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Ingenco Holdings, LLC v. ACE American Insurance Co.

United States Court of Appeals, Ninth Circuit

April 15, 2019

Ingenco Holdings, LLC, a Delaware limited liability company; Bio Energy (Washington), LLC, a Delaware limited liability company, Plaintiffs-Appellants,
v.
ACE American Insurance Company, Defendant-Appellee.

          Argued and Submitted June 12, 2018 Seattle, Washington

          Appeal from the United States District Court for the Western District of Washington D.C. No. 2:13-cv-00543-RAJ Richard A. Jones, District Judge, Presiding.

          Philip A. Talmadge (argued), Talmadge/Fitzpatrick/Tribe, Seattle, Washington; Robert J. Rauch, Law Offices of Robert J. Rauch, Bow, Washington; for Plaintiffs-Appellants.

          Anton Metlitsky (argued), O'Melveny & Myers LLP, New York, New York; Kimya Saied and Jonathan D. Hacker, O'Melveny & Myers LLP, Washington, D.C.; Michael L. Foran and Thomas B. Orlando, Foran Glennon Palandech Ponzi & Rudloff PC, Chicago, Illinois; for Defendant-Appellee.

          Before: Dorothy W. Nelson and Paul J. Watford, Circuit Judges, and Dean D. Pregerson, [*] District Judge.

         SUMMARY[**]

         Washington Insurance Law / Fed. R. Civ. 37 Sanctions

         The panel affirmed the district court's application of Washington law and its discovery sanctions against appellants, reversed the grant of summary judgment that was entered in an insurer's favor, and remanded for trial in a diversity insurance coverage case.

         Appellants operate a gas purification plant in King County, Washington. Appellants' insurer, Ace American Insurance Company, denied coverage when appellants sought to recover for damages sustained after metal brackets broke resulting in an eventual shutdown of the entire plant.

         The panel held that the district court properly applied Washington law to this insurance coverage dispute.

         Concerning the insurer's argument that appellants' failure to give notice of the initial failure and shutdown violated a condition precedent to coverage under the all risks policy, the panel held that there was a triable issue of fact as to whether the insurer was prejudiced by appellants' remedial actions.

         Concerning the insurer's argument that the cause of the damage was an "external" force not covered by the all risks policy, the panel held that there was at the very least a triable issue of fact whether appellants' loss was fortuitous. The panel further held that a determination that a particular loss was fortuitous could obviate the need to examine whether that loss was caused by an external force. The panel concluded that the district court's grant of summary judgment to the insurer on the question of whether appellants' loss was the cause of an "external cause" must be reversed because the district court failed to consider the role of fortuity in all risks insurance disputes.

         In Vision One, LLC v. Philadelphia Indem. Ins. Co., 174 Wash.2d 501, 515 (2012), the Washington Supreme Court held that insurance ensuing loss clauses ensure that, where an uncovered event takes place, any ensuing loss which is otherwise covered by the policy remains covered, even though the uncovered event itself is never covered. Applying Vision One to the facts at hand, the panel held that even if it were conclusively established that appellant's diffuser shield suffered from some inherent defect, the subsequent destruction of absorbent beads would be covered under the policy's ensuing loss exception.

         The panel held that there was a genuine dispute of material fact as to whether the policy's Boiler and Machinery endorsement applied to independently confer coverage for appellants' losses.

         Assuming there was coverage, the policy covered business interruption losses for only the time required with the exercise of due diligence to rebuild the damaged property. The panel held that although appellants' actual time to repair might be relevant to the question whether the sixteen-month shutdown was consistent with the exercise of due diligence, it was by no means dispositive of the issue.

         The district court determined that appellants willfully withheld evidence of damages on its state law statutory claims, and as a Fed.R.Civ.P. 37(c) sanction, the district court precluded appellants from introducing such evidence. The panel held that appellants failed to explain its failure to meet its affirmative obligations under Fed.R.Civ.P. 26. The panel also held that the district court did not abuse its discretion in sanctioning appellants for failure to disclose statutory damages information to the insurer, even though those damages resulted in the dismissal of appellants' statutory claims.

