See Net Operating Losses and Business Income Insurance.

Losses Resulting from Drain Backup

The insured owner of apartment buildings brought an action against the property insurer after the insurer denied coverage for flooding of basement apartments from waste water entering the buildings through drains. This case is Pichel v. Dryden Mut. Ins. Co., 986 N.Y.S.2d 268 (2014).

The insured, Pichel, owned a four building apartment complex and two of the four sustained water damage when waste water entered the first-floor apartments through toilets, bathtubs, and drains. After a claim was filed, the insurer, Dryden Mutual, denied coverage based on the water damage exclusion. This exclusion stated that the policy did not apply to loss caused by water that backs up through sewers and drains. The exclusion also denied coverage for loss caused by repeated or continuous discharge or leakage of liquids from within a plumbing system; an exception to this exclusion allows coverage for loss caused by the accidental leakage, overflow, or discharge of liquids or steam from a plumbing system.

The insured filed a lawsuit over the coverage dispute and the Supreme Court, Tompkins County, ruled in favor of the insured. This appeal followed.

The Supreme Court, Appellate Division, Third Department, New York, said that in its view, when the exclusion and coverage provisions at issue in this case are read together, an ambiguity exists as to losses resulting from a backup and/or overflow from sewers, drains, and/or plumbing systems. Listing cases from other jurisdictions for support, the court stated that water damage caused by backup/overflow that originates from a pipe or clogged drain located within the insured's property line comes from the insured's plumbing system and is covered by the policy; conversely, if the cause of the backup/overflow is from outside the insured's property boundaries, the sewer or drain exclusion is applicable.

The court went on to state that the insurer failed to establish that its interpretation—that the loss is excluded from coverage so long as water backs up through a sewer or drain regardless of where the sewer or drain is located—is the only fair interpretation of the policy provisions. Furthermore, the insurer's interpretation of the exclusion provision essentially renders meaningless the coverage for overflow or liquids from a plumbing system as provided in the coverage provision. Accordingly, the appeals court ruled that the trial court correctly resolved the ambiguity in the insured's favor.

However, the court then said that the trial court erred in granting the insured's motion for partial summary judgment. As the moving party, the insured was required to prove that a loss occurred and that such loss was a covered event under the terms of the policy. In the viewpoint of the appeals court, the insured failed to offer sufficient admissible evidence to demonstrate the absence of any factual issues as to whether he suffered a covered loss. The testimony regarding comments made by the claims adjuster and the engineer with respect to the origination of the backup was inadmissible hearsay. So, the court ruled that the dearth of admissible evidence showing the actual cause of the damage warranted the denial of the insured's motion for partial summary judgment on the issue of liability.

The ruling of the trial court was affirmed as to the ambiguity of the policy terms but was denied as to the granting of the insured's motion for partial summary judgment.

Editor's Note: Regardless of the final outcome of this coverage dispute, the point to be made here is that, as a matter of first impression, the Supreme Court, Appellate Division, New York, declared that plumbing systems included drains that were on the insured's property. Cases from Washington, North Carolina, Florida, Pennsylvania, and Colorado were cited in support of this proposition.

Playing the Float

The provider of money transfer services brought an action against the insurer seeking reimbursement for losses sustained as a result of the armored transfer company “playing the float.” This case is Omnex Group v. United States Fire Ins. Co., 985 N.Y.S.2d 73 (2014).

The insured, Omnex, a provider of money transfer services, contracted with Armored Money Services (AMS) for AMS to pick up money held by the insured's agents in various locations for delivery to its account at Wells Fargo Bank. AMS picked up the money but failed to wire it to the insured's account by the next business day. Later, two officers of AMS and an affiliated company were arrested by the FBI and subsequently admitted to engaging in a practice known as “playing the float”; this is using the continual influx of cash to cover the operating expenses of AMS and the affiliated company, repay prior obligations to other customers, and make officer loans.

The policy issued to Omnex by United States Fire provided coverage for loss of money outside the premises in the care and custody of an armored motor vehicle company resulting directly from theft, disappearance, or destruction. After the insurer denied the claim of the insured, the insured sued for coverage. The trial court ruled in favor of the insured and this appeal followed.

