Up Against a Chinese Drywall

One reality is clear: The Chinese drywall issue continues to develop at a rapid pace on numerous fronts. Future announcements from the Interagency Drywall Task Force will continue to shed light on the viability and potential scope of alleged bodily injury claims. Interested parties can also expect that pressure on the manufacturers will continue and that the pace of coverage decisions will accelerate. Developments in these areas will further clarify how Chinese drywall remediation efforts will be funded going forward.

John David “J.D.” Dickenson is a senior associate in the West Palm Beach, FL, offices of Edwards Angell Palmer & Dodge LLP. He represents insurers and reinsurers in complex coverage, claims handling and bad faith litigation, and also provides coverage and excess exposure opinions.

Homeowners from 42 states, the District of Columbia, American Samoa, and Puerto Rico have reported concerns about drywall imported from China and installed in their homes. These homeowners believe that health symptoms and the corrosion of metal components in their homes are related to Chinese drywall. The reports began to arrive in force in 2009 and have triggered the largest consumer product investigation in the history of the federal Consumer Product Safety Commission (“CPSC”).

Drywall, also known as wallboard or plasterboard, is an essential element in residential construction. Home builders in the United States historically used domestically produced drywall, composed primarily from gypsum, a mineral. However, the housing boom of 2004-2006, and the scramble for materials that followed the 2004-2005 hurricanes, led suppliers to import vast amounts of drywall from China to keep up with demand. According to the CPSC, more than 550 million pounds of drywall and associated building materials were imported from China to the United States between 2006-2007. According to the investigations, use of Chinese drywall was widespread, but the vast majority of the product was used in Florida, Louisiana and Virginia.

Now, it is estimated that more than 60,000 residential units in the southeastern United States alone contain Chinese drywall. Complaints about it have been numerous. Chinese drywall allegedly corrodes copper coils and electric wires, emits fumes that smell like rotten eggs, and allegedly causes respiratory health problems. As a result, state and federal lawmakers have taken action, and thousands of lawsuits have been filed. This article provides an update on the Chinese drywall investigation as well as a summary of significant insurance coverage decisions to date.

Federal and State Action to Date

With the majority of the affected homes, Florida is at the center of the Chinese drywall controversy. Three-hundred million pounds ' more than half of the total amount of imported Chinese drywall ' was imported to Florida, enough to build approximately 36,000 homes. With the concurrence of the U.S. Centers for Disease Control and Prevention (“CDC”), the Florida Department of Health (“FDOH”) conducted the first testing of Chinese drywall in 2009; two Chinese manufactured drywall samples from Florida houses were selected for analysis. Additionally, four samples of U.S. manufactured drywall were tested. The FDOH found a corrosive sulfide-based compound in the Chinese drywall samples.

Ultimately, an Interagency Drywall Task Force, spearheaded by the CPSC, was established to study homes with Chinese drywall and to investigate claims of property damage and bodily injury associated with the product. The Interagency Drywall Task Force includes the CPSC as the lead agency, along with the CDC, the U.S. Environmental Protection Agency (“EPA”), the U.S. Department of Housing and Urban Development (“HUD”), as well departments of health from Florida, Louisiana and Virginia, among others.

On Friday April 2, 2010, the CPSC and HUD issued “interim remediation guidance” to homeowners impacted by Chinese manufactured drywall. The two federal agencies advised homeowners that “problem drywall” should be removed and replaced along with other components that the drywall may have corroded. The guidance relates that completed studies show a clear connection between certain Chinese manufactured drywall and corrosion in homes.

The CPSC also released a staff report on data from a study by Lawrence Berkeley National Laboratory that measured chemical emissions from samples of drywall obtained for the CPSC as part of the federal investigation. The study confirmed the presence of hydrogen sulfide in some Chinese drywall. Hydrogen sulfide is a potentially corrosive gas that was suspected of causing the corrosion associated with Chinese drywall. The hydrogen sulfide emission rates of certain Chinese drywall samples were 100 times greater than the rates of drywall samples not produced in China. According to the interim guidance, the patterns of reactive sulfur compounds emitted from drywall samples show a clear distinction between the Chinese drywall samples manufactured in 2005/2006 and non-Chinese drywall samples.

