Chinese Drywall Claims
New Developments in Chinese Drywall Claims -- Summer 2010
Ellen Clarke and Sallie Kraus
September 1, 2010
The pace of litigation in the Chinese drywall ("CDW") claims has escalated in recent months. It is alleged that the gypsum that was used to manufacture that drywall came from particular Chinese mines and became contaminated with other potentially dangerous minerals. The product was used mainly in the southeastern US between 2004 and 2008 when real estate boomed and Hurricane Katrina, Rita and Wilma boosted demand. Up to 100,000 homes could be affected as builders used drywall from multiple sources. Towers Watson estimates insurance costs at $8-$10 billion for indemnity, and $5-$10 billion for legal fees. However, the number of claims is finite and the potential claims tail is relatively short. The amount of coverage available will probably be small in comparison to the total damages, but the exposure is still considerable. We address recent developments in the underlying litigation and developments regarding homeowner and general liability coverage cases.
The gypsum in CDW came from one particular mine in Shan Dong province that was likely contaminated with coal fly-ash and other materials. Natural gypsum is often found in close proximity to sulfur. However, The U.S. Consumer Product Safety Commission ("CPSC") has found some CDW samples had hydrogen sulfide emission rates 100 times greater than domestic samples. CDW degrades in humid climates, emitting strontium sulfide and other sulfuric gases. The pervasive "rotten egg" smell and metal decay affects electrical, plumbing, HVAC systems, appliances and computers, and may increase fire risk. Multiple causes for the problem have been suggested, including bacteria unique to contaminated drywall. The CPSC has received complaints from 37 states, mainly in the Gulf States and Southeastern US and has recommended the complete removal and replacement of affected drywall and building systems.
Drywall Claims
Lawsuits have been brought against Taishan Gypsum Co., Ltd ("Taishan") a Chinese company and Knauf Gips, KG, a German building materials manufacturer which operates Chinese subsidiaries, Knauf Plasterboard (Tianjin) Co., Ltd ("KPT"), Knauf Plasterboard (Wuhu) Co., Ltd., and Knauf Plasterboard (Dongguan) Co., Ltd. At least 200 federal suits have been filed against KPT alone.
There have already a number of court decisions. Federal cases consolidated in the multi-district litigation (MDL) in the Eastern District of Louisiana have yielded a few big awards. Seven Virginia homeowners were awarded a total of $2.6 million default judgment in Germano et al. v. Taishan Gypsum Co. Ltd., Case No. l 09-6687, MDL No. 2047 (U.S. Dist. Court, E.D. La) (April 8, 2010) although in June, Taishan appeared for the first time in a US court to appeal the decision. The Germano opinion sets the standards and cost guidelines for remediation of CDW, which includes complete removal and replacement of the drywall and all HVAC and mechanical systems, and furniture and personal property that cannot be cleaned or restored. Shortly thereafter, in Hernandez, et al v. Knauf Plasterboard (Tianjin) Co., Ltd., Case No. 2:2009 CV 06050 (U.S. Dist. Court, E.D. La) (April 28, 2010) two Louisiana homeowners were awarded just over $164,000 for remediation and related repairs and legal fees.
State courts have also yielded significant verdicts. In June, a jury awarded over $2.47M to a Miami homeowner, with $1.7M just for loss of enjoyment. In Armin Seifart, et al. v. Knauf Gips KG, et al., (No. 2009-038887-CA-42, Fla. Cir., 11th Judicial Cir., Miami-Dade Co) drywall supplier Banner Supply Company was hit with 55 per cent of the liability, the drywall importer who connected the Chinese manufacturers to the Florida market was assessed five percent and is likely to become a target in more cases.
It was revealed at trial that Banner had advised Knauf that two major builders, WCI and GL, had forced it to remove CDW and replace it with domestic product. The judge also released a confidential settlement agreement between Banner and KPT not to disclose the problem and to mutually release each other from any claims. Banner has filed a JNOV based on the controversial disclosure and the suit is still pending against KPT. Banner has been named in over 2800 individual suits. Its carriers filed a declaratory judgment action in Florida that was dismissed without prejudice. Chartis Specialty Ins. Co. et al. v. Banner Supply Co., No. 8:10-cv-00339-JSM-EAJ (M.D. Fla.) (dismissed July 12, 2010).
Several class actions have been filed, mostly in Florida. In the first to be tried, Harrell v. South Kendall Homes, et, al. (11th Judicial Circuit, Fla.) 132 homeowners settled for $6.6M against the builder and a realtor with claims against KPT still pending.
