Cracking the Known-Loss Doctrine
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26 No. 31 Westlaw Journal Insurance Coverage 1
Westlaw Journal Insurance Coverage
May 13, 2016
CRACKING THE KNOWN-LOSS DOCTRINE
By Steven Plitt, Esq., Cavanagh Law Firm aa1
Copyright © 2016 Thomson Reuters .
Steven Plitt of the Cavanagh Law Firm discusses a recent 9th Circuit ruling that analyzes the application of the known-loss doctrine in the construction defect context.
The purpose of insurance coverage is to provide protection against fortuitous risk. 1 As a practical matter, insurance cannot be provided for losses when the insured is aware of the loss prior to the purchase of the policy because such a loss would be a certainty as opposed to a risk. 2
The known-loss doctrine provides guidance for those situations where the insured has some knowledge of certain facts or circumstances relating to a claimed loss that have occurred and are continuing, or may have occurred at the time that the insurance policy was purchased.
Under the known-loss doctrine, if an insured knows or has reason to know when it purchases liability insurance that there is a substantial probability that it will suffer a loss (or it has already suffered a loss), the risk ceases to be contingent and becomes a probable or known loss. The loss is thus uninsurable unless the parties otherwise contract, because the risk of liability is no longer unknown. 3
The known-loss doctrine is triggered by an awareness that a loss may or will happen. Courts have, however, applied different standards to gauge the level of awareness required to trigger the doctrine’s application. 4 Under the known-loss doctrine, the insurance company must prove that the insured knew or had reason to know — at the time that it purchased its insurance policy — that claims against it had been made or would be made and also knew the likely extent of that exposure. 5
In Kaady v. Mid-Continent Casualty Co. the 9th U.S. Circuit Court of Appeals considered whether the known-loss doctrine should be applied in a construction defect case. 6 The insured, Randy Kaady, was a mason who was hired under a subcontract to install manufactured stone and masonry caps at a project site. After the project was completed, Kaady was called back to the site to inspect cracks in his work.
According to the opinion, Kaady told the general contractor that the cracks “had something to do with settling, being struck, or the substrate contracting or expanding.” Three months after Kaady inspected the cracks, he bought a one-year commercial general liability policy from Mid-Continent. Six months later, the homeowner’s association sued the general contractor on the project. In turn, the general contractor sued all relevant subcontractors, including Kaady. The lawsuit’s allegations involved damage caused by allegedly defective workmanship.
*2 Kaady settled the claim brought against him and then tendered the claim to Mid-Continent for indemnification. When Mid-Continent denied the claim, Kaady sued. The U.S. District Court for the District of Oregon granted summary judgment to Mid-Continent based on the known-loss provision in the policy. It concluded that there was relevant property damage that was known to Kaady before he obtained the policy.
Kaady asserted that damage to the deck posts and wall sheathing under the manufactured stone that he installed constituted “property damage” covered by the policy. Mid-Continent did not dispute Kaady’s claim that “property damage” had occurred or that he caused it. Mid-Continent did assert that Kaady’s claim was barred because he bought the policy after he knew of the loss. It relied on the policy’s known-loss provision, which stated that the policy “applie[d] to … ‘property damage’ only if … no insured … knew that the … ‘property damage’ had occurred, in whole or in part.” 7
Kaady admitted that he was aware of the cracks in the manufactured stone and masonry caps before he purchased the Mid-Continent policy. However, he said he did not know about the damage to the underlying deck posts and wall sheathing at the time. Mid-Continent did not proffer any evidence to contradict Kaady’s declaration. Instead, it argued that while Kaady may not have known about the damage to the deck posts and wall sheathing before he purchased the policy, his knowledge of the cracks in the stone was sufficient to bar coverage.
Mid-Continent made two arguments supporting its interpretation. First, it argued that as long as Kaady knew about any damage to a structure, the known-loss provision barred coverage of any other damage to the same structure. Second, it asserted that once Kaady knew the property was damaged he could not recover for any damage to that particular property. Mid-Continent bolstered this interpretation because the policy deemed “‘property damage’ … to have been known to have occurred at the earliest time when any insured … [b]ecomes aware … that … ‘property damage’ has occurred or begun to occur.” 8
The question of whether Kaady’s knowledge of the cracks automatically precluded coverage for damage to the structural components depended upon the level of generality at which “tangible property” and “physical injury” were defined by the policy. As an example, was the “property” that had to be examined the structure as a whole or only the components, i.e., the deck posts and wall sheathing that Kaady claimed coverage for? Would Kaady’s prior knowledge of one type of physical injury to property automatically preclude coverage of all types of physical injury to the property?
