Explosion Of Claims May Push Drywall Suppliers, Installers Into The E&S Market

While comparisons to mold and asbestos are inevitable, liability insurance exposures arising from the installation of tainted Chinese drywall in Southeast homes will not grow to asbestos-like proportions, legal experts predicted recently.

Still, news of the filing of the first class action over defective drywall may have already moved some at-risk suppliers, builders and contractors into the surplus lines market, a specialty insurance underwriter noted.

"We believe that the litigation explosion surrounding Chinese drywall issues is only at its beginning–not nearly at its peak," said Robert Horst, a founding partner of Nelson Levine deLuca & Horst, a Blue Bell, Pa.-based law firm that represents insurers, kicking off a recent webinar on the coverage implications of this emerging exposure.

In recent weeks, problems caused by Chinese drywall imported to repair properties damaged by hurricanes in 2004 and 2005 have escalated, with reports that once focused on "a rotten egg smell" now fueling more than two dozen lawsuits, alleging property damage and health issues from emitted gases, the law firm reported.

In addition, one lawmaker has called for the declaration of a "state of emergency" in Florida, while introducing federal legislation seeking an outright ban on further imports–all of which could have insurance implications, the lawyers said.

"Once you say 'class action' [and] 'construction defect,' those [accounts] are guaranteed to go into the E&S marketplace," said Nan Meyer, managing director of products liability for Markel Corp. in Deerfield, Ill., responding to the question of whether product liability risks of drywall suppliers and construction liability risks for builders or contractors that installed drywall are most likely residing in the standard or E&S markets.

"I think it was in the standard market. I think it's now in the E&S market," she said, noting that such accounts "now require a bit more attention to craft" coverage solutions.

Likewise, new businesses sprouting up to screen and inspect homes for the presence of Chinese drywall and to remediate damage could become underwriting opportunities for specialty insurers, she predicted.

"We would evaluate the risk as we do any new type of opportunity," Ms. Meyer said. "If we can understand it, we can underwrite it, and we can oftentimes be the solution for these new types of companies that come out into the world."

Such businesses offering services to homeowners are easily located on the Internet by typing the words "Chinese drywall" into any search engine, as are plaintiffs' law firms.

Attorneys are "moving quickly and efficiently" to process as many claims in the Southeast as they can, Mr. Horst said during the webinar, displaying an example of one ad from a South Florida firm. In addition to free inspections and legal consultations, the firm offered a five-step Chinese drywall investigation book–already in its "third edition," Mr. Horst noted.

Providing some background information to listeners, Mr. Horst explained that in the wake of Hurricane Katrina in 2005 and the storms that preceded it in 2004, there was a shortage of domestic drywall, fueling a huge market for imported substitutes from China.

In moist and hot climates like Florida's, the drywall is giving off what people generally refer to as "a rotten egg smell," and houses that have the drywall have seen corrosion in electrical wiring, air conditioning components and other appliances, he reported. In addition, homeowners are alleging health issues such as nosebleeds and respiratory problems.

While the science is still in its infancy, the Florida Department of Health has posted conclusions of a hygienist's initial report on its Web site stating there is a "distinct difference" between Chinese and U.S. drywall, and that the Chinese drywall has a unique sulfur odor when exposed to extreme heat and moisture.

The report noted, however, that both the drywall outer paper and the gypsum core released sulfur compounds upon testing, suggesting there are possible causes of gas emissions and the observed aftereffects aside from the drywall itself. These include the treatment of the drywall or the outer paper with an insecticide before it entered the United States, or contaminants in the adhesive binding the paper to the drywall.

The department, which had received 65 complaints about Chinese drywall in February, reported just over 150 in early April, with the figure vaulting to over 300 by late April.

WHO'S AT RISK?

Lawsuits alleging property damage and health impacts have so far targeted the manufacturer Knauf Gips, a German company with Chinese operations (known as Knauf Tianjin), and distributors, Mr. Horst said, noting that the firm's review of court dockets combined with an Internet search has turned up 28 lawsuits–24 in Florida and Louisiana, and the others in Alabama and Mississippi.

Plaintiffs are mostly homeowners, although construction and supply companies have sought indemnification in at least two cases, he said–adding that many of the cases have been brought as class actions.

One notable individual action has been brought by homebuilder Lennar, which voluntarily began repairing homes that have defective drywall. Lennar filed suit in the 11th Judicial Circuit Court of Florida against Knauf Gips, Knauf Tianjin, six Florida suppliers and a dozen drywall installers.

Lennar sued Knauf Gips for vicarious liability and negligence, the suppliers for breach of implied warranty, and the installers for breach of contract and breaches of express and implied warranty.

The suit includes excerpts of the warranty provisions in Lennar's contracts with its installer subcontractors, which state Lennar may elect to repair defective work or materials in the event the subcontractors fail to do so, and backcharge or withhold repair costs from the subcontractors.

In addition to repair costs, Lennar seeks reimbursement of costs to relocate homeowners to temporary housing while repairs are performed, "as well as damages for loss of goodwill and reputation."

"We are witnessing the likely beginning of a litigation explosion," Mr. Horst said. "Personally, I believe we will see many different attempts to shift liability back and forth between manufacturers, suppliers, builders and even architects, planners and home inspectors."

Parties to contracts will seek to enforce hold-harmless agreements and raise defenses pointing to design problems such as inefficient ventilation and improper placement of air conditioners, Mr. Horst speculated.

Ms. Meyer explained generally how a drywall manufacturer's product liability problem can become a contractor's liability issue, agreeing that a complicating factor in this case is the problem of suing a foreign manufacturer.

The manufacturer is responsible if the drywall is defective and causes bodily injury or property damage, and it is required to make sure the product is appropriately labeled to indicate its fitness for use in certain settings or climates, she explained.

For example, she noted that only a certain type of drywall that doesn't hold moisture (greenboard) can be used in bathrooms. It's up to the contractor to heed the labels–selecting the appropriate type of drywall and following instructions for installation, hammering and taping over seams, among other things, she said.

While several Florida press reports have indicated that the Chinese drywall manufacturing operation was not insured, Ms. Meyer was not surprised and suggested it might not matter.

Noting that Markel's Singapore office insures Asian product manufacturers, she said the only reason some Chinese manufacturers exporting to the United States might have insurance is because a large U.S. vendor, like a Target or Walmart, require it.

In general, she said, Chinese insurers won't come to the United States to defend claims, and there's no way for U.S. plaintiffs to have judgments enforced in China. "The Chinese government and Chinese insurers do not recognize the jurisdiction of the United States. Therefore, they will not respond, and it is very costly to go to Asia and bring a lawsuit," she said.

Michael Hamilton, chair of the national insurance coverage group of Nelson Levine deLuca & Horst, agreed that it would be difficult for plaintiffs to recover from a foreign corporation.

"However, in light of the fact that the complaints that have been filed include allegations of strict products liability, any entity in the chain of distribution, including installers and other contractors, could be found liable and end up absorbing the exposure for the original manufacturer," he told NU.