Ensuing Loss: Getting Around a Property Policy's Defective Construction Exclusion
Jay Levin | April 1, 2007
Most property insurance policies contain some version of a "faulty workmanship" exclusion.
Typical language is as follows:
The last clause is frequently referred to as "an ensuing loss exception." Under this type of language, while the insurance company need not pay for damages caused solely by the excluded cause of loss, if there is an "ensuing loss," the insurer must pay for that damage. A classic example is if faulty repair resulted in improper wiring and the improper wiring caused a fire. Almost every insurer would pay for the fire damage, but not for the repair of the improper wiring. Of course, as a practical matter, the fire damage would subsume the improper wiring and there would be no question as to what portion of the damage was covered and what portion was excluded.
Water Damage—Ensuing Loss
The issue is far more problematic when separating the excluded loss from the ensuing loss is not as clear-cut. This problem frequently arises in the context of water damage. For example, if faulty construction or repair leads to a leaky roof, many insurers take the position that the resulting water and mold damage is "caused by or resulting from" faulty workmanship, and will not pay for it. Some courts have upheld this rather cramped reading of the exclusion, while others construe it properly and require insurers to pay for the water damage.
Eckstein v. Cincinnati Insurance
An example of the proper reading of the exclusion may be found in Eckstein v. Cincinnati Ins., ___F. Supp. 2d ___ 2007 WL 79316 (W.D. Ky.). In Eckstein, the insureds' house experienced water damage due to a variety of construction related issues. That water damage ultimately resulted in the house becoming contaminated with toxic mold. The home became uninhabitable, and the Ecksteins were forced to live in temporary housing for nearly 2 years. The Ecksteins' expert concluded that the mold damage was caused by massive amounts of water which entered the house and destroyed walls and related structures. Great Northern provided the homeowners coverage (Cincinnati provided builders risk coverage and the same issues arose and were decided in the same way as to Cincinnati in the companion case of Eckstein v. Cincinnati Ins., ___F. Supp. 2d ___, 2007 WL 79319 (W.D. Ky.)), and took the position that the water damage and mold damage were losses which resulted from the faulty construction.
The district court noted that many courts have defined ensuing loss as:
a loss that is not directly caused by faulty workmanship or faulty materials, but nonetheless follows as a chance, likely, or necessary consequence of the loss caused by faulty workmanship or materials.
2007 WL 79316 at *8, citing Atlantic Mutual Ins. v. Lotz, 384 F. Supp. 2d 1292, 1305 (E.D. Wis. 2005).
The district court held that the water damage and resulting mold were ensuing losses. The district court differentiated between the cost of repairing the water damage and resulting mold and the cost of repairing the faulty construction. Because the water and mold damage "ensued," and was separate from, the faulty construction, it was a separate and covered loss. The cost of re-doing the faulty construction, i.e., repairing the roof, was excluded.
Bloom v. Western National Mutual Insurance
Another court reached the opposite conclusion when faced with similar facts. In Bloom v. Western Nat'l Mut. Ins., 2006 WL 1806415 (Minn. App.), the insureds discovered the presence of moisture, deterioration, rot, and mold in the wooden sheathing and structural members of their home. The primary cause of the mold and structural damage was water infiltration through the exterior envelope of the house. The cause of the water intrusion was failure of the window installations, absent or inadequate roof flashing, and other construction defects.
The Blooms' homeowners policy had a typical faulty workmanship exclusion. However, the Minnesota appellate court viewed the exclusion much more broadly than did the Kentucky District Court. The Minnesota court looked for a causal connection in the cause of loss between the faulty workmanship and the water damage. The court concluded that the damage caused by mold and rot was not an ensuing loss because it was not a separable and distinct peril. Instead, the mold resulted from water that entered the home through the faulty installation and workmanship of the contractor. Without the faulty installation and workmanship, the water and moisture would not have entered the Blooms' house, and no mold and rot would have resulted. The court also held that the water intrusion and resulting rot and mold were "a single phenomenon," and were, therefore, also excluded under the faulty workmanship exclusion.
The Bloom court went on to find that coverage for the mold and rot was also precluded by another policy exclusion, which precluded coverage for wet or dry rot and mold. Because the ensuing loss, the mold and rot, was otherwise excluded, the court held that it was not covered. While this was not the primary basis for the court's holding, it may well have influenced the result.
Conclusion
The Bloom construction of the exclusion is one frequently adopted by insurance companies, and, in fact, by other courts around the country. However, it is difficult to reconcile the Bloom position, i.e., as long as there is an unbroken chain of causation, there is no coverage, with the concept of ensuing loss. By definition, an "ensuing loss" will always be causally related to the excluded cause. Were it not, the loss would be separate, not "ensuing." It is difficult to logically differentiate an ensuing fire loss from ensuing water damage, but most insurers try. In light of the fact that almost every jurisdiction requires exclusions to be read narrowly and policies construed to afford coverage, the Eckstein approach is more consistent with the rules of construction and is logically consistent with the purpose of an "ensuing loss" provision.
When faced with this issue, risk manager and policyholder counsel should be sure to highlight the logical inconsistency in the broad reading of the exclusion and the narrow reading of the "ensuing loss" exception. In addition, the cost of repairing the faulty workmanship itself is most likely excluded under most versions of this exclusion (although there are forms which might allow such recovery) and resolution of claims will be easier if policyholders do not attempt to recover that cost as part of the claim. Of course, because different jurisdictions approach this in different ways, usually in one of the two outlined above, one must always be mindful of applicable law.
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