“Our investigations now show a clear path forward,” said CPSC Chairman Inez Tenenbaum. “We have shared with affected families that hydrogen sulfide is causing the corrosion. Based on the scientific work to date, removing the problem drywall is the best solution currently available to homeowners. Our scientific investigation now provides a strong foundation for Congress as they consider their policy options and explore relief for affected homeowners.”

Who Is Going to Pay?

Once it became clear that remediation of Chinese drywall was necessary, the focus turned to how to pay for it. It has been estimated that Chinese drywall remediation efforts could average approximately $100,000 per home. The Internal Revenue Service approved a rule in late 2010 that would permit taxpayers with defective drywall in their houses to deduct the cost of repairs and replacement of damaged appliances. Under the new rule, taxpayers can deduct drywall related “casualty losses” in the year in which the loss occurs, as long as those losses are not compensated by insurance or other sources. This rule, of course, primarily benefits homeowners who can afford to fund the necessary remediation themselves. Obviously, most homeowners are not in a position to conduct such remediation. Thus, the core question remains: Who is going to pay?

While there has been some discussion of potential federal relief, the primary targets to date have been: 1) the manufacturers, and 2) insurers. These targets have been pursued via thousands of state and federal lawsuits. The federal products liability suits, along with some insurance coverage suits, have been rolled into the Chinese Manufactured Drywall Products Liability Multi District Litigation (“MDL”) pending in the Eastern District of Louisiana. Still other suits are pending in state courts across the United States. So far, the results have been mixed with respect to the manufacturers, with some progress being made with a significant manufacturer. On the insurance coverage side, some clarity has developed with respect to first-party claims. However, questions abound, particularly with respect to third-party coverages.

Knauf Remediation

Pilot Program

Although the numbers are not yet precisely known, it is thought that two primary manufacturers, Knauf Tianjin and Taishan Gypsum, produced the bulk of the problem Chinese drywall used in the United States between 2004-2007. Knauf is a German company that manufactured drywall in China through a Chinese subsidiary (Knauf Tianjin) and then imported it to the United States. Taishan Gypsum is reportedly a Chinese “state sponsored” drywall manufacturer with operations in China. Until recently, no manufacturer had formally stepped forward to discuss problems with its product or to negotiate potential remediation efforts.

In a significant development, it was announced in October 2010 that Knauf has agreed to pay to repair 300 homes in four states in a remediation pilot program. Owners of homes in Florida, Louisiana, Alabama and Mississippi with drywall manufactured by Knauf are eligible to participate in the program. Reportedly, a Louisiana-based supplier and several home builders and insurers are contributing to the cost of the repairs.

According to reports, more than 3,000 claims are pending against Knauf. The pilot remediation program might provide the framework for a larger settlement of these claims. It remains to be seen whether Knauf will expand its remediation program to include more homes, and perhaps condominium developments.

CPSC Chairman Tenenbaum described Knauf's decision to participate in the remediation pilot program as a “major breakthrough.” Tenenbaum also said that she believes one particular government-sponsored Chinese company is resistant to cooperating and currently represents an impediment to international collaboration on the issue. She did not name the company, but is likely referencing Taishan Gypsum. Tenenbaum said in January 2011 that the United States has not been able to persuade Chinese officials to agree to compensate U.S. homeowners for losses associated with Chinese drywall. At a media briefing during a trip to China, Tenenbaum said:

We have not been able to get any of the Chinese manufacturers to come to the table to discuss our scientific findings and what, if any, they think their responsibility is to the American homeowner ' We are still very hopeful that the Chinese companies can come to the table and let us explain what our findings are and see if they can participate in helping us make our homeowners get a remedy in getting the Chinese drywall out.

Thus, while there continues to be progress with respect to the resolution of claims involving Knauf-manufactured drywall, considerable roadblocks still exist regarding Chinese participation in the necessary remediation. The situation continues to evolve.

Insurance Coverage Decisions

The landscape of Chinese drywall related insurance coverage decisions is also continually evolving. There have been a few important decisions to date in both the first-party (primarily homeowners) and third-party (primarily CGL) claims contexts. The focus of the coverage decisions has been in a few key areas. Specifically, decisions to date have principally discussed: trigger of coverage issues, definition of “occurrence,” number of “occurrences,” pollution exclusions, and “business risk” exclusions. This section discusses a few key Chinese drywall coverage decisions issued to date.

