SUBROGATION OF CLAIMS
ARISING FROM BOILER, INDUSTRIAL MACHINERY & EQUIPMENT FAILURES
This
blog is intended to assist the claims professional in protecting the insurer’s
subrogation interests in losses arising from BOILER, INDUSTRIAL MACHINERY &
EQUIPMENT FAILURES, including losses caused both by electrical and mechanical
anomalies and malfunctions. These frequently
complex claims present unique recovery challenges. The machinery or equipment that failed may be
old and original purchase records as well as complete repair and maintenance
records may be unavailable. Insureds may
begin repairs and reconstruction of the equipment before or shortly after
notifying the carrier. In such
situations, a proper investigation into the cause of the failure may not be
possible and evidence crucial to a subrogation claim may be lost or destroyed.
This
blog will provide an overview of the subrogation specific issues that often
arise with these types of claims. It should serve as a guide to the property
and subrogation professional to insure that the evidence necessary for pursuing
claims against responsible third parties is gathered and preserved from the
onset of the investigation. As with any substantial loss, the adjuster is
advised to retain counsel in a timely manner to oversee the investigation of
the loss and fully explore subrogation potential.
A.
COMMON TYPES OF LOSSES
There
are a variety of claim scenarios that an adjuster may encounter in handling equipment
and machinery losses, including:
(1)
failure of industrial machinery or equipment which may halt production in a
plant and/or damage other property;
(2)
failure of a turbine generator, with resulting interruption of power;
(3)
failure of an electrical transformer with a resulting power outage or electrically
induced fire;
(4)
an electrical anomaly or power surge which impacts the insured’s electrical
system and electric or electrical equipment, damages other equipment, leads to
a loss of power and/or starts a fire;
(5)
failure of a refrigeration or HVAC system which causes death of livestock or
spoilage of goods due to loss of ventilation or temperature changes;
(6)
failure of a compressor or pump in a hydraulic system leading to a rupture or
release of fluids with explosive force;
(7)
failure of a boiler with catastrophic consequences, including explosive damage
and ensuing fires.
B.
INVESTIGATION
The
adjuster should instruct the insured not to begin repairs until the condition
of the machinery or equipment can be examined and documented, and where
practicable, the appropriate parties placed on notice of the loss and given the
opportunity to examine the damaged items. Generally, an expert, such as a
mechanical or electrical engineer, will need to inspect the damaged equipment
to determine the precise mode of failure and cause of the loss.
Regardless
of the specific type of loss at issue, the claims handler needs to act promptly
to insure that a proper investigation into the cause of the loss is conducted
and to make certain that all relevant evidence and information is identified
and collected. Any component parts that are replaced need to be preserved.
1.
MACHINERY AND EQUIPMENT LOSSES
To
assist any retained experts with their investigation and to enable counsel to evaluate
a machinery or equipment loss for subrogation potential, the adjuster should
ask the following questions and try to gather the following documents and
information from the insured:
(a)
INSTALLATION
·
How old is the machinery or equipment
that failed?
·
Who installed the machine?
·
Is there a written warranty from the
manufacturer/installer?
·
Was there a written contract with the
seller/installer?
·
Were written or oral start-up
instructions provided?
(b)
OPERATION
·
What is the purpose of the machine and
how was it being used at the time of failure?
·
Who was operating the machine at the
time of failure?
·
Where specifically was the operator at
the time of failure?
·
What happened? What was seen, heard,
smelled?
·
Did the manufacturer/seller/installer
provide written or oral operating instructions?
·
Were any written or oral warnings
provided prior to the loss?
(c)
MAINTENANCE/REPAIR HISTORY
·
Is there a service/maintenance contract
or agreement with an outside contractor for the machine?
·
Is there a preventative maintenance
program for the machine?
·
Was any preventative maintenance
recommended by the seller, manufacturer or installer?
·
Are there maintenance records and
invoices?
·
What was the planned or implemented
maintenance schedule for the machine?
·
Was the machine modified by anyone
prior to the loss?
·
Have any parts of the machine been
replaced in the past?
·
Were there any recent problems with the
machine or have repairs been performed?
2.
ELECTRICAL EVENTS
When
a loss appears to have been caused by an electrical anomaly or malfunction, the
adjuster should ascertain the name of the electric utility providing service to
the insured, inquire into past problems or unusual occurrences, and gather
specific information about any abnormal electrical events immediately preceding
the loss. The adjuster also should note
the location of any outside meters, power lines and transformers and these
items should be inspected for evidence of a failure. In most instances, an electrical
expert will be needed to investigate the specifics of the loss and to gather particular
information about the utility’s electrical distribution system and protective devices.
