September 19, 2014 Leave a comment
There has been a tremendous amount of construction defect litigation in Minnesota over the past fifteen years which has had a major impact on both the construction and insurance industries. In an effort to slow the tide, commercial general liability (“CGL”) insurers introduced a series of coverage restricting endorsements and provisions which either eliminate coverage for certain types of construction defect claims or significantly reduce the coverage that had generally been since the late 1980’s. This article addresses one such policy provision, the “Known Injury or Damage” exclusion. Originally introduced by way of endorsement, it was later built into the basic CGL coverage form. With regard to property damage claims, the Known Injury or Damage provision states that insurance will only apply to “property damage” if:
Prior to the policy period, no insured … knew that … “property damage” had occurred in whole or in part. If such a listed insured … knew prior to the policy period, that … “property damage” occurred, then any continuation, change or resumption of such … “property damage” during or after the policy period will be deemed to have been known prior to the policy period.
…“[P]roperty damage” will be deemed to have been known to have occurred at the earliest time when any insured …:
1. Reports all, or any part, of the … “property damage” to us or any other insurer;
2. Receives a written or verbal demand or claim for damages because of the … “property damage”; or
3. Becomes aware by any other means that … “property damage” has occurred or has begun to occur.
Before addressing case law interpreting the Known Injury or Damage provision, some history is necessary. The Known Injury or Damage provision is, to a large extent, a policy codification of two common law doctrines — “known loss” and “loss in progress”. Establishing a known loss or loss in progress under Minnesota common law has been difficult. Absent proof the insured was on actual notice that a loss had already occurred (“the house burned down”) or a loss was virtually certain to occur (“the house is on fire”), the common law doctrines rarely provide a viable policy defense. Whether insurers will fare better under the Known Injury or Damage provision remains to be seen. The “deemed to have been known” language suggests somewhat of an objective standard of knowledge, as opposed to the common law’s purely subjective standard, which may be pro-insurer. However, there has been only one reported Minnesota appellate decision addressing the Known Injury or Damage provision, which is discussed at the end of this article.
Common Law Known Loss & Loss in Progress Doctrines
A “known loss” is a loss that has already occurred while a “loss in progress” is one involving an ongoing, progressive loss. In Minnesota, the common law doctrine of “known loss,” and its counterpart, the “loss in progress” doctrine, is a fraud-based defense. Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724 (Minn. 1997) (citing Franklin v. Carpenter, 309 Minn. 419, 424-25, 244 N.W.2d 492, 496 (1976); Waseca Mut. Ins. Co. v. Noska, 331 N.W.2d 917, 924-25, n. 6 (Minn. 1983); Oster v. Riley, 276 Minn. 274, 280-81, 150 N.W.2d 43, 48-49 (1967)). “The known loss doctrine has been described as ‘a compilation of practical concepts intended to prevent a windfall for insureds and manifest unfairness for the insurance industry.’” Domtar, Inc., v. Niagara Fire Ins. Co., 563 N.W.2d 724 (Minn. 1997) (quoting Buckeye Ranch, Inc. v. Northfield Ins. Co., 134 Ohio Misc.2d 10, 839 N.E.2d 94, 104 (Ct. Common Pleas 2005)). Commentators have noted that “losses which exist at the time of the insuring agreement, or which are so probable or imminent that there is insufficient ‘risk’ being transferred between the insured and insurer, are not proper subjects of insurance.” 7 Lee R. Russ & Thomas F. Segalla, Couch on Insurance, § 102:8 at 20 (3d ed.1997). The common law doctrine focuses on the insured’s actual knowledge prior to the application for liability insurance. Domtar, 563 N.W.2d at 731 (Minn. 1997).
The known loss and loss in progress doctrines are two variants of the principle of fortuity. Insurance is intended to insure against unknown, future events. Thus, the known loss defense bars coverage when the putative insured seeks insurance after knowing that the house has burned down while the loss in progress doctrine will bar coverage when the putative insured seeks insurance knowing that the house is in the process of burning down. In either situation there is insufficient risk to transfer to an insurer; the risk or contingency of the house burning down has already taken place. As noted, the common law known loss and loss in progress defenses are considered to be part of the fortuity requirement that runs throughout insurance law. As such, the circumstances in which they arise usually give rise to other policy defenses such as the “expected or intended” exclusion. In fact, this exclusion has been described as the contractual version of the known loss doctrine. Domtar, 563 N.W.2d at 735.
