Expert Commentary

Does Mold Constitute a Direct Physical Loss under a Property Policy?

A major issue affecting policyholders and their insurers is mold. Over the past 10 years, mold awareness has increased significantly, and the direct and indirect costs of mold problems have skyrocketed. Property owners and tenants are far more focused on locating and remediating mold damage than ever before, and an entire mold remediation industry has sprung up. As with any new and expensive peril and risk, property insurers have responded by adding exclusions and limitations to their policies.


Property Insurance
June 2012

Many commercial property policies provide coverage for mold damage and mold remediation, although usually subject to a relatively small sublimit. Mold coverage must still, however, meet the normal requirement of a property insurance policy that the mold caused direct physical loss or damage. Some courts construe this requirement more narrowly than others. Knowing how the court will make this determination is very important to the proper presentation of a mold claim.

No "Tangible Damage," No Coverage

A prime example of this is the unpublished opinion of the Sixth Circuit Court of Appeals in Universal Image Prods., Inc. v. Federal Ins. Co., 2012 U.S. App. LEXIS 7187 (6th Cir. Mich. 2012). In that case, Universal occupied space in a three-floor commercial building in Southfield, Michigan. At the time of the loss, Universal had just relocated from the third floor to the first floor of the building. Almost immediately thereafter, there were heavy rains in the area, and a strong odor was soon detected on the first floor of the building.

Universal retained a certified indoor air quality professional, who concluded that there was mold in the heating, ventilating, and air-conditioning (HVAC) system. The HVAC system had to be shut down and inspected, and areas of water damage in the building had to be tested and inspected. Universal's expert found mold and staining in the walls throughout the building, but did not recommend evacuation of the building. The landlord's expert reached the same conclusions. The landlord's expert recommended that Universal move its operations from the first to the third floor of the building during the remediation. The landlord shut down the HVAC system, and tests revealed mold in the building's ductwork and elevated bacteria in the air.

Once the HVAC system was shut down, Universal's business suffered severe disruptions, in part because the diminished ventilation caused temperatures in the building to exceed 100 degrees on some days. On September 11, 2002, Universal circulated a memorandum to its employees and clients asserting that the air quality on the second and third floors of the building was acceptable and that no health threat existed. Nevertheless, Universal decided it would vacate the premises and completed the move 2 weeks later. The building remediation was completed in December.

Universal gave timely notice of its mold losses to its insurer, Federal, claiming lost leasehold improvements, cleaning and moving expenses, and lost business income. Federal denied coverage, claiming that there was no direct physical loss.

The Sixth Circuit began by noting that the policy excluded "air" from the definition of insured property and did not define "direct physical loss or damage." Federal argued that direct physical loss or damage required structural damage to the insured property. Universal argued that, if the building became uninhabitable or substantially unusable, there was direct physical loss or damage. Relying on a Texas case, de Laurentis v. United Servs. Auto. Ass'n, 162 S.W.3d 714 (Tex. Ct. App. 2005), the Sixth Circuit held that "tangible damage" to the policyholder's property caused by mold constituted "physical loss." Using that definition, the Sixth Circuit held that Universal did not have any form of "tangible damage" to its insured property.

The court noted that the landlord paid for all remediation efforts, and not a single piece of Universal's physical property was lost or damaged as a result of mold or bacterial contamination. The court held that coverage for cleaning and moving expenses and lost improvements attached to the building were economic losses, not tangible, physical losses. The court relied on cases from other jurisdictions, which held that a direct physical loss contemplates some change in the physical condition of the property. While Universal did clean several pieces of personal property as a result of mold, the cleaning was performed with hot water and household cleaning things, which the court characterized as "basic cleaning," and it held that the need for "basic cleaning" did not constitute physical loss or damage.

The court rejected Universal's argument that physical loss or damage occurs when the building becomes uninhabitable because, according to the Sixth Circuit, the building was not, in fact, uninhabitable. While the court acknowledged that lack of HVAC created very high temperatures on some days, the court pointed to the fact that both Universal's and the landlord's experts did not recommend that the building be evacuated, merely that Universal move to an upper floor during the remediation process. Because those conditions were temporary, the court held that Universal did not prove that the building was uninhabitable or substantially unusable.

While the Sixth Circuit applied a very limited reading of "direct physical loss" and a very cramped reading of "tangible damage," the key to understanding this case is the fact that the mold damage appeared to have been in the HVAC system and the walls, which was property owned by the landlord. The landlord remediated that mold at no charge to Universal. Therefore, as to the physical property that suffered tangible damage, none belonged to Universal. While Universal ultimately moved, Universal did not meet its burden of proving that it moved because of direct physical loss or damage to insured property. Indeed, an undercurrent to the Sixth Circuit's opinion is that there was no reason for Universal to move at all, and its voluntary choice to move was not as a result of a covered loss.

Conclusion

Insureds faced with mold claims should evaluate very carefully what property is damaged and the appropriate level of remedial measures. To the extent that moving out of the insured premises is necessary, the insured must make a satisfactory claim, supported by admissible expert evidence, that the move was necessitated by tangible damage to insured property. While moving out of potentially mold-infected premises may make business sense from the standpoint of protecting employees and making sure employees are comfortable with the working environment, a business decision is not necessarily covered by property insurance.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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