Property Insurance Coverage Law Blog : Florida Insurance Lawyer & Attorney : Merlin Law Group Law Firm : Tampa, Houston, Coral Gables, Gulfport

Another ground upon which Safeco denied the Millers’ claim was that the Millers discovered “additional” water damage shortly after closing on the property and did not report the loss until four months later. As discussed in last week’s post titled A Wisconsin Policyholder's Success in a Bad Faith Lawsuit Against Safeco, Part II, the inspection report prepared in connection with the sale of the property to the Millers did not prove Safeco’s allegation that the Millers were on notice of the damages before, during or shortly after the date upon which they purchased the property. Mytas, the Safeco adjuster who prepared the report upon which coverage was denied, concluded in his report that he thought the damages reported by the Millers had only recently been discovered. Mytas did not specify what “only recently discovered’ meant in terms of when the damages were discovered:

There is nothing in Mytas’ notes that would suggest he thought the loss was discovered before the Millers bought the Property. Thus, the Mytas Report does not provide Safeco with a reasonable basis upon which to deny coverage for the Millers’ loss.

Safeco also argued that the Abshire Report confirmed that the Millers were aware of the damages before purchasing the property. The Abshire Report was prepared in September 2005, the month after the Millers purchased the property. It was prepared at the Millers’ request in order to obtain cost proposals for repair work after they began the renovations to their new home. Safeco claimed that the Abshire Report confirmed the roof as a main factor in the water infiltration that caused the damages. However, the Abshire Report was prepared after the Miller’s purchased the property, after they moved in, and after they began renovations. It was only after they received the Abshire report that they discovered the damages. As such, the Court determined that it was unreasonable for Safeco to deny coverage based on this report.

With regard to the timeliness of the notice given by the Millers, the Court again found Safeco’s argument meritless. The four month delay was attributable to the Millers contacting their attorney and retaining the appropriate inspectors to assess the damage. This was supported by the documents that the Millers provided to Safeco at the time that they filed their claim. The Court explained further that the Millers’ delay in reporting their loss did not serve as a legitimate reason for denying the claim because Safeco did not demonstrate that it was in any way prejudiced by the delay.

Such being the case, this reason simply does not provide a reasonable basis for denying benefits under the policy, and Safeco acted with knowledge or reckless disregard for its lack of a basis to deny coverage because of the Millers’ delay in reporting their claim.

The Court rejected Safeco’s argument that no covered loss occurred to trigger the additional coverage for fungi, wet or dry rot.

Even assuming Safeco was correct in stating that the “Additional Property Coverage for Fungi, Wet or Dry Rot, or Bacteria only applies if a covered loss occurs” (citation omitted) its reason for denying the additional coverage cannot save the day for Safeco because its rationale rested upon a flawed premise, i.e., that no covered loss occurred. Just as its underlying decision with respect to whether the Millers sustained a covered loss was without a reasonable basis, so too was its decision to deny the additional mold coverage.

The Court also rejected Safeco’s argument that the Millers did not mitigate their damages. Safeco’s own report, prepared by Mytas, reflected that the Millers installed plastic sheeting where the drywall was removed. Further, the Court found that:

The Millers made reasonable efforts to mitigate their damages by winterizing the house, running dehumidifiers, making repairs to the roof, and installing plastic sheeting.

With regard to making any other repairs or mitigating damages to a greater extent, the Court explained that the estimated cost of repair to the home exceeded $315,000, and it is unreasonable to expect insureds who sustained a total loss to expend that amount in repairs. The Court also pointed out that, at no time, did Safeco ever specify any action that the Millers should have taken to protect the property – there was nothing in the claims file nor was there anything disclosed through trial testimony.

Safeco’s inability to identify measures that should have been taken is consistent with Mytas’ testimony that he was not sure whether anything could have been done to prevent further damage. Indeed, if before it denied coverage Safeco had asked Mytas whether the Millers took proper precautions in protecting their home, it would have learned that there was no reasonable basis to deny coverage on this ground. Instead, Safeco blindly denied coverage because of its ill-founded claimed belief that the Millers failed to protect the property from further damage. Such decision was made in reckless disregard of the lack of reasonableness of such ground for denying coverage.

For those who have been following my posts, it may be apparent now why I am dedicating a few weeks to this decision. Please tune in next week for more.

A typical policy defines the duty to mitigate as follows:

The Insured has an obligation to incur any expense with the object of minimizing a loss hereunder, such expenses subject to prior agreement of Insurers being for Insurers account, provided that the loss is reduced as a result of such expenditure, and provided such expenditure is not recoverable from other policies taken out by the Insured. Insurers have the right to require the Insured to incur any expense which would reduce Insurers liability under this policy provided such expense is for Insurers account.

