Chinese Drywall

The final years of the U.S. housing boom, coupled with the devastation caused by Hurricanes Katrina and Rita, led to an acute shortage of building materials. In particular, drywall manufactured in the United States became very scarce. As a result, builders turned to purchasing imported drywall. According to a July 4, 2009 article in the Los Angeles Times, imports of so called Chinese drywall jumped 1,700 percent in 2006.

There are claims that Chinese drywall emits sulfuric gas and other chemicals such as strontium. Some homeowners who had it installed in their homes blame it for various health problems and property damage.

Health-related complaints are generally non-specific and include dizziness, nosebleeds, respiratory problems, headaches, and skin irritations. The varied grievances seem similar to those that followed the mold scare about eight years ago. Just as some media reports then used the sensational term "toxic" mold, some are now using the term "toxic" drywall. Testing continues in regard to the existence of chemicals and any links to bodily injury or property damage. According to the Florida Department of Health (DOH), it "has not identified data suggesting an imminent or chronic health hazard at this time. DOH will continue to review all available data to help determine a more definitive answer to this question."

Homeowners allege the drywall releases a rotten egg smell and corrodes air-conditioner coils, electrical wiring, and copper plumbing. The sulfur-related gases allegedly affect copper worse than other metals and cause it to tarnish and blacken.

To date, the U.S. Consumer Product Safety Commission (CPSC) has received about 2,700 reports from residents in 36 states, the District of Columbia, and Puerto Rico who believe their health symptoms or property damage have a direct relationship to the presence of Chinese drywall. All but eight percent of the complaints came from Gulf Coast states. Sixty percent of the complaints came from Florida, followed by Louisiana with 21 percent. The number of complaints is low compared to the estimated 100,000 homes that press reports state have had Chinese drywall installed.

According to the CPSC, there is a strong association between the problem drywall, the hydrogen sulfide levels in homes with that drywall, and corrosion in those homes. The Commission further advises that while hydrogen sulfide levels detected in homes with Chinese drywall were at concentrations below health-irritant levels, it is possible that additive or synergistic effects of these and other compounds in the homes could cause irritant effects.

On April 2, 2010, the CPSC released interim guidelines recommending the removal of possible problem drywall from homes, as well as the following:

• Electrical components and wiring including outlets, switches, and circuit breakers;
• Smoke alarm and carbon monoxide alarms; and
• All gas service piping and fire suppression sprinkler systems.

Source of the Problem
Drywall is manufactured, in part with gypsum, a naturally occurring mineral, which is either mined or culled from flue gas desulfurization. Gypsum is processed and ultimately mixed with fibrous material such as paper or fiberglass, as well as other material. Mined gypsum normally contains sulfur compounds, though not at extremely high levels.

The single Chinese company to respond to litigation, Knauf Plasterboard Tianjin, Ltd., blames the problem on a single mine in Shandong Province that has gypsum with high iron disulfide content. Knauf has since stopped using that mine. Other Chinese manufacturers, however, still manufacture drywall with gypsum from mines in the same vicinity.

There are allegations that the source of the problem is the use of waste fly ash, from air scrubbers used in coal-fired plants, with unusually high sulfur content. Some point to the fumigants that the manufacturers spray on drywall.

Several Chinese companies manufactured drywall that was imported by the U.S. Most of it did not have any labeling identifying the manufacturer or country of origin. It is not certain that all of the imported drywall, from the various manufacturers, contain similar levels of sulfur or strontium. 

Claims and Litigation
According to media reports, there are now over 150 lawsuits, including multiple class actions, involving drywall manufacturers, importers, distributors, installers, suppliers, and homebuilders.

In June 2009, federal litigation against manufacturers of Chinese drywall was consolidated and assigned to the U.S. District Court, Eastern District of Louisiana.

In September 2009, U.S. District Court Judge Eldon Fallon found Taishan Gypsum Co. in contempt of court for not responding to lawsuits filed against it. Taishan Gypsum Co., which is the largest drywall manufacturer in China, is owned by the Chinese Government. Taishan never filed an appearance and in April 2010, the court issued a $2.6 million judgment in favor of the plaintiffs against the company. As noted above, Knauf, a subsidiary of a multi-national company, is the only Chinese manufacturer not to ignore the litigation. In May 2010, Knauf reported that it had settled a claim with Beazer Homes for an undisclosed amount. Knauf says that it is still in talks with other builders. Knauf has also settled some claims filed by homeowners.

