The Washington Supreme Court’s “Vision” of Ensuing Loss & Efficient Proximate Cause Issues

On May 17, 2012, the Washington Supreme Court issued two decisions construing ensuing loss coverage under first party property policies. The first was Vision One, LLC, et al. v. Philadelphia Indem. Ins. Co., et al., 85350-9 (May 17, 2012). In Vision One, the Washington Supreme Court overturned a Court of Appeals decision favorable to the insurer and reinstated the judgment of the trial court, which had awarded the insured damages for an ensuing loss, but not for the cost to repair damage due to faulty workmanship and defective design.

The Supreme Court explained coverage under an ensuring loss provision as follows:

While coverage may be excluded when a certain peril causes a loss, a resulting or ensuing loss clause operates to carve out an exception to the policy exclusion. For example, a policy could exclude losses “caused directly or indirectly” by the peril of “defective construction,” but then an ensuing loss provision might narrow the blanket exclusion by providing that “any ensuing loss not excluded is covered.”

In this way, ensuing loss clauses limit the scope of what is otherwise excluded under the policy. Such clauses ensure “that if one of the specified uncovered events takes place, any ensuing loss which is otherwise covered by the policy will remain covered. The uncovered event itself, however, is never covered.”

The court provided the following example to illustrate how an ensuing loss clause works:

Suppose a contractor miswires a home’s electrical system, resulting in a fire and significant damage to the home. And suppose the homeowner’s policy excludes losses caused by faulty workmanship, but the exclusion contains an ensuing loss clause. In this situation, the ensuing loss clause would preserve coverage for damages caused by the fire. But it would not cover losses caused by the miswiring that the policy otherwise excludes. Nor would the ensuing loss clause provide coverage for the cost of correcting the faulty wiring.

The Washington Supreme Court explained that an ensuing loss clause may not cover losses that are otherwise excluded. However, the Supreme Court rejected the Court of Appeals’ analysis regarding whether collapse was an independent cause of loss.

[The Court of Appeals’] analysis fails to consider that collapse is a covered peril under the policy. Many events can be characterized as both a loss and a peril. Characterizing collapse as the loss, rather than the peril, rests on a semantic distinction without a difference and ignores the policy’s coverage for all risks, including those “[c]aused by collapse of the building.”

The Supreme Court held the efficient proximate cause rule only “applies only when two or more perils combine in sequence to cause a loss and a covered peril is the predominant or efficient cause of the loss.”

The efficient proximate cause rule operates as an interpretive tool to establish coverage when a covered peril “sets other causes into motion which, in an unbroken sequence, produce the result for which recovery is sought.”

(emphasis added). The court held that “[t]he opposite proposition, however, is not a rule of law.” “When an excluded peril sets in motion a causal chain that includes covered perils, the efficient proximate cause rule does not mandate exclusion of the loss.”

The court left open the possibility that an insurer may draft policy language to deny coverage when an excluded peril initiates an unbroken causal chain, but held that Philadelphia had not preserved that issue for appeal.

The second case, Sprague v. Safeco Ins. Co. of Am., No. 85794-6 (May 17, 2012), is the companion decision to Vision One. There, Safeco issued a “homeowner’s all risk insurance policy,” which excluded construction defects and rot. These exclusions were subject to ensuing loss provisions, which stated that “any ensuing loss not excluded or excepted in this policy is covered.” The policy in effect during the relevant period was not subject to a collapse exclusion.

Safeco’s expert determined that wood decay had resulted in substantial impairment of the insured’s home. The expert opined that inadequate flashing and inadequate ventilation of fin walls supporting two large decks caused the decay. The Washington Court of Appeals held that “the losses that are faulty construction and rot are not covered, but the ‘ensuing losses,’ those that result from such faulty construction or rot, are covered because such an ensuing loss is not excluded elsewhere in the policy.”

The Washington Supreme Court overturned the Court of Appeals and held that the rot and faulty workmanship exclusions applied to preclude all coverage because, unlike in Vision One, there was no ensuing loss.

As in Vision One, there is no coverage here for the fin walls because of the policy exclusions for rot and defective workmanship. If there had been losses other than to the fin walls—an injury to a person hurt by the collapse or property damaged by the deck failure—coverage would have existed under the ensuing loss provisions of the policy. Unlike Vision One, that was not the case here. The only loss was to the deck system itself. That loss resulted from rot caused by construction defects.

Accordingly, because the court found that both causes of loss were excluded, the ensuing loss provisions in the policy did not apply. The Sprague Court did not discuss the efficient proximate cause rule.

Washington Court of Appeals holds that a directors' and officers' policy does not cover a corporate officer's execution of a guaranty that secured the indebtedness of the corporation

In Sauter v. Houston Casualty Co., No. 66809–9–I (Wash. App. May 14, 2012), the insurer issued a directors’ and officers’ liability policy to named insured S-J Management, LLC (“SJM”).  SJM’s directors and officers were also insureds “while acting in [their] capacity … as such on behalf of the Insured Organization.”  Michael Sauter (“Sauter”) was SJM’s CEO and manager.  Sauter was the guarantor on a line of credit to SJM and secured his guaranty with real property that he personally owned.  When SJM defaulted on the line of credit, the bank demanded payment from Sauter, who also failed to pay.  SJM’s board agreed to indemnify Sauter but, because it was insolvent, SJM could not do so.  SJM’s counsel then tendered to the insurer claiming that Sauter’s guaranty obligation was covered.  The insurer denied coverage.

Sauter filed suit against the insurer.  Sauter contended that he had executed the guaranty in his capacity as CEO and manager of SJM and that his failure to satisfy the obligation was a “Wrongful Act” under the policy.  The trial court granted summary judgment in favor of the insurer.

The Court of Appeals affirmed and held that the insurer had no duty to indemnify.  It reasoned that Sauter had acted in his personal capacity, rather than in his capacity as an officer or director of SJM, because (1) he signed the guaranty in his own name rather than as an officer of SJM, (2) he personally owned the real estate that was the collateral and (3) as a legal matter, SJM could not be the guarantor of its own obligation.  The court also reasoned that, if Sauter had executed the guaranty as SJM’s officer/director, then SJM, and not he, would have been liable.

The Court of Appeals then addressed whether Sauter’s assumption of the guaranty was a “loss” under the policy.  It noted that other jurisdictions have rejected the contention, as here, that a voluntary contractual obligation can be a “loss.”  However, the court did not resolve this issue because Sauter’s contention failed on another ground.  Under the policy, the “loss” must result from a claim for a “Wrongful Act.”  Here, the purported loss did not result from a “Wrongful Act” because the purported loss was Sauter’s assumption of the guaranty agreement and not his failure to satisfy his obligation under the guaranty.