A federal appeals court reversed an auto parts manufacturer’s summary judgment win, construing a policy limitation on flood hazards to apply broadly to all types of losses, even though the limit “does not expressly say what losses it limits.” In Federal-Mogul LLC v. Insurance Company of the State of Pennsylvania, manufacturer Federal-Mogul suffered more than $60 million in property and time-element losses following a 2011 flood in one of its factories in Thailand. Federal-Mogul submitted a claim to its insurer, but the insurer refused to pay more than $30 million because the flood occurred in a high hazard flood zone, to which the insurer argued a sublimit in the policy applied.

Federal-Mogul sued the insurer, an AIG company, in Michigan federal court, arguing that the $30 million sublimit applied only to property damage and could not be used to bar recovery for its unpaid $25 million in time-element losses (i.e., economic losses from interrupted business operations). The district court agreed and granted partial summary judgment for Federal-Mogul, finding that the high-hazard provision acted as an exclusion and, thus, the insurer’s “failure to clearly and unambiguously limit liability for time element losses under the high hazard sublimit” required that the provision be construed in favor of coverage.”

The Sixth Circuit reversed this pro-policyholder decision on appeal. In remanding to the district court, the Sixth Circuit recognized that “[t]he policy does not define the scope of [the] sublimit.” Moreover, “[t]o be sure,” the court confirmed, the sublimit “does not expressly say what losses it limits.”  Ignoring these acknowledged ambiguities, the court looked to other policy provisions—namely, the definition of “Flood” coverage and the policy’s general limit of liability—to broadly construe, improperly, the exclusionary language in the sublimit provisions to include both property and time-element losses. In particular, the court emphasized that the general limit of liability, which explicitly applied to all losses “regardless of the number of ‘locations’ or coverages involved,” stated that it “more specifically” limited the insurer’s liability through various sublimits, including the high-hazard sublimit at issue.  Contrary to generally accepted rules governing policy interpretation, the court rejected Federal-Mogul’s argument that the policy was unclear because it had not sufficiently demonstrated that the sublimit was ambiguous.

In construing the policy limitation broadly to apply to all types of coverages, the court ignored, and reversed, the pertinent burden of proof, which was an integral part of the district court’s decision. Under Michigan law—as is the case nationwide—where an insurer relies on an exclusion or limitation to limit recovery, the insurer must demonstrate that the policy clearly and unambiguously limits liability for the disputed loss. If the insurer fails to meet this high standard, then courts must construe the provision against the insurer and in favor of coverage, as the district court did on summary judgment.

Here, it was undisputed that the insurer applied the sublimit to reduce Federal-Mogul’s recovery of millions of dollars in time element losses to zero based on its interpretation of the high-hazard sublimit for floods. The correct question on appeal, therefore, was not whether the policyholder had shown that the sublimit was ambiguous, but rather whether the insurer had demonstrated that the $30 million sublimit for high-hazard zones clearly and unambiguously applied to all loss or damage arising out of a flood. This is a difficult burden to meet, especially where, as the Sixth Circuit noted, the policy fails to define the scope of the sublimit and the sublimit itself is silent on what losses it limits. The opinion raises many other issues, but we expect the policyholder to focus on this critical burden issue in fighting for coverage on remand.