Recent Developments in Property Insurance Coverage Litigation

The below article appeared originally in the ABA Tips Fall 2012 Issue (48:1) of the Tort Trial & Insurance Practice Law Journal.

Authors: William A. Schreiner, Jr., Heidi H. Raschke, William R. Lewis,

Craig A. Jacobson, Christina M. Phillips, James P. Bobotek,

Jay M. Levin, Lisa A. Szymanski, Anthony B. Crawford,

and Christine T. Phan

–William A. Schreiner, Jr. is counsel in the Washington, D.C., office of Zuckerman

Spaeder LLP. Heidi H. Raschke is of counsel and William R. Lewis is a partner in the

Tampa office of Butler Pappas. Craig A. Jacobson is a partner in the Chicago office of Gordon

Rees LLP. Christina M. Phillips is an associate in the Chicago office of Childress

Duffy. James P. Bobotek is counsel in the Washington, D.C., office of Pillsbury Winthrop

Shaw Pittman LLP. Jay M. Levin is counsel and Lisa A. Szymanski and Anthony B.

Crawford are associates of Reed Smith LLP, resident in the firm’s Philadelphia office.

All are members of the firm’s Insurance Recovery Group. Christine T. Phan was an associate

in the Boston office of Zelle Hoffman Voelbel & Mason LLP at the time of this writing

and is currently assistant litigation counsel at Jenzabar, Inc. Mesdames Raschke and

Phillips are vice chairs of TIPS Property Insurance Law Committee. The authors wish to

thank Lisa Gehlbach of Zuckerman Spaeder LLP for her valuable assistance in preparing

the final document.

Recent Developments in Property Insurance Coverage Litigation:

I. Introduction

II. Business Interruption/Civil Authority

III. Collapse

IV. Covered Property

V. Exclusions

A. Earth Movement

B. Dishonest Acts

C. Faulty Workmanship

D. Mold and Water Damage

1. No Direct Physical Loss

2. Anti-Concurrent Causation

E. Ensuing Loss

VI. Damages

A. Hold Back

B. Other Insurance

VII. Obligations and Rights of the Parties

A. Representations and the Application for Insurance

B. Examinations Under Oath

C. Proof of Loss

VIII. Appraisal

A. Scope of Appraisal

B. Timeliness of Demand or Refusal to Appraise

C. Enforcing and Modifying Appraisal Awards

D. Miscellaneous Appraisal Issues

IX. Miscellaneous Issues

A. Who Can Sue on the Policy and Collect Proceeds?

B. Suit Limitations

C. Bad Faith

I. Introduction

For the first time in several years, this year’s survey of developments in

property insurance law is not dominated by cases arising out of any one

particular substantive area. We discuss notable cases in many areas, but

there is no discernible overall trend or dominance by any singular substantive

event, like Hurricane Katrina or Chinese-manufactured drywall,

giving rise to one large set of claims. For example, we discuss the Seventh

Circuit’s rather unique application of a continuous trigger theory, more

often applied to a liability policy, to a property policy. We also look at

interesting cases involving the insurers’ reliance on, and some policyholders’

reluctance to participate in, examinations under oath.

II. Business Interruption / Civil Authority

The recent decision of Millennium Inorganic Chemicals Ltd. v. National

Union Fire Insurance Co. of Pittsburgh, PA1 adds to the relatively small

number of cases that have interpreted contingent business interruption

(CBI) coverage. In Millennium, the insured, a global producer of titanium

dioxide, claimed for business interruption losses it sustained due to the

loss of the natural gas supply at its plant in Western Australia. At issue

was whether the natural gas production facility was a “direct contributing

property” under the insured’s contingent business interruption coverage

even though the insured purchased the gas from an intermediary, which in

turn bought the gas from natural gas producers for resale. Millennium’s

policies provided coverage for loss resulting from the interruption of business

caused by damage to or destruction of any of the real or personal property

described below and referred to as CONTRIBUTING PROPERTY(IES)

