Mold and Moisture: What Every Real Estate Owner Must Know* (a publication of Phillips Nizer LLP)

06/02/2003

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A.     Overview of the Problem

1. What's So New?
   
   Mold, or more commonly mildew or fungi, has been with us for millions of years.  But over the past five years or so, for a variety of reasons, this substance has begun to have a profound impact on the real estate industry, the insurance industry, architectural and construction practices, and the legal system.
   
   Why is mold suddenly so important an issue -- prompting real estate lawyers to consult their clients about the lurking dangers of commercial transactions, environmental lawyers to clamor for building owners and lenders to perform due diligence, environmental consultants to urge extensive and costly testing, and insurance carriers and brokers to retreat rapidly from their standard comprehensive general liability policies by adding exclusions and offering mold-specific coverage instead?
   
   Mold, unlike asbestos or lead paint, is not a waste or pollutant, but a naturally occurring organism, flourishing in an environment enhanced by human activity.  Unlike those other environmental materials, which, if found to exist, do not multiply, mold is alive.  If you provide mold with moisture and an organic food source, it will continue to grow and spread.
    
2. Health Issues
   
   For the past few years, widespread media coverage and highly visible lawsuits have caused many people to experience fear, anxiety and usually overreaction when confronted with the presence of mold.  Not all mold is potentially hazardous to human health, however, and some people are more susceptible than others to adverse health affects from toxic mold.  In some instances, individuals are totally unaffected.  Others have reactions such as cold symptoms and pulmonary problems which abate once the irritant source is eliminated.  Still others, perhaps depending on pre-existing health conditions, can experience more severe respiratory difficulties and other illnesses.
   
   The federal and state governments, lacking the scientific basis upon which to make decisions, have abandoned the playing field almost entirely.  Unlike asbestos or lead paint, areas in which the government stepped in, set health-based standards, and regulated the conduct of affected individuals and industries, there is currently insufficient information in the mold field to make such determinations.  Science has not kept pace with the need for "safe" standards.
   
   Legislative proposals in both the federal and state arenas have continued to languish.  There is no federal legislation[1], and only one state, California, has enacted mold legislation.[2]
    
3. Issues For Real Estate-Related Businesses
   
   Financial lenders also have been sensitized to the mold issue and may require property-owning borrowers to make some or all of following representations and warranties: 

1.  The subject premises currently display no evidence of water infiltration or water damage;

2.  There are no prior or current complaints (leaks, odors, etc.) by tenants at the premises;

3.  The subject premises currently display no evidence of conspicuous mold growth;

4.  The subject premises are in compliance with any applicable building code currently in effect in the state where the property is located.

Lenders also have imposed new requirements for operation and maintenance on borrowers as conditions to loans.  These include:  mold management through training of maintenance personnel;  preparation of manuals for mold prevention and response; routine inspections; and identification and remediation of mold.

Property owners also have reacted.  Now more and more commercial transactions involve due diligence to evaluate buildings for the actual or potential presence of mold contamination.  Environmental representations and warranties in transactional documents have been expanded to include mold/fungi/bacteria within the more traditional definitions and requirements affecting hazardous wastes and contaminants. 

B.     Litigation
There have been some highly publicized verdicts and settlements in mold cases, mostly outside New York.  These include:

• the Ballard case in Texas ($32 million bad faith verdict against insurer, reduced to $4 million on appeal);
• a case involving Ed McMahon's house in California ($7.2 million settlement against insurers and contractors);
• a $14 million judgment against a company which built a mold-infested courthouse for a county government in Florida; and 
• a million-dollar-plus personal injury verdict for two Delaware apartment residents.

In New York, insurance claims for mold tripled last year, and the state moved from ninth to fourth in the number of claims nationally.  New York City has its own million-dollar mold settlement, but in a case involving 500 residential tenants in a Manhattan apartment complex.
 

1. Injury Claims
   
   The kinds of mold claims likely to be seen involve either personal injuries or property damage.  Injury plaintiffs can include tenants and the employees or invitees of tenants.  For example, a number of government employees whose offices are in private buildings have filed workplace mold claims against landlords in other states.  Tenants who have invitees arguably at higher risk  — for example, medical offices or children's day care centers -- should be a special focus of concern. A landlord's employees probably would be barred from suing the property owner by workers' compensation, but claims by such employees against others could become third-party claims against the owners.  Someone who bought real estate infested with mold also could sue.
    
2. Causation
   
   To make out an injury claim grounded in tort, a plaintiff has to show the defendant violated a duty to him or her.  Moreover, the plaintiff has to show that what was done or not done in violation of that duty caused the injury.  That causation requirement operates on two levels here:  that mold could have caused such an injury as a general matter; and that it in fact caused the particular plaintiff's injury.
   
   Causation usually is established through expert testimony.  Because the science is new and the standards are unset, causation is the wild card of mold cases.  Causation is a factual issue; it often means a defendant must go through discovery and perhaps a trial, rather than getting out of the case by an early motion to dismiss.
    
