SUBROGATION OF CONSTRUCTION DEFECTS, FIRE LOSSES, SURETY LOSSES, AND LOSSES CAUSED BY DEFECTIVE ELECTRICAL, MECHANICAL AND OTHER EQUIPMENT

SUBROGATION OF CONSTRUCTION DEFECTS, FIRE LOSSES, SURETY LOSSES, AND LOSSES CAUSED BY DEFECTIVE ELECTRICAL, MECHANICAL AND OTHER MISC EQUIPMENT

What is a CONSTRUCTION defect?

Construction-defect litigation has spread across the U.S. More and more court jurisdictions are finding coverage for defect claims in the completed operations coverage of CGL policies or E&O policies of architects, engineers, or contractors.

A construction defect is generally speaking, a deficiency in the design or construction of a building or structure resulting from a failure to design in accordance with federal, state or local building codes or failure to use applicable environmental safety codes or failure to construct in a reasonably workmanlike manner, or failure to adhere to building plans/design and/or in accordance with a buyer's reasonable expectation or failure of a building component. 

The most dangerous defects have the capacity to fail, resulting in physical injury or damage to people or property.  However, many defects present no increased risk of injury or damage to other property but nevertheless cause harm to the property owner in the form of loss of use, diminution in value, and extra expenses incurred while defects are corrected.  This latter type of defect is often referred to as a passive defect. 

Many states have more specifically defined the term "construction defect" for purposes of applying statutes that dictate processes for remedying and litigating construction defect claims.  These statutory definitions vary by state.  Nevada, for example, uses the term constructional defects and defines it as follows:

“Constructional defect” means a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance and includes, without limitation, the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance:

Which is done in violation of law, including, without limitation, in violation of local codes or ordinances;

Which proximately causes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed;

Which is not completed in a good and workmanlike manner in accordance with the generally accepted standard of care in the industry for that type of design, construction, manufacture, repair or landscaping; or

Which presents an unreasonable risk of injury to a person or property.

In California, for any home or condo completed or closed escrow after January 1, 2003, SB 800 (Civil Code Section 895 et seq.) clarified the types of defects that the builders are responsible to fix.  This statute takes the guesswork out of defining a defect and clearly identifies by statute all categories of defects for which the developer is responsible.

Prior to 2003, Courts recognized two primary categories of defects for which damages are recoverable by the homeowner or homeowner association.

Defects in design, workmanship and materials: These include, water seepage through roofs windows and sliding glass doors; siding and stucco deficiencies; slab leaks or cracks; faulty drainage; improper landscaping and irrigation; termite infestation; improper materials; structural failure or collapse; defective mechanical and plumbing; faulty electrical wiring; inadequate environmental controls; improper security measures and devices; insufficient insulation and poor sound protection; and inadequate firewall protection.

Landslide and earth settlement problems: Examples are expansive soils; underground water or streams; landslides; settlement; earth movement; improper compaction; inadequate grading; and drainage.

Structural failures and earth movement conditions can be catastrophic in nature and present both personal injury and substantial property damage exposure. Landslide and settlement conditions may result in collapse of buildings; cracks in slabs, walls, foundations, and ceilings; disturbance of public or private utilities; and sometimes a complete undermining of the structures.

For architects and other design professionals, one of the most devastating professional and business risks is from litigation alleging negligence in performing professional services.  These alleged negligent acts, errors, or omissions may cause damage to owners, contractors, or other third parties, and the architect’s firm may be found liable for these damages.  

WAYS OF TRANSFERRING THE PROFESSIONAL OR CONTRACTOR LIABILITY TO THIRD PARTIES

The most common way of transferring the construction defect liability from the design professional or contractor to a third party is through the purchase of insurance products.  Under these contractual agreements, a third party (the insurer) agrees to carry the risk of your malpractice or construction defect and you agree to pay him a certain premium.

While a commercial general liability (CGL) policy provides coverage for liability for bodily injury and property damage caused by an accident, it excludes coverage for liability for professional services. This is an occurrence-based policy.  

On the other hand, Errors and Omissions (E&O) insurance, also commonly referred to as “professional liability insurance” or “malpractice insurance,” provides liability coverage, typically including both defense and indemnity protection, for the design professional.  Typically engineers and architects are covered by E&O policies, but specialty carriers issue E&O policies for other types and categories of professionals as well.