Given its basis in the prevention of fraud, a fundamental requirement of the loss in progress doctrine is that the insured must know that a progressive loss is occurring prior to the inception of the policy. See e.g., Inland Waters Pollution Control, Inc. v. Nat’l Union Fire Ins. Co., 997 F.2d 172, 175-88 (6th Cir.1993) (rejecting argument that doctrine applies regardless of insured’s knowledge, and holding instead that the loss in progress doctrine “operates only where the insured is aware of the threat of loss so immediate that it might fairly be said that the loss was in progress and that the insured knew it at the time the policy was issued or applied for”).
Common Law: Subjective Standard of Knowledge
Under Minnesota common law, the insured’s knowledge will generally be judged by a subjective standard (what the insured actually knew) rather than an objective standard (what a reasonable insured should have known under the circumstances or have reason to know). Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724, 735 (Minn. 1997) (holding whether damages are “expected” by an insured requires a certainty of harm on the part of the insured that is greater than general standards of foreseeability used to impose liability on the insured). This standard does not preclude the use of circumstantial evidence, but proof of “objective indicia” is only permitted in exceptional circumstances. Id. (citing Morton Int’l, Inc. v. General Accident Ins. Co. of Am., 134 N.J. 1, 85-87, 90-95, 629 A.2d 831, 879-80, 882-84 (1993)).
Under the subjective standard, a finding that the insured “reasonably should have known” of an ongoing, progressive loss is insufficient to defeat coverage. Rather, the insured must have had actual knowledge of the ongoing loss for the loss in progress doctrine to apply. A subjective standard is appropriate in light of the doctrine’s history in fraud prevention. It is only when the policyholder has actual knowledge that a fraud can be perpetrated. State v. Hydrite Chemical Co., 280 Wis.2d 647, 671, 695 N.W.2d 816, 829 (Wis.App.2005); Aetna Cas. & Surety Co. v. Dow Chem. Co., 10 F. Supp. 2d 771, 789-91 (E.D. Mich. 1998); United Techs. Corp. v. American Home Assur. Co., 989 F. Supp. 128, 151 (D.Conn.1997). As one court noted: “[T]he purpose of the loss in progress doctrine, preventing fraud, will be served by a subjective knowledge analysis. The insurer is protected because the insured cannot misrepresent its knowledge to the insurer. The insured is protected because the insurer cannot refuse responsibility merely by learning of facts that both parties previously were unaware of.” United Tech Corp., 989 F. Supp. 128, 151 (D. Conn. 1997). “A subjective standard also protects against the misuse of hindsight to avoid indemnification coverage.” Dow Chem. Co., 10 F. Supp. 2d at 789.
Common Law: Knowledge of Actual Loss, Not Acts Which Produced Loss
It is well established that the loss in progress doctrine does not bar coverage simply because an insured knows of an act or omission that might result in a covered loss after the policy is purchased. In Gopher Oil Co v American Hardware Mut. Ins. Co., 588 NW2d 756 (Minn. Ct. App. 1999), American Hardware argued that Gopher State knew that the disposal of oil sludge at its Arrowhead site was causing groundwater contamination. The court disagreed holding that at best Gopher State knew that the oil sludge was unsightly and a risk to surface water; there was no evidence suggesting that it knew the oil sludge disposal was causing groundwater contamination. See also Domtar, Inc. v. Niagara Fire Ins. Co., 552 N.W.2d 738, 747 (Minn.App.1996) (known-loss defense requires evidence that the insured knew of the loss, not that the insured knew of the acts leading to the loss), affirmed in part, reversed in part on other grounds, 563 N.W.2d 724 (Minn.1997); Buckeye Ranch, Inc. v. Northfield Ins. Co., 134 Ohio Misc.2d 10, 23-28, 839 N.E.2d 94, 104 (Ct. Common Pleas 2005) (known loss doctrine does not bar coverage where the insured only knows of an act that someday might result in damages); United Technologies Corp., 989 F. Supp. at 148-52 (although insured may have known of the waste disposal practices that ultimately resulted in environmental contamination, question of fact remained whether it knew at the inception of the policy that those practices would result in contamination); Cincinnati Ins. Companies v. Pestco, Inc., 374 F. Supp. 2d 451 (W.D. Pa. 2004) (known loss doctrine did not apply to bar advertising injury coverage for alleged trade dress infringement, notwithstanding allegation that plaintiff sent insured cease and desist letter prior to policy).
