Insurance Company Lawyers Argue Physical Damage Requires Functional Damage—Can This Be True?

Chip Merlin | Property Insurance Coverage Law Blog | September 18, 2019

Judges should be aware of the extreme and aberrant arguments being made by a few insurance company lawyers about physical damage requiring damage to be “functional” damage. These lawyers argue that property insurance policies contemplate this “functional damage” requirement.

This first American flag above looks great and is beautiful. Suppose a hail storm comes by and it looks like this the next day:

Pressed to the extreme, some insurance companies would allow their attorneys to argue that the second depicted American flag is not covered damage. So, under their argument, what you see is not covered damage under your all risk property insurance policy. These lawyers argue that the flag is not “functionally” damaged and that your property has to have “functional damage” to have the type of physical damage which is covered under standard property insurance policies. What do you think about that? (A previous property insurance adjuster who is now an insurance claim expert sent me the American Flags to prove this obvious point.)

Seriously, the same insurance defense Colorado law firm with its very smart, clever and capable lawyers which advertise pretty significant bonuses to judicial law clerks as noted in my post, Policyholder Law Firms Should Ethically Be Hiring More Judicial Clerks, is making similar “functional damage” arguments on behalf of their insurance company clients. So, this novel and aberrant insurance concept continues to be raised by those who are paid handsomely to get them out of whatever perceived trouble they are getting into.

Maybe policyholders should stop purchasing policies from these insurance companies and from their agents to avoid these coverage denial problems? Would you like a list of the insurance companies arguing this?

Mike Duffy, Christina Phillips, Ed Eshoo, & Chip Merlin

I was in our Chicago office yesterday. Merlin Law group attorney Ed Eshoo was talking about the issue of functional damage and reminded me of his recent post, Does An Insurer Act In “Bad Faith” If It Denies Coverage For A Hail Loss Based On Its Retained Engineer Defining Hail Damage As Functional Damage?

Ed also mentioned that if the insurance companies ever intended for purely cosmetic damage to not be covered, why do they issue an endorsement that excluded cosmetic damage and charge a diminished premium for such policies?

I invite any insurance company defense attorney to write a guest blog that explains why they think their clients intended to cover only “functional damage.” I am still not certain what that term means since it was made up by HAAG engineering.1 In my opinion, this issue shows how desperate some insurers will act to avoid paying for what they clearly owe. That does not seem very American or ethical to me.

If you are a policyholder, public adjuster, contractor or policyholder attorney facing these wrongful functional damage denials, please call us. We can help.

1Cosmetic and Functional Damage – An Academic Discussion by Neil Hall.

Is Faulty Workmanship an “Occurrence” Under a CGL Policy?

Larry P. Schiffer | Squire Patton Boggs | September 16, 2019

Manufacturers often face multiple lawsuits when their products fail to perform as expected. Sometimes, the cause of the product’s failure is the faulty workmanship of a component manufacturer. When that is the case, the product manufacturer will seek damages from the component manufacturer for the underlying product defect claims. The component manufacturer will then turn to its insurance carriers to cover it for the dispute with the product manufacturer. In a recent case, the Third Circuit Court of Appeals addressed claims by a window component manufacturer against its insurance carriers after the insurance carriers disclaimed coverage for a settlement between the component manufacturer and the product manufacturer.

In Sapa Extrusions, Inc. v. Liberty Mutual Insurance Co., No. 18-2206 (3rd Cir. Sep. 13, 2019), the district court granted summary judgment to the insurance carriers, finding that the product defect claims were not covered under the various CGL policies. The circuit court affirmed in part and vacated in part. The court held that “recovery turns on the language of the specific insurance policies at issue” under Pennsylvania law.

The court first discussed how Pennsylvania law required the strict application of the “four-corners” rule and that if the court determines that there is no duty to defend, then there is no duty to indemnify. The court also discussed in detail how Pennsylvania law requires courts to interpret insurance policies. Here, the court focused on the definition of “occurrence” found in the 28 applicable insurance policies. The court organized the policies into three groups: (a) the “Accident Definition”; (b) the “Expected/Intended Definition”; and (c) the “Injurious Exposure Definition.” The details of this analysis are in the opinion. The basis for the division was the differences in the occurrence wording.