and which is not operated by the Insured, by the peril(s) insured against during

the term of this Policy, which wholly or partially prevents delivery of

materials to the Insured or to others for the account of the Insured and results

directly in a necessary interruption of the Insured’s business.2

The policies did not identify specific contributing property or define

“direct supplier” and “contributing property.” Neither the insurer nor

the insured argued that the language was ambiguous, but each offered

a contrary application of the CBI coverage. The court noted that the gas

company was a “supplier” of gas to Millennium, notwithstanding the

intermediary from which Millennium contracted to receive the gas. It held

that although the parties intended for CBI coverage to apply only to direct

contributing properties, there was no extrinsic evidence reflecting the

specific meaning of “direct” or how the coverage would apply in the context

of the insured’s natural gas supply. Therefore, the court relied on contra

proferentem and resolved any ambiguity in favor of the insured. The court

concluded that the “natural gas production facility was a ‘direct contributing

property’ to Millennium’s [o]perations, so as to come within the CBI coverage”

of the policies, because the gas facility physically provided a direct supply of

natural gas to Millennium’s premises despite the fact that the gas facility and

Millennium did not have a direct contractual relationship.3

III. Collapse

The question of whether coverage for “collapse” requires a building to

actually collapse or merely be structurally damaged and in danger of collapse,

albeit standing, continues to generate interesting case law. In Kappa

Ethanol, LLC v. Affiliated FM Insurance Co.,4 the Eighth Circuit affirmed a

trial court’s ruling that a property policy covered a collapse of ethanol

tanks where the tanks had shifted but remained standing, although it remanded

the case for a new trial on the issue of how imminent the collapse

of the tanks needed to be to trigger coverage.

The ethanol tanks in Kappa Ethanol were stainless steel tanks that began

to shift off of their concrete foundation rings soon after construction. The

ethanol plant owner reset the tanks on their foundations and replaced

the fill underlying them, but its property insurer declined to cover its

claim, citing the policy’s exclusions for faulty workmanship and settling.

The policy provided coverage for a collapse, but only as an exception

to the exclusion for loss caused by settling. In the ensuing coverage

case, the insurer did not object to a jury instruction that allowed the jury

to find a “collapse” without finding that the tanks were “in imminent danger

of falling down.”5 The jury found that $4 million of Kappa’s damages

were caused by a collapse.6

On appeal, the Eighth Circuit held that the insurer had waived its

argument that the loss was caused by a collapse because it had not objected

to the jury instruction.7 It held, however, that Nebraska law may

require the collapse to be “imminent,” and it remanded the case for a

jury finding on whether the collapse of the tanks was imminent.8

The Florida District Court of Appeal also confronted this issue in

Kings Ridge Community Ass’n, Inc. v. Sagamore Insurance Co.,9 where the

roof trusses of the insured’s clubhouse “deflected twelve inches” downward

and a drop ceiling similarly lurched downward. The policy defined

“collapse” as “an abrupt falling down or caving in of a building or part of a

building”; it also provided that a building “in danger of falling down or

caving in” or that is “standing . . . even if it shows evidence of cracking,

bulging [or] bending, leaning . . .” would not be considered to have collapsed.

10 The insured sued after the insurer denied the claim, and the

trial court granted the insurer’s motion for summary judgment, holding

that the clubhouse was not in a state of collapse that would trigger

coverage.11

The appellate court disagreed. It held that the downward movement of

the roof trusses and the drop ceiling constituted a “falling down” of those

elements of the building sufficient to trigger coverage; moreover, those

parts were not “standing” when a dictionary definition of that word,

meaning “upright on the feet or base,” was applied to the policy.12

IV. Covered Property

In Tracy v. USAA Casualty Insurance Co.,13 the District of Hawaii had to

decide whether plaintiff could bring a breach of contract claim against

her insurer for failing to pay a claim for stolen property under her homeowners

policy. Her policy provided “coverage for loss to trees, shrubs, and

other plants.”14 She filed a claim for the theft of twelve marijuana plants

that she “lawfully possessed, grew, nurtured and cultivated . . . consistent

with the laws of the State of Hawaii,” which allows individuals “to possess

and grow marijuana for medical purposes.”15 USAA agreed to pay the

claim and issued a check, but when the insured complained that it was

not enough, USAA refused to make any further payments because it believed

plaintiff did not have an insurable interest in the plants.16 Relying

on the Hawaii Legislature’s intent that users of medical marijuana not

face criminal penalties,17 the court predicted “the Hawai’i Supreme

Court would hold that a qualifying patient who is in strict compliance

with the Hawai’i medical marijuana laws has a lawful interest [and thus

insurable interest] in her marijuana supply.”18 Despite this prediction,

the court granted the insurer’s motion for summary judgment, holding

that “[p]laintiff ’s possession and cultivation of marijuana, even for State authorized