The Supreme Court, Appellate Division, First Department, New York, noted that the trial court correctly found that the insured's loss resulted from disappearance. Although the policy does not define that term, disappearance has, in other theft policies, meant not only a disappearance, but also a possible theft. The undisputed evidence in this instance, said the court, establishes that AMS did not deposit the funds into the insured's account the day after picking them up but retained the funds for its own purposes. In other words, there was a theft in that “there was an unlawful conversion of covered property to the involuntary deprivation of the rightful owners and to the illicit gain of the perpetrators.” The ruling of the trial court was affirmed.

The appeals court then rejected the insurer's argument that the loss comes under the policy exclusion for governmental seizure of property since the theft occurred several days before the FBI's seizure of the money. The theft occurred when AMS failed to deposit the money into the account of the insured.

Editor's Note: The Supreme Court, Appellate Division, New York saw the facts of this incident clearly matching the wording of the insuring agreement in that there was a loss of money outside the premises of the insured while in the custody of an armored motor vehicle and that the loss resulted directly from a theft or a disappearance. The court used Black's Law Dictionary to define “disappearance” since the policy itself did not offer a definition.

Coverage for Ongoing Operations after Operations Are Completed

The general contractor and its insurer commenced an action against the subcontractor's insurer alleging a breach of the duty to defend arising from claims of negligent construction. This case is Woodward v. Acceptance Indem. Ins. Co., 743 F.3d 91 (5th Cir. 2014).

Pass Marianne, L.L.C. contracted for the construction of condominiums on the Mississippi Gulf Coast. The general contractor was Appellee Carl E. Woodward. Among the subcontractors was DCM Corporation, L.L.C., who entered a contract with Woodward for the concrete work. In November 2005, DCM obtained a CGL policy from the Appellant, Acceptance Indemnity Insurance Co. DCM worked on the project from January to October 2006. The entire project was completed in August 2007. In October 2007, Pass Marianne sold the condominiums to Lemon Drop Properties. 

A year after purchasing the condominiums, Lemon Drop brought suit in Mississippi state court against its seller, Pass Marianne, and against Woodward. It sought rescission and actual and punitive damages for breach of contract and for gross negligence. Pass Marianne filed a cross-claim against Woodward alleging faulty construction and damage arising out of the construction. The claims were eventually arbitrated. One of the most significant issues in the arbitration was the fault of the concrete subcontractor, DCM. 

Woodward was an additional insured under the CGL policy that Acceptance issued to DCM. After Pass Marianne asserted its claims, Woodward through counsel demanded on May 6, 2009, that Acceptance provide a defense and indemnity. Woodward sent to Acceptance the complaint in the lawsuit and a report Pass Marianne had commissioned from the Rimkus Consulting Group, which stated conclusions about the nature and effect of the defective work.

Acceptance refused to defend Woodward based on language in a policy endorsement that limited coverage for the additional insured, Woodward. The endorsement stated that the additional insured was an insured “but only with respect to liability arising out of your ongoing operations performed for that insured.” There was another exclusion that stated the insurance did not apply to bodily injury or property damage occurring after all of the work has been completed. 

After Acceptance and other insurers refused to defend, Woodward and its insurer, Gray Insurance Company, filed a new suit in October 2009 in Mississippi state circuit court against Acceptance and several other insurers. Woodward and Gray claimed these defendant insurers failed to defend and indemnify Woodward in the arbitration. The case was removed to the United States District Court for the Southern District of Mississippi. By October 2010, all insurers settled except Acceptance. Woodward, Gray, and Acceptance filed motions for summary judgment. The district court held that Acceptance had a duty to defend Woodward and entered a final judgment for a total award to Woodward and Gray of $999,144.79. Acceptance appealed.

The United States Court of Appeals, Fifth Circuit, said that the appeal turned solely on the validity of the district court's conclusion that Acceptance had a duty to defend. The court emphasized that it would not discuss any other issue.

The court noted that the additional insured endorsement contained two clauses that are relevant to this appeal. Section A provided that Woodward was an insured “but only with respect to liability arising out of your [DCM's] ongoing operations performed for that insured.” Section B stated that the policy “does not apply to bodily injury or property damage occurring after [all work] to be performed by or on behalf of the additional insured(s) at the site of the covered operations has been completed.”

