Coverage Issues Under Homeowners' Insurance Policies in Chinese Drywall Cases

The recent litigation concerning insurance coverage under homeowners' insurance policies for damages related to Chinese drywall has produced a number of decisions at the district court level in various state and federal courts. Recently, a Louisiana Court of Appeal rendered a decision in what is believed to be the first state or federal appellate decision regarding insurance coverage for damages allegedly caused by Chinese drywall under a homeowners' insurance policy. In Ross v. C. Adams Construction & Design, 10-852 (La.App. 5 Cir. 6/14/11), __ So.3d __, 2011 WL 2328271, the Louisiana Fifth Circuit affirmed the granting of a summary judgment in favor of the defendant insurer and held that the claims made by the plaintiff homeowners for damages as a result of Chinese drywall in their home were excluded from coverage. The Ross case will no doubt serve as a guide for insurers in litigating coverage in Chinese drywall claims under a homeowners' policy. In that same light, this article provides a brief sketch of the various coverage considerations that will be important to insurers in Chinese drywall cases. A brief discussion of Ross will be helpful as a guide to the typical claims made in Chinese drywall cases.

The Ross Decision

Ross involved a property insurance claim made under a homeowners' insurance policy issued by Louisiana Citizens Property Insurance Corporation (“Louisiana Citizens”). In January 2007, plaintiffs Terrence and Rhonda Ross purchased a newly renovated house in Metairie, LA. More than two years later, after experiencing problems with their HVAC system, the Rosses discovered that their home had been remodeled using Chinese drywall. Thereafter, in March 2009, the Rosses submitted a homeowners' insurance claim to Louisiana Citizens, which investigated the claim and confirmed the presence of Chinese drywall and that there was damage to metal surfaces caused by corrosion. Following its inspection, Louisiana Citizens informed the Rosses that their claim was not covered under the policy issued to them.

In July 2009, the Rosses sued C. Adams Construction & Design (“C. Adams”), the seller and contractor of their home; State Farm Mutual Insurance Company, the liability insurer of C. Adams; and Louisiana Citizens. The Rosses claimed that Chinese-made drywall caused damage to their HVAC coils, electrical wiring, plumbing components, jewelry, appliances and electronics and also created noxious “rotten-egg like” odors. Like many of the Chinese drywall complaints filed to date, the Rosses' lawsuit alleged that the drywall installed in their home released sulfuric gases that caused corrosion of various metal components of their house. The Rosses' petition alleged that the Chinese drywall was “defective” and that the gases it released caused damage to their home, its component parts and the contents therein. Further, the Rosses described these problems as “hidden defects” in their home.

In a cross-motion for summary judgment, Louisiana Citizens asserted that coverage for the Rosses' claims was barred in a number of ways. First, there was no “direct physical loss” as required by the insuring agreement of the Louisiana Citizens policy. In addition, the claims were barred by four exclusions, including: 1) loss caused by faulty materials; 2) loss caused by a latent defect; 3) loss caused by corrosion; and 4) loss caused by pollution. Louisiana Citizens further argued that there was no ensuing loss stemming from any of these four excluded causes of loss; or in the alternative, should the court find there to be an ensuing loss, that such ensuing loss was the result of an excluded cause of loss such that there was no coverage available to the policyholder under any ensuing loss type argument. Finally, Louisiana Citizens asserted that the Rosses' claimed personal property losses were not covered because they were not caused by one of the 16 specified perils listed in the Louisiana Citizens policy. The trial court granted Louisiana Citizens' motion dismissing the Rosses' claims and an appeal followed. With this background in mind, the remainder of this article addresses a number of common policy provisions/exclusions that should be considered in analyzing drywall claims.

The Insuring Agreement

As an initial matter, it should be considered whether the cost of replacing Chinese drywall in an insured's home is covered by a homeowners' policy. In Ross, the Louisiana Citizens policy insured only “against risk of direct physical loss to property described in Coverages A and B” that is not excluded. Arguably, a claim for damages caused by Chinese drywall does not meet this threshold requirement for the simple fact that generally the drywall that homeowners complain of is still physically intact and functional. As one leading insurance treatise explains, “[t]he requirement that the loss be 'physical', given the ordinary definition of that term, is widely held to exclude alleged losses that are intangible or incorporeal, and, thereby, to preclude any claim against the property insurer when the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property.” 10 Couch On Insurance ' 148:46 (3d ed. 1998). Thus, the invisible migration of gases associated with Chinese drywall seemingly does not constitute a “physical” loss as it does not entail the physical alteration of the drywall. Further, the requirement of “physical loss” forces Chinese drywall claimants to maintain the seemingly inconsistent positions of having to claim both that the drywall itself has suffered a “direct physical loss” in order to satisfy the terms of the insuring agreement but also that the drywall remains in a non-defective state in order to avoid the Faulty Materials and Latent Defect Exclusion, discussed infra.

