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As the Atlantic hurricane season reaches its peak in September, bringing with it rainfall and flooding, a recent New Jersey court held a sewer overflow resulting from rainfall was not caused, directly or indirectly, by a flood and therefore did not trigger a flood exclusion. This decision, and the insured’s submission of evidence to prove causation, serves as a roadmap for policyholders challenging an insurer’s overbroad application of an exclusion. In G.E.M.S. Partners LLC v. AmGUARD Ins. Co., — F.Supp. 3d —, No. CV 22-1664, 2024 WL 3568932 (D.N.J. July 29, 2024)), the New Jersey district court denied an insurer’s motion for summary judgment, holding that property damage caused by rainfall associated with a hurricane did not trigger the policy’s flood exclusion.

The insured, G.E.M.S. Partners LLC (the Insured), purchased a commercial property policy from AmGUARD Insurance Companyy (AmGUARD). In September 2021, Hurricane Ida brought heavy rainfall that overwhelmed the local infrastructure and sewer system causing water to leak from plumbing fixtures. The Insured sought coverage under a Water Back-Up and Sump Overflow Endorsement covering “damage . . . caused by . . . [w]ater . . . which backs up through or overflows or is otherwise discharged from a sewer[.]” AmGUARD denied the insured’s claim for property damage citing a flood exclusion:

THIS IS NOT FLOOD INSURANCE. We will not pay for loss or damage from water or other materials that back up or overflow from any sewer, drain or sump that itself is caused, directly or indirectly, in whole or in part, by any flood. Flood means the overflow of surface water, waves, tides, tidal waves, streams, or other bodies of water, or their spray, all whether driven by wind or not.

AmGUARD’s motion for summary judgment required the court to decide  whether overflow from the sewer system constituted a “flood” triggering the exclusion. A plumber who inspected the buildings after the storm described the water loss as a “back up” of “sewer . . . water.” In the absence of any controlling New Jersey state law cases, the G.E.M.S. court predicted “the New Jersey Supreme Court would hold that for purposes of the Flood Exclusion here, ‘flood’ means ‘the overflow of . . . a bod[y] of water,’” which is distinct from overflow from a sewer system.

In reaching this conclusion, the court first considered dictionary definitions of “flood,” which focused on the overflow of a body of water. The court then noted that “flood” was generally understood in insurance policies (citing authorities) as “overflow of a body of water” and cited New Jersey contract principles applicable to insurance policies that require policy interpretation “to keep in step with the broader consensus view as to the meaning of a given insurance contract term.”

Next, the court applied these definitions of flood to the flood exclusion itself and noted that the exclusion equated “flood” with “an overflow,” which “implies a boundary – water pushes ‘over’ it, and then ‘flow[s]’ beyond it.” The court concluded: “This is why it is natural to say that a pond or stream overflows – each is a body of water. And that is why it is less natural to say that falling rain overflows.” The court also noted that the phrase “surface water, waves, tides, tidal waves, [and] streams” referred to “bodies of water” while the definition of flood was “the overflow of . . . bodies of water.” Finally, the G.E.M.S. court considered prior New Jersey case law interpreting the phrase “surface water” as a “permanent body of water that sits on the land – like a lake or river.”

In denying AmGUARD’s motion for summary judgment, the G.E.M.S. court concluded the New Jersey Supreme Court would hold that “surface water” means overflow from an “on-the-surface body of water” and not a rain event that “backs up through or overflows or is otherwise discharged from a sewer.” The G.E.M.S decision highlights the importance of framing causation at the outset of a claim to establish coverage, as well as the importance of working with experienced coverage counsel who can assist in interpreting policy language to articulate a covered – and not excluded – cause of loss.

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A recent Mississippi case reminds commercial and residential policyholders alike of the importance of updating insurance coverage when circumstances change to avoid a coverage dispute or the loss of coverage altogether. Commercial insureds should coordinate with stakeholders within their organizations to ensure prompt reporting of changing exposures to the personnel responsible for insuring risks. The insured did not do so in Clark v. Alfa Insurance Corp., No. 2022-CA-01251-COA, 2024 WL 3506638 (Miss. Ct. App. July 23, 2024), and found himself uninsured for liabilities arising out of a driver’s accident with his newly purchased cattle. The insured purchased 10 black heifers and penned them inside a barbed-wire enclosure behind his home rather than on separate property used for commercial purposes. The cattle escaped and wandered onto the adjacent highway that very night, causing a car accident that injured the driver.  The driver sued the insured and Alfa Insurance Company, which had issued a homeowners policy providing coverage for injury to others “caused by an animal owned by or in the care of an insured.”  

The insurer did not dispute that the cattle caused the driver’s alleged injuries and thus fell within the policy’s coverage grant. The insurer instead turned to a farming exclusion to bar coverage. The policy excluded coverage for “bodily injury or property damage arising out of business or farming engaged in by an insured” (emphasis added). The policy defined “farming” as “the operation of an agricultural… enterprise…” but did not define the term “enterprise.” 

Despite the murkiness of the terminology, the court concluded that the insured’s purchase and ownership of the cattle constituted an “enterprise” within the scope of the exclusion — while acknowledging established Mississippi law resolving ambiguities in insurance policies in favor of insureds and narrowly construing exclusions to preserve coverage. The court reached this result by turning to two dictionary definitions, which themselves defined “enterprise” differently. The court did not discuss a recent Mississippi Supreme Court case citing dictionary definitions of the terms “irritant” and “contaminant” utilized in a pollution exclusion to find an ambiguity favoring coverage(see Omega Protein, Inc. v. Evanston Ins. Co., 336 So. 3d 128, 132 (Miss. 2022)).  Instead, the court considered the conflicting definitions and then, rather than concluding that an ambiguity existed, said that “[i]t is not unreasonable that purchasing, raising, feeding, breeding, selling, and caring for cattle is an ‘agricultural enterprise’ even when no profit is involved” (emphasis added). The court noted that every business must begin somewhere, profit or not. The court thus indicated that its own interpretation of “enterprise” was the only logical one.

The court cited the insured’s federal income tax return to buttress its conclusion. The insured owned 620 acres of timberland, separate from his personal residence, and listed timber as his “principal crop or activity” on tax returns. He also listed the cost of the cattle and their feed as a loss to offset profit from his farming income. Although the insured had never before purchased cows and “did not have any specific plans for the cows, other than to purchase them in hopes of attempting to raise them with his son,” his purchase and ownership of the cows constituted an excluded enterprise in the court’s view.

Clark provides a cautionary tale to insureds who should evaluate coverage when circumstances change. The appellate court said as much, stating that the insured “should have notified Alfa before the heifers were delivered and obtained appropriate insurance coverage.” Although insureds typically evaluate liabilities at insurance renewals, periodic checks on exposures — including coordination with other stakeholders — can avoid coverage gaps like the one in this case.

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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.