In Buckeye Ranch, 839 N.E.2d 94 (Ct. Common Pleas 2005), one boy sexually assaulted his younger roommate in 1996 while both were long-term residents receiving treatment at The Buckeye Ranch, Inc. (“the Ranch”). The Ranch was a nonprofit institution that provided services, including a residential program, for children and families struggling with emotional, behavioral, and mental health issues. The Ranch was aware of the assault incident in 1996. However, the Ranch conducted an internal investigation, assisted in a criminal investigation, and participated in investigations by various agencies, but ultimately no investigation resulted in “specific allegations” of fault against the Ranch. Several years later, the Ranch was sued and its CGL insurer contended that the claim was barred under the common law known loss doctrine. The court held that these facts did not give rise to a “known loss” defense. The court noted that “[a] risk that the incident might produce a claim for damages can now be appreciated in hindsight. However, there is no “known risk.” Id. at 109. Thus, the Ranch was entitled to coverage under the policy.
One of the clearest cases of a known loss was involved in Crawfordsville Square, LLC. v. Monroe Guar. Ins. Co., 906 N.E.2d 934 (Ind. Ct. App. 2009). In that case, CS operated a shopping mall and in 1998 submitted a purchase agreement on a parcel of land adjacent to the mall which contained several businesses, including a dry cleaning business. Soon thereafter, as part of an environmental audit, CS had subsurface testing performed on the parcel. The testing revealed petroleum and cleaning agent contamination in the land. In September 1998, CS member L.E. Kleinmaier sent a letter to the seller stating: “Clean up [sic] of both petroleum and cleaning agent contamination must happen. The law requires it. We are willing to proceed with the closing provided an escrow account is established with the title company in the amount of $90,000. The title company will hold the funds and make disbursements from time to time to the environmental firm (AEAC) which will perform the clean-up.” CS ultimately agreed to proceed to closing on the Parcel and both the closing and escrow agreements provided, in part, that “[t]he parties have confirmed the existence of petroleum and other contamination of the soil and water on and under the real estate that is residual contamination from the operation of a cleaner and underground storage tanks on the real estate.” In February 1999, CS’s insurance agent contacted Monroe Guaranty, seeking to add the parcel to CS’s existing CGL policy. Although CS’s agent advised Monroe Guaranty that a dry cleaning business was operating on the parcel, neither the agent nor CS advised Monroe Guaranty of the existence or believed existence of dry cleaning contamination at the site. In 2005, an environmental engineering company reported evidence of contamination on the parcel to the Indiana Department of Environmental Management (“IDEM”). The IDEM sent notice of the contamination to CS and requested that it investigate the nature and extent of the contamination. CS, in turn, tendered the claim to Monroe Guaranty under the CGL policy. Monroe Guaranty denied coverage for the claim contending, among other things, that coverage was barred by the known loss doctrine. , CS claimed that it was not actually aware that a loss had occurred, was occurring, or was substantially certain to occur. CS relied on the October 2007 deposition testimony of Kleinmaier where he suggested, in contrast to his September 2008 letter, that CS only knew of a “possibility” of contamination. The trial court rejected CS’ position and granted Monroe Guaranty summary judgment. Indiana Court of Appeals agreed that the known loss doctrine barred the claim, stating:
On September 29, 1998, CS member Kleinmaier sent a letter to Hedrick indicating that “[c]lean up [sic] of both petroleum and cleaning agent contamination must happen. The law requires it….After two successive quarters of below action level reports, the Indiana Department of Environmental Management will issue ‘no further action’ letter is received from the state. [sic.]” Indeed, Kleinmaier’s letter included a request that an escrow account in a specific amount be made available for the clean-up, indicating that CS knew enough regarding the contamination to estimate the cost of its remediation. The communication clearly indicates knowledge of dry cleaning contamination and, by its references to legally-mandated clean-up and IDEM requirements for successful compliance with applicable regulations; that the contamination was at actionable levels. *** [The] letter represents specific knowledge of a loss that had already occurred . . . we conclude that the designated evidence establishes that CS had the required actual knowledge of dry cleaning fluid contamination at actionable levels, which constitutes a known loss.
