Subrogation Arising Out of Sprinkler Discharge by Peter Mumford, Reclaim Consulting, Chicago, Illinois Sprinkler systems are a good thing. They can be effective in reducing or even extinguishing fires in commercial premises. However, there is something of the sword of Damocles about their presence, with the actual sprinkler head lurking overhead. How many people have looked up with trepidation at a sprinkler head and thought, “Is it going to suddenly let go and drench everything and everybody in this room?” This happened in a ‘clean room’ at our clients’ premises, causing havoc with our clients’ product, tools and machinery. Our client is a major manufacturer of wafer fabrication equipment for the semi‐
conductor industry. Electronics and water are not good bedfellows and the inevitable result was a claim initially estimated at $3.5 million. The message of this case is that any trial can be subject to the whims of the Court ‘on the day!’ Background In October 2000, our client contracted with defendant A for the construction of tool and assembly bays at our client’s facility, including design and installation of a fire protection sprinkler system. To ensure its work under the contract and to protect our client against any loss or damage, A agreed to maintain at least $1,000,000.00 of insurance coverage, and further agreed to require any subcontractors it hired to maintain the same amount of coverage. A subcontracted the installation of the sprinkler system to defendant B, the installation of drywall and ceiling tiles to defendant C and subcontracted the installation of other components (i.e., mechanical, electrical, cabling, etc.). B installed the sprinkler system in December 2000. Despite B knowing other contractors, including C would be working in and around the sprinkler heads, B never inspected the heads prior to the clean room being turned over to our client. Thereafter, C installed the ceiling tiles. Subsequent roof leaks caused damage to some of these tiles. C returned on four separate occasions during January and February of 2001 to replace a significant number damaged ceiling tiles. On February 7, 2001, a sprinkler head installed by B discharged. Defendant D, who was contracted to manage the fire life safety system (i.e., to test, inspect, repair, etc.), hired defendant E to inspect the entire sprinkler system, to ensure that all of the heads possessed no defects. E’s employee inspected the system. However, he did not inspect the sprinkler heads at ceiling level but from the floor, 15’ to 20’ below. In his report, E’s employee noted leaks to two other sprinkler heads and other damage. Based on E’s employee’s visual inspection, D replaced 4 to 5 sprinkler heads. According to D’s employee, the sprinkler heads inspected by E fell apart in his hands. Thereafter, E’s employee performed two separate visual inspections of the system on April 27, 2001, and August 29, 2001, noting no deficiencies or damage to the sprinkler heads. However, as with the inspection he performed following the February incident, the employee merely walked the clean room floor and looked up at the ceiling for obvious signs of damage. On October 22, 2001, another sprinkler head discharged. Individuals in the room at the time saw nothing that caused the head to fail. Unlike the February incident, the discharge caused extensive damage to our client’s building and to its semi‐conductor manufacturing tools and inventories. B subsequently replaced all of the sprinkler heads in the clean room. B found that approximately 10 to 12 sprinkler heads located in the same area as the failed sprinkler head had fusible links. According to B, many sprinkler heads had ceiling tile/drywall material lodged in the bent fusible link area. An inspection by F, manufacturer of the sprinkler heads, revealed that at least three of the damaged sprinkler heads had drywall material on the sprinkler heads. Metallurgists studied the failed sprinkler head(s) and provided an opinion as to the cause of the burst. The fusible link was known to have been the part that was bent and exhibited a tear completely through one side of the link. It was assumed that metallurgical review would find some trauma to the link that caused it to fail later by tearing at the time of the incident. No evidence was initially found of a material defect causing the loss, no evidence of failure over time, and no evidence of microscopic tearing at the fracture point that would have later lead to complete tearing of the link. It was concluded, therefore, that, logically, there was an incident that caused the complete tearing of the fusible link. This was either an incident preceding the failure where the sprinkler was subject to sufficient force to tear the link without discharging the sprinkler, or the sprinkler head was hit at the time of failure. A further report was more encouraging. An eyewitness had noted that the sprinkler leaked slightly before fully discharging. Additional examination of several of the involved heads concluded that bending had been caused by impact and that residue found around the fusible links was discerned to be plaster from board or sheet rock used for ceilings. This indicated that the problem rested with the installers of the sprinklers, the parties who caused bending of the fusible links and the parties who failed to spot the bends at final inspection. The Contractual Position The contract between our client and general contractor A contained a waiver of subrogation. It also contained a warranty. The warranty had not expired at the time of the loss and, on anticipation that defect in material, equipment or workmanship would be proven, it was considered that a breach of the warranty had occurred. What, therefore, was the interaction between the warranty and the waiver of subrogation, and would a breach of the warranty be outside