Sin of Omission: Ninth Circuit Splits with the Fifth, Finds That Failure to Include Addendum No. 2 Creates Ambiguity in Marine Builder's Risk Policy

by Baker Donelson

In a marine builder's risk policy coverage dispute decided under Washington state law, the United States Court of Appeals for the Ninth Circuit reversed and remanded a grant of summary judgment for Underwriters. Alaska Village Electric Cooperative, Inc. v. Zurich American Insurance Company, et al, 2014 WL 185778 (Jan. 17, 2014) (unpublished). Lead Underwriter Zurich American Insurance Company and four other subscribing underwriters ("Underwriters") jointly issued the builder's risk policy in connection with the construction of two barges. The policy is a standard form American Institute of Marine Underwriters ("AIMU") policy but in this case did not include Addendum No. 2, a standard addendum that expressly excludes coverage for the cost to repair faulty workmanship.

The contractor, Sneed Shipbuilding, Inc. ("Sneed"), made improper welds during construction, necessitating approximately $1.2 million of corrective work to the vessel.  Sneed and other assureds under the policy ("Assured") sought coverage from Underwriters for the cost of the corrective work. Underwriters denied the claim, and litigation ensued.

In the district court, Underwriters moved for summary judgment, arguing that, as a matter of law, the policy provides no coverage for faulty workmanship when the faulty workmanship does not cause an accident or fortuitous event. In opposition, the Assured argued that the policy language respecting that issue is ambiguous, citing summary judgment evidence that the Assured negotiated for coverage of faulty workmanship and deletion of Addendum No. 2 (going so far as to require that the policy be procured in Washington state as opposed to Texas, so as to delete Addendum No. 2). The district court agreed with Underwriters and granted summary judgment.  However, on appeal, the Ninth Circuit reversed and remanded, finding as follows:

·         The language "[t]his Policy [i]nsures against all risks of physical loss of or damage to the Vessel occurring during the currency of this policy" is susceptible of more than one meaning, i.e., it does not clearly express that faulty workmanship is not a covered loss. Accordingly, due to the ambiguity, extrinsic evidence was necessary to answer the coverage question.

·         Not every all risk builder's risk policy contains a "faulty workmanship" exclusion.

·         Circumstances surrounding the genesis of this policy -- the Assured's demand that Addendum No. 2 be omitted; the marine insurance industry norm that without Addendum No. 2, faulty workmanship is covered; and the actual omission of Addendum No. 2 -- create a genuine issue of material fact as to the meaning of the all-risks policy in this case.

The Ninth Circuit's decision attempted to distinguish the Fifth Circuit's contrary decision in Trinity Industries,Inc. v. Insurance Company of North America, 916 F.2d 267 (5th Cir.1990) - a case that admittedly involved virtually identical policy language - on the grounds that the evidence regarding the intent of the parties and surrounding circumstances in Trinity were different, and that Trinity did not base its holding squarely on the identical policy language. However, this basis for distinction does not appear to withstand scrutiny: the Fifth Circuit's holding in Trinity was that "the policy was not ambiguous" based on the prevailing view in builder's risk coverage jurisprudence "reflect[ing] an interpretation of the all risks policy to cover accidents resulting from defective design or workmanship, but not the cost of repairing the defect itself." 916 F.2d at 271. This is consistent with the prevailing jurisprudence regarding Inchmaree clauses in hull insurance policies, pursuant to which damages caused by a latent defect - but not the latent defect itself - are covered. Accordingly, although the Ninth Circuit's opinion in Alaska Village purports to distinguish Trinity, it appears that the Ninth and Fifth Circuits have now effectively split on this issue. Moreover, the Ninth Circuit's conclusion is at odds with a leading commentator on marine insurance: "Builder's Risk policies do not cover. . . [l]oss or expenditure incurred solely in remedying errors or neglect in design or manufacture. . . ." Leslie J. Buglass, Marine Insurance and General Average in the United States, at 435 (2d Ed. 1981) (italics in original).

Underwriters can take some solace in the fact that the opinion is unpublished and the Ninth Circuit, while reversing the grant of Underwriters' motion, did not mandate that the Assured's motion for summary judgment be granted. Indeed, given that the appellate standard of review on summary judgment is de novo (such that the appellate court can perform its own review of the evidence with respect to any fact questions such as those inherent in review of extrinsic evidence of intent) as opposed to the much more deferential "clear error" standard that applies to post-trial factual findings, it is possible that the trial court may again deny coverage after a full trial (if the case does not settle), in which case any appellate reversal would be unlikely. Neither did the Ninth Circuit suggest the presence of bad faith in the denial of coverage. Nevertheless, in light of this recent decision and the apparent circuit split that it creates, Underwriters of marine builder's risk policies are well advised to remember the "add" in "Addendum."

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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