STEPHENSON, Circuit Judge.
This is a diversity case initiated by appellant City of Carter Lake, Iowa, alleging that its comprehensive general liability insurance policy issued by the appellee, The Aetna Casualty and Surety Company, provided coverage for the negligent actions of Carter Lake's personnel which resulted in six separate incidents of sewage backup into the basement of a Carter Lake residence owned by William and Kesano Mecseji. There are essentially two issues that must be resolved on this appeal: (1) whether the policy provided coverage for the risks involved, and (2) whether Aetna has waived or is estopped from asserting a defense of non-coverage under the policy because it undertook defense of the lawsuit by the Mecsejis against the city without a reservation of rights. Without specifically addressing the estoppel issue the district court
The events that give rise to this controversy are not in dispute and were adequately delineated by the district court in its memorandum opinion.
Id. at 48.
Carter Lake then brought this action against Aetna to recover not only the amount paid to the Mecsejis, but also the attorney fees which it incurred in appealing the adverse decision in state court after Aetna refused to appeal, and for the attorney fees incurred in bringing this action.
It is undisputed that the substantive law of Iowa applies in this case. However, this court has neither been directed to, nor independently discovered, any Iowa law which directly controls the issues presented in this action. Cf. Continental Cas. Co. v. Jackson, 400 F.2d 285, 288-89 (8th Cir. 1968); Poweshiek County Nat'l Bank v. Nationwide Mut. Ins. Co., 261 Iowa 844, 156 N.W.2d 671, 678-79 (1968) (Iowa law definition of accident as used in accidental death policies). Because it is not our task to "formulate the legal mind of the state, but merely to ascertain and apply it," Village of Brooten v. Cudahy Packing Co., 291 F.2d 284, 288 (8th Cir. 1961), we have the usual problem of endeavoring to determine what the Supreme Court of Iowa would, on the facts before us, declare the law of that state to be.
I. Policy Coverage
An examination of Iowa case law does reveal certain broad principles which are used for interpretation of insurance contracts.
Goodsell v. State Auto. & Cas. Underwriters, 261 Iowa 135, 153 N.W.2d 458, 461 (1967). However, "[t]his rule does not warrant an arbitrary judicial construction of the terms of the instrument. The court must give effect to exceptions and limitations in a policy as they are written and unless it may be said there is ambiguity in the words found in the policy, there is no occasion for the exercise of choice of interpretation." Hein v. American Family Mut. Ins. Co., 166 N.W.2d 363, 366 (Iowa 1969).
With these principles in mind, we examine the policy provisions in question. In the coverage part of the policy it is stated that: "The company will pay on behalf of the insured all sums which the insured shall become legally obliged to pay as damages because of bodily injury or property damage to which this insurance applies, caused by an occurrence * * *." In a separate part of the policy labelled "Definitions," "occurrence" is defined as "an accident, including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the Insured[.]" The term "accident" is not further defined in the policy.
Carter Lake contends that the policy should be construed by ascertaining the meaning of the word "occurrence," rather than the word "accident." We disagree. It is true that "occurrence" has a broader meaning than "accident" as those words are generally understood. However, when all of the provisions of the policy are considered as a whole, there is no ambiguity as to the intention of the parties to give the word "occurrence" the restricted meaning of an accident, including continuous repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured. See R. Keeton, Basic Text on Insurance Law § 5.4(c), at 300 (1971) (use of word "occurrence" rather than "accidents" broadens coverage by including losses from the continuing operation as well as a sudden event, but does not change coverage with relation to degree of expectability of the loss). But see Grand River Lime Co. v. Ohio Cas. Ins. Co., 32 Ohio App.2d 178, 289 N.E.2d 360, 365 (1972) (use of occurrence broadens coverage).
