Another Brick in the Wall: Application of the Pollution Exclusion to Chinese Drywall Claims

Not surprisingly, the allegedly defective and dangerous nature of Chinese drywall has resulted in a flood of lawsuits in recent years. To this point, however, the primary focus of those lawsuits has been whether and to what extent the Chinese companies (and their foreign subsidiaries) responsible for the drywall manufacture are subject to jurisdiction in U.S. courts. Several state and federal decisions in recent months have held that those companies are, in fact, subject to U.S. jurisdiction, marking a turning point in this litigation.

More significantly for the insurance industry, however, the Supreme Court of Virginia recently held that insurance coverage for Chinese drywall claims could be denied under a pollution exclusion. Answering a question of law certified by the U.S. Court of Appeals for the Fourth Circuit, the court held that the pollution exclusion ' which excluded coverage for loss caused by the discharge of “pollutants” including any “gaseous irritant,” “vapor” or “fumes” ' plainly and unambiguously excluded from coverage any damage resulting from the emission of gas from the drywall.

As the first state supreme court to rule on the issue, the Virginia Supreme Court's analysis, as set forth in its ground-breaking decision, could potentially be followed by other courts in Chinese drywall coverage litigation and create a significant hurdle to policyholders seeking coverage.

The History of Chinese Drywall

During the housing boom of the last decade, countless homes were constructed or renovated across the country. Many of these homes incorporated Chinese drywall ' particularly in Louisiana after Hurricane Katrina, and in Florida and Virginia. In fact, it is estimated that hundreds of millions of square feet of Chinese drywall were exported to the United States between 2004 and 2007; enough to construct many tens of thousands of homes at a size of 2,000 square feet each.

Chinese drywall, however, is alleged to be seriously and dangerously defective. In particular, coming on the heels of a number of safety problems with other Chinese exports in recent years, Chinese drywall is alleged to contain waste material from Chinese power plants. These materials contain high levels of harmful sulfur compounds, including sulfur dioxide and hydrogen sulfide, that can leak into the air in the form of gas or fumes.

According to homeowners' complaints, these fumes smell like rotten eggs and corrode wiring and piping, leading to health problems and the failure of numerous electronics and appliances. Specifically, the sulfur fumes tarnish and blacken silver and copper items, including wiring and pipes, leading to the destruction or disabling of air conditioning units, washing machines, dryers, microwaves, refrigerators and televisions. In addition, apart from the annoying odor, many homeowners have complained that the gases cause a variety of health problems, including headaches; respiratory ailments such as difficulty breathing, coughing and asthma attacks; skin and eye irritation; nosebleeds and rhinorrhea; sinus infections; and sore throats. These health problems are short-term; the long-term health effects of Chinese drywall exposure are not yet known.

Lawsuits against manufacturers of Chinese drywall began in the late 2000s. These lawsuits include several class action complaints and an MDL consolidated in the U.S. District Court for the Eastern District of Louisiana. Not surprisingly, given the source of the allegedly defective product, one of the main issues in these cases to date has been whether and to what extent the defendant Chinese drywall manufacturers and their foreign subsidiaries are even subject to jurisdiction in U.S. courts. Very recently, in both the MDL and a Florida state court case, judges have held that U.S. courts do, in fact, have jurisdiction over these manufacturers because they had sufficient business dealings and contacts with the United States. These decisions mark a turning point in lawsuits over Chinese drywall, although any positive effect will be delayed as the defendants appeal the decisions.

Problems with Chinese drywall and jurisdiction over Chinese manufacturers have also gained the attention of the U.S. government. In September 2012, the U.S. House of Representatives passed the “Drywall Safety Act of 2012,” pursuant to which Congress requests that the Secretary of State insist that the Chinese government require companies that manufacture and export drywall to the United States to meet with U.S. government representatives about remedying affected homeowners and to submit to the jurisdiction of U.S. courts. Also pursuant to the Drywall Safety Act, contaminated drywall is to be treated as a banned hazardous substance under the Federal Hazardous Substances Act and as an imminent hazard under the Consumer Protection Safety Act. The Drywall Safety Act, however, has not been signed into law, as it has not yet been taken up by the Senate.

Chinese Drywall Coverage Litigation

High-profile coverage litigation
often follows high-profile underlying litigation, and the matters involving Chinese drywall are no exception. Indeed, in the last few years, federal and state courts (primarily in Virginia, Florida and Louisiana) have issued numerous rulings on insurance coverage issues related to Chinese drywall. Both insurers and policyholders have prevailed in these coverage cases.

