The U.S. Court of Appeals for the First Circuit recently ruled that water damage to a mixed-use rental property resulting from a tropical storm was covered under an all-risk policy where the water was categorized as "surface water" and an endorsement to the all-risk policy provided for coverage for damages resulting from surface water.
A copy of the opinion is available at: http://media.ca1.uscourts.gov/pdf.opinions/12-1572P-01A.pdf.
Two borrowers ("Borrowers") owned a mixed-use rental property (the "Subject Property") with a drainage system consisting of a single drain located at the center of the roof. The Subject Property was mortgaged with a bank ("Bank"). The Subject Property was insured through an all-risk policy by insurer ("Insurer").
Although the main all-risk policy contained an exclusion for water damage, including damage resulting from "[w]ater or water-borne material, that backs up or overflows from a sewer, drain or sump," the exclusion was subsequently deleted. An additional endorsement to the policy added flood coverage for loss attributable to "[f]lood, meaning a general and temporary condition of partial or complete inundation of normally dry land areas due to … [t]he usual or rapid accumulation of runoff or surface waters from any source."
A tropical storm bringing heavy rains resulted in water accumulation on the roof of the Subject Property. The water overwhelmed the rooftop drain, which caused the water to pool on the roof and leak into the building's skylights, causing substantial damage. The Subject Property was ordered closed and all tenants were forced to move, leaving the Subject Property vacant.
Borrowers submitted a claim for reimbursement of the interior wall damage with the Insurer. Insurer investigated the damage by dispatching engineers, who concluded that the roof was not the path for water entry, and that the drain failed to drain rapidly accumulated water on the roof, and that the obstruction of the roof drain caused the ponding of water to a height that it flowed over the skylights and entered the building.
Insurer denied Borrowers' claim, citing a "rain limitation" exclusion and a "faulty workmanship exclusion." The "rain limitation" exclusion barred coverage if the loss suffered is to "[t]he interior of the building . . . caused by or resulting from rain, . . . whether driven by wind or not, unless [t]he building . . . first sustains damage by a Covered Cause of Loss to its roof or walls through which the rain . . . enters." The "faulty workmanship" exclusion excluded damage resulting from "[f]aulty, inadequate or defective . . . [d]esign, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction; materials used in repair, construction, renovation or remodeling; or maintenance of part or all of any property on or off your 'covered locations.'"
Insurer concluded that the rainwater entered the Subject Property because of the backed up roof drain and not through damage to the roof or walls, and that pursuant to the "faulty workmanship" exclusion, the roof drain strainer and the roof drain were inadequate to handle the water deposited from the storm.
After the claim was denied, the Subject Property was vandalized, with much of the copper piping removed, causing further damage. Borrowers submitted a separate claim relating to the vandalism, but Insurer denied the claim under the "vacancy exclusion," which provided that if the loss to the Subject Property occurs when the building is vacant for more than 60 consecutive days, Insurer will not pay for any loss resulting from vandalism or theft.
As a result of the denied claims, Borrowers could not make the necessary repairs and they defaulted on the mortgage. Subsequently, the Bank took deed to the property through a deed in lieu of foreclosure, and received an assignment of Borrowers' insurance claims.
As assignee of Borrowers, Bank filed suit in state court seeking a declaration for coverage, a declaration that loss of business income was covered, monetary damages for breach of contract, negligence, and violation of the Massachusetts' consumer protection statute. Insurer removed to federal court on diversity grounds, and the federal district court granted summary judgment in Insurer's favor, and denied Bank's cross-motion for summary judgment.
The federal district court held the "rain limitation" exclusion excluded coverage because "the water pooled on the roof, thus becoming surface water which entered the building through the eroded metal and glass skylights. That the water pooled due to faulty or inadequate drain does not trump the surface water exclusion which bars coverage." The lower court strictly construed the workmanship exclusion against Insurer and found that the single roof drain being inadequate to remove the rainwater did not, on its own, trigger the exclusion. Lastly, the district court rejected Bank's argument that the vacancy exclusion did not bar coverage because the vacancy was the result of a wrongful denial of coverage.