E&O insurance provides protection to third parties, usually clients of the particular professional insured by the E&O policy (but sometimes also intended third party beneficiaries of the professional’s contracted-for services) resulting from the negligent performance of professional services.  Intentional misconduct by the professional typically is excluded from E&O coverage under most policies, and indemnity for willful torts might otherwise be barred as a matter of public policy under California Insurance Code section 533, as well as other state’s statutes.  Economic and other intangible losses are covered by typical E&O policies, whereas losses due to property damage or bodily injury usually are excluded from coverage—as the latter categories of losses are insured under comprehensive general liability (CGL) policies.

E&O insurance almost always is “claims made” or “claims made and reported” coverage, which means that the insurance carrier is obligated (under typical E&O policies) to defend and indemnify the insured from liability only for covered claims made—and (in the case of claims made and reported coverage) actually reported—during the applicable policy period. See Slater v. Lawyers’ Mut. Ins. Co. (1991) 227 Cal.App.3d 1415, 1423 (claims made and reported policy); Chamberlin v. Smith (1977) 72 Cal.App.3d 835, 845 (claims made policy).

An insured may still be covered under a “claims made” policy despite giving tardy notice of the claim to the insurer, unless the insurer can show that it was substantially prejudiced due to the late notice (Pacific Employers Insurance Co. v. Superior Court (1990) 221 Cal.App.3d 1348, 1359).  On the other hand, the so-called “notice-prejudice rule” is inapplicable in the case of “claims made and reported” policies because the timely reporting requirement is an express policy condition to coverage.  The California Insurance Code requires special warnings in “claims made” policies so that professionals are made aware of that limitation. See California Insurance Code § 11580.01(b).

Most E&O policies have so-called “burning” limits, meaning that defense costs, including attorneys’ fees, reduce the policy limits and, accordingly, the amount of money available for indemnity payments for settlement or to satisfy a judgment.  By a “rider” or “endorsement,” however, a professional may be able to purchase defense coverage that is separate from and in addition to the applicable policy limit for indemnity coverage.

To be covered by a typical E&O policy, the claim against the professional must arise out of the professional service provided by the professional to others, typically the professional’s client. See Blumberg v. Guarantee Ins. Co. (1987) 192 Cal. App. 3d 1286, 1290.  Most E&O policies issued today, however, contain specific policy definitions and exclusions that contain the scope of activities that constitute “professional services” within the policy’s scope of coverage.

Most E&O policies issued today, like most Director’s and Officer’s (D&O) liability policies issued today, contain various conduct exclusions and claim exclusion that preclude coverage for intentional torts and claims arising from fraud or criminal acts, illicit personal profits, to recover attorneys’ fees paid by the client, for copyright or trademark infringement, for securities violations, or for illegal discrimination.  Most E&O policies also contain “insured v. insured” exclusions precluding coverage for claims between two or more insureds under the same E&O policy, as well as excluding coverage for breach of contract claims (apart from breach of the applicable professional services contract used by the insured).

Particular professions also generate policy exclusions in E&O policies designed specifically for that profession.  An architect professional liability policy typically will have exclusions tailored to the architectural profession that are not contained in attorney, engineer, or physician professional liability insurance policies.

There is a fundamental difference between a claims made and reported policy and an occurrence policy.  Under a claims-made and reported policy, only claims made to an insured and reported to the insured's insurance carrier during the policy period and any extended reporting period has liability coverage. In addition, the allegedly wrongful act must have taken place during the policy period or during the "prior acts" coverage period provided for in the policy. 

 Under a CGL or other occurrence policy, there is liability coverage for bodily injury or property damage caused by an accident that results in harm to the claimant during the policy period, regardless of when the claim is made against the insured, reported to the carrier or when the allegedly wrongful act took place. (Helfand v. National Union Fire Ins. Co., 10 Cal.App.4th 869, 888 (1992).) 

The important characteristic of a claims-made-and-reported policy is that the insurance carrier's exposure ends when the policy term and any extended reporting period end, thereby providing certainty as to the insurance carrier's potential liability.  If a claim is reported to an insurance carrier after the policy has expired and after any extended reporting period, the carrier can deny coverage whether or not it is prejudiced.

