Standard Fire Insurance Co. v. Chester-O'Donley & Associates, Inc.

IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE
FILED
STANDARD FIRE INSURANCE ) January 28, 1998
COMPANY, )
Cecil W. Crowson
)
Appellate Court Clerk
Plaintiff/Appellant, )
) Davidson Circuit
VS. ) No. 94C-3993
)
CHESTER-O’DONLEY & ASSOCIATES, ) Appeal No.
INC., OHIO CASUALTY INSURANCE ) 01A01-9508-CV-00382
COMPANY, CLARK & ASSOCIATES )
ARCHITECTS, INC., and HIGHLAND )
RIM CONSTRUCTORS, INC., )
)
Defendants/Appellees. )

APPEAL FROM THE CIRCUIT COURT FOR DAVIDSON COUNTY
AT NASHVILLE, TENNESSEE

THE HONORABLE BARBARA N. HAYNES, JUDGE

For the Plaintiff/Appellant: For the Defendants/Appellees
Chester-O’Donley & Associates, Inc.:
Arthur E. McClellan
McC lellan, Pow ers, Ehmlin g & D ix John B. Link, III
Nashville, Tennessee Nashville, Tennessee

Ohio Casualty Insurance Company:

Lewis B. Hollabaugh
Lawrence B . Hammet, II
Manier, Herod, H ollabaugh & Smith
Nashville, Tennessee

Clark & Associates Architects, Inc.:

Andrée Sophia B lumstein
Sherrard & Roe
Nashville, Tennessee

Highland Rim Constructors, Inc.:

C. Geor ge Caud le
Baker, D onelson, B earman & Caldw ell
Chattanooga, Tennessee

VACATED AND REMANDED

WILLIAM C. KOCH, JR., JUDGE
 OPINION

This appeal involves the scope of coverage of a mechanical subcontractor’s
commercial general liability insurance policy. The general contractor, the project
architect, and the subcontractor’s bonding company asserted various damage claims
against the subcontractor in litigation stemming from the total failure of the
subcontractor’s work. When the subcontractor called upon the issuer of its
commercial general liability policy to defend against these claims, the insurer denied
coverage and filed suit in the Circuit Court for Davidson County seeking a
declaratory judgment concerning the scope of its policy’s coverage and its obligation
to defend the subcontractor. In response to the parties’ motions for summary
judgment, the trial court held that the policy covered the claims asserted by the
general contractor, the project architect, and the subcontractor’s bonding company.
The insurer asserts on this appeal that its policy did not cover these claims. We
vacate the trial court’s order because the policy covers only one claim asserted by the
general contractor and the subcontractor’s bonding company.

I.

In March 1988 the State of Tennessee and Austin Peay State University
contracted with Highland Rim Constructors, Inc. to construct a new music building
on Austin Peay’s campus in Clarksville. Clark & Associates Architects, Inc. designed
the building and served as the project architect. Highland Rim subcontracted the
mechanical portions of the work to Chester-O’Donley & Associates, Inc., and
Chester-O’Donley, in turn, subcontracted the installation of the ductwork for the
heating, ventilation, and air conditioning system to H & R Mchanical Specialties, Inc.
Chester-O’Donley also obtained a performance and payment bond for its portion of
the work from Ohio Casualty Company.

The new music building was substantially completed in May 1990. Shortly
after Austin Peay occupied the building, serious problems with the HVAC system

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began to manifest themselves which could not be remedied by fine tuning the HVAC
system. Highland Rim determined that the problems were caused by defects in the
system’s ductwork and terminated its contract with Chester-O’Donley because H &
R Mechanical Specialties’ work failed to meet the project’s specifications. Highland
Rim also called upon Ohio Casualty to pay for removing and replacing the entire duct
system. Ohio Casualty eventually paid Highland Rim $1,425,835.88.

In August 1991 Chester-O’Donley filed suit in the Circuit Court for Davidson
County against Highland Rim, Clark & Associates, H & R Mechanical Specialties,
and others alleging various causes of action arising out of the performance of its
work. It eventually nonsuited these claims in March 1994, but not before Highland
Rim, Ohio Casualty, and Clark & Associates had filed counterclaims seeking
damages from Chester-O’Donley. Chester-O’Donley forwarded these claims to
Standard Fire Insurance Company, the issuer of its commercial general liability
policy, and requested a defense. Standard Fire asserted that its policy did not cover
these claims and, in March 1994, filed suit in the Circuit Court for Davidson County
seeking a declaratory judgment concerning the scope of its policy’s coverage and its
obligation to defend Chester-O’Donley. All parties sought summary judgments, and
the trial court determined that Standard Fire’s policy covered all the pending claims
and that Standard Fire was obligated to provide Chester-O’Donley with a defense.

