Northland Casualty Company v. Mulroy et al

Filing 49

ORDER re 37 MOTION for Partial Summary Judgment Regarding Coverage filed by Northwest Log Homes, Joseph S. Mulroy, Duane Keim, 32 MOTION for Summary Judgment Plaintiff Northland Casualty Company's Motion for Partial Summary Judgmen t filed by Northland Casualty Company, 35 MOTION for Partial Summary Judgment Regarding Plaintiff's Breach of Duty to Defend filed by Northwest Log Homes, Joseph S. Mulroy, Duane Keim. Telephonic Scheduling Conference set for 7/29/2015 at 3:00 PM in Missoula, MT before Judge Dana L. Christensen. Signed by Chief Judge Dana L. Christensen on 7/21/2015. (dle)

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MONTANA
MISSOULA DIVISION

NORTHLAND CASUALTY
COMPANY, a Connecticut Corporation,
Plaintiff and
Counter-Defendant,

CV 13–232–M–DLC

ORDER

vs.
JOSEPH S. MULROY DBA YORLUM
RANCH AND YORLUM RANCH LTD,
NORTHWEST LOG HOMES LLC, and
DUANE KEIM,
Defendants,
JOSEPH S. MULROY,
Counterclaimant and
Third-Party Plaintiff,
vs.
GLACIER INSURANCE OF LIBBY,
INC., a Montana Corporation,
Third-Party Defendant.
Before the Court are the parties’ cross motions for partial summary
judgment on the issue of coverage, and Defendants’ motion for partial summary

