The Chinese Drywall coverage litigation involving first party property insurance policies has been discussed in the past. Are Chinese Drywall Problems Covered Under Property Insurance Policies? discussed the complex issues involved and warned that these losses may not be covered. FC&S Says Ensuing Loss Coverage Applies to Chinese Drywall Claims and Chinese Drywall Claims May Be Covered Under Homeowners Policy–Favorable Developments in Louisiana gave hope to the policyholders suffering form this unexpected property loss. Unfortunately, a recent opinion, In re: Chinese Manufactured Drywall: Products Liability Litigation, issued December 16, 2010, did not rule in favor of the first party policyholders.

The Federal District Court Judge set out the Louisiana rule regarding interpretation of insurance contracts:

An insurance policy is a contract between the parties and should be construed by using the general rules of interpretation of contracts set forth in the Louisiana Civil Code. The judiciary’s role in interpreting insurance contracts is to ascertain the common intent of the parties to the contract.

Words and phrases used in an insurance policy are to be construed using their plain, ordinary and generally prevailing meaning, unless the words have acquired a technical meaning. An insurance contract, however, should not be interpreted in an unreasonable or strained manner under the guise of contractual interpretation to enlarge or to restrict its provisions beyond what is reasonably contemplated by unambiguous terms or achieve an absurd conclusion. The rules of construction do not authorize a perversion of the words or the exercise of invention powers to create an ambiguity where none exists or the making of a new contract when the terms express with sufficient clearness the parties’ intent.

Ambiguous policy provisions are generally construed against the insurer and in favor of coverage. Under this rule of strict construction, equivocal provisions seeking to narrow an insurer’s obligation are strictly construed against the insurer. That strict construction principle applies only if the ambiguous policy provision is susceptible to two or more reasonable interpretations; for the rule of strict construction to apply, the insurance policy must be not only susceptible to two or more interpretations, but each of the alternative interpretations must be reasonable.

If the policy wording at issue is clear and unambiguously expresses the parties’ intent, the insurance contract must be enforced as written. Courts lack the authority to alter the terms of the insurances contracts under the guise of contractual interpretation when the policy’s provisions are couched in unambiguous terms. The determinations of whether a contract is clear or ambiguous is a question of law.

He ruled that the Chinese drywall defects caused a physical risk of loss under the policy:

Similarly, the Merriam-Webster Dictionary defines “physical” as “having material existence: perceptible through the senses,” and defines “loss” as “destruction, ruin” and “the amount of an insured’s financial detriment by death or damage that the insurer is liable for.” The Free Merriam-Webster Dictionary…In the present cases, the Chinese-manufactured drywall has caused a “distinct, demonstrable, physical alteration” of the Plaintiffs’ homes (the covered properties) by corroding the silver and copper elements in the homes, often to the point of causing total or partial failure in electrical wiring and devices installed in the homes, as well as by emitting odorous gases. Thus, these definitions suggest that the Chinese drywall-related losses are covered.

Furthermore, while the mere presence of a potentially injurious material in a home may not qualify as a covered physical loss for purposes of homeowners’ insurance policies, when these types of materials are activated, for example by releasing gases or fibers, courts have held there exists a covered physical loss….Additionally, at least one of these cases, Trutanich, held that the odor caused by the material constitutes a physical loss….Here, the Chinese-manufactured drywall is not merely laying dormant in the Plaintiffs’ homes, but rather is releasing elemental sulfur gases throughout the homes. Furthermore, the Chinese-manufactured drywall renders the Plaintiffs’ homes useless and/or uninhabitable due to the damage to the electrical wiring, appliances, and devices, as well as the ever-present sulfur gases. Thus, the factual situation is more akin to the latter cases, weighing in favor of coverage.

Accordingly, the Court finds that the inclusion of “loss of use” as a type of property damage in the policies suggests that the damage caused by the Chinese-manufactured drywall in Plaintiffs’ homes constitutes a covered physical loss since the drywall prevents the Plaintiffs from fully using and enjoying their homes.

…the Court finds that the “physical loss” caused by the Chinese drywall in the Plaintiffs’ homes is “accidental” for purposes of coverage. The allegations in the complaint indicate that the damage caused by the Chinese drywall was “unusual,” “unexpected,” and not the result of any willful or intentional act.

Additionally, Louisiana jurisprudence defines the meaning of both “sudden” and “accidental” for purposes of a homeowners’ insurance policy as follows, “it appears that the critical phrase ‘sudden and accidental’ means an event which is either abrupt (though expected), or unexpected.

Also the event must occur from an unknown cause or be an unusual result of a known cause.

…Given these definitions, the Court finds that the damage caused by Chinese drywall in the homes of Plaintiffs’ insured…homeowners’ policies constitutes covered “accidental,” “sudden,” “physical,” “loss.” These Plaintiffs’ allegations indicate that the damage caused by the Chinese drywall was “unexpected,” “unknown,” and “unusual.” (emphasis added)

I agree with this analysis. There is "physical" and "accidental" damage to the structure. However, as indicated in Chinese Drywall Losses Covered Under First Party Property Insurance Policy, the difficult issue for the policyholder seeking benefits following a denial is:

…what is the covered cause of loss that is not excluded or is an exception to an exclusion?

