Insurance Policy Did Not Cover Preemptive Measures to Avoid a Larger, Covered Loss

This is a non-construction case that will impact construction parties. The Massachusetts Supreme Judicial Court has held that costs incurred by an insured in order to prevent greater losses are not covered by insurance, even though the greater losses (now avoided) would have been covered.

The Massachusetts SJC takes pains to note that its decision is not a general rule and is specific to the policy terms in question. And yet, it signals to insured parties that they may face an uphill battle when they mitigate the impact of what could be covered losses, and then seek to recover the cost of mitigation.

Ken’s Foods had a pollution liability policy that covered cleanup costs, emergency expenses, and business interruption losses arising from a covered pollution event. When a wastewater treatment system malfunctioned, resulting in a release of contaminated water into a public river, Ken’s Foods took immediate action. It performed the cleanup and implemented a temporary wastewater treatment system in order to avoid suspension of operations. It reportedly incurred, and sought coverage for, $3 million in costs. Ken’s Foods further claimed that without incurring those costs, it would have sustained $10 million per month in business interruption losses, for a 1-2 month period at issue. Although Steadfast reimbursed Ken’s Foods for emergency cleanup costs of more than $850,000, it denied coverage of any other amounts claimed for the temporary system.

After the denial of coverage, Ken’s Foods sued. The federal court reported the issue in question to the Massachusetts SJC:

To what extent, if any, does Massachusetts recognize a common-law duty for insurers to cover costs incurred by an insured party to prevent imminent covered loss, even if those costs are not covered by the policy?

The policy excluded costs associated with any “maintenance, upgrade or improvement of, or installation of any control to, any property or processes,” even if such action was required either by a governmental authority, or as a result of cleanup costs or other losses covered by the policy. Further, the business interruption coverage only became effective after four days’ suspension of operations. Steadfast argued that the temporary treatment system was an “upgrade or improvement” and, further, that Ken’s Foods had never suspended operations, and thus never invoked the business interruption coverage.

The policy included a mitigation of loss provision, in the event that operations were suspended. But this mitigation provision did not require Ken’s Foods to prevent any such suspension.

The SJC stated that it would not answer the question with respect to common law duties, since it was able to answer specific to the policy language at issue. With reference to the policy terms, the court noted that –

[T]here was no suspension of operations. Ken's Foods was not ordered to discontinue operations, nor did it do so itself to avoid such an order. Rather, Ken's Foods avoided a “partial or complete suspension” by implementing process changes allowing for the pretreatment and release of wastewater, and negotiating pollution allowances and accompanying fines with the county authority. These very measures showed that a partial or complete shutdown was not “necessary,” albeit due to the creative response of Ken's Foods and the flexibility of government regulators. Because there was never a suspension of operations, Steadfast was not responsible for the costs according to the express terms of Coverage H.

Although this decision is limited by policy terms, the message is clear – there will be no aid given to insured parties, for coverage of preemptive costs incurred, if the policy language can be read otherwise. For contractors who voluntarily undertake remedial work of otherwise-covered claims, in order to maintain their reputation or good business relations, this will cut off an avenue of recourse that might otherwise be available – even when that preemptive action avoids larger, covered claims.

The case is Ken's Foods, Inc. v. Steadfast Insurance Company, 491 Mass. 200 (Jan. 6, 2023).