Special Causation
Problems in First-Party Property Insurance*
Douglas G. Houser
Linda M. Bolduan
“Cause”: Something that produces an effect,
result, or consequence.[1]
[T]he causation inquiry stops at the efficient
physical cause of the loss; it does not trace events back to their metaphysical
beginnings.[2]
I.
Introduction[3]
All-risk property insurance commonly provides
coverage for “all fortuitous losses not resulting from misconduct or fraud,
unless the policy contains a specific provision expressly excluding the loss
from coverage.”[4] All-risk property insurance therefore
requires an inquiry into causation.
What caused the loss? On its
face, that is a simple inquiry.
However, “[t]he question of . . . causes in property damage insurance
lends itself to logic chopping as well as philosophic reflection.”[5]
The
crucial question is what causal event will be held legally accountable for that
loss. This article will examine that question in the context of “all-risk”
property insurance.
II.
Efficient Proximate Cause
In
our common experience, we tend to simplify causative events: Event A caused Loss B, the fire caused the house to burn down. However, multiple events are often
implicated in losses to property, and, for purposes of determining coverage
under a particular policy, the insurance company needs to know which event
“caused” the loss and whether that event is a covered peril.
To
determine causation when multiple events lead to a property loss, the majority
of jurisdictions have adopted a “proximate cause” type analysis.[6] Also sometimes called “efficient proximate
cause,” “moving cause,” “predominant cause,” or combinations thereof,[7]
the “proximate cause” of a loss is the “dominant, efficient one,”[8]
the one that “sets in motion a chain of events that results in the loss without
the intervention of any new or independent force.”[9] Thus, when there is an “unbroken connection”
between the event and the injury, the act “causes” the injury, and an
intervening event is not a proximate cause of the injury “unless it is
efficient to break the causal connection.”[10]
As
explained by the Supreme Court of West Virginia:
[W]hen
examining whether coverage exists for a loss under a first-party insurance
policy when the loss is caused by a combination of covered and specifically
excluded risks, the loss is covered if the covered risk was the efficient
proximate cause of the loss. No
coverage exists for a loss if the covered risk was only a remote cause of the
loss, or conversely, if the excluded risk was the efficient proximate cause of
the loss. The efficient proximate cause
is the risk that sets others in motion. It is not necessarily the last act in a
chain of events, nor is it the triggering cause. The efficient proximate cause doctrine looks to the quality of the
links in the chain of causation. The
efficient proximate cause is the predominating cause of the loss.[11]
However,
the efficient proximate cause doctrine applies only when there are at least two
distinct perils, which “could each, under some circumstances have occurred
independently of the other and caused damage.”[12] Conversely, the efficient proximate cause
doctrine does not apply when a loss is caused by a “single cause, albeit one
susceptible to various characterizations.”[13] Moreover, an insured may not avoid a policy
exclusion “merely by affixing an additional label or separate characterization
to the act or event causing the loss.”[14]
A. Some Representative “No Coverage” Cases
Point
Triumph Condominium Ass’n v. American Guarantee & Liability Insurance Co.[15] involved a condominium association (“Point
Triumph”) that owned a complex in a small town located near the mouth of the
Columbia River. Situated only one and a
half miles from the Pacific Ocean, the condominium complex had been exposed to
normal violent wind and rainstorms. Beginning in 1993, Point Triumph began
experiencing problems with water penetration into buildings finished with a
siding material called Forestex. The
single building finished with cedar siding did not experience any water penetration
problems. Point Triumph sought coverage
for damage to the buildings sided with Forestex, alleging damage “‘as a result
of weather.’”[16] The insurance company denied coverage,
asserting that, based upon its investigation, the damage was due to failure of
the siding, i.e. the siding
“‘developed buckling’”[17]
and then wind blew rainwater under the siding, causing wet and dry rot in the
buildings.
The subject policy excluded loss resulting from
“fungus, decay, deterioration, hidden or latent defect or any quality in the
property that causes it to damage or destroy itself”[18]
and faulty workmanship or materials.
Based upon the record before it, the court found that the plaintiff’s
damages consisted of “‘fungus, decay, [and] deterioration,’” causes of loss expressly
excluded from coverage.[19] Further, the court found that the damage was
caused by faulty workmanship or materials, also expressly excluded from
coverage under the policy.
However, the plaintiff contended that the efficient proximate cause of its loss was covered wind-driven rain. The court disagreed, concluding that there was no evidence in the record that wind-driven rain, “a common phenomenon on the Oregon Coast,” would have damaged the plaintiff’s buildings absent defects in the materials or inadequacies in the construction or maintenance of the buildings.[20]
In granting the insurance company’s motion for summary judgment, the court opined:
The damage to plaintiff’s buildings was not a
“natural” direct or indirect consequence of the rain, but instead was an
abnormal occurrence that would not occur in the absence of other conditions, --
the faulty material, construction, or maintenance established by the record –
that were specifically excluded from coverage under the policy. . . . [T]he
rain cannot be characterized as the “dominant” or “most important” cause of
loss. Accordingly, a trier of fact
could not conclude that wind-driven rain constituted the efficient proximate
cause.[21]
The court also rejected the
plaintiff’s argument that the damage to the underlying structures of its
buildings was covered even if the siding was defective. The court declined to distinguish damage to
the buildings’ structure and damage to the siding, opining that damage to the
underlying structures was a “direct result” of the defects in material,
construction, or maintenance causes of loss excluded from coverage.[22]
Borton
& Sons, Inc. v. Travelers Insurance Co.[23] involved a situation in which Borton grew,
stored, and packed apples for sale in the domestic market. In January 1993, one of its storage
buildings collapsed due to ice and snow.
