Source: http://www.lexology.com, January 7, 2013
By: John David Dickenson and Matthew Criscuolo, Edwards Wildman Palmer LLP
On November 1, 2012, the Virginia Supreme Court issued its opinion in TravCo Insurance Company v. Ward,1 and became the first state high court to determine that several exclusions contained within a homeowners’ insurance policy were applicable and barred coverage for damages associated with Chinese Drywall. Specifically, the Court considered whether damages allegedly caused by Chinese Drywall fell within one or more of the following policy exclusions: (i) latent defect; (ii) faulty, inadequate, or defective materials; (iii) rust or corrosion; or (iv) pollutants. Applying traditional contract principles as well as those doctrines particular to insurance policies, the Court held that all four exclusions applied to bar coverage under a homeowners’ insurance policy.
Like many Americans during the recent housing boom, in May 2007, Larry Ward purchased a newly constructed home in Virginia Beach built using drywall imported from China. Mr. Ward purchased a homeowners’ insurance policy through TravCo Insurance Company, and renewed the policy for the next two years. About two years after he bought the home, beginning in May 2009, Mr. Ward and his family began to experience problems, including health issues and property damage.2 Mr. Ward hired an expert, Zdemek Hejzlar, Ph.D., who determined the home’s Chinese Drywall was to blame.3 Dr. Hejzlar has a doctorate in Occupational Safety and Health Engineering and has investigated hundreds of homes and condominiums reporting problems associated with Chinese Drywall.4 Armed with the results of Dr. Hejzlar’s findings, Mr. Ward commenced a lawsuit in Virginia state court against the developer, builder and drywall contractor for his home, alleging claims for breach of contract, breach of warranties, negligence, unjust enrichment, nuisance, and other counts claiming that his home “was built with defective drywall.”5
Mr. Ward also submitted a claim to TravCo, which included Dr. Hejzlar’s report, and asserted that the Chinese Drywall “caused fumes and odors, health issues, and damage to the home’s air conditioning system, garage door, and flatscreen televisions.”6 After denying Mr. Ward’s claim based upon the four exclusions mentioned above, TravCo filed suit in the United States District Court for the Eastern District of Virginia, seeking a declaratory judgment that Mr. Ward’s homeowners’ policy did not provide coverage for his claim.7 After the district court granted TravCo summary judgment,8 Mr. Ward appealed to the United States Court of Appeals for the Fourth Circuit, which in turn certified questions to the Virginia Supreme Court regarding whether any of the exclusions applied under Virginia law.9
Virginia Supreme Court’s Decision
Although asked by the parties to consider authority from other jurisdictions, the Virginia Supreme Court only considered Virginia law. The Court first reaffirmed longstanding contract principles, including several specific to insurance policies. For instance, the Court explained that Virginia law required courts to construe insurance policies according to their plain and obvious meaning, resolving any doubt in favor of the insured.10 With respect to the application of exclusions, the insurer bears the burden to establish that any such exclusions apply to bar coverage.11 Methodically wading through each exclusion, the Court then applied these principles and relied heavily upon dictionary definitions to determine that each was unambiguous and reasonable, providing multiple bases to bar coverage for Mr. Ward’s claim.
Mr. Ward’s policy excluded coverage for loss caused by “[l]atent defect, inherent vice, or any quality in property that causes it to damage or destroy itself.”12 Mr. Ward argued that this exclusion was ambiguous or at least inapplicable because testing of the Chinese Drywall would have revealed problems, meaning the defect was not latent. The Court rejected these arguments, reasoning that the exclusion was unambiguous and that the defect was latent because it was “hidden or concealed” for two years after Mr. Ward purchased the home before he discovered any problems.13 The Court explained that “the actual defect is the release of sulfuric gases by the drywall” further noting that “[t]he future release of gas by the drywall was not discoverable.”14 Therefore, the Court held that the latent defect exclusion applied to bar coverage for Mr. Ward’s claim.
The policy also excluded from coverage loss caused by “[f]aulty, inadequate or defective… [m]aterials used in repair construction, renovation or remodeling…of part or all of any property whether on or off the ‘residence premises.’”15 Mr. Ward argued that this exclusion did not apply because the “drywall maintains its form and performs its function,” and is thus not “faulty, inadequate or defective.”16 TravCo argued that the exclusion plainly applies because “drywall that releases sulfuric gas is ‘faulty, inadequate or defective.’”17 After turning to several dictionary definitions of the key terms from the exclusion, the Court agreed with TravCo and held that “the drywall at issue in this case could not reasonably be said to perform its function; its sulfuric gases rendered Ward’s home uninhabitable.”18 Accordingly, the Court held that the defective materials exclusion also barred coverage for any claimed damages Mr. Ward asserted were caused by Chinese Drywall.