          OPINION

          PREGERSON, District Judge.

         Appellants operate a gas purification plant in King County, Washington. In 2010, metal brackets securing a crucial component broke, resulting in damage to other components and an eventual shutdown of the entire facility. Appellants' insurance carrier Appellee ACE American Insurance Company ("Ace"), denied coverage, and Appellants sued. The district court, applying Washington law, granted summary judgment in Ace's favor and sanctioned Appellants for discovery violations.

         We have jurisdiction under 28 U.S.C. § 1291. We affirm the district court's application of Washington law and its discovery sanctions against Appellants, but reverse its grant of summary judgment in Ace's favor and remand for trial.

         FACTUAL AND PROCEDURAL BACKGROUND

         A. Damage to the gas purification plant

         Appellants, Ingenco Holdings, LLC and its wholly owned subsidiary, Bio Energy (Washington), LLC (collectively, "Ingenco") operate a gas purification plant at the Cedar Hills landfill in King County, Washington. The plant converts raw landfill gas into usable natural gas. The final step of the purification process involves the removal of excess nitrogen from the landfill gas in a nitrogen rejection unit, or "NRU". The gas is directed through adsorbent beads, to which nitrogen adheres, contained within pressure vessels. The beads, which are essentially a filter medium, cannot withstand the direct pressure of the landfill gas inflow, which, if unmediated, can grind the beads down into dust. To reduce the force of the gas flow on the beads, a "diffuser basket" is suspended from the top of, and surrounds, each bead-filled pressure vessel. The diffuser basket, in particular its perforated bottom plate, acts as a shield that prevents the full force of the incoming landfill gas from striking the beads directly. Instead, the incoming stream of gas strikes the diffuser basket's bottom plate first, is diffused, and then passes through the beads in the pressure vessel with reduced force.

         The diffuser basket bottom plate, or shield, is secured to the rest of the diffuser basket by metal straps, or brackets. On October 1, 2010, the metal straps securing the bottom plate of pressure vessel number thirty-two's ("V32") diffuser basket broke and the bottom plate fell away, leaving the beads in V32 unprotected. The parties dispute the reason for the breakage. Ace maintains that the bottom plate flexed, leading to excess stress upon, fractures in, and ultimately failure of, the metal straps. Ingenco contends that the bottom plate could not flex unless subjected to pressures far greater than those present within the nitrogen rejection unit. Instead, Ingenco posits, the flow of landfill gas caused the bottom plate's metal straps to vibrate at a frequency that coincidentally matched the straps' natural vibration frequency, or resonant frequency.[1] These unforeseeable vibrations, Ingenco argues, caused the metal straps to change shape and break.

         Whatever the cause of the strap breakage, once the diffuser basket's bottom plate fell away from the assembly, there was no longer any shield in place to protect the adsorbent beads from the full pressure of the incoming stream of landfill gas. The unmediated gas flow pulverized the 30, 000 pounds of beads in V32 into dust, resulting in an automatic total shutdown of the facility on October 5, 2010.

         Ingenco thought it had removed, or would be able to remove, the dust from all gas processing systems, and restarted the facility on October 13, 2010. Unbeknownst to Ingenco, however, dust from the pulverized beads in V32 had infiltrated other parts of the system, including other bead-containing pressure vessels. Dust from the V32 beads abraded against undamaged beads in the other pressure vessels, degrading those beads as well. Eventually, the accumulation of bead dust forced an automatic shutdown of the plant in March 2011. The plant remained idle for several months as Ingenco investigated alternative nitrogen filtration options and undertook repairs. Ingenco did not begin cleanup or repair operations until November 2011. The plant resumed operation in August 2012.