However, these arguments have not been well received by the courts as evidenced by the early trend in this litigation concerning the interpretation of the insuring agreement. For example, in Ross, the court found that “the inherent qualities of the Chinese drywall did create a physical loss to the home and required that the drywall be removed and replaced” without giving an explanation as to what that physical loss was. Ross, supra. Similarly, in TRAVCO Ins. Co. v. Ward, 715 F.Supp.2d 699 (E.D. Va. 2010), the court found that a residence constructed with Chinese drywall had suffered a direct physical loss. In TRAVCO, the court concluded that because the insured had been forced to leave his residence, the insured had suffered a “direct physical loss.” Id. Relying in part on the decision in TRAVCO, the court in In re Chinese Manufactured Drywall Prod. Liab. Litigation, 759 F.Supp.2d 822 (E.D. La. 2010), also found that damages cause by Chinese drywall constituted physical loss. In that case, the court reasoned that the drywall was not merely lying dormant in the insureds' homes, but was releasing elemental sulfur gases throughout the homes and that the Chinese drywall rendered the homes useless and/or uninhabitable due to the damage to the electrical wiring, appliances, and devices, as well as the ever-present sulfur gases. Id. at 832.

Common Homeowners' Exclusions to Consider

While courts have been reluctant to find that Chinese drywall does not cause “direct physical loss,” insurers have been successful in asserting a number of exclusions contained in homeowners' policies to preclude coverage. Four common exclusions that should be considered include: 1) the Faulty Materials Exclusion; 2) the Latent Defect Exclusion; 3) the Corrosion Exclusion; and 4) the Pollution Exclusion.

Faulty Materials Exclusion

The Louisiana Citizens policy in Ross contained an exclusion for faulty, inadequate or defective materials, which provided:

B. We do not insure for loss to property described in Coverages A and B caused by any of the following.

***

3. Faulty, inadequate or defective:

***

c. Materials used in repair, construction, renovation or remodeling ' of part or all of any property whether on or off the “residence premises.”

The plain language of this exclusion leads to the conclusion that it applies to losses associated with Chinese drywall. The essential complaint with regard to Chinese drywall is that it releases sulfuric gas that causes corrosion to metal components in a homeowner's residence. It stands to reason then that the drywall is “faulty, inadequate or defective” within the ordinary, generally prevailing meaning of those terms. Thus, Chinese drywall claimants are faced with having to argue on the one hand that the drywall has sustained a “direct physical loss” in order to satisfy the terms of the insuring agreement while at the same time argue that the drywall is not “faulty, inadequate or defective” on the other.

A common response to the Faulty Materials Exclusion is that the exclusion does not apply because the drywall continues to function as drywall. That is, the drywall continues to serve its function by dividing rooms and holding artwork. TRAVCO, supra at 712. However, this argument has been summarily rejected and the Faulty Materials Exclusion has been held to preclude coverage. See Ross, supra; TRAVCO, supra at 713; and In re Chinese Manufactured Drywall, supra at 845-46. In Ross, the court relied on the plain meaning of “faulty, defective or inadequate” to conclude that the Chinese Drywall in the Rosses' home was a faulty material and thus, that the Faulty Materials Exclusion applied. Further, the Ross court found that even if the drywall was still in place in the Rosses' home, it was not truly serving its purpose as a component of a livable residence because of its inherent qualities of emitting sulfuric gas. In fact, a Chinese drywall claimants' complaint will almost always implicate the application of the Faulty Materials Exclusion because the substance of that complaint is that their home was damaged by a defective material. If the Chinese drywall were not defective, there would be no damage and thus, no reason to assert a homeowners' claim.

Latent Defect Exclusion

Like the Faulty Materials Exclusion, the Latent Defect Exclusion is one that should be implicated by the very nature of a Chinese drywall complaint. The defect in Chinese drywall, i.e., its gas-emitting characteristic, is one that is not visible or easily discovered and therefore, one that can be described as latent. In Ross, the Louisiana Citizens policy contained the following Latent Defect Exclusion:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

(b) Mechanical breakdown, latent defect, inherent vice or any quality in property that causes it to damage or destroy itself.

In Louisiana, where there has been extensive Chinese drywall litigation, courts have generally interpreted the term “latent defect,” based on its plain and ordinary meaning, as “a defect that is hidden or concealed from knowledge as well as from sight and which a reasonable customary inspection would not reveal.” See, e.g., Nida v. State Farm Fire & Cas. Co., 454 So.2d 328 (La.App. 3 Cir. 1984); Barbier v. Wade, 517 So.2d 321 (La.App. 1 Cir. 1987); Sheilds v. Penn. Gen. Ins. Co., 488 So.2d 1252 (La.App. 4 Cir. 1986); and Harris v. Bardwell, 373 So.2d 777 (La.App. 2 Cir. 1979). Applying this interpretation of “latent defect,” there can be little doubt that the damages caused by Chinese drywall should be excluded under the Latent Defect Exclusion. Again, Chinese drywall appears to the naked eye to be undamaged, but it emits invisible gases that corrode household components. Drywall that is visibly undamaged but silently emits gases and causes corrosion contains a latent defect by its very nature. Simply put, if Chinese drywall does not contain a “latent defect,” it is difficult to imagine what would.