There are two ways insureds can protect themselves in advance:  First, they can and should purchase prior acts coverage to be protected in case of a claim from work done before the policy goes into effect.  Second, they can obtain coverage permitting them to report claims after the policy has expired, called an extended reporting period (ERP).  Some policies include a 30 or 60 day ERP as part of the basic coverage.  For an additional premium, an insured usually can purchase optional coverage allowing an ERP for up to a few years.

Also, if a professional retires, he or she has no future coverage unless the professional purchases "tail coverage." Because retirement does not end one's exposure to malpractice claims, a professional should consider such coverage, especially if the business closes with the professional's retirement. 

Many policies require that the insured consent to settle. But the carriers protect themselves with a "hammer clause." If the insured has an opportunity to settle but refuses, the carrier's liability, including defense expenses, is capped at the settlement amount.

A significant recent change in the professional market has evolved the insurance coverage to extend beyond purely third-party liability.  Previously, first-party protective coverage was not readily available in the market. Over the past few years, the market has significantly expanded to the point where now almost all the major carriers offer it, either through new products or updates of their existing liability forms.

Whereas basic professional liability coverage responds only after a claim has been made by a third party, the addition of protective coverage provides the contractor with first-party coverage excess to professional liability insurance carried by subcontractors.  For example, if design errors lead to additional costs incurred to bring a project to completion on time and the limits of the design professional's policy are not high enough to cover the increase, protective coverage will pay the contractor for the difference.

Closely related to the expansion of protective coverage is the growth of rectification or mitigation coverage, which provides primary insurance subject to a self-insured retention.  As the name implies, rectification or mitigation coverage covers costs to remedy design errors discovered during construction that would lead to a liability claim if left uncorrected.

We also handle contribution and indemnification claims against responsible parties, either partially responsible or fully responsible for a property loss.  Contribution refers to apportioning fault among tortfeasors who are jointly liable to the plaintiff for an incident.  Indemnification refers to a party being entitled to total compensation from another party based on a relationship between them.  We determine whether there are available other insurance policies that also provide coverage for the same loss.   

A contract favoring the insured may have required the insured to be listed on the responsible party’s liability insurance policy and naming the insured as an additional insured.  As part of our investigation, we secure copies of the additional insured endorsements, as well as the insurance certificate which provides all the necessary insurance policy information, including the insurance company name, policy number, effective dates, policy limits, and other pertinent information.

The attached link to another blog presents an examination of additional insured status under the CGL, umbrella and excess, automobile, commercial property, and workers compensation insurance policies.  Thousands of times a day, sophisticated companies around the globe negotiate commercial contracts.  Virtually all of those contracts contain indemnification agreements of one kind or another. The majority also include “additional insured” provisions — requirements that one party be covered under the other's insurance policies.

http://metroforensics.blogspot.com/2014/10/examination-of-additional-insured.html

In the attached link we discussed the Wrap-Up insurance programs (or the Onwer Controlled Insurance Programs (OCIP) as they are commonly called).

http://metroforensics.blogspot.com/2014/10/construction-wrap-up-insurance.html

Wrap-Up insurance programs are an increasingly popular risk management technique used by owners and general contractors of large construction projects to exert greater control over total construction costs while enhancing overall project safety.

A wrap-up policy consolidates (or “wraps up”) insurance coverage for multiple general and subcontractors working on a project into one program negotiated, purchased and managed by a single sponsor. That sponsor can be either the owner (owner-controlled insurance program) or the general contractor (contractor-controlled insurance program).  

 Relying on the individual policies of the hundreds of contractors that will be on the site injects a great deal of risk into a project. The basic concept of a wrap up fends off gaps in coverage such as lapsed policies and inadequate limits. The singular insurance carrier streamlines the claims process allowing injured workers to get the help they need in a more simple and efficient manner. Furthermore, wrap ups typically include site safety programs which strive to avoid those accidents in the first place.

TYPES OF SUBROGATION ACTIONS
 

Having briefly discussed the available insurance policies and the relationship between the CGL and E&O policies, we will now discuss the importance of performing an early and comprehensive investigation.  METROPOLITAN has a proven track record of successful recoveries in thousands of large property subrogation matters in the United States, including electrical or mechanical damage to equipment, construction defects, fires and so on.  As a result, many insurers entrust their subrogation cases to METROPOLITAN.