At least four builders have filed for bankruptcy under Chapter 11: WCI, Levitt and Sons, Tousa Homes and South Kendall Homes. WCI's 2009 Second Amended Plan of Reorganization provides that all rights to insurance coverage for drywall claims are reportedly transferred to the Chinese Drywall Trust. The trustee has also sued 14 insurers who provided more than $200 million in aggregate limits. Robert C. Pate v. American International Specialty Lines Ins. Co., et al, Case 2:09-cv-0779 (U.S. Dist. Court E.D. La) (filed December 23, 2009). Old Republic has already paid the full $3 million limits of its primary fronting policy to the Trust, splitting the policy proceeds equally with WCI. Other settlements are likely also under discussion. Lennar Homes, the second-largest US home builder has been settling homeowner claims in several states but has also sued manufacturers, suppliers and installers.
Insurance Litigation
The claims of homeowners has spawned litigation with insurers. As of May 2010, the coverage cases include 25 under CGL policies, with 15 in Florida alone, and 13 that involve first-party property coverage, with 10 in Louisiana. Mody, N., Roehler, K, & Gilvary, K. (June 22-23, 2010), "Deconstructing Chinese Drywall: Analysis of First- and Third-Party Chinese Drywall Coverage Claims" [PowerPoint Presentation]. There are also a few coverage cases in the MDL, although there are questions as to whether the MDL may not be the right place for coverage actions. Most recently, the Judicial Panel on Multi-District Litigation has denied motions to transfer the cases. "Catherine Collinvaux and Seth Jackson,"Avoiding the MDL for Insurance Coverage Disputes," Insurance Law 360, July 1, 2010.
Decisions have been handed down in two cases involving a homeowners policy and one under a CGL. In Finger v. Audubon Insurance Company, No. 09-8071 (Civil District Court for the Parish of Orleans) (March 22, 2010), the court struck three affirmative defenses related to exclusions in an all-risks policy: pollution; a gradual or sudden loss caused by gradual deterioration (including corrosion) and faulty, inadequate or defective planning (including materials used in repairs). Reasoning that all-risk policies generally cover all fortuitous losses unless a specific exclusion applies, the insured has "light burden" and need only show that property damage occurred. The court held the carrier had not demonstrated that any exclusion applied. This decision may be the harbinger of things to come in Louisiana, a jurisdiction favorable for policyholders.
A more conservative Virginia federal court expressly refused to follow Finger. In Travco Insurance Co. v. Ward, Civ. No. 2:10cv14 (E.D. Va., Norfolk Division, June 3, 2010) 2010 U.S. Dist. LEXIS 54387, the homeowner policy at issue did not define 'direct physical loss' but did define property damage. The court held that loss of use constituted direct physical loss insured by the policy and that physical damage to the property is not a necessary condition for coverage. The court determined there was a direct physical loss because the home was rendered uninhabitable by the toxic gases. However, the homeowner's claim was precluded by the policy's latent defect, faulty materials, corrosion, and pollution exclusions. The policy's ensuing loss provision also applied as the other exclusions already barred coverage. The court did leave open the possibility that other, yet unclaimed, secondary losses may be covered. The more narrowly written policy and the court's comprehensive analysis in Travco may support carrier arguments to restrict coverage, especially in more insurer-friendly jurisdictions.
The most frequently raised CGL coverage issues can be summarized as follows:
- Is there "bodily injury" or "property damage" caused by an "occurrence," i.e., an accident or exposure to repeated conditions. Is a CDW claim a fortuitous, unexpected, unintended happening or a failure to perform a contract?
- How many occurrences are there? The number will depend on the facts and state law, and the test varies. Sometimes the answer depends on whether a large SIR applied to many occurrences would deprive the insured of any coverage at all. In the recent Delaware case, Stonewall Ins. Co. v. E.I Dupont de Nemours & Co. (Case No. 523, 2009) (Del. Jun 3, 2010) the court said application of a $50 million SIR applied to 469,000 claims totaling $239 million would create an "absurd" result.
- Which policies are triggered: when the drywall was installed, when homeowner made a complaint, when the loss was in progress? Again, the cases from the mass tort field are instructive, but note that that CDW was only used for a few years, and the coverage period is compressed.
- The exclusion for "property damage" to "your work" arising out of it or any part of it that is included in the "products-completed operations hazard" may apply. The exemption protects the insured (here the builder or general contractor) if the work was performed by subcontractor.
- There may be no coverage for "property damage" to "your product" arising out of it or any part of it." This means "any goods or products... manufactured, sold, handled distributed or disposed of by the policyholder... includes "warranties or representations." This exclusion could bar claims by installers, and homebuilders but the question is whether it applies only to the actual drywall or if the product is the entire structure.
- Will bodily injury claims or those for medical monitoring, be allowed and are they covered? In Florida, to support a monitoring claim, plaintiffs must show exposure greater than background levels to a proven hazardous substance caused by the defendant's negligence and as a proximate result, has a significantly increased risk of contracting a serious latent disease. The monitoring procedure is only done where exposure is demonstrated, can detect the disease and is reasonably necessary. Petito v. A.H. Robins Co., 750 So. 2d 103 (Fla Dist Ct. App 1999) review denied, 780 So 2d 912 (Fla 2001). These claims are not allowed in Alabama, Mississippi and Texas.
