Ensuing Loss Clauses Are Often Confusing

Ensuing loss clauses give rise to a lot of coverage debate. They also give rise to a lot of litigation. I was about to write about a recent ensuing loss decision, but that decision cited a Maryland judge’s discussion of the ensuing loss clause as he wrestled with its meaning. So, I am writing about that discussion first to prove my point.

We try to make the interpretation of property insurance policies clear for our readers. However, when it comes to ensuing loss clauses, the analysis is often confusing.

The genesis of the ensuing loss provision helps to illuminate its intended effect. The clause got its start in the wake of the 1906 San Francisco earthquake. See James S. Harrington, Lessons of the San Francisco Earthquake of 1906: Understanding Ensuing Loss in Property Insurance, 37 THE BRIEF 28, 28 (Summer 2008). The 7.9 magnitude earthquake not only toppled buildings, it also sparked massive fires that ravaged the city for three days. Harrington, supra, at 28. Together, the earthquake and fires consumed more than 28,000 buildings. Id.

At the time, the garden-variety insurance policy covered fires but excluded coverage for losses caused by earthquakes. See French, supra, at 216. As a result, many insurers refused to pay policy holders for fire damage, arguing that it was the product of the earthquake. Id. The California legislature responded by enacting a series of laws barring insurers from disclaiming coverage for fire damage that followed an earthquake. Id. To comply with the law, insurance companies began inserting language in their policies to make clear that losses caused by fires would be covered, notwithstanding the earthquake exclusion. Id. Thus, the origin of the ensuing loss clause reveals that it is designed to preserve coverage for insured losses, such as a fire, but not to resurrect coverage for excluded losses, such as an earthquake or faulty workmanship.

Ensuing loss clauses are ‘well recognized in Maryland case law.’ Selective Way Ins. Co. v. Nat’l Fire Ins. Co. of Hartford, 988 F. Supp. 2d 530, 538 (D. Md. 2013) (citing McEvoy v. Sec. Fire Ins. Co. of Balt., 110 Md. 275, 73 A. 157 (1909); Transatlantic Fire Ins. Co. of Hamburg v. Dorsey, 56 Md. 70 (1881)). In 1881, the Maryland Court of Appeals ruled that a clause that excepted from coverage ‘explosions of any kind, unless a fire ensures, and then for the loss of damage by fire only,’ Dorsey, 56 Md. at 77 (emphasis in original), covered fire damage ‘even though the fire had originated in an explosion.’ Id. at 79. The court cautioned that although the exception was ‘certainly very broad and comprehensive,’ it ‘must not be so construed as to defeat the main and principal object of the insurance.’ Id.

Although ensuing loss clauses are not new to Maryland, there appears to be a paucity of published decisions on the subject. To my knowledge, no Maryland appellate court has confronted an ensuing loss clause since the turn of the Twentieth Century. The parties point to no case, nor has the Court uncovered a published decision, addressing the question presented here: whether an ensuing loss clause applies to a covered loss that is causally related to an excluded peril, or applies only when the covered loss is the result of an independent or superseding event.

Furthermore, of the handful of decisions issued by courts in this District involving ensuing loss clauses governed by Maryland law, only one had the opportunity to opine on the provision’s scope. See Selective Way Ins., 988 F. Supp. 2d at 540 (water damage caused by faulty water line was an ensuing loss), and compare with James McHugh Constr. Co. v. Travelers Prop. Cas. Co. of Am., 223 F. Supp. 3d 462, 473-74 (D. Md. 2016) (ensuing loss clause was inapposite where the only claimed loss—scratched windows—was directly caused by faulty workmanship); Morgan-Keller, Inc. v. Lexington Ins. Co., GLR-12-2958, 2014 WL 12737621, at *4 (D. Md. June 16, 2014) (same); Carney v. Assurance Co. of Am., JFM-04-3434, 2005 WL 899843, at *2 n.4 (D. Md. Apr. 19, 2005) (claimed loss was improperly treated wood siding), aff’d, 177 F. App’x 282 (4th Cir. 2006). The case of Selective Way Insurance, 988 F. Supp. 2d at 538, cited only two Maryland cases, Dorsey and McEvoy, and only for the proposition that ensuing loss provisions have long been recognized in Maryland.

The role of a federal court when considering an issue of state law is to ‘apply the governing state law, or, if necessary, predict how the state’s highest court would rule on an unsettled issue.’ Askew v. HRFC, LLC, 810 F.3d 263, 266 (4th Cir. 2016) (quoting Horace Mann Ins. Co. v. Gen. Star Nat’l Ins. Co., 514 F.3d 327, 329 (4th Cir. 2008)); see also Private Mortg. Inv. Servs., Inc. v. Hotel & Club Assocs., Inc., 296 F.3d 308, 312 (4th Cir. 2002). Although it appears that the scope of ensuing loss clauses is an issue of first impression in Maryland, neither party asked this Court to certify a question of law to the Maryland Court of Appeals. And, I am satisfied that certification is not warranted.