The investigative engineers at METROPOLITAN have a wide array of experience and training in various areas of the forensics and the associated law regularly encountered in the practice of property subrogation, such as:

·         Fires and explosions and fire spread theories;

·         Industrial equipment and mechanical failures;

·         Code compliance failures;

·         Structural failures, inadequate soil compaction, foundation defects, roof collapses and geotechnical failures;

·         Power line maintenance and inverse condemnation;

·         Product design, warning, or manufacture defects;

·         Electrical, mechanical equipment failures;

·         Sprinkler system failures;

·         Pool failures;

·         Human factors/warnings cases;

·         Airplane, heavy equipment, and trucking accidents/failures.

To maximize their recovery potential, many clients prefer to get us involved in a loss from its very inception to identify and retain evidence, talk to witnesses when memories are still fresh, prevent to spoliation of evidence, lock the parties into positions and testimonies, identify all possible third parties, identify any roadblocks to recovery early on (such as indemnity agreements, waivers of subrogation and so on).   

METROPOLITAN prides itself on its early investigation, evaluation, and assistance in the prosecution of subrogation claims, where our experts may assist with, among other things:

·         Protecting the integrity of the site and evidence to maximize the effectiveness and accuracy of the investigation and minimize spoliation of evidence allegations;

·         Protect against disappearing witnesses and evidence;

·         Taking measurements and numerous and detailed photos of the loss scene;

·         Obtain statements (written or recordings) from witnesses and/or parties;

·         Obtain information on product or instrumentality causing the loss;

·         Immediately dispatching the proper experts to the loss, and maintaining communications with the legal personnel throughout their investigations;

·         Quickly identifying potential defendants and, when appropriate, work with legal personnel in notifying such parties of a loss or claim;

·         Coordinating and/or attending loss site inspections and destructive testing;

·         Working with lawyers to ensure thorough analysis, adherence to the scientific method, and proper evaluation of losses;

·         Performing critical reviews of other expert reports;

·         Protecting client privileges, including the confidentiality of METROPOLITAN’s consulting experts retained by the insurer and its counsel in anticipation of litigation; and

·         Preparing cost estimates to assist the legal personnel in evaluating the subrogation potential and financial feasibility of each loss, with on-going written status reports to keep the clients apprised of the issues involved, and their impact on recoverability and/or the costs associated therewith.

We endeavor to eliminate common subrogation obstacles like spoliation of evidence, statements by adjusters and other experts that may be harmful to the pursuit of subrogation, incorrect or harmful expert reports, inadequate documentation of claims, made-whole disputes, insured’s signing releases, poor lawyer selection, and insured apathy to the subrogation process.  

 METROPOLITAN is committed to subrogation excellence, and our experts’ experience and professional designations illustrate that fact.  We have experts who are Certified Fire Investigation Investigators (C.F.E.I.), certified in burn pattern recognition/analysis, licensed professional engineers in many disciplines and two Certified Subrogation Recovery Specialists by the National Association of Subrogation Professionals.

SUBROGATION OF CONSTRUCTION DEFECTS

Construction defect investigations and litigation, like our large property & casualty claim investigation practice, is expert-driven.  METROPOLITAN’s experts interact almost daily with lawyers in various specialties.  Our experts have the substantive knowledge, training, and experience to cut through the technical legal jargon and trade-speak smokescreen that many lawyers throw up to disguise a bad faith position.  This smoke screen does not deter our experts when helping interrogating adverse experts.  Our playing devil’s advocate with the legal staff to ensure a complete, thorough, accurate and defensible expert opinion.

Most of the states experienced a building boom during the period that preceded the economic downturn.  Contractors were building quickly; construction work and jobs were plentiful; but the pool of talent was limited.  This created a fertile environment for mistakes.  METROPOLITAN expects construction defect litigation to be a prominent component of its claim investigation and subrogation practice for the next decade.

Early intervention is the key to recovering subrogation dollars.  At METROPOLITAN, it’s our specialty.  Arriving promptly at the scene and gathering critical information, getting the right parties on notice of a loss, ensuring that evidence is protected and analyzed – we know that it is efforts like these that maximize recovery for the insurer.  

 Our experts are unique in that they are as comfortable leading the charge at a equipment damage or fire loss scene or in a laboratory examination as they are in a courtroom testifying as experts.  Our expertise in fire and accident investigation, causation theories, and fault analysis provides an unrivaled foundation when it comes to complex loss litigation.  We also have access to a network of skilled lawyers who are ready to support us in analyzing your loss and advocating in court when the loss warrants it. 