C.
THEORIES OF RECOVERY
1.
MACHINERY AND EQUIPMENT LOSSES
In
losses involving industrial equipment and machinery, subrogation may be pursued
against the manufacturer, seller and/or installer of the equipment as well as
any service or maintenance companies who worked on the equipment. Parties may be held responsible under products
liability case law or statutes, consumer protection statutes, common law
negligence principles, the Uniform Commercial Code or the terms and conditions
of any contract with the insured. Subrogation may be pursued for:
(a) Manufacturing defects. The manufacturer or seller may be liable for supplying a
machine with faulty components or for assembling the machine improperly.
(b) Defective
design. The manufacturer or seller may be
liable for failing to design the machine with appropriate safety features, such
as high temperature or low fluid shut-offs.
(c) Improper
installation. The manufacturer may be liable for
failing to provide appropriate installation instructions for the machinery or
the installer may be liable for failing to follow the manufacturer’s
instructions and/or failing to comply with any applicable standards and codes,
such as by placing the machinery too close to combustibles or using undersized electrical
wiring.
(d) Improper
repairs or maintenance. An
outside service company may be liable for failing to inspect, test and repair
the machinery in accordance with the manufacturer’s specifications and good
industry practices.
(e) Improper
or inadequate operating instructions or warnings. The manufacturer, seller or installer may be liable for
failing to provide adequate warnings regarding the operation of the machinery
and any dangers inherent in its use.
(f) Breach
of contract. The manufacturer, seller, installer and
any repair or maintenance company may be liable for the failure of the machinery
to operate and perform as promised, pursuant to a written or oral contract.
(g) Breach
of warranty. The manufacturer, seller, installer and
any repair or maintenance company may be liable for breach of any oral or written
warranties, including a warranty that the machinery was safe and suitable for a
particular purpose.
2.
ELECTRICAL EVENTS
Equipment
and machinery may be damaged by electrical malfunctions such as a voltage surge
or “out of phase” power. Goods or livestock also may be adversely affected by a
loss of power and/or damage to an HVAC system or from the failure of related
equipment. Subrogation should be evaluated against an electric utility or electrical/mechanical
contractor for the following:
(a) Improper
placement of a transformer. It
is well-recognized that there is a danger of fire when a transformer fails due
to the flammable insulating fluids (mineral oil) inside the transformer.
Accordingly, the National Electric Code requires an installer to consider this
risk of fire and to take appropriate safeguards when installing a transformer
near a building, such as installing the transformer in a fireproof enclosure, providing
a fire-resistant barrier, automatic extinguishing system and/or maintaining a
safe distance between the transformer and any adjacent structures. A utility or
independent contractor may be liable for failing to provide such safeguards
when a transformer fails catastrophically and ignites an adjacent building.
(b) Uncoordinated
electrical overcurrent protection in an electrical distribution system.
Electrical
failures should be expected by utilities.
Occurrences such as power lines being damaged during storms are not uncommon.
Utilities must provide appropriate protection in the form of fuses and circuit
breakers. Fuses and circuits do not prevent electrical failures, instead, they
mitigate the damage that can be caused by a failure.
Utilities
must select and install properly sized fuses in their electrical distribution
systems to protect transformers and other equipment from overcurrents or out of
phase power, which can cause electrical equipment to overheat and fail,
sometimes catastrophically.
(c) Improper
maintenance. Utilities may be liable for failing to maintain
their electrical distribution systems, including the failure to trim tree
branches where they may interfere with power lines. Utilities also may be liable for reconnecting
power to damaged circuits without confirming that the circuits and attendant
electrical equipment are undamaged and functioning properly.
(d) Improper response to requests for
troubleshooting.
Utilities
may be liable in certain situations for failing to respond appropriately to a customer’s
requests for service or repairs.
D.
SIGNIFICANT ISSUES AFFECTING RECOVERY
1.
ECONOMIC LOSS DOCTRINE
A
majority of states have adopted the economic loss doctrine, which precludes a party
from bringing a tort action, such as a negligence or products liability claim,
to recover strictly economic damages resulting from the failure of a defective
product. Economic damages include the
cost to repair or replace a defective piece of equipment or machinery and any business
interruption loss or extra expenses that result from the failure of the
equipment or machinery. In such situations,
where a party’s damages are solely economic, the party’s remedies against a
seller are limited to those which were provided in the contract of sale or which
exist under the Uniform Commercial Code (“UCC”).