II.
THE CHOICE OF SUBSTANTIVE LAW

This case presents a threshold choice of law question. Chester-O’Donley is a
Kentucky corporation whose principle place of business is in Paducah, Kentucky. It
purchased its commercial general liability policy from Standard Fire in Kentucky, and
Standard Fire delivered the policy to Chester-O’Donley in Kentucky. In the absence
of an enforceable choice of law clause, Tennessee courts apply the substantive law
of the state in which the policy was issued and delivered. See Ohio Cas. Ins. Co. v.
Travelers Indem. Co., 493 S.W.2d 465, 467 (Tenn. 1973); Kustoff v. Stuyvesant Ins.
Co., 160 Tenn. 208, 212-13, 22 S.W.2d 356, 358 (1929); Hutchison v. Tennessee

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Farmers Mut. Ins. Co., 652 S.W.2d 904, 905 (Tenn. Ct. App. 1983).1 Accordingly,
questions concerning the construction and operation of Chester-O’Donley’s
commercial general liability policy must be decided using Kentucky law.

Kentucky law provides little substantive guidance in this case. We have been
unable to find any reported Kentucky cases construing commercial general liability
policy provisions similar to the ones at issue in this case. Nonetheless, we can apply
Kentucky’s canons for construing insurance policies, and we may also inform our
judgment by reviewing decisions from other jurisdictions construing similar policy
provisions. See Norton-Children’s Hosp., Inc. v. First Ky. Trust Co., 557 S.W.2d
895, 898 (Ky. Ct. App. 1977); Collins v. Kentucky Tax Comm’n, 261 S.W.2d 303,
305 (Ky. Ct. App. 1953).

III.
THE USE OF A SUMMARY JUDGMENT TO RESOLVE COVERAGE ISSUES

Tennessee’s law governs the procedural aspects of this case even if Kentucky’s
law governs the substantive issues. See State ex. rel. Smith v. Early, 934 S.W.2d 655,
658 (Tenn. Ct. App. 1996); McReynolds v. Cherokee Ins. Co., 815 S.W.2d 208, 211

1
These decisions embody the traditional “lex loci contractu” choice of law theory. The
Tennessee Supreme Court abandoned a similar choice of law theory applicable to tort actions, “lex
loci deliciti,” because it was outmoded and increasingly irrelevant in today’s modern industrial
world. See Hataway v. McKinley, 830 S.W.2d 53, 57 (Tenn. 1992). In its place, the court adopted
the “most significant relationship” approach found in Restatement (Second) of Conflict of Laws §§
6, 145, 146, & 175 (1971).

The court has yet to adopt the similar approach for contract disputes, although Restatement
(Second) of Conflict of Laws § 188 embodies such an approach when the parties have not effectively
chosen the law applicable to their contract. With specific regard to insurance contracts, the location
of the insured risk is given greater weight than any other factor unless the insurance covers a group
of risks scattered throughout two or more states. See Restatement (Second) of Conflict of Laws §
193 cmt. b. Policies insuring multiple risks in two or more specific states may be treated as insuring
individual risks in each state. See Restatement (Second) of Conflict of Laws § 193 cmt. f.

Were we to apply the approach in Restatement (Second) of Conflict of Laws §§ 6, 186, 187,
188, & 193 to this case we would reach the same result reached using the traditional lex loci
contractu rule. Standard Fire’s insurance policy covered liability incurred by Chester-O’Donley
anywhere in the United States of America. Since it did not identify particular risks in specific states,
the location of the insured risk is not of controlling importance. See Continental Ins. Co. v.
Beecham, Inc., 836 F. Supp. 1027, 1035-37 (D.N.J. 1993). Notwithstanding the fact that the project
was located in Tennessee, Kentucky remains the state with the most significant relationship with this
insurance contract after taking into consideration the factors in Restatement (Second) of Contracts
§§ 6 & 188(2).

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(Tenn. Ct. App. 1991). Questions involving an insurance policy’s coverage and an
insurer’s duty to defend require the interpretation of the insurance policy in light of
claims asserted against the insured. See Drexel Chem. Co. v. Bituminous Ins. Co.,
933 S.W.2d 471, 480 (Tenn. Ct. App. 1996); American Nat’l Property & Cas. Co. v.
Gray, 803 S.W.2d 693, 695-96 (Tenn. Ct. App. 1990). A declaratory judgment
proceeding provides an appropriate vehicle for deciding coverage questions. See
Allstate Ins. Co. v. Merritt, 772 S.W.2d 911, 912 (Tenn. Ct. App. 1989).

Issues relating to the interpretation of written contracts involve legal rather
than factual issues. See Rapp Constr. Co. v. Jay Realty Co., 809 S.W.2d 490, 491
(Tenn. Ct. App. 1991); Taylor v. Universal Tire Co., 672 S.W.2d 775, 777 (Tenn. Ct.
App. 1984). Accordingly, issues relating to the scope of coverage and an insurer’s
duty to defend likewise present questions of law. See Pile v. Carpenter, 118 Tenn.
288, 296, 99 S.W. 360, 362 (1907); Pennsylvania Lumbermens Mut. Fire Ins. Co. v.
Holt, 32 Tenn. App. 559, 566, 223 S.W.2d 203, 206 (1949). These essentially legal
questions can be resolved using a summary judgment when the relevant facts are not
in dispute. See St. Paul Fire & Marine Ins. Co. v. Torpoco, 879 S.W.2d 831, 834
(Tenn. 1994); Rainey v. Stansell, 836 S.W.2d 117, 118 (Tenn. Ct. App. 1992).

