Defense Digest

Direct Physical Loss Does Not Equal Direct Physical Damage
The Third Circuit Expands the Scope of Property Insurance Coverage

Virtually all first party property policies cover an insured's dwelling for "direct physical loss," unless an exclusion applies. This is the typical "all risk" insurance policy. While there had been little case law developed in Pennsylvania as to what constitutes a direct physical loss, the industry's position has been that a "direct physical loss" contemplates a "distinct, demonstrable, and physical alteration of the structure." Port Authority of New York and New Jersey v. Affiliated F.M. Insurance Co., 311 F.3d 226 (3rd Cir. 2002), quoting Couch on insurance § 148.46 (3rd Ed. 1998). Accordingly, a "constructive loss," where there is no actual damage to the dwelling, would not be considered a coverage triggering event. "Fire, water, smoke, and impact from another object are typical examples of physical damage from an outside source that may demonstrablely alter the components of a building and trigger coverage."

However, the Third Circuit Court of Appeals altered the traditional analysis in the May 2005 case of Motorist's Mutual Insurance Co. v. Hardinger, 131 F.E.D. Appx. 823 (3rd Cir. 2005). In Hardinger, the insureds were forced to vacate their home because e. coli bacteria contaminated their well and made their children ill. The insureds claimed coverage under their homeowner's policy due to this contamination. There did not seem to be any contamination to the dwelling itself. The policy at issue covered the "dwelling" and excluded any land, including land on which the dwelling was located. The policy covered the dwelling for "risk of direct loss to property … only if that loss is a physical loss to property."

The insurer eventually filed a Declaratory Judgment action asserting, among other things, that contaminated ground water does not constitute a "direct physical loss" to the dwelling. In an unpublished opinion, the U.S. District Court for the Eastern District of Pennsylvania agreed with the insurer and found that loss of use of the property due to well contamination that renders a dwelling unfit for habitation is a "constructive loss" not a physical loss that creates a "distinct, demonstrable and physical alteration" of the property. The District Court determined that the term "physical loss" is unambiguous and that to essentially turn the policy into a "loss of use" policy by covering consequential losses would torture the policy language. Motorists Mutual Insurance Co. v. Hardinger, 02-8310, slip op. at 11 (E.D.P.A. February 27, 2004).

However, the Third Circuit reversed the Eastern District Court. The Third Circuit applied its holding in Port Authority (supra.), related to asbestos removal, and held that there was an issue of fact as to whether coverage applied to the case. In Port Authority, the insureds argued that the threat of asbestos fibers being released was a physical loss to property and that removal should, therefore, be covered under the various policies. The Third Circuit held in Port Authority that such a situation was not a "direct physical loss" and that for coverage to be triggered in such an event "the [asbestos fibers] must result in 'contamination of the property such that its function is nearly eliminated or destroyed, [or] the structure is made useless or uninhabitable'."

The Trial Court reasoned that because the well contamination could have eliminated the functionality of the Hardinger's property or made the property useless or uninhabitable, an issue of material fact existed and Summary Judgment was not appropriate.

In Hardinger, the Third Circuit cited with approval the Court of Common Pleas opinion of Hetrick v. Valley Mutual Ins. Co., 15 Pa. D.& C. 4th 271 (1992). In Hetrick, a fire caused by vandalism resulted in an oil spill that contaminated the soil and ground water of the residence. The court recognized that the dwelling coverage only insured the dwelling and not the land. The court noted that because there is no damage to the dwelling at first blush, there is no coverage.However, the court found that if a building is rendered uninhabitable because of contamination or fumes from a chemical spill, such an occurrence constitutes a direct physical loss under the policy and coverage exists for the remediation.

While Federal decisions are not binding on state courts, they are highly persuasive. Additionally, if a case is filed in Pennsylvania or New Jersey Federal District Courts, "direct physical loss" will encompass situations where there is no discernable "damage" to the property if the property is rendered "useless or uninhabitable." This would potentially include cases (depending on the applicability of any pollution exclusion) involving fumes from oil or gasoline spills. Of course, this holding creates a slippery slope as it does not specify any limitations relative to what would cause a building to become "uninhabitable." For example, if noise from a factory renders the building uninhabitable, would coverage apply? If noxious odors from a nearby rendering plant causes the building uninhabitable, would coverage apply? Unfortunately, in an effort to craft a case specific result, the court has potentially expanded coverage to an extent that will inevitably result in additional litigation.

*Jim is an associate in our Doylestown, PA office and is Chairman of the firm's Property Practice Group. He can be reached at (267) 880-2026 or jcole@mdwcg.com.