The building contained boxes of various types of apples, including a
number of boxes of Fuji apples. All of
the apples were exposed to leaking ammonia as well as the weather.
After being notified of the loss, Travelers sent adjusters to the site. They requested that Borton repack and sell as many of the apples from the damaged building as it could. Borton sold a good portion of the apples, including boxes of Fuji apples. Borton did not tell its customers that the fruit had been involved in a roof collapse or that it might have been exposed to ammonia.
Borton also sold Fuji apples that had been stored in buildings not involved in the collapse. However, the company could not sell some 1,089 bins of the undamaged Fuji apples, claiming that the domestic market for Fuji apples was in its infancy, with a limited customer base, and also that the sale of “inferior” apples from the damaged building eroded, in general, confidence in Borton’s Fuji apples.
Travelers declined to pay that portion of Borton’s claim for the 1,089 bins of Fuji apples. Borton then filed suit, alleging breach of contract and bad faith. The trial court granted Traveler’s motion for summary judgment and dismissed Borton’s claims. The Washington Court of Appeals affirmed.
The policy issued by Traveler’s contained a
clause that excluded coverage “for loss or damage caused by or resulting from .
. . [d]elay, loss of use or loss of market.”[24] Borton argued that its losses were caused by
“loss of market value,” not “loss of market” as provided for in the
exclusion. The court concluded that, to
the extent Borton claimed its loss was the result of conditions in the domestic
apple market, the exclusion applied to bar coverage. However, Borton contended that, even if the “loss of market”
exclusion applied to its loss, the “efficient proximate cause” rule required
the insurance company to pay for the loss because that loss resulted from a
covered roof collapse. The court
disagreed, ruling that the “efficient proximate cause” rule could not override
a policy exclusion for loss of market, and consequently found no coverage.
In State
Farm Fire & Casualty Co. v. Slade,[25]
during a severe storm, lightning struck a retaining wall attached to the
insureds’ house. The wall collapsed,
causing the ground to give way, which eventually resulted in the cracking of
the walls and ceilings in the house. The insureds sought coverage under their
homeowners policy. The insurance
company denied coverage based upon an earth-movement exclusion in the
policy. However, the insureds asserted
that the efficient proximate cause of their loss was the covered lightning and
that the application of the earth-movement exclusion would violate the
efficient proximate cause rule.
The Alabama Supreme Court disagreed with the
insureds, noting that, under Alabama law, insurance companies and their
insureds “are free to agree to any terms in a contract ‘so long as they do not
offend some rule of law or contravene public policy.’”[26] Therefore, at issue before the court was
whether the efficient proximate cause rule stated a principle of public policy.
The court determined that the rule did not state
a principle of public policy, and, if the court elevated the rule to a principle
of public policy, it would invade the province of the legislature. The court
concluded that the efficient proximate cause rule did not require it to
invalidate the policy’s earth-movement exclusion, “which indicate[d] [the
insurance company’s] efforts to contract for narrower coverage.”[27]
Accordingly, the court held that the insurance company was entitled to a
pre-verdict judgment as a matter of law with respect to the insureds’ claim
that covered lightning caused the soil movement that resulted in the insureds’
loss “because the earth-movement exclusion unambiguously exclude[d] coverage
for any loss caused in any way by earth movement and because that exclusion is
enforceable.”[28]
In Pieper
v. Commercial Underwriters Insurance Co., [29]
a brush fire caused by arson destroyed the insureds’ collection of rare
ceremonial masks. The insureds sought
coverage under an all-risk policy that contained an exclusion for loss or
damage to property caused by brush fire.
The insureds contended that the efficient proximate cause of the fire
was covered arson. At issue before the
California Court of Appeal was whether “arson” and “brush fire” constituted two
separate perils, thereby triggering the application of the efficient proximate
cause rule.
The court concluded that there was a
single cause of the fire – the excluded peril of “brush fire” and therefore the
efficient proximate cause doctrine did not apply. The court agreed with the insurance company that “‘just as a leak
cannot occur without a break in a pipe[], a brush fire cannot occur without a
source of ignition.’”[30] In affirming the trial court’s grant of
summary judgment in favor of the insurance company, the appellate court opined:
There are certain elements required to create a
fire—oxygen, combustible material and a source of ignition. By labeling this
fire as an ‘arson fire’ the [insureds] have artificially divided these
essential elements into separate perils, which thereby flies in the face of
common sense and the mutual intention of the parties.
We
find that the cause of the [insureds’] loss, damage to their fine arts
collection, was due to one cause, the brush fire. The cause of the brush fire
under the circumstances in which it was ignited seven miles from the
[insureds’] residence is irrelevant to the issue of coverage. The efficient
proximate cause doctrine does not apply.
“If every possible
characterization of an action or event were counted an additional peril, the
exclusions in all-risk insurance contracts would be largely meaningless.”[31]
Kish v.