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judgment on Plaintiff Northland Casualty Company’s (“Northland”) duty to
defend. For the reasons explained below, Defendants’ motions for partial
summary judgment are denied and Northland’s motion is granted.
BACKGROUND
This case arises out of a construction defect claim involving a beetleinfested log home. In June 2006, Defendant Joseph Mulroy (“Mulroy”) hired
Defendant Duane Keim (“Keim”) and Keim’s company, Defendant Northwest Log
Homes (“Northwest”), to construct a log home on Mulroy’s property in Trego,
Montana. Northwest was primarily responsible for construction of the “log shell”
of the home, while subcontractors were to perform the remaining work to make the
structure livable. Northwest purchased the logs to be used in the home from a log
broker out of Striker, Montana, who in turn purchased the logs from one or more
loggers in the northwest Montana region. The logs were standing dead timber.
Northwest processed the logs by peeling, notching, pressure washing, and sorting
them, but did not chemically treat the logs with insecticide. Northwest completed
the project, which included a remodel of a guest house on the property, in 2008.
Through 2009 and 2010, Mulroy and his wife began noticing insect bore
holes and track marks in the logs comprising the shell of the home. Mulroy
attempted to treat the logs himself, but was unsuccessful. In 2011, Mulroy
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brought the infestation issue to Northwest’s attention and made a claim to
Northwest’s insurer, Northland. At the time Mulroy, Keim, and Northwest entered
into their construction contract and through the time it took to build the home,
Northland insured Northwest under an occurrence-based commercial general
liability (“CGL”) insurance policy with $1,000,000 per occurrence and $2,000,000
aggregate limits.
On July 5, 2011, Northland advised Keim and Northwest by letter that there
was no coverage under the CGL policy for Mulroy’s claims. In this initial letter,
Northland indicated that there was no coverage because Mulroy’s claims were for
“breach of contract and faulty workmanship,” and therefore did “not constitute
claims for ‘property damage’ caused by an ‘occurrence’ as those terms [were]
defined by the policy.” (Doc. 39-3 at 2.) Northland further identified a number of
exclusions contained in the policy which it contended would preclude coverage
even if the claims did meet the “occurrence” definition. Northland advised
Mulroy of its opinions and conclusions on July 18, 2011. Mulroy responded on
October 19, 2011, urging Northland to accept Northwest’s tender of a defense for
his claims. Northland again declined a defense on November 16, 2011.
On December 16, 2011, Mulroy filed a complaint against Keim and
Northwest in the Montana Nineteenth Judicial District Court of Lincoln County.
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The complaint alleged negligence, negligent misrepresentation, and breach of
warranty. Upon receipt of the complaint, Northland accepted defense of the
claims under a reservation of rights in a letter dated March 1, 2012. Northland
articulated the same coverage concerns in the reservation of rights letter as it had
nearly a year before in its initial denial letter.
After nearly nineteen months of litigation in the underlying case, which
included a $490,000 demand from Mulroy, Northland filed this declaratory
judgment action on November 15, 2013. The parties then attended a settlement
conference ten days later. The parties failed to resolve the case at the conference,
and trial was set for January 28, 2014. The state court then granted Mulroy’s
motion to vacate the trial date, and on January 22, 2014 Northland sent a second
reservation of rights letter to Keim and Northwest. The letter contained the same
coverage analysis as Northland’s previous two letters, and further reminded
Northwest that it “may not voluntarily make a payment assume any obligation, or
incur any expense . . . without [Northland’s] consent.” (Doc. 34-10 at 10.) At this
point, Northland had been providing a defense to Northwest for just shy of two
years.
On March 19, 2014, with this action pending and without notifying
Northland, Mulroy, Keim, and Northwest entered into a “Settlement Agreement
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and Assignment of Claims,” providing for Northwest’s “admission of liability and
agreement to hold a hearing on damages in exchange for a covenant not to execute
and assignment of all right relating to insurance.” (Doc. 34-11 at 1.) Northwest
was represented in this settlement and assignment by different counsel than had
been provided by Northland since March 2012.
The hearing contemplated in the settlement agreement took place before the
state court judge in Lincoln County on August 6, 2014, the same day the parties
filed pretrial conference documents in this case. Northwest elected to be
