Sears, Roebuck and Co. v. Reliance Ins. Co.

• Decision Date: 21 July 1981
• Docket Number: Nos. 80-2048,80-2049,s. 80-2048
• Citation: 654 F.2d 494
• Parties: SEARS, ROEBUCK AND CO., a New York corporation, Plaintiff-Appellee, v. RELIANCE INSURANCE COMPANY, a Pennsylvania corporation, Defendant-Appellant. SEARS, ROEBUCK AND CO., a New York corporation, Plaintiff-Appellant, v. COMMERCIAL UNION INSURANCE COMPANY, a Massachusetts corporation and Reliance Insurance Company, a Pennsylvania corporation, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 494

654 F.2d 494

SEARS, ROEBUCK AND CO., a New York corporation, Plaintiff-Appellee, v. RELIANCE INSURANCE COMPANY, a Pennsylvania corporation,

Defendant-Appellant.

SEARS, ROEBUCK AND CO., a New York corporation, Plaintiff-Appellant, v. COMMERCIAL UNION INSURANCE COMPANY, a Massachusetts

corporation and Reliance Insurance Company, a

Pennsylvania corporation, Defendants-Appellees.

Nos. 80-2048, 80-2049.

United States Court of Appeals Seventh Circuit.

Argued Jan. 6, 1981.

Decided July 21, 1981.

Jay S. Judge, Park Ridge, Ill., for defendant-appellant.

Arthur L. Klein, James P. DeNardo, Chicago, Ill., for plaintiff-appellee.

Before SWYGERT, Senior Circuit Judge, FAIRCHILD and SPRECHER, Circuit Judges.

SPRECHER, Circuit Judge.

This case involves a retailer's attempt to receive legal representation and indemnity for products liability from two insurance companies. The underlying products liability suit alleges that fabric used in girls slacks was defective and that the design and manufacture of the slacks was defective. The insurance carriers for the fabric manufacturer and the slacks manufacturer had each named the retailer as insured in a vendor's endorsement. The carrier for the fabric manufacturer declined coverage on the ground that the fabric was "changed" when it was used as slacks. The carrier for the slacks manufacturer declined coverage on the ground that the retailer "provided" the fabric to the slacks manufacturer. Because we find that the argument of each carrier would render the vendor's endorsement a nullity, we find that both carriers must defend the retailer.

I

This case arises out of a products liability suit filed against Sears, Roebuck and Company ("Sears") by Rollie and Francine Cumberland in the Circuit Court of St. Clair County, Illinois. In that lawsuit, the Cumberlands alleged that their daughter died of injuries sustained when a pair of girls slacks purchased from Sears caught fire.

The Riegel Textile Corporation ("Riegel") manufactured the fabric from which the slacks were made. Sears purchased the fabric from Riegel. Riegel was insured for products hazard liability claims by the Commercial Union Insurance Company ("Commercial"). The Commercial policy covering Riegel named Sears as a "person insured" in a vendor's endorsement.

After Sears purchased the fabric from Riegel, it instructed Riegel to send the fabric to Rollic, Inc. Sears contracted with Rollic for finished slacks; the fabric was measured, cut, sewn, labeled, and packaged for Sears by Rollic. Rollic was insured for products hazard liability with the Reliance Insurance Company ("Reliance"). The Reliance policy covering Rollic named Sears as an "additional insured" in a vendor's endorsement.

The Cumberland lawsuit advanced two specific and separate claims with regard to the slacks purchased from Sears. First, the complaint alleged that the fabric from which the slacks were made was inherently and unreasonably flammable. Second, the complaint alleged that the final slacks were defective, aside from any defect in the fabric, because they were defectively produced and manufactured.

Both the Commercial and the Reliance policies provide that the carrier shall defend any suit, even if groundless, brought on account of goods or products manufactured, sold, handled, or distributed by the named insured. Each policy further provides that the carrier shall pay on behalf of the named insured all sums which the insured shall become legally obliged to pay as damages. But when Sears requested a defense for the Cumberland suit, each insurance company refused to provide such a defense.

Sears then brought this action seeking a declaratory judgment that each carrier must defend and indemnify Sears in the Cumberland suit. The district court granted Sears' motion for summary judgment against Reliance. But the district court denied Sears' motion for summary judgment against Commercial and instead, granted summary judgment in favor of Commercial. Reliance and Sears now appeal the respective rulings awarding summary judgment against them. For the reasons discussed below, we affirm the award of summary judgment against Reliance and reverse the award of summary judgment against Sears.