The first definition, which covered 19 of the policies, focused on the term “occurrence” being defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Under Pennsylvania law, this definition required fortuity and “faulty workmanship” did not come within that definition. Thus, held the court, the factual allegations of the product manufacturer’s complaint did not amount to an occurrence that could trigger coverage. The allegations of faulty workmanship, said the court, did not amount to an unforeseeable, fortuitous event. Thus, the court affirmed the grant of summary judgment for those 19 policies.

The court vacated the judgment and remanded the remaining 9 policies back to the district court to consider the implications of the latter two occurrence definitions. The differences in the definitions, held the court, were unique and the district court should have considered those policies separately. The court declined to interpret these 9 policies other than to say that the additional language was not mere surplusage and may be considered ambiguous under Pennsylvania law.

The court held that the rule it reemphasized in this opinion was simple: “in Pennsylvania, insurance policies must be interpreted and applied in accordance with their plain language and relevant Pennsylvania law.” The remand, said the court, was to give the district court the opportunity to give the latter two categories more consideration based on the difference in the language so as to determine if coverage is triggered.

Colorado Supreme Court Decision Could Tarnish Appraisal Process for Policyholders

Michael V. Pepe | SDV Insights | July 23, 2019

On June 24, 2019, the Colorado Supreme Court ruled that the plain language of appraisal provisions in insurance policies, requiring “impartial appraisers,” direct appraisers to be “unbiased, disinterested, and unswayed by personal interest,” regardless of who hires them, and prohibits the party-appointed appraisers from acting as advocates.

A common and attractive alternative dispute resolution option, the appraisal process usually entails the policyholder and insurer each hiring their own appraiser, who estimates how much the claim is worth. These appraisers also select a third-party umpire, and if they cannot agree upon one, a court appoints one. The umpire analyzes the conflicting estimates and presents a number to resolve the dispute. If two of the three parties agree with the outcome, the number becomes binding.

Owners Ins. Co. v. Dakota Station II Condo. Ass’n, Inc.began when Dakota Station II Condominium Association Inc. (“Dakota”) and its insurer, Owners Insurance Company (“Owners”) could not agree on how to value two claims arising out of weather damage. To settle the differences and come to a resolution, Dakota invoked the appraisal provision in the insurance policy instructing each party to select its own “competent and impartial appraiser.” Ultimately, a court-appointed umpire considered six cost categories in dispute and adopted four of Owners’ estimates and two of Dakota’s.

Owners filed a petition to vacate the award, alleging that Dakota’s appraiser “acted improperly by entering into a contract … that capped her fees at five percent of the insurance award (allegedly giving her a financial interest in the outcome).” Under this fee arrangement it was possible that the appraiser would collect more fees for a higher award. Owners argued that the appraiser’s potential financial interest meant that the appraiser was not “impartial” as required by the policy.

After two lower courts held in favor of the insured, the Colorado Supreme Court granted certiorari and considered two issues: (A) the meaning of the language “impartial” in the appraisal provision, and (B) whether the fee arrangement meant that Dakota’s appraiser was not impartial as a matter of law.

The Court affirmed the lower court’s holdings in part, holding that appraisers were not necessarily held to the same strict standards of impartiality as arbitrators. On the other issues, the Court overturned the lower court. The Court held that the appraisal provision is not ambiguous, and that the plain meaning of “impartial” is “[n]ot favoring one side more than another; unbiased and disinterested; unswayed by personal interest.” In comparing this with the plain meaning of “advocate” – “[s]omeone who assists, defends, pleads, or prosecutes for another” – the court concluded that an appraiser cannot simultaneously advocate for a party and be impartial.

The Court relied on the fact that there is nothing in the provision suggesting that an appraiser would put forth values on behalf of a party that hired it. “[W]e can’t endorse a reading of the impartiality requirement that suggests one can simultaneously be an ‘advocate’ for one of the parties and be ‘impartial.’”

The Court also concluded that in this case, the contingent-cap fee arrangement did not render the appraiser biased as a matter of law. The fees did not reach a level that would have been capped, even under Owner’s appraiser’s valuation, and thus the contingent-cap did not affect what the appraiser was paid. The appraiser did not “believe the cap was in effect and there is seemingly no relationship between the fees billed by the appraiser and the estimates she put forth, we can’t say that hypothetical incentives rendered her partial.”

Several judges dissented from the majority opinion, warning that the holding further “tips the scale in favor of the insurance industry,” widening the imbalance of power in this area.

