This article address whether, under New York law, a commercial general liability (“CGL”) insurer would be liable for its insured’s breach of contract if the insured botches a building renovation resulting in foul odors permeating the building so much so that tenants move out and stop paying rent. In order to predict how the New York courts would rule on this issue, it is necessary to examine both third-party liability and first-party property decisions in New York and in other jurisdictions.
THIRD-PARTY LIABILITY COVERAGE
Under New York Law, an “occurrence” does not include claims for mere faulty workmanship of the insured, but rather only for consequential third-party damage resulting from the insured’s activity. J.Z.G. Resources, Inc. v. King, 987 F.2d 98, 102 (2d Cir. 1993). While New York courts generally acknowledge that a CGL policy does not insure for damage to the work product itself, the courts hold that a CGL Policy does insure “faulty workmanship in the work product which creates a legal liability by causing bodily injury or property damage to something other than the work product.” George A. Fuller Co. v. U.S. Fid. & Guar. Co., 613 N.Y.S.2d 152, 155 (1st Dep’t 1994); Aquatectonics, Inc. v. The Hartford Cas. Ins. Co., 2012 WL 1020313 (E.D.N.Y. Mar. 26, 2012).
Let’s assume the building owner can show that its contractor (the insured) failed to install insulation in strict accordance with manufacturer specifications, which resulted in pervasive odor from the insulation throughout the building’s carpet and ceiling tiles, necessitating their replacement and requiring tenants temporarily to vacate the premises. Under established case law, there would be no coverage under a CGL policy inasmuch as the insured’s faulty installation of the insulation would be excluded under the policy’s exclusion for “your work.”
However, assuming arguendo that the bad odor emanating from the faulty insulation caused “property damage” as defined under the policy to other parts of the building that were not within the scope of the insured’s work, then is there an “occurrence” that will “trigger” coverage under the policy? Further, assuming an “occurrence,” is there also CGL coverage for the building’s air testing and purification expenses? Yes to all, according to Essex Ins. Co. v. BloomSouth Flooring Corp., 562 F.3d 399, 406 (1st Cir. 2009), a First Circuit CGL decision that was one of the earliest cases – – and thus far the only significant third-party coverage case – – finding an occurrence and property damage from pervasive odors.
Many CGL policies broadly define property damage as both physical injury to tangible property and loss of use of tangible property that is not physically injured. As in our hypothetical, Essex involved a coverage dispute between the insurer, Essex, and its insured contractor, BloomSouth, in relation to a faulty workmanship claim. The CGL policy defined “property damage” as “[p]hysical injury to tangible property, including all resulting loss of use of that property,” and “[l]oss of use of the work” for which it was hired. BloomSouth installed a carpet at the premises. Sometime thereafter, the occupants noticed an offensive odor that caused some of the occupants to become ill. The First Circuit held that the odor permeating the premises from the installation of new carpeting constituted physical injury to the building when it rendered the building unusable. Whether the allegations of bodily injury tipped the Essex court in favor of finding coverage we will never know but, in any event, pervasive odors are likely to attract a court’s attention.
FIRST-PARTY PROPERTY COVERAGE
To date, no reported New York decision – either first- or third-party – has held that permeating odors constitute property damage. The Appellate Division, Fourth Department came fairly close in 1988 when it held in a third-party case that the physical properties of gases escaping from the installation of foam insulation caused property damage to vapor barriers and the roof membrane of a building. Apache Foam Prods. Div. v. Continental Ins. Co., 528 N.Y.S.2d 448 (4th Dep’t 1988). Until recent years, only a few scattered cases from around the country had held, in either a first- or third-party setting, that permeating odors could cause property damage. Today, the case law may be changing but, with the single exception of Essex, only in the first-party arena.
Cases Finding No Coverage
As recently as 2012, the Sixth Circuit held firmly to a no coverage position relative to claims involving odors. In Universal Image Productions, Inc. v. Fed. Ins. Co., 475 Fed. App’x 569, 575 (6th Cir. 2012), the insured attempted to recover for mold and bacteria contamination. The court observed that, unlike in Essex, there was no evidence that the odor in the case before it permeated the entire building; rather, it was confined to one floor. The court considered the insured’s “damage” as intangible harms, such as pervasive odor, mold and bacterial contamination, and water damage. Ultimately, the court opined that these types of harms did not constitute physical loss.