Insurance Co. of North America,[32]
involved insureds who owned residences in a river basin. Heavy and continuous
rainfall caused high levels of water in the basin, which eventually broke
through protective dikes and damaged the insureds’ homes. The insureds sought coverage under their
all-risk homeowners policies, which expressly excluded coverage for losses
resulting directly or indirectly from flood and surface waters. The insureds contended, however, that the
efficient proximate cause of their loss was rain, a covered peril. At issue before the Washington Supreme Court
was whether rain and flood constituted two separate perils, thereby triggering
the application of the efficient proximate cause rule.
Looking
to the “plain, ordinary, and popular” meaning of the terms “rain” and “flood,”
the court determined that an average purchaser of insurance would expect the
term “flood” to include flood induced by rain.[33] Because there was only one cause of the
damage – rain-induced flood – that was “clearly and reasonably” excluded under
the policies, the court held there was no coverage.[34]
In
reaching its decision, the court commented that the purpose of the efficient
proximate cause rule is to provide a “‘workable rule of coverage that provides
a fair result within the reasonable expectations of both the insured and the
insurer.’”[35] In the case at bar, the court found that
application of the rule would circumvent the intentions and expectations of the
parties:
Plaintiffs lived on a nationally recognized
floodplain. The fact that their particular houses are located on parcels
usually not flooded does not detract from this fact. They knew that flood would be excluded by any insurance policy
they purchased, as exemplified by the existence of the National Flood Insurance
Program (of which Plaintiffs’ county was a part). . . . The insurance companies anticipated that
they would not have to pay for flood damage under their all-risk policies,
particularly where the risk of flood is high and the National Flood Insurance
Program applies. To construe rain as a
separate peril from flood in this case would fail to acknowledge the intent and
expectations of the parties.”[36]
B. Some
Representative “Coverage” Cases
In Tento International, Inc.
v. State Farm Fire & Casualty Co.,[37]
Tento rented space for its electrical equipment company. In making repairs to the roof covering
Tento’s business, the roofing contractor removed a portion of the roof, but
failed to install a temporary covering.
Rain fell and damaged Tento’s equipment. Tento sought coverage under a policy covering accidental direct
physical loss to property, unless the loss was “to the interior of any building
or structure, or the property inside any building or structure, caused by rain,
. . . unless: a. the building or structure
first sustains damage by an insured loss to its roof or walls through which the
rain . . . enters . . . .”[38] The trial court granted the insurance
company’s motion to dismiss, holding that the policy clearly excluded coverage
for the insured’s rain damage because the building did not first sustain damage
to its roof by an insured loss. The Ninth Circuit reversed.
The appeals court agreed with the
insured that the predominant or “‘most important cause of the loss’”[39]
was the roofing contractor’s negligence, not the rain. Because the contractor’s
negligence was the efficient proximate cause of the loss, the court held that
the loss would be covered, subject to any exclusions in the policy.
Bowers
v. Farmers Insurance Exchange[40] involved a situation in which Bowers owned a
rental house. Without her knowledge,
the tenants converted the basement of the house into a hothouse for growing
marijuana. The cultivation of the
marijuana caused damage, including the growth of mold throughout the
house. As described by the court:
[T]he tenants diverted all of the heat from the
furnace to the basement in order to create a marijuana grow room. They
irrigated the marijuana plants under grow lights. This created a sauna-like
environment in the basement. Additionally, they sealed the house and thereby
trapped the water vapor generated by their activities in the basement.[41]
Bowers sought coverage under a landlord’s
protection policy for warped paneling in the basement and the clean up of
mold-related damage. The insurance
company paid for the damaged paneling, but denied coverage for the mold damage,
asserting it was not covered under the policy.
The policy covered loss from vandalism, but not from mold. Bowers contended that her loss was covered
vandalism because the tenants willfully, wantonly, and recklessly damaged her
property. However, the insurance
company argued that Bowers’ loss was due to mold, and mold losses were
expressly excluded by the policy. At
issue was whether the efficient proximate cause of Bowers’ loss was the
tenants’ vandalism, a covered peril, or the mold, an excluded peril.
Under Washington law, when an insured peril is
the proximate cause of a loss, there is coverage, “even if subsequent events in
the causal chain are specifically excluded from coverage.”[42] In the case at bar, the court found that
there could be no reasonable difference of opinion regarding the proximate
cause of Bowers’ loss, holding that it was the tenants’ acts, which “‘in an
unbroken sequence . . . [produced] the result for which recovery is sought[.]’”[43]
II.
Ensuing Loss
Although
a loss may, at first glance, appear to fall within an exclusion, a property
policy may contain an exception to the exclusion for some, but not all, of the
damage. There are several types of ensuing
loss clauses. One type broadly covers
any loss occurring subsequent to an excluded loss, so long as that subsequent
loss is not excluded by the policy.[44] A second type
more narrowly covers losses subsequent to an excluded loss arising from
specified perils.[45]
A
covered ensuing loss that follows an earlier excluded cause of loss may be
related to or totally unrelated to that earlier loss. For example, a “related” cause of loss may occur when excluded
“faulty workmanship” or “earth movement” results in the breaking of a natural
gas line – an uncovered loss. But if
the natural gas was then ignited by a spark, thereby causing a second, separate
“fire” loss, the “fire” loss would be covered to the extent it could be
reasonably identified and distinguished from the earlier uncovered loss. A covered but “unrelated” ensuing loss may
occur, for example, when a covered lightning strike follows a loss resulting
from excluded “earth movement.” The
“lightning” damage would be covered to the extent it could be apportioned to
the lightning event and would be a second, separate covered loss. An interesting question arises in any
attempted apportionment between an excluded cause of loss and a separate,
second ensuing loss from a covered peril.