medical use, clearly violates federal law. To require the insurer

to pay insurance proceeds for the replacement of medical marijuana plants

would be contrary to federal law and public policy.”19

In Gilbert v. Allstate Insurance Co.,20 plaintiff owned a building as a tenant

in common that he insured solely in his name.21 After a fire destroyed

the building, plaintiff filed a claim and defendant paid him for one-half of

the value of the property.22 The court held that “[w]hen two co-tenants

own real property which is damaged by a fire and insurance is procured

in the name of only one co-tenant, recovery under the policy is limited

to the insured co-tenant’s one-half interest in the real property.”23

V. Exclusions

A. Earth Movement

The Supreme Court of New Hampshire held that an earth movement

exclusion did not bar coverage for damage caused when a cellar chamber

holding the insured’s septic pump gave way under the pressure of heavy

groundwater, allowing water to ruin the pump. In Barking Dog, Ltd. v.

Citizens Insurance Co. of America,24 the insured’s septic system failed during

a period of heavy rain and melting snow. Although its expert opined that

the underground septic box failed due to water pressure and the pressure

of water-swollen earth, the insurer declined coverage based on the earth

movement exclusion.25 In its declaratory judgment action, the insured argued

the earth movement exclusion gave way to the “Broad Form Water

Damage” endorsement it had purchased, which covered damage caused

by “water under the ground surface pressing on . . . foundations, wall,

floors [or] basements.”26 After the trial court held that the endorsement

trumped the earth movement exclusion, the insurer appealed. The New

Hampshire Supreme Court, affirming, rejected the insurer’s argument

that a subterranean septic chamber did not have a “wall,” “ceiling,” or

“floor” as those terms are commonly used.27 It also held that to the extent

the two conflicting provisions of the policy, the earth movement exclusion

and the water damage endorsement, were in conflict, the resulting ambiguity

was to be read in favor of coverage: “a reasonable layperson would

not understand that the additional coverage he paid for does not provide

such coverage.”28

Also during the survey period, a Massachusetts appellate court affirmed

a trial court’s holding that the earth movement exclusion barred coverage

for damage to a condominium unit where the insured’s expert opined that

the damage resulted from “hydro-compaction related to a leak in a water

pipe.”29 The insured in Audubon Hill South Condominium Association v.

Community Association Underwriters of America, Inc.30 argued that another

portion of the expert’s opinion, i.e., that the damage to the unit occurred

suddenly, made the loss a covered collapse despite the earth movement

exclusion, but the court held that anti-concurrent causation language in

the earth movement exclusion barred coverage.31

B. Dishonest Acts

In 2315 St. Paul Street v. Hartford Fire Insurance Co.,32 an insured sought

coverage under a builder’s risk policy for a demolition contractor’s theft

of fixtures, construction equipment, and other items. The demolition

contractor was given unsupervised access to the property and had removed

the items without the owner’s permission while the property’s

supervisor was away on vacation.33 Upon learning of the items’ removal,

the property supervisor contacted the demolition contractor and entered

into a second contract under which the demolition contractor agreed to

“fulfill the terms of his original contract” and “correct and repair any damage

and replace any stolen or destroyed items at his expense.”34 When the

demolition contractor failed to honor the second contact, the insured contacted

law enforcement and filed an insurance claim for the theft.35 The

insurer denied the claim, contending the policy’s entrustment exclusion

precluded coverage because “the loss in question was caused exclusively

by dishonest and criminal acts of a contractor to whom you entrust[ed]