The holding may be impractical, requiring humans to ignore their natural instincts, because “when an appraiser advocates for her own work and final valuation, she essentially advocates for one party, and it’s human nature to expect (and want) an appraiser to advocate for her own work and final valuation.” It seems unlikely that each party would select and compensate its own appraiser and expect that appraiser to not advocate for or favor its side. After all, the umpire is supposed to fulfill the unbiased third-party role in the appraisal process.

Colorado’s holding should put both insurers and policyholders on notice to review the language of appraisal provisions commonly found in first party policies, including homeowners, commercial property, and builders risk insurance. Parties should consider whether this is the arrangement they want and whether to negotiate for a process that expressly allows for appraisers to advocate on their behalf to the umpire. Otherwise, they run the risk that a favorable award can be vacated based on an after-the-fact showing of partiality or bias.

In addition to reviewing appraisal provisions, parties should carefully consider the appraiser selection process and vet potential appraisers before the appraisal process begins.

Techniques for Resolving Construction Disputes

Jason Lambert | Construction Executive | June 23, 2019

With most construction projects involving dozens, if not hundreds, of companies and individuals, it is no surprise that conflicts arise that are not always able to be resolved on the jobsite. But these conflicts need not always reach the court room or cost thousands (or much more) to resolve. With some planning, contractors can build faster and less expensive dispute resolution options into their project so they can spend more time keeping the project moving and less time arguing over who is right. 

Even for modest-sized projects, a multi-tiered approached to dispute resolution can be helpful. As a first level of dispute resolution, consider requiring the relevant parties to attend informal or formal mediation. The benefits of even an informal mediation is that it can get stalemated parties to the table to talk again. Formal mediation adds the benefit of a neutral third-party who can help get talks moving or help antagonistic parties communicate. 

Further, mediation allows each side an opportunity to hear what the other side is looking for to resolve the dispute. Not only is this valuable in reaching a compromise, but it also gives each side an idea of what the other will bring to the table in any subsequent litigation. Finally, there are many ways to implement these procedures. General contractors can require pre-suit mediation with their subcontractors to resolve one-on-one disputes but should also consider requiring subcontractors to use pre-suit mediation to resolve disputes between subcontractors or between subcontractors and sub-subcontractors or material suppliers if the dispute threatens the progress at the project. 

Another alternative (or addition) to mediation can be to appoint a specific person to resolve certain kinds of dispute. For example, assume that a drywall contractor begins to do his work, but stops because he claims that a trade contractor’s work interferes with the drywall or is deficient and cannot be covered up. The trade contractor disagrees and refuses to correct the issue raised by the drywall contractor. If the contract calls for it, this disagreement could be resolved by an appointed engineer, architect, construction manager or almost any other third party. That is much more efficient solution than terminating a subcontractor from the project or bringing in a new subcontractor to perform work. 

Assuming these methods of resolution fail, there remain two traditional means of dispute resolution—binding arbitration and litigation. While arbitration is touted as less costly than litigation, this is not always the case. Arbitration filing fees can be more expensive than court filing fees and in most arbitration cases the parties will still be able to conduct depositions and discovery to aid the arbitrator in reaching a final decision. The key benefits to arbitration are that it can be done in a much more condensed time frame and it is largely private. Thus, the discovery, evidence and any other items that might normally become part of the public record in litigation are kept private in arbitration. Only the final outcome will generally become part of any public record, and that is assuming that the prevailing party uses a court to affirm or enforce the arbitration award. 

Litigation, like arbitration, results in a final resolution of a dispute and an enforceable judgment for the prevailing party. Unlike arbitration, though, the timelines can be stretched out by crowded court dockets and nearly ever occurrence in litigation becomes a public record. One of the primary benefits to litigation though are that there are actions that a court can take that an arbitrator cannot. For example, an arbitrator cannot enter an order foreclosing a construction lien; only a court can. Thus, the claims a contractor plans to file can play an important role in deciding whether to arbitrate or litigate. 

Moreover, these dispute resolution options do not exist independently of each other. Many contracts nowadays contain pieces of each. One way to do this is to require mediation of all disputes, litigation of claims that must be heard by a court (such as lien foreclosure) and arbitration of any remaining issues. By using a layered approach, the benefits of several types of dispute resolution are preserved while providing opportunities to use them that hopefully result in resolution. 