Because most of the manufacturers have no current business or assets in this country, there is little chance of successfully serving them with a summons and complaint or successfully recovering a judgment against them. Chinese companies are effectively insulated against liability because suing them through international court is costly and time-consuming and China does not enforce civil judgments from U.S. courts.

Some plaintiffs' lawyers suggest that they may file lawsuits against U.S. investment bankers who financed the Chinese companies, and seize ships that brought the drywall to the United States. However, the success of such action is remote. It appears that the cost of most settlements or judgments stemming from the litigation will not be borne by the Chinese manufacturers or their insurers.

In June 2010, a jury in Miami-Dade District Court awarded a Florida couple $2.5 million for damages to their home. The award was entered against Banner Supply Co., a drywall supplier. Banner is still facing a class action lawsuit.

In August 2010, Lowes’ Cos., a national retailer of home improvement material and supplies, settled a class action lawsuit that alleged that Lowe’s sold defective drywall to customers. The settlement involved Lowe’s gift cards and attorneys fees for a total value of $8.7 million.

Numerous homeowners claims arising out of loss related to the presence of Chinese drywall have been submitted to insurers. Media reports indicate that insurers have denied the claims. In the reports, insurers cite multiple policy provisions as reason for the denials. Some of these provisions are discussed in this report.

On June 3, 2010, the Eastern District of Virginia issued a decision for Travco Ins. Co. v. Ward. Judge Robert G. Doumar's ruling stated that due to one or more of the exclusions for latent defect, corrosion, pollutants, and faulty materials, no coverage was owed under the plaintiff's homeowner's policy, for the cost of removing or replacing the drywall, or any damages stemming from the material.

Homeowners

AAIS offers seven homeowners forms; however, the focus of this portion of the report is on form HO 0003 09 08. There are multiple provisions in that form that may be applicable to Chinese drywall-related losses.

Direct Physical Loss
Under the Perils Insured Against for Coverages A and B, HO 0003 specifies, '"We" insure property covered under Coverage A or Coverage B for risks of direct physical loss, unless the loss is excluded under the
Exclusions That Apply To Coverage A And Coverage B.' Coverage C includes a similar provision.

If a claim for damages, arising out of the presence of Chinese drywall, is submitted as a loss under Coverages A, B, or C, it would need to be established that the installation of drywall with undesired characteristics gave rise to a direct physical loss.

Exclusions - Pollutants
HO 0003 clearly excludes loss caused by pollutants. Under the Exclusions That Apply To Coverage A And Coverage B, loss caused by the emission, escape, release, etc. of "pollutants" is excluded, unless the release is caused by a Peril Insured Against described under Coverage C.

HO 0003 defines a "pollutant," in part, as any solid, gaseous, or radioactive irritant or contaminant, including acids, alkalis, chemicals, fumes, vapor, and waste.

In a recent Civil District Court case in New Orleans Parish, the court ruled that the pollution exclusion does not, and was never intended, to apply to residential homeowners claims for damages caused by substandard building materials.

Exclusions - Wear and Tear
One exclusion that is often cited in regard to Chinese drywall claims is the Wear and Tear exclusion. Under Coverages A and B, the Wear And Tear exclusion excludes loss caused by:

• Wear and tear, marring, or deterioration;
• Mechanical breakdown, latent defect, inherent vice, or any quality, fault, or weakness in property that causes it to damage or destroy itself; or
• Rust or other corrosion or smog.

Exclusions - Errors, Omissions, and Defects
Another exclusion that may be pertinent is the Errors, Omissions, And Defects exclusion, or the comparable exclusions in other industry forms. The Errors, Omissions, And Defects exclusion precludes coverage for, among other things, loss or damage to property covered under Coverages A or B that is caused by or results from a defect, a weakness, the inadequacy, a fault, or unsoundness in the:

• Construction, compaction, design, grading, remodeling, renovation, repair, specification, workmanship; or
• Materials used in construction, remodeling, renovation, or repair;

of any property, whether in whole or in part, and whether on or away from the "described location".

Water, Humidity, Moisture, Or Vapor
The Water, Humidity, Moisture, Or Vapor exclusion has not been noticeably cited in the media in articles concerning Chinese drywall. However, if humidity is an essential element leading to problems with drywall, it may be that the exclusion for loss due to the presence or condensation of humidity, moisture, or vapor over a period of weeks, months, or years, unless no "insured" knew of or could reasonably be expected to suspect such humidity, moisture, or vapor could be applicable.