The
UCC is a national sales code which governs the sale of commercial goods. The
UCC may permit recovery for breach of the implied warranty of merchantability
or fitness for a particular purpose, or for breach of express warranties.
Unfortunately, UCC claims typically must be brought within four years of tender
of delivery (i.e., purchase), which precludes claims for products older than
four years. Further, the UCC permits sellers to disclaim warranties and
strictly limit a party’s remedies, which sellers often do in their sales
contracts. This may leave a buyer
without recourse.
Further,
the economic loss doctrine may prohibit a negligence claim against a service
provider unless the offending party breached a duty of care which exists
independent of the contract. Thus, a party which negligently services or
maintains a machine and causes damage to the machine or otherwise causes the
insured to suffer economic losses may be immune from a negligence suit. In such
cases, the insured would be limited to whatever remedies were provided under
the service contract. However, service
providers often exclude any implied warranties under their contracts, disavow
any liability for consequential damages and limit the applicable period for any
warranties.
The
harshness of the economic loss doctrine varies state by state. Some jurisdictions
allow an injured party to recover for damages to a product itself, while others
allow a negligence claim when a product fails suddenly or catastrophically, as
opposed to wearing out over time. Nevertheless, even in the more restrictive
states, recovery is often permitted for damages to property other than the
product itself. Thus, when a machine or
equipment causes a fire, generates smoke, or releases fluids, recovery for the
damages to the other property in the premises generally is allowed.
The
economic loss doctrine is subject to varied interpretations by courts even within
the same jurisdiction. The complexity of this doctrine, and its potential
ability to bar or limit even the most meritorious of subrogation claims,
demands the early retention of specialized recovery counsel to make sure time
restrictions are recognized and recovery opportunities are effectively pursued.
2.
SPOLIATION OF EVIDENCE
In
recent years, spoliation of evidence has been the subject of increased focus by
the courts. Spoliation includes the
failure to retain material evidence, alteration of evidence and/or the loss or
destruction of evidence. Litigants increasingly are arguing that physical artifacts
from a loss site must be preserved and that the unavailabilty of evidence
irreparably prejudices their case. Courts
have shown an increased willingness to impose sanctions against offending
parties. Such sanctions may include an adverse inference instruction to a jury,
the exclusion of certain evidence from trial, and even, in certain
circumstances, preclusion of expert testimony, or the outright dismissal of a
claim.
To
avoid spoliation concerns, it often is advisable to identify potential
defendants, place them on notice of a loss and provide them with an opportunity
to inspect a loss site or piece of machinery prior to any repairs being
conducted. In situations where this is not feasible, due either to severe time
constraints or the inability to immediately identify potentially responsible third
parties, the claims handler should be certain to photograph and document the
loss site thoroughly. This includes recording of fluid levels in a machine,
documenting control settings, noting environmental conditions and interviewing
operators and maintenance personnel. Further,
all components of a machine or equipment that are replaced must be preserved.
3.
STATUTES OF REPOSE
Many
states limit the period of time for which a seller or manufacturer can be held
liable for supplying a defective product. For example, in some states, an aggrieved
party cannot bring an action against a manufacturer for supplying a defective
product if the product is more than ten years old. The stated policy of these statutes is to
prevent a manufacturer or seller from being responsible indefinitely for
defects in all of the products that they have made or sold.
A
statute of repose is different from a statute of limitation. A statute of limitation typically begins
running on the date when the cause of action accrues and sets the period of time
within which a lawsuit must be filed. For example, in states with a two year
statute for negligence, an action must be must be commenced within two years
from the date of loss. A statute of
repose, however, sets a time limit from the date of sale of a product for how
long the manufacturer or seller can potentially be held liable for a defect in
the product. A statute of repose may extinguish a potential cause of action
before the loss even occurs. Thus, if an
insured purchases a piece of equipment which fails and causes a fire in the
eleventh year of operation, there may be no recovery from the manufacturer or
seller if there is a ten year statute of repose.
Some
jurisdictions also have statutes of repose for the construction of improvements
to real property. These statutes may bar
a claim against a contractor, architect or engineer for deficient construction
of the building, as well as for improper installation of building fixtures. The
issue is whether the improvement or fixture will “run” with the property. Factors relevant to this analysis may include
the nature of the equipment, its purpose and use, and whether it was purchased
separately from the building.