Further, technology adds a new twist on dispute resolution, particularly informal mediation or arbitration. Witnesses, evidence and information can be shared electronically or over video, making the use of specialized experts or testing more accessible. This can be another critical consideration in determining what forms of dispute resolution to require in the contract with another party and the disputes to which that resolution mechanism will apply. 

Above all it is critical to include dispute resolution mechanisms in the contract at the beginning. Without, there is no way to require anything other than litigation which could set a contractor up for costly legal fights that could have been avoided through another form of dispute resolution. Think these issues through can result in projects that run more smoothly and that are not delayed when the inevitable conflict arises. 

Can Misrepresentations In a Proof of Loss Void Coverage?

Christina Phillips | Property Insurance Coverage Law Blog | September 20, 2019

It can be difficult after a fire for an insured to remember with 100% certainty what personal property they had in their home. Most likely, receipts and other purchase records have also been destroyed. As such, public adjusters in preparing estimates and/or proofs of loss are typically left to rely upon the insured’s memory. After all, who knows better than the insured what property was there before the fire? But what if there are inaccuracies in the proof or estimate….is that enough to cause the claim to be denied based on the concealment and misrepresentation clause?

According to the United States Court of Appeals for the Eighth Circuit: Yes. In Borchardt v. State Farm Fire and Casualty Co., 931 F.3d 781 (8th Cir. July 29, 2019), the Eighth Circuit Court of Appeals recently affirmed that the evidence presented at trial regarding certain misrepresentations in a proof was sufficient to support the jury’s finding that misrepresentations were material and thus voided the right to recovery under the policy.

Following a fire to their home, the insureds retained the services of a public adjuster to assist them in preparing an inventory and valuing the items destroyed by the fire. At trial, the public adjuster testified that he relied upon the insureds to provide an inventory of the contents.

At the time of trial State Farm identified items on the proof of loss that it argued were material misrepresentations. For instance, the insured identified the value of a wedding ring at $2,000, whereas the insured had declared the value of that same ring at only $50.00 in a prior bankruptcy petition. The testimony of various family members presented either through deposition or at trial also did not line up with what was being claimed on the proof. The proof listed that the insureds owned 1,000 DVDs. The son’s deposition testimony was that they only owned about 100 DVDs. Similarly, there was divergent testimony about the number of televisions, lawn mowers and laptops owned.

The jury was instructed on the meaning of “material” and “intent to defraud” under Minnesota law:

For a concealment or misrepresentation to be “material,” it must be sufficiently substantial to matter to a reasonable insurer. A concealment or misrepresentation that impacts the investigation of an insurer into the cause of the fire is material. Likewise, a concealment or misrepresentation about items of personal property that were allegedly destroyed by a fire is material unless the amount of money involved in the concealment or misrepresentation is so small that a reasonable insurer is not likely to care about it.

To act with an “intent to defraud” means to act with the purpose or intent of deceiving or cheating someone else. In considering whether any of the Borchardts acted with an intent to defraud, you may consider whether they acted with a desire or purpose to bring about some gain or benefit to themselves at the expense of State Farm.

Ultimately, the jury determined that the inaccuracies on the proof of loss statement were enough to establish a willful intent to defraud State Farm by concealment or misrepresentation of a material fact or circumstances relating to the claim.

In affirming this determination, the Eighth Circuit noted that it was apparent from the record, particularly the fact that the jury had submitted a question during deliberations, that the jury did not presume materiality. In relevant part, the jury had submitted the following question:

Is there a specified amount State Farm considers to be a ‘small amount’. ex. % or dollar amount.

The trial court responded by directing the jury’s attention to the jury instructions and reiterating that State Farm had the burden to prove that any concealment or misrepresentation was ‘material’ – that is, “sufficiently substantial to matter to a reasonable insurer.”

The Eighth Circuit affirmed the jury’s conclusion, believed there was sufficient evidence to sustain the jury’s determination and therefore the material misrepresentations regarding the personal property lost voided the right to recovery under the policy.

This case is a good reminder to public adjusters, insureds, and attorneys alike to consider alternative sources of information that may provide quantities or values such as bankruptcy pleadings or prior insurance claims information. Obtaining this information before an estimate, inventory or proof of loss is submitted may very well help guard against claims by an insurer that a misrepresentation was made.