Lead Opinion
An earthquake struck Taiwan in September 1999, disabling a substation that provided electric power to two Taiwanese factories. Lacking power, the factories could not manufacture products they were supplying to a subsidiary of Pentair, Inc. When production resumed two weeks la.ter, Pentair shipped orders from Taiwan via airfreight to meet its customers’ needs for the Christmas season, resulting in additional costs of $634,731. Pentair filed a claim for this loss under the “Contingent Time Element” provision- of the all-risk manuscript property insurance policy issued to Pentair by American Guarantee and Liability Insurance Company. American, Guarantee denied coverage, and Pen-tair commenced this diversity action. The district court
Section 10(a)(1) of the American Guarantee policy provided that the policy insures “all real and personal property ... owned, used, or intended for use by” Pen-tair. Section 11 provided that the policy covers “all risk of direct physical loss of or damage to property described herein.” Section 10(d)(1) extended the policy’s business interruption coverages
The parties agree that the Taiwanese factories were Pentair suppliers located within a covered territory for purposes of Section 10(h)(2). The district court concluded that the “direct physical loss or damage” limitation in Section 11 applies to the contingent time element coverage in Section 10(h)(2). On appeal, Pentair does not challenge this conclusion. The district court then held that Pentair’s extra expense loss is not covered under Séction 10(h)(2) because (1) the electric substation, though physically damaged by the earthquake, was not a Pentair supplier for purposes of Section 10(h)(2); and (2) the resulting power outages did not cause direct physical loss or damage to the Taiwanese factory suppliers. On appeal, Pentair challenges both conclusions, arguing that the Taiwanese substation was a Pentair supplier within the meaning of Section 10(h)(2) and, in any event, its Taiwanese factory suppliers suffered “direct physical loss” when power outages rendered them unable to perform their “intended function” of manufacturing products for Pen-tair.
1. We agree with the district court that the power substation was not “a supplier of goods and/or services” to Pentair within the plain meaning of Section 10(h)(2). Pentair relies on two cases holding that Midwest farmers who sold grain to a licensed grain dealer, which in turn resold grain to the insured, were suppliers of the insured for purposes of a policy’s contingent business interruption coverage. Archer-Daniels-Midland Co. v. Phoenix,
2. The question whether Section 10(h)(2) covered the extra expenses incurred by Pentair because its Taiwanese suppliers suffered power outages is more difficult. Pentair initially argues that, under an all-risk policy, once it proves that a fortuitous loss occurred, American Guarantee must prove “that an express exception to the coverage applies.” Pillsbury Co. v. Underwriters at Lloyd’s, London,
On appeal, Pentair argues that its Taiwanese suppliers’ inability to function after the loss of power constituted direct physical loss or damage. Pentair cites np case holding that mere loss of use or function constitutes “direct physical loss or damage” within the meaning of a provision like Section 11 of the American Guarantee policy. . Pentair relies on two Minnesota Court of Appeals opinions that emphasized the functional impairment of insured property in concluding that the insureds had established “direct physical loss.” Sentinel Mgt. v. N.H. Ins. Co.,
Though the parties framed the coverage issue in terms of Section 10(h)(2) as limited by Section 11 and cases construing the term direct physical loss or damage, we conclude that these are not the only relevant policy provisions. The loss to Pentair resulted from a power outage. In this age of massive electric power grids, occasional catastrophic blackouts, and broad business interruption coverages, we would expect the subject of power outage losses to be explicitly addressed in cases construing all-risk policies, and perhaps in the policies themselves. Surprisingly, we found no reported case addressing whether a loss of poweif by itself constitutes property damage. But a few courts, including the Supreme Court of Minnesota, have addressed whether a loss of power that causes other damage to the insured’s property results in a covered loss. In Lipshultz v. General Insurance Co. of America,
Lipshultz is not directly relevant to this case because it involved coverage of physical property damage, not coverage of a business interruption loss. Closer to the mark is American Guarantee & Liability Insurance Co. v. Ingram Micro, Inc.,
Presumably in response to cases like Lipshultz and Ingram, some insurance policies have included an off-premises services exclusion to eliminate coverage for property and business interruption losses caused by power outages. This exclusion has met with mixed success in the courts. Compare Pressman v. Aetna Cas. & Sur. Co.,
With this case law on the landscape, the parties to a large all-risk manuscript policy covering property and business interruption losses might sensibly decide to explicitly cover the foreseeable question of whether and to what extent the policy will cover losses caused by power-failures resulting from covered perils such as an earthquake, rather than relying on a court to resolve this issue applying the direct-physical-loss-or-damage limitation in Section 11. And in fact, the parties to the American Guarantee policy did address the issue. The second sentence of Section 24 of the policy provided:
This policy is also extended to insure against loss resulting from necessary interruption of business conducted by the Insured resulting from physical damage to off-premises utility and power stations ... furnishing electricity ... to Described Premises caused by physical damage of the type insured against.
Section 24 broadly extended the policy’s business interruption, coverages to include losses from power outages resulting from covered perils, without regard to whether the power outages also cause other physical property damage. But the extended coverage was limited to losses resulting from damage to off-premises power stations “furnishing electricity ... to Described Premises.” Though the portion of the policy defining Described Premises was not included in the record on appeal, Pentair’s reply brief conceded that the term does not include “Pentair’s suppliers.” Thus, if the earthquake had damaged a substation directly servicing Pentair, any resulting business interruption losses would be covered by Section 24. But Section 24 did not broaden the contingent business ' interruption coverage of Section 10(h)(2) because Section 24 was limited to power outages at “Described Premises.” We may not assume that this
For the foregoing reasons, we conclude that the contingent business interruption loss in question was not covered either by Section 24, the policy provision explicitly dealing with damage to off-premises power suppliers, or by the plain meaning of Section 10(h)(2) and Section 11 as construed by the district court. Accordingly, the judgment of the district court is affirmed.
Notes
. The HONORABLE DONOVAN W. FRANK, United States District Judge for the District of Minnesota.
. In this type of policy, business interruption coverage is "secondary” or "consequential” in the sense that the coverage is triggered when a peril damages business property but compensates the insured for secondary consequences of the property damage. See 11 Couch on Insurance, 3d § 167:1 at p. 167-8 (1998).
. The word “contingent” is something of a misnomer; it simply means that the insured’s business interruption loss resulted from damage to a third party’s property. The term "time element” refers to business interruption losses, including extra expenses incurred, as defined in other policy provisions.
Dissenting Opinion
dissenting.
I respectfully dissent. I am persuaded by Pentair’s argument that the Taiwanese factory suppliers suffered direct physical loss when power outages rendered them unable to perform their intended function of manufacturing products for Pentair. See Sentinel Mgmt. Co. v. New Hampshire Ins. Co.,