We understand that subrogation for you as an insurer not only involves the recovery of what is rightfully yours, but also represents a major profit center for your business.  At METROPOLITAN, we make every effort to maximize your profit by giving each claim, big or small, the attention it deserves – and all that by charging you a small hourly fee for our investigators.  And we persevere –Subrogation is not a side business for us; rather, it is a keystone of our practice and expertise. 

Whether you have a property damage claim ready to pursue or are simply seeking advice on whether a loss has subrogation potential, we stand ready to assist.  Our staff is versatile and can adapt to your reporting systems and on-line claim management programs, becoming a seamless member of your team.  We also work closely with your insureds, providing them another level of customer service that reflects on you as a carrier, helping you retain your customers.  When we can recover subrogation dollars for you and a deductible for your insured, it’s a win-win situation. Let METROPOLITAN help you make that happen. 

Structure Collapse Claims

There are few loss investigations which can be more problematic than large structure collapse claims.  The construction of commercial buildings requires input from a myriad of contractors who must work closely with the other contractors on the project to ensure that the finished project is proper and safe.  When these buildings collapse, it is often difficult to pinpoint the precise cause of the failure, and identify the entities responsible for the loss. 

Through the assistance of our highly-trained experts, METROPOLITAN can coordinate the investigation of these losses, and let the insurance claims handler focus on getting the insured back on its feet.  We have handled numerous large building collapse claims, including claims stemming from the collapse of roofs throughout the United States.

Fire Suppression Systems

Building Codes and the National Fire Protection Association (NFPA) identify numerous types of fire suppression systems which can be utilized in various residential and commercial structures.  Determining how and why these systems fail takes skill and expertise.  At METROPOLITAN, we have handled suppression system failures in both large and small buildings, and in commercial and residential structures.   

Through the use of highly-trained experts, we can lead the charge in identifying the circumstances surrounding these failures, and assist you in recovering the subrogation dollars to which you are entitled.  Failures of products, negligence of public utilities, general contractors, and electricians; human error (such as improper use of the structure or product); vehicle fires; and failures from a manufacturer's culpable conduct in design, manufacture, testing and warning, all may lead to subrogation.

This October 5th-11th marks the 93rd year the National Fire Prevention Association holds their Fire Prevention Campaign. The campaign was first launched in 1922 after President Woodrow Wilson issued the first National Fire Prevention Day proclamation to commemorate the Great Chicago Fire (October 8th, 1871). 

This year the theme is “Working smoke alarms save lives, test yours every month!” As part of the theme the NFPA has released some tips for installing, checking, and maintaining smoke alarms.

Below are some smoke alarm tips from the NFPA:

•       Install smoke alarms inside and outside each bedroom.

•       Install smoke alarms on every level of the home and in the basement.

•       Large homes may need extra smoke alarms.

•       It is best to use interconnected smoke alarms so that when one alarm sounds they all sound.

•       Test all smoke alarms at least once a month.

•       There are two kinds of alarms. Ionization smoke alarms are quicker to warn about flaming fires. Photoelectric alarms are quicker to warn about smoldering fires. The fire department recommends using both types of alarms in the home.

•       A smoke alarm should be on the ceiling or high on a wall. Keep smoke alarms away from the kitchen to reduce false alarms. They should be at least 10 feet from the stove.

•       People who are hard-of-hearing or deaf can use special alarms. These alarms have strobe lights and bed shakers.

•       Replace all smoke alarms when they are 10 years old.

 

Construction Defects

Many states have a rather complex statutory scheme in place for handling contractor liability claims.  Without proper adherence to these statutes, construction defect claims can be lost even before the investigation gets underway.  METROPOLITAN is well-versed in the handling of these claims, and has handled a wide variety of construction defect, fire and water subrogation claims which stem from the improper construction of commercial and residential properties or the incorrect installation of equipment or appliances by the contractors.  

The subrogation of these losses include: Losses due to poor construction practices; claims against architects, building designers, general contractors, developers, the design team of engineers, and the various subcontractors; and claims against public entities.

Mold

Mold can occur as the result of the original loss or as the result of a contractor's repairs.  Mold is especially prevalent in the South due to high mumidity.

Burst Pipe Losses

Burst pipe and freeze failure claims really aren’t as simple as they look.  Did the pipe line fail due to the insured forgetting to keep the heat on or due to abrupt freezing temperatures or due to some insulation or material defect in the pipe itself? Perhaps it was a combination of factors which led to the failure? 

