Insurer Defeats Business Interruption Claim on Property Insurance Policy and Accompanying Bad Faith Claim in Federal Court in North Carolina

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A Raleigh jewelry store recently lost its bid to prove coverage, bad faith and punitive damages in a classic case of seemingly strong evidence but actually nothing-burger evidence. In Michael Borovsky Goldsmith, LLC v. Jewelers Mutual Insurance Company, 2019 W.L. 165703 (E.D.N.C. January 9, 2019), the Eastern District of North Carolina granted summary judgment on all counts and sent the jeweler home empty handed. This is an all-too-familiar outcome for insureds and insurers in North Carolina – insured sustains a loss, insurer denies the claim due to exclusions, insured sues for coverage and bad faith and insurer gets a 100% win on summary judgment.

Here is what happened in this one: during the fall of 2013, Michael Borovsky Goldsmith, LLC (“Goldsmith”) and its customers noticed a foul odor permeating the jewelry store. It smelled like rotten eggs, sewage and mold. A plumber hired by Goldsmith “speculated” that a grease trap on the adjacent restaurant’s premises was the cause. For some reason, the landlord and property management company could not assist and thereafter customers signed a petition urging action to address the odor. A year later, in December 2014, Michael Borovsky (“Borovsky”), the owner of Goldsmith, first noticed a water leak on the premises coming from a water tank in an adjacent restaurant and also noticed mold on the wall of the jewelry store. A mold remediation firm inspected the premises and found visible mold growth in the store and a high level of mold in the interior air sample. Sometime during 2015, a store clerk noticed the mold begin to “bubble.”

The jewelry store decided to make a claim for lost business income on its property insurance policy due to the presence of mold. At about the same time, the store closed its Raleigh location, operated online for a while and then re-opened in a new location several months later. The property policy covers lost business income due to the “necessary suspension” of operations “caused by direct physical loss of or damage to” covered property that was “caused by or resulted from a Covered Cause of Loss.” The policy generally excludes coverage for fungi, which includes mold and mildew, unless the fungi result from fire or lightning or damage results in a “specified cause of loss.” The policy provides for limited coverage in the event of a “specified cause of loss.” A “specified cause of loss” means, among other things, “water damage” with a sublimit of $15,000. However, the policy also excludes loss or damage that result from “continuous or repeated seepage or leakage of water ... that occurs over a period of 14 days or more.”

Upon receipt of the claim, the insurer, Jewelry Mutual Ins. Co., retained an independent claims adjuster who inspected the Raleigh store. The adjuster provided a report to the insurer and concluded that “the loss appeared to be the result of a long term leak in the water supply line.” The report noted that there was evidence of rust on the steel framing between Goldsmith’s unit and the adjacent restaurant. Although the report stated that it “is unclear if [the odor] is related to the water damage,” it recommended denying Goldsmith’s claim for coverage because the water leak fell within the insurance policy’s exclusion for continuous water damage. The report also recommended denying coverage for the claim because Goldsmith did not provide prompt notice of the claim as required by the insurance policy. Whereupon, the insurer denied the claim because the policy “excluded coverage for loss or damage caused by a long-term water leakage and mold” and because Goldsmith failed to provide prompt notice of the loss. The insured Goldsmith countered that the water leak from the adjacent restaurant was not the sole cause of the odor, which was never identified conclusively. Furthermore, Goldsmith denied that it failed to submit a timely claim because Borovsky believed that the landlord would provide assistance and saw no immediate need to involve Jewelers Mutual.

Goldsmith filed a complaint in state court against the insurer alleging breach of contract, breach of the implied covenant of good faith and fair dealing and bad faith refusal to settle, seeking $25,000 in damages on each claim and $25,000 in punitive damages on its bad faith claim. The insurer removed the case to federal court, the Eastern District of North Carolina. Presiding United States District Court Judge was James C. Dever, III.

On the insurer’s motion for summary judgment, the court seemed to have no trouble finding for the insurer and handing the insured a defeat. The lack of evidence supporting the insured was key.

