W. Bend Mut. Ins. Co. v. Arbor Homes LLC

Decision Date06 February 2013
Docket NumberNo. 12–2274.,12–2274.
Citation703 F.3d 1092
PartiesWEST BEND MUTUAL INSURANCE COMPANY, Plaintiff–Appellee, v. ARBOR HOMES LLC, Defendant–Appellant.
CourtU.S. Court of Appeals — Seventh Circuit


Mark R. Smith (argued), Attorney, Smith Fisher Maas & Howard, Indianapolis, IN, for PlaintiffAppellee.

Darren A. Craig (argued), Attorney, Frost Brown Todd LLC, Indianapolis, IN, for DefendantAppellant.

Before POSNER, ROVNER and SYKES, Circuit Judges.

ROVNER, Circuit Judge.

A plumber hired by homebuilder Arbor Homes, LLC, (Arbor) made one of the biggest mistakes a plumber can make: he forgot to connect the home's drainage system to the city's sewer. The question here is whether Arbor or the plumber's insurer is liable for the resulting damages to the newly built home. Although Arbor behaved very admirably in addressing the problem for the new homeowners, it failed to protect its own interests, and we must affirm the judgment in favor of the insurer.


Arbor builds single-family homes in central Indiana. In 2005, Arbor contracted with Willmez Plumbing Inc. (“Willmez”) for plumbing services in connection with the construction of new homes. The contract required Willmez to obtain insurance:

Contractor [Willmez] shall take out, carry, and maintain the following insurance to protect Contractor and Owner [Arbor] ...

(b) Comprehensive General Liability insurance to protect against bodily injury and property damage in an amount of not less than $1,000,000 per Occurrence;


(d) Umbrella Liability Insurance in an amount of not less than $1,000,000.

R. 80, at 9. The contract also required that the insurance policies name Arbor as an additional insured. Any subcontractors hired by Willmez were bound to the same contract terms as Willmez.

In 2006, Arbor issued three purchase orders to Willmez to serve as Arbor's plumbing subcontractor for the construction of a new home. The plumbing work included underslab plumbing, plumbing rough-in, and plumbing finish work on the house. Willmez, in turn, subcontracted the work to Oscar Alarcon, d/b/a A & M Plumbing Company. Plumbing work began on the home in December 2006 and was ostensibly completed in February 2007. Homebuyers Kurt and Joy Lorch closed on their purchase of the house on March 8, 2007 and moved in shortly thereafter.

The Lorches soon noticed a foul odor emanating from the lower part of the house. The smell grew worse over time and the Lorches began to feel ill. Unfortunately, A & M Plumbing had failed to connect the home's plumbing to the main sewer line, and raw sewage was being discharged into the crawl space of the home. The Lorches complained to Arbor, and on April 1, 2007, Arbor confirmed that the plumbing had not been properly installed. At Arbor's request, Willmez connected the main sewer line. On April 2, Arbor engaged ACT Environmental Services, Inc. (“ACT”) to assess the damage. ACT tested the home and developed a plan to remove the sewage and decontaminate the home. Arbor then hired a number of contractors to fulfill ACT's recommendations. The required clean-up was comprehensive and costly. The crawl space was excavated to a depth of twelve inches and then restored with clean materials. Everything from the furniture and insulation to the ductwork required decontamination because of the extensive spread of dangerous bacteria and mold from the discharge of raw sewage into the home. In the end, Arbor paid more than $65,000 for cleaning, repairs and follow-up testing for the home.

Not surprisingly, the Lorches, who had purchased a brand new home, were unwilling to accept a brand new home that had been filled with sewage and then cleaned. On April 18, 2007, they sent a letter to Arbor demanding, among other things, that Arbor buy the home from them and build them a new home. In April and May 2007, Arbor and Willmez discussed possible resolutions of the Lorches' claims. Arbor told Willmez to place its insurer, West Bend, on notice of the Lorches' claims. On May 4, 2007, Arbor also sent a letter to Willmez memorializing the parties' understanding of a settlement with the Lorches, and Willmez's responsibilities. In that letter, Arbor requested that Willmez or West Bend contact Arbor immediately if Willmez or the insurer needed any additional information regarding the settlement. Willmez later told Arbor that it forwarded this letter to West Bend.

