Early court decisions involving tainted Chinese drywall have handed both sides minor victories, but attorneys say it will be how courts interpret the pollution exclusion in insurance policies that will really determine who has the upper hand.

Insurers and policyholders—homeowners, developers, contractors, distributors and manufacturers—have been engaged in insurance coverage and liability issues in state and federal courtrooms since 2009, with neither side faring better than the other, legal experts say.

“It's yet to be determined where courts are going to come out in how they will view and apply the pollution exclusion,” said Michael Hamilton, Blue Bell, Pa.-based partner and chairman of Nelson Levine de Luca & Horst L.L.P.'s national insurance coverage group. “Some jurisdictions are going to view it with a more traditional view of pollution and say that the exclusion doesn't apply to indoor contaminants, and others may look at it more broadly.”

Likely, the most notable and recent Chinese drywall-related decision was Dec. 16, 2010, when U.S. District Court Judge Eldon Fallon granted 10 insurers' motions to dismiss claims in the case, In re: Chinese Manufactured Drywall Products Liability Litigation, ruling that faulty materials and corrosion exclusions in homeowners' policies barred coverage.

In his decision, the New Orleans federal judge said the homeowners' policies did not define “faulty” or “corrosion” and that neither term had been defined under Louisiana case law. Judge Fallon cited dictionary definitions of each word to support his decision.

The ruling was an important one for property insurers, Mr. Hamilton said, but he noted that the judge also ruled that the pollution/contamination exclusions for latent defects did not apply in the denial of coverage.

That ruling could determine how future cases brought in Louisiana will be viewed and handled, Mr. Hamilton said.

“(Forum) could make a big difference if the insurer perceives one state's law to be quite favorable on a particular exclusion that they want to assert,” said Matthew L. Jacobs, a partner in Jenner & Block L.L.P.'s Washington office and a member of its insurance litigation and counseling department. “In Florida, the pollution exclusion law is generally adverse to policyholders, although it's never been interpreted in the context of Chinese drywall cases.”

Mr. Jacobs recently helped defend Denver-based building material supplier ProBuild Holdings Inc. in a Chinese drywall-related case against Granite State Insurance Co., a subsidiary of Chartis Inc.

Granite State had sought a declaration by the court to see if it had a duty to defend ProBuild and its subsidiaries under its insurance policy for pending and future lawsuits alleging ProBuild companies supplied drywall imported from China. The motion was filed Feb. 19, 2010, in U.S. District Court for the Southern District of Florida, according to court documents.

The hope by Granite State as well as other Chartis subsidiaries, Mr. Jacobs said, was that Florida would be more favorable to the insurer in its view of the pollution exclusion and thus deny ProBuild coverage.

ProBuild countered by arguing that the case in Florida should be dismissed. It also sought a declaratory judgment in U.S. District Court for the District of Colorado on March 3, 2010, saying Granite State and 10 other insurers “may have the obligation to pay ProBuild's claims,” and alleged breaches of duty, good faith and fair dealing.

The Florida judge ruled in favor of ProBuild and granted dismissal of Granite State's case against it in Florida; the Colorado case is still pending.

“Chartis is asserting the pollution exclusion will bar coverage (in Florida). That's why all of their companies have filed there,” Mr. Jacobs said. “If they can find any connection to Florida, they will file in Florida.”

Chartis declined to comment on the case.

Forum shopping is not uncommon when it comes to insurance coverage disputes, said Sheila Raftery Wiggins, Newark, N.J.-based partner for Duane Morris L.L.P., who specializes in coverage cases.

“Forum shopping is always an issue in cases like this, but it's never an unbridled action,” she said. “You have to show (that the case) has a connection to the venue in consideration.”

Robert Friedman, West Palm Beach, Fla.-based shareholder and insurance practice leader for Gunster, Yoakley & Stewart P.A., said that Florida “has about the worst case law” when it comes to the pollution exclusion and that courts tend to favor insurers because they interpret the exclusion so literally.

However, “for the most part,” insurers are working with their policyholders involved in Chinese drywall cases under reservation-of-rights agreements or are trying to work out remediation deals.

“Insurance companies are recognizing the liability involved in these cases and that it can get out of control,” Mr. Friedman said, adding that liability is being pushed from developers to builders, from builders to contractors, from contractors to subcontractors and so on.

“Insurers realize they are better off trying to work with the policyholder to get a resolution rather than fighting out coverage disputes in court. However, some insurers are handling it differently than others,” Mr. Friedman said.

An example of a remediation effort made by an insurer happened in October when State Farm Fire & Casualty Co. agreed with drywall maker Knauf Plasterboard (Tianjin) Co. Ltd. and builders to fund the removal of drywall and rebuild up to 300 homes in Alabama, Florida, Louisiana and Mississippi.

Meanwhile, Virginia Beach, Va.-based homebuilder Dragas Cos., remediated homes containing Chinese drywall but is finding it difficult to secure insurance coverage to fund remediation.

Dragas is mired in a dispute with its insurance company, Raleigh, N.C.-based Builders Mutual Insurance Co., in federal court in the Eastern District of Virginia after the homebuilder spent $5 million to repair 73 condominiums in Chesapeake and Virginia Beach, Va., that were built with Chinese drywall.

Dragas did remediated the homes and filed a claim with Builders Mutual asking that it be covered under its insurance policy. Builders Mutual said Dragas' decision to remediate the homes was voluntary and that the insurer is not obligated to pay, however Dragas claims the remediation took place after homeowners issued oral and written demands to make repairs.

Builders Mutual is pushing for a summary judgment asserting that the pollution exclusion in Dragas' general liability policy bars coverage.

Additionally, third-party insurers-Hanover Insurance Co. and Citizens Insurance Co. of America-also are seeking a motion for summary judgment against Dragas. They too assert that the “total pollution exclusion” bars coverage for the homebuilder and they are not responsible for any costs associated with the remediation.

Both motions were filed in late January and are pending action.

“The homeowners provided Dragas with demands even though they didn't file a formal lawsuit,” Ms. Raftery Wiggins said. “It provides sufficient facts that there was a threat (of claims) and provides a legal obligation to pay.”

It's important to note, however, that insurance coverage issues are subject to the law of individual states and how they interpret policy language, attorneys say.

While none of the battles being fought and won by either policyholders or insurers are significant, legal experts say these decisions will help set precedent and provide guidance to courts as cases move forward.

“There will be some very important decisions made in these early cases and in the next 6 to 12 months that will help shape arguments going forward,” Mr. Hamilton said. “Other courts may look at these decisions and use them to shape their decisions, while others will be jurisdiction specific.”