This Court must predict how the Maryland Court of Appeals would rule if it confronted the issue. See, e.g., Delawder v. Am. Woodmark Corp., 178 F. App’x 197, 202 n.3 (4th Cir. 2006) (because no West Virginia court had defined a statutory term, the court ‘must predict how the West Virginia Supreme Court would define this term if it had to confront this Issue’). In forecasting how the Maryland Court of Appeals would approach the question, I may consider treatises and the practices of other jurisdictions. See St. Paul Fire & Marine Ins. Co. v. Am. Int’l Specialty Lines Ins. Co., 365 F.3d 263, 272 (4th Cir. 2004).

Despite the ensuing loss clause’s quotidian nature and centuries-old pedigree, its effect remains clouded in confusion. French, supra, at 220 (the clause has ‘confused and divided the courts’); Harrington, supra, at 30 (the clause has ‘perplexed’ courts). And, inconsistent decisions involving similar facts have led commentators to lament that the law is in disarray. See Paul T. Sullivan & Jeffrey A. Gordon, A Review of Ensuing Loss Case Law: 2010 To Present, 43 THE BRIEF 18, 19 (Spring 2014); see also 4 CONSTRUCTION LAW § 11:454 (detailing conflicting opinions concerning ensuing loss clauses issued by the Washington Supreme Court on the same day). In particular, jurisdictions are openly divided as to whether an ensuing loss clause applies to all covered losses that occur subsequent to an excluded peril, or only those losses that are independent of the excluded event. See Taja Invs. v. Peerless Ins. Co., 196 F. App’x 587, 593 (E.D. Va. 2016) (acknowledging the split); Leep v. Trinity Univ. Co., 261 F. Supp. 3d 1071, 1082 (D. Mont. 2017) (canvassing divergent lines of authority); Sullivan & Gordon, supra, at 20-25 (discussing the conflict).

On the one hand, the ‘consensus approach’ is that an ensuing loss clause provides coverage ‘only when there is significant attenuation between the direct result of the workmanship defect and the ultimate loss for which coverage is sought, usually due to an independent or fortuitous intervening cause.’ Taja Invs., 717 F. App’x at 192 (applying Virginia law); see, e.g., Friedberg v. Chubb & Son, Inc., 691 F.3d 948, 953 (8th Cir. 2012) (under Minnesota law, an ensuing loss provision ‘excludes from coverage the normal results of defective construction, and applies only to distinct, separable, and ensuing losses’) (cleaned up); TMW Enters., Inc. v. Fed. Ins. Co., 619 F.3d 574, 579 (6th Cir. 2010) (under Michigan law, if ‘damage came naturally and continuously from the faulty workmanship, unbroken by any new, independent cause, the exclusion applies and the ensuing loss provision does not’) (cleaned up); Alton Ochsner Med. Found. v. Allendale Mut. Ins. Co., 219 F.3d 501 (5th Cir. 2000) (under Louisiana law, ensuing loss provision was triggered only when a distinct and unrelated event caused damage).

In these jurisdictions, courts have uniformly declined to find that an ensuing loss clause covers damage that resulted, in part, due to a defect. For example, mold is not a separate and distinct peril from water damage caused by faulty workmanship because the design or construction defect ‘naturally and foreseeably leads to water infiltration.’ TMW Enters., 619 F.3d at 579; see also Friedberg, 691 F.3d at 953; Prudential Prop. & Cas. Ins. Co. v. Lillard-Roberts, CV-01-1362, 2002 WL 31495830 (D. Or. June 18, 2002); Russell v. NGM Ins. Co., 170 N.H. 424, 437, 176 A.3d 196, 206 (2017); Wright v. Safeco Ins. Co., 124 Wash. App. 263, 275, 109 P.3d 1, 7 (2004). Similarly, noxious gas released by defective drywall is not a covered loss because the ‘odors are inseparable from the drywall and are a continuous result of the drywall,’ rather than ‘the result of an extraneous event.’ In re Chinese Manufactured Drywall Prods. Liab. Litig., 759 F. Supp. 2d 822, 851 (E.D. La. 2010); see also Bishop v. Alfa Mut. Ins. Co., 796 F. Supp. 2d 814 (S.D. Miss. 2011); Travco Ins. Co. v. Ward, 715 F. Supp. 2d 699 (E.D. Va. 2010), aff’d, 468 F. App’x 195 (4th Cir. 2012).