         B. The insurance coverage dispute

         Ingenco filed a property damage and business interruption insurance claim with Ace in May 2011. Ingenco's all risks insurance policy, issued by Ace, covered against "all risks of direct physical loss or damage occurring . . . from any external cause." The policy, however, excluded "[f]aulty or defective material, faulty workmanship, faulty methods of construction, [or] errors or omissions in plan or specification or designs . . . unless loss by a peril not otherwise excluded ensues . . . ." The policy also excluded "[g]radual deterioration, depletion, inherent vice, [or] latent defect . . ., unless such loss is caused directly by physical damage not otherwise excluded . . . ." A separate Boiler and Machinery endorsement ("the Endorsement") covered property damage and business losses "resulting from an Accident" to a pressure vessel. The Endorsement's definition of "Accident," however, excluded "depletion, deterioration[, . . . and] wear and tear."

         Ace denied coverage on several grounds. Ace claimed that, as a threshold matter, Ingenco failed to comply with a notification provision that required Ingenco to notify Ace of all losses. Specifically, Ace claimed that Ingenco failed to notify Ace of both the October diffuser shield failure and the resulting loss of beads in V32 until May 11, when the plant shut down for the second time. With respect to coverage, Ace took the position that Ingenco's losses were not caused by any "external" force, but rather from defects in the diffuser basket and the overly delicate adsorbent beads. Thus, Ace reasoned, without an "external cause" there was no covered loss, and even if there were an external cause, coverage would nevertheless be lacking under the "defective material," "wear and tear," "deterioration," and other, similar exclusions.

         C. Procedural history

         Ingenco brought suit in the Western District of Washington, alleging causes of action for breach of contract and declaratory relief, as well as statutory claims under Washington's Consumer Protection Act and Insurer Unfair Conduct Act. The parties eventually filed cross motions for summary judgment. The district court granted Ingenco's motion insofar as Ingenco argued that Washington law should apply to all claims, and that, under Washington law, Ingenco's alleged failure to comply with the policy's notice provision did not preclude coverage absent prejudice to Ace. The court ruled for Ace, however, that Ingenco's losses did not result from an "external cause," but rather from an "inherent problem in the system," which system had been designed to withstand the "external" force at issue, i.e., the landfill gas.

         The district court also ruled that the "ensuing loss" exception to the "defective material" exclusion did not apply to create coverage because there was no covered loss in the first place. In a similar vein, the district court concluded that Ingenco's losses were caused by wear and tear resulting from normal operation, and therefore fell outside the Endorsement's definition of covered "Accident." Lastly, the district court ruled that, even in the event of coverage, business interruption losses would be limited to the "hypothetical" reasonable repair period, regardless of the actual time necessary to complete repairs.

         In a separate order, the district court found that Ingenco had failed to timely disclose or produce evidence related to its state law bad faith claims. As a discovery sanction, the district court precluded Ingenco from introducing any such evidence and, accordingly, dismissed Ingenco's statutory claims for lack of proof of damages.

         Ingenco now appeals the district court's orders.

         STANDARD OF REVIEW

         We review grants of summary judgment, and partial grants of summary judgment, de novo. Flores v. City of San Gabriel, 824 F.3d 890, 897 (9th Cir. 2016). Discovery rulings, including the imposition of discovery sanctions, are reviewed for abuse of discretion. R & R Sails, Inc. v. Ins. Co. of Pennsylvania, 673 F.3d 1240, 1245 (9th Cir. 2012). A district court abuses its discretion if it bases its decision "on an erroneous view of the law or on a clearly erroneous assessment of the evidence." Holgate v. Baldwin, 425 F.3d 671, 675 (9th Cir. 2005); Marchand v. Mercy Med. Ctr., 22 F.3d 933, 936 (9th Cir. 1994).

         ANALYSIS

         In resolving this appeal, we must first determine whether Washington or Virginia law applies to this insurance coverage dispute. Only then can we proceed to analyze the coverage issues, including whether Ingenco violated a condition precedent to coverage. We address these questions before turning to the remaining damages and discovery issues.

         A. ...


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