In addition, the “loss in progress” doctrine will only apply “where the insured is aware of a threat of loss so immediate that it might fairly be said that the loss was in progress and that the insured knew it at the time the policy was issued or applied for”. Inland Waters Pollution Control, Inc. v. Nat’l Union Fire Ins. Co., 997 F.2d 172, 178 (6th Cir.1993). While there is no bright-line test, there is a major distinction between (a) knowledge of a risk or a potential for loss; and (b) knowledge that a loss is virtually certain to occur. Thus, more is required than mere awareness of a potential risk of a loss or of the potential that damages may arise sometime in the future.
In Insurance Co. of North America v. U.S. Gypsum Co., 870 F.2d 148 (4th Cir.1989), the Fourth Circuit held that the insured’s knowledge that its plant was built on a mining site which had suffered several incidents of subsidence over the years did not justify its insurer in denying coverage when an area of more than twenty-one acres collapsed and dropped as much as six feet. Although the insurer could show that other smaller sink holes had appeared from time to time and that the insured periodically hired professionals to evaluate the stability of the site, the insured’s witnesses testified that the “catastrophic subsidence” that occurred was entirely unexpected. On these facts, the court held that the fact that it is known that subsidence will occur does not mean that it will occur during the policy period. Moreover, there is a fundamental distinction between the certainty of subsidence and the certainty of resulting loss. Id. at 152. Significantly, the court went on to reject the insurer’s “loss in progress” argument “for the same reasons.” Id. It concluded that this is not a case where the forces which eventually led to the subsidence and collapse created an immediate threat of loss at the time the policy was issued. Id. at 153.
Common Law: Different Damages or Unrelated Causes not Barred
Similarly, mere knowledge of prior damage is insufficient to establish a defense under the fraud-based loss in progress doctrine where the insured is sued for different damages or there remained uncertainty as to the cause of the prior damage or the scope of damages at the time the insured purchased the liability policy. While “losses stemming from the same cause relating to a previously discovered and manifested loss are included within the ‘loss-in-progress’ rule,” Factory Mutual Ins. Co. as Successor in Interest to Arkwright Mutual Ins. Co. v. Estate of James Campbell, 81 Fed. Appx. 918, 919-20 (9th Cir. 2003), the doctrine does not apply to damages resulting from unrelated causes or damages of different scope or dimension. See e.g., Pines of La Jolla Homeowners Assn. v. Industrial Indemnity, 5 Cal. App. 4th 714, 7 Cal. Rptr. 2d 53 (4th Dist. 1992) (loss in progress rule does not apply as to a distinct item of damage that was not known by insured prior to the policy period); MAPCO Alaska Petroleum, Inc. v. Central Nat. Ins. Co. of Omaha, 784 F. Supp. 1454, 1462 (D. Alaska 1991) republished as corrected at 795 F. Supp. 941 (loss in progress doctrine did not apply to claim of groundwater contamination where insured “believed the problem was localized and capable of remediation”). In Stonehenge Eng. Corp. v. Emp. Ins. of Wausau, 201 F.3rd 296 (4th Cir. 2000), defects in condominium foundations and balconies appeared in 1989. Wausau undertook the risk in 1992-1995, after the owners’ association had formally notified the general contractors of difficulties and solicited a response from their lawyer. The court rejected the known-loss defense. It pointed out that the exact cause of the difficulties with the concrete was not known when coverage was bound. The insured only “knew of the obvious potential for problems with the remaining twenty-eight villa units” by 1992, after four floors had failed and were replaced. “Such knowledge on the part of Stonehenge, however, does not equate to knowledge prior to the effective dates of the three Wausau policies that imposition of liability upon it for construction of the lightweight concrete floors in all of the villa units was substantially certain to occur.” 201 F.3d at 303. The known loss defense did not apply.
