An Update on Chinese Drywall Claims

The Difference in Chinese Drywall

North America is the largest manufacturer of gypsum wallboard in the world with a total capacity of 42 billion ft.² per year. An average 2,400 ft.² new home contains from 165 to 185 sheets of drywall. While drywall is normally produced in sufficient quantities to make shipping material from China to the United States impractical, from 2004 through 2007 demand outstripped the supply due to a housing construction boom and the need to restore properties damaged by a series of severe hurricanes that struck the Gulf States.

The Chinese wallboard has been found to emit reduced sulfur gases; the cause of these emissions has not been determined, but may be attributable to sulfur-rich plaster or impurities introduced during the manufacturing process. The emissions from the drywall are alleged to produce an unpleasant odor, cause corrosion of metals and result in harmful impacts on the human body.

The Possible Extent of the Chinese Drywall Problem

It is estimated that 550 million pounds (more than 6.21 million sheets) of drywall were imported into the United States between 2002 and 2007, largely from two manufacturing plants in China: Knauf Tianjin and Taishan Gypsum Company, Ltd. It is not clear whether defective products might have been manufactured by other plants or whether all of the material coming from these two manufacturers was contaminated.

According to published reports, 60,000 to 100,000 homes in the United States may contain contaminated wallboard. As of the end of February, the U.S. Consumer Product Safety Commission (CPSC) had received 2,931 complaints, with 80 percent coming from Florida and Louisiana. Cases filed in federal district courts have been consolidated into a multi-district litigation (MDL) in New Orleans, which has registered 205 cases involving 332 plaintiffs. At the last count, other actions in state courts numbered less than 500.

Since these Chinese drywall cases have received a significant amount of publicity, the number of cases filed in state of federal courts seems remarkably small, suggesting that: (1) a significant percentage of the Chinese product imported was not contaminated; (2) a large number of cases are being hoarded by plaintiff law firms awaiting the outcome of the test cases in the MDL actions; or (3) there will be a flood of cases at some point in the future when additional problem homes are discovered.

The Parties in Chinese Drywall Legal Actions

When homeowners have discovered the damage in their homes, their first calls have often been to their builders. When the builders have not responded to complaints, many of the homeowners have turned to their property insurance policies, which appear to cover losses to real and personal property on an "all risks" basis. Homeowners insurers have typically responded with reservation of rights letters or outright denials of coverage based on exclusions for pollution, expected loss, gradual deterioration, or faulty workmanship. Homeowners, with the assistance of plaintiff law firms, have filed suits against their insurers in an effort to compel them to pay these losses.

At the same time, purchasers of homes affected by Chinese drywall have brought claims against the homebuilders that constructed their homes, subcontractors that installed the drywall, building material suppliers, distributors that were responsible for it being imported into the United States, and the manufacturers in China. Securing jurisdiction over foreign manufacturers and exporters has been challenging. Some of the class action suits filed in federal and state courts have identified more than 500 defendants as causing or contributing to the homeowners' problems.

The actions against builders, subcontractors, suppliers, distributors, and manufacturers are typically seeking restoration of the homes to the condition they would be in if the defective drywall had not been installed. In addition, most claimants are also alleging harmful impacts on their health as a result of exposures to the sulfide gases while living in contaminated homes.

The drywall problems are also alleged to have impacted the real estate values of the affected homes, and even after restoration, most homeowners feel that values will remain lower than normal due to the stigma associated with the problem drywall.

Repairing a Home Impacted by the Presence of Chinese Drywall

There are no standards that apply to the removal or replacement of defective drywall in homes. However, an interim guidance document prepared by the CPSC and endorsed by the U.S. Department of Housing and Urban Development recommends the removal and replacement of all tainted drywall, and replacement of components that can pose safety problems, including electrical wiring, outlets, switches, circuit breakers, smoke and carbon monoxide detectors. The procedures recommended by the CPSC are far short of what some plaintiffs are seeking in the homeowners' class action suits.