3. Damage Claims
   
   Tenants also could make claims for mold damage to their property.  Owners also may have property damage claims against contractors and architects who did work for them.  Tenants may have rent abatement claims.  Again, property buyers may have claims.  In situations where there are shared walls or utility systems, there may be owner vs. owner claims.  Causation often will be easier to establish in the property damage context than in the personal injury context.
   
   We think mold cases will be easier to handle for defendants than lead or asbestos cases have been.  They are unlikely to be deemed "long-tail" claims by New York courts; the statute of limitations, barring any claim of concealment, is likely to be three years.  Mold claims also will not lend themselves very well to treatment as class actions.  Most important, best litigation defense practices for mold typically will dovetail with best property maintenance practices.

C.     Insurance

One possible source of reimbursement for property owners in the event of mold claims or losses is insurance.  Policyholders have made mold coverage claims under property, liability, homeowner's, builder's risk and other similar coverages. 

In contrast to Texas and California, there has been limited coverage litigation over mold in New York.  With mold claims on the rise here, more coverage disputes may follow.  Insurers, apparently anticipating greater loss exposure in New York, have filed more than 100 requests for approval of new policy forms restricting mold coverage with the New York Superintendent of Insurance.  So far, the Superintendent has not approved any of these insurer applications. 
 

1. Likely Coverage Issues
   
   Insurers may deny coverage for mold claims relying on the same or similar grounds they have asserted to deny claims for asbestos, lead and hazardous waste damage.  Likely coverage issues include:
   • Is mold a pollutant?  
   • Did the mold damage result from a covered cause of loss?
   • Did the mold damage commence prior to the policy's effective date?
   • Did negligence by the policyholder or a third party cause the problem?
   • Did the policyholder give sufficiently prompt notice of the events giving rise to the claim?
     
     Depending upon the facts of the claim, the policyholder may well have coverage for mold liabilities and losses under standard form property, homeowner's and liability policies.  With respect to commercial property and homeowner policies, the initial inquiry will be whether the mold contamination resulted from a covered cause of loss.  One example of a covered loss would be water damage caused by a burst pipe which subsequently contributes to mold contamination.  With respect to both property and liability policies, insurers are likely to invoke policy exclusions to try to preclude coverage.  These include one or more of the following: continuous or repeated seepage; a design or construction defect; loss or damage caused by fungus, rust, corrosion, decay, hidden or latent defect; and/or pollution. 
      
2. Coverage Restrictions, Buy-Backs
   
   Policyholders should be alert to possible restrictions of mold coverage that may appear at policy renewals.  An increasing number of states are permitting insurers to restrict coverage for mold claims by authorizing the insertion of new forms of mold-specific exclusions in their policies or permitting policy limits for mold claims that are capped at relatively low dollar amounts ($5,000.00 -$10,000.00).  Insurers appear increasingly unwilling to insure the costs of testing, treating, containing or disposing of mold beyond that necessary to repair or replace property that is physically damaged by covered water damage. 
   
   Policyholders may be able to purchase coverage to fill all or a portion of any gaps in coverage for mold damage.  Mold coverage may be available as part of environmental insurance policies.  There also are forms of buy-back endorsements for mold coverage that may be added to existing property and liability policies at additional cost.

D.     Ten Practical Things To Do

• Practice active risk management for moisture and mold claims.  The nightmare cases arose because prompt, appropriate action was not taken.
• Train your staff to deal with moisture and mold.  Have a response manual.[3]
• Do the best you can to document moisture/mold complaints, recording what you were told, by whom, when, what inspection showed and what you did.  Use photographs, too.
• Consider making someone the "go to" person in your organization for moisture and mold issues.
• Review lease and rule provisions concerning tenant responsibilities.
• For tenants with special moisture risks, consider special lease provisions.
• Maintain records of past tenants and their occupancy.  Include checking for mold problems as part of exit inspections before security deposits are returned.  If no mold or moisture condition is found, document that fact.
• Know what insurance coverage you have.
• Check insurance renewals for new coverage exclusions and limitations.

GIVE NOTICE IMMEDIATELY TO YOUR INSURER IF YOU BECOME AWARE OF A MOISTURE/MOLD PROBLEM.

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[*]     Highlights of a Phillips Nizer presentation in conjunction with Leighton Associates, Inc., June 17, 2003, at Phillips Nizer's New York City office.

[1]     See proposed United States Toxic Mold Safety and Prevention Act, introduced by Congressman John Conyers in June 2002, calling, among other things, for government-sponsored studies to ascertain the health consequences of exposure to toxic mold and to develop standards for the prevention, detection and remediation of indoor mold growth.

[2]     California's Toxic Mold Disclosure Act requires that anyone selling, leasing or transferring property disclose any known potential dangerous mold problems.  In New York, the Legislature failed to enact the Toxic Mold Protection Act sponsored by Senator Marcellino which would have established a Department of Health Task Force to advise on setting safe standards and evaluating potential health risks.

[3]     We will set out some suggestions for a response manual in a future alert.