The rest of the opinion was not favorable because the Court found the loss was excluded:

…the Court finds that the Chinese-manufactured drywall contained in the Plaintiffs’ homes constitutes “faulty materials” as that term is used in their homeowners’ insurance policies, and thus, the loss therefrom is excluded from coverage. Although the drywall serves its intended purpose as a room divider, wall anchor, and insulator, the allegations in the complaints provide that the drywall emits foul-smelling odors and releases gases which damage silver and copper components in the home, including electrical devices, appliances, and wiring. Accordingly, the drywall is like the radioactive table bases and building components containing asbestos or lead which function for all practical purposes as table bases and building components, but are faulty because the materials of which they are composed. In fact, this Court has previously recognized the factual similarities between Chinese drywall and asbestos on these same bases for purposes of a different legal controversy. See In re Chinese Manufactured Drywall Prods. Liab. Litig., 680 F.Supp.2d 780 (E.D. La. 2010)(“The Chinese drywall has been installed in numerous homes and in each instance is functioning as drywall.

This is similar to the asbestos fire-proofing which was installed in numerous buildings and functions as fire-proofing. Additionally, the Chinese drywall is releasing contaminants, causing damage to the building and those occupying the buildings, just as the asbestos”). The broad definition of faulty materials under common usage of a defect or imperfection in a physical thing lends further support to the finding that the Chinese drywall constitutes a faulty material.

Each of the complaints involved in the present motions allege that the Chinese drywall in the Plaintiffs’ homes emits gases which cause corrosion to metallic and electrical components in the home. These allegations indicate that the present cases are not ones in which corrosion is de minimis and no loss is caused thereby. Rather, the Court finds that these allegations trigger the corrosion exclusion since the corrosion is responsible for the majority of losses suffered by the Plaintiffs….

…the Eastern District of Virginia rejected an insured’s argument that the corrosion caused by the Chinese drywall in his home was not excluded by the corrosion exclusion because the corrosion was not the cause of the loss, but rather the actual loss. The court held that based upon the applicable law and ordinary meaning of corrosion, the corrosion exclusion was triggered by the presence of the Chinese drywall related corrosion in the insured’s home, whether or not it was the loss itself or the cause of the loss.

And, no exceptions to the exclusions applied:

In the above analysis, the Court has concluded that the Plaintiffs’ claims for losses related to Chinese drywall are excluded by the faulty materials exclusion and the corrosion exclusion. However, this does not end the discussion. It is now necessary to consider the effect of the ensuing loss provisions of the policies. All of the insurers, except Allstate, provide coverage for ensuing losses from faulty materials and corrosion. These ensuing loss provisions, though the language varies slightly, generally provide coverage for ensuing or resulting losses which (1) constitute covered losses, (2) not excepted from coverage by any coverage exclusion.

Plaintiffs argue that they are entitled to coverage from the Insurers, including the excluded losses, based upon the ensuing loss provisions in their homeowners’ insurance policies.

Plaintiffs claim that although a loss may be excluded from the policies, the ensuing loss provisions are “Lazarus-like,” resurrecting coverage for the excluded losses. Plaintiffs draw a distinction between the faulty Chinese drywall itself, an excluded loss, and the covered ensuing losses which are the losses caused by or resulting from the drywall. Plaintiffs note that the industry FC&S Bulletin states that any ensuing loss “as a result of the faulty drywall would be covered, for example if the drywall caused corrosion damage to wires or pipes,” and that there “is coverage for ensuing losses from faulty workmanship. (emphasis added)

I think that the policyholder attorneys plagiarized the "Lazarus" phrase from me. I noted this in Water Loss Denied? Ensuing Loss Provisions May Provide Coverage:

"Ensuing loss" provisions are the "Lazarus" clauses in property insurance policies. Property damage claims otherwise excluded from coverage, are raised from the dead and paid as a result of them. They are difficult to understand and the court decisions seem inconsistent. However, when there seems to be an event that is excluded, many times a water damage event, these clauses are often the only means of recovery.

Unfortunately, the ensuing loss provisions were held not to apply to Chinese drywall:

As to the losses caused by the odors emitted by the Chinese drywall, the Court finds that these losses are not ensuing because they are neither sufficiently different in kind from the losses caused by the Chinese drywall, nor the result of an extraneous event. The odors are inseparable from the drywall and are a continuous result of the drywall, much like the cracking foundation in Alton and the sagging, rotting home components in Holland. The emanation of odors from the Chinese drywall also is distinguishable from the “second accidents” which occurred when sweet potatoes were ruined by condensation caused by a faulty refrigerator in Dawson, and when an entire crane, with a few faulty components, was entirely ruined when it fell into a river in Holden.

The Court also finds that the corrosion-related losses caused by Chinese drywall do not constitute ensuing losses. However, even assuming that the corrosion or corrosion-caused losses due to the Chinese drywall in Plaintiffs’ homes were ensuing or resulting losses, they remain excluded losses because, as discussed above, corrosion and corrosion-related losses are specifically excluded from coverage…Whether the Chinese drywall in Plaintiffs’ homes causes corrosion pitting or residue on a metal pipe, wire, or surface, or causes more extreme loss, such as the failure of a system, device, or appliance in which these metal components are located, because these losses are the result of corrosion, they are excluded from coverage. This is consistent with the holding in Morgan, where the court concluded that even if mold caused by a defectively constructed roof was an ensuing loss, it was excluded from coverage because the applicable insurance policy specifically excluded losses constituting mold.

State Farm, USAA, Allstate, and Hartford are among other insurers that refused to pay their customers for losses stemming from damages caused by defective Chinese drywall. You don’t see those insurers advertising how often they refuse to pay for damage and explaining how little may be covered following a catastrophe. People really do not have "peace of mind" when it comes to all-risk property insurance despite the rosy scenarios of a safety net insurers promise in advertisements.