matter of course, and it granted The Home
summary judgment on both of those issues. Id. at 830. This
appeal followed. Because the material facts are not disputed, we
have plenary review of the district court's decision. Pacific
Indemnity Co. v. Linn, 766 F.2d 754, 760 (3d Cir. 1985).
II. CHOICE OF LAW
Faced with the possibility that either Pennsylvania or
Wisconsin law apply to this diversity case, a choice of law
question looms on the horizon. Before a choice of law question
arises, however, there must actually be a conflict between the
potentially applicable bodies of law. See Oil Shipping B.V. v.
Sonmez Denizcilik Ve Ticaret A.S., 10 F.3d 1015, 1018 (3d Cir.
1993). Where there is no difference between the laws of the
forum state and those of the foreign jurisdiction, there is a
"false conflict" and the court need not decide the choice of law
issue. In re Complaint of Bankers Trust Co., 752 F.2d 874, 882 (3d Cir. 1984) ("If the foreign law to which the forum's choice-
of-law rule refers does not differ from that of the forum on the
issue, the issue presents a 'false conflict.'"); Lambert v.
Kysar, 983 F.2d 1110, 1114-15 (1st Cir. 1993) ("We need not
resolve the [conflict of law] issue . . . as the outcome is the
same under the substantive law of either jurisdiction.").
10 Neither party has pressed a choice of law question on
this appeal because neither has been able to identify any
differences between Wisconsin and Pennsylvania law on the
questions of an insurer's duty to defend and indemnify. Our own
research has not identified any relevant differences either. As
far as we can tell, the outcome of this lawsuit should be the
same under either Wisconsin or Pennsylvania law. Since there is
no conflict of law under such circumstances, we will avoid the
choice of law question. Cf. Melville v. American Home Assur.
Co., 584 F.2d 1306, 1311 (3d Cir. 1978) (warning courts to avoid
dicta on conflicts questions when not put in issue). We
therefore will interchangeably refer to the laws of Wisconsin and
Pennsylvania in discussing the law governing The Home's duty to
defend and indemnify.0
III. THE DUTY TO DEFEND
A. General Principles and The Pleading Question
Under the governing law, an insurance company is
obligated to defend an insured whenever the allegations in a
complaint filed against the insured potentially fall within the
policy's coverage. This duty to defend remains with the insurer
until facts sufficient to confine the claims to liability not
within the scope of the policy become known to the insurer. See Imperial Casualty & Indem. Co. v. High Concrete Structures, Inc.,
0 The only real choice of law issue in this case involves the applicability of Pennsylvania's insurer bad faith statute, 42 Pa. C.S. § 8371. We need not reach this issue given our resolution of the duty to defend and duty to indemnify questions.
11 858 F.2d 128, 131-32 (3d Cir. 1988); Sola Basic Indus., Inc. v.
United States Fidelity & Guar. Co., 280 N.W.2d 211, 213 (Wis.
1979) ("[I]t is necessary to determine whether the complaint
alleges facts which, if proven, would give rise to liability
covered under the terms and conditions of the policy."); Stidham
v. Millvale Sportsmen's Club, 618 A.2d 945, 953-54 (Pa. Super.
1992) (if indemnification depends upon the existence or
nonexistence of disputed facts, the insurer has a duty to defend
until the claim is narrowed to one patently outside the policy
coverage).
Before considering whether a complaint is potentially
covered by a policy, it is necessary to determine the coverage of
the policy in the first instance. In both Pennsylvania and
Wisconsin (as in the majority of jurisdictions), the inquiry into
coverage is independent of and antecedent to the question of duty
to defend.0 See Erie Ins. Exch. v. Transamerica Ins. Co, 533
A.2d 1363, 1368 (Pa. 1987) (first construing the terms of the
policy, and then determining whether the complaint alleged facts
which, if proven, would come within the scope of the policy as
0 A minority of courts have held that where the question of coverage is an open question the insurer has a duty to defend. See St. Paul Fire & Marine Ins. Co. v. National Computer Sys., Inc., 490 N.W.2d 626, 632 (Minn Ct. App. 1992) (where the question whether binders with confidential information in them were covered was an open one, the insurer had a duty to defend); see also Centennial Ins. Co. v. Applied Health Care Sys., Inc., 710 F.2d 1288, 1291 (7th Cir. 1983) (applying California law, the court determined that the question whether information stored in a data processing system could be tangible property was irrelevant for purposes of determining the duty to defend because it was an unresolved question).