represented at this hearing by an attorney from the law firm which Northland had
retained to represent the interests of its insured. The parties presented testimony
from four witnesses: (1) William Finley, a log home restoration specialist, testified
on Mulroy’s behalf as to the available course of action for remedying the beetle
infestation; (2) Terry Comstock, a real estate broker from Eureka, Montana,
testified on Mulroy’s behalf regarding the diminution in value of the log home
even if remediation was successful in the future; (3) Mulroy himself testified; and
(4) Dr. David Weaver, an entomologist from Montana State University, testified
on Northwest’s behalf as to the characteristics of the beetle species found in the
logs. Notably, Dr. Weaver testified that the beetles “were in the timber when
harvested, when it was delivered, and when construction occurred.” (Doc. 34-1 at
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2.) Keim did not attend the hearing.
This Court conducted a preliminary pretrial conference in this matter on
August 13, 2014. The parties agreed that, due to the dispositive nature of the
coverage question, it was appropriate to set discovery and motions deadlines as to
that issue only. The Court therefore set a fully-briefed coverage motions deadline
of April 10, 2015, but did not set this matter for trial.
Shortly after the pretrial conference, the state court judge issued findings of
fact and conclusions of law on August 29, 2014. Ultimately, he concluded that
Northwest and Keim were liable on all three counts in Mulroy’s complaint, as
stipulated, and awarded $208,824.58 in remediation damages and another
$120,000 in damages related to diminution in the value of the home.
The parties filed the instant motions for partial summary judgment on
March 20, 2015.
LEGAL STANDARD
A party is entitled to summary judgment if it can demonstrate that “there is
no genuine dispute as to any material fact and the movant is entitled to judgment
as a matter of law.” Fed. R. Civ. P. 56(a). Summary judgment is warranted where
the documentary evidence produced by the parties permits only one conclusion.
Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 251 (1986). Only disputes over
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facts that might affect the outcome of the lawsuit will preclude entry of summary
judgment; factual disputes that are irrelevant or unnecessary to the outcome are
not considered. Id. at 248. In ruling on a motion for summary judgment, a court
must view the evidence “in the light most favorable to the opposing part.” Tolan
v. Cotton, 134 S. Ct. 1861, 1866 (2014) (quoting Adickes v. S.H. Kress & Co., 398
U.S. 144, 157 (1970)). “[T]he evidence of the nonmovant is to be believed, and
all justifiable inferences are to be drawn in his favor.” Id. at 1863 (quoting
Anderson, 477 U.S. at 255).
“[W]hen parties submit cross-motions for summary judgment, each motion
must be considered on its own merits.” Fair Hous. Council of Riverside Co., Inc.
v. Riverside Two, 249 F.3d 1132, 1136 (9th Cir. 2001) (citations omitted). “The
court must rule on each party’s motion on an individual and separate basis,
determining, for each side, whether a judgment may be entered in accordance with
the Rule 56 standard.” Id. (quoting Charles Alan Wright et al., Federal Practice
and Procedure vol. 10A, § 2720 (3d ed. West 2014)). “In fulfilling its duty to
review each cross-motion separately, the court must review the evidence submitted
in support of each cross-motion.” Id.
ANALYSIS
A federal court sitting in diversity applies the substantive law of the forum
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state to state law claims. Mason & Dixon Intermodal, Inc. v. Lapmaster Intern.
LLC, 632 F.3d 1056, 1060 (9th Cir. 2011). Thus, the Court decides these motions
for partial summary judgment pursuant to Montana insurance law.
“The interpretation of an insurance policy presents a question of law” to be
decided by the Court. Allstate Ins. Co. v. Wagner-Ellsworth, 188 P.3d 1042, 1044
(Mont. 2008). The Court must “examine insurance contracts as a whole, with no
special deference to specific clauses, . . . accord the usual meaning to the terms
and the words in an insurance contract, and . . . construe them using common
sense.” Modroo v. Nationwide Mut. Fire Ins. Co., 191 P.3d 389, 395 (Mont.
2008) (citations omitted). “[W]hen the language of a policy is clear and explicit,
the policy should be enforced as written.” Steadele v. Colony Ins. Co., 260 P.3d
145, 149 (Mont. 2011) (citations omitted). “Courts should not . . . seize upon
certain and definite covenants expressed in plain English with violent hands, and
distort them so as to include a risk clearly excluded by the insurance contract.”
Travelers Cas. & Sur. Co. v. Ribi Immunochem Research, Inc., 108 P.3d 469, 474
(Mont. 2005) (citations and internal quotation marks omitted).
I.