For example, what damage is there from the destruction by fire of
building materials incorporated into a building that was arguably already
worthless and uninhabitable as a result of an excluded faulty design or
workmanship?
Most
courts appear to agree that the ensuing loss clause is clear and
unambiguous. For example, in McDonald v. State Farm Fire & Casualty
Co., [46] the
Washington Supreme Court stated:
The
ensuing loss clause may be confusing, but it is not ambiguous. Reasonably
interpreted, the ensuing loss clause says that if one of the specified
uncovered events takes place, any ensuing loss which is otherwise covered by
the policy will remain covered. The uncovered event itself, however, is never
covered.[47]
Richland Valley Products, Inc. v. St. Paul
Fire & Casualty Co.,[48]
a case decided by the Wisconsin Court of Appeals, illustrates the application
of the ensuing loss clause. In Richland Valley, brine mixed with
ammonia in the insured manufacturer’s faulty ice cream machine, leading to
crystallization and precipitation of salts and resulting in clogged pipes. The insured’s policy excluded loss or damage
caused or made worse by “contamination” and contained the following ensuing
loss provision: “If a loss that would
otherwise be covered results from one of these causes, we’ll pay for the direct
loss that results.”[49] At issue was whether some portion of the
insured’s loss constituted a covered ensuing loss.
The court held that the insured’s
loss constituted excluded “contamination.”[50] The court reasoned that the initial contamination
of the ammonia by the brine led to a subsequent contamination loss resulting
from the crystallization and precipitation of salts, which eventually clogged
the system. The ensuing loss clause did
not apply because this subsequent contamination was not a loss that would
otherwise be covered under the policy.
In contrast, if the initial contamination had resulted in a fire, the
fire loss would have been covered under the ensuing loss clause because loss by
fire was a loss otherwise covered under the insured’s policy.[51]
A.
Direct Cause v. Ensuing Loss
The
purpose of an ensuing loss exception to an exclusion is to provide coverage
only for certain losses that occur subsequent to an excluded loss, “not to
enlarge the list of items covered under the policy.”[52] Therefore, courts seek to ensure that the
exception does not swallow the exclusion by precluding coverage for ensuing
losses that are “directly related to the original excluded risk.”[53] Absent a second, separate covered cause of
loss, there should be no coverage.[54]
For
example, in Alwart v. State Farm Fire
& Casualty Co.,[55] the insureds sought coverage under their homeowners
insurance for losses resulting from the buckling, wrinkling, and bulging of the
exterior wall surface of their house. It was undisputed that the problem was
due to contractor error and improper workmanship. The policy at issue provided coverage for any ensuing loss to
property not excluded or excepted by the policy. The ensuing loss clause was located in “Section I – Exclusions”
and was followed by a list of specific exclusions, including one for faulty
workmanship. The insureds conceded that
the policy excluded ensuing losses resulting directly from defective
workmanship. However, the insureds contended that their losses were an
“indirect” consequence of the faulty workmanship and were therefore
covered. The insureds gave as an
example of an indirect loss water damage resulting from defective flashing,
where the defective flashing was a non-covered, direct consequence of faulty
workmanship. The North Carolina Court
of Appeals disagreed with the insureds. It held that the policy excluded the
cost of repairing faulty workmanship, whether direct or indirect.
In
Acme Galvanizing Co. v. Fireman’s Fund
Insurance Co.,[56]
the California Court of Appeal expressly stated that, for an ensuing loss to be
covered, it must be an independent, covered peril separate from the initial
excluded peril. In Acme Galvanizing, a steel kettle in the insured’s galvanizing plant
ruptured, allowing several tons of molten zinc to spill, damaging or destroying
the surrounding equipment. The evidence
showed that an inadequate weld caused the rupture. The court ruled that the loss was caused by a latent defect,
which was excluded under the all-risk commercial property policy at issue.
However,
the insured contended that, even if the kettle rupture was caused by an
excluded latent defect, the discharge of the molten zinc that damaged or
destroyed the surrounding equipment was a covered “ensuing loss.” The court disagreed.
