Insurance Coverage Disputes Ahead
Chinese Drywall: Big Damage Claims and Big Insurance Coverage Disputes Ahead
Seth D. Lamden
October 25, 2010
Over the last several years, thousands of homeowners have sued developers, contractors, manufacturers and suppliers alleging that Chinese-manufactured drywall installed in their homes is defective because it emits harmful gases that can corrode metal components and cause a variety of health problems (and smells like rotten eggs).
Studies have shown that much of the Chinese drywall imported into the United States between 2004 and 2008 contains more sulfur than typical drywall. According to the U.S. Consumer Product Safety Commission, the excess sulfur leads to the release of hydrogen sulfide gas at levels high enough to corrode metal building components, including pipes, vents and wires, in homes built with Chinese drywall. The corroded metal has been shown to cause mechanical, electrical and electronic failures and creates a fire risk. While the effects on humans of long-term exposure to emissions from Chinese drywall are largely unknown, hydrogen sulfide is a known irritant at high enough concentrations, and claimants have alleged that Chinese drywall has caused an array of health problems, including respiratory infections, asthma attacks, headaches, nausea and allergic reactions.
How Big Is the Problem?
According to some estimates, the construction industry faces potential liability of more than $10 billion for Chinese drywall claims. It has been estimated that as many as 100,000 homes in the United States may contain defective Chinese drywall. Homeowners have brought class actions in Alabama, Florida, Louisiana, Mississippi and Ohio seeking damages caused by “smelly corrosive gas” emitted by Chinese drywall in the plaintiffs’ homes. The U.S. Judicial Panel on Multidistrict Litigation consolidated these actions in the U.S. District Court for the Eastern District of Louisiana. Many individual claimants also have filed lawsuits seeking damages caused by Chinese drywall.
The courts and regulatory agencies generally are in agreement that the only way to remediate damage caused by defective Chinese drywall is to completely remove and replace all drywall in the house as well as any corroded metal building components. In a 108-page opinion, the court in Germano v. Taishan Gypsum Co., Ltd., No. 09-6687, MDL No. 2047 (E.D.La. April 8, 2010) concluded that based on “scientific, economic, and practicality concerns,” the proper method for remediating homes containing Chinese drywall “is to remove all drywall in [the home], all items which have suffered corrosion as a result of the Chinese drywall, and all items which will be materially damaged in the process of removal.”
Although most Chinese drywall lawsuits remain pending, several Chinese drywall lawsuits already have resulted in judgments awarding substantial damages to the homeowner-plaintiffs. In a jury trial, the court in Seifart v. Banner Supply Co., Dade County 2009-038887-CA-42 (Fla. Cir. Ct., June 18, 2010) awarded damages to a single homeowner totaling $2.5 million for the removal and replacement of the drywall and corroded metal building components, replacement of damaged personal property, loss of use of the home and diminution in value of the home as a result of stigma.
The Germano court entered a judgment in favor of seven homeowners totaling $2.6 million for losses caused by Chinese drywall. The Germano judgment included damages for the cost of removing and replacing the drywall and corroded metal components of the HVAC and mechanical systems. The Germano judgment also compensated the plaintiffs for damage to furniture and other personal property, loss of use and enjoyment of their homes, temporary living expenses, and diminution in value. The court in Hernandez v. Knauf Plasterboard (Tianjin) Co., Ltd., No. 09-CV-06050 (E.D.La. April 28, 2010) awarded damages totaling $164,000 to a homeowner to remove and replace all drywall, insulation, duct work, switches, molding and countertops.
CGL Insurers Have Begun Contesting Coverage for Chinese Drywall Claims
Given the potential for multi-billion dollar losses, CGL insurers undoubtedly will contest coverage for Chinese drywall claims. Indeed, a number of CGL insurers have filed declaratory relief actions against developers, contractors and distributors that have sought coverage for their Chinese drywall liability. See, e.g., American Home Assurance Co. v. Peninsula II Developers, Inc, No. 09-CV-23691 (S.D.Fla. Dec. 11, 2009) [underlying claims against residential developer, general contractor and subcontractor]; Chartis Specialty Insurance Co. v. Banner Supply Co., No. 10-CV-00339 (M.D.Fla. Feb. 10, 2010) [underlying homeowner claims against drywall distributor]; Builders Mutual Insurance Co. v. Dragas Management Corp., No. 2:09-CV-185 (E.D.Va. April 23, 2009) [underlying claims against residential developer]; Taylor Woodrow Communities at Vasari, LLC v. Mid-Continent Casualty Co., No. 2:09-823 (C.D.Fla. Dec. 21, 2009) [underlying homeowner claims against residential developer and contractor]; General Fidelity Insurance Co. v. Foster, No. 09-80743 (S.D.Fla. May 15, 2009) [underlying claims against residential developer]. In a June 2010 order, the U.S. Judicial Panel on Multidistrict Litigation denied motions to transfer the Taylor Woodrow, Banner and Foster actions to the Chinese drywall MDL.