The trial court’s decision to grant the motions for summary judgment is not
entitled to a presumption of correctness on appeal. See McClung v. Delta Square Ltd.
Partnership, 937 S.W.2d 891, 894 (Tenn. 1996); Carvell v. Bottoms, 900 S.W.2d 23,
26 (Tenn. 1995). Rather, we must make a fresh determination concerning whether
the requirements of Tenn. R. Civ. P. 56 have been met. See Mason v. Seaton, 942
S.W.2d 470, 472 (Tenn. 1997); Hembree v. State, 925 S.W.2d 513, 515 (Tenn. 1996).
A summary judgment is warranted only when there are no genuine, material factual
disputes with regard to the claim or defense asserted in the motion and when the
moving party is entitled to a judgment as a matter of law. See Bain v. Wells, 936
S.W.2d 618, 622 (Tenn. 1997); McCall v. Wilder, 913 S.W.2d 150, 153 (Tenn. 1995).

The insurance policy that Standard Fire issued to Chester-O’Donley is in the
record, as are the counterclaims against Chester-O’Donley filed by Highland Rim,
Clark & Associates, and Ohio Casualty. There are no factual disputes concerning the
contents of these documents; accordingly, their interpretation presents questions of

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law. The summary judgment in this case can stand only if these documents establish
as a matter of law that Standard Fire’s commercial general liability policy covers the
asserted claims as a matter of law.

IV.
COMMERCIAL GENERAL LIABILITY INSURANCE POLICIES

Commercial general liability insurance policies are designed to protect the
insured against losses arising out of business operations.2 These policies have been
in use for over fifty years,3 and their provisions have become relatively standard over
the years through refinements by casualty ratings bureaus.4 In order to prevent
overlapping coverage and to minimize gaps in coverage,5 they combine several
historic forms of coverage into an integrated whole with coverage being broadly
stated in a single insuring agreement and exclusions circumscribing the broad grant
of coverage.6

General liability polices are not “all-risk” policies. See Diamond Heights
Homeowners Ass’n v. National Am. Ins. Co., 277 Cal. Rptr. 906, 910 (Ct. App. 1991);
Bausch & Lomb, Inc. v. Utica Mut. Ins. Co., 625 A.2d 1021, 1033 (Md. 1993). They
provide an insured with indemnification for damages up to policy limits for which the
insured becomes liable as a result of tort liability to a third party. See Weedo v. Stone-
E-Brick, Inc., 405 A.2d 788, 791 (N.J. 1979); Vernon Williams & Son Constr., Inc.
v. Continental Ins. Co., 591 S.W.2d 760, 764 (Tenn. 1979).7 The risk insured by

2
See 9 Lee R. Russ, Couch on Insurance 3d § 129:2 (1997) (“Couch on Insurance 3d”).
3
See 2 Rowland H. Long, The Law of Liability Insurance § 10.03[2] (1997) (“Long”); Roger
C. Henderson, Insurance Protection for Products Liability and Completed Operations - What Every
Lawyer Should Know, 50 Neb. L. Rev. 415, 418 (1971) (“Henderson”).
4
See 1 Eric M. Holmes & Mark S. Rhodes, Holmes’s Appleman on Insurance 2d § 1.15, at
65-66 (1996) (“Holmes’s Appleman on Insurance 2d”); Long, § 10.03[1]; George H. Tinker,
Comprehensive General Liability Insurance - Perspective and Overview, 25 Fed’n Ins. Couns. Q.
217, 218-19 (1975) (“Tinker”).
5
See Holmes’s Appleman on Insurance 2d, § 1.15, at 65.
6
See Tinker, 25 Fed’n Ins. Counsel. Q. at 220.
7
See also Robert J. Franco, Insurance Coverage for Faulty Workmanship Claims Under
Commercial General Liability Policies, 30 Tort & Ins. L.J. 785, 786 (1995); Robert E. Keeton &
(continued...)

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these policies is the possibility that the insured’s product or work will cause bodily
injury or damage to property other than the work itself for which the insured may be
found liable.8

Exclusions for “business risks” began to be included in commercial general
liability policies in 1966 to make clear that these policies did not cover the costs of
repairing or replacing the insured’s defective product or faulty work. See Glens Falls
Ins. Co. v. Donmac Golf Shaping Co., 417 S.E.2d 197, 200 (Ga. Ct. App. 1992);
Vernon Williams & Son Constr., Inc. v. Continental Ins. Co., 591 S.W.2d at 765;
Blaylock & Brown Constr., Inc. v. AIU Ins. Co., 796 S.W.2d 146, 153 (Tenn. Ct. App.
1990); Henderson, 50 Neb. L. Rev. at 438. These exclusions are based on the
premise that general liability coverage is not intended as a guarantee of the insured’s
product or work. See Neeson & Meyer, at 79.