The court in Ross found that the Latent Defect Exclusion applied to preclude coverage for the Rosses' claim because the defect in the Chinese drywall in their home was hidden and unknown. Similarly, in TRAVCO, supra at 711-12, the court stated that the Latent Defect Exclusion is intended to remove the risk of losses that result from flaws in property that are undetectable, and hence unexpected, and that losses associated with Chinese drywall fit squarely within this category. There can be no doubt that if the Rosses had known of the defective quality of the drywall used in their home they would not have purchased it. The same can be said for virtually all Chinese drywall claimants. Instead, because the defective nature of the Chinese drywall was “hidden or concealed” from their “knowledge as well as sight,” the Rosses purchased their home and did not learn of the damages caused by the drywall for two years. In fact, the Rosses alleged in their petition that their loss was caused by hidden defects and that the emission of gases was unknown to them. Ross, supra. However, even if no such allegations are made, it stands to reason that in virtually all Chinese drywall cases, the Latent Defect Exclusion will be implicated due to the very nature of Chinese drywall, i.e., its gas-emitting qualities.

The Corrosion Exclusion

The third exclusion that should be considered in analyzing homeowners' coverage for a Chinese drywall claim is the Corrosion Exclusion. It is well documented that the gases emitted from Chinese drywall cause corrosion to metal components, wiring, plumbing and appliances. For example, in Ross, the plaintiffs specifically alleged that the gases emitted from the drywall in their home caused corrosion to the metal components in their home. The Louisiana Citizens policy in Ross contained a Corrosion Exclusion that provided:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

c) Smog, rust or other corrosion, or dry rot.

The In re Chinese Manufactured Drywall court defined corrosion as “the chemical or electrochemical reaction between a material, usually a metal, and its environment that produces a deterioration of the material and its properties.” In re Chinese Manufactured Drywall, supra at 664. That is precisely the process that occurs when the gases emitted from Chinese drywall interact with metal components in a home. In fact, the plaintiffs in Ross alleged that the emission of the gases from the drywall corroded components in their home. Based on those allegations and the plain language of the Corrosion Exclusion in the Louisiana Citizens policy, the Ross court held that the Corrosion Exclusion applied.

A common response by Chinese drywall claimants to the Corrosion Exclusion is that the damage to a home's metal components was not caused by corrosion, but rather that the damage is the corrosion itself. TRAVCO, supra at 714. The courts in Ross, TRAVCO and In re Chinese Manufactured Drywall all rejected that argument. As the court in TRAVCO explained, “the ordinary meaning of corrosion includes the 'action or process of corroding.'” Id. at 715. The exclusion for loss caused by corrosion plainly refers to the process of corrosion and not to its end product. Further, the end product of corrosion cannot exist without the process of corrosion. In sum, the “loss” sustained by a Chinese drywall claimant is no longer having non-corroded metal components in their home and the cost associated with repairing or replacing those items. That “loss” is caused by corrosion and the plain meaning of that term implicates application of the Corrosion Exclusion to preclude coverage.

The Pollution Exclusion

Finally, the Pollution Exclusion should also be considered in Chinese drywall claims against a homeowners' policy. In Ross, the Louisiana Citizens policy contained the following Pollution Exclusion:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

(e) Discharge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself cause by a Peril Insured Against named under Coverage C.

The term Pollutants was defined as any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

Like the other exclusions discussed above, the Pollution Exclusion seemingly applies to a Chinese drywall claim by its plain language. The sulfuric gases produced by Chinese drywall can easily be considered “gaseous ' irritant[s] or contaminant[s]” as described in the Pollution Exclusion. In fact, a number of courts have held that sulfur-based gases and other invisible airborne material qualify as an “ irritant” and “contaminant.” See, e.g., Wakefield Pork, Inc. v. RAM Mut. Ins. Co., 731 N.W.2d 154,161 (Minn. Ct. App. 2007) (hydrogen sulfide); Mountain States Mut. Cas. Co. v. Kirkpatrick, 2007 WL 2506640 at *1 (D. Colo. Aug. 30, 2007) (hydrogen sulfide); and Board of Regents of Univ. of Minnesota v. Royal Ins. Co. of Am., 517 N.W.2d 888, 892 (Minn. 1994) (asbestos fibers).