Metalmasters of Minneapolis v. Liberty Mutual, 461 N.W. 2d 496 (Minn. App. 1990) is an example of what can happen if the insured and insurer are not the same page with respect to mitigation costs.

Metalmasters manufactured precision computer disk drives and other small machine parts. A two-inch overhead pipe carrying water for cooling and air conditioning ruptured during the night and flooded Metalmasters' shop. Metalmasters was shut for nine weeks, with partial production resuming after three weeks.

Metalmasters began using its clean rooms within four months after the water damage, but in order to produce a rust-free product (and protect its product from the water intrusion due to the pipe loss), Metalmasters incurred an additional expense of $4.90 for each of 15,500 spindle assemblies, totaling $75,590.

Unfortunately, Metalmasters was not able to recover $193,500 of loss of net sales during the nine week interruption period because Metalmasters was not able to show a loss in gross earnings since it had a buyer purchase all of its non-damaged goods. However, Metalmasters was able to recover the $75,590 as a mitigation cost under the Extra Expense provision of the policy, despite Liberty Mutual’s hard fight.

I am always tickled by case law that restates obvious principles and where the court’s frustration with one of the parties is apparent.

These additional production expenses were expenses of mitigation. Liberty cannot have it both ways. If, as they strenuously urge, the insured has a contractual as well as a common law duty to mitigate damages, then the expenses of that mitigation must be covered. If the mitigation efforts take longer than the interruption period, then the business interruption clause cannot limit coverage to that period, since the activity is in the interest of the insurer. In this case the expense continued beyond the four weeks during which the clean rooms were inoperable.

Mitigation is a duty the insured performs for the insurer's benefit. Mitigation cost is recoverable so long as it is reasonable and less than the damages would have been without it. In this case the cost of mitigation is unquestionably less than damages would have been without the additional production expense.

Mitigation costs are generally recoverable under a range of coverages, but to avoid a Catch-22 situation where the insurer denies payment for mitigation efforts taken because they do not meet a certain definition under the policy, I suggest that after a business loss, the inusured or its representative openly discuss the insurer’s expectations with respect to mitigation efforts and how these costs should be presented for recovery.

In Gordon Chemical Co. v. Aetna Cas. & Sur. Co., 266 N.E. 2d 653 (1971), there was an explosion at the insured’s manufacturing plant which forced the insured to shut down operations for 15 months after the loss. In this case, the insured manufactured high impact polystyrene and sold its entire output to another manufacturing plant next door, which converted the polystyrene into different byproducts. The insured was unable to continue servicing its sole customer for 15 months and thus sustained a net profit loss of $215,350.00. Aetna contended that in order to mitigate its losses, the insured was obligated to purchase manufacturing materials from its competitors in the open market and resell the materials to its sole customer. The court did not find that such a feat was required under the terms and conditions of the policy.

Gordon was required to continue or to resume manufacture of polystyrene from monomer liquid plastic when and if possible and to sell the product manufactured by it as it would have done if no fire had occurred. However, it was not required to buy from competing manufacturers and resell their product, which it would never have done had no fire occurred. The purpose of the policy is to preserve the continuity of the insured's earnings. The policy does not accomplish that purpose if the insured manufacturer is required to act as a distributor for its competitors in order to reduce its business interruption loss.

Alternatively, most policies provide as part of an insured’s duties to mitigate that existing inventory should serve as a means for reducing a business loss. In Northwestern State Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1966), a cement company suffered a loss of production at one of two clinker plants. However, the insured did not suffer a loss in sales because there was a large inventory of finished cement and stock pile clinker. In this case, the court did not allow recovery for the loss of clinker production, but it did, however, allow recovery for extra expenses necessarily incurred in replacing finished stock to reduce to the loss.

Under the terms of [the policy] the insured is not permitted to sit idly by during a business interruption but must take affirmative action to reduce the loss of earnings. It must reduce the loss resulting from the interruption of business, if possible, by partial or complete resumption of the business; by making use of other property at the location; by making use of stock, raw, in process or finished. Such reduction is to be taken into account in arriving at the amount of loss.

It is clear that there would have been a loss of sales (income) except that plaintiff took the steps required of it by Paragraph 3 to reduce, and in fact to prevent, any loss of sales from occurring. Thus, the actual loss sustained by plaintiff was its loss of stock used to prevent loss of sales and thereby protect its earnings which would result in the normal uninterrupted operation of the business. The policies specifically state what is to be paid an insured for taking these required steps to prevent loss. Paragraph 4 provides the insured is to be compensated therefore by receiving such expenses, in excess of normal, as would necessarily be incurred in replacing any finished stock used to reduce the loss.

