Insurance Coverage for Drywall Claims Chinese Drywall Claims As those in the construction industry are now well aware, the use of drywall imported from China between 2004 and 2007 has led to litigation in multiple states, including a multi-district litigation in New “Any company Orleans with trials scheduled as early as January 2010. Property owners or independent complain of sulfurous odors, corroded electrical wiring, damaged heating contractor in and air conditioning units, damaged appliances, damage to personal the supply and property, and diminution in the value of their property. Property owners also report numerous physical complaints, including headaches and installation chain upper respiratory ailments, and some are seeking the costs of medical could be affected by monitoring. Some estimate that Chinese drywall could be installed in the litigation.” as many as 100,000 homes. Costs are unknown but could reach the hundreds of millions of dollars. Although claims are concentrated in the southeast, the Consumer Product Safety Commission (CPSC) has received approximately 1,900 incident reports from 30 states with new incident reports expected. Any company or independent contractor in the supply and installation chain could find itself named as a defendant in the litigation. Lenders that foreclosed on homes with Chinese drywall and subsequently sold those homes could also be named for failing “Costs are estimated to disclose and/or remediate the Chinese drywall. Because plaintiffs’ to be in the counsel may find it difficult, if not impossible, to reach some of the hundreds of millions Chinese manufacturers, they will likely be casting their nets far and wide of dollars.” when naming defendants.

The Interagency Task Force on Chinese Drywall The CPSC is leading the state and federal Interagency Task Force on Chinese Drywall. On October 29, 2009, the task force released the preliminary results of three studies of Chinese drywall. The studies reported higher concentrations of elemental sulfur and strontium and “In addition to the higher emissions of total volatile sulfur gases in Chinese drywall but only pollution exclusion, very limited indications of sulfur compounds in the indoor air. The other likely insurer studies described concentrations of two known irritant compounds, acetaldehyde and formaldehyde, which were detected in homes with defenses include and without Chinese drywall, at levels that could exacerbate conditions the own product/ such as asthma in sensitive populations. The studies explained that the own work exclusion, levels of formaldehyde were not unusual for new homes. The task force’s which insurers will complete report as well as other CPSC information on Chinese drywall assert eliminates is available at the CPSC’s Chinese drywall information center at www. coverage..” drywallresponse.gov. The CPSC has also established a consumer hotline for drywall reports. The investigation is ongoing; in fact a CPSC agency representative has described the drywall investigation as one of the larg- est investigations in CPSC history. The CPSC plans to issue a report on its indoor air study of 50 homes as well as a preliminary engineering analysis of potential electrical and fire safety issues related to corrosion in November 2009. A study of long-term corrosion issues will not be completed until June 2010. Availability of Insurance Coverage Insurance coverage may be available to pay for the defense of Chinese drywall claims and to fund any resulting settlements or judgments. Individuals and companies facing drywall claims may be able to draw “With rare upon their commercial general liability (CGL) insurance policies exceptions, most for both a defense of claims and indemnity for any settlements or judgments. CGL policies typically require the insurer to pay “all sums” CGL policies should which the insured is legally obligated to pay as damages because of bodily respond to the injury or property damage. In addition, CGL policies typically require onslaught of Chinese insurers “to defend any suit against the insured seeking damages on drywall claims, account of such injury or property damage, even if any of the allegations although insurers of the suit are groundless, false or fraudulent.” Regardless of the typically will not do potential for settlements or judgments, the defense obligation alone is extremely valuable to defendants named in Chinese drywall litigation. so unless the insured As litigation expands, the costs incurred in defense could be significant, takes a stance thus making this insurance a valuable source of defense funding. and demands the coverage to which it In addition, defendants’ directors’ and officers’ insurance policies is entitled.” (D&O) may fund responses to governmental investigations and defenses to shareholder lawsuits. D&O insurance typically provides defense and indemnity for claims made against directors and officers as well as limited entity coverage. Errors and omissions policies may provide protection to third-parties such as lenders for claims arising out of their professional services. Defendants may have access to coverage under other insurance policies as additional insureds. For example, builders or general contractors are often added as additional insureds on subcontractors’ policies. In addition, for projects still under construction, builder’s risk insurance may respond.

Although insurance policies may provide coverage for Chinese drywall claims, many insurers will assert exclusions and other defenses to coverage. Some insurers have already asserted the so-called “pollution exclusion” as a bar to coverage. Although originally inserted into insurance policies to address traditional environmental contamination (such as landfills), insurers continually attempt to expand the reach of the exclusion beyond its intended scope. Insurers have obtained mixed success from those efforts. For example, one member of our policyholder coverage team successfully defeated an insurance company attempt to expand the “pollution exclusion” to welding liability claims. The court rejected the insurer’s argument that welding claims involved “fumes” and “fumes” are excluded from coverage. Although the case law is mixed, other courts have refused to apply the pollution exclusion to lead paint, asbestos, and carbon monoxide claims. In addition to the pollution exclusion, other likely insurer defenses include the own product/own work exclusion, which insurers may assert eliminates coverage for the drywall itself or even for damage to the remainder of the property (which the insurer would define as “your work”). Some contractors’ policies may include an exclusion for damage to work performed by subcontractors on the insured’s behalf. Insurers may also assert the impaired property exclusion, which excludes certain damage to tangible property that cannot be used or is less useful because it incorporates your product, subject to various exceptions. Insurers may also assert that coverage is precluded because the policyholder knew or should have known that the Chinese drywall would cause bodily injury and property damage. Each of these exclusions and defenses to coverage raises thorny issues of insurance law, but none of them should necessarily preclude insurance coverage for Chinese drywall claims.

