Between 2004 and 2008, Chinese drywall was installed in more than 100,000 homes in the United States. Since that time, it has been discovered that
Between 2004 and 2008, Chinese drywall was installed in more than 100,000 homes in the United States. Since that time, it has been discovered that Chinese Drywall emits sulfide gases, damaging property and raising human health concerns. As a result, homeowners are filing class actions and builders are filing a myriad of suits against the manufacturers and distributors of Chinese drywall. In response to this litigation, insureds will likely turn to both their property and liability carriers for coverage. This article draws decisions from multiple jurisdictions in an effort to provide an overview of the types of claims and defenses that can be expected from first party liability insurers.
A threshold issue when determining whether coverage exists is whether the damage can be considered a “direct physical loss” as defined by the policy. Although case law is somewhat scarce on the issue of whether construction defects constitute “direct physical loss,” the trend suggests that construction defects do not constitute a loss. For example, in Whitaker v. Nationwide Mut. Fire Ins. Co., 115 F. Supp. 2d 612 (E.D. Va. 1999), the court held that a claim for the cost to repair poor workmanship did not constitute a direct physical loss. The court explained:
. . . the language “physical loss or damage” strongly implies that there was an initial satisfactory state that was changed by some external event into an unsatisfactory state.
Id. at 616.
Despite this trend, there are recent cases recognizing that the odor element of a Chinese drywall claim does constitute a physical injury for insurance coverage purposes. To illustrate, in the liability context, the court in Essex Ins. Co. v. BloomSouth Flooring Corp., 562 F.3d 399 (1st Cir. 2009), concluded that allegations regarding odor constituted physical injury within the scope of coverage under a CGL policy. Accordingly, an analysis of the Chinese drywall property damage claim should include a thorough evaluation of the different manners in which the insured could present the claim.
Next, insurers will also need to evaluate whether particular exclusions apply to deny or restrict coverage. In the homeowner’s policy context, this would generally include the following:
1. The Pollution Exclusion
A typical pollution exclusion provides that coverage is excluded for bodily injury and property damage:
arising out of the discharge, dispersal, release or escape of any solid, liquid, gaseous or thermal irritant, pollutant or contaminant, including smoke, vapors, soot, fumes, acids, alkalis, chemicals and waste.
Courts have usually interpreted this policy language in a narrow fashion, requiring that the insurer satisfy a high standard of proof as to whether a particular substance is in fact an irritant, pollutant, or contaminant. For example, in Pipefitters Welfare Educ. Fund v. Westchester Fire Ins. Co., 976 F.2d 1037, 1043 (7th Cir. 1992), the court held:
The terms “irritant” and contaminant,” when viewed in isolation, are virtually boundless, for “there is virtually no substance or chemical in existence that would not irritate or damage some person or property.” . . . Without some limiting principle, the pollution exclusion clause would extend far beyond its intended scope, and lead to some absurd results. To take but two simple examples, reading the clause broadly would bar coverage for bodily injuries suffered by someone who slips and falls on the spilled contents of a bottle of Drano, and for bodily injuries caused by an allergic reaction to chlorine in a public pool. Although Drano and chlorine are both irritants or contaminants that cause, under certain conditions, bodily injury or property damage, one would not ordinarily characterize these events as pollution.
Id. at 1043.
Per the court’s rationale, the controlling factor is whether a reasonable policyholder would characterize the hazard as pollution. Accordingly, under Pipefitters, a court must determine whether a reasonable insured would consider the emission of gases from drywall to fall within the meaning of the exclusion.
In addition, courts must also determine what constitutes “discharge,” “dispersal,” or “release” under the pollution exclusion. Although limited, several courts have addressed this issue in the context of indoor air quality claims and have held that the policy terms should be narrowly construed. For example, in Lumbermans Mut. Cas. Co. v. Sw. Indus., Inc., 39 F.3d 1324, 1336 (6th Cir. 1994), the court was faced with whether to classify fumes in a manufacturing plant as a “discharge,” “dispersal” or “release.” In refusing to so classify the fumes, the court reasoned that:
It strains the plain meaning, and obvious intent of the language to suggest that these fumes, as they went from the container to lungs, had somehow been “discharged, dispersed, released or escaped.” Or considering that the fumes were confined to a work area, that they had been discharged into the “atmosphere” as that word is ordinarily understood.
With the limited case law applying the pollution exclusion to indoor air, it is impossible to determine exactly how a court will interpret this exclusion within the context of Chinese drywall. However, given other jurisdictions’ rejection of the pollution exclusion in indoor air cases, there is a significant likelihood that Georgia courts will apply the same reasoning and reject the pollution exclusion.
2. Water Exclusion
As a result of the hazardous effects of Chinese drywall when it is exposed to water, many first-party homeowners’ insurance claims may fall with the scope of water damage exclusions. Because water and the hazardous effects both contribute to the damage, an analysis of concurrent causation may be the determinative factor as to whether coverage is provided. This analysis will also require consideration of the policy’s “anti-concurrent causation” language, which provides that there is no coverage when a loss arises from both an excluded peril and a covered peril. Such language is routinely approved of by courts.
3. “Inherent Vice” Exclusion
For this discussion, a final exclusion that may apply to Chinese drywall claims relates to damage caused by “mechanical breakdown, latent defect, inherent vice, or any quality in property that causes it to damage or destroy itself.” Although such claims appear to fall within the plain language of the exclusion, courts have been skeptical of this argument.
For example, in NUCO Investments, Inc. v. Hartford Fire Ins. Co., No. 1:02 CV 1622 CAP, 2005 WL 3307089 (N.D. Ga. Dec. 5, 2005), an insurer cited the “inherent vice” exclusion as a reason for denying coverage in a mold damage case. Specifically, the insurer argued that a combination of the wall covering used, water, and a lack of an exhaust system all contributed to mold growth. The court rejected the argument, holding that “the fact that numerous conditions converged to increase moisture in the walls of the hotel resulting in mold damage is simply insufficient to allow the court to conclude that each and every one of these conditions is inherent vice or latent defect.” 2005 WL 3307089 at *6.. In applying NUCO Investments to the Chinese drywall claim, it seems unlikely that Georgia courts will allow the “inherent vice” exclusion to defeat a homeowners claim.
The number of Chinese drywall claims will undoubtedly increase. Accordingly, insurers should be mindful of the issues involved. Homeowners will have significant opportunities for insurance coverage, while insurers will be setting precedent with regard to policy interpretation and the application of certain exclusions to these claims.