The
policy provided coverage for a loss precipitated by an excluded peril where the
“loss by a peril not otherwise excluded ensues and then the Company shall be
liable for only such ensuing loss.”[57] The court interpreted this language to
provide coverage only for an ensuing loss arising from a separate, independent,
but covered peril resulting from the original excluded peril. The court concluded that, in the case at
bar, the ensuing loss clause did not apply to provide coverage for the
insured’s loss. It reasoned that:
[T]here was no peril separate from and in
addition to the initial excluded peril of the welding failure and kettle
rupture. The spillage of molten zinc
was part of the loss directly caused by such peril, not a new hazard or
phenomenon. If the molten zinc had
ignited a fire or caused an explosion which destroyed the plant, then the fire
or explosion would have been a new covered peril with the ensuing loss covered. That did not occur.”[58]
Like the California Court of Appeal in Acme Galvanizing, the Fifth Circuit
Court of Appeals in Alton Ochsner Medical
Foundation v. Allendale Mutual Insurance Co.[59]
recently concluded that a covered ensuing loss must be distinct from the
initial loss. In Alton, the insured sought coverage under an all-risk policy for
costs associated with the repair of cracks in the foundation of a building
under construction. In part, the policy did not insure against “faulty
workmanship,” “settling [or] cracking . . . , unless physical damage not excluded
by this Policy results, in which event, this Policy will cover only such
resulting damage.”[60]
The insured conceded that the initial cracking
of the foundation, which was only minor in extent, fell under one or both of
the exclusions. However, the insured
argued that later, more severe cracking occurred, described as “‘material impairment of structural
integrity,’” that constituted “resulting damage” covered under the policy.[61] In contrast, the insurance company argued
that the language at issue referred to physical damage that was “‘distinct and
separable’” from the excluded damage and made no quantitative distinction
between major and minor damage.[62]
The Fifth Circuit Court of Appeals agreed with
the insurance company, concluding that “‘resulting physical damage’” was
“different in kind, not merely different in degree”[63]
and perceiving no basis for the insured’s distinction between minor damage and
material impairment of structural integrity. The court concluded that
[D]irect harm from cracking or faulty design or
construction is excluded (no matter how severe it is) “unless physical damage
not excluded by this Policy results,” that is, unless damage of a different kind – a kind that is not excluded –
results. . . . [M]inor damage to the foundation does not “cause” the more
severe structural impairment. The cracking is
the impairment; they are synonymous.[64]
B. Builders’ Risk Insurance and Ensuing Loss
Builders’
risk insurance is a specialized type of temporary property insurance that
insures a building during the course of construction. Like other property insurance, builders’ risk policies may
contain exclusions modified by ensuing loss language. An example is a faulty workmanship exclusion, which may provide
that the policy does not cover the
“‘[c]ost of making good faulty or defective workmanship, material,
construction or design, but . . . shall not apply to the damage resulting from such faulty or defective
workmanship, material, construction or design.’”[65]
In
Allianz Insurance Co. v. Impero,[66]
the court held that a claim for bad concrete resulting from faulty inspection
was excluded under the above-quoted exclusion.
In that case, the insured contractor sought coverage for repairs to
deficiencies in the concrete wall of a building. The evidence showed that the “bad” concrete resulted from a
number of factors, including an erroneous determination by an inspector that
the concrete mix had an adequate water content. The insurance company argued that the faulty workmanship
exclusion barred the claim. The
insured, however, contended that the inspector’s error led to damage resulting
from that error within the meaning of the exception.
The court agreed with the insurance
company, reasoning that the sole claim was for the cost of correcting the
deficiencies in the concrete, not for correcting damage to some other portion
of the work. The court concluded that,
“when a contractor assumes the obligation of completing a structure in
accordance with plans and specifications and fails to perform properly, he cannot
recover under the all-risk policy for the cost of making good his faulty work.”[67]
In contrast to the court in Impero, some courts have held that the
“damage resulting from” language in a “cost of making good” exclusion permits
coverage for faulty workmanship. For
example, in Rosenberg v. First State
Insurance Co.,[68]
the insureds had a builders’ risk policy, which they had obtained for a
commercial building they were constructing. The policy covered lost rents due
to “untenantability, caused by damage to or destruction of the building . . .
by the peril(s) insured against during the term of this policy . . . .” and
also contained a “cost of making good” exclusion.[69]
The insureds did not complete the
building on schedule due to damage resulting from faulty workmanship. Although the damage rendered the building
“untenantable,” the insurer refused to compensate its insureds for the
resulting loss of rental income. It
argued that faulty workmanship was not a covered peril under the exclusion and
therefore there was no coverage for lost rents.
The court disagreed, finding that
the exclusion did not establish that faulty workmanship was not a covered
peril. The court concluded:
To
the contrary, the phrase stating this exclusion goes on to clarify that ‘this
exclusion shall not apply to damage resulting from such faulty or defective
workmanship, material, construction or design.’ Because damage resulting from
defective workmanship is expressly covered by the policy, the conclusion is
inescapable that the faulty workmanship is a covered peril.[70]
Similarly, in National Fire Insurance Co. v. Valero Energy Corp.,[71]
the court held that an exception for damages “arising as a consequence” of
faulty workmanship covered a loss due to the use of inadequately-designed components.
In that case, during the testing phase of an oil refinery expansion project, a
scrubber sustained substantial damage as a result of faulty design. As a consequence, the insured had to shut
down the refinery to make repairs and alterations. The builders’ risk policy at issue excluded the cost of making
good faulty workmanship, materials, construction, or design, but excepted
“physical loss or damage arising as a consequence of faulty workmanship,
material, construction or design.”[72]
The court reasoned that the loss at
issue could be characterized in one of two ways: (1) the use of inadequate components required the insured to
replace them to “make good” the faulty design; or (2) as a consequence of the
faulty design and the inadequacy of the components, there was physical damage
to the components necessitating their replacement. Adopting a construction of the exclusionary clause favoring the
insured, the court characterized the loss “as a consequence of” the faulty
design, thereby bringing the loss within the exception to the exclusion and
thus within the coverage of the policy.[73]
Both Rosenberg and Valero Energy
construed the “damage resulting from” or “damage as a consequence” language to
provide coverage for faulty workmanship.
In the context of builders’ risk policies, some courts have established
a rule that damage to the product, such as a building under construction,
caused by negligence is covered pursuant to such language. This contrasts sharply with the reasoning of
courts that exclude coverage for faulty workmanship when the exclusion is
modified by “ensuing loss” language.