Accordingly, general liability polices are not intended to cover the insured’s
contractual liability for economic loss because its work was not that for which the
damaged person bargained. See Glens Falls Ins. Co. v. Donmac Golf Shaping Co.,
417 S.E.2d at 200; Knudson Constr. Co. v. St. Paul Fire & Marine Ins. Co., 396
N.W.2d 229, 234 (Minn. 1986); Weedo v. Stone-E-Brick, Inc., 405 A.2d at 791.9 As
the New Jersey Supreme Court noted in one of the seminal cases construing general
liability policies: “The policy in question does not cover the accident of faulty
workmanship but rather faulty workmanship which causes an accident.” Weedo v.
Stone-E-Brick, Inc., 405 A.2d at 796.

V.
GENERAL RULES OF CONSTRUCTION

7
(...continued)
Adam I. Widiss, Insurance Law § 4.8(a) (1988) (“Insurance Law”).
8
See Michael J. Brady, The Impaired Property Exclusion: Finding a Path Through the
Morass, 63 Def. Couns. J. 380, 380 (1996) (“Brady”); Peter J. Neeson & Phillip J. Meyer, The
Comprehensive General Liability Policy and Its Business Risk Exclusions: An Overview 79-80, 91,
reprinted in Reference Handbook on the Comprehensive General Liability Policy (American Bar
Assoc. 1995) (“Neeson & Meyer”).
9
See also Brady, 63 Def. Counsel. J. at 380; Henderson, 50 Neb. L. Rev. at 441; Neeson &
Meyer, at 80.

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 Insurance contracts are subject to the same rules of construction and
enforcement as contracts generally. See McKimm v. Bell, 790 S.W.2d 526, 527
(Tenn. 1990); Hurley v. Tennessee Farmers Mut. Ins. Co., 922 S.W.2d 887, 892
(Tenn. Ct. App. 1995). In the absence of fraud or mistake, they should be interpreted
as written, see Allstate Ins. Co. v. Wilson, 856 S.W.2d 706, 708 (Tenn. Ct. App.
1992), and their terms should be given their natural and ordinary meaning. See Tata
v. Nichols, 848 S.W.2d 649, 650 (Tenn. 1993); Drexel Chem. Co. v. Bituminous Ins.
Co., 933 S.W.2d at 477. Because insurers are strictly accountable for the language
in their contracts, ambiguous language will be construed against the insurer and in
favor of the insured. See Harrell v. Minnesota Mut. Life Ins. Co., 937 S.W.2d 809,
814 (Tenn. 1996).

Insurance policies should be construed as a whole in a reasonable and logical
manner. See English v. Virginia Sur. Co., 196 Tenn. 426, 430, 268 S.W.2d 338, 340
(1954); Setters v. Permanent Gen. Assurance Corp., 937 S.W.2d 950, 953 (Tenn. Ct.
App. 1996). The essential components of a general liability insurance policy include
(1) the declarations, (2) the insuring agreements and definitions, (3) the exclusions,
(4) the conditions, and (5) the endorsements. When coverage questions arise, these
components should be construed in the above order to avoid confusion and error. See
Tinker, 25 Fed’n Ins. Counsel Q. at 222; Long, § 10.04.

The insuring agreement sets the outer limits of an insurer’s contractual liability.
If coverage cannot be found in the insuring agreement, it will not be found elsewhere
in the policy. Exclusions help define and shape the scope of coverage, but they must
be read in terms of the insuring agreement to which they apply. Exclusions can only
decrease coverage; they cannot increase it. See Stanford Ranch, Inc. v. Maryland
Cas. Co., 89 F.3d 618, 626 (9th Cir. 1996); Continental Cas. Co. v. Pittsburgh
Corning Corp., 917 F.2d 297, 300 (7th Cir. 1990); Marmone v. Liberty Mut. Ins. Co.,
695 A.2d 341, 344 (N.J. Super. Ct. App. Div. 1997); 13 John A. Appleman & Jean
Appleman, Insurance Law and Practice § 7387, at 175 (1976).

Exclusions should also be read seriatim. Each exclusion reduces coverage and
operates independently with reference to the insuring agreement. See Trinity

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Universal Ins. Co. v. Broussard, 932 F. Supp. 1307, 1310 (N.D. Okla. 1996);
Hartford Accident & Indem. Co v. A.P. Beale & Sons, Inc., 644 N.Y.S.2d 442, 443
(App. Div. 1996). Exclusions should not be construed broadly in favor of the insurer,
nor should they be construed so narrowly as to defeat their intended purpose. See
Midland Ins. Co. v. Home Indem. Co., 619 S.W.2d 387, 389 (Tenn. Ct. App. 1981).
Once an insurer has established that an exclusion applies, the burden shifts to the
insured to demonstrate that its claim fits within an exception to the exclusion. See
Just v. Land Reclamation, Ltd., 445 N.W.2d 683, 688 (Wis. Ct. App. 1989), rev’d on
other grounds, 456 N.W.2d 570 (Wis. 1990).