METROPOLITAN has extensive experience in the handling of flood claims which stem from the failure to properly insulate and protect water supply lines.  With our employment of some of the best engineers and metallurgists in the country, METROPOLITAN can assist you in establishing the mechanism of failure with respect to these losses, and make sure that you are maximizing your recovery of subrogation dollars.

Water Damage

These types of subrogation losses include: Failures of water and flood-control systems due to improper design, construction, and maintenance, whether by public entities or private contractors.

Fireplace System Failures

Over the years, METROPOLITAN has handled numerous claims stemming from the improper installation and maintenance of fireplace systems in homes throughout the United States.  Recently, we successfully investigated several fireplace system installation negligence claim which resulted in at least $5 million dollar settlement in favor of our subrogation clients.

METROPOLITAN has extensive experience handling multi-million dollar property loss cases arising from:

·         Defective Drainage Plane Construction

·         Defective floor Coating Applications

·         Defective Windows

·         Direct Applied Finish Systems

·         Exterior Insulation Finish Systems (EIFS)

·         Improper Vinyl Siding Installation

·         Mold Claims

·         Roof Leaks

·         Structural Design Flaws

·         Traditional Stucco Claims (Portland Cement Plaster)

·         Fire damage resulting from gas leaks

·         Water damage resulting from water leaks

·         Automobile liability cases

·         Product liability

·         Industrial equipment electrical and mechanical failures

·         Electrical malfunctions

·         Gas malfunctions

Most common Construction Defect Repair issues we have Investigated regarding Fires

Pyrolysis: The Result of Improper Fireplace Installation or Lack of Maintenance

When combustible objects are placed too close to a heat source at temperatures of 212°F or more for a long period of time, a chemical breakdown or decomposition called pyrolysis can occur.  Pyrolysis is a major cause of fires throughout North America.  Every year many tragedies and fires are caused by pyrolysis and yet most people don’t know what it is or the importance of preventing it.  Understanding the potential presence of the threat is where prevention of this little-known danger begins.

Materials break down chemically as they dry out due to exposure to extreme heat.  Essentially the ignition temperature of the material is lowered so that they ignite much more easily than it was possible before.  Severely pyrolyzed wood can ignite at only 212 degrees F, while it would normally have a catch-fire temperature of about 500 degrees F, before it had any exposure to intense heat.  Eventually the pyrolyzed wood will ignite, and a direct flame is not required for the fire to start.  All that is required for pyrolysis to occur is heat and oxygen.

METROPOLITAN’s fire investigators say that of all the solid fuel-related fires they have investigated are caused by pyrolysis over 86% of the time.  About 10% of the fires they have investigated were caused by improper installation or failure of the seals, connectors, appliance, piping, valves, or chimney.  Another 4% of the fires have been caused by careless use or improper maintenance of heating systems.

What Causes Pyrolysis?

Pyrolysis is practically an inevitable event when fireplaces, fireplace inserts, solid-fuel stoves and furnaces are installed improperly or the system is not maintained to prevent the escape of hot gases into the combustible components.  The tragedies resulting from pyrolysis are completely preventable. 

 All that needs to be done is to ensure that the amount of space between a wood-burning stove, stovepipe, and other heating appliances is at least the minimum recommended by the manufacturer.  It is also very common to see fires caused by pyrolysis in the latter years of a fireplace, when the system has deteriorated with time, allowing gases to escape through small gaps in the liner, failing mortar joints, etc.  The numerous freeze-thaw cycles that all chimneys in the north America have been subjected to, will eventually cause the chimney structure to fail, and the liner to be cracked.  A cracked liner puts the home at risk for a dangerous housed fire due to the effects of the pyrolysis.  It may not happen in one year or ten years – but eventually the wood will be catching fire from the escaping gases through the small cracks in the liner or other places of the fireplace.

It is common for unprotected furnishings, walls, and other combustible structural components to be placed too closely to heat sources.  Because everything seems fine for months or even years, homeowners fail to realize that the process of pyrolysis is occurring and could unexpectedly result in a fire at any time.

Pyrolysis is also caused by a damaged chimney liner. Even the smallest amount of deterioration in the chimney liner or the deterioration of seals and joints or the lack of sealants can cause nearby combustibles to catch fire from the escaping gases.

Insufficient Clearances between Fireplaces and Combustible Materials.