The court in Ross held that the Pollution Exclusion applied to exclude coverage under the Louisiana Citizens policy. The court relied upon the language of the policy in defining pollutants as any gaseous irritant or contaminant and concluded that the sulfuric gas emitted from the Chinese drywall in the Rosses' home qualified as a pollutant. While the insurer was successful in the application of the Pollution Exclusion in Ross, it should be noted that the application of this exclusion will vary greatly by state. As the court noted in TRAVCO with regard to the application of this exclusion, “there exists not just a split of authority, but an absolute fragmentation of authority” concerning the scope of the pollution exclusion. TRAVCO, supra at 715. Roughly speaking, there are two schools of thought with respect to the application of the pollution exclusion. The first is based on the thought that the exclusion is limited to preclude coverage for environmental pollution only, while the other refuses to assert such a limitation. Id. However, as Louisiana Citizens briefed, this dichotomy stems from the unrelated commercial general liability realm and ultimately has no application in the context of homeowners' insurance policies.

Ensuing Loss Clauses

While the Ross court did not discuss whether any of the damages associated with Chinese drywall could be classified as an ensuing loss, the issue must be considered. In TRAVCO, the policy provided that “any ensuing loss to property described in Coverages A and B not excluded by any other provision in this policy is covered.” TRAVCO, supra at 718. Typically, this type of clause should not apply in a Chinese drywall case for several reasons. First, there is no “ensuing loss” associated with Chinese drywall damages. While the sulfuric gas released may cause damage over a period of time, it still represents a single discreet loss from a single discreet injury, namely the off-gassing of the drywall. Id. at 718-19. Courts across the country have held that for the ensuing loss provision to apply, there must be a subsequent ensuing cause of loss separate and independent from the initial excluded cause of loss. See, e.g., Weeks v. Co-Operative Ins. Cos., 817 A.2d 292, 296 (N.H. 2003); Acme Galvanizing v. Fireman's Fund Ins. Co., 270 Cal. Rptr. 405, 411 (Cal. Ct. App. 1990); Hartford Cas. Ins. Co. v. Evansville Vanderburgh Pub. Library, 860 N.E.2d 636, 646 (Ind. Ct. App. 2007) and Gies v. City of Gering, 695 N.W.2d 180, 193 (Neb. Ct. App. 2005). An ensuing loss would occur, for example, if corroded electrical wiring caused a fire, resulting in fire damage. See, e.g., Aetna Ins. Co. v. Getchell Steel Treating Co., 395 F.2d 12, 15 (8th Cir. 1968). However, that type of scenario is not present with Chinese drywall.

Even if the damages caused by Chinese drywall could be considered ensuing losses, the ensuing loss clause would still not provide coverage. For the ensuing loss clause to apply, the loss must not be “excluded by any other provision” of a policy. As explained above, a number of homeowners' exclusions will likely apply to exclude coverage for the losses associated with Chinese drywall. For example, even though a Chinese drywall claimant may assert that the corrosion of the metal components in his home constitutes an ensuing loss separate and apart from the off-gassing by the Chinese drywall, and even if a court were to agree, that corrosion is still excluded by virtue of the corrosion exclusion as discussed above. Thus, the ensuing loss provision would not apply to provide coverage.

Personal Property

Also of interest in Ross is the plaintiffs' claim that their personal property losses were covered by the Louisiana Citizens policy, which covered personal property losses caused by one of 16 specified perils. One of those specified perils was smoke, which the policy defined as the sudden and accidental damage from smoke, including the emission or puff-back of smoke, soot, fumes, or vapors from a boiler, furnace or related equipment. Based on that definition, the court in Ross found that the damage to personal property was not covered because the emission of sulfuric gases did not constitute smoke as defined in the policy. The court reasoned that the emission of the sulfuric gases was not sudden and thus could not be considered smoke under the policy. Ross, supra. Indeed, the damage to personal property in Ross occurred gradually, and was not discovered for two years.

Conclusion

With respect to whether or not Chinese drywall losses are covered by homeowners' policies, it seems that insurers have the upper hand at this point. The difficulty for insureds lies in the fact that, in order to trigger coverage, there must be allegations of a direct physical loss. However, those allegations will likely implicate a number of exclusions, namely the Faulty Materials and Latent Defect Exclusions. Further, the very nature of Chinese drywall lends itself to the application of those exclusions as well as the Corrosion Exclusion and Pollution Exclusion. The Ross case provides a concise explanation of these four exclusions and their application to Chinese drywall cases, and it will surely be relied on by any homeowners' insurer involved in this type of litigation.

Travis B. Wilkinson is special counsel with the New Orleans firm of Lugenbuhl, Wheaton, Peck, Rankin & Hubbard. He practices primarily in the areas of insurance coverage, insurance defense, and trial and appellate litigation. Seth A. Schmeeckle is a shareholder with the firm.