The Cost To Remediate a Chinese Drywall Home

Lennar Homes, which has identified at least 400 impacted homes among those it built in Florida, reports that is spending approximately $100,000 on each property it remediates under its voluntary program. This appears to include only the direct costs of demolition and reconstruction as well as those incurred for temporary living cost for displaced families.

Another point of view has been provided by the plaintiffs' attorneys. They estimate the average loss per home to be more than $350,000. If the current 3,000 cases filed in state and federal courts represents the entire universe of affected properties, the total losses (using the average calculated by the Plaintiff's attorneys cited above) would be more than $1 billion. If, on the other hand, the estimated 60,000 homes in which Chinese drywall may have been installed all turn up as claims, the total costs could be in excess of $21 billion. The actual number may lie somewhere between these extremes, but it will be several months before more accurate estimates can be prepared.

Insurance Policies May Pay Only a Portion of the Losses

A number of insurance policies may be implicated in the property damage losses suffered by homeowners and in third-party claims owners make against builders, subcontractors, suppliers, distributors, and the manufacturers. Since many of these policies did not contemplate the types of losses that are involved in these drywall cases, they are not necessarily well suited to the issues raised by homeowners and insured defendants in the legal actions in state and federal courts.

For example, most homeowners policies have exclusions for damage arising out of pollution, "latent defects," and gradual deterioration. As a result of these and other exclusions, insurers have been reserving their rights or denying claims filed by homeowners for first-party losses. Commercial general liability and excess liability policies purchased by homebuilders, suppliers, distributors, and manufacturers also have exclusions that may be argued to apply to third-party claims by homeowners against these possible defendants.

In spite of the early responses of insurers, homeowners and insured defendants should file claims against all first-party and third-party policies that might apply to Chinese drywall losses. The policies might ultimately pay all or significant portions of the losses. Insurers may be required to pay defense costs even if portions of the claims are ultimately not covered. Courts and regulators may also intervene on behalf of insured parties when insurers deny claims. For example, the Civil District Court in New Orleans Parish recently ruled that the pollution exclusion and two other exclusions in a homeowner's policy could not be used by an insurer to deny coverage to the insured for a Chinese drywall claim. ² In his written opinion, Judge Lloyd J. Medley said "the pollution exclusion does not, and was never intended, to apply to residential homeowners' claims for damages caused by substandard building materials."

Lessons from the Chinese Drywall Fiasco

The most important lesson to be learned from the Chinese drywall problem is that unexpected events still occur. This is not the first defective product situation that has caught contractors, subcontractors, manufacturers, and homeowners by surprise. Two others that immediately come to mind are the thousands of cases involving exterior insulation and finish systems (EIFS) that plagued homebuyers in the 1990s and defective wood composite siding products manufactured from the 1980s through the mid-1990s. Both of these products resulted in billions of dollars of losses. Litigation to resolve homeowners' claims took more than a decade and resulted in partial payments for many of the losses.

In spite of these earlier events, homebuilders, subcontractors, building supply companies, distributors, and manufacturers may still not be fully protected for similar losses by conventional insurance programs. All of these parties should review their insurance programs with a view toward minimizing the impact of exclusions and to provide the highest limits they can purchase on a cost-effective basis. Qualified insurance brokers and risk management consultants should be utilized to negotiate favorable policy terms and to add coverage where possible for currently uninsured risks.

Homeowners may want to consider simple risk management approaches to lessen the chance of future problems with defective building products. For example, purchasing their next home from a larger builder could offer two advantages—the larger contractors have the resources to do more remediation on a voluntary basis if it should become necessary, and these firms may have more comprehensive insurance programs with higher overall limits than smaller firms. In addition, families that plan to purchase a new or existing home should consider more comprehensive due diligence than has normally been provided by a conventional home inspection service.

For building supply companies, it would be prudent to implement testing programs for foreign-made products. With increased customer requirements for certification of forest products and green building materials, there will be a greater need to verify the sources of materials and the content of recycled and recyclable products. Suppliers may also want to seek additional protection through the purchase of environmental insurance policies and to be included under manufacturers' insurance policies through the addition of vendors endorsements and higher limits for general and excess liability programs.