In those cases in which courts have ruled in favor of the insurers, various exclusions have been held to bar coverage for Chinese drywall claims, including exclusions for corrosion, latent defect, faulty materials and pollution. However, while coverage litigation involving Chinese drywall has substantially increased during the last several years, no state high court has yet weighed in on the issue, until now.

Against this background, recently the Supreme Court of Virginia, in TravCo Insurance Company v. Larry Ward, 2012 WL 5358705 (Va.), decided the question of whether insurance coverage for Chinese drywall claims is barred by the pollution exclusion. The court held that the pollution exclusion does, in fact, exclude coverage for those claims. As the first state supreme court to rule on the issue, this ground-breaking decision has the potential to reverberate across the coverage world and lead other courts to follow suit.

The TravCo Insurance Decision

The underlying facts of the TravCo Insurance case are relatively straightforward. Larry Ward, a homeowner, sought coverage under his homeowners' insurance policy issued by TravCo Insurance Company for damages allegedly caused by sheets of Chinese drywall that were installed in his home during its construction. TravCo denied Ward's claims and brought an action in the U.S. District Court for the Eastern District of Virginia, seeking a declaratory judgment that Ward's homeowners' policy did not provide coverage for such losses.

TravCo moved for summary judgment, and the district court granted the motion on the basis that the policy did not provide coverage for the damages allegedly caused by the drywall in Ward's home because of certain policy exclusions, including the pollution exclusion. Ward appealed the ruling to the U.S. Court of Appeals for the Fourth Circuit, which certified to the Supreme Court of Virginia the question of whether the policy exclusions were unambiguous in their “form, scope and application in light of the unusual nature of the losses involved.” The Supreme Court of Virginia accepted the certified question of law from the Fourth Circuit.

The pollution exclusion at issue was of a form common in various insurance policies across the country. The exclusion provided that TravCo does not insure for loss caused by:

Discharge, 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 [the policy]. Pollutants means 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 claimed.

Ward argued that the pollution exclusion was “ambiguous, overbroad, unreasonable” and inapplicable to his loss because he claimed that the process by which elemental sulfur escaped the Chinese drywall was not a “discharge” of “pollutants” as contemplated by the exclusion or as a reasonable person would understand.

TravCo argued that the pollution exclusion properly applied because the sulfuric gas emanating from the drywall was an “irritant or contaminant” under the plain language of the policy. In particular, TravCo claimed that the sulfur gas in Ward's house was a contaminant because it was not “supposed to be” in the home and it caused harm (specifically, nosebleeds and other problems). TravCo likewise argued that the sulfur gas moved from the drywall to the air in the home by way of “[d]ischarge, dispersal, seepage, migration, release or escape.”

In analyzing the arguments and issues of the case, the court relied on basic tenets of Virginia coverage law that are common throughout other U.S. jurisdictions. Specifically, the court noted that under Virginia law any limitation pertaining to the reasonableness of policy exclusions merely requires exclusions to be stated in “language that is reasonable, clear and unambiguous.” Additionally, the court noted that “[e]xclusions are to be construed according to their plain language.”

Applying these standards, the court recognized that while the release of sulfuric gases from Chinese drywall “is not traditional pollution,” it does not construe pollution exclusions so narrowly. To that end, the court noted that Ward, in his answer to the declaratory judgment complaint, admittedly described the sulfur as gaseous and claimed that these “odorous fumes” were “toxic” and caused “skin rashes,” “lesions,” “sinus congestion” and “nosebleeds.” Accordingly, the court held that “[i]t is beyond dispute that the sulfuric substance emanating from the drywall is gaseous” and that the properties of the gases “plainly place [them] within the definition of 'irritant or contaminant' contemplated by the policy and commonly understood.”

Moreover, the court noted that reduced sulfur gas is classified as a pollutant in relevant state and federal regulations. Finally, the court held that “it is difficult to envision how the sulfuric gases reached the air of the Ward home if not by the means encompassed by the ordinary meaning of '[d]ischarge, dispersal, seepage, migration, release or escape'” in the pollution exclusion. Accordingly, the court concluded that the pollution exclusion was clear and “unambiguously excludes from coverage any damage resulting from the drywall.”

The Supreme Court of Virginia's decision is unquestionably significant. Indeed, by becoming the first state high court to rule on the issue of the pollution exclusion's applicability to Chinese drywall claims, the court's decision sets a standard that ' while certainly not binding ' may potentially guide other courts in their analyses as drywall coverage litigation continues to increase across the country.