12 construed); U.S. Fire Ins. Co. v. Good Humor Corp., 496 N.W.2d
730 (Wis. Ct. App. 1993) (same).
Traditional principles of insurance policy
interpretation control the inquiry into coverage. The policy
language must be tested by what a reasonable person in the
position of the insured would have understood the words to mean.
See Imperial, 858 F.2d at 131. We must construe ambiguous
language to provide coverage. Id. A provision is ambiguous if
reasonable persons considering the relevant language in the
context of the entire policy could honestly differ as to its
meaning. Id.; see also Harford Mutual Ins. Co. v. Moorhead, 578
A.2d 492, 503 (Pa. Super. 1990) (the policy must unequivocally
indicate coverage or non-coverage), appeal denied, 590 A.2d 757
(Pa. 1991). Nevertheless, a court should be careful not to
create an ambiguity and, likewise, it should avoid rewriting the
policy language in such a way that it conflicts with the plain
meaning of the language. Imperial, 858 F.2d at 131.
Once coverage of the policy is determined, the court
then looks to the underlying complaint to see if it triggers
coverage. The underlying complaint need not track the policy
language for there to be coverage: under the liberal rules of
notice pleading, Lucker's complaint needed only to indicate the
type of litigation involved so that the defendant would have a
fair notice of the claim and its defenses. See First State Underwriters Agency of New England Reinsurance Corp. v. Travelers Ins. Co., 803 F.2d 1308, 1315 (3d Cir. 1986); Ollerman v.
O'Rourke Co., 288 N.W.2d 95, 98 (Wis. 1980); see also Western
13 Casualty & Sur. Co. v. Budrus, 332 N.W.2d 837, 839-40 (Wis. Ct.
App. 1983) (liberally construing a complaint to include a claim
for loss of use of tangible property).
Thus, the fact that Lucker did not include the magic
words "loss of use" or "tangible property" in its complaint does
not relieve The Home of its duty to defend. As the district
court recognized, the complaint, reduced to its relevant
essentials, averred that the failure of the Grede castings
prevented Lucker from being able to sell the LMS design to Shell.
Lucker, 818 F. Supp. at 825. The main question in this appeal,
then, is not whether there was adequate notice of such a claim,
but rather whether, given traditional principles of insurance
policy interpretation, such a claim is properly considered a
claim for loss of use of tangible property. With these general
principles in mind, we discuss first the question whether
Lucker's damages represented a loss of use of the LMS design. We
then turn to the question of whether the LMS design was tangible
property.
B. Loss of Use One of the two principal issues in this appeal --
whether the damages Lucker suffered because Shell wanted Lucker
to beef up its quality control of the steel in the LMS are
potentially "loss of use" damages as that term is used in the CGL
-- turns on a conflict between the connotations of the term "use"
on the one hand and the objectives of insurance on the other. As
has been mentioned, the district court agreed with The Home that
14 a "loss of use" within the meaning of the CGL form contract does
not occur when a customer demands from the injured party added
safeguards in the manufacturing process after a defect in the
insured's product is discovered.
Critical to the district court's decision that Lucker's
damages were not from a "loss of use" was the fact that Lucker
never claimed that the LMS design could not work after the
castings had failed at the Lehigh test. In the court's view, the
failure of the castings merely had the undesirable consequence of
"reducing the acceptability of the LMS and LMS design to Shell."
Lucker, 818 F. Supp. at 826 n.12. Apparently, the district court
saw a distinction between the loss of the ability to physically
use the LMS design and the loss of the ability to sell the LMS
design. One was use and the other was non-use. Cf. Eljer Mfg.
v. Liberty Mut. Ins. Co., 972 F.2d 805, 810 (7th Cir. 1992),
cert. denied, 113 S. Ct. 1646, 123 L. Ed.2d 267 (1993)
(discussing physical injury in the context of CGL standard
policies).