the property.”36 The trial court granted the insurer’s motion for summary

judgment, finding that the demolition contractor was responsible for the

theft and that the entrustment exclusion applied because the insured had

entrusted the property to the demolition contractor by providing the contractor

with “unfettered access to the property . . . and with the confidence

that he would complete the demolition work and secure the building.”37

C. Faulty Workmanship

In 1765 First Associates, LLC v. Continental Casualty Co.,38 a tower crane

collapsed on a construction site. The insurer agreed to pay for certain

costs arising from damage to and cleanup of the construction site and

building stemming from the crane collapse.39 Relying on the faulty workmanship

exclusion in the builder’s risk policy, the insurer refused to reimburse

the insured for costs associated with construction delays resulting

from the collapse.40 In entering declaratory judgment for the insured,

the court held that

the Faulty Workmanship Exclusion, as it is most naturally read, does not

apply to losses related to accidents or equipment malfunctions during con-struction. . . .

[T]he Faulty Workmanship Exclusion applies only to losses attributable to the quality

of the constructed property and arising from defects in the materials or process used

by the insured or its agents to construct the property, that provision does not exclude

losses incurred during construction associated with the crane collapse.41

D. Mold and Water Damage

No Direct Physical Loss

In Miller v. Safeco Insurance Co. of America,42 the Seventh Circuit affirmed

the somewhat unique application of a continuous trigger to a first-party

insurance loss. The case presented the question of whether the insureds

experienced an “accidental direct physical loss to property” during the

policy period.43 After purchasing a home, the insureds discovered extensive

water and mold damage. Their insurer denied the claim on the basis that

the claimed damage did not occur during the policy period.44 With respect

to the question of when the loss occurred, the court observed thatWisconsin

law applies the “continuous trigger theory to determine the date of

injury in cases where the exact date of harm is uncertain and potentially occurring

over several policy periods.”45 The court was not persuaded that

this trigger theory is only applicable to liability insurance cases but also

found that the loss manifested during the policy period.46 Safeco argued

that “because the district court found that the property was a total loss

when the [insureds] discovered the problem, the water leakage and mold

growth [could not] have caused any direct physical loss to the property during

the policy period.”47 The court disagreed, stating, “That the degree of

damage put the home beyond repair doesn’t mean water leakage wasn’t still

causing further direct physical loss to the property during the policy

period.”48 The court also held that Safeco could not rely on any policy exclusions

because the insureds did not receive the policy until after they discovered

the loss. “Wisconsin law provides that an insurer cannot rely on a

policy’s exclusions when it fails to inform the insured of those terms.”49

In Universal Image Productions, Inc. v. Federal Insurance Co.,50 the court

affirmed summary judgment in favor of the insurer after finding that mold and

bacteria contamination did not constitute “direct physical loss or damage.”51

The insured was a tenant in a building where a “significant microbial

contamination” was identified in the heating, ventilation, and air conditioning

system, which required the system to be shut down (during 100 degree heat)

and the insured to relocate from the first floor to the third floor during remediation.52

The insured made a claim for lost leasehold improvements, cleaning and

moving expenses, and lost business income.53 The insurer denied the claim, arguing

that the insured had not suffered a “direct physical loss.”54 The policy did not

define “direct physical loss or damage,” but the insurer argued that mold and bacterial

contamination did not qualify because no property of the insured was

“structurally damaged.”55

The court held that although the insured had suffered an inconvenience,

it had not demonstrated that it had experienced any “tangible

damage” to its property.56 The court held the claimed cleaning and moving

expenses were economic, not tangible, losses.57

2. Anti-Concurrent Causation

During the survey period, three cases dealt with the application of anticoncurrent

causation issues in water damage claims. This issue often

comes up when determining whether wind, which is often covered, or

water, which is frequently excluded or limited, caused the loss in question.

In Robichaux v. Nationwide Mutual Fire Insurance Co.,58 the insurer denied

coverage for an insured’s claim for property damage following Hurricane

Katrina. The trial court granted summary judgment for Nationwide, finding

that the insureds failed to create an issue of fact as to whether their

home was damaged by wind or destroyed by flood.59 Although the fact

that the home was ultimately destroyed by flood was not disputed, the

Supreme Court of Mississippi held that it was error for the trial court

to have concluded that there was no issue of fact as to whether the

home was damaged by wind prior to the storm surge.60 Not all the damage,

the court found, was caused by a simultaneous convergence of wind

and water. Therefore, the anti-concurrent causation clause would not

apply to damage caused by wind prior to the storm surge.