the scope of the waiver of subrogation? Elsewhere in the contract there was provision for indemnification by A to our client in circumstances such as this case. A saw its relationship with our client as close and valued, and therefore A’s attorney stated that it felt A had a clear duty to indemnify our client. This was open to interpretation, and more correctly, its application was in terms of claims against our client by third parties. Further, the wording was deemed to refer only to claims involving property. How does all this pull together? The waiver of subrogation waived all rights as between the owner and contractor, their contractors, subcontractors, agents and employees, for damage caused by fire or other perils to the extent covered by property insurance applicable to the waiving party, except such rights as each may have to the proceeds of such insurance deemed to be held by a party as fiduciary. Historically, the courts variously found that standard waiver language applied to: • The actual work done by the contractor (Town of Silverton vs. The Phoenix Heat Source System 948 P.2d 9 (Colo. 1997)), which was reasonably favorable for us. • The policies of Insurance actually in place (Lloyds Underwriters vs. Craig & Rush, Inc., 26 Cal.App.4th 1194 (Cal 1994)). This was against us since our client had significant insurance coverage in place via a stock throughput policy. Overall, it was felt that we could argue on a 50/50 success rating that the ‘waiver of subrogation’ was designed to preclude only claims relating to ‘property insurance’ contemplated by the parties with respect to the building itself, not personal property that may happen to be there and covered by a completely separate policy. No case could be found that held that a waiver of subrogation precludes cause of action for breach of an express warranty as may have been found to apply in this case. We were advised that, technically, a breach of warranty or contract is not a peril, although an underlying negligent act that constitutes the breach is a peril. The warranty stated that nothing in the warranty was to be construed to limit owners’ remedies against the contractor on account of any latent defect in materials, equipment or workmanship. There could be an argument that suit could be issued for consequential damage arising out of the breach of that warranty, but there was found to be no precedent. The contrary argument was that the warranty only encompassed replacement of the sprinklers, which was done at contractors’ cost. Our client considered avoiding the waiver of subrogation by pursuing third parties only to recover its losses, and not to claim under its policy. Ultimately, however, it was considered that such a strategy was inadvisable, since legally, declining to pursue the insurance claim or coming to some agreement for reimbursement if recovery cannot be obtained from third parties will not ultimately avoid the legal effect of the waiver. The waiver waived more than subrogation. It actually waived all rights to the extent covered by property insurance applicable to the waiving party. By its express terms, it applied (in this case) where there was coverage regardless of payment. The Action The type of damage (bent fusible link), the absence of any contemporaneous event causing the damage, the existence of similar bending damage to 10 to 12 sprinkler heads and the previous sprinkler head failure demonstrated that the sprinkler head failed due to some substantial and common cause during construction. It was considered that liability to a greater or lesser extent was shown to rest on several parties. However, whilst the cause of damage was more likely the responsibility of B and C, the general contractor A was fully liable for the loss. Whilst A had contractual indemnification rights against B and C, such rights did not affect A’s liability to our client. The manufacturer of the sprinkler heads, H, faced an action on grounds that the design of the head was unacceptably vulnerable to damage since there was no guard for the very fragile fusible link area. Moreover, the heads had no warning against their use in areas such as clean rooms. Proceedings were commenced against all third parties. It was expected that some defendants would attempt to avoid liability by claiming that others doing work in the ceiling area caused the damage. However, not only did the evidence not support such tactics, our client did not contract with any party to perform work in the ceiling area from the time they first took possession of the clean room in late January 2001 until the time of the discharge in October 2001. The only work occurring related to work performed by A’s subcontractors under the construction contract. In fact, our client contracted with F to perform routine maintenance for the mechanical systems in the building, however F performed no work in the ceiling area during 2001. Our client also contracted with another company, G, to provide routine electrical maintenance and service, however, again it was found that G performed no work in the ceiling area during this period. As the contractor hired E to inspect the sprinkler heads following the February incident, and to perform quarterly inspections on the system, it was considered that E was liable for failing to discover the defect in the sprinkler head. Had E performed a detailed, rather than cursory inspection of the system, the loss could have been avoided. As the general contractor that hired E, D was also liable. A responded by submitting a motion for summary judgment/ adjudication, addressing the waiver of subrogation clause. The Court threw the motion out but did not provide any comment or view on the waiver issue. Nevertheless, the matter then proceeded with discovery, depositions, etc. The case next went to mediation, with all parties in attendance. All