Northland’s duty to defend.
Defendants contend that Northland breached its duty to defend Northwest

and Keim not by actually denying a defense in the underlying action, but “by
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failing to consider the interests of its insured and attempt settlement of the
underlying action for an amount well within the policy limits, despite
opportunities to do so.” (Doc. 36 at 2.) Defendants further contend that, because
Northland breached the duty to defend by breaching the purported duty to settle,
Northland is liable for the amount of the consent judgment as determined by the
state court judge. Defendants’ argument is not supported by Montana law, and
their motion is denied.
“Montana law is well-settled that an insurer’s [contractual] duty to defend
its insured arises when an insured sets forth facts which represent a risk covered
by the terms of an insurance policy.” Farmers Union Mut. Ins. Co. v. Staples, 90
P.3d 381, 385 (Mont. 2004) (citations omitted). “The duty to defend is
independent from and broader than the duty to indemnify created by the same
insurance contract.” Id. The duty to defend specifically “arises when a complaint
against an insured alleges facts, which if proven, would result in coverage” under
the policy at issue. State Farm Mut. Auto Ins. Co. v. Freyer, 312 P.3d 403, 410
(Mont. 2013) (citations omitted). “If there is no coverage under the terms of the
policy based on the facts contained in the complaint, there is no duty to defend.”
Landa v. Assurance Co. of Am., 307 P.3d 284, 289 (Mont. 2013) (citations
omitted). Insurers are not required to “seek out facts beyond the complaint” –
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indeed, “insurers that look at facts beyond the allegations in the complaint do so at
their own risk as they will be required to defend and/or indemnify based on the
information discovered.” Id. at 291 (citing Revelation Indus., Inc. v. St. Paul Fire
& Marine Ins. Co., 206 P.3d 919, 926 (Mont. 2009)).
The duty to settle is a concept rooted in good faith. Montana statutory law
prohibits insurers from “neglect[ing] to attempt in good faith to effectuate prompt,
fair, and equitable settlements of claims in which liability has become reasonably
clear.” Mont. Code Ann. § 33-18-201(6). Similarly, any contractual duty to settle
on the part of an insurer flows not from an express provision, but from the
covenant of good faith and fair dealing implied in an insurance contract. Freyer,
312 P.3d at 418 (citing Jessen v. O'Daniel, 210 F. Supp. 317, 325-326 (D. Mont.
1962)); see also 14 Steven Plitt et al., Couch on Insurance pt. VIII § 203:14 (3d
ed., West 2014) [hereinafter Couch]. However, the Montana Supreme Court has
“never held an insurer liable in bad faith for failing to settle within policy limits
when it had a reasonable basis in law or fact for contesting coverage.” Freyer,
312 P.3d at 418; see Couch, § 203:26 (“it is not bad faith for an insurer to refuse to
settle an insured’s claim within the policy limits when the question of policy
coverage is fairly debatable and when the grounds for the refusal, if determined in
the insurer’s favor, would wholly defeat the indemnity responsibility of the insurer
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to its insured”). “Without coverage, a duty to settle does not arise, even if the
facts of the [underlying case] indicate that the insured’s liability . . . is reasonably
clear.” Freyer, 312 P.3d at 422 (citations omitted).
Defendants’ interpretation and application of the above is strained and,
ultimately, fatal to their motion for partial summary judgment. Defendants
recognize that the duty to settle derives from the implied covenant of good faith
and fair dealing, and not from the express terms of the CGL policy. However,
they urge the Court to evaluate whether the duty to settle was breached in this case
through a binary lens – i.e. settlement equals compliance with the insurance