Further, on the subject of inventory, a court has found that if an insured is able to sell its entire damaged inventory, the insured may not have a viable business interruption loss. In Baxter Inter., Inc. v. American Guarantee and Liability ins. Co., 861 N.E. 2d 263 (1st Dist. 2d 2006), the insured sustained property and inventory damage after a hurricane suspended its pharmaceutical manufacturing operations.

In this case, Baxter submitted claims to recover losses resulting from property damage and business interruption. American indemnified Baxter for the property damage portion of its claim, including losses to Baxter's damaged finished goods inventory. American paid Baxter the amount Baxter would have received had Baxter been able to sell the inventory. Of the $30.7 million American paid in damages to Baxter's inventory, about $15 million accounted for lost profit. Baxter did not claim business interruption losses resulting from the damaged inventory. Baxter, however, claimed it suffered business interruption losses due to damage of other property. American maintained the profit component of the damaged inventory payment must be considered in calculating Baxter's total actual loss during the period of interruption. Baxter maintained American could not consider payments it made under the personal property provision of the policy to reduce its obligation under the business interruption provision. The parties filed cross-declaratory actions.

Baxter sought a declaration that American's liability for losses due to business interruption is independent of its liability for damaged inventory. American asserted the policy covered only “actual loss” due to business interruption, which must be calculated by considering profits Baxter realized from American's “purchase” of the damaged inventory.

On summary judgment the court held that:

[A]n insured cannot recover for lost profit due to business interruption where there has been no actual loss. In other words, business interruption is not itself a loss. An actual loss occurs only where the insured is unable to reduce or eliminate lost profit caused by the interruption. Baxter was able to reduce its lost profits by selling its damaged inventory to American during the business interruption.

Without citation to authority, Baxter contends its business interruption loss is independent from the profit it realized from selling its damaged inventory to American. Baxter explains the profit it realized from the sale of the damaged inventory was not the result of business interruption but the result of property damage. We fail to see how this distinction matters. The business interruption provision provides coverage for actual loss resulting from business interruption but not exceeding “gross earnings.” “Gross earnings” is defined in the policy as “total” sales and other earnings minus costs. It is not defined, as Baxter suggests, as “only the gains or losses resulting from such business interruption.” In other words, there is no suggestion from the language in the policy that a distinction can be made between different types of profit.

The case American Medical Imaging Corp. v. St. Paul Fire & Marine Insurance Co., 949 F.2d 690 (3rd Cir. 1991), is the epitome of an extra expense Catch-22. In American Medical Imaging, the insured was in the business of providing ultrasound testing services. The imaging services were rendered at physicians' offices, joint venture sites, and other health care institutions, while the scheduling, marketing, billing, and clerical functions were performed at the insured’s headquarters location.

A fire at the insured’s headquarters resulted in smoke and water damage that allegedly made use of the facilities impossible. The insured immediately rented space at an alternative site and relocated there the next day, albeit with substantially fewer telephone lines. The insured did not return to its headquarters for approximately six weeks.

The insured submitted a claim for the policy's $500,000 limits for lost income and extra expense premised on the period of restoration.

The extra expense provision stated:

We'll pay your actual loss of earnings as well as extra expenses that result from the necessary or potential suspension of your operation during the period of restoration caused by direct physical loss or damage to property at a covered location. The loss or damage must occur while this coverage is in effect and must be due to a covered cause of loss.

We'll pay your earnings and extra expense loss from the date the property is damaged until the earliest of the following:

• the date you resume normal business operations;
• as long as it should reasonably take to repair, rebuild or replace the damaged property, plus 30 consecutive days; or
• 12 months, regardless of your policy's expiration date.

St. Paul denied the claim, citing the fact that no suspension of business had occurred. Surprisingly, the trial court agreed with Saint Paul on summary judgment. The insured appealed.

Fortunately the court of appeals read the policy in its entirety and remedied the Catch-22 situation that policyholders often face:

If a trier of fact believes AMIC's evidence, we conclude that the alleged loss would be a covered one. According to its version of the facts, AMIC experienced a “necessary suspension” of its business operations briefly on the morning following the fire. Moreover, on that morning, it faced a “potential suspension” of a much longer duration. Fortunately for AMIC and St. Paul, AMIC acted promptly to mitigate its loss and managed to make arrangements to conduct its business on a scaled-down basis at an alternative site. As a result of that “necessary suspension” and that “potential suspension,” St. Paul was required to indemnify AMIC for any lost earnings or extra expenses arising from such suspensions during the period up to the date upon which AMIC was able to resume its normal business operations at the Gibraltar Road site, i.e., the covered location.

