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IN Frankenmuth Mutual Insurance Company v. Fun F/X II, Inc. and Cao Enterprises II, LLCNo. 22-1933, United States Court of Appeals, Seventh Circuit (Feb. 28, 2023), the insurer dismissed a fire claim because the named insured knew, and did not tell Frankenmuth, that the sprinklers in his warehouse did not have water, a violation of substantial precedent for the insurance.
Fun F/X II, Inc. and Cao Enterprises II, LLC (collectively “FUN”) sought insurance coverage following a warehouse fire. The relevant policy issued by appellee Frankenmuth Mutual Insurance Company provides that it does not cover losses if, prior to the fire, the policyholder knew of a shutdown or malfunction in an automatic sprinkler system but had not notified Frankenmuth of the problem. Based on this policy exclusion, the district court granted summary judgment for Frankenmuth.
UNDISPUTED FACTS
FUN is a retailer of costumes and theater supplies that stored its inventory in a warehouse in South Bend, Indiana owned by Cao Enterprises II, LLC. Victor Cao is the sole member of Cao Enterprises II, LLC and the sole shareholder of FUN. Cao bought the warehouse in 1999. It then had a functional sprinkler system with a working water supply. Cao replaced the sprinkler heads around 2004 and hired inspection companies for routine system testing. In 2016, an inspector from Legacy Fire Protection found no problems.
When the same inspector returned on September 28, 2017, the sprinkler system had no water pressure. The inspector notified Cao and the two immediately called South Bend Water Works. On November 15, 2017, Cao spoke with the city’s fire inspector to try to resolve the issue.
Cao never heard from any waterworks staff and did nothing else to check if the water was actually restored. No one ever told Cao the source of the problem, let alone that the problem had been fixed.
The next year, another employee from Legacy Fire Protection performed the annual inspection of the warehouse. Cao was not present at that inspection in September 2018 and was not informed of any problems.
THE FIRE
A fire destroyed the warehouse and all its contents on July 26, 2019. FUN claimed losses of over $7 million. The sprinkler system still had no water flowing to it. After the fire, the cause of the problem was discovered:
The city had apparently cut and capped the pipe that feeds the sprinkler system in April 2017 when the building next door was demolished. Cao learned that the worker who cut the pipe mistakenly believed that the FUN warehouse would also be demolished.
Frankenmuth Mutual Insurance Company’s policy contained an exclusion stating that Frankenmuth “will not pay for loss or damage caused by or arising out of fire if, prior to the fire: 1. You knew of any suspension or impairment of any coverage set forth in the schedule above and failed to notify us of that fact.” The referenced schedule listed automatic sprinkler systems as protective measures.
It was undisputed that Cao never notified the insurer after learning in September 2017 that the sprinkler system lacked a functioning water supply. It is also undisputed that no one ever told Cao before the fire that the water flow had been restored.
Frankenmuth sued seeking a declaratory judgment that it did not owe insurance coverage to FUN for losses from the fire. FUN asserted a counterclaim for breach of insurance. The trial court granted summary judgment in favor of Frankenmuth based on the policy’s exclusion of coverage. The court found that the sprinkler system had no water flowing to it — and that FUN, through Cao, knew of this impairment but failed to notify Frankenmuth.
ANALYSIS
Insurance policies are generally interpreted using familiar contract analysis rules and the interpretation is often a legal matter. Where the policy language is unambiguous, plain meaning prevails.
The safeguards note is clear and easy to apply to the facts. Cao admits he knew water was not flowing to the sprinkler system on at least two occasions: the September 2017 inspection and his communication with the city fire inspector in November 2017. He admits no one ever told him the water flow had been restored. Cao also admits that he never told Frankenmuth about this lack of water flow.
The function of the sprinkler system was to deliver water in the event of a fire. When Cao learned there was no water in the system, he was told there was a “suspension or impairment” in the system and needed to report the problem to Frankenmuth if he wanted to keep the fire insurance. Because there is no genuine factual dispute on the triable issue that FUN knew of a shutdown or deterioration of the sprinkler system prior to the fire and failed to report this problem to Frankenmuth. Cao knew in September and November 2017 that the system had no water flowing to it but never reported the deterioration to Frankenmuth.
The approval of protective measures set a precedent for recovery of compensation under the policy. Because the insured knew that water was not flowing to the sprinkler system and did not tell its insurer about this, the seven million dollar loss was not covered by the policy. FUN and Cao are not without a cure. The city negligently turned off his water supply and he can sue to recover his loss due to its negligence.
(c) 2023 Barry Zalma & ClaimSchool, Inc.
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Barry Zalma, Esq., CFE, now limits his practice to serving as an insurance consultant specializing in insurance coverage, insurance claims management, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims attorney and more than 54 years in the insurance industry. He can be reached at http://www.zalma.com and zalma@zalma.com
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