Hearing nothing from West Bend, Arbor assumed the insurer had no objections to the settlement. On June 6, 2007, Arbor signed a settlement agreement with the Lorches that provided the homebuyers with a complete remedy. Among other things, Arbor agreed to buy the tainted home from the Lorches, build another new home for them (using a different plumbing contractor), pay for all of the closing costs and moving expenses related to the new home, and compensate the Lorches for any increase in their mortgage rate on the purchase of the second home.

Arbor then filed suit against Willmez in state court, alleging negligence, breach of contract, breach of the settlement agreement, slander of title, and constructive fraud. On October 12, 2007, Arbor's lawyer sent a copy of the complaint to West Bend, noting that Arbor was an additional insured on the relevant insurance policies and asking West Bend to discuss the resolution of the dispute. West Bend denied any liability under the insurance policies in the state court proceedings, and ultimately filed a declaratory judgment suit in federal court against both Willmez and Arbor.1 In federal court, West Bend sought a declaration that it had no duty under the insurance policies to defend and indemnify Arbor against the Lorches' claims and the settlement agreement. West Bend was not aware of any problem with the Lorches' home until May 4, 2007, and did not learn of Willmez's agreement to cover a large part of the damages until October 2007, when it received a copy of Arbor's lawsuit against Willmez. The insurer was not aware of the terms of the settlement with the Lorches until April 2008.

West Bend denied coverage for Arbor under a number of different theories. Initially, West Bend insisted that Arbor was not an “additional insured” under the policies. West Bend later acknowledged that this position was factually incorrect and conceded that Arbor should have been treated as an additional insured under its policies with Willmez. West Bend also denied coverage under three provisions of the insurance contracts: the fungi and bacteria exclusion, the voluntary payment provision, and the completed-operations provision. The district court granted summary judgment to West Bend, finding that the insurer was relieved of any duty to defend or indemnify Arbor under the fungi and bacteria exclusion as well as the voluntary payments provision. Arbor appeals.


On appeal, Arbor contends that a provision excluding coverage for damages caused by fungi and mold in a commercial general liability policy issued to a plumber renders the coverage illusory. Arbor also maintains that coverage may not be denied under the voluntary payments provision because West Bend denied for years that Arbor was an additional insured, and thus West Bend would not have participated in settlement discussions even if it had been given the opportunity to do so. Finally, Arbor argues that the completed-operations exclusion should not apply where the plumbing work was never “completed” as promised.

A district court sitting in diversity must apply the choice of law principles of the forum state (in this case Indiana) to determine which state's substantive law governs the proceeding. Tanner v. Jupiter Realty Corp., 433 F.3d 913, 915 (7th Cir.2006); French v. Beatrice Foods Co., 854 F.2d 964, 966 (7th Cir.1988) (citing Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941)). The parties agree that the insurance contract for the Indiana construction project at issue in this diversity action is governed by Indiana law. See Dunn v. Meridian Mutual Ins. Co., 836 N.E.2d 249, 251 (Ind.2005) (an insurance policy is governed by the law of the principal location of the insured risk during the term of the policy). We review the district court's grant of summary judgment de novo. Norman–Nunnery v. Madison Area Technical Coll., 625 F.3d 422, 428 (7th Cir.2010).

We begin (and end) our analysis with the voluntary payments provision of the insurance contract. The contract assigns several duties to the insured in the event of an occurrence that may result in a claim. For example, the insured must notify West Bend as soon as practicable of any occurrence, and provide details of the incident. The insured must also tell West Bend of any claims...

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