Under the district court's construction of the policy, the insured would have no motivation to mitigate its losses. Continuing in business at any level would bar recovery because the insured would be carrying on the same kind of activities that occurred at the covered location. We decline to accept the suggestion that this was the intent of the parties. Indeed, other provisions of the policy bear witness to a contrary intent. For example, the policy imposes on the insured an affirmative duty to mitigate its losses:

If you can reduce your loss by resuming operations at the covered location or elsewhere by using damaged or undamaged property ... you agree to do so.

Under the district court's reading, this provision would have imposed upon AMIC a duty, the performance of which would have forfeited its right to recover under the policy. We are confident that such an anomalous result was not intended and choose to read the policy terms regarding St. Paul's duty to indemnify as consistent with AMIC's duty to mitigate. Moreover, as appears from the earlier quoted portion of the policy, St. Paul's obligation to indemnify continues until the resumption of “normal business operations.” This necessarily implies that the obligation to indemnify can arise while business continues, albeit at a less than normal level.

This exchange surprised me for a number of reasons. First, it is a fundamental part of insurance that a policyholder has a duty to take reasonable steps to mitigate damages. Making temporary repairs to a leaking roof would seem like a logical place to start, especially in Florida during the middle of the rainy season. Second, I was surprised that this individual did not seem to understand the potential problems that his advice could have caused.

In my last post, I detailed some of the potentially harsh consequences of a policyholder’s failure to properly mitigate damages, however, an insurer may be estopped from arguing as much if its actions encouraged or led to the insured’s failure to mitigate. See for example Kubista v. Romaine, 549 P.2d 491 (Wash 1976).

An insurer’s agents and representatives can bind the insurer through their actions and statements. See Old Republic Ins. Co. v. Von Onweller Const. Co., 239 So.2d 503, 504 (2d DCA 1970); Hughes v. Pierce, 141 So.2d 280, 284 (Fla. 1st 1961). Thus, if an adjuster tells a policyholder to stop making temporary repairs, it is only logical that the insurer should not be able to later deny coverage based on a failure to mitigate. Furthermore, the insurer may be liable for any further damages that the insured property sustained as a result of the adjuster’s instruction to stop making repairs, even if these damages are not covered under the policy.

The homeowners in my case were lucky that no additional damages occurred as a result of their stopping repairs at the insistence of the adjuster. However, the insurer and adjuster are lucky as well, because they could have been held liable for any resulting damages. This is why educating both adjusters and policyholders about the proper steps to take after a loss is very important to both sides, and failing to do so can cause more coverage disputes than necessary.

Under those same set of facts, if our wannabe Emeril Lagasse fails to properly mitigate those same fire damages, coverage could be reduced or even avoided all together by the insurer.

The general rule in insurance law is that a policyholder’s prior actions will not necessarily void coverage for a loss, even if that loss is directly caused by the negligence of the individual. After the loss, however, failing to take the appropriate measures to mitigate could lead to an increase in the amount of damages and may substantially reduce coverage or even eliminate it in some instances.

In a fire loss, for instance, the insured should make sure to remove any undamaged property if there is a question about the stability of the walls in that particular area. This was the exact situation that one court addressed in Suttir v. Indemnity Co. of America, St. Louis, Mo,. 226 Ill.App. 214, (1st dist. 1922). In this case, the Court refused to hold an insurer liable for damage to a car that occurred when the walls around it collapsed as a result of previous fire damage. The Court reasoned that the insured knew the walls of the building might collapse and had failed to properly mitigate the damages by moving the automobile to a different location. Therefore, the insurer should not be responsible for the further damages.

The exact consequences of a failure to mitigate are determined by the terms of the policy as well as the particular jurisdiction. Normally, the damages that result from the failure to mitigate the loss may not be covered, leaving the insurer responsible for only the original damages. A Louisiana court followed this partial recovery theory when a policyholder’s roof was damaged by wind and the house suffered periodic water damages over a long period of time. Higginbotham v. New Hampshire Indem. Co., 498 So.2d 1149 (La.App. 3 Cir.1986).

In Higginbotham, the Court held that although the insurer was responsible for the cost of replacing the roof, the policyholders were liable for damages sustained after the storm “where measures could have been taken to reasonably protect the premises from further deterioration.”

A similar decision was reached in Texas, when one court was asked to determine whether the duty to mitigate damages was a condition precedent to recovery, meaning that coverage was void if the appropriate steps were not taken. Fortunately for the policyholder, the Court found that “the failure to mitigate damages is an offset to recovery under the generic homeowners policy, and the district court erred and abused its discretion when it instructed the jury that mitigation was a condition precedent to recovery.” Carrizales v. State Farm Lloyds, 518 F.3d 343 (5th Cir. 2008).

