Have you ever wondered whether the liability policy you purchased covers losses you already knew about before you bought the policy?  How much do you have to know?  What if you knew about certain property damage at a construction project you caused but not about other related damage your policy would otherwise cover?  A recent case from the Ninth Circuit sheds light on these issues, and it is good news for policyholders.

In Kaady v. Mid-Continent Casualty Co., 2015 WL 3894394 (9th Cir. June 25, 2015), the Ninth Circuit, applying Oregon law, strictly construed the known-loss provision in a commercial general liability policy in favor of the insured.  Despite that the insured subcontractor knew about property damage to his work before he purchased a policy to cover it, the Court held the provision did not preclude coverage.  Namely, it did not preclude coverage for different property damage to the work of others the insured did not know about, though the damage resulted from the insured’s work.

In Kaady, the insured, a masonry subcontractor, was sued in a construction defect action because the wall sheathing and deck posts behind the manufactured stone he installed over them had deteriorated.  He did not install the underlying wall sheathing and posts, which were installed by other subcontractors.  He was sued in the construction defect case for wall and post deterioration caused by his defective masonry work.

The insured settled the construction defect case and then tendered to his commercial general liability insurer seeking coverage for the settlement.  He claimed the wall and post deterioration of which he settled was “property damage” covered under his policy, defined as “physical injury to tangible property . . . .”  The insurer denied his claim and the insured sued for breach of the policy.

The insurer argued the insured’s claim was barred because he purchased the policy after he already knew about the “property damage.”  More specifically, the insurer contended the insured’s settlement of the construction defect case was not covered based on the policy’s known-loss provision.  That provision states the policy “applies to ․.. ‘property damage’ only if ․.. no insured ․.. knew that the ․.. ‘property damage’ had occurred, in whole or in part.”  The insurer argued that the manufactured stone and underlying structural components are the same “property” and part of the same structure, and, “so long as the insured knew about any damage to a structure, the known-loss provision bars coverage of any other damage to the same structure.”

There was undisputed evidence that the insured knew about some cracks in the manufactured stone he had installed.  But he did not know about any of the property damage for which he sought coverage: the damage to the wall sheathing and deck posts behind the stone facade.

The insurer prevailed on summary judgment but the Ninth Circuit reversed.  It rejected the insurer’s argument that it should treat components the insured provided and components provided by others as the same “property.”  The Court reasoned that a commercial general liability policy, in the construction defect context, necessarily distinguishes between the two in every other policy provision and therefore should also in the known-loss provision.

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 Ninth Circuit then soundly rejected the insurer’s next argument.  Even if the insured’s masonry stone and the underlying walls and deck posts (furnished by others) were considered the same “property,” the Court concluded the known-loss provision still did not preclude coverage.  It reasoned the provision does not preclude coverage for a different type of “property damage” than the type the insured knew about when he bought the policy, even if both types of damage were to the same “property.”  In other words, the insured only knew about the cracks in the stone, not about the deteriorated walls and posts, which is a completely different type of “property damage.”  Since the policy’s known-loss provision bars coverage for “property damage” if the insured “knew that the . . . ‘property damage’ had occurred,” the Court reasoned use of the definite article “the” particularizes the subject which it precedes and indicates “that the claimed damage must be the same as the known damage.”

The Court went on to explain that the insurer’s interpretation of the policy would eviscerate the known-loss provision’s “continuing property damage” language, which 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.”  The Court correctly reasoned that “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,” rendering that policy provision meaningless.

The Court summarized its holding as follows:

Applying our interpretation of the policy to [the insured’s] claim, we conclude that [the insured’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 . . ., 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 [the insurer] advocates.

Lastly, the Court concluded the insured’s knowledge of one type of “property damage” when purchasing the policy would only preclude coverage for different, unknown “property damage” under the known-loss provision if the latter was a continuation of the former.  It stated,

the correct inquiry is whether the claimed damage to the structural components was a ‘continuation, change or resumption’ of the cracks. If it was, [the insured’s] knowledge of the cracks would bar coverage of the claimed damage; if not, his knowledge of the cracks wouldn’t bar coverage.

Courts regularly interpret policy provisions in favor of coverage, particularly where they are ambiguous or involve an exclusion.  This case is no different.  The Court looked at the policy and interpreted it as written, rejecting the insurer’s extremely broad reading of a provision limiting coverage.  Just because an insured knows some facts about a potential loss when he buys a policy does not necessarily mean there is no coverage.