Smell May Constitute Physical Loss Under Policy

The New Hampshire Supreme Court recently held that a persistent odor could constitute a “physical loss” under a homeowner’s insurance policy as long as the smell distinctly and demonstrably changed the condition of the property. The decision represents an important statement about policy interpretation, defining “physical loss” and applying pollution exclusions.

In Mellin v. N. Sec. Ins. Co., Inc., No. 2014-020, 2015 N.H. LEXIS 32 (Apr. 24, 2015) the insureds owned a condo that they rented to various tenants. Shortly after renting the upstairs unit, a tenant moved out complaining of a cat urine odor which had come through an open plumbing chase from the downstairs unit where another tenant owned multiple cats. After the insureds moved into the unit themselves and noticed the odor, a health inspector advised them to move out temporarily while the units were cleaned. Unfortunately, they could not rid the smell. They were unable to find new tenants and ultimately sold the condo at a significant loss.

The insureds sought coverage under their homeowner’s insurance policy due to the “direct physical loss” caused by the cat urine odor. The insurer said coverage did not apply because the smell did not constitute a “physical loss” and, even if it did, the damage caused by the smell was specifically barred under the policy’s pollution exclusion. The trial court agreed with the insurer but the New Hampshire Supreme Court reversed the decision, finding in favor of the insureds.

The policy covered “direct loss to property… only if that loss is a physical loss to property.” The insurer argued that “direct” and “physical loss,” though undefined in the policy, indicated coverage only for a tangible change to the property—altering the appearance, color, or shape of the unit. But the Supreme Court thought that “physical loss” need not be limited to changes that could be seen or touched, but could also include changes perceived by smell.

The court recognized that some jurisdictions interpret “physical loss” more narrowly. A Michigan court has said that intangible harms like pervasive odors, mold and bacterial contamination, and water damage, do not constitute physical loss. Universal Image Productions, Inc. v. Chubb Corp., 703 F.Supp. 2d 705 (E.D. Mich. 2010). And an Oregon court said that asbestos did not cause a direct physical loss because the building remained physically intact and undamaged. Great N. Ins. v. Benjamin Franklin Fed S & L, 793 F.Supp. 259 (D. Or. 1990). Nevertheless, the court found support for its ruling in a “substantial body of case law” holding that “a variety of contaminating conditions, including odors, have been held to constitute a physical loss to property.” A New Jersey court concluded that an ammonia spill constituted a physical loss as it “physically changed the air” and rendered the building temporarily unfit for occupancy. Gregory Packaging, Inc. v. Travelers Prop. Cas. Co. of Am., No. 2:12-cv-04418, 2014 U.S. Dist. LEXIS 165232 (D.N.J. Nov. 25, 2014). The Colorado Supreme Court found that gasoline vapors rendered a building uninhabitable and were a “direct physical loss.” Western Fire Ins. Co. v. First Presbyterian Church, 437 P.2d 52 (Colo. 1968). Likewise, the pervasive odor from a methamphetamine lab was found by an Oregon court to be “physical loss.” Farmers Ins. Co. v. Trutanich, 858 P.2d 1332 (Or. Ct. App. 1993).

But the court also noted that a certain threshold must be met to constitute a physical loss, and concluded that the term “physical loss” requires a “distinct and demonstrable alteration of the insured property.” The court said that whether tangible or intangible, changes rendering a property temporarily or permanently unusable or uninhabitable may support a finding of physical loss, as may have been the case here.

Turning to the pollution exclusion, the court found the exclusion ambiguous and was unwilling to read the exclusion as including the odor of cat urine. The pollution exclusion excluded coverage for damage caused by pollutants and defined “pollutants” as any “irritant or contaminant, including … vapor … and fumes.” But the court observed that if taken to include cat urine, such terms might also include items such as “soap, shampoo, rubbing alcohol, and bleach insofar as these items are capable of reasonably being classified as contaminants or irritants” and concluded that the definitional phrase “any irritant or contaminant” was too broad to meaningfully define pollutant, leaving the word effectively undefined by the policy. Without a definition, the court attributed a plain and ordinary meaning to pollutant, which it did not think included the smell of cat urine. The court distinguished between odors coming from industrial or commercial facilities, like large-scale farms or waste-processing facilities, which the insured may have reasonably understood to be excluded as pollution, and “everyday activities gone slightly awry” like an odor in a private residence caused by common domestic animals. The court found the exclusion ambiguous as applied to the facts of this case and therefore inapplicable.

Two dissenting judges would have read the pollution exclusion more favorably for the insurer, saying that it unambiguously excluded coverage for loss caused by “contaminants” which means “something that contaminates” and clearly included the odor of cat urine that contaminated the apartment. The dissent disagreed that the breadth of the pollution exclusion rendered it meaningless. Noting that the ambiguity should be guided by reference to the particular set of facts, the dissent argued that the fact that “many items could satisfy the definition of ‘pollutant’ does not change the fact that this term is clearly defined in the policy.” The dissent recognized the “unfortunate result” that its strict interpretation produced but thought “the remedy must be found in the market place or through legislative action.” The majority was not so convinced and avoided a literal interpretation of the exclusion by emphasizing interpretation in light of the reasonable policyholder’s expectations.

The majority’s decision returns the case to the trial level for a factual determination as to whether or not the cat urine odor constituted a physical loss.

The case offers important guidance on a number of issues. First, the court found that a pervasive smell could constitute a physical loss, even without tangible alteration to the property, as long as the smell caused a distinct and demonstrable change to the property. Second, the court explored the applicability of the pollution exclusion and found ambiguity in the broad definition of “pollutant.” While the dissent thought the terms of the exclusion, though broad, were clearly defined, the majority concluded that the breadth of the exclusion rendered it effectively undefined and applicable only to traditional pollutants but not to “everyday activities gone awry” in a residential context. Insurers and insureds should be aware of this case as it adds to the body of case law interpreting pollution-related coverage and intangible loss.