Conclusion

In just a few short years, Chinese drywall claims have burst onto the national scene, even grabbing the attention of Congress. Not surprisingly, the frequency and intensity of coverage litigation involving these claims has likewise expanded at a rapid pace. Despite this, however, guidance from a state supreme court on the question of the application of the pollution exclusion to these claims has been lacking.

The Supreme Court of Virginia has now filled that void. In holding, under insurance coverage standards common in many other jurisdictions, that the pollution exclusion clearly and unambiguously bars coverage for Chinese drywall claims, the court has provided potential guidance for other courts to follow and could lead to significant obstacles for policyholders seeking coverage.

Of course, it is not a certainty that other state or federal courts will necessarily adhere to the TravCo Insurance decision. Indeed, other courts are certainly not required to follow Virginia and may arrive at a different conclusion ' especially those states that, in contrast to Virginia, do not narrowly construe insurance policy provisions such as the pollution exclusion.

Nevertheless, while Chinese drywall will never be the most famous wall to originate from China, its impact on the coverage world will be both important and fascinating to watch in the coming years ' even if we can't do so from space.

Daren S. McNally is the managing partner and Matthew I. Gennaro is senior counsel in the New Jersey office of Clyde & Co US LLP. McNally, a member of this newsletter's Board of Editors, maintains a practice that is intensely focused on insurance coverage litigation and counseling, with an emphasis in complex insurance and reinsurance litigation, trials and arbitrations in both domestic and foreign arenas. Gennaro focuses his practice in the areas of insurance coverage law and litigation. Anupama Prasad, an associate in the New Jersey office, assisted with the preparation of this article.

It is frequently claimed that the Great Wall of China is the only man-made object that can be seen from space. For the most part, however, this is a myth. According to NASA, while there are many objects of human creation that can be seen from orbit, the Great Wall generally isn't one of them.

Meanwhile, back on Earth, a far different type of Chinese wall has gained notoriety of late. Specifically, drywall (also known as plasterboard, wallboard or sheetrock) manufactured in China and used in recent home construction in the United States has come under intense scrutiny for its allegedly harmful effects.

In particular, prior to the economic crisis of the last several years, thousands of homes in the United States were constructed or renovated with Chinese drywall ' many of them in Louisiana in the aftermath of Hurricane Katrina, and in Florida and Virginia during the housing boom. Unfortunately, Chinese drywall is alleged to contain high levels of sulfur, which emits a noxious smell and whose gases also corrode piping and wiring. As a result, Chinese drywall is alleged to have caused or contributed to myriad problems in the homes in which it was installed, including the disabling or destruction of household appliances and a variety of health problems, such as nosebleeds, headaches and respiratory ailments.

Not surprisingly, the allegedly defective and dangerous nature of Chinese drywall has resulted in a flood of lawsuits in recent years. To this point, however, the primary focus of those lawsuits has been whether and to what extent the Chinese companies (and their foreign subsidiaries) responsible for the drywall manufacture are subject to jurisdiction in U.S. courts. Several state and federal decisions in recent months have held that those companies are, in fact, subject to U.S. jurisdiction, marking a turning point in this litigation.

More significantly for the insurance industry, however, the Supreme Court of Virginia recently held that insurance coverage for Chinese drywall claims could be denied under a pollution exclusion. Answering a question of law certified by the U.S. Court of Appeals for the Fourth Circuit, the court held that the pollution exclusion ' which excluded coverage for loss caused by the discharge of “pollutants” including any “gaseous irritant,” “vapor” or “fumes” ' plainly and unambiguously excluded from coverage any damage resulting from the emission of gas from the drywall.

As the first state supreme court to rule on the issue, the Virginia Supreme Court's analysis, as set forth in its ground-breaking decision, could potentially be followed by other courts in Chinese drywall coverage litigation and create a significant hurdle to policyholders seeking coverage.

The History of Chinese Drywall

During the housing boom of the last decade, countless homes were constructed or renovated across the country. Many of these homes incorporated Chinese drywall ' particularly in Louisiana after Hurricane Katrina, and in Florida and Virginia. In fact, it is estimated that hundreds of millions of square feet of Chinese drywall were exported to the United States between 2004 and 2007; enough to construct many tens of thousands of homes at a size of 2,000 square feet each.

