The Fiess decision: Mold is out and more

In early 2005, the Federal Fifth Circuit Court of Appeals “certified” a very controversial state law question to the Texas Supreme Court. Certifying a question simply means that the Federal Appellate Court asks the state’s highest court to tell it what state law is on a specific, unresolved issue since it is the ultimate authority on Texas law. In this case, the certified question was:

“Does the ensuing loss provision contained in Section 1-Exclusions, Part 1(f) of the Homeowners Form B (HO-B) insurance policy as prescribed by the Texas Department of Insurance, when read in conjunction with the remainder of the policy, provide coverage for mold contamination caused by water damage that is otherwise covered by the policy?”

That may not sound all that clear, but in plain English the question is simply whether mold claims are covered by the standard homeowners policy. Since this is a question of great importance to the citizens of Texas, the Texas Supreme Court put it on an expedited docket and arranged for briefing and oral argument within several months, with the argument occurring on March 30, 2005. Due to the expedited schedule, observers expected a decision quickly.

Months passed, a year passed, and still the Fiesses, State Farm Lloyds, the insurance coverage bar, and many Texas homeowners waited for the Court’s decision. The decision, in Fiess v. State Farm Lloyds, ___ S.W.3d __ (Tex. Aug. 31, 2006), was finally issued on August 31, 2006. For insurance carriers, it was worth the wait.

Mold is out
By a 7-2 vote, the Texas Supreme Court found that the “mold exclusion” in the standard homeowners policy barred coverage for mold contamination. The case arose out of a dispute over the clean up of the Fiesses’ home in Houston after it was flooded by Tropical Storm Allison in 2001. When the drywall was replaced, mold was discovered throughout the house. An examiner determined that most of the mold damage was caused by water intrusion prior to the flood from any number of sources, including roof, plumbing, window and door leaks. In other words, the water sources (and mold) were long term problems.

State Farm paid for the mold remediation caused by the flood damage under a separate policy, but refused to pay for the mold remediation caused by the prior gradual water intrusion under the standard homeowners policy. The Fiesses sued State Farm, but the trial court granted State Farm’s motion for summary judgment. The Fifth Circuit Court of Appeals recognized that this issue affects potentially thousands of claims and asked the Texas Supreme Court for guidance.

Justice Scott Brister, writing for the Texas Supreme Court, held that the “mold exclusion” was clear and unambiguous, explaining that, “while the ensuing-loss clause that follows may be difficult to parse … few ordinary people would imagine that it changes the meaning of the [mold exclusion] to read ‘we do too cover loss covered by mold.”‘ Because the mold exclusion is unambiguous, the Court held that extrinsic evidence (that is, evidence other than the policy language itself) offered by the Fiesses and the Texas Department of Insurance (in an amicus brief) concerning the interpretation of the exclusion was irrelevant.

The Court also took issue with the applicability of the ensuing-loss clause to this set of facts. The Court explained that in order for the ensuing-loss clause to create an exception to the excluded peril, the water damage had to result from the excluded peril, not cause the excluded peril. The Court also concluded that the gradual water leaks were not the same thing as “water damage.”

The dissent vigorously disagreed, concluding that the ensuing-loss clause rendered the entire provision ambiguous and that the interpretation offered by the Fiesses and the insurance department was reasonable. Consequently, employing the legal rules of ambiguity, the dissent argued that there was coverage under the policy.

This decision, as you may imagine, will have a dramatic impact upon the many pending mold claims in Texas. But that is not the only important change brought about by this case.

Balandran is history
One of the accepted rules of interpreting insurance policies is that extrinsic evidence should not be used to create an ambiguity. In other words, if policy language is clear on its face, you cannot use such things as records from the Department of Insurance or testimony of regulators to argue that the language is really unclear for reasons beyond the language itself. However, the Texas Supreme Court in 1998 opened the door for the use of extrinsic evidence in the case of Balandran v. Safeco Ins. Co. of America, 972 S.W.2d 738 (Tex. 1998).

The Balandrans filed suit against Safeco for damage to their home caused by an underground plumbing leak. The jury found that the structural damage to the home was caused by the water leak and awarded the Balandrans a large sum of money under the policy. However, the trial court granted Safeco’s motion for summary judgment finding that the policy excluded the structural damage based upon the “settling, cracking and bulging” exclusion.

The issue before the Texas Supreme Court was interpretation of the exclusion. The insurer argued that the exclusion was unambiguous and thus extrinsic evidence could not be used. While, the Balandran court reiterated the rule that extrinsic evidence of the parties’ intent is not admissible to create an ambiguity, it disagreed with the insurer and held that the policy must be considered in light of the surrounding circumstances to determine whether an ambiguity exists. The majority then admitted evidence of the circumstances surrounding the promulgation of the policy form. The dissent chided the majority for its use of “inadmissible extrinsic evidence.”

In Fiess, the Texas Department of Insurance submitted an amicus curae brief supporting the Fiesses’ position that the language was ambiguous because there is an alternative, reasonable interpretation of the ensuing-loss clause. This is generally the type of evidence that Balandran allowed. Indeed, the Fiess dissent notes that “the Texas Department of Insurance, the author of the homeowners policy, and the regulatory authority charged with ensuring compliance with state law in this area, also has filed an amicus brief that similarly disputes the Court’s present policy construction.”

The insurance department argued that while mold is initially excluded, it is brought back into coverage by the ensuing-loss language, which provides an exception to the exclusion for mold which ensues from a covered peril. The Department rejected the Court’s construction as rendering the ensuing-loss provision superfluous and concludes that the provision can only be read to mean that despite any exclusionary language, it excludes coverage for certain previously excluded damage which is caused by a covered water loss.

The Fiess dissent believed that the Department’s interpretation was a reasonable alternative. Since ambiguity exists where the policy is capable of more than one reasonable interpretation, the Court should adopt Fiess’ interpretation if the dissent was correct. Under Balandran‘s standard, the use of the Department’s extrinsic arguments regarding the circumstances surrounding the promulgation of a policy form should be acceptable. The majority in Fiess, however, wholly rejected this approach.

The Court, to the surprise of many, heartily rejected the very underlying principle of Balandran regarding the use of extrinsic regulatory evidence. The Court said:

“Nor can we agree with the dissent that this policy is ambiguous because the Texas Department of Insurance advances an interpretation that, while not convincing, is a reasonable alternative to our own. It is true that courts give some deference to an agency regulation containing a reasonable interpretation of an ambiguous statute. But there are several qualifiers in that statement. First, it applies to formal opinions adopted after formal proceedings, not isolated comments during a hearing or opinions in documents like the Department’s amicus brief here. Second, the language at issue must be ambiguous; an agency’s opinion cannot change plain language. Third, the agency’s construction must be reasonable; alternative unreasonable constructions do not make a policy ambiguous. An agency’s opinion can help construe an existing ambiguity, but it cannot create one; that the Department agrees with Fiesses’ construction does not make the policy ambiguous.” (Emphasis in original)

For years now, policyholders have used Balandran to justify the use of drafting history or positions taken by the Department of In-surance to either create ambiguities or to seek to apply creative alternatives to otherwise clear po-licy language. The decision in Fiess dramatically curtails this abuse of regulatory authority.

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is a frequent author and CLE speaker on insurance topics.

Topics Texas Profit Loss Legislation Homeowners Construction