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USM Corp. v. FIRST STATE INS. CO. & ANOTHER
Citations: 641 N.E.2d 115; 37 Mass. App. Ct. 471; 24 U.C.C. Rep. Serv. 2d (West) 1092; 1994 Mass. App. LEXIS 928Docket: 93-P-748
Court: Massachusetts Appeals Court; October 14, 1994; Massachusetts; State Appellate Court
In the case of USM Corporation v. First State Insurance Company, the Appeals Court of Massachusetts addressed a dispute concerning insurance coverage related to a breach of contract case involving Arthur D. Little Systems, Inc. (ADLS). The court previously ruled that ADLS breached its contract with USM Corporation (USM) regarding a 'turnkey' computer system, resulting in a judgment against ADLS for $4,235,224.17, which remains unpaid. USM sought to access 'Consultants Errors and Omissions' insurance policies issued to ADLS's parent company, Arthur D. Little, Inc. (ADL), to satisfy the judgment. The Superior Court denied the insurers' motion for summary judgment, ruling that the policies provided coverage for ADLS's conduct leading to USM's liability. The insurers appealed, arguing that the policies did not cover breach of contract claims, asserting inconsistencies with USM's prior positions, citing exclusions from coverage, and claiming unresolved factual issues around notice and damages. The Appeals Court affirmed the ruling that the insurance policies cover ADLS's actions related to the liability but remanded the case to determine if ADLS complied with the notice requirements of the policies. The court clarified that the interpretation of the insurance contract is a legal matter and emphasized that the policies indemnified the insured for losses from negligent acts in the conduct of their consulting business. It was noted that while the contract between USM and ADLS primarily involved the sale of goods, it also included significant consulting services, thus qualifying as a hybrid contract eligible for insurance coverage. ADLS's activities as consultants and in providing professional services fall under the coverage of its "Consultants Errors and Omissions" insurance policy. A consultant is defined as someone who offers professional advice or services based on their specialized knowledge. In a related case, ADLS was found liable for breaching a warranty that the delivered system would be free of design defects, which included ensuring the hardware and software worked effectively together. The court interpreted "design" to encompass the combined functionality of these products, where failure to perform adequately constituted a defect. The insurers contended they were not liable for breach of warranty, asserting that the policy only covered negligent acts. However, both the trial judge and the Appeals Court determined that ADLS was not negligent in relying on the hardware manufacturer's assurances regarding response time issues. The policy language explicitly covers losses due to any negligent act, error, or omission, indicating a broader scope of coverage than the insurers argued. The interpretation of "error" and "omission" should not be limited to negligence, as it would render those terms redundant in the policy. Errors and omissions policies are designed to protect professionals from liabilities stemming from a range of risks, including honest mistakes. Case law supports the view that such policies encompass errors beyond mere negligence. The insurers' cited cases involved intentional acts, which are typically excluded from coverage. The terms "consulting business" and "error" are ambiguous within the context of ADLS's operations and the insurers' understanding, suggesting that the actions leading to the design defect may indeed fall under the policy's coverage. Ambiguities in insurance policies are generally resolved against the insurer, as established in Worcester Ins. Co. v. Fells Acres Day Sch. Inc. Insurers argued that this principle should not apply due to the equal sophistication of ADLS’s parent, but there is no evidence of their involvement in drafting the policies. The policies include an exclusion (exclusion 'e') that denies coverage for liability from errors in the design of tangible products, but the insurer agrees to indemnify costs related to such claims. The characterization of a turnkey computer system as a tangible product is contested. A turnkey system combines hardware and software into a ready-to-use package, and courts are increasingly recognizing software as 'goods' under the UCC. The distinction between tangible and intangible property is becoming blurred, with the UCC focusing on the movability of the item at the time of contract identification. Notably, a question on ADL’s proposal form inquired whether the firm designs tangible products, to which they answered affirmatively, indicating ambiguity in the term 'tangible' as it applies to software and turnkey systems. Given that exclusions are strictly construed, exclusion (e) is deemed inapplicable. Exclusion 'h' from the insurers' coverage is addressed, which negates liability assumed under a contract unless such liability would arise from negligent acts by the Insured without the contract. The court refutes the insurers' interpretation that ADLS's liability due to breach of warranty falls under this exclusion, citing Wolov v. Michaud Bus Lines, Inc., which suggests that "liability assumed by the insured under any contract" pertains to indemnification promises rather than breach of contract. Thus, exclusion (h) is deemed inapplicable to ADLS's situation. The insurers also assert a genuine issue of material fact regarding ADLS's knowledge of potential claims due to negligent acts. The trial judge noted that by June 1977, significant issues with the system were evident, though USM did not consider ADLS in breach until September 1979. Evidence of USM's dissatisfaction over failed attempts to resolve system issues raises the question of whether ADLS should have notified insurers, a point not yet examined by any trier of fact. The court clarifies that ADLS was not obligated to inform insurers of every client-related issue that might lead to a claim. Regarding damages, the insurers seek a remand but had not previously raised any issues concerning damages during the summary judgment proceedings. The judge was not required to address these claims post-judgment, and no abuse of discretion was found in denying the motions, as the insurers had opportunities to participate in the damages determination but chose not to. ADLS's insurance policies provide coverage for its liability to USM, but there is a factual issue regarding ADLS's compliance with the policy's notice provisions. The judgment affirming coverage is upheld, but the notice issue is remanded for further determination. On remand, USM can also raise questions regarding the waiver of this defense. The insurance policies include a basic policy from First State, which covers 80% of excess claims, with Granite State covering the remaining 20%. Coverage includes losses from claims made during the policy period for negligent acts prior to that period, provided ADLS had no prior knowledge of potential claims. The context suggests a trend toward treating mixed contracts of hardware and software under the UCC, where definitions of "goods" can impact the applicability of provisions. The excerpt also notes that software is typically regarded as intangible personal property in tax contexts. Additionally, it is indicated that ADLS's parent confirmed having written contracts with clients, with attempts to limit liability in those contracts. USM's objection to evidence of dissatisfaction is waived since it was not raised during the proceedings. The issue of whether the insurers waived their defense is connected to the notice issue and will also be addressed on remand. Although the insurers claim inadequate defense was provided by ADLS, there is no supporting record, and the insurers are obligated to cover defense costs exceeding $1,000,000.