Insufficient clearances between fireplaces and combustible materials can be a serious construction defect.  The construction, placement, chosen material, and other aspects of fireplaces have to adhere to certain regulations and building codes.  These regulations and building codes are in place to look out for the safety of the inhabitants of a building. They can be strict but they do serve a public purpose. Not being compliant with these restrictions can result in a hazardous situation. Insufficient clearances between fireplaces and combustible materials are fire hazards.

Clearances to combustibles is something they didn’t worry about in the old days. It is quite common to see wood beams or 2x4s right against the masonry of a chimney.  When there are fires in old homes, it’s also common to find that some of this wood ignited. Oddly enough, the process of pyrolization takes place over many, many years. The unscientific definition of that is that the ignition temperature of wood gets lower over time. In other words, it takes less heat to catch it on fire 50 or 100 years later than when it was new.

Use of Non-Approved Decorative Chimney Terminations.

Use of non-approved decorative chimney terminations is a common problem that many homeowners may have, unbeknownst to them. A construction defect like this may only become evident to a homeowner when there are some obvious issues, such as excessive smoke collection or when products of combustion are venting into the dwelling. If you are having issues with the functioning of your fireplace and chimney you may need to verify that use of non-approved decorative chimney terminations is not the issue.

Non-manufacturer approved accessories installed into fireplace.

Due to the strict requirements and testing process, all manufacturers require that only manufacturer approved parts be used in conjunction with their fireplaces. By using aftermarket glass doors, refractories and other fireplace components that aren’t approved by the original manufacturer, there is a risk of voiding the UL listing and the warranty, creating a liability issue for the person or person(s) providing the services or even for the homeowner.

The chimney structure or flue or connections to the fireplace have become settle, separated or disconnected

Based on our forensic investigations, we see that gaps have been created around the chimney structure or around the liner or the firebox.  This resulted in hot gases escaping the fireplace and drying out the wood around it.  As we stated earlier, the process of pyrolization takes place over many, many years.  And one fatal year, the wood finally burns and causes extensive damage and loss of life.

There are many reasons this shifting or disconnection can happen.  At times, it could be a construction defect, or installer error.  Many times we observe inadequate mortar or missing mortar due to lack of maintenance or installation of incorrect type of mortar.  It is not uncommon to observe lack of seal between the firebox and the lintel at the top of the firebox – this is a common construction defect leading to fires as the escaping gases will slowly pyrolize the wood framing.

Other times, the flue may have shifted in an earthquake, or a metal strap supporting a bend in the system could have failed.  At other times, the chimney moves due to severe weather (excessive freeze-thaw cycles, heavy winds, erosion, flooding, and so on).  There are also instances where a chimney sweep unfamiliar with prefabricated metal fireplace systems may have disconnected the flue in the process of cleaning the flue, or removing the cap.

Leaking Gas Connections had led to Fires

After gas line is connected, it is a code requirement  that each appliance connection, valve, valve train, shall be checked while under normal operating pressure with either a liquid solution, or leak detection device, to locate any source of leak.  Tighten any areas where bubbling appears or leak is detected until bubbling stops completely.  DO NOT use a flame of any kind to test for leaks.

Leak test with a soap solution after installing or servicing with main burner on.  Coat pipe and tubing joints, gasket etc. with soap solution. Bubbles indicate leaks.  Tighten any areas where the bubbles appear until the bubbling stops completely.

Before performing any service on the appliance, ensure the gas has been completely shut off, the unit cooled, and the electricity shut off to the appliance.  The burner and valve control compartments must be cleaned annually.  A vacuum with a brush attachment works well. The logs should be cleaned gently with a soft bristle brush. The logs are fragile and are easily damaged.

Miscellaneous Fireplace Construction Defects

Several times we have observed missing or blocked out cleanout pits.  

 Oftentimes during renovation of old homes, we see that the fireplace ash pits are covered to create a finished room.  This has created fire hazards as the ash inside the pit will ignite when enough of it accumulates inside the ash pit.

At other times, the valves inside the fireplace will get clogged with debris (pet hair, ash, dust, etc.).  Sometimes these valves are improperly installed and they leak, creating fire hazards.

Finally, we often see that manufacturer’s instructions are not followed during fireplace installation.  The key point to make here is that all equipment and appliances and instruments have a certain operating range that if exceeded due to improper construction or installation or maintenance, these components will fail causing property damage and loss of life.