Two Massachusetts cases addressed anti-concurrent causation clauses

in the context of surface water exclusions. In Boazova v. Safety Insurance

Co.,61 the insured brought a claim for water damage to her home,

which was built against the side of a hill with a full basement and garage

below the house. A concrete patio was added at the rear of the house at a

grade higher than the foundation. There was no waterproofing barrier or

membrane between the patio and the rear wall of the house to prevent

water from entering the home’s wooden frame. Extensive interior wall

damage was found during kitchen renovations.62 The insured informed

the insurer that ground water, surface water, or both entered the home

through the sill and rear wall where the patio was added.63 The insurance

company denied the insured’s claim because the damage was “caused by a

combination of surface water, deterioration, settling, and improper construction

of the concrete patio. . . .”64 The court agreed with the insurer,

unconvinced by the insured’s argument in favor of coverage built on a distinction

between “hidden seepage” and “surface water.”65 Because the

surface water exclusion included anti-concurrent causation language,

the court held that it barred coverage where the loss was caused by a combination

of covered and excluded perils.66

The same court reached the same conclusion in Surabian Realty Co. v.

NGM Insurance Co.67 The insured made a claim for damage caused when a

parking lot drain, which backed up during a heavy rainstorm, caused

flooding in the building. The insured argued that the loss was covered

as a result of “water that backs up or overflows from a sewer, drain or

sump.”68 The court found that although the loss did result in part due

to a backup, it was also caused by the accumulation of surface water.69

As a result, the policy’s anti-concurrent causation provision excluded coverage

for damage caused by surface water “regardless of any other cause or

event that contributes concurrently or in any sequence to the loss.”70

E. Ensuing Loss

In Vision One, LLC v. Philadelphia Indemnity Insurance Co.,71 the insured

was developing a condominium project.72 Temporary shoring, which was installed

during construction to support the pouring of a concrete slab, failed; as a result,

the framing, rebar, and newly poured concrete crashed onto a lower level.73

The carrier denied coverage, contending that the builder’s risk policy excluded

faulty workmanship and defective design.74 The insured contended that the

resulting loss due to the faulty workmanship was the collapse of the concrete

and thus coverage should be extended.75 The court found that ensuing loss

clauses limit the scope of what is otherwise excluded under the policy because

they ensure that any ensuing loss that is otherwise covered remains covered

even if the original event is never covered.76 Applying this reasoning, the court