In defending its position, the Sixth Circuit cited to De Laurentis v. United Servs. Auto. Ass’n, 162 S.W.3d 714, 716 (Tex. Ct. App. 2005), to determine whether mold constitutes “direct physical loss.” In that case, the insured submitted a claim for mold damage requiring the remediation of her furniture and personal property. The insurer denied the claim, asserting that mold damage did not constitute “physical loss.” The Texas court relied upon dictionary definitions, holding that a “physical loss” is “simply one that relates to natural or material things.”
However, the policy language in both De Laurentis and Universal is different from several more recent iterations of CGL wordings. The court in Universal made its decision relying heavily on the property policy’s “direct physical loss” requirement as contrasted with the CGL policy requirement of “[p]hysical injury to tangible property.” Additionally, the court noted that even if its De Laurentis analysis was not on point, the presence of mold at the insured’s premises did not force people to leave the premises, nor it did it extend beyond a narrow area. In contrast, in our hypothetical there may be a different conclusion, given the CGL policy wording and the presence of a more severe odor that permeated other portions of the owner’s premises, forcing tenants from the damaged area.
Other courts too, however, have continued to opt for relatively narrow definitions of “physical damage,” citing as recently as 2014 to the discussion in Couch on Insurance of what triggers such coverage. In Advanced Cable Co. v. Cincinnati Ins. Co., No.13-cv229, 2014 WL 975580 (W.D. Wis. June 20, 2014), analyzing whether cosmetic hail damage to a roof constituted physical damage, the court cited to Couch in defining physical damage. The court noted, “[a]s with any insurance, property insurance coverage is ‘triggered’ by some threshold concept of injury to the insured property. . . . In modern policies, especially of the all-risk type, this trigger is frequently ‘physical loss or damage,’ but may be any of several variants focusing on ‘injury,’ ‘damage,’ and the like. . . . There is little question this threshold has been met when an item of tangible property has been physically altered by perils like fire, or water.” 10A Couch on Insurance § 148:46 (3d ed. 2013), available at Westlaw COUCH; accord, e.g., Port Auth. of N.Y. and N.J. v. Affiliated FM Ins. Co., 311 F.3d 226, 235 (3d Cir. 2002) (“[i]n ordinary parlance and widely accepted definition, physical damage to property means ‘a distinct, demonstrable, and physical alteration’ of its structure”). The court ultimately concluded that minor, cosmetic hail damage constituted “direct physical loss,” thereby triggering coverage. While Advanced Cable and Port Authority were both discussing relatively clear, tangible physical damage to the property, the decisions illuminate that some courts still adopt a more literal interpretation of “physical.”
Cases Finding Coverage
While Essex is the only CGL case of significance to have found insurance coverage for such a claim, a number of first-party cases after 2009 – – but accelerating in 2014 – – have reached a similar conclusion. In Travco Ins. Co. v. Ward, 715 F. Supp. 2d 699 (E.D. Va. 2010), the insured sought coverage under his homeowners policy for damages allegedly caused by defective drywall that released sulfuric gas into the premises. The suit alleged that the drywall in his home “emits various sulfide gasses and/or other toxic chemicals . . . that create noxious odors and cause damage and corrosion.”
Although the Travco policy did not define the term “direct physical loss,” it defined “property damage” as “physical injury to, destruction of, or loss of use of tangible physical property.” Travco argued there was no direct physical damage because such a loss requires some physical alteration or injury to the property’s structure and the drywall itself remained “physically intact, functional and has no visible damage.” The insured argued that there had been “property damage,” and thus direct physical loss, because he was forced to leave his residence as a result of the noxious odors. The Travco court ultimately sided with the insured, finding that the insured’s home was rendered uninhabitable by the toxic gases released by the drywall and, thus, the property had sustained direct physical loss or damage. The court’s conclusion that the insured had suffered a direct physical loss was strengthened by the fact that the policy specifically defined “property damage” to include “loss of use of tangible property,” which is similar to the language found in Essex and many current policies.
The 2014 first-party decision of the Southern District in Newman Myers Kreines Gross Harris v. Great Northern Ins. Co., 17 F. Supp. 3d 323 (S.D.N.Y. 2014), provides some insight into how a New York federal court might view a claim for “direct physical loss or damage” resulting from odors or fumes. In Newman Myers, the sole issue presented was whether the insured’s claim for loss of business income and expenses suffered as a result of a power outage brought about by Superstorm Sandy constituted “direct physical loss or damage” under its property policy.
