Pipeline Rupture: Faulty Workmanship and Latent Defect Exclusions Inapplicable; Question of Fact Whether Loss Caused by Rupture or Corrective Action

An Arkansas Federal District Court, applying Arkansas law, denied summary judgment to insurers in a coverage dispute over a business interruption claim by an oil refinery, finding a question of fact as to whether the rupture of a pipeline or the subsequent corrective action was the principal cause of the loss. The court entered summary judgment in favor of the policyholder as to two policy exclusions (faulty workmanship and latent defect exclusions), holding that neither barred coverage under the facts.

Lion Oil Company owns and operates an oil refinery in El Dorado, Arkansas. In April 2012, a seam weld anomaly caused a pipeline owned by EMPCo, which fed crude oil to Lion Oil’s refinery, to rupture. EMPCo shut down the pipeline. The ruptured section of the pipeline was repaired within a few weeks; however, the pipeline remained shut down until October 2012 while EMPCo took corrective actions pursuant to an order from the Dept. of Transportation Pipeline and Hazardous Material Safety Administration (“PHMSA”). Lion Oil was unable to fully operate its refinery while the pipeline was shutdown and, therefore, submitted a contingent business interruption claim of approximately $44 million and an extra expense claim of approximately $36 million to its “all risk” insurers. The insurers denied the claim on the basis that (1) there was not “property damage” as required by the Contingent Time Element provision; (2) the loss was excluded by the “cost of making good…faulty workmanship” exclusion; and (3) the loss was excluded by the “latent defect” exclusion.

The district court denied the insurers’ motion for summary judgment as to the first basis, finding that it was undisputed that there was property damage to the pipeline, but there was a factual question as to whether the pipeline’s rupture or the subsequent corrective action ordered by PHMSA was the “dominant and efficient cause” of Lion Oil’s loss. Additionally, the court distinguished the present case from a 10th Circuit opinion cited by the insurers, stating: “Unlike the owner and operator in MarkWest, Lion Oil had no control over the maintenance of the pipeline or any testing that was done following the rupture…Thus, any concerns regarding ‘converting the parties’ policy against unforeseen fortuities into a maintenance contract’ do not apply to the fact in the present case.”

The court next entered summary judgment in favor of Lion Oil as to two exclusions that the insurers asserted barred coverage. The court found that the plain language of the “cost of making good…faulty workmanship” exclusion only excluded the actual costs incurred in repairing damage from faulty workmanship. The court stated that the second clause in the exclusion explicitly added back coverage for loss resulting from faulty workmanship.

The court also held that the “latent defect” exclusion did not apply in this case. The court reasoned that a latent defect was one “not discoverable by a careful inspection.” Because the welding flaw was actually found during a 2007 inspection, the defect was “discoverable” and the exclusion didn’t apply, according to the court, even though EMPCo wrongfully classified the defect as “not likely to cause a failure.” Lion Oil Co. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, No 13-cv-1071 (W.D. Ark. Sept. 10, 2015).