First-party property insurance policies often contain tear-out provisions that provide coverage for situations where there is a leak in the pipes of the plumbing system, and to repair the plumbing system from which the water escaped, there is a need to tear-out building materials to access the pipes. What if the only repair that can be performed to the plumbing system requires all of the pipes in the residence to be replaced (even those beyond the portion with the leak)? The tear-out provision could then require the insurer to pay for the entire costs of tear-out to do the repair.

This is a topic in class-action litigation against State Farm. Guadiana v. State Farm Fire & Cas. Co., No. CIV 07–326 TUC FRZ (GEE) (U.S. D.C. Ariz Jan. 25, 2012). The policyholder, Guadiana’s home sustained water damage when the plumbing leaked. She discovered that her plumbing was constructed out of polybutylene pipes and was informed this type of system cannot be repaired piecemeal—it must be completely replaced.  Guadiana replaced all of the pipes. She submitted a claim to State Farm for the water damage and for the “tear-out” costs associated with tearing out and replacing that portion of the structure necessary to replace her entire plumbing system. State Farm took the position that her water damage was covered by the policy, but the tear-out provision did not cover the cost of accessing and replacing those pipes that were not leaking. Guadiana filed a class action lawsuit in Federal Court claiming that State Farm’s failure to pay her entire tear-out costs is a breach of contract and a breach of the duty of good faith.

The policy contains the following “tear-out” provision:

We do not insure for any loss … which consists of, or is directly and immediately caused by …

* * *
f. continuous or repeated seepage or leakage of water or steam from a:

(1) heating, air conditioning or automatic fire protective sprinkler system;

(2) household appliance; or

(3) plumbing system, including from, within or around any shower stall, shower bath, tub installation, or other plumbing fixture, including their walls, ceilings or floors;

which occurs over a period of time. If loss to covered property is caused by water or steam not otherwise excluded, we will cover the cost of tearing out and replacing any part of the building necessary to repair the system or appliance. We do not cover loss to the system or appliance from which the water or steam escaped …

The Court noted that Guadiana suffered a covered loss when the pipes in her house leaked. This covered loss triggered the tear-out provision of the insurance policy where State Farm is obligated to pay the tear-out costs “necessary to repair the system or appliance.” The system is the plumbing system that caused the leak. The Court stated that if Guadiana can establish as a matter of fact that her plumbing system caused the covered loss and in order to repair that system it was necessary to replace all the pipes, State Farm is obligated to pay the tear-out costs necessary to replace all those pipes, even those not leaking.

State Farm maintains it is only required to pay the tear-out costs necessary to replace the particular pipes that burst. It argues a more expansive interpretation of the tear-out provision runs counter to those sections of the policy that exclude coverage for loss consisting of defective construction materials.

The Court held that State Farm’s construction does not jive with public policy. Guadiana intends to prove that the only way to repair her system was to replace all the existing polybutylene piping. There are situations where replacement is the appropriate, standard, or most cost-effective method for repairing a plumbing system. Under State Farm’s construction of the policy, tear-out costs would be paid if a plumbing system is repaired but would not be paid if the system is replaced, regardless of which method was most appropriate or cost-effective. State Farm’s construction would discourage replacement even if the resulting cost to both the homeowner and State Farm was less than it would be if the plumbing system were repaired. The Court noted that this policy construction could result in wasteful spending contrary to public policy.

Finally, the court concluded that State Farm’s construction does not facilitate the purpose of the insurance policy as a whole. The tear-out provision is designed to make the homeowner whole after an unforeseen loss. There is no reason why a homeowner with a system that can only be repaired by replacement would have any less desire or need to be reimbursed by their insurance carrier after suffering a covered loss.

This case discusses good news for policyholders in this part of the case. The outcome seems to be straight forward and seems to make sense, particularly if it is necessary to replace all the plumbing pipes to repair the system.