As we noted earlier, if subrogation is contemplated, it is important to notify potential responsible parties to inspect the scene, prior to evidence removal and storage, in order to avoid spoliation claims.

SUBROGATION ASSOCIATED WITH LOSSES CAUSED BY VENTLESS FIREPLACES

Ventless fireplaces have resulted in a number of losses caused by design failures, as well as failures caused by lack of regular maintenance or abuse.  

 These fireplaces can be inspected for the following defects or hazardous conditions:

•       A gas leak. During production, installation or servicing, a leak can be created;

•       plugged burner ports. The contractor may accidentally plug the burner ports while spreading ceramic tile over the burners, or they may be painted over at the factory. The resulting unbalanced burn will create excessive carbon monoxide;

•       a clogged burner. Dust, carpet lint and pet hair can gradually choke off the fireplace’s air supply, leading to incomplete combustion and high amounts of carbon monoxide that are vented into the living space;

•       high gas-input rate. Excessive carbon monoxide ventilation or overheating of the unit will result from firing the gas higher than the input rate set by the manufacturer’s specifications. This can be caused by high gas-supply pressure, an incorrect orifice drill size done at the factory, or if the installer gives the customer's unit a larger flame for aesthetic reasons;

•       the fireplace is oversized for the square footage of the area to be heated.

•       a cracked burner. The gas burner may develop a crack over time and function erratically, producing high levels of carbon monoxide;

•       the fireplace contains items other than the artificial logs designed for the unit. Problems caused by the incineration of firewood or other flammable items will be immediate and extreme. A more likely and less obvious hazard is created by adding pebbles, lava rocks, and other non-combustible aesthetic touches to the fireplace, as their exposure to flames will cause an unsafe rise in levels of carbon monoxide; and  

•       a missing or defective oxygen detection sensor.  As these components may fail, it is advisable to install a carbon monoxide detector near a ventless fireplace and, ideally, in other rooms, as well.

In summary, ventless fireplaces, while attractive and portable, suffer from a design flaw that may allow dangerous gases to enter the living space.

As we noted earlier, if subrogation is contemplated, it is important to notify potential responsible parties to inspect the scene, prior to evidence removal and storage, in order to avoid spoliation claims.

CONSTRUCTION SITE INJURY CLAIMS

The investigation of construction site injury claims is another practice areas of METROPOLITAN due to our expertise with construction activities and construction project management.  Our experience in defending a host of different claims provides us with a unique insight and ability to aggressively pursue these subrogation claims.  Our experts are often called upon to assist in the investigation and defense of catastrophic personal injury and wrongful death claims arising from a construction activities.

Just some of our construction accident experience includes:

·         Building Collapses

·         Contractor Safety Violations (OSHA, MSHA, Etc.)

·         Crane Accidents

·         Electrical Accidents (Circuit Breakers, Bus Bars, Transformers, Etc.)

·         Excavation and Trench Collapses

·         Explosions

·         Multi-Story Fall Downs

·         Pile Driving Accidents

·         Power Line Injuries

·         Roadway Construction Accidents

·         Scaffolding Accidents

·         Structure and Roof Collapses

·         Worksite Assaults

We have successfully assisted construction site owners, developers, construction managers, general contractors, subcontractors, crane and rigging companies, equipment owners, design professionals, project managers and industry consultants in these and many other construction accident injury matters.

SUBROGATION OF LOSSES CAUSED BY VEHICLE FIRES

Fires which occur as a result of vehicle defects not only pose a significant risk to occupants of the vehicle, and the vehicles themselves, but often cause serious damage to surrounding property.  METROPOLITAN has been at the forefront of claims-handling for fires which occur due to manufacturing and/or design defects in vehicles produced by vehicle manufacturers.   

With our use of a number of qualified experts who focus on vehicle fires, METROPOLITAN is well positioned to maximize the recovery of subrogation dollars on claims stemming from this unique type of loss.

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:

alarm/security boiler building, roof, crane collapses building system failures chemical explosions construction defects earth movement electrical failures employee dishonesty environmental explosions fires floods

geotechnical failures grill malfunctions industrial accidents industrial equipment failures machinery and equipment failures mechanical failures mold natural gas explosions product liability sewer back-up steam line failures spontaneous-combustion fires spread fires

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

Fax: (973) 810-0440

E-mail: metroforensics@gmail.com

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