Keeping dry: a mold claim leads the Ninth Circuit to examine the causation and loss-in-progress rule.

In 1964, the Serendipity Singers had a hit song with the chorus:"Oh no, don't let the rain come down, nay roof's got a hole in it and I might drown." The Serendipity Singers said nothing about insurance coverage, but a Nov. 20, 2003, decision by the Ninth Circuit Court of Appeals addresses this very issue. The decision, Factory Mutual Insurance Co. vs. Estate of Campbell, examined a policyholder that knew he had a bad roof, suffered damage from rain, and sought coverage. The court used these circumstances to address two important insurance law issues: causation and the "loss-in-progress" rule.

The Factory Mutual policyholder was aware of construction detects in the mid-1980s. The defects led to chronic water intrusion problems. In 1995, the relevant property coverage became effective. In 1997 and 1998, El Nino caused heavy rains. The policyholder argued that the El Nino rains that took place during the policy period caused the mold. The policyholder then sought coverage.

This case presented two questions. First, for purposes of insurance, what was the cause: the construction defects or the El Nino rains? Second, what is the significance of the policyholder's awareness of the construction detects?

With respect to causation, the court took a logical approach and focused on the sequence. The court noted that "when two independent 'perils' or causes interact to create an insurance loss, insurance coverage is determined by looking at the proximate cause of the loss." In essence, the cause of the insurance loss is defined to be the first event that set the chain of events in motion. Here, the construction defects allowed the rain to cause mold. The court, therefore, concluded that the defective construction was the cause.

The question then became the significance of the policyholder's knowledge of the construction defects. The court held that the prior knowledge barred coverage: "All losses stemming from the same cause relating to a previously discovered and manifested loss are included within the 'loss-in-progress' rule.' As the construction defects were the cause, the mold represented a"loss-in-progress" at the time the coverage began and thus it was not covered.

The court's "loss-in-progress" finding affects much more than leaky roofs. Policyholders and insurance carriers often disagree as to the effect of prior knowledge. Policyholders often try to dismiss the significance of the prior knowledge:"Sure, we were aware of a risk, that is why we bought insurance." Insurance carriers, on the other hand, will sometimes point to prior knowledge as precluding coverage. The ultimate question is at what point does prior knowledge bar coverage?

The Ninth Circuit answered this question by stating that losses resulting from a "previously discovered and manifested loss" are not covered. In the words of the old song, once an insured knows that his "roof's got a hole in it," the policyholder cannot buy insurance and get coverage for problems caused by that hole.

Importantly, there are many circumstances where losses are "discovered and manifested" before the date on which the policyholder places the loss. Insurance carriers' investigations must be designed to identify losses that are "previously discovered and manifested. "This issue will often involve asking the policyholder the classic question of"what did you know and when did you know it?"

In litigation, this question may be answered through deposition and document discovery. In non-litigated matters, answering this difficult question may be even more arduous, but the effort is not impossible. Public records may reveal evidence of inspections, citations or other complaints. The policyholder may have received complaints or made complaints about a defect. Circumstances surrounding the defect may have been obvious. There may have been earlier accidents or injuries.

Whatever the status of a matter, litigated or not litigated, insurance carriers can ask policyholders about the history concerning a problem. Information can be requested orally or in writing. Policyholders may be reluctant to disclose information, but almost all policies require policyholders to cooperate with insurers' coverage investigations. Courts routinely enforce these provisions as conditions to obtaining insurance coverage.

Despite the evidentiary difficulties, insurance carriers should remain mindful of the "loss-in-progress" issue. Certainly, the Ninth Circuit provided important guidance on this often overlooked issue. The only thing that the Ninth Circuit overlooked was the Serendipity Singers' song which did, after all, climb to No. 6 on the 1964 charts.

Alan S. Rutkin, a Best's Review columnist, is a partner in Rivkin Radler LLP, Uniondale, N.Y. He can be reached at [e-mail].