Illinois Court Rules Business Contracts, AI Provisions Must Match to Gain Coverage

In a decision with more than the usual transaction guidance, an Illinois federal district court has taught businesses how important it is to satisfy with precision the requirements of their counterparties’ insurance policies, if they hope to gain the shelter of contractual, additional insured policy provisions. The decision is Federal Signal Corporation v.Tammcor Industries, Inc., and Peerless Indemnity Insurance Company, filed April 7, 2016 and reported at 2016 U.S. Dist. LEXIS 47574.

The background facts in the case are straightforward. Federal Signal Corporation (Federal) manufactured a speaker system that was installed in a US Navy supply ship, the USNS Matthew Perry. Tammcor Industries (Tammcor) supplied Federal with the metal housing for the speaker system on the ship. One of the speakers allegedly malfunctioned, sending debris into the eyes of a bystander. The injured person sued Federal in California state court, and the case was settled for an undisclosed sum of money.

Federal then sued Trammcor and its general liability insurer, Peerless, in federal court in Illinois for indemnity for the loss Federal sustained in defending and settling the California lawsuit. Federal alleged that Tammcor manufactured the speaker component responsible for the injury, and that Federal was an additional insured under the Peerless policy, making Peerless directly liable for Federal’s losses in the California case.

The basis of the latter contention was an endorsement to the Peerless policy amending who was an insured to include any person or organization with which Tammcor and such other person or organization had agreed in writing by contract that such person or organization be added as an additional insured under the policy. The endorsement stipulated that such person or organization was an additional insured only with respect to bodily injury or property damage arising out of Tammcor’s products distributed or sold in the regular course of its business.

The case turned on whether there was a written contract between Tammcor and Federal agreeing that Federal be added as an additional insured under Tammcor’s policy. The candidate “contract” was a purchase order for the parts supplied by Tammcor for the speaker system installed in the supply ship. The decision quotes in its entirety the purchase order provision relied upon by Federal:

“INDEMNIFICATION: [Tammcor] shall defend, indemnify, and hold harmless [Federal] against all damages, claims or liabilities and expenses (including attorney’s fees) arising out of or resulting in any way from any defect in goods or services purchase[d] hereunder, or for any acts or omissions of [Tammcor], its agents, employees, or subcontractors. This indemnification shall be in addition to the warranty obligations of [Tammcor] and [Tammcor] agrees to provide Certificates of Insurance for such Indemnity upon request.”
The issue, decided by the court on summary judgment, was whether Peerless agreed to indemnify Federal as an “additional insured” under the liability policy Federal issued to Tammcor. Even though the court sat in Illinois, and a California lawsuit was the subject matter of the decision, the court applied Kentucky law to resolve the issue because the parties agreed that that state had the most significant relationship to the insurance policy between Peerless and Tammcor. The court indicated, however, that the decision would have been same had the court applied Illinois law.

The court found the issue to be straightforward, since the two relevant contracts – the policy and the purchase order – were unambiguous. Under its policy Peerless had agreed to consider a party as an additional insured only when Tammcor and that other party had “agreed in writing in a contract or agreement that such [party] be added as an additional insured.” The purchase orders did not satisfy this policy requirement, the court held, because they specified that Tammcor – not Peerless – would indemnify Federal. Had Tammcor and Federal agreed that Federal “be added as an additional insured on [Tammcor’s] policy,” Peerless would have an indemnity obligation.

Federal argued that, even though Tammcor was obligated under the purchase orders to indemnify Federal, if Tammcor failed to do so, Federal could look to Peerless for that relief, but it provided no reason as to why that was so. Under the unambiguous purchase order terms, the court noted, Tammcor alone was responsible for Federal’s legal liability, not Peerless.

The court then considered whether the purchase order clause requiring Tammcor to provide Federal with certificates of insurance for “such Indemnity upon request” satisfied the additional insured policy requirement. The court found that it did not. The problem with the clause in question is that the phrase “such Indemnity,” due to its context, had to refer to Tammcor’s indemnification of Federal, not indemnification of Federal by Peerless. The court observed that certificates of insurance are not themselves insurance; they are proof of existing insurance, so this clause implied only that Tammcor has existing insurance and would furnish proof of it to Federal on request. The court found that the clause provided Federal assurance that Tammcor had insurance to back up its financial risk in agreeing to indemnify Federal. It did not create or recognize a direct indemnification obligation from Peerless to Federal.

In its teaching for future transactions, the court stated that the Peerless insurance policy required an explicit, written contract between Federal and Tammcor to add Federal as an additional insured. The terms of the purchase order simply did not satisfy that requirement. After considering and rejecting several decisions applying Kentucky law, the court held that, even if there were an ambiguity in the additional insured endorsement, Federal had no reasonable expectation that it would be covered by the Peerless policy. When Federal signed the last purchase order it was reasonable for it to expect only that Tammcor would indemnify it, because the terms of the purchase said so. If Federal did entertain an expectation that it was an additional insured under the Tammcor policy, it was an unreasonable expectation, because a third- party insurer is nowhere mentioned in the purchase orders.

The court also found it important that Federal is a large, established public company, not an unsophisticated consumer. “If it wanted additional insured status, it should have contracted for it.” The court held, therefore, that Peerless was not directly liable to Federal for its losses in the California injury litigation, and granted Peerless’s motion for summary judgment.