First-Party Claims

In one of the first drywall coverage decisions, the U.S. District Court for the Eastern District of Virginia found on June 3, 2010 that a homeowner's policy did not cover damages associated with Chinese manufactured drywall. In Travco Insurance Company v. Larry Ward , 715 F. Supp. 2d 699 (E.D. Vir. June 3, 2010), Larry Ward alleged that the drywall in his Virginia Beach home released sulfuric gases into his home, damaging his air conditioning, garage door and flat-screen televisions. When Ward made a claim under his homeowner's insurance policy, his insurer sought declaratory relief as to whether there was coverage.

On the insurer's motion for summary judgment, the court found that the damages alleged did constitute a “direct physical loss” within the meaning of the policy. However, the court found that the policy's latent defects, faulty materials, corrosion and pollution exclusion clauses excluded coverage for Ward's damages. The court also found that none of the losses qualified for coverage under the policy's ensuing loss provisions. Thus, the court ruled that the policy did not cover the costs associated with removing or replacing the drywall, or any damages stemming from the drywall. However, the court would not “categorically rule out” that other, as-yet unclaimed, losses might be covered.

Critically, and in reliance in part upon Travco, the presiding judge in the Chinese drywall MDL granted 10 homeowners' insurers' motions to dismiss. In In re Chinese Manufactured Drywall Prods. Liab. Litigation, 2010 U.S. Dist. LEXIS 133497 (E.D. La. Dec. 16, 2010), the court applied Louisiana substantive law, as the policies were all issued to Louisiana homeowners on Louisiana properties. Presiding MDL Judge Eldon Fallon found that, based upon Travco, the damages alleged did constitute a “direct physical loss,” but that the loss was excluded under the policies' faulty materials and corrosion exclusions. The judge concurrently found that latent defect, pollution, contamination, dampness and temperature exclusions in some or all of the policies did not preclude coverage for the Chinese drywall claims. Importantly, the court's refusal to apply the pollution exclusion was based upon the prevailing Louisiana interpretation of the pollution exclusion, which limits its application to the industrial environmental pollution context.

Most of the existing first-party decisions have been decided in favor of the insurers, and the landscape regarding such claims has begun to be charted. These decisions, particularly the MDL decision regarding the application of the pollution exclusion, may provide clues regarding how third-party coverage claims may be decided going forward.

Third-Party Claims

In the first significant Florida coverage decision, Amerisure Mutual Insurance Co. v. Albanese Popkin The Oaks Development Group L.P., 2010 U.S. Dist. LEXIS 125918 (Nov. 30, 2010), the U.S. District Court for the Southern District of Florida held that the developer's insurer had no duty to provide coverage or a defense for claims related to Chinese drywall made against a developer. The court ruled that the commercial general liability policies issued to the developer did not cover the claimed losses because the damages at issue “manifested” before the developer's policies were issued.

The coverage dispute arose from the lawsuit that Alan and Annette Goddard filed against the developer, Albanese Popkin. According to court documents, Albanese Popkin completed construction on the Goddards' Florida home in October 2006. The Goddards discovered damage to the air conditioning coils in one of their seven air handling units and a periodic sulfur odor in December 2006. Based upon the allegations made in the Goddards' complaint, the court found that the damages related to Chinese drywall “manifested” before the applicable policies' January 2008 effective date. Reaffirming Florida's adherence to the “manifestation” trigger doctrine, the court wrote:

Manifestation of the damage is relevant in this context because it establishes that the Goddards sustained actual damage before the policy in question became effective. Therefore, there was no “bodily injury” or “property damage” during the policy period.

In an unreported decision involving third-party coverage, Scottsdale Ins. Co. v. American Safety Indemnity Co., Case No. 10-0445-WS-N (S.D. Ala. Nov. 10, 2010), the U.S. District Court for the Southern District of Alabama considered whether an insurer had an obligation to defend a complaint based upon Chinese drywall damages. The insured builder was issued commercial general liability policies by it insurers, Scottsdale and American Safety. The builder sought coverage from its insurers for allegations brought against it in two underlying lawsuits pending in Alabama state court that allegedly arose from property damage caused by defective Chinese drywall. Scottsdale agreed to defend the builder against the allegations in the underlying lawsuits, however, American Safety declined to participate in the defense on the basis that the pollution exclusion applied to preclude coverage. Scottsdale filed suit, and American Safety filed a 12(b)(6) motion to dismiss on the basis that it had no duty to defend or indemnify the builder in the underlying lawsuits.