For example, in Tzung v. State Farm Fire & Casualty Co.,[74]
the insureds purchased a nine-unit apartment building. At the same time, they obtained an
“Apartment Special Form” policy that insured “‘against all risks of direct
physical loss’” not otherwise excluded.[75] The policy excluded, in part, “loss caused
by . . . faulty materials or workmanship unless
loss by fire or explosion not otherwise excluded ensues. . . .”[76]
Within a year after purchase, the
insureds noticed cracks in the building and driveway and sought coverage for
their losses. They contended that the
apartment was damaged by the contractor’s negligence in improperly constructing
the building, arguing that the contractor’s negligence was an included peril
under the policy. In other words, the insureds contended that if the rule
applied in builders’ risk policies applied to their all-risk commercial
property policy, the faulty workmanship exclusion in their policy would not
apply to bar coverage for losses caused by the negligent design and
construction of their apartment building.
The insurance company, on the other hand, argued that the faulty
workmanship exclusion precluded recovery.
The Ninth Circuit Court of Appeals
agreed with the insurance company, concluding that the faulty workmanship
exclusion unambiguously barred recovery of losses caused by defects in the
design and construction of the insureds’ building. The court commented that “only a strained interpretation of the
exclusion for faulty workmanship would permit recovery for losses caused by the
negligent design and construction of the [insured’s] apartment building.”[77]
In declining coverage, the Tzung court concluded that the faulty
workmanship exclusion at issue unambiguously excluded losses caused by the
defective construction and design of the insureds’ building. The court reasoned that “this rule does not
necessarily have any meaning in the context of this all risk policy, mainly
because the exclusion here clearly states that damages caused by faulty
workmanship are not covered unless a fire ensues.”[78]
C. “Ensuing Loss” Clauses vs. “Unless” Clauses
It may be important to distinguish
an “ensuing loss” exception to an exclusion from a so-called “unless” clause
following an exclusion. For example, in
Libbey-Owens-Ford Co. v. Insurance Co. of
North America, [79]
the wear and tear exclusion in the policy at issue contained an “unless” clause
“excluding coverage for ‘wear and tear . . . unless such loss is caused
directly by physical damage not otherwise excluded in this policy . . .’”[80]
The insured argued that the “unless”
clause referred to “loss from wear and tear not excluded by other sections of
the policy.”[81] In effect, the insured contended that the
specific wording of the wear and tear exclusion required the court to look
beyond the initial wear and tear damage to determine whether any other loss or
damage was caused by “damage not otherwise excluded in this policy.”
However, the Sixth Circuit Court of
Appeals rejected the insured’s argument, noting that the cases cited by the
insured were “inapposite because they construe ‘ensuing loss’ clauses, not
unless clauses like the one at issue here.”[82] The appeals court explained that “[a]n ensuing
loss clause provides, for example, that the policy excludes loss caused by
mechanical breakdown, ‘unless an insured peril ensues and then only for the
actual loss or damage caused by such ensuing peril.’”[83]
IV.
Opting Out:
Anti-Concurrent Causation Clauses – Freedom Of Contract
In order to preclude application of
the efficient proximate cause doctrine, insurance companies have added language
to all-risk policies providing that loss or damage is excluded “‘regardless of
any other cause or event that contributes concurrently or in any sequence to
the loss.’”[84] Most courts that have addressed the issue
have found such exclusionary language enforceable.[85] Courts generally reason that the parties to
an insurance contract can opt out of the efficient proximate cause doctrine by
clear and unambiguous exclusionary language.[86]
For example, Toumayan v. State Farm
General Insurance Co.[87]
involved a period of unusually heavy rains in the St. Louis, Missouri
area. The land at the rear of the
insureds’ property moved downward and away from their home, causing the
concrete patio and retaining wall to subside.
The insureds sought coverage under their homeowners policy for the
loss. The insurance company denied
their claim.
Sometime later, the insureds had a
large portion of the land at the rear of their residence excavated for the
purpose of stabilizing the land and replacing the destroyed patio and retaining
wall. During the excavation, the
insureds discovered a broken sewer line leading from underneath their residence
out toward the rear of their home and found evidence of previous attempts at
repair or remediation. The insureds
eventually brought suit against the insurance company, alleging breach of
contract and vexatious refusal to pay.
The trial court granted summary judgment in favor of the insureds on the
breach-of-contract claim and in favor of the insurance company on the
vexatious-refusal-to-pay claim. The
insurance company appealed. The Missouri Court of Appeals reversed on the
breach-of-contract claim.
The policy at issue contained an
earth movement exclusion, barring coverage for “the sinking, rising, shifting,
expanding or contracting of earth, all whether combined with water or not.”[88] The appeals court found the exclusion
applied to bar the insureds’ loss. However, the insureds argued that the cause
of their loss was water saturation from the broken sewer pipe, a peril
specifically covered by a “Back-Up of Sewer or Drain Endorsement.” Therefore,
it was irrelevant that the resulting damage was caused by an excluded peril, i.e. earth movement. The insureds’
argument thus relied upon an application of the efficient proximate cause
doctrine.