4.
OPERATOR ERROR
The
adjuster should ascertain the names of all employees operating or observing a machine
at the time of failure. These employees need to be questioned about their
training and experience and the circumstances surrounding the operation of the
machine immediately before the loss. Often, a loss is caused by the operator’s
failure to follow prescribed procedures, such as maintaining proper fluid
levels. Nevertheless, a seller or manufacturer may be liable for failing to
provide adequate instructions or warnings to the user or for failing to
incorporate appropriate safety mechanisms into the machine.
5.
UTILITY TARIFFS
When
a loss is caused by a malfunction in equipment owned by an electric utility, such
as a transformer or power distribution lines, or by negligent maintenance
procedures by the utility, it is necessary to evaluate tariffs that may protect
the utility. Tariffs have the force of law. In some jurisdictions, an electric
utility is shielded from liability unless the utility was grossly negligent.
Some jurisdictions also limit recovery for physical property damage or damages
caused by fire, as opposed to economic losses, such as business interruption
caused by a loss of power.
The
claims professional should be mindful of photographing and documenting evidence
of burn patterns around equipment such as transformers, power lines or meters,
as well as noting the presence of foreign matter or conductive debris, such as
corrosion or carbon tracking.
6.
APPLICABILITY OF LIABILITY INSURANCE COVERAGE
Many
liability insurance policies do not cover claims against insureds for completed
operations or for product failures unaccompanied by damage to other property.
In some situations, a responsible party may have a claim against its broker or
agent for negligently failing to broker a policy with appropriate coverages. In
such situations, the responsible party may assign its right of action against
the broker or agent to the prospective plaintiff in exchange for an agreement
not to pursue recovery from the defendant’s assets.
Case
study: Subrogation and Insurer Intervention in Construction Defect Case
Involving Water and Mold
By paying a portion
of its insureds claims for property damage to their house, State Farm Insurance
obtained partial subrogation rights under the homeowners policy entitling it to
intervene in a construction defect lawsuit that the homeowner brought against
third parties who they alleged caused the loss.
The homeowners
("Hodges") submitted a claim in the amount of $1,699,680 to State
Farm under its homeowners policy for water and mold damage to their house. They
alleged the damage was caused by the negligence of third parties. State Farm
denied the claim for mold damage but paid $150,000 for water damages.
Homeowner Suit
against Third Parties
The Hodges
subsequently filed a construction defect suit against the former owner, the
developer, the general contractor, and a subcontractor who had constructed the
house. They alleged the defendants caused the water and mold damage by
performing defective work, violating building codes, failing to comply with
plans and specifications, using unauthorized or unqualified subcontractors,
failing to repair defective work, conducting inadequate repair work, and
negligently supervising construction of the house.
Homeowner Suit
against State Farm
A couple months after
filing that lawsuit, the Hodges filed a separate lawsuit against State Farm, in
the same county court in California. This suit alleged that State Farm acted in
bad faith in denying coverage. State Farm filed a motion with the court to
consolidate the construction defect case and the bad faith case. The trial
court denied the motion.
State Farm Moves to
Intervene in the Third Party Suit
State Farm then filed
a motion for leave to intervene in the construction defect case to file a
subrogation complaint to recover what it had paid its insured homeowner as a
result of the alleged negligence of those responsible for the construction
defects. The trial court in the third-party suit ruled against State Farm and
denied the motion to intervene in the suit.
As a result of the
adverse outcomes of both trial courts against State Farm's motions, State Farm
would be unable to participate in the underlying actions involving those that
were allegedly responsible for the loss to the homeowner—which loss State Farm
had already partially paid, and which loss State Farm might potentially be
required to pay additional amounts.
State Farm Appeals
State Farm appealed
the denial of its motion to intervene. The appellate court concluded that as a
partially subrogated insurer, State Farm had an interest "relating to the
property or transaction" that was the subject of the construction defect
lawsuit. The court explained that:
·
Under
the doctrine of subrogation, when an insurer pays money to its insured for a
loss caused by a third party, the insurer succeeds to its insured's rights
against the third party in the amount the insurer paid.
The court also stated
that, "Upon subrogation, the insurer steps into the shoes of its
insured." An insurer has a direct pecuniary interest in the outcome of the
litigation between the insured and the responsible third party, says the court,
and in this case "State Farm has a direct pecuniary interest in the
Hodges' action against the allegedly responsible third parties."