The recent litigation concerning insurance coverage under homeowners' insurance policies for damages related to Chinese drywall has produced a number of decisions at the district court level in various state and federal courts. Recently, a Louisiana Court of Appeal rendered a decision in what is believed to be the first state or federal appellate decision regarding insurance coverage for damages allegedly caused by Chinese drywall under a homeowners' insurance policy. In Ross v. C. Adams Construction & Design, 10-852 (La.App. 5 Cir. 6/14/11), __ So.3d __, 2011 WL 2328271, the Louisiana Fifth Circuit affirmed the granting of a summary judgment in favor of the defendant insurer and held that the claims made by the plaintiff homeowners for damages as a result of Chinese drywall in their home were excluded from coverage. The Ross case will no doubt serve as a guide for insurers in litigating coverage in Chinese drywall claims under a homeowners' policy. In that same light, this article provides a brief sketch of the various coverage considerations that will be important to insurers in Chinese drywall cases. A brief discussion of Ross will be helpful as a guide to the typical claims made in Chinese drywall cases.

The Ross Decision

Ross involved a property insurance claim made under a homeowners' insurance policy issued by Louisiana Citizens Property Insurance Corporation (“Louisiana Citizens”). In January 2007, plaintiffs Terrence and Rhonda Ross purchased a newly renovated house in Metairie, LA. More than two years later, after experiencing problems with their HVAC system, the Rosses discovered that their home had been remodeled using Chinese drywall. Thereafter, in March 2009, the Rosses submitted a homeowners' insurance claim to Louisiana Citizens, which investigated the claim and confirmed the presence of Chinese drywall and that there was damage to metal surfaces caused by corrosion. Following its inspection, Louisiana Citizens informed the Rosses that their claim was not covered under the policy issued to them.

In July 2009, the Rosses sued C. Adams Construction & Design (“C. Adams”), the seller and contractor of their home; State Farm Mutual Insurance Company, the liability insurer of C. Adams; and Louisiana Citizens. The Rosses claimed that Chinese-made drywall caused damage to their HVAC coils, electrical wiring, plumbing components, jewelry, appliances and electronics and also created noxious “rotten-egg like” odors. Like many of the Chinese drywall complaints filed to date, the Rosses' lawsuit alleged that the drywall installed in their home released sulfuric gases that caused corrosion of various metal components of their house. The Rosses' petition alleged that the Chinese drywall was “defective” and that the gases it released caused damage to their home, its component parts and the contents therein. Further, the Rosses described these problems as “hidden defects” in their home.

In a cross-motion for summary judgment, Louisiana Citizens asserted that coverage for the Rosses' claims was barred in a number of ways. First, there was no “direct physical loss” as required by the insuring agreement of the Louisiana Citizens policy. In addition, the claims were barred by four exclusions, including: 1) loss caused by faulty materials; 2) loss caused by a latent defect; 3) loss caused by corrosion; and 4) loss caused by pollution. Louisiana Citizens further argued that there was no ensuing loss stemming from any of these four excluded causes of loss; or in the alternative, should the court find there to be an ensuing loss, that such ensuing loss was the result of an excluded cause of loss such that there was no coverage available to the policyholder under any ensuing loss type argument. Finally, Louisiana Citizens asserted that the Rosses' claimed personal property losses were not covered because they were not caused by one of the 16 specified perils listed in the Louisiana Citizens policy. The trial court granted Louisiana Citizens' motion dismissing the Rosses' claims and an appeal followed. With this background in mind, the remainder of this article addresses a number of common policy provisions/exclusions that should be considered in analyzing drywall claims.

The Insuring Agreement

As an initial matter, it should be considered whether the cost of replacing Chinese drywall in an insured's home is covered by a homeowners' policy. In Ross, the Louisiana Citizens policy insured only “against risk of direct physical loss to property described in Coverages A and B” that is not excluded. Arguably, a claim for damages caused by Chinese drywall does not meet this threshold requirement for the simple fact that generally the drywall that homeowners complain of is still physically intact and functional. As one leading insurance treatise explains, “[t]he requirement that the loss be 'physical', given the ordinary definition of that term, is widely held to exclude alleged losses that are intangible or incorporeal, and, thereby, to preclude any claim against the property insurer when the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property.” 10 Couch On Insurance ' 148:46 (3d ed. 1998). Thus, the invisible migration of gases associated with Chinese drywall seemingly does not constitute a “physical” loss as it does not entail the physical alteration of the drywall. Further, the requirement of “physical loss” forces Chinese drywall claimants to maintain the seemingly inconsistent positions of having to claim both that the drywall itself has suffered a “direct physical loss” in order to satisfy the terms of the insuring agreement but also that the drywall remains in a non-defective state in order to avoid the Faulty Materials and Latent Defect Exclusion, discussed infra.