As explained by the court:
If the language of the sewer endorsement covered
the specific facts of this case and the efficient proximate cause doctrine
applied, then plaintiffs [the insureds] could recover under the policy because
a covered risk under the endorsement, a broken sewer pipe, set in motion a
sequence of events which ultimately caused the loss from an excepted risk,
earth movement.[89]
However, the court opined that the
efficient proximate cause doctrine could be applied only if the policy did not
contain pertinent exclusionary language or was ambiguous. The policy contained the following exclusionary
language:
We do not insure under any coverage for any loss
which would not have occurred in the absence of one or more of the following
excluded events. We do not insure for such loss regardless of:
(a) the cause of the excluded event; or
(b) other causes of the loss; or
(c) whether other causes acted concurrently or
in any sequence with the excluded event to produce the loss; or
(d) whether the event occurs suddenly or
gradually, involves isolated or widespread damage, arises from natural or
external forces, or occurs as a result of any combination of these: [Listed
Exclusions].[90]
The Toumayan court found this exclusionary language was “unambiguous”
and prevented application of the efficient proximate cause doctrine.[91] The court therefore reversed the trial court’s
grant of summary judgment in favor of the insureds and remanded the case to the
trial court.[92]
Although most jurisdictions find
anti-concurrent clauses enforceable, there are some exceptions. For example, in Safeco Insurance Co. of America v. Hirschmann, [93]
the Washington Supreme Court, relying upon its prior decisions, expressly held
that “[w]hen an insured risk sets into operation a chain of causation in which
the last step may be an excluded risk, the [anti-concurrent cause] exclusion
will not defeat recovery.”[94] The court did comment, however, that such a
clause “may operate to circumvent coverage for losses resulting from causal
chains in which excluded perils are the only proximate causes, or chains in
which an excluded peril is the efficient proximate cause.”[95]
Similarly, in Murray v. State Farm Fire & Casualty Co.,[96]
the high court of West Virginia declined to enforce an anti-concurrent
causation clause like that quoted above, finding that enforcement would
conflict with the reasonable expectations of the parties. Relying upon the California Court of Appeal
opinion in Howell v. State Farm Fire
& Casualty Co.,[97]
discussed previously, the West Virginia court reasoned that “‘[n]o reasonable
person would pay for insurance against some future peril if it were possible
for the insurer to avoid liability by discovering an excluded peril somewhere
in the chain of causation.’”[98] The court concluded that, because the
anti-concurrent causation clause at issue conflicted with what the court
considered to be the reasonable expectations of the parties, the clause should
be construed “to allow coverage for losses proximately caused by a covered
risk, and [to] deny coverage only when an excepted risk is the efficient
proximate cause of the loss.”[99]
In California, federal and state
courts disagree as to whether anti-concurrent causation language is
enforceable. Thus, in State Farm Fire & Casualty Co. v. Martin,[100]
the Ninth Circuit Court of Appeals affirmed a California federal district
court’s holding that anti-concurrent causation policy language is
enforceable. This occurred in a
diversity case in which the federal court was trying to predict what the
California Supreme Court would ultimately do when faced with the issue of enforcing
or refusing to enforce anti-concurrent cause language. The policy at issue provided: “We do not insure for such loss regardless
of: a) the cause of the excluded event; or b) other causes of the loss; or c)
whether other causes acted concurrently or in any sequence with the excluded
event to produce the loss.”[101]
In contrast, under California Insurance Code
section 530:
An insurer is liable for a loss of which a peril insured against was the proximate cause, although a peril not contemplated by the contract may have been a remote cause of the loss; but he is not liable for a loss of which the peril insured against was only a remote cause.[102]
Notwithstanding section 530, the
appeals court agreed with the district court that “‘[a]n insurance company has
the right to limit the coverage of a policy issued by it and when it has done
so, the plain language of the limitation must be respected.’”[103] The appeals court concluded that section 530
“provides guidance when a policy is silent on concurrent causation; it does not
prohibit inclusion of a provision similar to the concurrent causation provision
[in the policy at issue].”[104]
The California Supreme Court has not spoken on
the issue. However, in Howell v. State Farm Fire & Casualty Co.,[105]
the California Court of Appeal concluded that a property insurer cannot
contract out of coverage when a covered peril is the efficient proximate cause
of the loss, even though an excluded peril has “contributed or was necessary
to” the loss.[106] The court explained that California
statutory and judicial law make an insurance company liable “whenever a covered
peril is the ‘efficient proximate cause’ of the loss, regardless of other
contributing causes.”[107]
V.
Causation and Appraisal
When a policyholder and its
insurance company disagree on the amount of a property loss, the appraisal
provision generally found in all-risk policies allows either party to make a
written demand for an appraisal of the loss.
Such a provision typically directs each party to select a competent and
impartial appraiser, who then select an umpire. Each appraiser separately
states the actual cash value, the amount of loss, or the cost of repair or
replacement. If the appraisers fail to agree, they submit their differences to
the umpire. A decision agreed to by any
two is binding on the parties.
However, courts sometimes disagree
as to the scope of the appraisal. Does
the “amount of loss” include a determination of the “cause” of that loss? Some courts squarely hold that appraisers
may not consider causation, other courts squarely hold that appraisers may
consider causation, and there are still other courts that express a more
ambiguous view.[108]
A. Some
Representative Cases Holding that Appraisers May Determine Causation
In 201 N.
Wells, LLC. v. Fidelity & Guaranty Insurance Co.,[109]
a case being handled by the authors’ office, the court found that “determining
the cause of the damages is inherent to the appraiser’s duties.”[110] In Wells,
a float valve in the insured building’s tower water tank malfunctioned, causing
a large volume of water to cascade through the building. All 30 floors of the building sustained
water damage. The malfunction occurred
during a weekend, when the building was largely unoccupied, and consequently
was not discovered immediately.