The TravCo policy issued to Mr. Ward also did not cover loss caused by “[s]mog, rust or other corrosion, mold, fungi, wet or dry rot.”19 Claiming the exclusion was inapplicable, Mr. Ward asserted that the damage to his home “was not caused by corrosion, but was the corrosion itself.”20 Mr. Ward also argued that the exclusion was ambiguous and should be construed to limit corrosion to only include a gradual natural process, which would not include the problems associated with Chinese Drywall. The Court again relied upon dictionary definitions of the key terms contained within this exclusion, explaining that “[t]hese definitions and the logical, common understanding of the term ‘corrosion’ do not draw a distinction between ‘naturally occurring’ and other corrosion.”21 Thus, the Court held that the corrosion exclusion was “unambiguous and when interpreted according to its plain meaning, encompasses the corrosion caused by the off-gassing of sulfur from the Chinese drywall in Ward’s home.”22
Finally, the pollution exclusion contained within Mr. Ward’s policy from TravCo excluded loss caused by: “[d]ischarge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself caused by peril insured against under Coverage C.”23 According to the policy, “[p]ollutants means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”24 Mr. Ward argued that this exclusion was ambiguous, overbroad, and unreasonable, further asserting that “the process by which elemental sulfur escaped the drywall, off-gassing, is not a ‘discharge’ of ‘pollutants’ as contemplated by the exclusion or as a reasonable person would understand.”25
The Court first rejected the notion that the exclusion was either overbroad or unreasonable because it “could not reasonably be argued to invalidate coverage for almost any condition or function in the Ward home.”26 Then, as with the other exclusions, the Court examined several dictionary definitions of the crucial language contained within the pollution exclusion, determining that none of it was ambiguous as argued by Mr. Ward.27 The Court also cited several allegations from Dr. Hejzlar’s affidavit as well as Mr. Ward’s pleadings and discovery responses from the federal declaratory judgment action and state court claims against the developer, builder and drywall contractor, to further demonstrate that the exclusion applied. Specifically, Mr. Ward asserted the presence of “odorous fumes in the residence” caused by the home’s Chinese Drywall and described the gas as “toxic,” causing “skin rashes,” “lesions,” “sinus congestion,” and “nosebleeds.”28 Considering the plain meaning of the terms used in the exclusion, along with Mr. Ward’s own allegations from the related lawsuit, the Court determined that the sulfuric gases from the Chinese Drywall constituted pollutants, and thus, the policy excluded any damages caused by the drywall.
Impact of the Virginia Supreme Court’s Decision
The Ward opinion is important because it is the first state high court to definitively consider these rather common exclusions in a first-party homeowners’ insurance claim for Chinese Drywall damages. Notably, the court in the Chinese Manufactured Drywall Products Liability Multi-District Litigation pending in the United States District Court for the Eastern District of Louisiana29 relied in part upon the trial court’s decision in Ward30 in considering whether several similar policy exclusions applied to bar coverage to first-party homeowner claims. In In re Chinese Manufactured Drywall Prods. Liab. Litigation, Judge Eldon Fallon applied Louisiana law in granting multiple motions to dismiss filed by several insurers. While the court held that the damages alleged did constitute a “direct physical loss” under the policies, the court also held that the loss was excluded under the policies’ faulty materials and corrosion exclusions. However, unlike the Virginia Supreme Court decision in Ward, Judge Fallon held that the latent defect, pollution, contamination, dampness and temperature exclusions in some or all of the policies did not preclude coverage. The court’s refusal to apply the pollution exclusion was based upon the prevailing Louisiana interpretation of the pollution exclusion, which limits its application to the industrial environmental pollution context. The Virginia Supreme Court in Ward did not apply such a limited interpretation to the pollution exclusion and determined that several exclusions similar to the ones considered by Judge Fallon did apply to bar coverage. These distinctions further highlight the jurisdictional differences that exist in the context of Chinese Drywall litigation.
While Louisiana remains the epicenter of Chinese Drywall litigation through the multi-district litigation pending there, Virginia was a state heavily affected by Chinese Drywall. Other state and federal courts now have a state high court decision to consider in addressing the applicability of similar exclusions. As the law continues to develop in this area, insurers continue to successfully argue that various policy exclusions apply to bar coverage. In the end, and depending upon jurisdiction, homeowners and other claimants may be left with claims against the developers, builders, contractors and manufacturers, some of which have similar insurance coverage concerns.