Ensuing Loss
According to the Insurance Information Institute, some homeowners may be vacating their homes "thereby raising dramatically the likelihood that a fire, theft, vandalism or undetected water leaks, all covered perils, could occur at the home. Also, defective drywall in and of itself might generate hazardous conditions to the infrastructure of the home, creating a potential for burst pipes or an electrical fire."

As noted above, hydrogen sulfide that is allegedly emitted from Chinese drywall is linked to electrical wire corrosion. Many have taken the position that corroded wires would create a fire hazard within an affected structure. Note that no structure with Chinese drywall is known to have had an electrical fire as a result of wire corrosion. However, such a fire might be alleged to be an ensuing loss from fire. Under HO 0003, an ensuing loss to property covered under Coverages A or B that is otherwise covered by the policy is covered. This provision pertains to the exclusions mentioned above, though not all exclusions in the form.

Coverage C
Since there may be a link between the drywall and metal corrosion, metallic personal property could be at risk. Such property could include jewelry, coin collections, silverware, art, and appliances with copper tubing or wiring. However, HO 0003 specifies that under Coverage C, '"We" insure against direct physical loss to property covered under Coverage C caused by the following perils, unless the loss is excluded under the Exclusions That Apply To Property Coverages.'

For a claim for loss to personal property, it would need to be established that the presence of Chinese drywall falls under one of the named perils.

Commercial Liability

Generally, homeowners who believe that they have homes with problem drywall pursue claims with the builder or contractor who installed the drywall. Claims are generally pursued on the basis of contractual law under either an implied or expressed warranty that the materials used in construction were fit for use.   

At least some homebuilders that used Chinese drywall in construction have agreed to replace the drywall and make repairs at no cost to the homeowners. However, replacing the drywall, electrical wiring, and plumbing in affected structures costs about $100,000.

In an SEC filing in July, Lennar, a publicly traded homebuilder, specified that it identified 400 Florida homes that have problems with defective Chinese drywall and set aside $39.8 million to fix the problem. The high cost of remediation has forced other homebuilders to file for bankruptcy.

In the absence of viable manufacturer defendants, homebuilders, contractors, and installers are emerging as targets in litigation. However, in many, if not most cases, drywall installers probably do not have any idea where the drywall they used was manufactured.

According to a March 2010 report by Moody's Investors Service, commercial insurers could face significant property damage claims and litigation costs stemming from Chinese drywall.

Some insurers may determine that claims arising out of the installation of Chinese drywall are strictly contractual issues between the contractor and the homeowner. Some insurers may choose to defend lawsuits against homebuilders, contractors, or subcontractors, depending upon the allegations in the complaints. (Retailers and importers may also see litigation but that is not a part of the focus of this report.) 

Among the commercial liability products offered by AAIS is an artisans form, AP-100, Contractors Special Policy, and GL-200, Commercial Liability Coverage (Broad Form Coverage).

AP-100 includes commercial liability coverage for an artisan contractor account, which can be insured for property and liability or for liability only. Whether they are sole tradesmen or firms with up to 10 employees, operations with up to $3 million in sales or $500,000 in payroll are eligible.

GL-200 provides coverage for claims, including bodily injury or property damage arising out of the premises/operations exposures of the insured's business. Coverage is also provided for claims of bodily injury and property damage arising out of the products/completed work exposures of the insured's business. The form provides broad form contractual liability coverage.

Completed Work Hazard
Insureds who seek coverage under commercial liability policies are likely to invoke coverage under the completed work hazard.

Definition of completed work hazard

Damage to the Insured's Work
There are two issues regarding damage arising out of the insured's completed work. The first issue is the cost of replacing the contaminated drywall. The commercial forms reviewed in this report exclude property damage to the insured's work.   

Exclusion for PD to Insured's work Includes

A contentious issue will likely be whether the exclusion pertains to any bodily injury or property damage, such as corrosion to wiring and pipes, ensuing from the insured's work.

Alienated Premises
The alienated premises exclusion is sometimes invoked regarding contractors liability when there is damage to premises on which the contractor or the insured's subcontractor worked, if property damage arises out of the insured's product or work.

Alienated premises exclusion

* AP-100 and GL-200 define "your work" as including materials, parts, and equipment supplied for such work or operations.

Occurrence
An issue with many construction defect cases is whether the damage constitutes an "occurrence." Different jurisdictions may rule differently. Insurers may assert that drywall claims are not fortuitous events. As the drywall issue develops, it may be alleged that homes were continuously exposed to sulfur gasses over a number of years. Insurers will need to determine whether an occurrence falls under a given policy period when determining whether coverage is triggered.