In everyday English, the district court's distinction
makes sense. The term "use" conjures the idea of some kind of
physical application of property, as when a carpenter uses a
hammer. If someone does not want to buy the hammer but it can
still pound nails into wood, the hammer can still be "used." That
a customer does not want to buy it has no effect on its
usefulness. But such a distinction has little to do with the
objectives of parties to insurance contracts. See Eljer Mfg., 972 F.2d at 809. As we see it, the focus of the insurance
15 coverage determination should be on whether a customer's
unwillingness to use a hammer, regardless of whether it is
physically possible to use the hammer, is a type of lost use for
which a risk-averse business pays its premium. "Ordinary
language" interpretations of phrases are not the only plausible
interpretations of insurance contracts, especially when the
contract is between sophisticated business entities. It is
important to ask what function "loss of use" was intended to
perform in a CGL policy before relying on a common sense or lay
distinction between physical use and other uses. See Erie Ins.
Exch., 533 A.2d at 1367 (stating that the term "use" must be
considered with regard to the setting in which it is employed).
The 1966 version of the CGL defined "property damage"
as "injury to or destruction of tangible property." Yet cases
interpreting that policy often afforded coverage for non-physical
injuries, like diminution in value. On the other hand, a number
of cases excluded injuries where there was no physical contact
between the injurer and the property injured. See Sola Basic,
280 N.W.2d at 214-15 (citing cases). In 1973, the CGL policy was
revised to clear up these internal tensions. The new CGL policy
replaced the old definition of property damage with the two-part
definition contained in the policy involved in this case. The
first part repeats the old definition, except that the word
"physical" is put before "injury." The second part is the "loss
of use" definition, which covers injury which is not physical
because the insured's property does not physically contact that
16 of the injured party. The revised language, then, allows
coverage for both physical and non-physical injuries.0
Of course, Lucker did not suffer physical injury to the
LMS (since it did not exist) or the LMS design. Nor did it lose
the physical use of the LMS or LMS design. Indeed, Lucker could
still have manufactured it and offered it for sale, and, even
according to Lucker, the original LMS design would still have
worked properly. Nevertheless, Lucker did lose the economic use
of the original LMS design: because of the defective castings,
Shell was no longer willing to buy the product, and Lucker could
no longer use the LMS design as a source of income.
The question in this case, therefore, reduces to
whether the lost "use" has to have been a lost physical use of
the property, or whether it can also include a lost non-physical
or economic use of the property. The district court thought that
loss of use should cover only lost physical use, and that
customer acceptance simply was not a "use." Lucker, 818 F. Supp.
at 828. We believe, however, that both the purposes behind
liability insurance and the case law interpreting liability
insurance suggest that the loss of a non-physical use of a
product, such as offering it for sale, should be considered a
0 The classic example of a loss of use injury is a case in which a manufacturer of construction cranes sells a defective crane which collapses in front of a restaurant, thereby impairing the restaurant's income. If the restaurant sues the manufacturer and recovers the lost income, the manufacturer would be covered by the "loss of use" component of the CGL policy. See Eljer, 972 F.2d at 810; George H. Tinker, "Comprehensive General Liability Insurance -- Perspective and Overview," 25 Federation of Ins. Counsel Q., 217, 232 (1975).
17 "loss of use"; and that the decreased value of a product because
of loss of customer acceptance of the product is a "loss of use"
within the meaning of the standard CGL policy.
We test our understanding against the baseline case for
both parties, Sola Basic. In Sola Basic, 280 N.W.2d at 211, the
insured was sued when a transformer it had manufactured for use
in an electrical steel furnace owned by Thunder Bay Manufacturing
was damaged by the insured's employee who had been sent to repair
the transformer. Id. at 212-13. Because of the damage to the
transformer, Thunder Bay could not operate the furnace. The
Supreme Court of Wisconsin held that Thunder Bay's loss of use of
the furnace was a covered loss. Id. at 217.
