filed: May 12, 1994; As Corrected June 24, 1994.
On Appeal From the United States District Court for the Eastern District of Pennsylvania. D.C. Civil No. 92-04271
Before: Becker, Roth, and Lewis, Circuit Judges.
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 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 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 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 "loss 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 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.*fn1
The dispute between Lucker and Grede eventually went to trial, and Lucker won a jury award of approximately $500,000.*fn2 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. 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 resulting from ...