Pursuant to its insurance policy, 201 N. Wells, LLC (“201”) sought
coverage for water damage to the building “caused by accidental discharge or
leakage of water as a direct result of the breaking or cracking of any part of
a system or appliance containing water or steam.”[111] As required by the policy, 201 filed a Proof
of Loss, claiming almost $8 million in damages and more than $1 million in
supplemental damages under the replacement cost coverage of the policy.
The insurance company undertook its own
evaluation of the loss and then made two settlement offers, both of which were
rejected. Finding a dispute as to the
amount of the loss to the building, the insurance company demanded an appraisal
under the policy’s appraisal provision.
201 did not deny that the appraisal provision at
issue was enforceable under Illinois law or that it was a generally valid
contractual provision. Rather, 201
asserted that the provision did not apply in the case at bar because the
parties were not disputing the value
of the property or the amount of loss.
Instead, they were disputing the causes
of the loss and whether the insurance company was liable for that portion of
the damage it claimed that 201 caused by failing to dry out the building. According to 201, its own estimates included
asbestos-, fungi- and mold-related damage to the building resulting from and
occurring after the water damage, whereas the insurance company’s estimates
evaluated the damage as if the building had been dried out.
The court commented that an appraisal provision
is used to determine the amount of damages, not liability. Nevertheless, the court found the provision
applicable to the instant case even though the parties had used allegedly
different methods to determine the loss, pointing out that “disagreements over
the amount of loss often occur for precisely this reason.”[112] Moreover, “[a] finding that the parties can
ignore a demand for appraisal in such situations would render the provision
meaningless in many cases.”[113] However, the court noted that the insurance
company could not direct its appraiser to ignore certain types of damage to the
building because the insurance company had already decided that it was not
liable for that particular type of damage; “[s]uch behavior would also render
an appraisal (and therefore appraisal provisions) largely useless if a court
subsequently decides that liability does
exist for the type of damage the insurer excluded from the appraisal process.”[114] The court concluded that an appraiser’s
proper duty is to evaluate the amount of damage to covered property, after
which the insurance company can apply any alleged mitigating factors.
The court required the appraisers not only to
evaluate the amount of damage to the building, but also to determine the amount
of loss caused by water damage and the amount of loss caused by asbestos, mold,
and fungi. Finding that a determination
of causation is “inherent” in the duties of an appraiser, the court gave the
following illustration: “For example,
if a building has damage before a covered event occurred, the appraiser cannot
determine the amount of loss without evaluating what damage was caused by the
covered event and which damage was caused, for instance, by previous wear and
tear.”[115]
In granting the insurance company’s
stay pending the appraisal, the court concluded that, if it found that the
insurance company was not ultimately liable for the full amount of damage to
the building, the appraisers’ assessment as to each type of damage “will avoid
the need for additional litigation.”[116]
Similarly, in CIGNA Insurance Co. v. Didimoi Property Holdings, N.V.,[117]
the court ruled that causation is a matter for an appraiser, not the
court. In CIGNA, a fire started in a tenant file storage room of the insured
building, causing severe damage and rendering the building unusable. Following the fire, the insureds (the
building owner and the mortgagee) and the insurance company unsuccessfully
attempted to reach an agreement on the amount of loss, including the extent of
the fire damage and the cost to repair or replace the building. Notwithstanding their disagreement over the
amount of loss, the insurer paid more than $18,000,000 to initiate repairs and
$5,000,000 for business interruption.
Pursuant to the policy, the insureds filed their
sworn proof of loss for approximately $92,000,000. The insurance company rejected the proof of loss as excessive and
invoked the policy’s appraisal provision.
The insureds argued for a narrow construction of the phrase “amount of
loss,” limiting the appraisers to determining the amount of money necessary to
repair or replace the damages without determining the cause of the loss or the
amount of the covered loss. On the
other hand, the insurance company contended that at issue was the extent of the
fire damage, a question concerning the amount of loss and therefore
appropriately determined by the appraisers.
The court agreed with the insurance company,
concluding that, “in the insurance context, an appraiser’s assessment of the
‘amount of loss’ necessarily includes a determination of the cause of the loss,
as well as the amount it would cost to repair that which was lost.”[118] The court reasoned that its conclusion was
consistent with the plain meaning of the terms “amount of loss” and “loss,”
commenting that the insureds confused “coverage” and “amount of loss.”[119] In distinguishing Auto-Owners Insurance Co. v. Kwaiser,[120]
a Michigan case relied upon by the insureds, the court opined:
Unlike the instant case, the parties in Kwaiser did not merely contest the scope
or extent of the damage, rather the parties in Kwaiser raised the issue of whether that damage was excluded under
the policy. Because questions involving the application of policy exclusions
are legal questions concerning liability and coverage, they are not, as the Kwaiser court correctly concluded, within
the appraiser’s authority.[121]
B. Representative
Cases Holding that Appraisers May Not Consider Causation
In Wausau Insurance Co. v. Herbert Halperin Distribution Corp.,[122] the insureds discovered that a portion of the roof of an insured building had collapsed. An independent inspection concluded that the collapse was due to framing members and plywood that, due to long-term exposure to water, were rotten and decayed by fungus and mold. The insurance company offered to pay $56,000 as satisfaction of th