When does an excluded loss end and a covered “resulting loss” begin? This thorny question was the subject of a recent decision out of the Southern District of Texas, EMS USA, Inc. v. The Travelers Lloyds Insurance Co., No. H-16-1443, 2018 U.S. Dist. LEXIS 54509 (S.D. Tex. Feb. 28, 2018), adopted by EMS, USA, Inc. v. Travelers Lloyds Ins. Co., 2018 U.S. Dist. LEXIS 52884 (S.D. Tex., Mar. 29, 2018). EMS involved a builder’s risk policy that covered a natural gas pipeline construction job in southeast Texas. The insured, the pipeline contractor, had through a subcontractor, drilled a “pilot hole” for the pipeline. The next step was to widen the pilot hole to accommodate the pipeline. This operation involved using a reamer attached to a guide wire that directed the operation. When the guide wire broke, the reamer was stuck in the pilot hole and could not be removed, and a new pilot hole had to be excavated. Travelers denied coverage for the cost of attempting to salvage the first pilot hole, and redrilling the second, arguing that the loss was not covered because (1) the pilot hole was “land” that was not covered under the policy; (2) the hole had not suffered “direct physical loss or damage” as required by the policy’s coverage grant; and (3) the loss, even if within the grant of coverage, fell under the policy’s exclusion for faulty workmanship. The faulty workmanship exclusion provided that the policy would pay for “resulting loss or damage” caused by a covered cause of loss, but would not pay for the “cost of correcting or making good” the faulty workmanship. As to the faulty workmanship exclusion, EMS argued that while the broken guide wire may have been the result of faulty workmanship, the costs of attempting to salvage the pilot hole, and redrilling a new one, were covered resulting losses.
In considering the parties’ cross-motions for summary judgment the magistrate judge agreed with EMS that the pilot hole, once drilled, ceased to become “land” and could be considered a “structure” covered under the policy. The court also held that the pilot hole, and not merely the broken guide wire, as Travelers argued, had suffered “direct physical loss or damage.” But the court agreed with Travelers as to the application of the faulty workmanship exclusion. It found “without merit” EMS’ argument that the faulty workmanship was the broken guide wire, and everything that followed was covered resulting loss. The court refused to fragment EMS’ claim: “Plaintiff is seeking to recover the costs of losing the original hole and drilling a new pilot hole, which is a claim for the costs to repair faulty workmanship, not an ensuing or resulting loss under the Policy.” The magistrate judge recommended that summary judgment be granted for Travelers, and the district court judge adopted the report and recommendation.
The court in EMS adopted a common sense approach to analyzing whether excluded faulty workmanship resulted in an ensuing loss. Like the court in the landmark case of Acme Galvanizing Co., Inc. v. Fireman’s Fund Insurance Company, 221 Cal.App.3d 170 (1990), it focused on the absence of an event separate and distinct from the defective construction process itself, such as an explosion or damage to a separate structure. Because EMS’ only damage was the cost of making good the damage caused by faulty workmanship, and not a separate and independent loss, it fell squarely within the ambit of the exclusion, and not within the ensuing loss clause.