Sola Basic suggests that the use of a product as
merchandise for sale or as a means of production is a "use"
within the meaning of a CGL form policy. In real terms, such a
loss of use affects the injured party's ability to supply a
product. In Sola Basic, demand for Thunder Bay's product
remained the same, but its ability to supply its product -- that
is, to supply the product at a competitive price -- was impaired
because the furnace could not work. It is as if the supply curve
was suddenly shifted to the left due to the negligence of the
insured, and the liability insurance loss of use concept made up
the difference.0
0 Another way to think of Sola Basic is by viewing the furnace as an income stream. When the furnace was shut down, Thunder Bay was deprived of the income stream from the furnace for the period it was inoperative. That loss was lost use and was within the scope of the coverage.
18 The district court accepted the Sola Basic decision as
authority but distinguished it from this case because the change
in customer acceptance did not affect the ability of Lucker to
supply the product. A change in customer acceptance is a change
in the demand curve, not the supply curve. Apparently, the court
believed that the change in demand should be analyzed differently
from a change in supply. But it is not clear to us why this
should be the case.
When a manufacturer supplies a defective product that
injures a third party, the injury from that particular defect
may, depending on the reaction of the injured third party, affect
either the demand for the third party's goods or the supply of
those goods. Differing factors may influence whether the effect
is on supply or demand. For example the time of discovery of the
defect is important. If a manufacturer of enamel finishes
produces a defective batch and sells it to a manufacturer of
widgets, the discovery of the defect before the enamel is applied
to the widgets will affect the supply of widgets the manufacturer
has available to sell because production must be halted while new
enamel finish is obtained. If the discovery is made after the
enamel is applied, the demand for widgets will be affected
because customers won't want to buy widgets with blotchy
finishes. Another factor that may influence whether supply or
demand is affected is the need of the widget producer to move
merchandise. He may decide he would rather sell blotchy widgets
at a lower price in order to keep up cash flow. The type of
injury, whether caused by the widget producer's loss through
19 reduction in supply or in demand, may thus be beyond the control
of the enamel finish manufacturer. However, in purchasing CGL
coverage, the manufacturer will want protection from liability
for the widget producer's loss in either event. For the same
reason, if Grede were supplying steel to the widget producer,
Grede would want CGL coverage whether the defective steel caused
a reduction in supply because the production of widgets was
halted or a reduction in demand because customers doubted the
durability of widgets.
Consequently, a manufacturer worried about liability
has no reason to see a difference in the type of coverage he has
bought unless the insurance contract says otherwise, and the
standard CGL insurance contract does not say otherwise. CGL
insurance appears to protect the insured from making up the
difference in the injured party's revenue, regardless of whether
the liability is for shifting supply or demand. Therefore,
coverage for both sorts of injuries appears to be within the
reasonable expectations of the insured.
The relevant case law supports our view that no
difference exists between coverage for wrongful acts that affect
supply, and those that affect demand. One case from this Court
interpreting Pennsylvania law apparently held that a change in
demand for a product may be considered a "loss of use." See
Imperial Casualty, 858 F.2d at 128. In Imperial Casualty,
Keystone, a manufacturer of washers, had a contract with Nice
Bearing Company to supply it with a special kind of washer. Id. at 130-31. Keystone bought special steel from High Concrete to
20 make the washers. Id. Nice discovered that Keystone's washers
were defective and rejected them. Id. Apparently the steel High
Concrete had supplied was defective. Id. Keystone then sued
High Concrete for breach of warranty, seeking "loss of use"
damages in the form of lost profits and other incidental charges,
including added freight charges. Id. at 135. This court held
that these damages were potentially recoverable under High
Concrete's CGL policy as "loss of use." Id. at 135-36.
In Imperial, we allowed recovery for loss of use
despite the fact that Keystone could have produced all of the
washers made from the defective High Concrete steel that it
wanted. Nothing stopped Keystone from supplying washers made
from the High Concrete steel except for the fact that its
customer refused to accept them. As in this case, a change in
customer acceptance of the product caused the loss of use to
Keystone, which had no use for the product other than selling it.
To the extent there was a loss of use, it had to have been that
Keystone's lost ability to sell the product was due to decreased
demand. The Home's attempt to distinguish Imperial on the ground
that in Imperial there was physical injury to the washers does not change the fact that this Court found a loss of use that was
attributable solely to a change in customer acceptance of the
product.
The cases upon which The Home relies do not
specifically address the contours of the loss of use provision.
