Source: http://constfpn.advisen.com, March 11, 2015
By: John Carver and Todd M. Rowe

Recent news investigations have brought to light allegations that flooring manufactured in China may use glue that contains the toxin formaldehyde.

The potential for insurance claims increases each day as homeowners begin to remove this toxic flooring from their homes. Unfortunately, we saw a similar situation involving Chinese-manufactured drywall a few years ago.

These cases can provide a roadmap for the toxic flooring claims under first party insurance policies.

The stock of Lumber Liquidators dropped more than 20 percent since “60 Minutes” March 1, 2015 broadcast showing hazardous levels of formaldehyde, a known carcinogen, were found in some of the company’s laminate wood floors.

The “60 Minutes” investigation reported flooring manufactured in China contained unusually high levels of formaldehyde and was sent to the US. Test results offered in the “60 Minutes” report indicated some samples of the Chinese-manufactured flooring exceeded, by up to 20 times, permissible levels allowed by the California Air Resources Board.

There are current allegations that Lumber Liquidators was aware glues with formaldehyde were being used rather than more expensive, safer glues.

In a statement on its website, Lumber Liquidators disputed the “60 Minutes” findings and claimed the reporters used “an improper test method” and that its products were safe.

Of course, the damage is not limited to Lumber Liquidators’ shareholders. There are reports this toxic laminate flooring was used in hundreds of thousands of homes. A number of class-action lawsuits were filed in the first week after the “60 Minutes” broadcast. For example, a lawsuit entitled Bloomfield et al., v. Lumber Liquidators, Inc., et al., was filed March 4 in the District Court for the Northern District of Illinois.

The class-action plaintiffs claim they suffered damages resulting from the Chinese-manufactured laminate flooring from Lumber Liquidators. In addition to claims for negligence, breach of express and implied warranties, violations of the Illinois Consumer Fraud and Deceptive Trade Practices Act, negligent and fraudulent misrepresentation and unjust enrichment, the class-action plaintiffs claim Lumber Liquidators misrepresented the amount of formaldehyde contained in its products and that the flooring does not conform to Illinois building codes.

In the short time this story has been in the news, the allegations involving Lumber Liquidators’ flooring have been compared to the toxic Chinese-made drywall installed in thousands of homes during the recent US housing boom.

It is estimated that Chinese-made drywall was used in more than 20,000 homes in the US. The building material is claimed to cause nosebleeds, headaches, difficulty breathing and asthma attacks in those exposed to it. Homeowners also clam hydrogen sulfide and other chemicals found in the drywall caused foul odors and corroded pipes and wiring.

In addition to giving rise to substantial litigation against manufacturers and builders, the toxic Chinese-drywall also spawned litigation involving first-party property insurance policies. For example, in In re Chinese Manufactured Drywall Prods. Liab. Litig., in the District Court for the Eastern District of Louisiana, held that while a Chinese drywall claim may trigger coverage under a first-party property policy, exclusions barred coverage for such losses.

In finding these claims potentially triggered coverage, the District Court held the Chinese-manufactured drywall caused a “distinct, demonstrable, physical alteration of the home it was installed in by corroding the silver and copper elements in the homes, often to the point of causing total or partial failure in electrical wiring and devices installed in the homes, as well as emitting odorous gases.” In this case, the central question was whether the losses fell into the definition of “physical loss” as used in the homeowners policies.

Noting the policies did not define “physical loss,” the District Court held “physical loss” required a “distinct, demonstrable, physical alteration of the property.” And, the Court further held the losses fell into this definition because the Chinese-manufactured drywall caused “‘distinct, demonstrable, physical alteration’ of the plaintiffs’ home (the covered properties) by corroding the silver and copper elements in the homes, often to the point of causing total or partial failure in electrical wiring and devices installed in the homes.”

Based on this reasoning, the District Court held the losses related to the Chinese-manufactured drywall may be covered. However, the District went on to find coverage was barred under the faulty materials exclusion and the corrosion exclusion.

