Establishing Severity

Exactly what is the scope of the problem? A Florida Department of Health study found that the drywall in question emits “volatile sulfur compounds,” and contains traces of strontium sulfide. It has been suggested that Chinese drywall causes a chemical reaction that releases a stench similar to that of rotten eggs. It also corrodes metal. Ultimately, it could cause damage to the structure itself, appliances, attachments, and personal property. In certain situations, the entire property may be condemned, requiring that the building be torn down. Perhaps most significantly are the potential health-related effects to the individuals who have been living in homes containing Chinese drywall.

Indeed, the issue and its possible implications for public health have led a number of states to investigate the problem. The Louisiana Department of Health reports that it has received complaints from at least 350 people about the Chinese drywall issue. In April 2009, Governor Charlie Crist of Florida wrote to the heads of the Environmental Protection Agency (EPA) and the Centers for Disease Control and Prevention (CDC), seeking assistance to assess human health exposures. In the letter, Crist also advised that reports from other states such as Louisiana, Virginia, and North Carolina have shown that this issue warrants multi-state attention.

So what does this all mean for the claim professional who thought the 2004-2005 storm season was a thing of the past? The proverbial bottom line is this: a boomerang of claims related to the storms of 2004 and 2005 should be anticipated if the property in question was rebuilt or repaired with Chinese drywall.

Tip of the Litigation Iceberg?

Professionals in the first-party property insurance business should take note of the recent litigation involving the allegedly defective drywall. The case of Vickers et al. v. Knauf Gips KG, et al. — one of two class-action lawsuits involving Chinese drywall filed in March 2009 in Florida district court — was initiated by a group of plaintiffs/homeowners against parties involved in the manufacture, distribution, and sale of this product, as well as homebuilders.

The Vickers lawsuit did not name a first-party property insurer as one of the defendants. Still, an analysis of the allegations made by the Vickers plaintiffs is informative and enlightening for purposes of evaluating whether these claims might be covered under a homeowner's policy as well as contemplating what the anticipated scope of losses an insured might seek if and when filing a claim against the carrier.

The Vickers plaintiffs assert that the drywall in question contains latent defects and is “inherently defective because it emits various sulfide gases and/or other chemicals through 'off-gassing' that causes property damage and potential health hazards.” This, in turn, “causes corrosion … of air-conditioner and refrigerator coils, microwaves, faucets, utensils, copper tubing, electrical wiring, computer wiring, personal property, electronic appliances, and other metal surfaces and household items.” According to the Vickers plaintiffs, repairs are not an option because they allege that “there is no repair that will correct the defect.”

The other class-action lawsuit, Riesz, et al. v. Knauf Plasterboard, et al., further describes the cause and effect of the damages. According to that class-action complaint, Chinese drywall “is defective in that it emits levels of sulfur, methane, and/or other compounds that cause corrosion of air-conditioner and refrigerator coils, copper tubing, electrical wiring, and other materials, as well as creating noxious, foul-smelling odors that can be harmful to humans and pets.”

The litigation that has popped up in Florida may just be chapter one of the story. Moreover, while the cases that have graced the courts thus far have involved claims against those involved in the construction of these properties, it is possible that future cases might involve breach-of-contract actions, petitions for declaratory relief, or demands for appraisal by insureds against their first-party property insurers.

By using any search engine and plugging in the words “Chinese drywall lawsuits,” one will come up with any number of results, such as “Do you believe you have defective drywall in your home?” or “Help is available for you if your home was constructed with Chinese drywall,” from plaintiffs' firms that are offering legal services to homeowners.

With plaintiffs' counsel actively seeking clients, insurers should expect more litigation in the months and years to come associated with drywall-related cases, possibly involving first-party claims.

Implications for Insurers

With the possibility of first-party litigation on the horizon, the question facing insurance claim professionals is as follows: Will a claim filed by an insured involving alleged defective Chinese drywall be covered under a homeowner's policy?

Obviously, there is no absolute answer to this question. Nevertheless, there are certain general guidelines that may be considered while exploring this issue. By way of example, a universal governing principle in insurance law is that a contract of property insurance will give rise to liability only if the loss sustained is within the coverage as set forth by the contractual language of the policy, and is not otherwise excluded. Another general rule in the realm of insurance law is that a court is prohibited from rewriting the terms of an insurance contract as bargained for by the parties to find coverage for a loss if the four corners of the policy does not include such coverage.

Therefore, determining whether coverage is afforded for a particular loss must be evaluated on a case-by-case basis (see sidebar, Three-Prong Approach to Coverage). Under the facts of a case involving latent defects and faulty manufacturing or repair associated with Chinese drywall, an insured might file a claim for the loss of the entire structure, its contents, and for loss of use associated with additional living expenses involving temporary housing. While considering this type of loss, a claim professional might note that the following contractual language may be included in the insuring instrument:

“We insure against risk of direct loss to property described in Coverages A and B only if that loss is a physical loss to property. We do not insure, however, for loss … caused by … any of the following: (2) Inherent vice, latent defect, mechanical breakdown ….”

The insurance contract could also very well include the following language under the exclusions section of the policy:

“We do not insure for loss caused directly or indirectly by any of the following. Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to the loss … faulty, inadequate, or defective: … 2) Design, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction; … materials used in repair, construction, renovation, or remodeling ….”

In accordance with the aforementioned contractual language, and without consideration of any other language within the insuring instrument or endorsements thereto, it appears that coverage would likely not be found for claims for structural losses, additional living expenses, and personal property under most homeowners' policies in light of the provisions excluding losses associated with latent defects as well as faulty, inadequate, or defective workmanship, repair, construction,” and “materials used in repair, construction, renovation, or remodeling.” Again, however, the policy as a whole must be evaluated to address any specific claim.

Indeed, the language cited above should be just the starting point for purposes of considering whether such losses might or might not be covered. An important step in the process is conferring with either in-house or outside defense counsel experienced in insurance law to determine whether under the facts of a particular situation, the insurance contract in question affords or does not afford coverage for the claim in question.

Yet another issue of interest to first-party insurance carriers is the potential for subrogation against those parties involved in the sale, manufacture, distribution, and use of Chinese drywall. Additionally, in situations where the insurer has been named in a first-party lawsuit by its insured, the carrier might consider filing a counter-claim against those aforementioned entities.

Finally, as the Chinese drywall dilemma constitutes an ever-evolving dilemma, insurance professionals should continue to monitor the situation as further developments occur.