held that the collapse resulting from the faulty workmanship was covered due to

the ensuing loss clause.77

In Sprague v. Safeco Insurance Co.,78 the insured discovered that the supports

of a deck were improperly constructed and made a claim to its

insurer.79 The insurer denied coverage based on the defective construction

exclusion.80 The insured contended that the deck was in a state of

imminent collapse due to the rot and resulting damage from the defective

construction.81 The court found that the damage to the deck was excluded

by the policy because the rot and imminent collapse was only to the deck

itself.82 There was no damage to any other property that would have triggered

coverage under the ensuing loss provision.83

In Friedberg v. Chubb & Son, Inc.,84 the insureds discovered extensive

water damage to their home and requested coverage from their insurer.85

After an investigation, the insurer denied coverage, contending that the

water damage was a loss caused by faulty construction and therefore

was excluded from the policy.86 The insureds argued that the water damage

was an ensuing loss and thus an exception to the exclusion.87 Examining

Minnesota law, the court determined that an ensuing loss provision

applies only to “distinct, separable, ensuing losses.”88 The damage due to

faulty construction and resulting water intrusion were not “separable and

distinct perils.”89 The interpretation advocated by the insureds, it held,

would “nearly destroy the exclusion.”90 In the court’s view, “[t]o define

a loss that is contributed to, made worse by, or in any way results from

faulty construction as only the cost of remedying the construction defect

itself would be an unnatural reading of the language.”91

VI. Damages

A. Hold Back

In Florida Insurance Guaranty Association v. Somerset Homeowners Association,

Inc.,92 the Florida District Court of Appeal reversed a trial court ruling

and held that plaintiff properly withheld depreciation.93 After suffering

hurricane damage to its condominiums, defendant filed claims with its

insurer; when a dispute arose about the amount of loss, it was submitted

to appraisal.94 The umpire issued an award for both the replacement cost

value (RCV) and the actual cost value (ACV) of the loss.95 The insurer

neither timely paid the award nor contested it, and the insured obtained

a final judgment of $6,262,339 from the trial court as the ACV.96 The

insurer appealed on the grounds that the appraisal award included

$951,262 attributed to depreciation.97 The policyholder countered that

it should receive “the depreciation under the doctrine of prevention of

performance because [the insurer] failed to timely pay the appraisal

award.”98 Under the language of the policy, “an insured must actually

repair or replace the damage as a condition precedent to payment of

replacement costs.”99 The court found this policy language to be unambiguous

and remanded the case to the trial court to deduct the

depreciation.100

B. Other Insurance

In Tyler v. Pacific Indemnity Co.,101 two parties entered into a land contract

for the purchase and sale of real property. Although the seller had existing

property insurance on the property, the land contract required the purchaser

to obtain property insurance on the property.102 Thus, two property

insurance policies were in effect at the same time on the property.103

After a fire occurred, the purchaser made a claim under his property policy.

The insurer denied the claim and, as a result, the purchaser filed suit

against the insurer.104 One issue on summary judgment was the insurer’s

reliance on the policy’s “other insurance” clause, which required a pro

rata allocation in the event that other property insurance applied to a covered

loss. The Eastern District of Michigan, applying Michigan law in

connection with “other insurance” clauses, held that those clauses “only

apply [when] the applicable insurance policies cover the same interests

in the same property.”105 In entering summary judgment in favor of the

purchaser, the court stated that “the policies were on the same property

and against the same risks[,] but on different interests and payable to different

parties. . . . As such, the other insurance clause does not apply.”106

VII. Obligations and Rights of the Parties

A. Representations and the Application for Insurance

In Sexton-Walker v. Allstate Insurance Co.,107 the insurer, investigating a

claim for water damage, learned the insured had made several misrepresentations

on her insurance application. The insured answered “yes” in

the application when asked whether “the dwelling . . . [was] on a solid

and continuous foundation,” but the insurer discovered “the property

was a mobile home and therefore not on a solid and continuous foundation.”

108 The insured also stated in the application that the property was

regularly occupied in the days and evenings, but she conceded in her

examination under oath that she “mostly live[d] in [another state].”109

Finally, the insured had made nine property claims in the last five

years, despite answering “none” when asked to describe her five-year

loss history at the residence.110 On appeal, the Fifth Circuit affirmed

the district court’s grant of summary judgment, finding the misrepresentations

were material and that there were no genuine issues of fact for

trial.111

In Landmark American Insurance Co. v. Moulton Properties, Inc.,112 the

insured made a claim for damage related to Hurricane Dennis. During

the claim adjustment, the insurers discovered that the “damage at issue

was not from Hurricane Dennis, but instead was unrepaired or partially

repaired damage from Hurricane Ivan.”113 The insured’s insurance broker

had previously submitted a property summary to the insurers during

the policy application process representing that the repairs of prior storm

damage from Hurricane Ivan were complete.114 The insurers rescinded

coverage and filed suit for declaratory judgment based upon the misrepresentations

made by the broker about the status of repairs for damage

related to Ivan.115 The district court rejected all of the insurers’ arguments

for rescission, and the insurers appealed.116 On appeal, the Eleventh

Circuit considered whether the insurance broker was acting as an

agent of the insured when it submitted the alleged misrepresentations

regarding the status of repairs.117 The court found that the broker was

in fact the agent of the insured and held that, based on Florida law and

the language of the brokerage contracts, all representations made by the

broker were attributable to the insured.118 The case was remanded to the

district court for a finding of whether the representations were material.119