There are certain factors that make an insurer-loss potentially significant.  These include a decision that (1) involves an issue with potentially broad applicability and frequency, i.e., it is not tied to a narrow set of facts and can arise under various types of liability policies; (2) goes against a generally accepted insurer position on an issue; and (3) comes from a state high court.

The recent decision, in Sapienza v. Liberty Mutual Insurance Company, No. 29000 (S.D. June 2, 2021), has all of these.  The South Dakota Supreme Court held that coverage was owed to an insured, under a liability policy, for its cost to comply with an injunction.  The court held that such costs qualified as covered “damages.”

In my experience, insurers generally do not treat an insured’s obligation, to comply with an injunction, as covered “damages.”  While I believe that Sapienza was wrongly decided – as did two of the five justices – the decision provides an opportunity for policyholders to make the argument, that was successful before the South Dakota high court, to secure coverage for injunctive relief.

Sapienza involved a battle royale between neighbors.  The Sapienzas obtained a building permit to raze their existing home and build a new one.  The McDowells lived next door, in a home listed on the state and national register of historic places.  You know where this is going.

After the Sapienzas home was completed, the McDowells filed suit, alleging illegalities in its construction and problems that it caused for the McDowells:

• Only seven feet of space between their home and the Sapienzas’ home, which violated applicable administrative regulations governing height, mass, and scale;

• McDowells prohibited from using their fireplace because of the close proximity and height of the Sapienzas’ home.

• Sapienzas’ home detrimentally affected the historic and sentimental value of their home, blocked a substantial amount of natural sunlight from the south, and invaded the privacy of their home by having windows that overlook the McDowells’ windows (including the window into the bathroom and bedroom of their daughter)

The McDowells’ complaint sought, in addition to injunctive relief, “compensatory, general, special, consequential and punitive damages in an amount to be determined to compensate [the McDowells] for all injuries sustained as a result of the conduct of [the Sapienzas.]”

The Sapienzas’ homeowner’s insurer, Liberty Mutual, undertook their defense.  A bench trial was held and the court granted the McDowells a permanent injunction. The Sapienzas were ordered to either bring their residence into compliance with the applicable regulations or rebuild it.

The Sapienzas appealed – Liberty Mutual continued to defend – and the South Dakota Supreme Court affirmed.  The case went back to the Sioux Falls Board of Historic Preservation to cure and remedy the violations.  It did not get worked out and the Sapienzas had their home demolished and allegedly incurred $60,000 in complying with the permanent injunction.

The Coverage Case

Liberty Mutual denied coverage for these costs and the Sapienzas filed suit against Liberty in federal court.  The insurer argued that the insuring agreement, of the liability potion of the policy, had not been satisfied, on the basis that the Sapienzas were not legally obligated to pay “damages.”  In other words, as the insurer saw it, there were no damages awarded to the McDowells, but, rather, the Sapienzas were ordered to modify or tear down their own home.

The federal court certified the following question to the South Dakota Supreme Court: “Do the costs incurred by the Sapienzas to comply with the injunction constitute covered ‘damages’ under the Policies such that Liberty Mutual must indemnify the Sapienzas for these costs?”

The competing positions went like this.  The Sapienzas argued the term “damages” is unambiguous and “encompasses both money paid to compensate for harm as well as any expenses, costs, charges, or loss incurred to remedy a harm.”  They argued that “damages” includes “any economic outlay compelled by law to rectify or mitigate damage caused by the insured’s acts or omissions.”  Of course, the Sapienzas also argued that the term “damages” is ambiguous if it has more than one meaning.

Liberty argued that “the nature of liability insurance contemplates an obligation to pay the damages to another party for which the insured is legally liable. . . .[B]ecause there were no damages awarded to the McDowells and the court instead required the Sapienzas to modify or tear down their own home, the Sapienzas did not become legally liable for damages to the McDowells because of property damage.”

The high court sided with the Sapienzas for various reasons – principally based on a dictionary definition of damages: “[A]pplying the definition of ‘damages’ that includes not only reparation in money as a form of compensation, but also a ‘satisfaction imposed by law for a wrong or injury caused by a violation of a legal right,’ the costs the Sapienzas incurred to comply with the injunction are covered ‘damages’ under Liberty Mutual’s policies. The Sapienzas paid these costs to ‘satisfy the wrong or injury’ they caused to the McDowells’ property—an injury for which they were ultimately held legally liable.”  The court described “damages” as “costs predicated on [the Sapienzas] legal liability for what would otherwise be assessed as money damages had the court determined that a monetary payment to the McDowells would have been adequate to remedy the harm.”

Of note, the court did make an important point that insurers will likely point to in response to arguments for coverage: “[I]t is important to recognize that the nature of the injunctive relief governs whether sums paid for such would be covered under policy provisions of the sort here.  Not all injunctions have the same purpose. . . . [C]osts associated with injunctive relief ordered to prevent property damage that has yet to occur “are not ‘damages because of property damage’” and, as a result, may not fall within coverage provisions.”

Two dissenting justices -- after criticizing the majority for being too quick to find ambiguity, just because of multiple dictionary definitions of an undefined term – saw the issue this way: “[W]e now know that the Sapienzas complied with the injunction by razing their house which, in turn, had the effect of removing the impediment to the McDowells’ fireplace and allowed more sunlight back into their home. But that result was not required or assured by the circuit court’s mandatory injunction, which directed only compliance with regulations governing construction in historic districts and was not specifically crafted to remedy the McDowells’ property damage claims. The plain fact that the McDowells’ concerns were ultimately alleviated does not mean that the Sapienzas were ordered to remedy the McDowells’ property damage claims relating to the lost use of their fireplace and diminished sunlight.”

The dissent also observed that the decision turned the liability policy into a first-party policy: “[A]applying the rule the Sapienzas and the Court suggest alters the Liberty Mutual liability insurance agreements, straining the text of the policies well beyond their limits and effectively converting the liability provisions into something more akin to first-party insurance by requiring ostensible liability coverage for property owned by the insured.”