VI.
STANDARD FIRE’S POLICY LANGUAGE

We turn first to the insuring agreement of Standard Fire’s policy to establish
the outer boundaries of coverage. Then, we will examine the exclusions from
coverage relied on by Standard Fire to limit the scope of its policy’s coverage.

A.
The Insuring Agreement

The insuring agreement in Coverage A of Standard Fire’s policy provides
succinctly that “[w]e 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 applies.” The insuring agreement also states that the policy covers bodily
injury and property damage that occur within the policy period and that are caused
by an “occurrence” that takes place within the coverage territory. The present dispute
concerns whether an “occurrence” has caused “property damage;” there is no dispute
that the claims arose during the policy period and within the coverage territory.

Standard Fire’s policy defines “property damage” as
a. Physical injury to tangible property, including all
resulting loss of use of the property; or
b. Loss of use of tangible property that is not
physically injured.

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It also defines an “occurrence” as “an accident, including continuous or repeated
exposure to substantially the same general harmful condition.” Accordingly,
Standard Fire’s policy covers only the sums its insured becomes legally obligated to
pay for physical injury to tangible property or for the loss of use of tangible property
that is not injured.

The “physical injury” requirement was added to the standard policy language
in 197310 to reinforce that these policies cover only visible harm or impairment11 or
actual physical loss to tangible property. 12 Thus, in circumstances that do not involve
personal injuries, these policies do not cover economic loss without some sort of
physical injury to tangible personal property that is not owned by the insured or that
is not part of the insured’s work. See Gulf Ins. Co. v. L.A. Effects Group, Inc., 827
F.2d 574, 577 (9th Cir. 1987); Transcontinental Ins. Co. v. Ice Sys. Of America, Inc.,
847 F. Supp. 947, 950 (M.D. Fla. 1994); Hommel v. George, 802 P.2d 1156, 1158
(Colo. Ct. App. 1990).

Additional construction expenses, lost profits, or diminution in value of the
project caused by the insured’s defective work are the sort of economic losses that do
not fit within the definition of “property damage.” See SLA Property Management
v. Angelina Cas. Co., 856 F.2d 69, 72-73 (8th Cir. 1988); Wyoming Sawmills, Inc. v.
Transportation Ins. Co., 578 P.2d 1253, 1256 (Or. 1978). On facts similar to those
in this case, one intermediate appellate court held that the inclusion of defective
energy storage units that contributed to the failure of an HVAC system was not
“property damage” because the defective units did not cause physical injury to the
HVAC system. Accordingly, the court held that the claims for the costs to repair the
HVAC system, the lost rent, the lost productivity of the workers in the building, and
the excessive electrical consumption were not covered by the contractor’s general
liability policy. See Diamond State Ins. Co. v. Chester-Jensen Co., 611 N.E.2d 1083,

10
See Herbert J. Baumann, Broad Form Property Liability Coverage 125, reprinted in
Reference Handbook on the Comprehensive General Liability Policy (American Bar. Assoc. 1995)
(“Baumann”).
11
See Donald S. Malecki & Arthur L. Flitner, Commercial General Liability 8 (3d ed. 1990)
(“Malecki & Flitner”).
12
See Baumann, at 126 n.29.

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1091-92 (Ill. App. Ct. 1993); see also Bituminous Cas. Corp. v. Gust K. Newberg
Constr. Co., 578 N.E.2d 1003, 1009-10 (Ill. App. Ct. 1991); Sentry Ins. Co. v. S & L
Home Heating Co., 414 N.E.2d 1218, 1221-22 (Ill. App. Ct. 1980).

B.
The Exclusions Claimed by Standard Fire

In addition to the language in its policy’s insuring agreement, Standard Fire
also relies on two exclusions to support its position that its policy does not cover the
damage claims asserted by Highland Rim, Clark & Associates, and Ohio Casualty.13
These exclusions are commonly known as the “impaired property” exclusion and the
“sistership” exclusion.

The Impaired Property Exclusion

The “impaired property” exclusion in Standard Fire’s policy states that the
coverage in the policy does not apply to:
“Property damage” to “impaired property” or property that
has not been physically injured, arising out of:
(1) A defect, deficiency, inadequacy or dangerous
condition in “your product” or “your work”; or
(2) A delay or failure by you or anyone acting on your
behalf to perform a contract or agreement in
accordance with its terms.
This exclusion does not apply to the loss of use of other
property arising out of sudden and accidental physical
injury to “your product” or “your work” after it has been
put to its intended use.

The policy defines “impaired property” as

13
Highland Rim and Ohio Casualty also request the court to address the policy’s “completed
operations hazard” exclusion. We decline to do so for two reasons. First, Standard Fire has not
based its denial of coverage on this exclusion, and second, the language of an exclusion cannot add
coverage to a policy when the coverage is not provided in the insuring clause. Consideration of the
“completed operations hazard” exclusion adds nothing to the resolution of the parties’ dispute.

