Heather Howell Wright | It Pays to Be Covered
In construing policies that covered loss “caused by or resulting from water damage” but excluded coverage for loss caused by “dampness of atmosphere” or by “[e]xtremes or changes in temperature,” the United States Court of Appeals for the District of Columbia recently preserved coverage under an ensuing loss exception to the exclusions in 3534 East Cap Venture LLC et al. v. Westchester Fire Insurance Co. et al., No. 22-7136, 2024 WL 3076909 (D.C. Cir. June 21, 2024). The D.C. Circuit applied the ensuing loss exception providing coverage where “[l]oss by an insured peril ensues” to ensure that the dampness and extreme temperature exclusions did not obliterate the coverage for property damage “caused by or resulting from water damage.”
This case follows the addition of “ensuing loss” clauses in standard form property policies after the 1906 San Francisco earthquake and subsequent fires. The San Francisco earthquake ruptured gas mains, which in turn sparked massive fires that caused even greater damage than the earthquake itself. Coverage for the losses turned on whether property damage was caused by the earthquake, an excluded cause, or fire, a covered cause. In response to the San Francisco fire losses and to comply with statutes passed after the fires, insurers added ensuing loss exceptions to provide coverage for ensuing loss that was caused by a covered cause.
Over the past century, however, interpretation and application of ensuing loss provisions has confounded courts. Some courts consider only the efficient proximate cause of the loss and whether the initial peril that started a chain of events is a covered cause of loss. If this initial peril is not covered, then there is no coverage for the loss. Other courts consider whether the loss was caused at least in part by a covered peril and hold coverage can be reinstated, at least in part, by the ensuing loss clause. Some courts require an ensuing loss to be separate and independent from the initial loss. Under this theory, courts interpret the exception as requiring a second, entirely distinct, loss event – in which one cause is an excluded peril and the other is a covered peril. If the excluded peril is “inextricably intertwined” with a covered peril, there is no coverage.
In 3534 East Cap Venture LLC, the D.C. Circuit found coverage through the ensuing loss exception: the “ensuing loss clause applies to losses from water damage caused by the excluded perils of dampness and temperature changes.” The policies provided coverage for “[l]oss… caused by or resulting from water damage” but excluded loss caused by “dampness of atmosphere” or by “[e]xtremes or changes in temperature.” These exclusions, in turn, contained an ensuing loss exception providing coverage where “[l]oss by an insured peril ensues.”
The dispute arose out of a construction project. 3534 East Cap Venture, LLC hired McCullough Construction, LLC (collectively, the “Policyholders”) to construct a residential and retail building in Washington, D.C. Westchester Fire Insurance Company and Endurance American Insurance Company (collectively, the “Builders Risk Insurers”) shared jointly in the risk and issued identical builders risk policies. The cause of the loss to the East Cap Venture project was not disputed. Due to lack of a vapor barrier (which was not included in the design), moisture under the roof condensed during cold weather, causing what deposition testimony described as water falling from the ceiling “like rain drops.” This water soaked building materials, including wood, insulation, and drywall, resulting in approximately $1.5 million in loss. The Policyholders submitted claims for the loss, which the Builders Risk insurers denied, citing the dampness of atmosphere and changes in temperature exclusions. The Policyholders then filed suit. On cross-motions for summary judgment, the trial court held the ensuing loss provision did not apply because the losses from “water damage” were “inextricably intertwined” and were “one and the same” as losses caused by dampness and water exclusions.
On appeal, the parties focused on causation and whether the property damage was caused by dampness and temperature or was instead caused by the lack of a vapor barrier. In reversing the trial court, the D.C. Circuit concluded it was not necessary to resolve these causation issues because “if the exclusions apply, the ensuing-loss exception also applies and provides coverage here.” The D.C. Circuit began its analysis with the coverage grant providing coverage for “water damage,” which the court noted was “broadly” defined to include “[a]ll water damage, except Loss caused by or resulting from the peril of Flood.” The D.C. Circuit assumed both exclusions applied and focused its analysis solely on the ensuing loss exception in the policies and whether the water damage “ensued” within the meaning of the policies. In finding coverage, the court rejected the argument of the Builders Risk Insurers “that water damage did not ensue from dampness and temperature changes if the dampness and temperature changes directly caused the water damage.”
The D.C. Circuit considered dictionary definitions of the term ensue so that its construction would be “consistent with ordinary speech.” Applying these dictionary definitions and prior case law, the court concluded “losses from water damage ensued from the dampness and cold if the water damage resulted from those causes.” The court also applied standard “interpretive presumptions” that ambiguities must be resolved against the insurer and exclusions must be interpreted narrowly in favor of coverage.
The D.C. Circuit concluded it was not necessary to distinguish between the various ensuing loss interpretation theories because “the excluded perils – dampness of atmosphere and change in temperature – are not inexplicably intertwined with the covered ensuing peril of water damage.” The court then identified examples in which humidity and temperature changes could damage a building without causing condensation or “water damage.” Ultimately, the East Cap Venture court held the loss was “more directly caused by ‘an insured peril’ namely water damage.” The court’s decision focused on the breadth of the initial coverage grant to interpret the ensuing loss clause explaining that “a broad reading of ensuing-loss clauses … provide[s] coverage whenever an insured peril is a ‘direct cause of the loss,’ even if the insured peril was itself caused by an excluded peril.” In short, the D.C. Circuit applied the clause as it was intended: The purpose of the exception is to ensure the exclusions do not swallow the coverage provided by the policies.
Property loss and damage to a project during construction can significantly impact scheduling and profitability. Causation language in property insurance policies is increasingly complex as insurers seek to limit liability for losses. The East Cap Venture decision highlights the importance of policy language and the role of coverage counsel in framing a builders risk claim properly to maximize coverage and recovery.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.