The Home relies on McDowell-Wellman Eng'g Co. v. Hartford Acci. & Indem. Co., 711 F.2d 521 (3d Cir. 1983), and Trio's, Inc. v.
21 Jones Sign Co., 444 N.W.2d 443 (Wis. Ct. App. 1989), for the
proposition that loss of use does not include the type of loss
Lucker suffered. In each case, the insured's product failed
(McDowell-Wellman involved an ore bridge0 and Trio's involved a
restaurant sign) and the insured incurred liability for a number
of costs associated with the product's failure. In McDowell-
Wellman the costs included the expenses incurred to keep the
steel plant operational without a functional ore bridge, and in
Trio's the costs included lost revenues for the time the
restaurant went without a sign. Although the courts denied
recovery for those costs in both cases, neither court did so
because there was no loss of use. Rather, in both cases the
courts thought that the costs recovered represented loss of use
of the insured's product, costs which the policies specifically
excluded from coverage. McDowell-Wellman, 711 F.2d at 526-27;
Trio's, 444 N.W.2d at 444-45.0 Because both cases were decided
on the basis of policy exclusions, and not on the basis of loss
of use, they are inapposite.
0 An ore bridge is part of a system in a steel plant that carries raw materials to a blast furnace for processing. McDowell- Wellman, 711 F.2d at 523. 0 Both McDowell-Wellman and Trio's are essentially cases about allocating damages between the loss of use of the malfunctioning component and loss of use of the other property. Both employ a sort of "but for" causation approach to deny coverage: "but for" the malfunctioning ore bridge, the steel company would not have incurred the additional costs; and "but for" the malfunctioning sign, the restaurant would have lost no revenues. Such an approach essentially reads the term "loss of use" right out of the policy. Whenever there is a malfunctioning component, all loss of use of other property is caused at some level by the malfunctioning product or else there would simply be no injury due to the insured's product to which liability may attach.
22 Apparently at the heart of the district court's opinion
in this case was a fear that allowing coverage for Lucker would
link insurance coverage to the "vagaries of customer desire" and
turn liability insurers into "guarantors of markets for goods and
services." Lucker, 818 F. Supp. at 828. That fear in the
context of this case is exaggerated: the loss of use provision
is triggered only when the change in preference is due to the
insured's wrongful act, and obviously not all changes in customer
preferences are due to an insured's wrongful act. To be sure,
identifying the cause or magnitude of damages due to changes in
customer preference might prove difficult in some cases, but
substantive principles of tort and contract law account for such
difficult inquiries with doctrines that shield defendants (the
insureds) from liability where appropriate. For example, the
economic loss doctrine, by denying recovery under the rubrics of
duty and probable cause, protects defendants from unanticipated
plaintiffs and disproportionate liability.0
Even though reasonable minds may disagree with our
construction of the language, the language is, at the very least,
reasonably susceptible to more than one construction from the
viewpoint of the insured and is therefore ambiguous. Since under
Pennsylvania and Wisconsin law we must resolve any ambiguity in
0 Concerns about vastly increased liability are not at all implicated in this case. Quite to the contrary, when Lucker replaced the castings and added safeguards so that faulty castings would not be installed in the LMS, it was mitigating the consequences of Grede having supplied it with a defective product. It was thus curtailing rather than expanding potential liability.
23 favor of coverage, we hold that loss of use includes the loss of
customer acceptance that Lucker suffered in this case.
C. Tangible Property
We need not reverse, however, if the LMS was not
tangible property within the meaning of the insurance contract.
Although the underlying complaint may have potentially alleged
that the LMS existed as a tangible entity, at the time The Home
disclaimed coverage for Lucker's complaint against Grede it was
apparent that the LMS itself was not tangible at the time the
castings failed.