There are cases in which a failure to mitigate may void coverage completely. Some courts have found that where the cooperation clause requires an insured to exercise all reasonable means to protect, safeguard, and salvage property, there is a possibility that the policyholder could void coverage altogether if this is not done. See Slay Warehousing Co., Inc. v. Reliance Ins. Co., 471 F. 2d 1364 (8th Cir. 1973).

Regardless of whether coverage is lessened or outright forfeited, these cases all have one thing in common – the problem could be avoided. Generally after loss, the first thing on an insured’s mind is not “how can I mitigate these damages, and have I done enough to comply with my obligations under the policy.” In fact, most insureds do not even know what the cooperation clause is, and who can blame them? How many people spend their lives immersed in insurance case law and treatises?

This is why it is important for homeowners to have professionals working for them as quickly as possible after the loss. Whether it is a public adjuster, attorney, or water remediation specialist, having someone there to guide you and make sure things are done properly can be priceless in the end.

If the policy is silent as to whether the policyholder is entitled to reimbursement for these expenses, many courts have found that they are. In City of Laguna Beach v. Mead Reinsurance Corp., 226 Cal.App. 3d 822 (Cal.App. 4 Dist. 1990), for instance, the Court focused on the fact that the insured’s duty to mitigate the damages is intended for the benefit of the insurer by lessening the amount that must be paid under the policy. The Court held that since the temporary repairs were intended to benefit the insurer, the policyholder was entitled to reimbursement.

In McNeilab, Inc. v. North River Ins. Co., 645 F. Supp. 525 (D. N.J. 1986), a New Jersey court came to a similar conclusion. The McNeilab Court found that where an insured took steps to minimize damages which had already occurred, the insurer must reimburse the policyholder for the reasonable expenses incurred.

Also, for mitigation expenses to be reimbursed, the loss being mitigated usually must be covered under the policy. See Swire Pacific Holdings, Inc. v. Zurich Ins. Co., 139 F.Supp. 2d 1374 (S.D. Fla. 2001). Likewise, in Witcher Const. Co. v. Saint Paul Fire and Marine Ins. Co., 550 N.W.2d 1 ( Minn. Ct. App. 1996), the Court held that the policyholder’s obligation to prevent or mitigate harm does not arise until insured subject matter is threatened by covered loss, but if the prevented loss falls within an exclusion, the insured has no right to indemnity for its efforts.

Therefore, if the loss is determined not to be covered by the policy, the insurer may not have an obligation to reimburse the policyholder for expenses associated with temporary repairs. This, however, should not deter anyone from taking all reasonable steps to prevent further harm. Many times, there is coverage for things which at first glance may seem to be excluded by the policy. With the exclusions, exceptions to exclusions, and the like, insurance policies are a maze of coverages, and many require a professional to interpret. Even if you think a loss may not be covered, it is important to take the steps reasonably necessary to prevent any further damage so as not to provide the insurer with a possible basis for denying a claim that turns out to be covered.

Most policies read something like this:

B. Duties After Loss

4. Protect the property from further damage. If repairs to the property are required, you must:
a. Make reasonable and necessary repairs to protect the property and;
b. Keep an accurate record of repair expenses

In the industry, this is called “mitigating the loss,” which means taking steps to keep the severity of the loss from increasing. While the language of a particular policy may be different, the general principle remains the same and for good reason. Pennsylvania Lumbermens Mut. Fire Ins. Co. v. Nicholas, 296 F.2d 905 (C.A.Fla. 1961). Simply put, this provision is intended to keep the loss from unnecessarily increasing and thus increasing the cost to both the insured and the insurer.

Keep in mind that this does not mean that permanent repairs are immediately required. In most, if not all, cases, this means that temporary repairs must be made to ensure that the damages do not get worse. Tarping a damaged roof to keep rain water out or turning off the water supply to a broken pipe are both common temporary repairs which can be sufficient to mitigate the loss.

While this may seem like common sense, even a cursory reading of the provision above should raise some red flags. There can be many questions raised regarding whether the temporary repairs were “reasonable,” “necessary,” or even possible. This can cause a wide variety of issues with a claim and can provide the insurer with an excuse to avoid prompt payment under the policy and could even lead to the claim being denied.

Over the next few weeks, I will post on many of the issues surrounding this obligation. As always, I welcome and encourage your comments and questions. In the end, these posts are for the readers, so please feel free to chime in.