In addition, the trustee for the WCI Communities, Inc. bankruptcy estate filed a declaratory judgment action against 14 insurers that had issued CGL policies to WCI, a residential developer, seeking coverage for Chinese drywall losses. See, Pate v. American International Specialty Lines Insurance Co., No. 2:09-cv-07791-EEF-JCW (E.D.La. Dec. 23, 2009). As part of its Chapter 11 plan of reorganization, WCI established a Chinese Drywall Trust to assume WCI’s liability to more than 700 homeowners for Chinese drywall losses. One of the insurers, Old Republic, was dismissed from the Pate action in June 2010 after settling with the trustee. The other insurers have filed motions to dismiss based on jurisdiction and venue, which remain pending.
Do CGL Policies Cover Chinese Drywall Claims?
The determination of whether Chinese drywall claims are covered under CGL policies will draw heavily on the complex and varied body of case law that has evolved over more than two decades of insurance coverage litigation regarding coverage for claims involving asbestos exposure, pollution liability, defective products and construction defects. Because the law on many important coverage issues varies across the country, the issue of which state’s law governs the coverage dispute may prove to be dispositive in many cases. In fact, the first round of substantive briefing in the Peninsula II Developers, Inc. declaratory judgment action was a motion for partial summary judgment on this issue.
Many CGL insurers have taken the position that Chinese drywall claims are not covered under CGL policies on the basis of policy exclusions that eliminate coverage for property damage caused by the discharge of pollutants (the toxic sulfur gas) and that eliminate coverage for property damage caused by “business risks.” CGL insurers also have taken the position that Chinese drywall claims do not allege covered bodily injury or property damage caused by an “occurrence.”
If a court finds that Chinese drywall claims are covered by CGL policies, additional complex coverage issues will arise, including: 1) during which policy period(s) did the Chinese drywall cause property damage; 2) if multiple policies are triggered, what is the proper methodology for allocating damages among the triggered policies; and 3) how many occurrences caused the property damage for purposes of determining the number of applicable policy limits or deductibles.
To date, the only CGL declaratory judgment action in which a ruling on a substantive insurance coverage issue has been entered is Builders Mutual Insurance Co. v. Dragas Management, Corp., No. 2:09-CV-185 (E.D.Va. April 23, 2009). In the Dragas declaratory judgment action, a developer, Dragas Management Corp., sought coverage from its CGL insurer, Builders Mutual Insurance Co., for the cost of remediating property damage in 73 condominiums containing Chinese drywall. After a subcontractor warned Dragas that the drywall was causing corrosion of metal building components in the homeowners’ condominiums, Dragas implemented a $5 million repair project. Several homeowners sued Dragas but then dismissed the lawsuits after Dragas commenced its repair project.
Dragas notified Builders Mutual of a potential claim under its primary and umbrella policies. Builders Mutual denied the claim and filed a declaratory judgment action against Dragas, alleging that coverage was barred pursuant to the “business risk” exclusions and the pollution exclusion, and because the claim did not allege a covered “occurrence.” Dragas filed a counterclaim for declaratory judgment, which the court dismissed without prejudice on the basis that Dragas had failed to allege facts in support of the allegation that amounts spent to remediate the claimants’ condominiums constituted liability for covered damages, as required by Dragas’ CGL policies. The court did not address whether there was an “occurrence” or whether any policy exclusion barred coverage.
Dragas filed an amended counterclaim asserting that the homeowners’ written and oral demands and the lawsuits that some of the homeowners had filed against Dragas and subsequently dismissed gave rise to legal obligations. In a July 15, 2010 decision, the court denied a motion to dismiss filed by Builders Mutual and held that although the “threat of litigation is itself sufficient to support a ‘legal obligation’ to pay sums ‘as damages,’ the court finds that such explicit threats, coupled with Dragas’ other factual allegations, are at least sufficient to survive the present motions to dismiss.” The court also held that Dragas adequately pled that the claims involved “property damage” caused by an “occurrence” by alleging that the Chinese drywall damaged “other building components of homes… and personal property in those homes….” The court held Builders Mutual’s position that the pollution and business risk exclusions barred coverage was an affirmative defense to be addressed at the summary judgment stage. The Dragas court has set a trial date of March 28, 2011.
| 1. | Did the Chinese Drywall Cause Covered Property Damage? |
Subject to a number of conditions and exclusions, CGL policies provide coverage for liability resulting from “property damage” caused by an “occurrence.” Standard-form CGL policies define “property damage” to “include physical injury to tangible property” and an “occurrence” to include an “accident” as well as “continued or repeated exposure to the same or similar conditions.”