Although that particular claim did not involve an odor, the insured relied for support on several out-of-state decisions, each holding that the presence of odors, fumes, or noxious gases in a workplace was “direct physical loss or damage” because the property at issue was rendered unusable or unsatisfactory for its intended purpose. The court reasoned that, although these cases did not involve tangible, structural damage to the architecture of the premises, in each case there was some compromise to the physical integrity of the workplace. Critical to the court’s analysis, however, was that the policy term at issue, requiring “physical loss or damage,” did not require that the damage be tangible, structural, or even visible. The Newman Myers court felt that the invasions of noxious or toxic gases in two of the cases in particular, although not tangible as typically understood, rendered the premises unusable or uninhabitable because “invisible fumes can represent a form of physical damage.” Newman Myers grounded its reasoning in both the first-party Travco case and the third-party Essex case.
Later in 2014, the New Jersey federal district court decided Gregory Packaging, Inc. v. Travelers Prop. Cas. Co. of Am., Civ. No. 2:12–cv-04418 (WHW), 2014 WL 6675934 (D.N.J. Nov. 25, 2014), another first-party case. The court concluded that under New Jersey law the release of ammonia “physically transformed the air” in the facility, rendering it “unfit for occupancy until the ammonia could be dissipated.” The court then held that the ammonia discharge constituted physical loss under Georgia law, because it “physically changed the facility’s condition to an unsatisfactory state needing repair.”
Only a year ago, the New Hampshire Supreme Court opined on the issue of whether pervasive odor constituted an occurrence. In Mellin v. Northern Sec. Ins. Co., Inc., 115 A.3d 799 (N.H. 2015), a first-party case, the insureds sued for the loss of use of their apartment from cat urine odor emanating from a neighboring apartment. The insureds argued that they were entitled to coverage because “physical loss” includes pervasive odors. The court rejected the insurer’s argument that a physical loss requires “tangible alteration to the appearance, color, or shape” of the covered apartment. Alternatively, the court opined that “physical loss need not be read to include only tangible changes to property that can be seen or touched, but can also encompass changes that are perceived by the sense of smell.” The New Hampshire court relied in part on Gregory Packaging.
The most recent decision on this issue is only a few months old, Or. Shakespeare Festival Ass’n v. Great Am. Ins. Co., Civ. No. 1:15-cv-01932-CL, 2016 WL 3267247 (D. Or. June. 7, 2016). Shakespeare Festival is a first-party case in which the insured sought coverage for loss and damage to its concert venue when smoke from a nearby wildfire filled its theatre, causing the insured to cancel performances and lose business income. The insured argued that it should recover because the smoke caused harm to the interior of the theatre, specifically including the inside air.
The court rejected the insurer’s argument that the damage must be physical, opining that “certainly, air is not mental or emotional, nor is it theoretical.” The court relied on many of the cases discussed supra in concluding that a pervasive odor caused physical damage. It noted that wildfire smoke entered the interior of the theatre, making it uninhabitable and unusable for holding performances. Similar to a home tainted by methamphetamine odor as in an earlier Oregon state case, or a facility overcome with ammonia as in Gregory Packaging, the theatre filled with smoke was “unusable for its intended purpose.” See Farmers Ins. Co. of Or. v. Trutanich, 123 Or. App. 6, 858 P.2d 1332, 1336 (1993) (cost of removing odor from methamphetamine lab constituted direct physical loss). The court concluded that the theatre sustained “physical loss or damage to the property” when the smoke rendered the premises unusable for its intended purpose.
Shakespeare Festival provides further insight into the classification of non-dangerous odors. While methamphetamine and ammonia odors arguably provide an immediately dangerous environment for persons in close proximity, the Oregon district court did not focus on the potential danger from the smoke. Rather, the court stressed the inability to use the premises as expected as a result of the odor’s permeation of the covered property. In addition, Shakespeare Festival rejected the insurer’s argument that the smoke might fall under the pollution exclusion in the policy, holding that wildfire smoke did not fall under the exclusion because “wildfire” clearly was omitted from the policy.
Similarly, in Pepsico, Inc. v. Winterthur Int’l Am. Ins. Co., 788 N.Y.S.2d 142, 144 (2d Dep’t 2004), New York’s Appellate Division failed to extend the pollution exclusion beyond the exact wording of the policy, concluding that the exclusion did not apply to losses that were “non-environmental in nature.” In our hypothetical, the insurer would likely have a similarly difficult time in claiming a pollution exclusion unless the exclusion language in the policy specifically addressed the type of pervasive odor caused by the insured’s faulty workmanship. Under both Shakespeare Festival and Pepsico, a pollution exclusion defense would be unlikely to prevail.
We again note that none of the decisions discussed herein other than Essex – the earliest, from 2009 – concerns third-party coverage, and all are from out of state. Nevertheless, pervasive odors seem to be attracting substantial coverage in the courts, so beware and use those breathing masks!