This view of ensuing loss clauses rests on the belief that identifying a distinct, unrelated peril is necessary to avoid nullifying the policy’s faulty workmanship exclusion. As the Sixth Circuit explained, TMW Enters., 619 F.3d at 576-77:

[A]n ‘all-risk’ policy … basically covers everything unless specifically excluded. That means the number of possibilities for last-in-time ‘but for’ causes of damage are limited only by the imagination of the reader. What if a roof contains a flawed design … and it leaks water into the house, which ruins one of the floors? But for the water, no damage to the floor would have occurred. Yet the contract does not exclude damages caused by ‘water.’ Coverage? What if faulty construction allows humid summer air to enter the building, which rusts metal fixtures? But for the exposure to the summer air, no damage to the fixtures would have occurred. Yet the contract does not exclude damages caused by ‘air’ Coverage? What if a poorly constructed ceiling beam falls, smashing the floor below? But for the force of gravity, no damage to the floor would have occurred. Yet the contract does not exclude damages caused by ‘gravity.’ Coverage? As in each of these examples, so too here: The very risk raised by the flawed construction of a building came to pass. To say that the risk was not covered because other elements or natural forces were the last causative agents of the damage, though to be sure utterly foreseeable causes of the damages, is to eliminate the exclusion.

Reading ensuing loss clauses narrowly does not necessarily preclude coverage in all cases of faulty workmanship. The case of Costco Wholesale Corp., v. Commonwealth Insurance Co., 45 F. App’x 646 (9th Cir. 2002), is instructive. There, the plaintiff filed a claim for damage to a new warehouse that had differentially settled. Id. at 647. The insurer denied the claim under the policy’s faulty workmanship exclusion because the building’s foundation was plagued by design defects. The plaintiff brought a declaratory judgment action against the insurer, and the district court granted summary judgment in favor of the plaintiff on the ground that the damage was covered under the policy’s ensuing loss clause. Id. The Ninth Circuit affirmed, explaining that the uneven settling was ‘distinct from the defective design’ because it was caused by shifting soil. Thus, because ‘[m]ovement of the earth’ was a covered peril that occurred separate and apart from the defective installation, the policy covered the plaintiff’s claim. Id.

In contrast to the preceding cases, some jurisdictions do not require the covered event to be independent from the excluded peril, but only the direct cause of the loss. See Leep, 261 F. Supp. 3d at 1083; Bartram, LLC v. Landmark Am. Ins. Co., 864 F. Supp. 2d 1229 (N.D. Fla. 2012); Selective Way Ins., 988 F. Supp. 2d at 538-39; Eckstein v. Cincinnati Ins. Co., 469 F. Supp. 2d 455, 462 (W.D. Ky. 2007); Vision One, LLC v. Phila. Indem. Ins. Co., 174 Wash.2d 501, 276 P.3d 300 (2012); Arnold v. Cincinnati Ins. Co., 276 Wis.2d 762, 688 N.W.2d 708 (2004); Ariston Airline & Catering Supply Co., Inc. v. Forbes, 211 N.J. Super. 472, 511 A.2d 1278 (1986). In these jurisdictions, the analysis is straightforward: ‘If the ensuing loss is also an excluded peril or an excluded loss under the policy, there is no coverage. But, if the policy covers the peril or loss that results from the excluded event, then the ensuing loss clause provided coverage.’ Vision One, 174 Wash.2d at 516, 276 P.3d at 307 (internal citation omitted). Put differently, ‘the dispositive question in analyzing ensuing loss clauses is whether the loss that ensues from the excluded event is covered or excluded.’ Id.

For instance, in Arnold, 276 Wis.2d 762, 688 N.W.2d 708, the Wisconsin Court of Appeals considered whether an ensuing loss clause covered water damage to a home caused by rain that had entered through defective window caulking. The court found that there was ‘no basis in the policy language for limiting the cause of an ensuing loss to a ‘separate and independent peril.’ Id. at 785, 688 N.W.2d at 719. Rather, the court explained that ‘an ensuing loss is a loss that is not directly caused by faulty workmanship or faulty materials, but nonetheless follows as a ‘chance, likely, or necessary consequence’ of the loss caused by faulty workmanship or faulty materials.’ Id. at 779, 688 N.W.2d at 716. Turning to the facts of the case, the court held that while the policy did not cover the cost to repair the caulking, the water damage caused by the rain that leaked through the damaged windows was an ensuing loss. Id. at 785, 688 N.W.2d at 719.

When somebody says they can easily explain the ensuing loss clause, run from that arrogant liar. The clauses are interpreted differently in different states, and the distinctions are often confusing after careful study.

So. when I write about the ensuing loss clause case I was about to write about today, I will try to make it less complex and easier to understand. But it still will not be a simple explanation.

“If we knew what it was we were doing, it would not be called research, would it?”
—Albert Einstein