It is beyond dispute that Carter Lake did not intend to cause the sewage backups. Thus, the exclusion for intentional acts is not applicable even though the underlying acts and omissions of Carter Lake were intentional. See, e. g., N. W. Elec. Power Coop., Inc. v. American Motorists Ins. Co., 451 S.W.2d 356, 361-64 (Mo. App.1969); Messersmith v. American Fidelity Co., 232 N.Y. 161, 133 N.E. 432, 433 (1921); 7A J. Appleman, Insurance Law and Practice § 4492 (1962). Nevertheless, Aetna maintains that the backups subsequent to February 25, 1976, were not occurrences or accidents as those terms are used in the policy because the subsequent backups were "expected." Aetna attempts to equate expected with reasonable foreseeability. In arguing for such an interpretation, Aetna primarily relies on the cases of City of Aurora v. Trinity Universal Ins. Co., 326 F.2d 905 (10th Cir. 1964), Gassaway v. Travelers Ins. Co., 222 Tenn. 649, 439 S.W.2d 605 (1969), and Town of Tieton v. General Ins. Co., 61 Wn.2d 716, 380 P.2d 127 (1963).
In City of Aurora v. Trinity Universal Ins. Co., supra, the policy provided coverage for losses "caused by accident." The question before the Tenth Circuit was whether a sewage backup was caused by accident. The city had absorbed the sewage system of a newly annexed area, and later discovered
Id. at 906 (citations omitted).
In Gassaway v. Travelers Ins. Co., supra, a suit was brought by homeowners against the insurer of a corporation which had owned a lot and installed a drainage facility which discharged water underneath the house. The corporation had not disclosed the existence of the drainage facilities. The issue before the Tennessee Supreme Court was whether the corporation was insured under a policy which insured against liability caused by "accident." The court found that the corporation had not intended to cause the damage and had been guilty of only ordinary negligence. The court held that although the policy covered some acts of negligence, it did not cover all such acts. The court approved the following definition: "Accident as used in insurance liability policies [is] an event not reasonably to be foreseen, unexpected and fortuitous." Id., 439 S.W.2d at 608. The court further stated:
Id. 439 S.W.2d at 608-09.
In Town of Tieton v. General Ins. Co., supra, the town constructed a sewage lagoon adjacent to the property of David and Jean Pugsley. As a result of the operation of the sewage facility, the Pugsleys' well became contaminated and they recovered a judgment from the town. The record indicated that seepage is a normal and expected result of this type of sewage facility, and that prior to the construction of the lagoon the town had been advised by health officials of the possibility of the lagoon contaminating the Pugsleys' well. In holding that the damage to the Pugsleys' property was not caused by accident, the Washington Supreme Court stated:
Id. 380 P.2d at 130-31.
The opinions in these cases paint with too broad a brush and apparently represent a minority view. See 7A J. Appleman, Insurance Law and Practice § 4492 (1962). Cases from other jurisdictions view the problem
Id. at 611.
In the present case after the first incident of flooding the Mecsejis presented a claim to the city for their actual damages of $418.12. After examination of the claim the city's attorney recommended that it be paid, and it was forwarded to Aetna. Aetna responded in a letter to the Mecsejis denying liability. The letter stated in part: "In order for us to be legally responsible, our insured must be guilty of negligence." Aetna is now in effect claiming that because the city was negligent, i. e., the injury was reasonably foreseeable, there is no coverage.
To adopt Aetna's interpretation that an injury is not caused by accident because the injury is reasonably foreseeable would mean that only in a rare instance would the comprehensive general liability policy be of any benefit to Carter Lake. Enforcement of the policy in this manner would afford such minimal coverage as to be patently disproportionate to the premiums paid and would be inconsistent with the reasonable expectations of an insured purchasing the policy. See 7A J. Appleman, Insurance Law and Practice § 4493, at 16 n.26 (1972). Under Aetna's construction of the policy language if the damage was foreseeable then the insured is liable, but there is no coverage, and if the damage is not foreseeable, there is coverage, but the insured is not liable. This is not the law. The function of an insurance company is more than that of premium receiver. See, e. g., Hutchinson Water Co. v. United States Fidelity & Guaranty Co., 250 F.2d 892, 894 (10th Cir. 1957); City of Kimball v. St. Paul Fire & Marine Ins. Co., 190 Neb. 152, 206 N.W.2d 632 (1973); N. W. Elec. Power Coop., Inc. v. American Motorists Ins. Co., supra.
