Kaady v. Mid-Continent Casualty Company

(Question of Fact Precludes Application of Known Loss Provision in CGL Policy to Bar Coverage of Construction Defect Claim)

In Kaady v. Mid-Continent Cas. Co., 790 F.3d 995 (June 25, 2015), the United States Court of Appeals for the Ninth Circuit, applying Oregon law, reversed the district court’s entry of summary judgment in favor of Mid-Continent Casualty Company (“Mid-Continent”) in connection with application of the known loss requirement in the insuring agreement of a CGL policy issued to a subcontractor with respect to an underlying claim for defective construction of stonework affixed to multi-unit residential structures. The insured, Kaady, was a professional mason who installed manufactured stone at the Collins Lake Resort, a multi-unit residential project. Kaady affixed manufactured stone to the wall sheathing of certain buildings, wrapped deck posts with manufactured stone and installed masonry caps on the top of the stone that was wrapped around the deck posts. Construction was completed in May 2006. Subsequently, in September 2006, Kaady was called back to the project to inspect cracks in the manufactured stone and masonry caps he installed. Thereafter, in December 2006, almost 3 months after he had inspected the cracks in his stone work, Kaady bought a one (1) year commercial general liability policy from Mid-Continent.

Thereafter, the Collins Lake Homeowners’ Association (“HOA”) sued the developer of the project, who in turn, sued the general contractor, who in turn, sued all of the relevant subcontractors who performed work on the project, including Kaady. The HOA’s action alleged defective construction of the project. Kaady settled the claims brought against him for damage caused to other parts of the structure due to his defective installation of the stone work. Essentially, the general contractor alleged that deterioration of the deck posts and wall sheathing behind the manufactured stone had sustained damage due to Kaady’s defective work. The deck posts and wall sheathing were installed by other subcontractors.

Mid-Continent denied coverage of Kaady’s claim for reimbursement based on the argument that the damage sustained by the structures was known by Kaady prior to the inception of the Mid-Continent policy. Mid-Continent relied on the policy’s known-loss provision, which states that the policy “applies to . . . ‘property damage’ only if . . . no insured . . . knew that . . . ‘property damage’ had occurred, in whole or in part.”

Kaady admitted that he was aware of cracks in his work, however, he also stated that he did not know about any damage sustained by the deck posts and underlying wall sheathing. In response, Mid-Continent argued that the cracked stone and underlying damaged posts and sheathing all constituted the same property damage such that Kaady’s knowledge of cracks in the stone also applied to the damage sustained by other property and, therefore, the known loss provision in the insuring agreement for the policy barred coverage of Kaady’s claim.

The district court agreed with Mid-Continent’s arguments and entered summary judgment in its favor.

In reversing the district court’s entry of summary judgment, the Court of Appeals stated as follows:

But the question of whether Kaady’s knowledge of the cracks automatically precludes coverage of damage to the structural components depends on the level of generality at which “tangible property” and “physical injury” are defined. Is the “property” we must examine the structure as a whole or only the components — the deck posts and wall sheathing — that Kaady claims coverage for? And does prior knowledge of one type of physical injury to property automatically preclude coverage of all types of physical injury to the property? Because the policy doesn’t define “tangible property” or “physical injury,” we must examine the policy as a whole to determine how the “ordinary purchaser of insurance” would understand these terms.

First, we are unpersuaded by Mid-Continent’s argument that we should not treat components the insured provided and components provided by others as separate “property.” In the construction context, a commercial general liability insurance policy necessarily distinguishes between the components the insured provided and components furnished by others. That’s because the policy is designed to cover damage to property that is installed by others, but exclude damage to property the insured provided.

Once the insured’s work is complete, the policy covers damage to property provided by others, including property that the insured’s work was “performed on,” but it doesn’t cover damage to the insured’s own product or work. Mid-Continent doesn’t argue on appeal that the claimed damage was to property that Kaady provided (nor could it).

Mid-Continent has offered no reason to treat the insured’s work and the work of others as different property in every provision of the policy except the known-loss provision. Thus, we conclude that the known-loss provision also distinguishes between them. The insured’s knowledge of damage to his own work doesn’t automatically constitute knowledge of damage to the components of the structure furnished by others.

The Court of Appeals also found that the known loss provision in the Mid-Continent policy did not bar coverage because the type of damage sustained by the structure was different than the cracks in the stonework. The Court of Appeals held as follows:

Mid-Continent’s position faces a second difficulty: Even if the masonry and underlying structural components were considered the same “property,” the claimed damage (deterioration of the deck posts and wall sheathing) is a different type of damage than the known damage (cracks in the masonry). Mid-Continent suggests that the insured’s prior knowledge of any damage to property bars coverage for any other damage to that property, regardless of its type. But the known-loss provision bars coverage of “property damage” if the insured “knew that the . . . ‘property damage’ had occurred, in whole or in part.” (Emphasis added.) Use of the definite article “particularizes the subject which it precedes” and indicates that the claimed damage must be the same as the known damage. See Gale v. First Franklin Loan Servs., 701 F.3d 1240, 1246 (9th Cir. 2012) (internal quotation marks omitted). Such an interpretation makes sense considering that a commercial general liability insurance policy covers(as its name implies) many different types of hazards that have no relationship to one another. Thus, an insured’s knowledge of one type of damage to property doesn’t automatically constitute knowledge of any and all damage to the property; the claimed damage must be related to the known damage.

Mid-Continent’s proffered interpretation would eviscerate the known-loss provision’s “continuing property damage” language. The provision states that if the insured “knew, prior to the policy period, that the . . . ‘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.” (Emphasis added.) But if the insured’s knowledge of any damage to any part of the structure automatically barred coverage of all damage to that structure, it wouldn’t matter whether the claimed damage was a “continuation, change or resumption” of the known damage. The problem is avoided if the known-loss provision is interpreted as barring coverage only if the claimed damage is a “continuation, change or resumption” of the known damage. This interpretation permits coverage of damage unrelated to the damage known before acquisition of the policy, but prevents insurance of a loss in progress.

Because the known loss provision did not involve damage to the same property or the same type of damage, the Court of Appeals concluded as follows:

Applying our interpretation of the policy to Kaady’s claim, we conclude that Kaady’s knowledge of the cracks in the masonry before he bought the policy doesn’t constitute knowledge of the claimed “property damage” to the structural components. Not only are the wooden deck posts and wall sheathing different “property” than the manufactured stone and masonry caps, the claimed damage is of a different type. We don’t think that the ordinary purchaser of the policy would interpret the known-loss provision as broadly as Mid-Continent advocates. Rather, the correct inquiry is whether the claimed damage to the structural components was a “continuation, change or resumption” of the cracks. If it was, Kaady’s knowledge of the cracks would bar coverage of the claimed damage; if not, his knowledge of the cracks wouldn’t bar coverage.

Lastly, the Court of Appeals rejected Mid-Continent’s argument that the damage for which Kaady seeks coverage was in fact a “continuation, change or resumption” of the earlier cracks. Essentially, Mid-Continent argued that the damage sustained by the deck posts and wall sheathing flowed from the cracks due to ongoing water intrusion. In response, Kaady disputed Mid-Continent’s argument that the damage to the deck posts and sheathing was due to water intrusion through the cracks in the stonework. Rather, he suggested that the damage sustained by the other property was caused by another source. The Court of Appeals agreed and held that there was a question of fact as to whether the damage sustained by the posts and sheathing flowed from the same cause, i.e., water intrusion through the cracks of Kaady’s work.