The appellate court
concluded that intervention in the construction defect case is necessary
because the outcome of that case could impair or impede State Farm's ability to
protect its subrogation rights. The safest course to protect the interests of
an insurance company is to seek intervention in the insured's lawsuit against
the legally responsible third party. The court pointed out that there are two
theoretical alternatives to intervention. These are for the insurance company
to (1) file a separate lawsuit against the responsible third party, or (2) to
recoup payments directly out of the insured's recovery from the responsible
third party. But both of these alternatives would be inadequate and
inconsistent with the purpose of intervention.
Absent intervention,
"the insurer is to a large extent at the mercy of the insured's efforts
and success in recovering from the responsible third party." If State Farm
had to rely only on recoupment from its insured, "State Farm would not be
able to assert its rights of recoupment against the Hodges until they fully
recovered from the construction defect lawsuit defendants, and then only to the
extent the Hodges recovered more than the amount of their insured loss."
This could be particularly problematic because as the court noted, "the
Hodges' interests are not necessarily aligned with State Farm's. The Hodges
would have little incentive to invest time, effort, and fees pursuing
defendants to recovery for covered claims."
Indeed, State Farm's
interests would potentially be inadequately represented by the parties in the
construction defect case because, as noted by the court, the Hodges and State
Farm have opposing interests as concerns proving whether the losses resulted
from mold damages or from water damages. State Farm's interests are not
adequately represented by the Hodges because they have an incentive to advance
their interests in the construction defect lawsuit at the expense of protecting
State Farm's subrogation rights. For these reasons, the appellate court held
that State Farm was entitled to intervene in the case and, therefore, reversed
the trial court. Douglas M. Hodge v. Kirkpatrick Development, Inc. (Cal. 4th
App. Div., G034361).
Comment
State Farm was found,
pursuant to the terms of the insurance policy as well as by law, to be entitled
to intervene in the construction defect case. The subrogation paragraph in
Hodges policy stated in relevant part:
·
An
insured may waive in writing before a loss all rights of recovery against any
person. If not waived, we may require an assignment of rights of recovery for a
loss to the extent that payment is made by us.
In this case,
subrogation rights had not been waived before the loss in question. State Farm, therefore, had a right under the
terms and conditions of the policy to participate in the lawsuits to protect
its right of subrogation. State Farm needed to exercise its right in this
matter to assure that the strongest case was made against the construction
defect defendants. It had an interest in assuring that the facts and evidence
were fairly presented to determine who and what caused the damages. In
particular, it was important to determine to what extent losses resulted from
mold versus water damage.
As with the standard
insurance policies, this policy included a condition requiring that the Insured
"do nothing after a loss to prejudice State Farm's subrogation
rights." If the Hodges had proceeded in the construction defect litigation
without State Farm's participation (as they desired to do), and had they
obtained a result that State Farm reasonably believed was designed to harm
State Farm's interests, State Farm would have been legally entitled under the
policy to bring a law suit against the Hodges for impairment of its subrogation
rights.
It would appear that
the interests of all parties were best served by having State Farm intervene in
the underlying construction defect action. The court in this case reached the
correct decision. It provided a well-reasoned opinion that will serve as a
valuable educational tool for others contemplating similar issues concerning
subrogation and the right to insurance company intervention in litigation.
SUBROGATION
SERVICES AT METROPOLITAN
METROPOLITAN
has broad experience handling subrogation claims arising from water, fires,
explosions, construction defects, product failures, energy and oil release
claims, and boiler and machinery failures. Our cases range from highly complex commercial
losses to smaller scale business and personal lines claims. Claims we handle include:
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We
routinely involve our teams of origin and cause investigators; civil,
structural, geotechnical, electrical, mechanical, metallurgical, materials, and
automotive engineers; combustion scientists; fire protection specialists;
certified fraud examiners; accountants; law enforcement; and coverage counsel
in the underlying claim to analyze and determine the causes of losses and
accidents. We work with outside or
insurer counsel to ensure thorough analysis, proper evaluation of losses, and
to exhaust and/or eliminate alternative theories. We, along with the team of lawyers, develop
non-destructive and destructive testing protocols, coordinate transfer of
evidence and preservation of evidence.
Metropolitan Engineering, Consulting & Forensics
(MECF)
Providing
Competent, Expert and Objective Investigative Engineering and Consulting
Services
P.O. Box
520
Tenafly,
NJ 07670-0520
Tel.:
(973) 897-8162
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(973) 810-0440
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