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 tangible property, other than “your product” or “your
work”, that cannot be used or is less useful because:
a. It incorporates “your product” or “your work” that is
known or thought to be defective, deficient,
inadequate or dangerous; or
b. You have failed to fulfill the terms of a contract or
agreement;
if such property can be restored to use by:
a. The repair, replacement, adjustment or removal of
“your product” or “your work”; or
b. Your fulfilling the terms of the contract or
agreement.

This exclusion was first included in commercial general liability policies in
1966 and was later amended and refined in 1973, 1986, and 1990.14 It narrows
coverage for claims involving the reduced usefulness or impairment of property other
than the insured’s. See Hamlin, Inc. v. Hartford Accident & Indem. Co., 86 F.3d 93,
96 (7th Cir. 1996); Franco, 30 Tort & Ins. L.J. at 800. The exclusion targets
situations where a defective product, after being incorporated into the property of
another, must be replaced or removed at great expense thereby causing loss of use of
the property.

The effect of the “impaired property” exclusion is to bar coverage for loss of
use claims (1) when the loss was caused solely by the insured’s failure to provide
work of the quality or performance capabilities called for by the contract and (2)
when there has been no physical injury to property other than the insured’s work
itself. The exclusion does not apply if there is damage to property other than the
insured’s work, see Imperial Cas. & Indem. Co. v. High Concrete Structures, Inc.,
858 F.2d 128, 136 (3d Cir. 1988); Transcontinental Ins. Co. v. Ice Sys. of Am., Inc.,
847 F. Supp. at 950, or if the insured’s work cannot be repaired or replaced without
causing physical injury to other property. See Oscar W. Larson Co. v. United Capitol
Ins. Co., 845 F. Supp. 445, 448-49 (W.D. Mich. 1993); Action Auto Stores, Inc. v.
United Capitol Ins. Co., 845 F. Supp. 417, 425-26 (W.D. Mich. 1993); Elco Indus.
v. Liberty Mut. Ins. Co., 361 N.E.2d 589, 591 (Ill. App. Ct. 1977).

14
See Brady, 63 Def. Counsel J. at 381; Malecki & Flitner, at 49-50; Tinker, 25 Fed’n Ins.
Counsel Q., at 264.

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 Several texts have illustrated applications of the “impaired property” exclusion
works using heating and ventilation systems. One text gives the following example:
[S]ay that the insured installs a heating and ventilation
system in a new building. If the system later proves to be
defective, resulting in the loss of use of the building while
the system is being repaired or replaced, the insurer can
cite the portion of the exclusion relating to “impaired
property” in denying coverage for a resulting loss-of-use
claim against its insured.

Malecki & Flitner, at 52. Another text provides a similar, although more detailed,
example:
The completion of an office tower for DEVCORP was
delayed by WARMCO’s delay in completing its contract
for the installation of heating, ventilation and air
conditioning systems. When WARMCO informed
GENERAL and DEVCORP that the heating system was
completed and ready for use, it was determined that defects
in the heating system prevented the heating system from
generating sufficient heat to meet the specifications. As a
result, the office tower could not be occupied while repairs
were made and DEVCORP suffered additional delays and
substantial lost rental income. DEVCORP brought an
action against GENERAL and WARMCO and GENERAL
cross-claimed against WARMCO. Are the claims covered
by WARMCO’s CGL policy?

Under this exclusion, there is no coverage for the
claims against WARMCO because WARMCO’s failure to
perform resulted in delay and loss of use of property that
had not been physically injured.

Joseph G. Blute, Analyzing Liability Insurer Coverage for Construction Industry
Property Damage Claims, available in WESTLAW, 7 No. 3 Coverage 1, 32
(American Bar Assoc. 1997).

The Sistership Exclusion

The “sistership” exclusion in Standard Fire’s policy withdraws coverage for
claims involving
[d]amages claimed for any loss, cost or expense incurred
by you or others for the loss of use, withdrawal, recall,

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 inspection, repair, replacement, adjustment, removal or
disposal of:
(1) “Your product”;
(2) “Your work”; or
(3) “Impaired property”;
if such product, work, or property is withdrawn or recalled
from the market or from use by any person or organization
because of a known or suspected defect, deficiency,
inadequacy or dangerous condition in it.

This provision first appeared in commercial general liability policies in 196615 and
takes its name from the occurrences in the aircraft industry where enormous loss-of-
use claims resulted from the grounding of all airplanes of the same type because one
airplane crashed, and its “sisterships” were suspected of having a common defect.
See Arcos Corp. v. American Mut. Liab. Ins. Co., 350 F. Supp. 380, 383, 384-85 (E.D.
Pa. 1972); Paper Machinery Corp. v. Nelson Foundry Co., 323 N.W.2d 160, 163-64
(Wis. Ct. App. 1982).16

The exclusion is designed to shield insurers from liability for the costs
associated with unanticipated product recalls. See Forest City Dillon, Inc. v. Aetna
Cas. & Sur. Co., 852 F.2d 168, 173 (6th Cir. 1988); Paper Machinery Corp. v. Nelson
Foundary Co., 323 N.W.2d at 164. It does not apply to claims involving losses
resulting from the failure of the insured’s product or work, see Imperial Cas. &
Indem. Co. v. High Concrete Structures, Inc., 858 F.2d at 136 n.9, or to claims that
are not based on the withdrawal or recall of the insured’s own product or work. See
Imperial Cas. & Indem. Co. v. High Concrete Structures, Inc., 858 F.2d at 137;
Fitness Equip. Co. v. Pennsylvania Gen. Ins. Co., 493 So. 2d 1337, 1343 (Ala. 1985).