However, these arguments have not been well received by the courts as evidenced by the early trend in this litigation concerning the interpretation of the insuring agreement. For example, in Ross, the court found that “the inherent qualities of the Chinese drywall did create a physical loss to the home and required that the drywall be removed and replaced” without giving an explanation as to what that physical loss was. Ross, supra. Similarly, in TRAVCO Ins. Co. v. Ward , 715 F.Supp.2d 699 (E.D. Va. 2010), the court found that a residence constructed with Chinese drywall had suffered a direct physical loss. In TRAVCO, the court concluded that because the insured had been forced to leave his residence, the insured had suffered a “direct physical loss.” Id. Relying in part on the decision in TRAVCO, the court in In re Chinese Manufactured Drywall Prod. Liab. Litigation, 759 F.Supp.2d 822 (E.D. La. 2010), also found that damages cause by Chinese drywall constituted physical loss. In that case, the court reasoned that the drywall was not merely lying dormant in the insureds' homes, but was releasing elemental sulfur gases throughout the homes and that the Chinese drywall rendered the homes useless and/or uninhabitable due to the damage to the electrical wiring, appliances, and devices, as well as the ever-present sulfur gases. Id. at 832.

Common Homeowners' Exclusions to Consider

While courts have been reluctant to find that Chinese drywall does not cause “direct physical loss,” insurers have been successful in asserting a number of exclusions contained in homeowners' policies to preclude coverage. Four common exclusions that should be considered include: 1) the Faulty Materials Exclusion; 2) the Latent Defect Exclusion; 3) the Corrosion Exclusion; and 4) the Pollution Exclusion.

Faulty Materials Exclusion

The Louisiana Citizens policy in Ross contained an exclusion for faulty, inadequate or defective materials, which provided:

B. We do not insure for loss to property described in Coverages A and B caused by any of the following.

***

3. Faulty, inadequate or defective:

***

c. Materials used in repair, construction, renovation or remodeling ' of part or all of any property whether on or off the “residence premises.”

The plain language of this exclusion leads to the conclusion that it applies to losses associated with Chinese drywall. The essential complaint with regard to Chinese drywall is that it releases sulfuric gas that causes corrosion to metal components in a homeowner's residence. It stands to reason then that the drywall is “faulty, inadequate or defective” within the ordinary, generally prevailing meaning of those terms. Thus, Chinese drywall claimants are faced with having to argue on the one hand that the drywall has sustained a “direct physical loss” in order to satisfy the terms of the insuring agreement while at the same time argue that the drywall is not “faulty, inadequate or defective” on the other.

A common response to the Faulty Materials Exclusion is that the exclusion does not apply because the drywall continues to function as drywall. That is, the drywall continues to serve its function by dividing rooms and holding artwork. TRAVCO, supra at 712. However, this argument has been summarily rejected and the Faulty Materials Exclusion has been held to preclude coverage. See Ross, supra; TRAVCO, supra at 713; and In re Chinese Manufactured Drywall, supra at 845-46. In Ross, the court relied on the plain meaning of “faulty, defective or inadequate” to conclude that the Chinese Drywall in the Rosses' home was a faulty material and thus, that the Faulty Materials Exclusion applied. Further, the Ross court found that even if the drywall was still in place in the Rosses' home, it was not truly serving its purpose as a component of a livable residence because of its inherent qualities of emitting sulfuric gas. In fact, a Chinese drywall claimants' complaint will almost always implicate the application of the Faulty Materials Exclusion because the substance of that complaint is that their home was damaged by a defective material. If the Chinese drywall were not defective, there would be no damage and thus, no reason to assert a homeowners' claim.

Latent Defect Exclusion

Like the Faulty Materials Exclusion, the Latent Defect Exclusion is one that should be implicated by the very nature of a Chinese drywall complaint. The defect in Chinese drywall, i.e., its gas-emitting characteristic, is one that is not visible or easily discovered and therefore, one that can be described as latent. In Ross, the Louisiana Citizens policy contained the following Latent Defect Exclusion:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

(b) Mechanical breakdown, latent defect, inherent vice or any quality in property that causes it to damage or destroy itself.

In Louisiana, where there has been extensive Chinese drywall litigation, courts have generally interpreted the term “latent defect,” based on its plain and ordinary meaning, as “a defect that is hidden or concealed from knowledge as well as from sight and which a reasonable customary inspection would not reveal.” See , e.g. , Nida v. State Farm Fire & Cas. Co. , 454 So.2d 328 (La.App. 3 Cir. 1984); Barbier v. Wade , 517 So.2d 321 (La.App. 1 Cir. 1987); Sheilds v. Penn. Gen. Ins. Co. , 488 So.2d 1252 (La.App. 4 Cir. 1986); and Harris v. Bardwell , 373 So.2d 777 (La.App. 2 Cir. 1979). Applying this interpretation of “latent defect,” there can be little doubt that the damages caused by Chinese drywall should be excluded under the Latent Defect Exclusion. Again, Chinese drywall appears to the naked eye to be undamaged, but it emits invisible gases that corrode household components. Drywall that is visibly undamaged but silently emits gases and causes corrosion contains a latent defect by its very nature. Simply put, if Chinese drywall does not contain a “latent defect,” it is difficult to imagine what would.