Most courts have held that incorporation of the insured’s defective work or product into a larger system or structure does not constitute “property damage” unless the insured’s work or product causes damage to property other than the work or product itself. Claims alleging that gas emitted from Chinese drywall damaged property or parts of the claimants’ homes other than the Chinese drywall itself will satisfy the CGL “property damage” requirement. In addition, some courts have held that “property damage” occurs when an insured’s work or product is incorporated into a system or structure if the work or product is inherently harmful or otherwise renders the entire system or structure useless.
| 2. | When Did the Property Damage Occur? |
CGL policies only provide coverage for damages because of property damage that happens during the policy period. The issue of when property damage occurs in a Chinese drywall claim will not always be straightforward, and the answer may vary by jurisdiction. In claims involving the installation of asbestos or contaminated insulation into a structure, some courts have held that property damage occurs immediately upon the installation or incorporation of a defective product into a larger product. Other courts have held that property damage occurs only when the insured’s defective product causes physical injury to, or loss of use of, tangible property other than the insured’s product itself.
In addition, Chinese drywall claims typically allege property damage caused by the continuous exposure to harmful gases. In the context of asbestos and pollution claims, some courts have held that property damage and bodily injury occur continuously during the entire time that exposure to the asbestos or pollutants occurs. Accordingly, in some jurisdictions, only the policy in effect when Chinese drywall was installed will provide coverage. In other jurisdictions, all policies in effect from the time of installation through the time that the drywall is removed will provide coverage.
| 3. | Was the Property Damage Caused by an Occurrence? |
Some Chinese drywall plaintiffs have brought breach of contract claims against developers and contractors. CGL policies cover only liability for unexpected and unintended property damage or bodily injury. In the defective construction context, a frequently-litigated issue is whether a claim against a developer or contractor for breach of contract involves a covered “occurrence” for purposes of CGL coverage. Courts in some jurisdictions have held that a claim for breach of contract cannot constitute an “occurrence” because a breach of contract cannot be deemed to be accidental. In other jurisdictions, however, courts disregard the cause of action under which a claim is pled and, instead, focus on whether the losses at issue were unexpected and unintended by the insured.
| 4. | Was the Property Damage the Result of an Excluded “Business Risk?” |
Coverage under a CGL policy is limited by a number of exclusions, often referred to as “business risk” exclusions, that eliminate coverage for liability that is solely for the repair or replacement of the insured’s own defective work or product. These exclusions do not, however, eliminate coverage for liability because of bodily injury or damage to the property of a third party caused by the insured’s defective work or products. Moreover, these exclusions do not eliminate coverage for liability arising out of work performed for the insured by a subcontractor.
CGL policies also exclude coverage for costs associated with a market recall of the insured’s products and for liability associated with loss of use of “impaired property,” which, in general, is property that incorporates the insured’s defective work or product when the property has not been physically damaged and can be restored to use simply by removing the insured’s defective work or product. It should be noted that the interpretation of the “business risk” exclusions varies significantly by jurisdiction, and inconsistencies in decisions interpreting these exclusions has created a confusing and often contradictory body of case law across the country.
| 5. | Does a Pollution Exclusion Eliminate Coverage? |
Insurers will argue that coverage for property damage caused by gas emitted by Chinese drywall is barred by policy exclusions for pollution events. Standard CGL policies exclude coverage for damage caused by a release or discharge of a “pollutant,” which often is defined to include “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, and waste.” Hydrogen sulfide gas falls within the plain meaning of the term “pollutant” because it is an “irritant” or “contaminant.”
Courts are split, however, with regard to whether the scope of coverage eliminated by CGL pollution exclusions is limited to liability for “traditional” pollution claims or whether it also includes liability for a discharge or release of pollutants that is confined solely to the interior of a building or other structure. Compare, Nautilus Insurance Co. v. Country Oaks, No. 08-50652, 2009 WL 1067587 (5th Cir. April 22, 2009) [pollution exclusion barred coverage for claim involving indoor release of carbon monoxide from broken furnace] with American States Insurance Co. v. Koloms, 680 N.E.2d 672 (Ill. 1997) [absolute pollution exclusion did not bar coverage for claim involving indoor release of carbon monoxide from broken furnace].
In the context of a first-party homeowners policy, the Civil District Court in New Orleans Parish held in Finger v. Audubon Insurance Co., No. 09-8071, that a pollution exclusion did not bar coverage for property damage caused by hydrogen gas emitted from Chinese drywall because “the Pollution Exclusion does not, and was never intended, to apply to residential homeowners’ claims for damages caused by substandard building materials.”
Conclusion
From an insurance coverage standpoint, Chinese drywall claims do not involve any issues that have not arisen repeatedly in defective construction, pollution, asbestos and product liability claims. Nevertheless, even after more than two decades of hotly-contested litigation and thousands of reported decisions, most of these issues are far from settled. Given the complexity of these coverage issues and the billions of dollars at stake, there should be little doubt that Chinese drywall claims will spawn insurance coverage litigation for years to come.
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