The removal of defective products that failed after their installation does not
come within the sistership exclusion of the insured’s general liability policy because
there has been no general withdrawal of similar products from the general
marketplace. See Forest City Dillon, Inc. v. Aetna Cas. & Sur. Co., 852 F.2d at 173-
74; Marathon Plastics, Inc. v. International Ins. Co., 514 N.E.2d 479, 487 (Ill. App.

15
See Tinker, 25 Fed’n Ins. Counsel Q. at 264.
16
See Malecki & Flitner, at 52; Jean E. Maess, Annotation, Validity and Construction of
“Sistership” Clause of Products Liability Insurance Policy Excepting From Coverage Cost of
Product Recall or Withdrawal of Product From Market, 32 A.L.R. 4th 630, 631 (1984).

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Ct. 1987). Based upon the undisputed facts, the “sistership” exclusion does not apply
in this case because there is no evidence of a general recall of similar products or
materials from the marketplace.

VII.
STANDARD FIRE’S OBLIGATION TO DEFEND THE CLAIMS
AGAINST CHESTER-O’DONLEY

All that remains is to determine whether Standard Fire has a duty to defend
Chester-O’Donley with regard to the claims made by Highland Rim, Ohio Casualty,
and Clark & Associates. This duty is measured by the factual allegations in the
counterclaims. See First Nat’l Bank v. South Carolina Ins. Co., 207 Tenn. 520, 523,
341 S.W.2d 569, 570 (1960); Drexel Chem. Co. v. Bituminous Ins. Co., 933 S.W.2d
at 480; I. Appel Corp. v. St. Paul Fire & Marine Ins. Co., 930 S.W.2d 550, 552 (Tenn.
Ct. App. 1996). An insurer’s duty to defend is triggered when its policy arguably, as
opposed to distinctly, covers the claims being made, see Hamlin, Inc. v. Hartford
Accident & Indem. Co., 86 F.3d at 94; O’Banon v. Aetna Cas. & Sur. Co., 678 S.W.2d
390, 392 (Ky. 1984); Dempster Bros. Inc. v. U.S.F.&G., 54 Tenn. App. 65, 71, 388
S.W.2d 153, 156 (1964), and continues until the facts and the law establish that the
claimed loss is not covered. See James Graham Brown Found., Inc. v. St. Paul Fire
& Marine Ins. Co., 814 S.W.2d 273, 279 (Ky. 1991).

A.
The Claims of Clark & Associates

In its counterclaim, Clark & Associates asserts that it issued a certificate of
substantial completion for the new music building based on Chester-O’Donley’s
assertions that the mechanical systems in the building, including the HVAC
ductwork, had been constructed in accordance with the contract. It seeks to recover
$500,000 representing damages for (1) Chester-O’Donley’s negligent or fraudulent

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misrepresentations, (2) the time required to discover and correct the defective work,
(3) its loss of income because the rate of compensation for its remedial work was less
than its regular rate, and (4) the injuries to its business reputation and good will.

None of Clark & Associates’ claims involve physical damage to tangible
property. Rather, they amount to economic losses stemming from Chester-
O’Donley’s breach of contract. Accordingly, based on the undisputed facts in the
record, Standard Fire’s policy does not cover the claims asserted by Clark &
Associates.

B.
The Claims of Highland Rim and Ohio Casualty

Highland Rim alleges in its counterclaim that Chester-O’Donley failed to
provide a mechanical system in accordance with its subcontract. It asserts that
Chester-O’Donley breached its subcontract and that Highland Rim was required to
replace and rework substantial portions of the mechanical systems provided by
Chester-O’Donley. As a result, Highland Rim sought damages for (1) the liquidated
damages it was required to pay the State, (2) the “additional damages as a result of
delays caused by the defective work,” (3) impairment of its reputation with the State
of Tennessee and the business community, and (4) potential damages stemming from
the State’s claims for substantial delay and disruption in its use of the music building.

For its part, Ohio Casualty asserted in its counterclaim that it had been required
to pay Highland Rim $1,425,835.88 after Chester-O’Donley was declared in default
of its subcontract. According to its counterclaim, these funds were used to complete
Chester-O’Donley’s work and to correct defects or nonconforming work as
determined by the project architect.

The definition of “property damage” in Standard Fire’s policy limits the
policy’s coverage to physical injury to tangible property and to the loss of use of
tangible property other than the insured’s work that has not been physically injured.
The “impaired property” exclusion in Standard Fire’s policy narrows the loss-of-use

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coverage by excluding loss-of-use claims based solely on the insured’s failure to
provide the work or products called for in the contract. When read together, these
provisions exclude coverage when there has been no physical injury to tangible
property other than the insured’s work.

