June 4, 2010 

Written By Attorneys: Mark H. Rosenberg and Robert T. Horst

This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney. 

On June 3, 2010, the United States District Court for the Eastern District of Virginia issued an opinion offering a detailed and thorough analysis of the availability of coverage under a standard homeowners' insurance policy for damage allegedly caused by defective Chinese drywall. In Travco Ins. Co. v. Ward, Civ. No. 2:10cv14 (E.D. Va. Jun. 3, 2010), the Court held that while such damage constitutes a "direct physical loss" falling within the general scope of coverage under the subject policy, a number of standard policy exclusions applied to preclude coverage for these claims.

In Travco, the policyholder contended that defective Chinese drywall resulted in the release of sulfur gas into his residence, resulting in the corrosion of metal components. The policyholder submitted a claim under his homeowners' policy for the removal and replacement of the drywall, damage to air conditioning equipment and a garage door, and damage to flat-screen televisions. The insurer responded by instituting a declaratory judgment complaint, seeking a determination that it was not liable for any of these damages, or any damage caused by the drywall.

The Court initially considered the insurer's contention that the claim for the removal and replacement of the drywall was not covered under the policy, as it did not concern a "direct physical loss." Largely relying upon case law from other jurisdictions, as well as the fact that the term "property damage" was defined in the policy to include "loss of use of tangible property," the Court held that the fact that the property was rendered uninhabitable due to the sulfur fumes constituted a "direct physical loss" that brought the claim for removal and replacement of the drywall within the scope of coverage.

The Court next analyzed whether coverage for the policyholder's claims fell within the scope of a policy exclusion for damage caused by a "latent defect." The Court noted that this exclusion applies when a latent defect is "integral to the damaged property by reason of its design or manufacture or construction." As the drywall was not "integral" to the garage door and air conditioning equipment, the Court held that the "latent defect" exclusion did not apply to these claims. However, the Court held that the exclusion applied to the claim for removal and replacement of the defective drywall, as this drywall was "plainly integral" to the manufacture and construction of the residence.

Given the policyholder's contention that the drywall was defective, the Court also found that coverage for removal and replacement of the drywall also fell within a policy exclusion pertaining to "faulty materials." In addition, the Court held that coverage for the claimed damage to metals and metallic surfaces (including the garage door and air conditioning equipment) was excluded under a policy provision pertaining to "corrosion," as these items were damaged through contact with corrosive sulfur gases.

The Court next held that coverage for all of the claims at issue was precluded by the policy's standard pollution exclusion. The Court noted that under Virginia law, this exclusion was not limited to "traditional environmental pollution," and applied to the release of household pollutants. The Court concluded that as sulfur gases were clearly pollutants, the pollution exclusion therefore applied to bar coverage.

Finally, the Court analyzed whether any of the claims qualified for coverage under policy language stipulating that the latent defect, pollution, corrosion, and faulty materials exclusions will not bar coverage for any "ensuing loss" to property that is not otherwise excluded from coverage under the policy terms. The Court rejected the policyholder's argument that the damage to components of the residence (such as the garage door and air-conditioning equipment) constituted an "ensuing loss." To the contrary, the Court held that the damage to these components was the result of a single loss: the release of sulfur gases from the defective drywall. The Court also noted that as these losses were the direct result of corrosion, they would be excluded from coverage under the policy even if they could be characterized as an "ensuing loss." In addition, the Court held that the "ensuing loss" provisions could not establish a right to coverage for the damaged televisions, because such damage was not caused by any of the 17 enumerated perils for which coverage was provided under the policy's Personal Property provision.

The Court therefore issued a declaratory judgment that the subject insurance policy did not provide coverage for any of the damage as claimed by the policyholder. However, the Court declined to issue a judgment that the policy did not provide coverage for any damage caused by the drywall or the release of gases (given that the policyholder could potentially bring a new claim for an "ensuing loss" that would fall within the scope of coverage).

In light of the many media reports regarding the risks to health and property posed by defective Chinese drywall in recently built residences, insurers have been understandably concerned about potential exposure arising from drywall claims. As one of the earliest decisions to address the availability of property insurance coverage for Chinese drywall claims, Ward may lead other jurisdictions to adopt its common-sense approach to policy interpretation with regard to such claims.