The court first addressed the contract claim. On one hand, the evidence for the insurer was strong. In December 2014, Goldsmith first detected a water leak coming from a water tank in the adjacent restaurant. Jewelers Mutual determined that the long-term water leak and resulting mold caused Goldsmith’s loss of business income. The report from the independent claims adjuster concluded the “loss is the result of a long term leak” that “has been ongoing since at least December 2014.” That report also noted “evidence of rust on the steel framing between the insured’s unit” and the adjacent restaurant. On the other hand, the insured had no evidence to defeat summary judgment. The court observed that although Goldsmith argued that the precise cause of the odor was not identified and that the odor was a separate issue from the mold and the water leak, the insured failed to produce specific admissible evidence to rebut the insurer’s evidence and create a genuine issue of material fact. Goldsmith did not cite any evidence to support the theory that the mold, odor and water leak were causally unrelated. Viewing the evidence in the light most favorable to Goldsmith, the court held that no rational jury could find that the continuous water leak that occurred in 2014 over a period of 14 days or more from the adjacent restaurant did not cause the mold and odor that caused Goldsmith’s loss of business income. Accordingly, the court granted Jewelers Mutual’s motion for summary judgment concerning the breach of contract claim.

The court next addressed the bad faith claims - breach of the implied covenant of good faith and fair dealing and bad faith refusal to settle.  

Every contract contains an implied covenant of good faith and fair dealing, whereby neither party will do anything which injures the right of the other to receive the benefits of the agreement. Where parties have executed a written contract, an action for breach of the covenant of good faith and fair dealing is part and parcel of a claim for breach of contract. Accordingly, when a court rejects a breach of contract claim, it likewise rejects any claim for breach of the covenant of good faith and fair dealing contained in the contract. Thus, here the court concluded the insured’s claim failed on this basis. 

The court then considered the insured’s alternate theory of bad faith. North Carolina law recognizes a claim for breach of the covenant of good faith and fair dealing in the insurance context, which requires proof of (1) a refusal to pay after recognition of a valid claim; (2) bad faith; and (3) aggravating or outrageous conduct. The claim for bad faith refusal to settle has the same three elements of proof. However, legitimate and honest disagreement over the scope of coverage under an insurance contract does not amount to bad faith. Rather, when an insurer denies a claim because of a legitimate, honest disagreement as to the validity of the claim, the insurer is entitled to judgment as a matter of law because the plaintiff cannot establish bad faith or any tortious conduct on the part of the insurer. Bad faith does not encompass an honest disagreement or innocent mistake. Aggravated conduct includes fraud, malice, gross negligence and insult, as well as actions denying coverage willfully, or under circumstances of rudeness or oppression, or in a manner which evinces a reckless and wanton disregard of the plaintiff’s rights. Here, the problem for the jewelry store was that no evidence showed that the insurer ever recognized the insured’s claim as a legitimate one for coverage under the policy. Further, because Jewelers Mutual denied coverage based on a legitimate, good-faith disagreement, Goldsmith also failed to show that bad faith or aggravating circumstances exist. Accordingly, the court granted summary judgment to the insurer concerning Goldsmith’s claims for breach of the covenant of good faith and fair dealing and bad faith refusal to settle.

In closing, this was not a good result for the policyholder. On the surface, the evidence seemed supportive of the insurance claim because the policy covered mold resulting from water damage and in December 2014 the owner of the insured discovered a water leak that was caused by a water tank from the adjacent restaurant. The insured even had a mold remediation firm conduct an investigation and the presence of mold was confirmed. Had the insured notified the insurer right then and there, the claim might have turned out favorably for Goldsmith (assuming there was “business income” lost between the fall of 2013 and December 2014). But the insured waited too long. And failing to present evidence to support the theory that the mold, odor and water leak were causally unrelated was fatal for the insured. 

On the flip side, the result for Jewelers Mutual was another example of a strong defense defeating a questionable insurance claim. The report of the independent claims adjuster was the key piece of evidence with which the insurer could defend itself. The finding of a long term leak in the water supply line clearly fit within the exclusion for damage resulting from “continuous or repeated seepage or leakage of water ... that occurs over a period of 14 days or more.” The bad faith claim carried no weight in light of the fact that the insurer never recognized the insured’s claim as a valid one and the fact that the insurer denied coverage based on a legitimate good faith disagreement. We will see whether Goldsmith appeals to the Fourth Circuit.

Jim Bryan is the leader of Nexsen Pruet's Torts, Insurance and Products group, and is based in the firm's Greensboro office. His litigation practice concentrates on insurance coverage/bad faith, trucking industry defense, commercial disputes, lender liability, premises liability, environmental disputes and fiduciary trust litigation.