They Could Have Used a Captive: Chicago Flameproof and Wood Specialties

If your company has at least $10 million in gross revenue, 25 employees, or is in a high-risk business, a pure captive might be an appropriate risk management tool.  If you'd like to learn more, please attend our webinar this Friday at noon, titled, "The Stand Alone Captive Alternative."  You can sign up at this link.

 
This fact pattern is derived from Lexington Ins. Co. v. Chi. Flameproof & Wood Specialties Corp. (N.D. Ill., 2018)
 
Chicago Flameproof and Wood Specialties sold fireproof wood to JL Schwieters Construction, Inc. and JL Schwieters Building (“JLS”).  JLS ordered wood they believed to be FRT compliant lumber; however, Chicago Flameproof delivered its Flame Tech lumber, which lacked this requirement.  JLS’s customer could not tell the difference and installed the Flame Tech product.  When it was discovered that the installed product was deficient, JLS’s customer removed the wood and informed JLS who then sued Chicago under a number of causes of action, alleging, among other things, consumer fraud, breach of warranties, and breach of contract.

This is where it gets interesting.  Chicago had a standard CGL policy which, of course, covers damages to “property” by an “occurrence.”  On the surface, that doesn’t seem to be the case here.  Instead, these facts are better explained as a warranty claim, where the plaintiff alleges that the defendant claimed a good was “fit for a particular purpose” when it wasn’t.  Yet Chicago argued the CGL language applied while the carrier Lexington Insurance said it didn’t.  The court sided with the insured, ruling:

In the underlying complaints, JLS plainly seeks to hold Chicago Flameproof liable for physical injury to tangible property. In its federal suit, JLS repeatedly claims that the removal and replacement process caused or will potentially cause damage to existing elements of the four building projects, including damage to the exterior walls, wiring, and Tyvek insulation.

…..

While it is true that, under Illinois law, the costs of repairing and replacing an insured's defective product or work generally do not constitute property damage, see Eljer, 757 N.E.2d at 502, this does not necessarily foreclose coverage where, as here, there are actual allegations of physical alterations to property other than the insured's product.

The event leading to the coverage contest involves JLS’ customer removing the non-compliant wood and replacing it with compliant material.  Some property damage would naturally ensue as part of that work.  This is supported by CGL Commercial General Liability from National Underwriters 8th Edition (page 9), “Reference to physical injury suggests that the tangible property must sustain some form of visible harm or impairment.”   

That reading, however, is not clearly apparent at first blush from the policy language.  I have a sneaking suspicion that Chicago's lawyers feel they pulled a rabbit our of their hat when they won this case.

            Chicago Firewood would benefit from a captive in the following ways:

1. Under standard UCC doctrine, several implied warranties occur when someone sells a product.  This case highlights the “fitness for a particular purpose warranty,” although there are others.  Warranty risk is best underwritten by a captive. It's a primary risk faced by the insured; covering it in the captive allows the parent company to design specific policy language, triggering events, and coverage options unique to that business.

 

1. Legal liability is a common captive insurance coverage option.  This is from my old copy of The Business Insurance Handbook from Dow Jones (page 695): “Business legal expense insurance reimburses a business, professional, or professional group for its business-related legal expenses in an unforeseen lawsuit.”  This was at the heart of this suit.  If Chicago had lost, this captive policy would have at least reimbursed them for legal expenses.