contract, refusing to settle equates to a breach of the insurance contract – rather
than through the “reasonableness” lens normally attending questions of good faith.
Defendants cannot have it both ways, insofar as they cannot import the extracontractual duty to settle into the CGL policy without also allowing Northland to
justify why it refuses to settle. Defendants’ citation to Freyer in this regard is
misleading. Defendants quote the Montana Supreme Court’s statement that “[a]
breach of contract cannot be ameliorated by the reasonableness of the breaching
party’s actions.” Freyer, 312 P.3d at 411. However, they do so out of context –
the breach of contract at issue in that part of the court’s opinion was State Farm’s
breach of the duty to indemnify, which was had been established by the court’s
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previous ruling on coverage. Defendants turn a blind eye to the part of the court’s
opinion specifically stating that whether the duty to settle has been breached is a
question of reasonableness. Freyer, 312 P.3d at 418-419. Thus, whether
Northland is liable for failing to settle within policy limits depends on whether it
had a reasonable basis in law or fact for contesting coverage under the CGL
policy.
Turning to Northland’s conduct in this case, it is clear that it breached
neither the duty to defend nor the duty to settle. Northland expressed its
reservations concerning coverage in its July 2011 letter pre-dating Mulroy’s suit.
Nevertheless, Northland did accept a defense of the claims and informed
Northwest of the acceptance under a reservation of rights within two and a half
months of Mulroy filing his complaint. The reservation of rights letter was timely
and consistent with industry practice in terms of its content. See Couch, § 202:46
(citing cases where courts found that reservation of rights letters sent five weeks,
two months, and 120 days after the insurers’ duty to defend was triggered were
timely); Id. at § 202:47 (“[a]n insurer’s notice of reservation of rights must fairly
inform the insured of the insurer’s position . . . [and] must provide sufficient
factual information to alert the insured to the terms and conditions of the policy
that the insurer relies upon, and how the insurer views their application to the facts
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of the case”); see also Portal Pipe Line Co. v. Stonewall Ins. Co., 845 P.2d 746,
749-750 (Mont. 1993) (indicating that reservation of rights letters, pursuant to §
33-18-201(14) of the UTPA, must “inform the insured of all policy defenses [the
insurer] intends to rely upon”); Allan D. Windt, Insurance Claims and Disputes §
2:7 (6th ed., West 2014) (“[o]ut of an abundance of caution – in order to avoid a
potential future estoppel – insurers sometimes issue reservation of rights letters
when all of the coverage defenses reserved are without merit . . . [s]uch letters do
not constitute a breach of contract”). The record does not indicate precisely what
activity occurred in the underlying case between March 2012 and November 2013,
but by that time the parties were prepared to participate in a settlement conference.
The settlement master’s report, dated November 25, 2013, shows that the parties
negotiated for over five hours, but could not come to an agreement. The parties
predictably dispute why they were unable to break the impasse, but the fact is
Northland participated in the conference and made a tactical decision not to settle
on that day. Whether Mulroy, Keim, and Northwest believe that Northland’s
participation was meaningful or not is irrelevant, given that any obligation to settle
depended on the reasonableness of Northland’s coverage evaluation. As the Court
will explain below, Northland’s basis for contesting coverage was more than
reasonable – it was entirely correct. Consequently, Defendants’ motion for partial
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summary judgment as to the duty to defend is denied.
II.

