Travelers Ins. Companies v. Penda Corp.

Decision Date29 September 1992
Docket NumberNo. 91-1333,91-1333
Citation974 F.2d 823
PartiesTRAVELERS INSURANCE COMPANIES, Plaintiff-Appellee, v. PENDA CORPORATION, Defendant-Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Thomas H. Fegan (argued), Robert M. Burke, Johnson & Bell, Chicago, Ill., for plaintiff-appellee.

William F. Conlon, Eugene A. Schoon (argued), John M. Breen, Sidley & Austin, Chicago, Ill., for defendant-appellant.

Before POSNER, RIPPLE, and MANION, Circuit Judges.

RIPPLE, Circuit Judge.

Travelers Insurance Companies (Travelers) brought a declaratory judgment action against its insured, Penda Corporation (Penda), to determine its responsibilities under a liability insurance policy. After cross-motions for summary judgment, a magistrate judge recommended that Travelers be found to have no duty to defend Penda in a suit for breach of contract and breach of warranty brought by Penda's customer, U.S. Sample Company (U.S. Sample). Penda objected to the magistrate judge's recommendation. Nevertheless, the district court held that Travelers had a duty neither to defend Penda nor to indemnify it in the U.S. Sample suit. Penda appeals and, for the following reasons, we reverse in part and vacate in part the judgment of the district court. This case is remanded to the district court for proceedings consistent with this opinion.

A. Facts

Penda is a Wisconsin company engaged in the business of commercial plastics extrusion. In December 1985, it received an order from its customer U.S. Sample for a number of white, lithograde styrene sheets. U.S. Sample intended to finish these sheets and then use them as display pages in sample books it had contracted to provide to its customer, Joanna Western Mills (Joanna Western). Pursuant to its agreement with U.S. Sample, Penda delivered the sheets to Bruce Offset Company, which U.S. Sample had hired to lithograph and varnish them. Bruce Offset then delivered the sample books to U.S. Sample, which, in turn, affixed color and material swatches to the pages. In March 1986, U.S. Sample began making partial shipments of the completed books to Joanna Western.

In October 1986, Joanna Western informed U.S. Sample that the pages of the sample books had yellowed. As a result, Joanna Western refused to pay for the Penda requested defense of this claim from Travelers, which had previously issued it a comprehensive general liability policy. In its pertinent parts, this policy stated that Travelers

                books unless U.S. Sample agreed to replace the defective sample books and to provide other concessions.   Later, U.S. Sample filed suit against Penda and Bruce Offset Company in Illinois state court, claiming that the sheets were "unusable and unacceptable, and were rejected by the intended user, [Joanna Western]," R. 1, Ex.  B, Complaint at p 18, and alleging breach of contract and breach of warranty.   As relief, U.S. Sample sought, along with costs and attorneys' fees, (1) $200,000 for loss of foreseeable profit from U.S. Sample's contract with Joanna Western;  (2) $1,000,000 for loss of foreseeable profit on identified future business with Joanna Western;  and (3) $1,000,000 for damage to its reputation.   R. 1, Ex.  B, Complaint at p 21

will pay on behalf of [Penda] all sums which [Penda] shall become legally obligated to pay as damages because of ... bodily injury or ... property damage to which this insurance applies, caused by an occurrence, and the Company shall have the right and duty to defend any suit against [Penda] seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent....

R. 1, Ex. A (App. at A-47). The policy defined "property damage" as

(1) physical injury to or destruction of tangible property which occurs during the policy period, including the loss of use thereof at any time resulting therefrom, or (2) loss of use of tangible property which has not been physically injured or destroyed provided such loss of use is caused by an occurrence during the policy period.

R. 1, Ex. A (App. at A-43(a)). Travelers undertook the defense of the suit under a reservation of rights. It took the position that U.S. Sample's complaint alleged no property damage that would trigger insurance coverage. It later filed a declaratory judgment action in Illinois state court to adjudicate the rights and liabilities of the parties under the policy. Diversity of citizenship exists in the declaratory judgment action, and Penda removed it to the United States District Court for the Northern District of Illinois.

