The primary question raised on this appeal is whether under the insurance contracts issued to Pittsburgh Plate Glass Company ('Pittsburgh') by Fidelity and Casualty Company of New York ('Fidelity') it was incumbent upon Fidelity to appear and defend on Pittsburgh's behalf a law suit instituted by Columbia Air-O-Bling Company in the United States District Court for the Eastern District of South Carolina and indemnify Pittsburgh for the amount paid by it in settlement.

Fidelity, a New York corporation engaged in the insurance business in the Commonwealth of Pennsylvania, sold to Pittsburgh two liability insurance policies. So far as this suit is concerned, the policies were identical. It is the extent of their coverage which is in issue.1

Pittsburgh, a manufacturer of paint, sold its product to Columbia Air-O-Blind Company ('Columbia') of Columbia, South Carolina, during the years 1949 to 1954. Columia was a manufacturer of jalousies, or outside venetian blinds, and applied the paint to louvers and other steel parts which it incorporated into the jalousies. The finished product was sold and installed by Columbia throughout South Carolina and Georgia.

The paint supplied by Pittsburgh had been satisfactory during the period 1947-1949; however, Columbia thereafter began to receive numerous complaints to the effect that the paint was peeling and flaking off. The paint came off in patches varying from the size of a quarter to that of a man's hand. Inasmuch as the rest of the paint adhered to the surface of the jalousies, they were partially painted and partially bared. These bare surfaces which were exposed. to the elements rusted and deteriorated. As a result of customer's demands, Columbia was compelled to remove the jalousies, return them to its plant, soak them in a chemical bath, strip them to remove the adhering paint, and brush off the excess paint, repair and reweld rusted parts, treat the rusted areas with rustinhibitor, clean and prepare the metal for repainting, apply and bake the new paint, and finally reinstall the jalousies.

Following unsuccessful attempts to settle their differences amicably, Columbia brought suit against Pittsburgh on August 3, 1954, in the United States District Court for the Eastern District of South Carolina to recover the expenses of repairing the jalousies and other damage caused by the use of Pittsburgh paint. Pittsburgh made elaborate preparations to defendant the suit but finally settled with Columbia by paying $33,000. Fidelity was fully apprised of Columbia's claims and suit at all stages of the litigation, and Pittsburgh specifically demanded that it come in and defend the action.

Fidelity, when demand was first made upon it, examined the complaint and refused to defend on the ground that the complaint alleged merely a peeling of Pittsburgh paint without specific mention of any damage to the jalousies. It contended that the peeling of the paint was not a physical injury to the jalousies as comprehended by the policies. Inasmuch as Fidelity adhered to this view even following the settlement of the action, Pittsburgh instituted suit in the Western District of Pennsylvania.2 The district court entered judgment for the defendant.

No jurisdictional issue has been raised, nor do we perceive one. In this diversity case, Pennsylvania law was applied and we see no error in so doing.

The duty of a liability insurance carrier to defend actions against its insured has been considered in the very recent case in the Supreme Court of Pennsylvania, Cadwallader v. New Amsterdam Casualty Co., 1959, 396 Pa. 582, 152 A.2d 484. It was there stated, 152 A.2d at page 488:

'It is clear that where a claim potentially may become one which is within the scope of the policy, the insurance company's refusal to defend at the outset of the contoversy is a decision it makes at its own peril.'

In support of this proposition, the court cited as the leading case on the subject Lee v. Aetna Casualty & Surety Co., 2 Cir., 1949, 178 F.2d 750. At pages 752-753 of that opinion, Judge Learned Hand stated:

'* * * The injured party might conceivably recover on a claim, which, as he had alleged it, was outside the policy; but which, as it turned out, the insurer was bound to pay. Such is the plasticity of modern pleading that no one can be positive that that could not happen. In such a case of course the insurer would not have to defend; yet, even then, as soon as, during the course of the trial, the changed character of the claim appeared, we need not say that the insured might not insist that the insurer take over the defence. When, however, as here, the complaint comprehends an injury which may be within the policy, we hold that the promise to defend includes it. * * *

'It follows that, if the plaintiff's complaint against the insured alleged facts which would have supported a recovery covered by the policy, it was the duty of the defendant to undertake the defence, until it could confine the claim to a recovery that the policy did not cover.'