Coverage for Mulroy’s claims under the CGL policy.
The parties each move for partial summary judgment on the issue of

coverage. Defendants contend that the CGL policy provides coverage for the
damage to Mulroy’s log home “because the re-infestation of bugs was clearly a
fortuitous occurrence and none of the exclusions [in the policy] apply.” (Doc. 38
at 6.) Northland contends that there is no coverage under the CGL policy “for the
defective work of Northwest or the damages awarded in the underlying suit”
because the damage did not arise from an “occurrence,” as the term is defined in
the policy and by Montana law. (Doc. 33 at 10.) Northland further contends that
even if the damage was the result of an occurrence, a number of well-established
exclusions in the CGL policy preclude coverage.1 The Court agrees with
Northland.
The Court begins with a review of two key terms of the CGL policy at issue.
The policy provides coverage for “property damage” caused by an “occurrence.”
(Doc. 26-1 at 21.) “Property damage” refers to “physical injury to tangible

1. The Court need not reach the applicability of policy exclusions in this case, based on
its analysis under the operative definition of “occurrence.” However, similar considerations to
those explained below apply to both the “your work” and “products-completed operations
hazard” exclusions – namely, that CGL policies do not serve as warranties or guarantees of
workmanship. See Couch, § 129:1.
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property, including all resulting loss of use of that property.” (Id. at 34.) An
“occurrence” under the policy “means an accident, including continuous or
repeated exposure to substantially the same general harmful conditions.” (Id. at
33.)
Whether coverage exists for a particular loss under an insurance policy is a
narrower question than that of the duty to defend. “Unlike an insurer’s duty to
defend, which arises when a complaint against an insured alleges facts, which if
proven, would result in coverage, an insurer’s duty to indemnify arises only if
coverage under the policy is actually established.” Freyer, 312 P.3d at 410-411
(citations, quotations, and alterations omitted). “An insurer thus breaches the duty
to indemnify by failing to provide coverage when (1) the established facts trigger
coverage under the terms of the policy, and (2) the extent of the claimant’s
damages are undisputed or clearly exceed policy limits.” Id. at 411. “‘Established
facts’ in this context are facts that are either undisputed or are initially disputed
but subsequently determined by the fact finder.” Id.
When evaluating coverage pursuant to the above definition of “occurrence,”
“the proper focus is on whether [the insured’s] deliberate operation . . . is covered
– not whether [the insured] intended the resulting damages allegedly stemming
from the operation.” Blair v. Mid-Continent Cas. Co., 339 Mont. 8, 12 (Mont.
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2007); see Landa v. Assurance Co. of Am., 307 P.3d 284, 289 (Mont. 2013)
(“[W]e do not look to whether [the insured] intended the specific harm or damages
that [the claimant] alleged. Instead, we must focus on the [insured’s] acts . . . .”).
An intentional business decision on the part of an insured generally does not
constitute an “occurrence” within the scope of this definition. King v. State Farm
Fire & Cas. Co., 2010 WL 1994708, at *4 (D. Mont. May 18, 2010) (finding that
the insured log home builder’s decision to use logs which “were factory seconds
and of lesser quality [than] those ordinarily provided in the industry” was not a
covered “occurrence” under a CGL policy containing the above definition); See
also Couch, § 129:4 (“[A] claim for faulty workmanship, in and of itself, is not an
occurrence under a commercial general liability policy because a failure of
workmanship does not involve the fortuity required to constitute an accident.
Instead, what does constitute an occurrence is an accident caused by or resulting
from faulty workmanship, including damage to any property other than the work
product and damage to the work product other than the defective workmanship. In
other words, although a commercial general liability policy does not provide
coverage for faulty workmanship that damages only the resulting work product,
the policy does provide coverage if the faulty workmanship causes bodily injury or
property damage to something other than the insured's work product.”)
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In this case, the facts established in the underlying action do not trigger
coverage under the CGL policy. Pursuant to the parties’ settlement agreement,
Keim and Northwest admitted liability to the counts in Mulroy’s complaint, which
included negligence, negligent misrepresentation, and breach of the implied
warranty of habitability. The complaint provided that “[r]easonable and prudent
standards in the construction of log homes include the chemical treatment of logs
for beetle larvae and insects prior to installation.” (Doc. 39-1 at 3.) At the
damages hearing, Mulroy’s expert witness, William Finley, testified that “had
[Keim] treated the logs with pesticide prior to installation, a cost of twelve
hundred dollars ($1,200), neither the home nor the guest home would have
suffered from the current insect issues.” (Doc. 34-1 at 2.) The decision not to
treat the logs is the basis for the claims here, and cannot reasonably be
characterized as an “occurrence” under the policy, as it was a volitional act and
business choice on Keim’s part. Dr. Weaver’s testimony at the hearing does not
change the calculus – whether the beetles were in the timber at the time of harvest
does not transform Keim’s decision against treating the logs into an accident.
Instead, the notion that the beetles inhabiting the logs in the Mulroy home could
go undetected from the time of harvest, through construction, and for several years
thereafter, simply highlights the need to treat logs with insecticide, as a matter of
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course in the industry, prior to their use in a finished home. Failure to do so is not
a covered “occurrence” under the CGL policy at issue in this case.
CONCLUSION
Based on the foregoing, the Court concludes that Northland did not breach
the duty to defend its insured, Northwest, under the circumstances. Further, the
facts established in the underlying case compel the conclusion that there is no
coverage under the CGL policy for the damage to Mulroy’s log home.
Notwithstanding these conclusions, the Court views Mulroy’s counterclaims
related to Northland’s representations regarding coverage, as well as Mulroy’s
third-party claims against Glacier Insurance of Libby, Inc., as pending. The
Court’s rulings on the instant motions for partial summary judgment does not
appear to affect these claims.
Accordingly, IT IS ORDERED that:
(1)

Defendants’ motion for partial summary judgment regarding
Northland’s breach of the duty defend (Doc. 35) is DENIED.

(2)

Defendants’ motion for partial summary judgment regarding coverage
(Doc. 37) is DENIED.

(3)

Northland’s motion for partial summary judgment (Doc. 32) is
GRANTED.
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(4)

The Court will conduct a telephonic status conference in this matter
on July 29, 2015 at 3:00 p.m. for the purpose of issuing a new
scheduling order. The Court will contact the parties regarding call-in
procedures prior to the conference. On or before July 28, 2015, the
parties shall confer and jointly file proposed dates for completing
discovery and filing additional motions. The Court will set a trial
date accordingly.

DATED this 21st day of July, 2015.

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