When is Ensuing Loss Not Ensuing Loss?
In Friedberg v. Chubb & Son, Inc., No. 11-3063 (9/7/2012), the Eighth Circuit Court of Appeals severely restricted property coverage for water damage caused by defective construction by interpreting the ensuing loss exception to apply only to “distinct and separable” ensuing losses. The Court, under Minnesota law, held that water damage to a home was not distinct from excluded mold-and-rot loss. This holding goes against the rule that if the insurer meant to limit the ensuing loss exception to distinct and separable ensuing losses, it could have clearly done so.
The facts are familiar; the reasoning is not. Insureds’ home was built in 1989 and coated with Exterior Insulation Finish System (“EIFS”). In 2006, the insureds noticed a crack in the EIFS and a subsequent forensic investigation revealed extensive water damage to the house. The insurer’s expert opined that a failure to install control joints and defective construction had enabled water to enter the wall and beam systems. Chubb denied coverage on the basis of the exclusions for fungi and mold and faulty construction. The insureds’ expert offered a different theory of the cause of damage, finding that the roof was the primary point of entry for the water and that the cracks were the result of water infiltration rather than its initial cause. The district court granted summary judgment in favor of Chubb, ruling that water damage was a loss caused by faulty construction and therefore excluded. The Court of Appeals affirmed.
On appeal, the insureds argued that Minnesota’s concurrent causation rule applied, contending that since the loss resulted from both a covered peril and an excluded peril, coverage existed unless the excluded peril is the overriding cause of the loss. The Court of Appeals found that the faulty construction of the insureds’ house was the efficient and proximate cause of the loss. “But for the faulty construction, the water damage would not have taken place.” Although water intrusion played an essential role in the damage, it was not an independent and efficient cause of the loss.
Even if the faulty construction exclusion applied, the insureds correctly argued that the ensuing loss exception carved out coverage for the ensuing water loss. (“But we do insure ensuing covered loss unless another exclusion applies.”). The Court rejected the standard interpretation of the clause, which would limit the defective construction exclusion to apply to the cost of remedying the construction defect, but allow coverage for the ensuing water damage, which was a covered peril. Instead, it followed what it deemed to be the “better view” that the ensuing loss provision applies only to “distinct, separable, ensuing losses.” Since the water damage to the home was not distinct from the excluded mold-and-rot related loss, there was no coverage. They further dug themselves into a minority position by holding that the “but we do” followed by a general reference to ensuing loss, did not create an exception to the exclusion, but rather clarifies that the exclusion ought not to be applied beyond its terms.”
This case is an important example of why the issue of causation is so important in the analysis of coverage in property policies. What is the chicken and what is the egg? Is the crack in the EIFS evidence of faulty construction or is it the result of faulty construction? Is the ensuing water damage due to the crack or due to faulty construction? How can a policy cover water damage, but exclude mold and rot, since no mold or rot would ever occur without moisture?
There is a similarity in the analysis of whether the ensuing loss exception in the property policy applies and the determination that an occurrence exists under a CGL policy. In the CGL policy context, courts will often make the distinction that the policy does not cover loss to property that was defectively constructed, but does cover property damage that results from faulty construction. The occurrence is not the faulty construction. The occurrence is the unintended and unexpected result of the faulty construction, such as the intrusion of water that resulted from defective construction of the EIFS. Similarly, in the property policy, the policy will not cover the cost of remedying the faulty construction (in this case, the cost to remove and replace the EIFS), but should clearly have covered the damage that resulted from the water intrusion.