The court in Ross found that the Latent Defect Exclusion applied to preclude coverage for the Rosses' claim because the defect in the Chinese drywall in their home was hidden and unknown. Similarly, in TRAVCO, supra at 711-12, the court stated that the Latent Defect Exclusion is intended to remove the risk of losses that result from flaws in property that are undetectable, and hence unexpected, and that losses associated with Chinese drywall fit squarely within this category. There can be no doubt that if the Rosses had known of the defective quality of the drywall used in their home they would not have purchased it. The same can be said for virtually all Chinese drywall claimants. Instead, because the defective nature of the Chinese drywall was “hidden or concealed” from their “knowledge as well as sight,” the Rosses purchased their home and did not learn of the damages caused by the drywall for two years. In fact, the Rosses alleged in their petition that their loss was caused by hidden defects and that the emission of gases was unknown to them. Ross, supra. However, even if no such allegations are made, it stands to reason that in virtually all Chinese drywall cases, the Latent Defect Exclusion will be implicated due to the very nature of Chinese drywall, i.e., its gas-emitting qualities.

The Corrosion Exclusion

The third exclusion that should be considered in analyzing homeowners' coverage for a Chinese drywall claim is the Corrosion Exclusion. It is well documented that the gases emitted from Chinese drywall cause corrosion to metal components, wiring, plumbing and appliances. For example, in Ross, the plaintiffs specifically alleged that the gases emitted from the drywall in their home caused corrosion to the metal components in their home. The Louisiana Citizens policy in Ross contained a Corrosion Exclusion that provided:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

c) Smog, rust or other corrosion, or dry rot.

The In re Chinese Manufactured Drywall court defined corrosion as “the chemical or electrochemical reaction between a material, usually a metal, and its environment that produces a deterioration of the material and its properties.” In re Chinese Manufactured Drywall, supra at 664. That is precisely the process that occurs when the gases emitted from Chinese drywall interact with metal components in a home. In fact, the plaintiffs in Ross alleged that the emission of the gases from the drywall corroded components in their home. Based on those allegations and the plain language of the Corrosion Exclusion in the Louisiana Citizens policy, the Ross court held that the Corrosion Exclusion applied.

A common response by Chinese drywall claimants to the Corrosion Exclusion is that the damage to a home's metal components was not caused by corrosion, but rather that the damage is the corrosion itself. TRAVCO, supra at 714. The courts in Ross, TRAVCO and In re Chinese Manufactured Drywall all rejected that argument. As the court in TRAVCO explained, “the ordinary meaning of corrosion includes the 'action or process of corroding.'” Id. at 715. The exclusion for loss caused by corrosion plainly refers to the process of corrosion and not to its end product. Further, the end product of corrosion cannot exist without the process of corrosion. In sum, the “loss” sustained by a Chinese drywall claimant is no longer having non-corroded metal components in their home and the cost associated with repairing or replacing those items. That “loss” is caused by corrosion and the plain meaning of that term implicates application of the Corrosion Exclusion to preclude coverage.

The Pollution Exclusion

Finally, the Pollution Exclusion should also be considered in Chinese drywall claims against a homeowners' policy. In Ross, the Louisiana Citizens policy contained the following Pollution Exclusion:

2. We do not insure, however, for loss:

***

c. Caused by:

***

(6) Any of the following:

***

(e) Discharge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself cause by a Peril Insured Against named under Coverage C.

The term Pollutants was defined as any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

Like the other exclusions discussed above, the Pollution Exclusion seemingly applies to a Chinese drywall claim by its plain language. The sulfuric gases produced by Chinese drywall can easily be considered “gaseous ' irritant[s] or contaminant[s]” as described in the Pollution Exclusion. In fact, a number of courts have held that sulfur-based gases and other invisible airborne material qualify as an “ irritant” and “contaminant.” See , e.g. , Wakefield Pork, Inc. v. RAM Mut. Ins. Co. , 731 N.W.2d 154,161 (Minn. Ct. App. 2007) (hydrogen sulfide); Mountain States Mut. Cas. Co. v. Kirkpatrick, 2007 WL 2506640 at *1 (D. Colo. Aug. 30, 2007) (hydrogen sulfide); and Board of Regents of Univ. of Minnesota v. Royal Ins. Co. of Am. , 517 N.W.2d 888, 892 (Minn. 1994) (asbestos fibers).