The LMS design did exist, however, and the complaint
potentially pled that Lucker had lost the use of its design after
the castings had failed.0 Thus, we must determine whether a
design is tangible property as that term is used in a CGL.0 We
0 The LMS designs and plans existed prior to the catastrophic failure of Grede's product. They were used previously in AmClyde's Placid Oil Project, the Conoco Project, and the Akashi Bridge Project in Japan. The existence of the design was also apparent from the complaint. 0 The Home has argued vigorously that since the underlying complaint sought only loss of profits and other economic losses, Lucker was not seeking damages for loss of use of tangible property. Economic harms, The Home argues, are simply not tangible. While such an observation may be correct, it misunderstands the nature of the losses Lucker was seeking from Grede. Lucker was not seeking compensation for economic losses qua economic losses; rather, Lucker was pointing to its economic losses as a proxy for the value of the lost use of its LMS design. Even the cases on which The Home relies recognize that an intangible economic loss, such as the diminution of value of a fixed asset, is recoverable if it provides a measure of damage to the tangible property. See Liberty Bank of Montana v. Travelers Indem. Co., 870 F.2d 1504, 1509 (9th Cir. 1989); Giddings v. Industrial Indem. Co., 112 Cal. App. 3d 213, 219, 169 Cal. Rptr. 278, 281 (1980) (a complaint seeking to recover for economic
24 conclude that the language of the policy, analogous case law from
Pennsylvania and Wisconsin, and case law from other jurisdictions
compel the conclusion that the term tangible property does not
include non-tangible property like system designs.
Under Pennsylvania and Wisconsin law, tangible property
is property that can be felt or touched, or property capable of
being possessed or realized. In re Estate of MacFarlane, 459
A.2d 1289, 1291-92 (Pa. Super. 1983); see also United States
Fidelity & Guar. Co. v. Barron Indus., Inc., 809 F. Supp. 355,
360 (M.D. Pa. 1992) (the term tangible in a CGL covers things
which are physical -- capable of being touched and objectively
perceivable); Holsum Foods, Div. of Harvest States Coop. v. Home
Ins. Co., 469 N.W.2d 918, 921 (Wis. Ct. App. 1991) (similar
approach).
In contrast, intangible property is defined as property
that does not have intrinsic value but which is merely
representative or evidence of value, like stock certificates.
MacFarlane, 459 A.2d at 1292; Barron Indus., 809 F. Supp. at 360
(under Pennsylvania law CGL policy does not cover intangible
property, such as property that represents value but has no
intrinsic marketable value of its own (e.g., stock, investments,
losses "falls within the scope of the insurance coverage only where these intangible economic losses provide a measure of damages to physical property which is within the policy's coverage") (internal quotation omitted). In this case, Lucker lost the use of its LMS design. The absorbed costs of beefing up its specifications for the steel in the LMS and the other costs it recovered from Grede are a proxy for the value of the lost use of the original LMS design. As such, they are recoverable under the policy if the LMS design was tangible property.
25 copyrights, promissory notes); property regarded as intangible
rights (e.g., goodwill and reputation); or economic interests
(e.g., overhead, profits, investment value, and productivity));
Columbia Gas Transmission Corp. v. Commonwealth, 339 A.2d 912,
918 (Pa. Commw. Ct. 1975) (natural gas is tangible property for
tax purposes even though it cannot be felt because it is capable
of being perceived as materially existent; "[i]ntangible
properties in the law are such incorporeal rights as shares of
capital stock, choses in action, copyrights and the like"), error
dismissed, 350 A.2d 193 (Pa. Commw. Ct. 1975), rev'd on other
grounds, 360 A.2d 592 (Pa. 1976); Palmolive Co. v. Conway, 43
F.2d 226, 227 (D. Wis. 1930) (trademarks, trade secrets, and good
will not tangible property), aff'd, 56 F.2d 83 (7th Cir. 1932),
cert. denied, 287 U.S. 601, 53 S. Ct. 8, 77 L. Ed. 524 (1932);
American Tel. & Telegraph Co. v. Department of Revenue, 422
N.W.2d 629, 631 (Wis. Ct. App. 1988) (cash, shares of stock,
notes, bonds, etc., not tangible as defined in tax statute). But
see Man, Levy & Nogi, Inc. v. School Dist. of Scranton, 375 A.2d
832, 834 (Pa. Commw. 1977) (insurance premiums are tangible
property for tax purposes).0 0 The distinction between tangible and intangible property made by these cases tracks the definitions found in Black's Law Dictionary. Black's defines tangible property as "property that has physical form and substance and is not intangible" and intangible property as "such property as has no intrinsic and marketable value, but is merely the representative or evidence of value, such as certificates of stock, bonds, promissory notes, copyrights, and franchises." Black's Law Dictionary (6th ed. 1990). Insurance companies reasonably might want to exclude coverage for damage to such intangible interests because estimating the potential liability for purposes of setting the
