In its recent decision in Arch Ins. Co. v. Commercial Steel Treating Corp., 2013 U.S. Dist. LEXIS 121574 (E.D. Mich. Aug. 27, 2013), the United States District Court for the Eastern District of Michigan had occasion to consider the application of a pollution exclusion in a D&O policy to a violation of an air emissions permit.

Arch insured Curtis Metal Finishing Company (“Curtis”) under a Private Company Management Liability and Crime Insurance policy.  Curtis operated a zinc-phosphate plating operation in Sterling Heights, Michigan.  As a result of a windstorm that damaged its exhaust equipment, Curtis operated its facility without the benefit of all required air emissions control technologies for a period of nearly three months, thereby violating its air use permit issued by the Michigan Department of Environmental Quality.  Following several inspections, the Michigan Department of Natural Resources and Environment (“MDNRE”) issued a Violation Notice to Curtis.   

Curtis forwarded a copy of the notice to Arch, and requested coverage for any subsequent criminal proceedings that might be brought by the state.  Arch, in turn, denied coverage based on a pollution exclusion arising from, based upon, or attributable to any:

  1. discharge, dispersal, release, escape, seepage, migration or disposal of Pollutants, . . . or any threat of such discharge, dispersal, release, escape, seepage, migration or disposal; or
  2. direction, request or voluntary decision to test for, abate, monitor, clean up, remove, contain, treat, detoxify or neutralize Pollutants . . . .

In fact, the Macomb County prosecutor later commenced criminal proceedings against Curtis, alleging a count for failure to report an equipment malfunction and a count for failure to comply with its emissions permit.  As a result of Arch’s denial of coverage, Curtis retained its own counsel and eventually negotiated a plea of no contest in return for payment of $90,000 to be used for an environmental study.  Arch later brought a coverage action against Curtis seeking a declaration that it had no coverage obligations with respect to the settlement or Curtis’ defense costs.

On motion for summary judgment, Arch argued that both subparagraphs of the pollution exclusion applied.  With respect to subparagraph b., Arch contended that the air use permit initially issued to Curtis was a “direction to … clean up … Pollutants,” and that the underlying criminal action, therefore, arose out of or was attributable to this direction.  Alternatively, Curtis argued that subparagraph a. of the exclusion was applicable since the underlying criminal action arose out of Curtis’ improper discharge of pollutants into the atmosphere.  Curtis, on the other hand, argued that the underlying complaint contained no allegation of a discharge of pollutants, and that because its facility is kept at a negative air pressure, any emissions would have been into its own building rather than into the atmosphere.  The court rejected Curtis’ argument, noting that the plain language of the exclusion applied to any discharge of pollutants, or any threatened discharge of pollutants, and that the exclusion did not specific the location of the discharge.   In other words, the court refused to read into the exclusion a distinction between traditional environmental pollution and indoor air pollution.

Curtis also argued that the underlying criminal action pertained to permitting violations and failure to disclose rather than a discharge of pollutants.   The court rejected this argument, finding that Curtis could not ignore purpose behind the permit:

The purpose of the Air Use Permit was to prevent the release of potentially hazardous fumes ... A direct result of Defendants' operation of Lines 11 and 14 without a functioning scrubber, in violation of the Air Use Permit, is the release of fumes from Lines 11 and 14 into the Sterling Heights facility. There is thus "significantly more than a remote connection" between Defendants' permit violations and the actual or threatened release of pollutants from Lines 11 and 14 … Furthermore, even if there was no threatened or actual release of pollutants from Lines 11 and 14, the criminal charges arise out of a direction or request from MDNRE, via the Air Use Permit, to abate potentially hazardous pollutants. Accordingly, both subparagraphs a. and b. of the Pollution Exclusion apply to bar the criminal charges against Defendants.

The court also rejected Curtis’ arguments that the amount of actual emissions from the facility was insignificant, explaining:

Whether any pollutants actually leaked is immaterial where Defendants have clearly violated their Air Use Permit, which directed Defendants to abate pollutants. The Pollution Exclusion expressly applies to such criminal charges. Plaintiff thus properly denied coverage for Defendants' claims under the Policy, and Plaintiff is entitled to summary declaratory judgment that the Policy does not apply to the underlying criminal matters.

While the court held that the pollution exclusion operated to preclude Curtis’ right to coverage, the court also agreed in passing that the $90,000 payment made by Curtis to settle the underlying matter – an amount to be used to conduct a study of a nearby lake – did not qualify as “loss” under the Arch policy, a term specifically defined to exclude fines.