Chinese Drywall Update: Builders Burdened by Repair Costs

Legal action continues in the case of defective imported Chinese-made drywall installed in thousands of homes in Florida, Louisiana, Virginia, and other states. The second of several "bellwether" test trials will begin on March 15 in the Louisiana federal courtroom of Judge Eldon Fallon, where cases have been consolidated into a "multi-district litigation" ( MDL-2047) proceeding. One interesting wrinkle in the upcoming set of cases is whether insurance companies will be held accountable to defray the costs incurred by builders who have been sued by homeowners over the bad drywall. Some insurers have fallen back on a so-called "pollution exclusion" policy clause to avoid paying claims, although the applicability of that exclusion has been questioned. Louisiana attorney Scott Wolfe discussed the pollution exclusion on his Chinese drywall blog in April, 2009. In any case, builders may find relief elsewhere. As legal experts point out, even when a builder's own liability policy has loopholes that limit coverage, builders may be covered by an insurance policy carried by one of their subcontractors — in this case, the drywall sub. And even if the subcontractor is a small company, or has actually gone out of business, the sub's insurance policy could represent a deep pocket. It's standard practice for builders to require subcontractors to carry policies that include the builder as a "named insured" — and sometimes, the subcontractor liability policies have fewer exclusions and looser coverage limits than the builder's own policy has. Expert bankruptcy attorney Sandy Esserman, from the Dallas law firm Stutzman, Bromberg, Esserman & Plifka, told a New Orleans legal conference in summer of 2009, "Subcontractors are not big targets. They're not big, fat, juicy companies — they are usually small operations. And even if they're big operations, they're low-margin. So why in the world would we ever sue a contractor? Well, let me tell you, some of my clients have made the most money suing contractors. Why? Insurance." That legal tactic, however, opens a new can of worms. The legal issues of who is covered by which insurance policies, how coverage limits are defined, and whether limitations such as the so-called "pollution exclusion" are applicable, are questions that have to be thrashed out under state law, not federal law. And that brings up a whole other complicated legal issue called "choice of law" — will the policy be interpreted under the law of the state where the home was built, the law of the state where the builder has its headquarters, or the law of the state where the insurance company resides? Attorney Stephen Mysliwiec of the Washington law firm DLA Piper told the 2009 New Orleans conference, "Different states take different views of the pollution exclusion [and other coverage limitations]. So I think the name of the game in insurance coverage litigation will not be so much the substantive terms of the policy. It will be in persuading whatever court the insurance coverage suit is pending in to apply the law of the state which favors your side." The choice-of-law question itself is an issue that is typically decided in — you guessed it — a state court. But in the Chinese drywall MDL, that question will now come before Judge Fallon, a Federal judge. That's because Taylor Woodrow Homes, which has already settled suits with several Florida homeowners and has carried out gut-and-replace remediation on some houses, is now suing the Scottsdale Insurance Company, the insurer for Taylor Woodrow's drywall sub on the houses, NuWay Drywall, LLC. And the Taylor Woodrow case has been pulled into Fallon's Louisiana MDL. The Bradenton (Florida) Herald has that story (" Lawsuits over defective Chinese drywall heading to trial," by Duane Marsteller); also available online is Taylor Woodrow's complaint in the case. Judge Fallon is likely to attempt to solve the "choice of law" riddle in a way that can be applied across every similar case. In theory, Fallon could even choose to apply a body of law from a state where none of the parties reside or do business, simply for the court's convenience. So his decision in the Taylor Woodrow example may set a precedent that enables builders to turn to the insurers of their drywall subs in any case where the sub carries strong insurance — and at least to know what rule book everyone has to play by. Many smaller builders would welcome any help they can get with handling the mountain of drywall claims. While big, well-funded builders such as Lennar and Beazer have been tearing out and removing drywall on their own nickel, some smaller builders say they can't afford to do that. Bradenton, Florida-based Medallion Homes, for example, says that the company will go bankrupt if it tries to repair homes without help, according to the Sarasota Herald-Tribune (" Drywall fix could spell bankruptcy," by Aaron Kessler). Alan Tannenbaum, an attorney for Medallion, told the Herald-Tribune that with its back against a financial wall, the builder was trying to get compensation from its insurance company, its subcontractors, and the subs' insurance carriers, before attempting any repair. Meanwhile, the extent of repairs that should be required is itself still an open question — and one that is also under consideration in Judge Fallon's courtroom. In a puzzle for builders, the two companies who have been proactive in repairing homes — and who have also testified in the federal court — have offered different views about the appropriate repair protocol. As the Sarasota Herald-Tribune points out, this leaves questions about whether repairs already carried out by builders were sufficient, or may have to be re-done (" Drywall evidence presents dilemma for Lennar Corp.," by Aaron Kessler). Lennar, for example, has carried out numerous gut-and-replace jobs in which only exposed copper wiring was replaced — wiring under insulation was assumed to be undamaged. But Beazer testified in last month's federal trial that even insulated wiring would sometimes be corroded by off-gassing from the drywall.

Writes the Herald-Tribune, "A fundamental question remains: What about those early homes in Heritage Harbour and elsewhere where the wiring was left behind? If that wiring is now known to be affected, representing a serious safety hazard, what will be done? Lennar did not respond to questions from the Herald-Tribune on these issues."

Beazer has also gone a step further than Lennar in cleaning homes after stripping the drywall: Lennar has so far chosen only to vacuum the houses, but witnesses for Beazer told the court that offensive odors can only be eliminated by power-washing or wet-wiping as well as vacuuming. For now, reports the Herald-Tribune, Lennar appears to be sticking to its original method and relying on vaccuming to remove drywall residues.

Ultimately, Judge Fallon will be the one to rule on the extent of remediation that homeowners are entitled to. And when the question of insurance coverage is raised, it will also fall to Fallon to decide whether builders' insurance companies — and their subcontractors' insurers — will be required to pony up the funds to make it so.