The judges of the Seventh Circuit affirmed summary judgment in favor of an insurer that refused to cover a fire loss because the insurer had not been notified of an issue with the fire sprinkler system on the insured property. The case is Frankenmuth Mut. Ins. Co. v. Fun F/X II Inc., 61 F.4th 514 (7th Cir. 2023).
The Sprinklers
Victor Cao was the sole stockholder of Fun F/X II Inc., a retailer for costumes and other theatrical supplies. The company's entire inventory was stored in a warehouse owned by an LLC, whose only member was Cao. A routine fire inspection in September 2017 revealed that the sprinkler system had no water pressure. When Cao contacted the water company, they told him there was no record of a water shutoff to the warehouse and could not explain the lack of water. When Cao followed up with the city fire inspector two months later, there was still no water, and the inspector did not know how to restore the water. Cao called the water company again and asked the person who answered to restore the water to his warehouse. Cao admitted he assumed the problem would be brought to the attention of higher-level management and addressed. Cao was not present for the routine fire inspection in 2018 and was not informed of any problems it had revealed or whether the water had been restored.
The Claim
The warehouse and all its contents were destroyed in a fire in July 2019; there was no water supplied to the fire sprinklers at that time. After the fire, the city fire inspector discovered that the water supply to the warehouse had been cut and capped in error when an adjacent building had been demolished two years earlier.
Cao filed a claim under his policy with Frankenmuth Mutual. The insurer denied coverage based on the policy's "notice-of-impairment" exclusion, which stated Frankenmuth wouldn't pay fire damages if the insured knew about an issue with the fire sprinklers before a fire and did not inform Frankenmuth. The insurer sought a declaration from the District Court that it was not obligated to cover the fire loss to the warehouse. Fun F/X countersued for breach of policy. Both parties filed motions for summary judgment, and the District Court ruled in favor of Frankenmuth based on the "notice-of-impairment" exclusion. Cao appealed.
Location of the Impairment
The judges of the Seventh Circuit said the application of the "notice-of-impairment" exclusion was outcome-determinative to Fun F/X's case. Cao admitted he had knowledge of the sprinkler issue in the fall of 2017. He also admitted he never told Frankenmuth of the water supply issue.
However, Cao argued that the impairment caused by the cut and capped pipe was located outside Fun F/X's sprinkler system. The Seventh Circuit, like the District Court, found this argument unavailing. A reasonable policyholder, the judges said, would focus on whether or not the fire sprinklers worked properly, not on the precise physical location of the impairment. Once Cao was aware of the faulty sprinklers, he was obligated to inform Frankenmuth in order to sustain coverage under his fire policy. Nothing in the policy suggested Cao's narrow interpretation of the exclusion would create ambiguity regarding its application.
Knowledge at the Time of Loss
Cao also argued he wasn't obligated to notify Frankenmuth because he did not know whether there was an impairment at the time of the fire. He had requested the return of water services in late 2017 and was not notified of further issues after the 2018 inspection. The judges pointed that application of the exclusion was based on whether the insured knew of a problem regarding the sprinklers before the fire and whether Frankenmuth was notified of the problem. Cato admitted he was made aware of the inoperable sprinklers twice in 2017, once in September and once in November. He was obligated to inform Frankenmuth each time, but he did not do so.
Exception to the Exclusion
Cao asserted that an exception to the exclusion applied to his case. The exception stated that notice to Frankenmuth wasn't required if the sprinklers were shut off due to breakage, leakage, freezing, or open sprinkler heads if full protection was restored within 48 hours. Cao had called the city the first time he knew of the issue, and he referenced a city regulation that required municipal utilities to reconnect water within one working day after a request was made. The first phone call to the city did not end with a promise to restore water; nothing about the call indicated that Cao's problem could be resolved in a single day. During the second call, it didn't add up that the first phone call had resolved the problem, particularly because the city still hadn't found a record of the water supply to the warehouse being shut off. Neither was there an implication that the issue could or would be resolved within 48 hours.
Conclusion
The judges acknowledged it was bad luck that Cato's calls to the city did not lead to further investigation, and that he wasn't told of the results of the 2018 fire inspection. Unfortunately, even the worst of luck does not negate the fact that Cao knew there was an issue with the fire sprinklers, and that he had failed to notify Frankenmuth of the problem, before the fire. Summary judgment for Frankenmuth was affirmed.
Editor's Note: This case shows why it is necessary to inform your insurer of an impairment to the insured property as soon as you are aware of it. Insurers may help find a solution, but they can't fix what they don't know about.
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