Thus, we fortunately need not speculate as to what the law of Pennsylvania is on the subject before us.3

Turning to the facts of the instant case, we are first met with the complaint Columbia filed in the federal district court. As the district court stated, Columbia predicated its complaint upon the theory of warranty.4 However, as the Supreme Court of Pennsylvania recogized in the Cadwallader case, supra, the complaint must be viewed in light of the liberality of pleading under the Federal Rules of Civil Procedure. Not only does Rule 8(e)(2)5 permit alternative and inconsistent pleading, but Rule 15(b) permits amendments to conform to the evidence. In addition these provisions must be read in light of Rule 8(a), which states:

'A pleading which sets forth a claim for relief * * * shall contain * * * (2) a short and plain statement of the claim showing that the pleader is entitled to relief, and (3) a demand for judgment for the relief to which he deems himself entitled.'

In light of the foregoing rules, the opinion in the Cadwallader case, supra at page 489 of 152 A.2d, recognized that there was merit to the contention that if a claim based on action which would fall within the policy would ultimately be sustained in a federal court under the complaint, despite other allegations which fall without the policy, the insurer is duty bound to defend the insured. The Supreme Court of Pennsylvania was not required to decide the issue in that case but clearly indicated its position on the matter here in controversy.

Certainly Columbia's claim for damages could have been sustained on the basis of negligence if the case had gone to trial, and proof of damage to the jalousies by rust would have been permitted. The complaint adequately set forth damage to the finished product, i.e., the jalousies, painted and baked. Once the paint has been baked on to the steel and aluminum parts of the jalousies, the paint is no longer identifiable as a separate entity but is intended to and does become a part of the finsihed product. Thereafter, any damage to the finished product, such as flaking or pelling of the paint, is property damage covered by the liability insurance policies here in question. A reading of the complaint convinces us that the damage alleged was such that the insurer was more than adequately apprised that damage to the completed product had been sustained. This point would appear to be one of first impression in Pennsylvania, but we are confident that the Pennsylvania courts if presented with the problem would so decide it.6

An additional issue had been raised by the appellant concerning the amount of damages it is entitled to recover. Following Fidelity's refusal to come in and defend the Columbia action, Pittsburgh not only hired a South Carolina firm of attorneys to defend the action which had been instituted against it, but assigned two members of its legal department to prepare the defense. No question has been raised by Fidelity concerning the appropriateness of the former charges; however, Fidelity does assert it is not liable for the latter counsel fees. Fidelity maintains that since these two attorneys were members of Pittsburgh's legal department, paid on an annual salary basis, maintained no separate offices of their own, and since they were paid nothing more than their normal salaries, it is not required to reimburse Pittsburgh for the time they devoted to the defense of this action.

A thorough search of the authorities has failed to uncover any case other than Liberty Mutual Insurance Co. v. Atlantic Coast Line R. Co., 1942, 66 Ga.App. 826, 19 S.E.2d 377, which considers the application of the reasonably attorney's fee standard to attorneys paid on an annual basis. In that case the railroad defended an action through a firm of attorneys employed on an annual retainer. The railroad sued the insurer to recover the reasonable value of the attorney's services and the court held that inasmuch as the insurer had breached the contract of insurance, it was liable to the insured for all damages directly resulting to it from the refusal to defend. At page 382 of 19 S.E.2d the court stated:

'Counsel of the plaintiff in defending the suit against it, notwithstanding they were employed by the year, were being compensated by the plaintiff for their services in the particular suit. Counsel represented the railroad in defense of a suit against it, the defense of which another had contracted for a consideration to undertake, and the plaintiff if entitled to recover on the policy, would be entitled to recover for such services a reasonable fee.'

We are convinced that this is the proper measure of damages and that a Pennsylvania court presented with the problem would so find. If Pittsburgh's attorneys had refrained from activity, the workload and consequently the fee of the South Carolina attorneys necessarily would have been increased. There is no reason in law or in equity why the insurer should benefit from Pittsburgh's choice to proceed with some of the work through its own legal department.

The reasonableness of the traveling expenses incurred by Pittsburgh's attorneys was stipulated. However, the amount of their salary to be allotted to the defense preparations for the Columbia suit was not stipulated nor was its reasonableness. The district court made no findings whatsoever in this regard.

Accordingly, the judgment of the district court will be reversed and the cause remanded for further action not inconsistent herewith.