- Will the disclosure of the parties' state of knowledge give carriers a basis to deny claims? Insurers have already been filing pre-emptive coverage suits against policyholders and the revelations in the Seifart case that builders and suppliers were aware of CDW problems may provide further incentives.
The pervasive sulfur odor is very difficult to remove from the structure and personal effects. In Travco, discussed above, the court had little difficulty finding the odor constitutes "direct physical damage." In a case of first impression under a CGL policy, Essex Insurance Co. v. Bloomsouth Flooring Corp., 562 F.3d 399 (1st Cir. 2009), the appellate court held that an alleged strong odor that permeated the building may constitute "property damage" under Massachusetts law and rejected the carriers' defenses regarding "your work," "your product" and "impaired property."
In the first CGL case regarding CDW, Builders Mutual Ins. Co. ("BMIC") v. Dragas Mgt., Corp. et al, Case No. 2:09 CV -185 (U.S. Dist Court, E.D. Va) (March 24, 2010) a developer recognized the problem and sought to recoup the costs of voluntary remediation. Dragas' approached owners of 73 condominiums to inspect their units after a subcontractor warned about the drywall problem. Four owners filed then dismissed suits as Dragas implemented a $5 million repair project. Dragas notified BMIC of a potential claim under its 2006 and 2008 primary and umbrella policies, with no response. Dragas interpreted BMIC's silence as consent. BMIC denied the claim and filed a DJ, citing a total pollution exclusion, a "your work" exclusion and an "impaired property" exclusion. The insured cross-claimed against BMIC and Firemens' Fund, the 2007 carrier, and added a bad faith claim against BMIC. Firemen's Fund was dropped from the suit. The court granted BMIC's motion to dismiss, holding that Virginia law does not require an insurer to pay damages before a lawsuit is filed against its insured. There is a split of authority as to whether an insurer has a legal obligation to pay sums "as damages" if no third-party lawsuit is filed. The court recognized the business reasons why the insured might undertake remediation, but refused to endorse its actions on legal or public policy grounds. The court did not reach other coverage issues, such as whether there was an "occurrence" or if the pollution, the "your product," "your work," owned or impaired property exclusions would apply.
Dragas was allowed to amend its counterclaim, asserting that the homeowner lawsuits, local ordinances banning CDW and CPSC guidance regarding removal of CDW all constitute legal obligations. Another motion to dismiss is still pending. If this narrow decision stands, it may not provide much guidance concerning whether mitigation efforts might be covered under a different set of facts.
Reinsurance Implications of CDW Claims
As these claims are in the early stages, the reinsurance aspects of ("CDW") claims have yet to develop. Direct insurers include large well-known US writers, such as the AIG -related companies, which typically have large retentions. However, smaller companies, especially homeowners mutuals, and smaller commercial carriers have lower retentions and broader coverage.
The CDW claims will undoubtedly raise reinsurance issues. Reinsurers will have to reconcile the definition of occurrence in the underlying policy with that of "Loss Occurrence" in the reinsurance treaty. Typically, "loss occurrence" is defined more broadly than "occurrence" in the underlying policy. There may be bodily injury and property damage claims which may be separate "occurrence" and "loss occurrences" even at the same residence or "site." Those claims could impact separate reinsurance contracts as well.
Allocation will also be a key issue as the damage caused by the drywall appears to pose "exposure" or "progressive injury" claims. While CDW was in use for a relatively short period of time, multiple years of coverage may still be implicated and courts will be asked to determine how the losses should be apportioned.
Number of occurrences is another important reinsurance issue, as one insured could be implicated at hundreds of sites. Contractors may argue for a single occurrence in order to aggregate claims from multiple developments, while primary first-party insurers can be expected to argue that multiple occurrences (and therefore multiple deductibles or SIRs) should apply. Primary liability insurers may take a different view. Since insurance issues are a matter of state law, choice of law in the particular jurisdiction will affect the outcome. Depending on the approach and the application of policy aggregates, if claims are compressed into a short coverage block, we may see some significant acculumulation of claims.
The cost of litigation-and particularly coverage litigation-is also a concern. The underlying cases are expensive to defend and as we have seen before, ALAE and LAE can easily equal or exceed verdicts or settlements. So, it is possible that reinsurers will receive billings for expense even if the indemnity does not exceed the retention. Reinsurers may expect that cedents will seek to recoup both the defense costs and DJ expense.
Reinsurers will have to be vigilant for signs that carriers have settled claims that were excluded or otherwise not covered. In sum, it would be pure speculation to comment on the financial implications of the CDW claims to reinsurers at this time. However, to the extent reinsurance claims are made, it is likely that they will present some interesting coverage issues.