defendants denied liability and were clearly looking to suggest that our client was in fact guilty of horseplay resulting in an object hitting the sprinkler heads. The manufacturers, H insisted that the sprinkler heads were not faulty and the general contractor A submitted that if the case were to go to trial, they would revive the waiver issue and fight it. Various proposal packages were offered to the defendants but all were rejected, thus preparation for trial continued, although there was still every hope that a settlement could be negotiated out of court, provided our evidence could be strengthened. A second mediation was set up, at which it was forecast that some of the defendants might be willing to participate in a settlement package. Research prior to the mediation suggested that damage likely occurred during the construction work by A or one of their subcontractors. C submitted an allegation that one of its employees saw one of our clients’ people kicking a soft football around. There was found to be little substantiation for this theory amongst those present at the time. Evidence was also obtained suggesting design fault, or vulnerable design, or impact from ceiling tile or sheet rock during initial installation, but looming in the background was the potential waiver issue that A threatened to resurrect at a trial. It was therefore considered the best tactic to try to settle. At the second mediation, the defendants split into two camps. Manufacturer H and fire life safety contractor E declined any interest in settlement negotiations, whereas Construction defendants A, B and C expressed willingness to separately negotiate a settlement, and offered $300,000.00, which was unacceptable. It was not possible to reach settlement on that day and the defendants engaged in tactical arguing. H was the subject of a deposition that reflected badly on them. H had submitted a summary judgment application, which it then withdrew after it had seen the weight of evidence showing a number of similar failures and design issues with its sprinklers. Considering the heavy cost of preparing for trial involving all defendants, it was felt that if settlement could be agreed at best possible terms with construction defendants, the risk of losing leverage against those defendants who did not participate in such settlement was less than the advantage gained by recouping money from those willing to settle. It would also significantly reduce the cost burden of trial preparation. The actual cost of replacing the damaged equipment was found to be potentially less than originally assessed, and the real value of the claim in court was assessed at something around $1.4 million plus costs, which if proved raised the claim to approximately $2 million. Adding interest and costs to the above figures produced a claim between $1.6 million and $2.3 million. At the second mediation, construction defendants had offered $300,000.00. Our figure was $800,000.00. The mediator thought that our case was worth $600,000.00 or thereabouts. Construction defendants A, B and C plus defendant D, the fire life and safety management company then requested further negotiations, omitting E, the inspectors, and H. A third mediation was quickly set up. After a long day, settlement was agreed at $100,000.00 with D, and at $600,000.00 with the other construction defendants. The cases against manufacturer H and inspector E were a little different. This was effectively a product liability case and focused on producing evidence of previous failures to prove fault to the court. The case against the inspectors was far simpler. We had to simply establish that the inspections carried out after both sprinkler discharges were inadequate (which basically had already been done). The only caveat was that we nevertheless were obliged to prove that the damage occurred after the first incident. The Trial Pretrial, further attempts at settlement with H and E failed. The offers were unacceptable, hence trial went ahead and further costs incurred in additional depositions, investigation and evidence gathering. Evidence obtained in the month leading up to trial gave a stronger case of a design defect. On the day of the trial, therefore, there was optimism that the Court would find in our favor. The spirits were not with plaintiffs on the day! • The Judge disallowed much crucial evidence for the prosecution. The evidence on previous failures was thrown out, thus the case for design fault was significantly weakened by not being able to finesse the argument. • The jury had five engineers, who took a defensive view. • The defense put a witness on the stand that, within the rules of the trial, should not have been there. It was obvious why he had been brought in ‐ he was a good speaker and very persuasive. Objections were made to the Judge, however, these were disallowed. The trial ended in a verdict in favor of the defense, on the grounds that there was insufficient proof of negligence on the part of E who had submitted that they were only required to get the system back and running and any inspections were the responsibility of other parties. The case against H of course foundered on the basis that the crucial evidence of previous failures had been disallowed. Ultimately, negotiations over costs culminated in payment to the two defendants of a sum, which although disappointingly significant, was far lower than had originally been demanded by the defendants. Plaintiffs had the option of appeal and a new trial, however, the outcome was deemed to be too risky to warrant the further substantial cost. The Message Trials can be fraught with unknowns, improbabilities, injustices, and surprises. There is no such thing as a cast iron case and confidence can be extremely misplaced. This article appeared in the Winter 2007 Issue of the NASP Subrogator. ©NASP