Highland Rim’s claims based on (1) its payment of liquidated damages to the
state, (2) the damage to its business reputation, and (3) the State’s claims of delay and
disruption of its occupation and use of the building are not covered by Standard Fire’s
policy. These claims involve economic losses stemming from Chester-O’Donley’s
breach of contract, and they do not involve physical injury to tangible property other
than Chester-O’Donley’s work. Using the same reasoning, the portion of Ohio
Casualty’s claim based on the funds it was required to pay Highland Rim to correct
Chester-O’Donley’s defective work is not covered by Standard Fire’s policy.

There is, however, some evidence in the record that the failure of the HVAC
system may have caused some physical injury to tangible property other than Chester-
O’Donley’s work. Standard Fire concedes in its brief that a portion of the funds paid
by Ohio Casualty were used to repair “inconsequential damages to wall[s], ceilings
and other parts of the business necessitated by the removal of the [HVAC] system.”
These damages may be covered because, as we have already pointed out, physical
injury to other tangible property not part of the insured’s work necessarily resulting
from the repair or replacement of the insured’s work is not excluded by the “impaired
property” exclusion. See Oscar W. Larson Co. v. United Capitol Ins. Co., 845 F.
Supp. at 448-49; Action Auto Stores, Inc. v. United Capitol Ins. Co., 845 F. Supp. at
425-26; Elco Indus. v. Liberty Mut. Ins. Co., 361 N.E.2d at 59.

None of the claims asserted in Highland Rim’s and Ohio Casualty’s
counterclaims are covered by Standard Fire’s policy except for the claim based on
physical injury to portions of the building that were not within the scope of Chester-
O’Donley’s work. Claims based on physical injury to the building caused by the
repair or replacement of the defective ductwork installed by Chester-O’Donley’s
subcontractor may be covered by Standard Fire’s policy. The record does not permit
determining the existence or extent of these injuries.

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 The proper course is to vacate the order denying Standard Fire’s motion for
summary judgment and to remand the case with directions to enter an order finding
that Clark & Associates’ claims and all the claims of Highland Rim and Ohio
Casualty, except for their claims based on damage to the building caused by the repair
or replacement of the defective ductwork, are not covered by Standard Fire’s policy.
On remand, the trial court may determine that these claims are likewise not covered
if the undisputed evidence demonstrates either that the repair or replacement of the
defective ductwork did not damage the other portions of the building or that this
damage was truly “inconsequential.”

Since Standard Fire’s policy arguably covers one of the claims made by
Highland Rim and Ohio Casualty, we find that Standard Fire has a duty to defend
Chester-O’Donley. Accordingly, we affirm the trial court’s order and remand the
case for further proceedings consistent with this opinion. Should the trial court later
conclude that other portions of the building were not physically damaged by the
repair or replacement of the defective ductwork or that this damage was truly
“inconsequential,” the court may then find that Ohio Casualty no longer has a duty
to provide Chester-O’Donley a defense with regard to this claim.

VIII.
ESTOPPEL TO DENY COVERAGE

Chester-O’Donley and Clark & Associates also assert that Standard Fire should
be estopped to deny coverage because a claim consultant told them that he believed
that the policy might cover Highland Rim’s claim that it had to perform substantial
work on the “mechanical system” and Clark & Associates’ claim for lost income. We
find little merit with this argument for two reasons. First, an insurer’s duties to
defend and indemnify arise from the terms of its policy, not from later statements of
its agents. See Kentucky Farm Bureau Mut. Ins. Co. v. Cann, 590 S.W.2d 881, 883-
84 (Ky. Ct. App. 1979). Second, we have determined as a matter of law that Standard
Fire’s policy does not cover any of Clark & Associates’ claims and that it may cover
only those claims asserted by Highland Rim relating to physical injury to the portions

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of the building not within the scope of Chester-O’Donley’s work that resulted from
the repair or replacement of the defective ductwork.

IX.

We vacate the order finding that Standard Fire’s policy provides coverage for
Chester-O’Donley with regard to all the claims asserted by Highland Rim, Clark &
Associates, and Ohio Casualty. We remand the case with directions to enter an order
finding that Standard Fire must provide a defense only with regard to the Highland
Rim’s and Ohio Casualty’s claims based on physical damage to portions of the
building not within the scope of Chester O’Donley’s work that resulted from the
repair or replacement of the defective ductwork and to take any other actions
consistent with this opinion. We tax the costs of this appeal in equal proportions to
Standard Fire Insurance Company and its surety, Clark & Associates Architects, Inc.,
Highland Rim Constructors, Inc., Chester-O’Donley & Associates, Inc., and Ohio
Casualty Insurance Company for which execution, if necessary, may issue.

____________________________
WILLIAM C. KOCH, JR., JUDGE

CONCUR:

____________________________________
HENRY F. TODD, PRESIDING JUDGE
MIDDLE SECTION

____________________________________
SAMUEL L. LEWIS, JUDGE

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