The decision in Travco Ins. Co. v. Ward, provides a more detailed analysis of the exclusions for coverage of losses caused by Chinese drywall when the Virginia Supreme Court held four exclusions in a property policy barred coverage for an insured’s claims related to Chinese drywall installed in his home. In Travco, the insured claimed the toxic drywall caused fumes, odors, health issues and damage to the home’s air conditioner system. After denying coverage, Travco filed a declaratory judgment action in the District Court for the Eastern District of Virginia. The District Court granted Travco’s motion for summary judgment finding exclusions barred coverage under insured’s homeowners policy.

On appeal, the Fourth Circuit Court of Appeals certified the question of whether the exclusions would bar coverage under Virginia law to the Virginia Supreme Court. Specifically, the Virginia Supreme Court held the following exclusions barred coverage:

• Latent Defect: The insurance policy at issue barred coverage for any loss caused by “latent defect, inherent vice, or any quality in property that causes it to damage or destroy itself.” Travco argued this exclusion applied because the “latent defect” was “hidden or concealed” for two years before the insured discovered a problem with the drywall. In first finding the exclusion was unambiguous, the Virginia Supreme Court agreed with Travco and found the fact that the insured lived in his home for about two years before discovering the problem indicated that the defect was “hidden or concealed” and therefore, excluded under the homeowners policy.

• Faulty/Defective Materials: The insurance policy barred coverage for any loss caused by “faulty, inadequate or defective…materials used in the repair, construction, renovation or remodeling…of any part or all of any property whether on or off the ‘residence premises.’” The insured argued this exclusion did not apply because the “drywall maintains its form and performs its function.” Travco, on the other hand, argued the exclusion was applicable because the drywall released sulfuric gas and is “faulty, inadequate or defective.” In agreeing with Travco that the exclusion applied, the Court held the release of sulfuric gas made the home uninhabitable and, therefore, the drywall was defective.

• Pollution: The insurance policy also barred coverage for any loss caused by “[d]ischarge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself caused by peril insured against under Coverage C.” The policy defined “pollutants” as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”

• Travco argued the sulfuric acid released by the drywall was an “irritant or contaminant” under the policy because the sulfuric acid “was not ‘supposed to be’ in the home and it caused harm.” Additionally, Travco asserted the sulfuric gas was an “irritant” because it caused the insured and his family “to suffer nosebleeds and other problems.” And, the sulfuric gases “moved from the drywall to the air in the home by way of ‘discharge, dispersal, seepage, migration, release or escape.” After reviewing Virginia law and the plain meaning of the words, the Court held this exclusion barred coverage.

There are sufficient similarities to allow the Chinese-manufactured drywall cases to provide guidance for toxic flooring cases. As seen in the Chinese drywall cases discussed above, the coverage analysis was driven by the fact that the Chinese drywall emitted sulfuric acid which caused damage to metal wiring and plumbing inside the homes. That is not the case here. Based on the information currently available, it appears the toxic flooring cases do not include damage to other components of the home or building. That is, there are no allegations that the wiring or pipes of a home being destroyed like those made in the Chinese drywall cases. However, if a court found coverage was triggered, the Chinese drywall cases provide support for insurers to argue the exclusions for “latent defects,” “faulty/defective materials” and pollution bar coverage for toxic flooring cases.

Todd M. Rowe is an attorney in the Chicago office of Tressler LLP. He focuses his practice in insurance coverage representing specialty, property and commercial lines insurers in litigation and non-litigation disputes. He also regularly provides guidance on issues related to policy analysis and drafting and claims handling procedures. Todd has actively practiced in Wisconsin, Michigan and Illinois and has been involved in a number of insurance coverage matters in various other states.

John Carver is an experienced trial lawyer who represents insurers in first party property coverage and litigation matters. He has been to trial 15 times, including on two first-party cases and the recent defense of a large insurer in the arbitration of a fraudulent jewelry theft claim. Carver has conducted more than 100 examinations under oath and has considerable experience directing the work of consultants typically retained in first party property matters. He handles both commercial and personal lines involving employee dishonesty, theft, valuable articles, inventory loss, fraud, arson, robbery, accidental fire loss, mold and water damage.