The Bank moved for reconsideration, which motion the lower court denied. The Bank then appealed.
Reversing the lower court, the First Circuit held: (1) in applying the "efficient proximate cause" analysis, the failure of the drain was the efficient proximate cause of the damage, not the rain; and (2) the water that damaged the Subject Property was properly categorized as "surface water" by the district court, but the damage was covered by the amendatory endorsement of the policy. The First Circuit did not disturb the district court's ruling with respect to the faulty workmanship exclusion, finding that because the roof was not repaired by Borrowers, and Insurer's expert testified that the roof strainer or drain did not constitute faulty, inadequate or defective maintenance, the exclusion did not apply.
First, the Appellate Court ruled that the "efficient proximate cause" test must be applied to resolve the coverage controversy relating to the chain of causation because the policy clearly covered water damage caused by "surface water," but excluded water damage caused by or resulting from rain. The Bank argued for a narrow interpretation of the "caused by rain" provision in the "rain limitation" exclusion, and further argued that the court may only exclude coverage for damage whose efficient proximate cause was rainfall.
As you may recall, the efficient proximate cause "that sets in motion a train of events which brings about a result without intervention of any force started and working actively from a new and independent source is the direct and proximate cause." Lynn Gas & Elec. Co. v. Meridien Fire Ins. Co., 158 Mass. 570, 575 (1893).
In deciding this issue, the First Circuit examined Insurer's expert conclusions, which found the blocked or inadequate drain caused the water to accumulate, and that the damage occurred because rainwater backed up on the roof and ponded. Thus, the Court found that the blocked or inadequate drain set in motion a train of events lacking intervention of any forces or activation of a new source to cause the interior water damage. Accordingly, the First Circuit agreed with Bank's position that the failure of the drain was the efficient proximate cause of the damage, and therefore that the "rain limitation" exclusion did not bar coverage.
Next, the First Circuit upheld the district court's ruling that the faulty workmanship exclusion did not apply. In so ruling, the Court recognized that the undisputed evidence established that the roof was repaired prior to Borrowers' ownership and that Insurer's expert admitted the roof strainer and drain did not constitute faulty, inadequate or defective maintenance.
The First Circuit further agreed with the district court's ruling that surface water caused the damage to the Subject Property.
In analyzing Massachusetts case law, the Court found that the water in this case met the definition of surface water, emphasizing that in previous cases, damage resulting from water that flooded into properties after accumulating on artificial surfaces does not lose its character as surface water merely because it flowed along artificial surfaces. Therefore, here, the water was also surface water.
However, the First Circuit disagreed with the district court on the issue of whether surface water damage was excluded from coverage under the policy. The endorsement to the policy provided for coverage from flooding caused by unusual or rapid accumulation of runoff of surface waters of any source, and that the flood coverage provision defined flood as a "general and temporary condition of partial or complete inundation of normally dry areas." According to the First Circuit, the inundation of the roof was such an area.
The First Circuit's majority opinion also commented on and rejected the dissent's view that urged no coverage exists because the original policy language excludes coverage for any loss caused by surface water. The majority found that in strictly construing the policy against Insurer, the deletion of the subject exclusion language "[w]e will not pay for loss or damage directly or indirectly by [water or water-borne material, that backs up or overflows from a sewer, drain or sump]. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss or damage" was critical. The majority concluded that the damage caused by drain overflow, even if indirectly caused in a sequence with other causes, would be entitled to coverage as a result of the endorsement.
Accordingly, because the evidence established that damage to the interior of the Subject Property was not "caused by rain" and should have been covered by the amendatory endorsement of the policy as "surface water," the First Circuit reversed the district court's judgment in favor of Insurer regarding coverage, and reversed the denial of Bank's cross-motion for summary judgment on the claim, and remanded for further proceedings.
Finally, because the district court reached erroneous legal findings on Bank's business income loss claim and other state law claims, these claims were also remanded.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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Chicago, Illinois 60602
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