An interpretation of the word "accident" as used in this type of comprehensive general liability policy which is consistent with the results reached in most of the cases confronting the issue, if not the broad language sometimes employed, is to look at the question of whether a result is "expected" as a matter of probability. We reject the argument that a result is expected as that term is used in insurance policies simply because it was reasonably foreseeable. The reasonable expectation of an insured in securing a comprehensive general liability policy is that it will cover some negligent acts. It does not follow, however, that because the policy covers some negligent acts it must cover all negligent acts. An insured need not know to a virtual certainty that a result will follow its acts or omissions for the result to be expected. But see State Farm Fire & Cas. Co. v. Muth, 190 Neb. 272, 207 N.W.2d 364 (Neb.1973). Rather, each case must be determined by examination of the totality of the circumstances. For the purposes of an exclusionary clause in an insurance policy the word "expected" denotes that the actor knew or should have known that there was a substantial probability
After the first backup, the probability of an identical equipment failure and consequential flooding of the Mecsejis' basement on a particular day was relatively slight, about 2% with hindsight. However, there was clearly a substantial probability of another backup at some time caused by an identical equipment failure if the equipment was not replaced or an alarm system installed. Nevertheless, Carter Lake took the calculated risk that such backup would not occur, and elected to continue operations without correcting its methods. Once the city was alerted to the problem, its cause, and the likelihood of reoccurrence, it could not ignore the problem and then look to Aetna to reimburse it for the liability incurred by reason of such inaction. See Western Cas. & Sur. Co. v. City of Frankfort, 516 S.W.2d 859, 860 (Ky.1974); Bennett v. Fidelity & Cas. Co., 132 So.2d 788 (Fla.App.1961). Accordingly, the floodings subsequent to the February 26, 1975, incident were not unexpected and thus were not accidents or occurrences as those terms were used in the insurance policy.
The vexing problem of determining whether Aetna is estopped
Iowa follows the general rule that the doctrine of estoppel may not be used "to bring within the coverage of a policy risks not covered by its terms, or risks expressly excluded therefrom." Randolph v. Fireman's Fund Ins. Co., 255 Iowa 943, 124 N.W.2d 528, 531-32 (1963). See also Richardson v. Iowa State Traveling Men's Ass'n, 228 Iowa 319, 291 N.W. 408, 412 (1940); Pierce v. Homesteaders Life Ass'n, 223 Iowa 211, 272 N.W. 543, 546 (1937). A widely recognized exception to this general rule is that when an insurance company assumes the defense of an action, with knowledge, actual or presumed, of facts which would have permitted it to deny coverage, it may be estopped from subsequently raising the defense of non-coverage. See, e. g., Pacific Indem. Co. v. Acel Delivery Serv., Inc., 485 F.2d 1169, 1173 (5th Cir. 1973); National Union Fire Ins. Co. v. Aetna Cas. & Sur. Co., 127 U.S.App.D.C. 364,
Aetna claims on this appeal that since its policy provided coverage for the first backup, it had a duty to accept the defense of the entire lawsuit and that it informed Carter Lake of non-coverage by a reservation of rights
Aetna's first contention rests on the premise that it timely reserved its rights to assert non-coverage because it did not learn of the true facts concerning the subsequent backups until the Mecsejis' depositions were taken on February 13, 1976. The reservation of rights letter to Carter Lake followed on February 26, 1976. However, Aetna was informed by Carter Lake of the first backup on March 20, 1975, and conducted an investigation of the February 26, 1975, incident at that time. Moreover, the Mecsejis filed an action to recover damages for the first four backups on August 26, 1975, and the city timely tendered to Aetna the defense of that action. At least by September of 1975 Aetna was apprised of the contents of the complaint. The original letter from the Mecsejis requesting reimbursement for their expenses and the complaint in the suit filed in August disclose precisely the nature of their claim and the ground upon which they sought to hold the city liable. It is evident that the Mecsejis were claiming that the injury they suffered from the four separate backups was caused by the city's negligence in not maintaining a working pump. The depositions of the Mecsejis did not reveal any new evidence in this regard. Thus, at least by September of 1975 Aetna had sufficient knowledge of facts to put it on constructive notice of the possibility of non-coverage. See Fidelity & Cas. Co. v. Riley, 380 F.2d 153, 157 (5th Cir. 1967); Ford Motor Co. v. Commissary, Inc., supra, 286 F.Supp. at 233-34. See generally 14 Couch on Insurance 2d § 51:77, at 583 (R. Anderson 2d ed. 1965).
