Insurance Breach of Contract, Bad Faith & Fraud

Case Study

Larry Arnold, Margaret Miglietta, and Annabelle Harris of Cummins & White, LLP, successfully obtained affirmation by the California Court of Appeals of a summary judgment in favor of a group of insurance companies, upholding their denial of a multi-million dollar claim by the owner and builder of a new high-rise condominium for repairs to cracked marble flooring caused by the defective design and construction of the floor systems.

The primary coverage issue was whether the builder’s risk policies’ exclusions applied and whether there was an ensuing peril that resulted in a covered loss. The appellate court ruling absolves the insurers of asserted claims for breach of contract, bad faith, and fraud.

Background

The owner developer (an LLC) of a luxury high-rise hotel and condominium built as part of the L.A. Live complex in downtown Los Angeles obtained builder’s risk insurance policies from a consortium of insurance companies. When cracks appeared on some of the marble flooring, the developers filed a claim with the insurers for the cost of replacing the flooring in all 180 condominium units even though just a small percentage of the flooring had fractured. The insurance companies’ adjuster estimated the cost of replacing that flooring to be approximately $7.5 million, while the LLC calculated those costs to be more than $37.5 million.

The insurers denied the claim citing defective design and defective workmanship in the construction of the floor system as the causes of the fractures. More specifically, tile and construction consultants retained by the insurers had opined that certain types of marble were more prone to fracturing and such propensity combined with the overly thickly applied mortar resulted in the cracked tile. The insurers asserted that the cost of replacing the flooring fell within the policies’ exclusions for the:

• Cost of making good faulty or defective workmanship or material, and/or;
• Cost of making good fault, defect, error, deficiency, or omission in design, plan, or specification.

The LLC then sued the individual insurers in the consortium for breach of contract, bad faith denial of coverage, and fraud.

A number of the insurance companies retained Larry Arnold, Margaret Miglietta, and Annabelle Harris of Cummins & White, LLP, to represent them in the litigation. The trial court found based on the LLC’s own evidence that the overly thick mortar bed was the primary cause of the cracking of the natural stone laid by the tile-setters who both placed the wet mortar bed in place and then placed the natural stone on top of the wet mortar bed.

The court further found that the LLC’s re-design of the floor system for the repairs, which included replacement of the marble with more crack resistant tile assemblies and thin mortar application specifications further supported the primary causes of the cracking, thereupon, concluding that exclusions for the cost of making good defective design and defective workmanship applied. The trial court also concluded that the “ensuing loss” exception to those exclusions did not apply, and granted summary judgment against the LLC on all of its claims. The LLC then filed an appeal.

Court of Appeals Affirmation

The Cummins & White team continued with representation on appeal, defending the trial court judgment and arguing against the LLC’s claims that the builder’s risk policies’ exclusions did not apply.

The court agreed, finding that:

• Applying the preambles to exclude only loss caused by the “costs of making good” would have the absurd result of negating the application of the exclusion for the cost of replacing the defective mortar, something the insureds recognized and conceded.
• There was no “peril separate and independent” from the initial excluded peril (defective design and workmanship when the flooring was installed) as required by Acme Galvanizing Co. v. Fireman’s Fund Ins. Co. Rather, the cracked flooring was the very loss or damage resulting from the excluded perils.

The appellate court also affirmed the lower court’s ruling on the fraud cause of action, which was based on alleged misrepresentations made by a broker and an independent adjuster. The court found there was no detrimental reliance by the insured on the representations made by the broker in deciding to purchase a permanent property insurance policy.

The court further found that a failure to disclose additional provisions that may have applied and citations to an inapplicable policy in a reservation of rights letter did not result in any damage to the insured. Ultimately, the claim was denied on the basis of the policy provisions correctly cited to the insured.

Concluding there was no error, the California appellate court affirmed the trial court’s decision and upheld the insurers’ denial of the claim by LLC.

Mr. Arnold said the court’s ruling, currently unpublished, reinforces the principle that builders’ risk policies are not intended to cover costs to repair or replace a contractor’s defective work, or the costs to replace or repair a contractor’s satisfactory work that is damaged by defective work.

“Our clients are happy with this appellate court victory. Ensuing loss provisions present a multi-step analysis that is often confusing, so we were pleased to see from an insurance coverage perspective, reinforcement and clarification of these issues.”