In Aenta Cas. & Sur. Co. v. Commonwealth, (Ky. Sept. 22, 2005), the Kentucky Supreme Court held that coverage applies to “any claim asserted against the insured arising out of property damage, which requires the expenditure of money, regardless of whether the claim can be characterized as legal or equitable in nature.” Slip op. at 13. The ordinary meaning of “damages” to which CGL-type policies apply includes response or cleanup costs “as long as the purpose is to rectify, correct, control, lessen or stop ongoing injury of the premises.” Id. The court further ruled that measures undertaken onsite (that is, at the insured’s own property) were covered “when the primary intent is to prevent additional harm to the property of others or to public waters.” Id. at 16.

The court likewise rejected the insurers’ argument that the word “suit” can refer only to actions in court. Instead, the court found that “the term ‘suit’ is susceptible of more than one interpretation.” Id. at 10. In finding a duty to defend, the Kentucky court recognized that the power of the environmental authorities to pursue matters in court or in an administrative proceeding should not result in coverage being afforded in one instance and not the other, ruling that the insurers were “clinging to an archaic definition of ‘suit.’” Id. at 11.

Turning to whether the insureds had acted with so much knowledge of the risk of loss that coverage should be denied, the Court reversed the jury verdict denying coverage on this point, finding fatal error in the instructions. More specifically, the court held that the insureds were “entitled to insurance coverage unless they specifically and subjectively intended to cause the migration of radioactive contamination.” Id. at 9.

All of the foregoing is essentially consistent with the majority law of the land. The court addressed another matter that caused the author of the dissenting opinion to charge that the majority’s ruling constituted “the exercise of arbitrary power” in violation of Section 2 of the Kentucky Constitution. Dissenting Opinion of Justice Cooper, slip op. at 32. The factual context is that defense costs paid under the policy applied against policy limits. As the policy states: “Each payment made by the companies in discharge of their obligations under this policies . . . shall reduce by the amount of such payment the limit of the companies’ liability under this policy.” Slip op. at 17.

The majority reasoned that this limitation on coverage – that is, counting defense costs within limits – applied only to “voluntary payments by the companies in furtherance of the contractual obligations under the policy . . . . .[It does not] include payment of damages under compulsion.” Id. at 18. In other words, the court found that a condition of the carriers’ ability to count the defense costs toward policy limits was their voluntarily making payment; as a result of their breach, the protection of the provision was not available to them.

The dissent took a different tack on this point, by arguing that the purpose of breach-of-contract damages was simply to place the insured in the same position it would have been in had the carrier performed as contractually required. Framing the issue this way, the dissent found that allowing recovery to the insured without offset against the policy limits was a windfall.

The dissent reflects the general instinct that contract damages should place the insured in the same position it would have other been in had performance been rendered. But that principle is misunderstood often to mean that damages are in effect substitute performance, i.e., if a contract to pay $100 is breached, the damages are $100. That conclusion, however, is too facile. At a minimum, the $100 = $100 does not account for the timing of performance – that is, that I was supposed to have received my $100 when the other side’s obligation to perform was mature. The point of contract damages is to compensate me for not receiving my $100 when it was owed, which at a minimum requires that the time value of money be accounted for (that is, interest on the principal amount should be paid). (In insurance, the policyholder also has lost the benefit of peace-of-mind protection, assistance in the time of need.) But my damages from not having the $100 at the time I should have received it could be more – maybe, I lost my house because I couldn’t make mortgage payments. That type of claim sometimes is derided as “consequential” damages, but that’s not the right way to look at it (because that largely assumes the conclusion). The questions for calculating contract damages are: (i) were those damages factually caused; (ii) are those damages not foreseeable within the meaning of Hadley v. Baxendale; and (iii) are they capable of being reasonably estimated. One of the more thoughtful cases on insurance contract damages is the Utah Supreme Court’s decision, Beck v. Framers Ins. Exch., 701 P.2d 795 (Utah 1985).

Moreover, the damages owed for breach of contract are not capped by the policy limits – where the contract-performance owed and the factually caused foreseeable damages exceed the policy limits. The policy limit is relevant to the insured’s expectation damages. But it does not resolve the question of the amount of damages that are proper to be awarded. One cannot turn around in the face of factually caused foreseeable damages that exceed policy limits and assert an affirmative defense that the additional amounts are not owed due to policy limits. The policy-limits cap is available where a carrier performs, not where it breaches.

The majority is surely right to consider the impact of the policy provision that as the court reads it counts defense costs toward policy limits only where the carrier voluntarily performs. Just as waivers of consequential damages clauses will be enforced (if clear, voluntarily entered, etc.), so too the provision here limiting the insurer’s obligations to pay should be treated similarly to other exculpatory clauses. Here, the carriers sought to limit their obligation to pay defense costs when they assumed the defense voluntarily.

That the provision does not apply to breaches creates a bit of a conundrum because, as the dissent points out, the expectation was not that defense would be paid in addition to policy limits. But in the absence of a policy provision that applied by its terms and given that the carriers were the breaching party seeking to cabin their damages obligation, the carriers lacked a valid basis to limit the damages to be awarded. Once the court interpreted the provision by its terms to apply only where the insurers voluntarily assumed the defense, then no other result really seems possible.