When Aetna assumed the defense of the action it had every means of ascertaining whether or not the losses were ones for which it was liable under the policy. Despite the fact that the complaint alleged four separate backups, Aetna immediately undertook defense of the action by filing a general appearance in September without any indication that it might deny coverage. An insurer has a right to a reasonable time to investigate a claim and decide whether to resort to policy defenses discovered. However, Aetna did not disclaim within a reasonable time. The complaint, which alleged
Aetna was under a duty to make a determination of its position based on the facts that it knew or should have known and to inform the city of its position within a reasonable time. See Pacific Indem. Co. v. Acel Delivery Serv., Inc., supra, 485 F.2d at 1174-75; Maryland Cas. Co. v. Peppers, 29 Ill.App.3d 26, 329 N.E.2d 788, 791 (1975); Ebert v. Balter, 83 N.J.Super. 545, 200 A.2d 532, 537 (1964). See generally 14 Couch on Insurance 2d § 51:77, at 583 (R. Anderson 2d ed. 1965). Since Aetna did not inform the city that it was disclaiming coverage until almost six months after the Mecsejis' lawsuit had been filed, its reservation of rights letter written on February 26, 1976, was not sufficiently timely to defeat the claim of estoppel.
A related contention urged by Aetna is that Carter Lake was not prejudiced by Aetna's delay in notifying Carter Lake that it was defending under a reservation of rights. In support of its position Aetna notes that Carter Lake's own attorney was involved in the lawsuit from the beginning and further claims that there was ample time between the February 26, 1976, reservation of rights letter and the trial on May 4, 1976, for Carter Lake to prepare an adequate defense.
There is authority for the proposition that prejudice is presumed from undertaking the defense of an action without a reservation of rights or, alternatively stated, that the loss of control of one's own case is itself prejudice. See, e. g., Salerno v. Western Cas. & Sur. Co., supra, 336 F.2d at 14; Pendleton v. Pan American Fire & Cas. Co., 317 F.2d 96, 99 (10th Cir. 1963) (settlement); Schmidt v. National Auto. & Cas. Ins. Co., 207 F.2d 301, 304-05 (8th Cir. 1953); General Tire Co. v. Standard Accident Ins. Co., 65 F.2d 237, 240 (8th Cir. 1933); Ford Motor Co. v. Commissary, Inc., supra, 286 F.Supp. at 234-35; American Cas. Co. v. Shely, 314 Ky. 80, 234 S.W.2d 303, 305 (1950); Transamerica Ins. Group v. Chubb & Son, Inc., 16 Wn.App. 247, 554 P.2d 1080 (1976). See generally 14 Couch on Insurance 2d §§ 51:80, 51:91-93 (R. Anderson 2d ed. 1965). In any event, Carter Lake was prejudiced by Aetna's untimely reservation of rights.
It is true that Carter Lake did have an attorney of record, John Churchman, from the beginning. However, a review of his testimony before the federal district court and the transcript from the state trial discloses that the bulk of the defense was prepared and executed by John Sens, attorney for Aetna. Carter Lake justifiably assumed from the time Aetna entered the lawsuit it was looking after the city's interests. See Ford Motor Co. v. Commissary, Inc., supra, 286 F.Supp. at 236. The city reasonably believed that Aetna was maintaining its original position first stated in the April 16, 1975, letter to the Mecsejis that the city was not negligent and that Aetna was covering the later incidents because it was covering the first. In these circumstances the participation of Carter Lake's attorney in the defense of the action did not prevent the operation of estoppel. See 14 Couch on Insurance § 51:77, at 583 (R. Anderson 2d ed. 1965).