Definition of occurrence

Pollutants
Based on a plain-reading of the forms, insurers may invoke the pollutants exclusion. The definition of "pollutants" includes contaminates including vapor.

In February 2010, Chartis and four subsidiaries filed a lawsuit in US District Court for the Middle District of Florida against a Miami-based drywall and building materials supplier, advising that they would deny coverage of umbrella policies based on the pollution exclusion.

Definition of pollutants includes

Pollutants exclusion includes

Impaired Property
One issue that may become contentious is whether there is damage to homes in which Chinese drywall has been installed but no smell or corrosion is detected. Claims may emerge that homes with Chinese drywall are less valuable because of the probability that the drywall might lead to property damage. This type of allegation would possibly be submitted as claims for impaired property in commercial liability claims.

It is far from certain that the mere presence of imported drywall is an indication that either bodily injury or property damage will occur. One cannot demonstrate whether any defects with drywall can remain latent for a number of years, only to emerge later as a problem. As noted above, it is not clear whether all imported drywall is problematic. Though the drywall may have been installed in up to 100,000 homes, only about 3,000 homeowners have come forward with complaints. The complaints are much more numerous in states with higher levels of humidity. There are theories that the problem is not solely with the drywall, but is due to its installation in conjunction with environmental factors. Note that the problem appears to be minimal outside the Southeast. The Artisans and Commercial Liability forms define impaired property for the purpose of effectively excluding coverage for liability arising out of it.

Definition of impaired property includes

Impaired property exclusion includes

Litigation is ongoing. In one publicized case, the trustee of one bankrupt builder, which operated in multiple states, filed a lawsuit against 14 insurers seeking indemnification for losses.

Other issues

Government Assistance
As noted above, the litigation will take several years to make its way through the court system. In some cases, when there are no viable defendants, homeowners may be left "holding the bag." Public policy runs against leaving blameless individuals with devastating financial consequences. There may be a shift in the burden to the public sector. There are some proposals in this regard. In an attempt to aid residents affected by the problem, the Louisiana Recovery Authority Board of Directors approved a plan to provide $5 million in aid to Louisiana homeowners in that state who own residences affected by contaminated imported drywall.

A bill passed by the U.S. House of Representatives in late October 2009 would allow loans by the Small Business Administration to homeowners and businesses impacted by "toxic" drywall. The bill now awaits consideration by the Senate, where it has not moved. 

Nonrenewals
According to an Associated Press article, at least three insurers either cancelled or non-renewed policies after homeowners submitted claims for contaminated drywall.

One particular cancellation was cited by both Associated Press and Wall Street Journal articles. In the letter of cancellation, the insurer reportedly stated that the cancellation was due to "the dwelling was built with Chinese drywall."

One large Florida insurer is advising insureds that they have six months to fix the problems or their policies will not be renewed. A Wall Street Journal article quotes an insurer as saying that it is standard procedure to require homeowners to repair conditions that could lead to further property damage and additional claims. The insurer says, "Corrosion leads to a likely future claim for a covered peril such as a fire or a water leak."

Other insurers were cited as stating they do not plan on non-renewing policies solely because homes may contain defective drywall made in China. The Florida Office of Insurance Regulations has not taken any position on this issue.

In November 2009, U.S. Rep. Charlie Melancon (D-LA) introduced a bill in Congress that would prohibit changes to homeowners coverage or rates based on the presence of imported drywall. It would also prohibit insurers from cancelling or non-renewing homeowners coverage based on:

• The presence of drywall containing elevated levels of sulfur or strontium; or
• The presence of drywall imported from China between 2004 and 2007.

The bill was referred to the House Committee on Financial Services on November 17, 2009 and has not moved since.

In July 2010, Louisiana Governor Bobby Jindal signed SB 595 into law. The new law prohibits property insurers from canceling or refusing to renew policies for businesses and homeowners due to a property containing Chinese drywall.

HO 0003 specifies that when the policy has been in effect 60 days or more, or if it is a renewal of a policy issued by the insurer, the insurer may cancel or not renew only at the anniversary date unless:
"…there has been a material change or increase in hazard of the risk."

Changes to Forms?
To date, there appears to be no need to change standardized homeowners forms to address the drywall problem. At this point there is nothing emerging from the Chinese drywall cases suggesting that existing policy language is inadequate to sustain the intent of coverage. Standardized exclusions address faulty, defective, or inadequate products, such as construction materials, in a very direct manner. Also, as noted by the Insurance Information Institute, "Homeowners policies do not exclude, nor mention, specific products, or manufacturers."

This report will be periodically updated.

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