Chinese drywall, however, is alleged to be seriously and dangerously defective. In particular, coming on the heels of a number of safety problems with other Chinese exports in recent years, Chinese drywall is alleged to contain waste material from Chinese power plants. These materials contain high levels of harmful sulfur compounds, including sulfur dioxide and hydrogen sulfide, that can leak into the air in the form of gas or fumes.

According to homeowners' complaints, these fumes smell like rotten eggs and corrode wiring and piping, leading to health problems and the failure of numerous electronics and appliances. Specifically, the sulfur fumes tarnish and blacken silver and copper items, including wiring and pipes, leading to the destruction or disabling of air conditioning units, washing machines, dryers, microwaves, refrigerators and televisions. In addition, apart from the annoying odor, many homeowners have complained that the gases cause a variety of health problems, including headaches; respiratory ailments such as difficulty breathing, coughing and asthma attacks; skin and eye irritation; nosebleeds and rhinorrhea; sinus infections; and sore throats. These health problems are short-term; the long-term health effects of Chinese drywall exposure are not yet known.

Lawsuits against manufacturers of Chinese drywall began in the late 2000s. These lawsuits include several class action complaints and an MDL consolidated in the U.S. District Court for the Eastern District of Louisiana. Not surprisingly, given the source of the allegedly defective product, one of the main issues in these cases to date has been whether and to what extent the defendant Chinese drywall manufacturers and their foreign subsidiaries are even subject to jurisdiction in U.S. courts. Very recently, in both the MDL and a Florida state court case, judges have held that U.S. courts do, in fact, have jurisdiction over these manufacturers because they had sufficient business dealings and contacts with the United States. These decisions mark a turning point in lawsuits over Chinese drywall, although any positive effect will be delayed as the defendants appeal the decisions.

Problems with Chinese drywall and jurisdiction over Chinese manufacturers have also gained the attention of the U.S. government. In September 2012, the U.S. House of Representatives passed the “Drywall Safety Act of 2012,” pursuant to which Congress requests that the Secretary of State insist that the Chinese government require companies that manufacture and export drywall to the United States to meet with U.S. government representatives about remedying affected homeowners and to submit to the jurisdiction of U.S. courts. Also pursuant to the Drywall Safety Act, contaminated drywall is to be treated as a banned hazardous substance under the Federal Hazardous Substances Act and as an imminent hazard under the Consumer Protection Safety Act. The Drywall Safety Act, however, has not been signed into law, as it has not yet been taken up by the Senate.

Chinese Drywall Coverage Litigation

High-profile coverage litigation
often follows high-profile underlying litigation, and the matters involving Chinese drywall are no exception. Indeed, in the last few years, federal and state courts (primarily in Virginia, Florida and Louisiana) have issued numerous rulings on insurance coverage issues related to Chinese drywall. Both insurers and policyholders have prevailed in these coverage cases.

In those cases in which courts have ruled in favor of the insurers, various exclusions have been held to bar coverage for Chinese drywall claims, including exclusions for corrosion, latent defect, faulty materials and pollution. However, while coverage litigation involving Chinese drywall has substantially increased during the last several years, no state high court has yet weighed in on the issue, until now.

Against this background, recently the Supreme Court of Virginia, in TravCo Insurance Company v. Larry Ward, 2012 WL 5358705 (Va.), decided the question of whether insurance coverage for Chinese drywall claims is barred by the pollution exclusion. The court held that the pollution exclusion does, in fact, exclude coverage for those claims. As the first state supreme court to rule on the issue, this ground-breaking decision has the potential to reverberate across the coverage world and lead other courts to follow suit.

The TravCo Insurance Decision

The underlying facts of the TravCo Insurance case are relatively straightforward. Larry Ward, a homeowner, sought coverage under his homeowners' insurance policy issued by TravCo Insurance Company for damages allegedly caused by sheets of Chinese drywall that were installed in his home during its construction. TravCo denied Ward's claims and brought an action in the U.S. District Court for the Eastern District of Virginia, seeking a declaratory judgment that Ward's homeowners' policy did not provide coverage for such losses.

TravCo moved for summary judgment, and the district court granted the motion on the basis that the policy did not provide coverage for the damages allegedly caused by the drywall in Ward's home because of certain policy exclusions, including the pollution exclusion. Ward appealed the ruling to the U.S. Court of Appeals for the Fourth Circuit, which certified to the Supreme Court of Virginia the question of whether the policy exclusions were unambiguous in their “form, scope and application in light of the unusual nature of the losses involved.” The Supreme Court of Virginia accepted the certified question of law from the Fourth Circuit.