The court in Ross held that the Pollution Exclusion applied to exclude coverage under the Louisiana Citizens policy. The court relied upon the language of the policy in defining pollutants as any gaseous irritant or contaminant and concluded that the sulfuric gas emitted from the Chinese drywall in the Rosses' home qualified as a pollutant. While the insurer was successful in the application of the Pollution Exclusion in Ross, it should be noted that the application of this exclusion will vary greatly by state. As the court noted in TRAVCO with regard to the application of this exclusion, “there exists not just a split of authority, but an absolute fragmentation of authority” concerning the scope of the pollution exclusion. TRAVCO, supra at 715. Roughly speaking, there are two schools of thought with respect to the application of the pollution exclusion. The first is based on the thought that the exclusion is limited to preclude coverage for environmental pollution only, while the other refuses to assert such a limitation. Id. However, as Louisiana Citizens briefed, this dichotomy stems from the unrelated commercial general liability realm and ultimately has no application in the context of homeowners' insurance policies.

Ensuing Loss Clauses

While the Ross court did not discuss whether any of the damages associated with Chinese drywall could be classified as an ensuing loss, the issue must be considered. In TRAVCO, the policy provided that “any ensuing loss to property described in Coverages A and B not excluded by any other provision in this policy is covered.” TRAVCO, supra at 718. Typically, this type of clause should not apply in a Chinese drywall case for several reasons. First, there is no “ensuing loss” associated with Chinese drywall damages. While the sulfuric gas released may cause damage over a period of time, it still represents a single discreet loss from a single discreet injury, namely the off-gassing of the drywall. Id. at 718-19. Courts across the country have held that for the ensuing loss provision to apply, there must be a subsequent ensuing cause of loss separate and independent from the initial excluded cause of loss. See , e.g. , Weeks v. Co-Operative Ins. Cos. , 817 A.2d 292, 296 (N.H. 2003); Acme Galvanizing v. Fireman's Fund Ins. Co. , 270 Cal. Rptr. 405, 411 (Cal. Ct. App. 1990); Hartford Cas. Ins. Co. v. Evansville Vanderburgh Pub. Library , 860 N.E.2d 636, 646 (Ind. Ct. App. 2007) and Gies v. City of Gering , 695 N.W.2d 180, 193 (Neb. Ct. App. 2005). An ensuing loss would occur, for example, if corroded electrical wiring caused a fire, resulting in fire damage. See , e.g. , Aetna Ins. Co. v. Getchell Steel Treating Co. , 395 F.2d 12, 15 (8th Cir. 1968). However, that type of scenario is not present with Chinese drywall.

Even if the damages caused by Chinese drywall could be considered ensuing losses, the ensuing loss clause would still not provide coverage. For the ensuing loss clause to apply, the loss must not be “excluded by any other provision” of a policy. As explained above, a number of homeowners' exclusions will likely apply to exclude coverage for the losses associated with Chinese drywall. For example, even though a Chinese drywall claimant may assert that the corrosion of the metal components in his home constitutes an ensuing loss separate and apart from the off-gassing by the Chinese drywall, and even if a court were to agree, that corrosion is still excluded by virtue of the corrosion exclusion as discussed above. Thus, the ensuing loss provision would not apply to provide coverage.

Personal Property

Also of interest in Ross is the plaintiffs' claim that their personal property losses were covered by the Louisiana Citizens policy, which covered personal property losses caused by one of 16 specified perils. One of those specified perils was smoke, which the policy defined as the sudden and accidental damage from smoke, including the emission or puff-back of smoke, soot, fumes, or vapors from a boiler, furnace or related equipment. Based on that definition, the court in Ross found that the damage to personal property was not covered because the emission of sulfuric gases did not constitute smoke as defined in the policy. The court reasoned that the emission of the sulfuric gases was not sudden and thus could not be considered smoke under the policy. Ross, supra. Indeed, the damage to personal property in Ross occurred gradually, and was not discovered for two years.

Conclusion

With respect to whether or not Chinese drywall losses are covered by homeowners' policies, it seems that insurers have the upper hand at this point. The difficulty for insureds lies in the fact that, in order to trigger coverage, there must be allegations of a direct physical loss. However, those allegations will likely implicate a number of exclusions, namely the Faulty Materials and Latent Defect Exclusions. Further, the very nature of Chinese drywall lends itself to the application of those exclusions as well as the Corrosion Exclusion and Pollution Exclusion. The Ross case provides a concise explanation of these four exclusions and their application to Chinese drywall cases, and it will surely be relied on by any homeowners' insurer involved in this type of litigation.

Travis B. Wilkinson is special counsel with the New Orleans firm of Lugenbuhl, Wheaton, Peck, Rankin & Hubbard. He practices primarily in the areas of insurance coverage, insurance defense, and trial and appellate litigation. Seth A. Schmeeckle is a shareholder with the firm.