B. District Court Proceedings

After removal, the declaratory judgment action was assigned to a magistrate judge. Both parties filed cross-motions for summary judgment on the question whether Travelers had a duty to defend Penda in the U.S. Sample lawsuit, and Travelers also sought summary judgment on the question of whether it had a duty to indemnify Penda. The magistrate judge recommended judgment for Travelers on the question whether it had a duty to defend. The magistrate judge was of the view that U.S. Sample's complaint against Penda alleged no property damage that would be covered under the insurance policy, but only a loss of profits and reputation damage. The magistrate judge concluded that, under Illinois law, "a claim alleging a loss of use of property or the necessity of scrap[p]ing property as a result of a defective product would bring a complaint under the ambit of property damages...." R.29, Magistrate's Rec. at 5. However, he found no such allegation in U.S. Sample's complaint, and instead characterized it as "involving the sale of defective products by the insured, who then attempts to categorize the cost of remedy for those products as property damage." Id. at 4.

Penda filed an objection to the magistrate's recommendation. The district court overruled this objection and held that there were no allegations in the complaint from which it reasonably could be inferred

that the lithograde styrene sheets supplied by Penda caused actual damage to property belonging to [U.S. Sample], diminished the value of [U.S. Sample] property, resulted in a loss of use of property, or that [U.S. Sample] sought to recover such losses from Penda. It is clear that [U.S. Sample] is seeking redress, not for damage to its own property, but for the damages resulting from receiving a R. 45, Mem.Op. at 11-12. Thus, the district court concluded that Travelers had no duty to defend Penda under the policy. The court also held that, because the duty to defend is broader than the duty to indemnify, Travelers had no duty to indemnify Penda for U.S. Sample's claim.

defective product from Penda, which was not fit for the purpose for which it was sold.


We review de novo a district court's decision to grant summary judgment. La Preferida, Inc. v. Cerveceria Modelo, S.A. de C.V., 914 F.2d 900, 905 (7th Cir.1990). Summary judgment is appropriate only if no genuine issue of material fact exists, and a party is entitled to judgment as a matter of law. Id. Because neither party raises the issue of choice of law, in this diversity case, we apply the substantive law of Illinois, the forum state. Wood v. Mid-Valley Inc., 942 F.2d 425, 426-27 (7th Cir.1991). Penda claims that the district court erred in finding that Travelers had no duty to defend and no duty to indemnify in the suit brought by U.S. Sample. Our task is to determine if Travelers is free of these duties as a matter of Illinois law.

A. The Duty to Defend
1. Applicable standards

The Illinois Supreme Court has recently articulated the legal standards that govern an insurer's duty to defend. United States Fidelity & Guar. Co. v. Wilkin Insulation Co., 144 Ill.2d 64, 161 Ill.Dec. 280, 284-85, 578 N.E.2d 926, 930-31 (1991).

To determine an insurer's duty to defend its insured, the court must look to the allegations of the underlying complaints. If the underlying complaints allege facts within or potentially within policy coverage, the insurer is obliged to defend its insured even if the allegations are groundless, false, or fraudulent.... An insurer may not justifiably refuse to defend an action against its insured unless it is clear from the face of the underlying complaints that the allegations fail to state facts which bring the case within, or potentially within, the policy's coverage.... Moreover, if the underlying complaints allege several theories of recovery against the insured, the duty to defend arises even if only one such theory is within the potential coverage of the policy.... The underlying complaints and the insurance policies must be liberally construed in favor of the insured.

Id., 161 Ill.Dec. at 284, 578 N.E.2d at 930 (emphasis in original) (citations omitted). Consequently, if U.S. Sample's complaint against Penda alleges facts that are within or potentially within policy coverage, Travelers has a duty to defend. See Ohio Casualty Ins. Co. v. Bazzi Constr. Co., 815 F.2d 1146, 1147 (7th Cir.1987). Focusing on the complaint is necessary because the insurer must determine whether it has an obligation to defend at the outset of the litigation. However, this emphasis on the specific allegations of the complaint also creates certain pitfalls for the insured. It leaves the insured at the mercy of its adversary's pleading skills. The adversary may or may not, depending on the individual case, be interested in triggering the insured's coverage. Illinois courts, aware of this pitfall, have given this requirement of focusing on the pleadings a common-sense interpretation. Indeed, Illinois has specifically acknowledged that, when the duty to defend is at issue, the complaint "need not allege or use language affirmatively bringing the claims within the scope of the policy, as the question of coverage should not hinge exclusively on the draftsmanship...

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