Specifically, American Safety asserted that the absolute pollution exclusion in its policy precluded coverage for the drywall-related claims, and thus American Safety had no duty to participate in the defense with Scottsdale. The court, applying Georgia law, but focusing on the language of the pollution exclusion in the American Safety policy, first opined that the fumes and off gassing from the allegedly defective drywall constituted a “pollutant” as defined by the policy.

The court then, pointing to the language in the exclusion that stated that it only applies to losses arising from the discharge of pollutants from a site where builder or its agents “are performing operations,” opined that the pollution exclusion did not unambiguously preclude coverage. The court ultimately concluded that the allegations against the builder in the underlying litigation appeared to relate, in part, to a discharge of a pollutant from the allegedly defective drywall that occurred and continued to occur long after the builder had ceased operations at the construction site. As such, the court was not satisfied that American Safety had shown that all claims in the underlying action were clearly excludable, and thus, American Safety had a duty to defend and the court denied its motion to dismiss.

In a more recent decision, U.S. District Court Judge K. Michael Moore of the Southern District of Florida has ruled that a pollution exclusion bars coverage for personal injuries and property damages associated with Chinese drywall. In General Fidelity Insurance Co. v. Katherine L. Foster et al., Case No. 09-80743, (S.D. Fla. Mar. 24, 2011), the court found that the compounds released by the Chinese drywall were “pollutants” within the meaning of the policy. The court further found that, under prevailing Florida law, the application of the pollution exclusion is not limited to injury or damage caused by environmental or industrial pollution. The court granted summary judgment to the insurer, ruling that it has no duty to defend or indemnify.

The construction of the pollution exclusion will continue to be a critical issue in ongoing third-party Chinese drywall coverage cases. Different jurisdictions have vastly different approaches to such exclusions. As the In re Chinese Manufactured Drywall Prods. Liab. Litigation first-party decision demonstrates, insurers subject to Louisiana law will have to contend with a more restrictive view of the pollution exclusion. In contrast, so far it appears that Florida will continue to take a broader view of the pollution exclusion, applying it outside of the industrial environmental pollution context, and specifically to indoor air claims. Accordingly, the law applicable to a particular Chinese drywall coverage case, along with the forum of that dispute, can have a potentially dispositive impact on the interpretation of the pollution exclusion.

The Bodily Injury Question

Based upon the investigations to date, it is clear that at least some Chinese manufactured drywall causes property damage. Corrosion to metal components, particularly copper, has been confirmed, and the emission of corrosive hydrogen sulfide fumes has been established.

There is less certainty with respect to allegations of bodily injuries associated with Chinese drywall. The CPSC has stated that hydrogen sulfide gases are acidic and, in instances of significant exposure, have been known to irritate the eyes and respiratory tract. Further, the CPSC has stated that it is “possible that the additive or synergistic effects of these and other compounds in the subject homes could cause irritant effects.”

The CDC, in its role as a member of the Interagency Drywall Task Force, recently released a study targeting 11 deaths that took place in Florida, Louisiana and Virginia about which family members had expressed a concern regarding a potential connection with Chinese drywall. The CPSC studies, released in February 2011, found that exposure to Chinese drywall was not believed to be a factor in the 11 deaths. Rather, in all 11 cases, the decedents had significant pre-existing chronic health conditions before their deaths, including cancer, diabetes, and chronic heart disease. While the CPSC concluded that none of the deaths were associated with exposure to Chinese drywall, the CDC recommended that the CPSC continue to monitor health reports and involve the CDC when appropriate.

Thus, the bodily injury investigations are ongoing and no conclusive determinations have yet been made regarding the alleged human health impacts of defective Chinese drywall. Now that the property damage aspect of Chinese drywall has been largely confirmed, and as the recent CPSC reports have demonstrated, increased attention will be paid to this component of Chinese drywall claims going forward.