Indiana's rapidly developing law interpreting commercial insurance contracts raises several important issues for both insurers and purchasers of insurance for property or operations located in Indiana. Although much of this litigation has involved disputes over coverage for environmental contamination, the two most recent cases break new ground by announcing legal principles applicable outside this context.

The recent case of Freidline v. Shelby Insurance, 739 N.E.2d 178 (Ind. Ct. App. Nov. 29, 2000), extended the previous case law favoring coverage for environmental contamination to a case involving bodily injury from chemical fumes, and imposed liability on the insurer for bad faith denial of coverage. The case of General Housewares Corporation v. National Surety Corporation, 2000 WL 1877828 (Ind. Ct. App. Dec. 28, 2000), held that insurers will not be liable for losses that an insured knows as of the policy date are substantially certain to occur. A brief summary of these cases follows, but to understand the issues completely, you should read the cases in their entirety and consult with a knowledgeable attorney regarding any specific situation.

Most commercial insurance contracts contain exclusions for damage or injury caused by pollutants. Despite these exclusions many companies facing large environmental liabilities have sought coverage. Indiana courts generally have been willing to construe insurance policies in favor of coverage, thereby imposing the costs of environmental cleanup on insurers and making Indiana an attractive litigation venue.

The first and most well-known of these cases is the 1996 Indiana Supreme Court case American States Insurance Co. v. Kiger, in which the owner of a gasoline station with leaking underground storage tanks sued an insurer that denied coverage based upon contractual pollution exclusions. After explaining that "where there is ambiguity, insurance policies are to be construed strictly against the insurer," the court determined that the exclusions were ambiguous and did not bar coverage. Although the court stated that it was "particularly troubled" by the facts of the case, other courts have cited Kiger for the general proposition that standard or absolute pollution exclusions are ambiguous as a matter of law.

Shortly thereafter, the Indiana Supreme Court required another insurer to defend an insured against pollution claims despite the policies' pollution exclusions, declaring that "the duty to defend is broader than an insurance company's coverage liability or its duty to indemnify." Since then other courts have held that environmental administrative proceedings are "suits" triggering the duty to defend, that covered "damages" include mandatory cleanup and response costs, that coverage may exist under both personal injury and property damage provisions, and that exclusions for damage to property owned by the insured do not apply to groundwater contamination. These cases clearly illustrate that Indiana courts favor coverage when interpreting insurance policies.

Indiana courts also warn that an insurer that refuses to defend a pollution damage case based upon a non-coverage determination "does so at its peril." In the recent case of Freidline v. Shelby Insurance, an insurer that refused to defend pursuant to a pollution exclusion clause was held liable for bad faith in light of its knowledge

of Indiana's previous case law finding similar exclusions to be ambiguous even though the claim involved bodily injury whereas previous cases dealt only with property damage.

In Freidline, workers sued the owners of their office building, alleging injury from fumes from carpet glue. The owners sued their insurer after it refused to defend and indemnify them based upon the policy's pollution exclusions. Despite the fact that the policy specifically defined "pollutant" as including "fumes," the court followed Kiger in finding it to be ambiguous and construing it in favor of coverage. It then imposed liability for bad faith on the insurer for refusing to defend, explaining that although an insurer has the right to dispute a claim, it must have a legitimate basis for doing so. Because the insurer "knew that the ‘pollution exclusion' it was relying on to deny coverage . . . had been previously found ambiguous" in Kiger, the court held that there was no legitimate basis for denying coverage.

The court did not address the fact that previous cases following Kiger all had involved soil or groundwater contamination, whereas this case involved bodily injury from fumes from a construction project. This case indicates that these factual differences are not a legitimate basis for denying coverage pursuant to a pollution exclusion clause, and may also stand for the blanket proposition that an insurer acts in bad faith if it denies coverage based upon an absolute or standard pollution exclusion. Consequently it is questionable how, if at all, an insurer may safely dispute such claims without being required to defend the insured.

The recent case of General Housewares Corporation v. National Surety Corporation marked a victory for insurers by being the first to apply the known loss doctrine. This doctrine, also known as the "fortuity principle," bars insurance coverage "if an insured has actual knowledge that a loss has occurred, is occurring, or is substantially certain to occur on or before the effective date of the policy."

In General Housewares, an insured filed suit after its insurers denied its environmental claims. The trial court granted summary judgment to one insurer based upon evidence that prior to the inception of the policies the insured knew of the liability. Although the appellate court reversed based upon evidence that the insured disclosed the liability as part of the underwriting process, it agreed that, absent knowledge by the insurer, the known loss doctrine would bar coverage.

After acknowledging that Indiana law generally favors coverage for environmental claims, the court explained that it is "intrinsic to the very concept of insurance" that substantially certain losses are not properly insurable. A substantially certain loss is "one that is not only likely to occur, but is virtually inevitable," uncertain only as to temporality rather than probability. The limiting principle is that parties may still agree to cover existing losses. Thus, if an insurer also knows of the loss at inception of the policy, the known loss doctrine will not allow the insurer to avoid coverage.

As these cases suggest, Indiana's law of insurance contract interpretation is complex and evolving. Buyers and sellers of commercial insurance should contact a knowledgeable attorney and carefully consider Indiana law when assessing their rights and obligations under a policy, negotiating policy terms, drafting policy language, making coverage determinations or addressing situations in which coverage has been denied. For assistance in any of these matters or to obtain additional information, please contact us.