Insurer Has To Defend Claims Involving Alleged Defective CNG Fuel Filtration Equipment

Company A, a gas company, purchases compressed natural gas (“CNG”) fuel filtration equipment from Company B in August 2011.  According to Company A, the equipment failed to conform to its specifications and failed to remove the appropriate amount of oil from the CNG fuel.  Subsequently, Company A‘s customers reported oil contamination and resultant loss of the use of their fleets’ vehicles.  Company A undertook to correct the issues and reimbursed its customers for their issues.  Company A then filed suit against Company B, who in turn filed a third-party complaint against Company C, alleging that Company C had provided Company B the equipment pursuant to an agreed-upon set of specifications.  Company C then tendered the third-party complaint to Insurer, which filed a declaratory judgment action asking the court to find that it had no duty to defend or indemnify Company C in the underlying lawsuit.

The U.S. District Court for the Eastern District of Michigan denied summary judgment to Insurer yesterday.  The underlying complaint from Company A alleges damage to property in addition to breach of contract and breach of warranty claims, so the claims fell within the scope of Insurer‘s commercial liability policy.  The court focused on whether a pollution exclusion applied, but ultimately construed that narrowly in favor of Company C‘s interpretation because the filtration system was never intended or required to eliminate virtually all traces of oil from the CNG fuel, and that any undesirable effects were not caused by the mere presence of oil but rather by its high concentration (in other words, the excess oil could not be considered a “contaminant” or “pollutant” under the policy exclusion)  As the court explained, “Analogously, an iron filter is designed to remove a certain percentage of iron deposits from hard water.  Yet, if the iron filter failed to remove the required percentage of iron, and, consequently, caused rust stains to appear inside a washing machine or on laundry, it is unlikely that those undesirable effects would be deemed pollution.”