Injured parties may be able to turn to their first-party property insurance policies for some relief, although many insurers will claim that the damaged drywall itself does not constitute insured direct physical loss and therefore is not covered by first-party property policies. Some first-party insurers may also attempt to argue that the associated damage to property other than the drywall, such as damage to electrical wiring and appliances, is also not insured and will cite various exclusions to coverage, including the faulty workmanship/materials exclusion and any pollution or contamination exclusions. Water damage exclusions may also come into play. The strength of the insurers’ arguments depends upon the particular policy language and the governing law. Protect and Pursue Your Insurance Coverage If your company is a defendant or potential defendant in Chinese drywall litigation or is named in any governmental investigation, you should immediately analyze your insurance policies and any policies on which you are named as an additional insured that were purchased during the last few years to determine the availability of insurance coverage. You should also notify all potential insurers of any claims or potential claims. If your insurer has already denied coverage, consult with an attorney to determine whether the insurer’s position is justified. With rare exceptions, most CGL policies should respond to the onslaught of Chinese drywall claims, although insurers typically will not do so unless the insured takes a stance and demands the coverage to which it is entitled. Our Chinese Drywall Team Our Chinese Drywall Team is led by attorneys from our policyholder insurance coverage practice, our construction practice, our real estate practice, and our litigation practice. This interdisciplinary team can advise clients on all aspects of Chinese drywall claims.

Katherine J. Henry Katherine J. Henry is a partner in the firm’s Washington, D.C. office. Ms. Henry represents policyholders seeking insurance coverage for all types of liabilities, including mass torts (such as asbestos, environmental, and welding), D&O and E&O, financial liabilities, and first-party property damage. Ms. Henry’s past and present policyholder clients include the world’s largest automaker, the world’s largest home improvement specialty retailer, a major utility company, a major lender, numerous health care-related entities, a private-equity investment firm, several distributors of welding products, and a national trade association for the gases and welding industry. Ms. Henry also provides clients with strategic advice and solutions for complex legal disputes. Her experience includes formulating a litigation and negotiation strategy that led to the industry-wide settlement of claims brought by the entire payphone industry as well as crafting a nationwide insurance coverage strategy for welding distributors. Ms. Henry is an effective appellate advocate and has appeared before numerous federal and state appellate courts, including en banc panels, on a wide variety of matters. David Pharr David Pharr is a partner in the firm’s Jackson, Mississippi office, where he represents commercial policyholders in negotiations and litigated disputes with insurance companies. David has significant experience representing manufacturers and contractors in defense of their products and work as well as in insurance coverage litigation. He represented an EIFS manufacturer in a complex dispute with multiple insurers arising from hundreds of homeowner claims in which the business risk exclusions were central issues. He also represented a steel processing company in coverage litigation focused on whether various pollution exclusions barred coverage for mass tort environmental liability claims. David also has experience with litigation and negotiation of hurricane damage claims involving property and builder’s risk insurance.

David regularly counsels businesses and organizations in matters related to insurance coverage. He is Vice-Chair of an American Bar Association committee on insurance coverage litigation and Chair of the Jackson Chamber of Commerce.

Keith Covington Keith Covington is a partner in the firm’s Birmingham, Alabama office, where he practices construction and labor and employment law. Keith advises contractors and others in the construction industry on contracts, contract administration, and claims. He also counsels employers in virtually all aspects of employment law, including discrimination issues, workers’ compensation, labor relations, worksite immigration enforcement, OSHA compliance, and union avoidance. Keith has broad experience litigating employment, construction, and construction defect cases. He was a member of Bradley Arant’s EIFS team and represented Dryvit Systems during the recent spate of EIFS litigation.

Keith is an active member of the Associated Builders and Contractors and a frequent writer and speaker on issues of interest to the construction industry. He is also a member of the Defense Research Institute and the American Immigration Lawyers Association. Keith holds a B.S. degree in Mechanical Engineering from Auburn University and a J.D. degree from the University of Alabama School of Law. Mike Brown Mike Brown is the head of the Real Estate Litigation Team at the firm. Mike is a member of the firm’s Environmental and Toxic Tort Practice Group and the General Litigation Practice Group. Mike’s emphasis in both practice groups is on real property and land use matters.

Mike has handled litigation involving real property, including disputes involving construction and construction defects. Specifically, since 1997 Mike has served as one of the lead counsel for Dryvit Systems, Inc. in its litigation in Alabama and Mississippi. Mike also assisted Dryvit Systems, Inc. in resolution of a nationwide class action on EIFS issues. Mike has also litigated other residential and commercial construction disputes as well as construction defect claims involving mold, asbestos and formaldehyde. Mike was one of the lead lawyers in Keck v. Dryvit Systems, Inc., 830 So. 2d 1 (Ala. 2002), in which the Alabama Supreme Court established a groundbreaking precedent for thousands of other cases as relates to real property and construction matters. For the past several years, Mike has served as an adjunct Professor at the University of Alabama School of Law teaching Land Use Planning and Real Estate Finance & Development. Mike has spoken to a variety of groups on issues involving Real Estate Land Use and Environmental issues. Chinese Drywall Team

Katherine J. Henry Washington DC Office Phone: 202.719.8244 Fax: 205.719.8344 [email protected]

David K. Pharr Jackson Office Phone: 601.592.9924 Fax: 601.592.1424 [email protected]

F. Keith Covington Birmingham Office Phone: 205.521.8389 Fax: 205.488.6389 [email protected]

T. Michael Brown Birmingham Office Phone: 205.521.8462 Fax: 205.488.6462 [email protected]

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