Acuity, a Mutual Insurance Company v. M/I Homes of Chi., LLC

Authors: Lauren A. Triebenbach, Leader – Construction Law, and Chelsea T. Zielke, Senior Associate, at Michael Best

On November 30, 2023, the Illinois Supreme Court issued a decision in Acuity, a Mutual Insurance Company v. M/I Homes of Chi., LLC, in which it agreed with the lower court’s ruling that the allegations in the underlying complaint sufficiently fell within the initial grant of coverage requirement. 2023 Ill. LEXIS 1019, ¶ 65 (Ill. Nov. 30, 2023). This is an important decision because the Illinois Supreme Court also ruled that prior case law, which relied upon considerations outside the scope of the insurance policy’s express language, should no longer be considered. As such, Illinois courts must now make coverage decisions based solely on the operative complaint and the insurance policy language.

I. Background

By way of background, M/I Homes of Chicago, LLC (“M/I Homes”) was the general contractor who constructed a residential townhome development in Hanover Parker, Illinois. Id. ¶ 3. The townhome owners’ association for that development (the “Association”) commenced the underlying lawsuit against M/I Homes, in which it alleged breach of contract and breach of implied warranty of habitability due to certain construction defects in the development. Id. The Association alleged that M/I Homes’ subcontractors caused construction defects by using defective materials, conducting faulty workmanship, and failing to comply with applicable building codes. The defects included leakage and/or uncontrolled water and moisture in locations in the buildings where it was not intended or expected. Id. ¶ 5. The Association alleged that the defects, in turn, caused physical injury to the townhomes after construction, including altering the exterior’s appearance, shape, color and other material dimension and also damage to other property. Id. Moreover, the Association alleged M/I Homes did not intend to cause the construction defects and that it neither expected nor intended the resulting property damage. Id. ¶ 6. Additionally, the Association alleged that M/I Homes did not perform any of the construction work and instead that all of the work had been performed by subcontractors, and it was the faulty work of these subcontractors that caused the property damage. Id. In its legal action, the Association sought damages for the cost of repairing or replacing the defects and the cost of repairing the damage to other property caused by the defects. Id. ¶ 7.

After the lawsuit was commenced, M/I Homes tendered the claim to and sought defense from Acuity. Id. ¶ 8. The basis for the tender was that M/I Homes was listed as the additional insured on a CGL policy that Acuity issued to H&R Exteriors, Inc. (“H&R”), which was a subcontractor to M/I Homes on this development. Id.  Acuity denied that it had a duty to defend M/I Homes as an additional insured under the CGL policy and sought declaratory judgment. Id. Acuity asserted several bases for its denial, including that the underlying amended complaint failed to allege any “property damage” caused by an “occurrence.” Id. ¶ 9. Following motion practice, the circuit court granted summary judgment in favor of Acuity. Id. ¶ 12. The circuit court found that property damage resulting from the faulty work was not an “occurrence,” because “it was a natural and ordinary consequence of the construction project and not an accident as required under the policy.” Id.  However, the court indicated that if the faulty workmanship had damaged something other than the townhome project itself, those damages could be covered, but the court found that was not the case in the instant action. Id.

The appellate court disagreed with the circuit court, finding that “the underlying complaint simply alleges, in the broadest possible terms, that there was damage to ‘other Property.’” Id. ¶ 16. Liberally construing the complaint and the insurance policy in favor of the insured, the appellate court held that there was potential for coverage and Acuity’s duty to defend was triggered. Id. Acuity appealed to the Illinois Supreme Court, and its decision is explained in the balance of this article.

II. Acuity’s Duty to Defend

The crux of M/I Homes was whether Acuity had a duty to defend its additional insured, M/I Homes, under a subcontractor’s CGL policy, in connection with the underlying lawsuit brought by the Association. Id. ¶ 1. This issue required the Illinois Supreme Court to interpret the coverage provisions in the CGL policy. The Illinois Supreme Court noted “the basic controlling principles for determining whether a duty to defend exists are well settled”—“a court compares the facts alleged in the underlying complaint to the relevant provisions of the insurance policy” and “if the facts alleged fall potentially within the policy’s coverage, the insurer is obligated to defend its insured.” Id. ¶ 28. Therefore, the first task is to determine whether the allegations in the underlying action are potentially covered by the language of the insurance agreement’s initial grant of coverage. Id. ¶ 33.

Here, the insurance agreement provided that the insurer, Acuity, “will pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance agreement applies” and also provided that “[t]his insurance applies to property damage only if property damage is caused by an occurrence.” Id. ¶ 35. The Illinois Supreme Court then looked to the definitions in the policy of “property damage” and “occurrence” to determine whether the policy would be applicable based upon the allegations in the amended complaint. Id. ¶¶ 37-53.

A. The Underlying Lawsuit Alleged “Property Damage” Occurred.

When looking at the definition of “property damage,” M/I Homes determined that the amended complaint in the underlying lawsuit included allegations showing that there was “property damage”, i.e., physical injury to tangible property, including resulting loss of use of that property.” Id. ¶¶ 37-39. Indeed, the amended complaint included allegations that buyers of the townhomes suffered water damage to the interior of the units because of leaks or moisture damage that arose from the subcontractors’ faulty exterior work and defective materials. Id. ¶ 38.

B. The Underlying Lawsuit Alleged There Was an “Occurrence.”

M/I Homes also determined the underlying amended complaint included allegations showing an “occurrence.” Id. ¶¶ 41-52. The policy defined “occurrence” as “an accident including continuous or repeated exposure to substantially the same general harmful conditions.” Id. ¶ 41. While “accident” was not defined in the policy itself, after looking at other case law and definitions of the term “accident,” the Illinois Supreme Court determined that the term “accident” in the policy at issue reasonably encompassed the unintended or unexpected harm caused by negligent conduct. Id. ¶ 47. When looking at the amended complaint, the allegations did not assert that the subcontractors intentionally performed substandard work that led to water damage—rather, “the allegations indicate that inadvertent construction effects accidentally caused property damage to the completed townhomes.” Id. ¶ 48. As noted earlier, the Illinois Supreme Court also held that the premise that the property damage had to be something beyond the construction project itself was incorrect based upon the insurance agreement. Id. ¶ 52.

C. Exclusions Can Preclude Coverage.

However, the Court noted that coverage under the insurance agreement could be precluded by an exclusion. Id. ¶ 53. Put simply, just because the allegations in the underlying lawsuit are sufficient to establish an initial grant of coverage, coverage can further be precluded by exclusion provisions in the insurance agreement. Thus, whether there is coverage under an insurance policy is a two-step process, requiring: (1) a determination of whether the allegations in the complaint are sufficient to establish an initial grant of coverage; and (2) a determination of whether any exclusions in the policy preclude coverage. Id. ¶ 53.

The Illinois Supreme Court recognized there were a number of exclusion provisions in the CGL policy at issue and ordered, on remand to the circuit court, for the parities to address whether any of the exclusions in the policy precluded a duty to defend. Id. ¶¶ 63-65.

III. Why This Case Matters?

M/I Homes matters because it marks a shift in courts’ interpretation of insurance policies. Indeed, M/I Homes provides that prior case law, which relied upon considerations outside the scope of an insuring agreement’s express language, which is not tied to the language of the policy, should no longer be relied upon. Id. ¶ 52. This includes the prior premise that there cannot be “property damage” caused by an “occurrence” under a policy unless the underlying action claims the property damage is to something beyond the project at issue. Id. Thus, now, property damage does not need to be damage to other property.