26 Because these principles are so well settled, Lucker
does not argue that the concept of the LMS is tangible property,
for such an idea cannot be touched and is not materially
existent. Rather, Lucker contends that a design which is reduced
to a tangible medium, like a blueprint or a computer disk, should
be considered tangible property. The Home, on the other hand,
argues that where the real value of a design is in the idea, not
in the physical plans that memorialize it, any loss in value of
the design represents a loss in the value of the idea, which is
not a loss of use of tangible property. We believe that The
premium might be very difficult, or even if the premium could be calculated, insuring against such liability might expose the company to such increased costs because of a great variance in liability that a CGL policy might become prohibitively expensive. It may also be that insurance companies are in no better position to insure against such losses than the insured. For example, assuming that the stock is publicly traded, one can insure against changes in market price by purchasing options. We note, however, that it is difficult to explain why liability for copyright or patent infringement would be included among the interests not covered by a CGL policy. There is no obviously increased moral hazard problem (an insufficient incentive to be careful) with respect to copyright or patent infringement as compared to other types of injuries. Nor does it appear to raise the possibility of huge liability, or liability that is difficult to calculate. And it does not appear that the marketplace provides an efficient alternative to an insurance policy as it does with things like stocks. Perhaps exclusion of coverage for copyright or patent violations can be explained by the fact that the CGL policy is a standard form and most customers of such policies are not as risk averse with respect to copyright and patent violations as they are with other types of tort damages and so they do not demand coverage for such injuries. At all events, it appears sensible to presume that purchasers of liability insurance, who are principally concerned with more conventional forms of tort damage that their product may cause a third party, reasonably would be willing to bear the risk of loss to traditionally intangible interests in exchange for lower premiums.
27 Home's position is the one best supported by the relevant case
law.
The Home principally relies on a taxation case from
Wisconsin which held that the sale of computer keypunch cards was
not a sale of tangible property for purposes of the Wisconsin
sales tax. See Janesville Data Center, Inc. v. Wisconsin Dep't
of Revenue, 267 N.W.2d 656, 658-59 (Wis. 1978). In Janesville,
the Wisconsin Supreme Court reasoned that the information on the
card, rather than the card itself, was the object of the
transaction, and that, the tangible medium keeping the
information was merely incidental to the transaction. Id.
Therefore, the court held, the sale of the keypunch cards was not
a sale of tangible property. Id.0 Lucker has cited no authority from the relevant
jurisdictions. Instead it has countered with a Minnesota case,
Retail Sys., Inc. v. CNA Ins. Cos., 469 N.W.2d 735 (Minn. Ct.
App. 1991), which held that a computer tape that stored
information was tangible property covered under a liability
policy, and a case from the United States District Court for the
Northern District of Georgia, State Farm Fire & Casualty Ins. Co.
0 The other case on which The Home places principle reliance, Gulf Insurance Co. v. L.A. Effects Group, Inc., 827 F.2d 574 (9th Cir. 1987), does not really advance The Home's position. In that case, L.A. Effects was sued by Twentieth Century Fox for failing to perform adequately in designing the special effects for the film Aliens. Although L.A. Effects' argument that Fox's damages amounted to a loss of use of Aliens was rejected, Fox did not allege as damage any diminution in value to the film. Id. at 577-578. Thus the issue presented here was not before that court and consequently that court did not hold that the loss of value of the film could not be loss of use of tangible property.
28 v. White, 777 F. Supp. 952 (N.D. Ga. 1991), which held that
architectural plans in blueprint form were tangible property
covered under a CGL policy.
Neither Retail Systems nor White extended the concept
of tangible property as far as Lucker would have us do here,
however. In Retail Systems the court limited the coverage to the
considerable value of the computer tape as a storage medium,
disallowing recovery for the value of the data it stored.
Similarly, in White, a case in which developers sought coverage
for costs they incurred in converting architectural drawings, the
district court recognized that the only recovery due the
developers under the policy was for the value of the paper and
ink, and not the value of the ideas the paper and ink embodied.