Carter Lake was prejudiced in that Aetna's untimely notification of denial of coverage hampered settlement efforts between the city and the Mecsejis. In his testimony in the federal district court, Churchman stated that if he had been aware that Aetna was denying coverage he would have made a concerted effort to settle the case at an earlier stage of the proceedings. There is evidence in the record that the Mecsejis would have accepted a settlement well under the amount obtained at trial.
Furthermore, Aetna's notice of reservation of rights within two months of trial deprived Carter Lake of the opportunity to conduct full and timely pretrial discovery
Another reason why Aetna will not be permitted to assume management of the defense for six months and then deny liability is that there is a possibility of a conflict of interest. During the time Aetna had control of the city's defense against the Mecsejis' claims, its attorneys could have simultaneously prepared a defense for Aetna against the city on policy coverage. See Pacific Indem. Co. v. Acel Delivery Serv., Inc., supra, 485 F.2d at 1176; Transamerica Ins. Group v. Chubb & Son, Inc., supra, 554 P.2d at 1083.
In sum, we are convinced that a holding of liability for the first four backups under all the circumstances of this case is consistent with Iowa law and the law of this circuit because it is based upon sound policy considerations. The proper conduct of the insurer in this case would have been to conduct a prompt investigation to determine whether there was coverage. Had Aetna, after filing its answer, made further inquiry in an attempt to determine whether there was coverage and reserved its rights within a reasonable time thereafter, we would perhaps draw different conclusions. See Inghram v. Dairyland Mut. Ins. Co., 178 N.W.2d 299, 304 (Iowa 1970); 7A J. Appleman, Insurance Law & Practice § 4693, at 529-30 (1962). Aetna made the decision to represent Carter Lake when it filed an answer on the city's behalf and it failed to give notice of its intention to deny coverage for over six months. It will not be permitted to now say that it was unaware of the existence of the policy defense at the time it assumed the representation of Carter Lake by entering an appearance and conducting the defense. Consequently, Aetna is estopped from denying coverage for the first four incidents of sewage backup.
III. Attorney Fees
Carter Lake has also requested that it be reimbursed for attorney fees incurred in the appeal of the state court action and the trial below. Carter Lake relies on Neb.Rev.Stat. § 44-359 (1974), which provides in general that in an action against an insurance company attorney fees are to be awarded to the opposing party if judgment is rendered against the insurance company.
The threshold question is whether Nebraska considers this statute to be substantive or procedural. See Klaxon Co. v. Stentor Elec. Mfg. Co., Inc., 313 U.S. 487, 496, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941). If the statute is substantive the law of the state governing the contract (Iowa) also controls on the issue of attorney fees, and if it is procedural the law of the forum (Nebraska) must be applied. In Hawkeye Cas. Co. v. Stoker, 154 Neb. 466, 48 N.W.2d 623, 634 (1951), the Nebraska Supreme Court stated that the statute is procedural. Thus, the law of Nebraska applies. But see Prudential Ins. Co. v. Carlson, 126 F.2d 607, 611 (10th Cir. 1942). Cf. National Postal Transport Ass'n v. Hudson, 216 F.2d 193, 200-01 (8th Cir. 1954) (applied Kansas law for interpretation of contract and for allowance of attorney fees even though forum was Missouri district court). Since Carter Lake was not the prevailing party below the district court did not consider whether it otherwise qualified under the statute. The case is remanded to the district court for a determination if the statute applies in all other respects to the facts of this case. If it does apply the district court shall award reasonable attorney fees to Carter Lake.
The decision of the district court is affirmed in part, reversed in part, and remanded for further proceedings not inconsistent with this opinion.