II

We begin with Commercial, insuror of Riegel, the fabric manufacturer. Commercial argues that exclusions in its policy preclude coverage to Sears. The relevant exclusions in the vendor's endorsement state that:

1. The insurance with respect to the vendor does not apply to

(b) bodily injury or property damage arising out of

(i) any physical or chemical change in the form of the product made intentionally by the vendor,

(ii) repacking, unless unpacked solely for the purpose of inspection, demonstration, testing or the substitution of parts under instructions from the manufacturer and then repacked in the original container,

(iv) products which after distribution or sale by the named insured have been labeled or relabeled or used as a container, part or ingredient of any other thing or substance by or for the vendor.

("Exclusion 1"). Commercial argues that because the Riegel fabric was fashioned into slacks and labeled by Rollic, Exclusion 1 excludes coverage of Sears. This argument must be rejected.

The law is clear that an insurance carrier's duty to defend is determined by reference to the allegations of the underlying complaint. Where, as here, the complaint contains allegations which may be covered by the policy, the carrier's duty continues until such time, if ever, as the claim might be confined to non-covered allegations. This well settled rule was stated by Judge Learned Hand in the landmark case of Lee v. Aetna Cas. & Surety Co., 178 F.2d 750, 753 (2d Cir. 1949):

(I)f the plaintiff's complaint against the insured alleged facts which would have supported a recovery covered by the policy, it was the duty of the defendant to undertake the defence, until it could confine the claim to a recovery that the policy did not cover.

This rule has been applied on numerous occasions by this and many other courts. See Carboline Co. v. Home Indemnity Co., 522 F.2d 363, 366 (7th Cir. 1975) (carrier must defend "if there is doubt whether the claim comes within the coverage of the policy"); and Sears, Roebuck and Co. v. Travelers Ins. Co., 261 F.2d 774, 777 (7th Cir. 1958) (carrier required to defend suit "until it could confine the claim to a recovery that the endorsement clearly did not cover, not merely one which it might not cover") (emphasis added). ¹

In the recent case of Solo Cup Co. v. Federal Ins. Co., 619 F.2d 1178 (7th Cir. 1980), we set forth the test for determining, under the above rule, whether a carrier has a duty to defend. In Solo Cup, the district court held that an insurance carrier did not have a duty to defend because the underlying complaint contained allegations which were inconsistent with the policy's definition of "occurrence". We reversed, stating:

It is well settled under the law of Illinois that

(this) duty to defend extends to cases where the complaint alleges several causes of action or theories of recovery against an insured, one of which is within the coverage of the policy while others (might) not be.

....

An insurer may not refuse the tendered defense of an action unless a comparison of the policy with the underlying complaint shows on its face that there is no potential for coverage.

619 F.2d at 1183 (citations omitted) (first emphasis in original; second emphasis added).

In applying the Solo Cup test to this case, we must compare the exclusion relied on by Commercial with the allegations of the Cumberland complaint. As the above cases indicate, until such time as it is clear that there is "no potential for coverage," Solo Cup, 619 F.2d at 1183, of any aspect of the Cumberland suit, Commercial must defend Sears.

Commercial argues that under Exclusion 1, it can escape its policy obligations because the fabric sent by Riegel to Rollic was "removed from its original container," "physically changed" by being "cut and sewn" and by having an elastic waist band added, and "labeled". But it is not clear that the "change and repacking" or "relabeling" exclusions relied on by Commercial mean that there is no potential for coverage of Sears.

In a recent case on all fours with this case, the Third Circuit rejected the exact argument advanced here by Commercial. Mattocks v. Daylin, Inc., 452 F.Supp. 512 (W.D.Pa.1978), aff'd mem., 614 F.2d 770 (3d Cir. 1979). We find the Mattocks decision persuasive because the underlying complaint here, as the underlying complaint in Mattocks, alleges both flammability inherent in the fabric and defective production and manufacture. Just as in Mattocks, a comparison of the complaint with the policy provisions shows that the exclusions in issue do not clearly preclude coverage.

In Exclusion 1, two categories of "change" conceivably could preclude coverage for Sears. The first category specifies physical or chemical changes or repacking; the second category specifies products which have been changed by labeling or by being made part of another thing. All of the exceptions are preceded by the phrase "arising out of."

First, the first category of Exclusion 1 excludes coverage for injury arising out of "any physical or chemical change" or arising out of repacking. But the injury here does not meet the "arising out of" requirement. Although the fabric was "changed" and "repacked" by Rollic, the Cumberlands allege, among other things, that their daughter's injury "arose out of" the fabric itself and not any change made in the fabric or any repacking. On this issue, it is worth quoting in full the Mattocks court's discussion of identical contract language:

The "arising out of" language of Section 1(b) of the endorsement limits the applicability of Section 1(b)(i). The changes in form by a vendor must cause plaintiff's injuries before the vendor is excluded from coverage under the endorsement. If...