The court rejected Mid-Continent’s argument that it should not treat components the insured provided and components provided by others as separate “property.” It observed that the CGL policy necessarily distinguished between the components the insured provided and components furnished by others. The court reached this conclusion by noting that the policy was designed to cover damage to property that was installed by others while excluding damage to property the insured provided. 9
*3 In the construction context, once the insured has completed its work, the policy would cover damage to property provided by others, including property that the insured’s work was “performed on,” but would not cover damage to the insured’s own product or work. Mid-Continent did not offer any 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. Therefore, the court concluded that the known-loss provision also distinguished between them. With that in mind, the insured’s knowledge of damage to his work did not necessarily constitute knowledge of damage to the components of the structure furnished by others.
The court further noted that even if the masonry and underlying structural components were considered to be the same “property,” the claimed damage — “deterioration of the deck posts and wall sheathing” — was a different type of damage than the known damage (cracks in the masonry). It concluded that the insured’s knowledge of one type of damage to property did not automatically constitute knowledge of any and all damage to the property; it said the specific claimed damage must be related to the known damage.
Moreover, the court found that Mid-Continent’s proffered interpretation would eviscerate the known-loss provision’s “continuing property damage” language. It stated, “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” as specified in the known-loss provision of the policy.
The court found that this problem would be avoided by an interpretation of the known-loss provision as barring coverage only if the claimed damage was a “continuation, change or resumption” of the known damage. Such an interpretation permits coverage of damage unrelated to the damage known before acquisition of the policy but prevents coverage for a loss in progress.
The court concluded that the insured’s knowledge of the cracks in the masonry before he bought the Mid-Continent policy did not constitute sufficient knowledge of the claimed “property damage” to the structural components. The wooden deck posts and wall sheathing were different “property” than the manufactured stone and masonry caps. Therefore, the claimed damage was of a different type.
The correct inquiry, given the language of the Mid-Continent policy, was 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 it was not, his knowledge of the cracks would not bar coverage.
The court reversed and remanded for further evidence on the question of whether the cracks in the masonry allowed water to seep in and damage the wood beneath. If that was established, then the claimed damage might well be considered a “continuation, change or resumption” of the cracks.
|.||Steven Plitt & Jordan R. Plitt, Practical Tools for Handling Insurance Cases, § 1:25, 1-96 (Thomson Reuters 2011) (citing Robert E. Keaton & Allan I. Widiss, Insurance Law: A Guide to Fundamental Principles, Legal Doctrines & Commercial Practices, § 1:3 (2008)).|
|.||See Plitt & Plitt, supra note 1, § 1:25, 1-97 (citing Barry R. Ostrager & Thomas R. Newman, Handbook on Insurance Coverage Disputes, § 8.01 (14th ed. 2008)).|
|.||See, e.g., Outboard Marine Corp. v. Liberty Mut. Ins. Co., 283 Ill. App. 3d 630, 219 Ill. Dec. 62, 670 N.E.2d 740 (Ill. App. Ct., 2d Dist. 1996), as modified on denial of reh’g (Sept. 16, 1996).|
|.||Compare Buckeye Ranch Inc. v. Northfield Ins. Co., 134 Ohio Misc. 2d 10, 839 N.E.2d 94 (Ohio Ct. Com. Pl. 2005) (substantial certainty); Mo. Pac. Rail Co. v. Am. Home Assurance Co., 286 Ill. App. 3d 305, 221 Ill. Dec. 648, 675 N.E.2d 1378 (Ill. App. Ct., 2d Dist. 1997) (probable); Rohm & Haas Co. v. Cont’l Cas. Co., 732 A.2d 1236 (Pa. Super. Ct. 1999), judgment aff’d, 566 Pa. 464, 781 A.2d 1172 (Pa. 2001) (appropriate standard for known-loss doctrine was not knowledge of the certainty of the damages and liability but instead knowledge reasonably showing that the insured was or should have been aware of a likely exposure to covered losses).|
|.||Cent. Mut. Ins. Co. v. Useong Int’l Ltd., 394 F. Supp. 2d 1043 (N.D. Ill. 2005).|
|.||790 F.3d 995 (9th Cir. 2015).|
|.||Id. at 997.|
|.||Id. at 998, citing 9A Steven Plitt, et al., Couch on Insurance §§ 129:1, 129:17 (3d ed. 2014); Gregory G. Schultz, Commercial General Liability Coverage of Faulty Construction Claims, 33 Tort & Ins. L.J. 257, 261 (1997).|
|aa1||Steven Plitt is the current successor author of “Couch on Insurance, 3d.” He is a senior member of the Cavanagh Law Firm in Phoenix, where he specializes in insurance practice. He frequently testifies as an expert witness in insurance-related cases on subjects including bad faith, coverage issues, insurance agent errors and omissions, and legal malpractice. He can be reached at [email protected]|
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