The Known Injury or Damage Policy Provision
There has been only one reported Minnesota appellate decision addressing the Known Injury or Damage provision. In Westfield Ins. Co. v. Wensmann, Inc., 840 N.W.2d 438 (Minn. Ct. App. 2013), review denied (Minn. Feb. 26, 2014), Diseworth at Somerby (“Diseworth”) a planned community consisting of 18 townhome units designed and constructed by Wensmann Homes, appealed the district court’s ruling that Wensmann’s general liability insurer, Westfield, excluded coverage for defective construction work because Wensmann knew of the property damage prior to the inception of the policy.
Diseworth sued Wensmann for negligence and breach of statutory warranties relating to claims of failed arches and water infiltration issues. Each unit had brick arches under the unit’s back deck. All of the buildings were built and occupied before April 1, 2007, the date Westfield issued the commercial general liability (CGL) policy to Wensmann.
Wensmann first became aware of cracks in the brick arches in July 2005 when a homeowner submitted requests for warranty work. The repair work was completed on September 15, 2005 and Wensmann hired a structural engineer to create a design plan for future arches as other arches were cracking and four townhome units had not yet been built. While the arch masonry complaints were documented prior to April 1, 2007, there was no documentation of water infiltration claims before that date.
The Westfield policy contained a known loss provision stating that the insurance only applied to “property damage” if
Prior to the policy period, no insured … knew that …”property damage” had occurred in whole or in part. If such a listed insured … knew prior to the policy period, that …”property damage” occurred, then any continuation, change or resumption of such … “property damage” during or after the policy period will be deemed to have been known prior to the policy period.
In addressing the known loss coverage issue, the appellate court separated the claimed damages into three classes: damage resulting from brick arches constructed before the new arch design; damage resulting from brick arches that were constructed with the new arch design; and damage resulting from water infiltration issues.
With regard to damages to brick arches constructed before the new arch design, Diseworth argued the exclusion did not apply because the cracks were minor and Wensmann repaired the cracks and, thus, could not have expected future damage. While the court engaged in a lengthy analysis of the issue, the result was clear. There were numerous cracks on different arches prior to the inception of the Westfield policy on April 1, 2007 caused by an improper design (or a lack of any design) and Wensmann was aware of the problem before the Westfield policy went into effect. The typical known loss provision, and that set forth in the Westfield policy, do not require knowledge of the full extent of the property damage. Rather, the provision excludes coverage where, before the policy was issued, the insured knew that the “property damage had occurred in whole or in part.” Thus, the known loss exclusion barred coverage for damages to brick arches constructed before the new arch design was implemented.
However, damages to the brick arches constructed with the new arch design in the last four units could not be barred as a matter of law because the known loss provision only excludes damages which are a “continuation, change or resumption” of damage that occurred before the policy inception date. Because of the changed design, the arch damages to the last four units may have been due to a different cause than the arch damages sustained prior to the policy period. The district court therefore erred in granting summary judgment as to the arches constructed in the last four units.
The damages resulting from water infiltration was not subject to the known loss exclusion because there was no evidence of water infiltration before the inception of the Westfield policy: “[t]o hold that the cracks in an exterior brick arch provided Wensmann with knowledge that there may be water infiltration resulting from improperly installed windows, doors, and siding would greatly expand the universe of potential claims excluded by an insured’s awareness of a known loss.” The district court therefore erred in granting summary judgment as to the water infiltration claims.
The last two holdings in Westfield are similar to several cases (discussed above) holding the common law known loss/loss in progress doctrines do not apply to damages resulting from unrelated causes or damages of different scope or dimension. See e.g., Pines of La Jolla Homeowners Assn. v. Industrial Indemnity, 5 Cal. App. 4th 714, 7 Cal. Rptr. 2d 53 (4th Dist. 1992) (loss in progress rule does not apply as to a distinct item of damage that was not known by insured prior to the policy period); MAPCO Alaska Petroleum, Inc. v. Central Nat. Ins. Co. of Omaha, 784 F. Supp. 1454, 1462 (D. Alaska 1991) republished as corrected at 795 F.Supp. 941 (loss in progress doctrine did not apply to claim of groundwater contamination where insured “believed the problem was localized and capable of remediation”).
This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.