777 F. Supp. at 954-55. Both cases drew a sharp distinction
between recovery for the value of a tangible medium storing
ideas, and recovery for the ideas themselves.0 To the extent
that the damage had been merely to the value of the idea, it was
not damage to "tangible" property.
In this case, none of the losses Lucker sought from
Grede represented a loss in value of the storage medium in which
the design for the LMS was embodied or in the costs in reducing
the design to blueprints or computer tape (e.g. the costs of
0 Other courts have also seen such a distinction. See, e.g., Commonwealth of Massachusetts v. Rizzuto, 1980 WL 4637 (Mass. Super. 1980) (Commonwealth could not prosecute for theft a defendant that copied someone else's idea for a film because the idea, although reproduced in tangible form and capable of being reproduced into tangible form, was not itself tangible; distinction must be drawn between cause of value and thing of value).
29 having engineers draw up the plans for the system). The recovery
Lucker sought was for the loss of use of the design itself -- for
the loss in usefulness of the original concept of the LMS. The
loss of use of this concept, however, was not loss of use of
something which could be touched or felt. For this reason, we
hold that Lucker's loss of use of the LMS design was not loss of
use of tangible property.
We note, however, that the "tangibility" limitation in
the standard form CGL seems to be in tension with what we believe
is its underlying rationale. As far as we can tell, the CGL
limits coverage to "tangible property" to avoid indemnifying the
insured for any liability the insured faces for damage caused to
stocks, bonds, copyrights and the like, items for which either
the insurer is arguably in no better position to spread risk than
the insured, or which would dramatically increase the premiums.0
But by making "tangibility" the touchstone of coverage, the CGL
excludes a significant class of property for which liability
insurance reasonably could be provided --property like system
designs or computer software.
The "tangibility" limitation was probably a reasonable
way to separate insurable from non-insurable property interests
in 1973 when the CGL standard policy was drafted. But the
tremendous increase in automation, and the concomitant increase
in demand for intangible products like computer software and
system designs during the past twenty years, has made such a
0 See note 13 above.
30 limitation of questionable value. As a matter of risk spreading,
we see no qualitative difference between the need for insurance
to protect a manufacturer from liability incurred because its
product shuts down a furnace, damages a computerized billing
system, or, as in this case, devalues a system design.0
Nevertheless, we are bound by the language of the
policy, and we cannot stretch it to include non-tangible property
like the LMS design. Unlike "loss of use," which can plausibly
be construed to include loss of customer acceptance, it would
require too great a departure from the meaning of "tangible" to
hold that a system design is tangible property covered under the
policy. Therefore, because the LMS design was not tangible
property, there was no "property damage" and thus no coverage
under the policy for Lucker's loss. As a result, we agree with
the district court that The Home did not breach its duty to
defend Grede when it disclaimed coverage.0
IV. THE DUTY TO INDEMNIFY
In light of our holding on the duty to defend, we may
dispose of the duty to indemnify summarily. An insurer has a
duty to indemnify its insured only if it is established that the
insured's damages are actually within the policy coverage.
0 A preferable way to approach the problem might be for the insurer to eliminate the overbroad "tangibility" requirement from the definition of property damage and instead specifically exclude traditional intangible property interests, like stocks, copyrights, or goodwill. 0 Because we hold that there was no "property damage," we need not construe the policy's exclusions.
31 Safeguard Scientifics v. Liberty Mut. Ins. Co., 766 F. Supp. 324,
334 (E.D. Pa. 1991), aff'd in part, rev'd in part without
opinion, 961 F.2d 209 (3d Cir. 1992). Lucker recovered from
Grede as a result of the jury verdict: 1) $32,934 for the actual
cost of the castings; 2) $200,007 in "Test Project Costs"; and 3)
$251,337 for "Costs Absorbed to reproduce Shell's casting to a
higher specification." Lucker cannot recover any of these costs
because neither the LMS nor the LMS design was tangible property,
and hence there was no property damage covered by the policy.0
The judgment of the district court will be affirmed.
0 Because we find that The Home was in breach of neither its duty to defend nor its duty to indemnify, it did not act in bad faith and did not violate 42 Pa. C.S. § 8371.