Both sections affected the scope of coverage offered by the additional insured endorsement. The first section established the broad parameters of the coverage as matters arising out of DCM's ongoing operations. The second limited the scope of coverage, specifically excluding property damage that occurs after all the work at the site of the covered operations has been completed.

Acceptance does not dispute that the policy is an occurrence policy. An occurrence policy provides coverage regardless of when the act complained of was discovered or notice provided to the insurer, as long as the act occurred during the policy period. So, the court said, while the plain language of the policy provides coverage only when damages occur during the policy period, there is no textual requirement that liability arise during ongoing operations, only that liability arise out of ongoing operations. The court agreed with Mississippi case law that policy language providing coverage for liability arising out of the named insured's work requires only a causal connection to that work. In other words, liability need not be alleged during ongoing operations. By that, the court meant that claims need not be asserted during the named insured's ongoing operations to fall within the scope of coverage, but the claims must be causally related to the ongoing operations.

The court then applied that opinion to the additional insured endorsement.

Mississippi substantive law governs this suit. The Mississippi Court of Appeals discussed the meaning of a CGL policy's additional-insured endorsement limiting coverage to liability caused in whole or in part by ongoing operations performed for the additional insured. The Mississippi Court of Appeals interpreted the phrase “ongoing operations” to refer to actions actually in process, concluding it could not encompass completed operations. The circuit court agreed and held that claims for liability can be brought after ongoing operations are complete, but the underlying liability cannot be due to the completed operations. The court interpreted the endorsement as applying to DCM's ongoing operations, regardless of when the claim is filed, so long as the liability does not arise out of completed operations.

Accordingly, the court said, the central issue is whether Woodward's liability arose out of DCM's ongoing operations or its completed operations. This determination is governed by the facts alleged in the complaint or, as here, in cross-claims. It is apparent from the face of the cross-claim that Pass Marianne's claims for fraud, defamation, and breach of contract did not arise out of DCM's ongoing operations of work for the condominiums. The court noted Pass Marianne's relevant claim stated: “Woodward built the foundation piers in non-conformity with plans and specifications and altered the blueprints in an attempt to cover up this problem….” Pass Marianne used these facts to support a claim that Woodward and a subcontractor other than DCM had violated their contract with Pass Marianne in an intentional and willful manner and that the violation caused damages. In effect, Pass Marianne's allegation that the foundation piers did not conform to specifications is a claim of a construction defect, and liability for defective work depends on policy language .

The court noted that other courts have held, quite logically, that liability for construction defects arises out of a subcontractor's completed operations. Here, the alleged breach is that the subcontractor did not build the foundation piers according to plans. That is an allegation that the completed building did not satisfy the terms of the parties' contractual agreement. Accordingly, even if Woodward's liability for Pass Marianne's breach of contract claim was related to DCM's concrete work, Woodward's liability did not arise out of DCM's ongoing operations. The breach necessarily arises from the completed construction, which is the point in time when Pass Marianne received the completed building.

Woodward disputed this conclusion, arguing that Pass Marianne's ownership of the property during construction means it was damaged regardless of when it received the completed project. By this logic, a project owner could assert a breach of contract claim against a contractor for any error made during the course of construction, notwithstanding that the contractor might correct the problem before completing the project. Rather, the case law supports that the liability for a construction defect, and any consequent breach of contract, is determined after completion. This proposition is also supported by the Mississippi courts' determination that claims arising from construction defects accrue, for statute of limitations purposes, after the construction project has been completed. It follows that liability for construction defects, while created during ongoing operations, legally arises from completed operations.

It is true that Woodward's liability for the alleged damage is causally related to DCM's operations. Though a causal relation is required, the policy specifically excluded liability for property damage occurring after all work has been completed. The damage alleged here arose from completed operations. Woodward's liability for breach of contract, if any, flows from defects in the completed construction project.

The court found that liability for damages in this instance arose out of completed operations, and Woodward was not an additional insured for completed operations. The decision of the district court was reversed and the insurer had no duty to defend.

Editor's Note: The key point here is that the circuit court ruled that the damages arose out of construction defects and as such, the damages arose from completed operations even though the defects were actually created during ongoing operations. Since the additional insured endorsement created additional insured status only for ongoing operations, the insured general contractor was not entitled to coverage.