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ACE American Insurance Co. v. RC2 Corporation

April 5, 2010


Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 07 C 5037-William T. Hart, Judge.

The opinion of the court was delivered by: Manion, Circuit Judge.


Before POSNER, MANION, and HAMILTON, Circuit Judges.

RC2 Corporation, Inc. and related entities (collectively "RC2") design and market toys that are primarily manufactured in China. ACE American Insurance Company issued commercial general liability policies to RC2 covering the period from August 1, 2003 to November 1, 2007. The policies excluded coverage of occurrences that took place within the United States. Notwithstanding this exclusion, the district court found that the policies potentially extended coverage to injuries that occurred in the United States, if some negligent act in the process of the product's manufacturing that caused the harm occurred in another country. The court thus ruled that ACE had a duty to defend RC2 against class action lawsuits brought against it for products sold and used exclusively in the United States but manufactured in China. Because we hold that, under Illinois law, the insurance policies unambiguously excluded coverage for the alleged harm caused by exposure to defective products that occurred in the United States, regardless of where antecedent negligent acts took place, we reverse.


RC2 designs, produces, and markets the popular "Thomas & Friends" toys based on the children's public television program of the same name (which is, in turn, based on the The Railway Series of books by British author Rev. W.V. Awdry). In June and September 2007,*fn1 RC2 recalled certain of its wooden railway trains and train set components that had been manufactured in China between 2005 and 2007 because they contained lead. This recall led to numerous class action lawsuits against RC2, alleging that the recalled toys were negligently manufactured and tested. At this stage, neither party disputes that the underlying lawsuits relevant to this appeal are based on products sold and used exclusively in the United States.

RC2 turned to its insurers for defense and indemnification. At the time of the alleged harm, RC2 maintained two separate lines of commercial general liability (CGL) insurance. The first covered only occurrences within the United States. The second set of policies, issued by ACE, applied internationally but excluded occurrences that took place within the United States. RC2 first tendered its claims to its domestic insurer. Unfortunately for RC2, the domestic policies expressly excluded damages resulting from lead paint; this oversight erased what would have been the obvious source of coverage for injuries occurring in the United States. Citing the exclusion, the domestic insurer denied coverage. That left the ACE international policy, which excluded occurrences within the United States, as RC2's only opportunity for obtaining coverage.

ACE also denied coverage, claiming that the international policies excluded the damages in question because the occurrences took place within the United States. ACE simultaneously filed the present action seeking a declaration that it had no duty to defend or indemnify RC2. RC2 counterclaimed seeking declaratory relief and dam-ages reflecting its defense and indemnity costs in the underlying lawsuits.

The insurance policies at issue, which were identical in all relevant respects, provided that ACE would 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 insurance applies only to "bodily injury" and "property damage" which occurs during the Policy Period. The "bodily injury" or "property damage" must be caused by an occurrence. The "occurrence" must take place in the "coverage territory." We will have a right and duty to defend any "suit" seeking those damages.

The policies defined "occurrence" as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." "Coverage Territory" included anywhere in the world but excluded "the United States of America (including its territories and possessions)."

The parties filed cross-motions for summary judgment. The district court ruled that because the negligent manufacture of the products had taken place in China, which was within the coverage territory, the policies potentially covered the damages and ACE therefore had a duty to defend the claims against RC2. The court granted RC2's motion with respect to the duty to defend claims and awarded RC2 defense costs of $1,620,114.77 plus interest. The parties settled the indemnity claims and the district court dismissed them with prejudice.*fn2 Thus, the only question that remains is whether ACE is obligated to pay the defense costs. ACE appeals the denial of its motion for summary judgment and the grant of summary judgment to RC2 on the duty to defend claim.


We review a district court's grant of summary judgment, as well as its construction of the CGL policy, de novo. Health Care Indus. Liab. Ins. Program v. Momence Meadows Nursing Ctr., Inc., 566 F.3d 689, 692 (7th Cir. 2009). The parties agree that Illinois law applies to the key legal question presented in this diversity case: whether ACE has a duty to defend RC2 under the terms of the insurance policies. An insurer's duty to defend its insured is much broader than its duty to indemnify: to determine whether an insurer has such a duty, a court must "look to the allegations contained in the underlying complaint against the insured and compare those allegations to the relevant coverage provisions of the insurance policy" and if the facts alleged even potentially fall within the policy's coverage, the insurer has a duty to defend. Guillen ex rel. Guillen v. Potomac Ins. Co. of Ill., 785 N.E.2d 1, 7 (Ill. 2003); Crum & Forster Managers Corp. v. Resolution Trust Corp., 620 N.E.2d 1073, 1079 (Ill. 1993); Outbound Marine Corp. v. Liberty Mutual Ins. Co., 607 N.E.2d 1204, 1220 (Ill. 1992). Ambiguous terms are construed against the drafter but, in construing a policy, "governing legal authority must, of course, be taken into account as well, for a policy term may be considered unambiguous where it has acquired an established legal meaning." Nicor, Inc. v. Associated Electric & Gas Ins. Serv. Ltd., 860 N.E.2d 280, 286 (Ill. 2006).

It is undisputed that the underlying lawsuits involve damages allegedly caused by exposure to lead paint that occurred within the United States, which under the contract is entirely excluded from the coverage area. It is also undisputed that the manufacture of the products occurred within the coverage area. Therefore, the resolution of this case turns on whether, under the policies, an "occurrence" takes place at the time and at the location where any antecedent negligent acts took place. In this case the allegedly negligent manufacture and testing of the defective products took place in China. ACE argues that Illinois law establishes that the occurrence took place in the United States, where purchasers of the toys and other products were exposed to the lead paint. RC2 argues, to the contrary, that governing Illinois law compels the conclusion that an "occurrence" takes place in China, where at least some of the negligent acts that ...

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