The pollution exclusion at issue was of a form common in various insurance policies across the country. The exclusion provided that TravCo does not insure for loss caused by:

Discharge, 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 [the policy]. Pollutants means 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 claimed.

Ward argued that the pollution exclusion was “ambiguous, overbroad, unreasonable” and inapplicable to his loss because he claimed that the process by which elemental sulfur escaped the Chinese drywall was not a “discharge” of “pollutants” as contemplated by the exclusion or as a reasonable person would understand.

TravCo argued that the pollution exclusion properly applied because the sulfuric gas emanating from the drywall was an “irritant or contaminant” under the plain language of the policy. In particular, TravCo claimed that the sulfur gas in Ward's house was a contaminant because it was not “supposed to be” in the home and it caused harm (specifically, nosebleeds and other problems). TravCo likewise argued that the sulfur gas moved from the drywall to the air in the home by way of “[d]ischarge, dispersal, seepage, migration, release or escape.”

In analyzing the arguments and issues of the case, the court relied on basic tenets of Virginia coverage law that are common throughout other U.S. jurisdictions. Specifically, the court noted that under Virginia law any limitation pertaining to the reasonableness of policy exclusions merely requires exclusions to be stated in “language that is reasonable, clear and unambiguous.” Additionally, the court noted that “[e]xclusions are to be construed according to their plain language.”

Applying these standards, the court recognized that while the release of sulfuric gases from Chinese drywall “is not traditional pollution,” it does not construe pollution exclusions so narrowly. To that end, the court noted that Ward, in his answer to the declaratory judgment complaint, admittedly described the sulfur as gaseous and claimed that these “odorous fumes” were “toxic” and caused “skin rashes,” “lesions,” “sinus congestion” and “nosebleeds.” Accordingly, the court held that “[i]t is beyond dispute that the sulfuric substance emanating from the drywall is gaseous” and that the properties of the gases “plainly place [them] within the definition of 'irritant or contaminant' contemplated by the policy and commonly understood.”

Moreover, the court noted that reduced sulfur gas is classified as a pollutant in relevant state and federal regulations. Finally, the court held that “it is difficult to envision how the sulfuric gases reached the air of the Ward home if not by the means encompassed by the ordinary meaning of '[d]ischarge, dispersal, seepage, migration, release or escape'” in the pollution exclusion. Accordingly, the court concluded that the pollution exclusion was clear and “unambiguously excludes from coverage any damage resulting from the drywall.”

The Supreme Court of Virginia's decision is unquestionably significant. Indeed, by becoming the first state high court to rule on the issue of the pollution exclusion's applicability to Chinese drywall claims, the court's decision sets a standard that ' while certainly not binding ' may potentially guide other courts in their analyses as drywall coverage litigation continues to increase across the country.

Conclusion

In just a few short years, Chinese drywall claims have burst onto the national scene, even grabbing the attention of Congress. Not surprisingly, the frequency and intensity of coverage litigation involving these claims has likewise expanded at a rapid pace. Despite this, however, guidance from a state supreme court on the question of the application of the pollution exclusion to these claims has been lacking.

The Supreme Court of Virginia has now filled that void. In holding, under insurance coverage standards common in many other jurisdictions, that the pollution exclusion clearly and unambiguously bars coverage for Chinese drywall claims, the court has provided potential guidance for other courts to follow and could lead to significant obstacles for policyholders seeking coverage.

Of course, it is not a certainty that other state or federal courts will necessarily adhere to the TravCo Insurance decision. Indeed, other courts are certainly not required to follow Virginia and may arrive at a different conclusion ' especially those states that, in contrast to Virginia, do not narrowly construe insurance policy provisions such as the pollution exclusion.

Nevertheless, while Chinese drywall will never be the most famous wall to originate from China, its impact on the coverage world will be both important and fascinating to watch in the coming years ' even if we can't do so from space.

Daren S. McNally is the managing partner and Matthew I. Gennaro is senior counsel in the New Jersey office of Clyde & Co US LLP. McNally, a member of this newsletter's Board of Editors, maintains a practice that is intensely focused on insurance coverage litigation and counseling, with an emphasis in complex insurance and reinsurance litigation, trials and arbitrations in both domestic and foreign arenas. Gennaro focuses his practice in the areas of insurance coverage law and litigation. Anupama Prasad, an associate in the New Jersey office, assisted with the preparation of this article.