Refinery’s Insurance Claims Following Supply Interruption Caused By Pipeline Rupture Taken Up In Arkansas
An Arkansas refinery received oil from a pipeline owned and operated by a third party. In 2007, the pipeline owner inspected the pipeline and identified anomalies at various locations. The inspection vendor, however, misidentified one anomaly as a seam weld unlikely to cause a failure but this particular weld anomaly caused the pipeline to rupture in April 2012. After the rupture, the pipeline owner shut down the pipeline and notified the Pipeline and Hazardous Material Safety Administration (“PHMSA”), which later issued a Corrective Action Order requiring the pipeline owner to develop and submit a re-start plan for PHMSA approval, undertake a failure analysis of the ruptured section, and submit an integrity verification and remedial work plan. During implementation of the remedial work plan that included hydrostatic pressure testing, the pipeline owner discovered seven leaks. In October 2012, after the pipeline owner repaired those additional leaks, PHMSA granted the company permission to restart the pipeline, and in March 2013, the Arkansas refinery again began to receive crude oil.
The refinery’s owners filed a breach of contract suit against their insurers after the insurers denied claims for $44 million in business interruption and $36 million in extra expenses for the time periods the pipeline was not operational. The insurers provided the refinery’s owners with certain “all-risk” insurance policies including insuring “all risk of direct loss or of damage to property described herein, except as hereinafter excluded.” The insurers argued that the cause of the interruption to the delivery of oil to the refinery was not property damage, but was the pipeline owner’s decision to inspect its pipeline for defects that might cause future events (following repair of the initial property damage less than a month after its discovery). In other words, the insurers argued that “once the damaged section of the pipeline was physically replaced, the extended closure of the pipeline and the resulting losses suffered by [the refinery] no longer ‘resulted from’ the April rupture.”
The U.S. District Court for the Western District of Arkansas ultimately concluded that it could not resolve the coverage question at the summary judgment stage: “A dispute exists . . . as to whether it was the rupture to the pipeline or [the pipeline owner’s] decision to hydrostatically test the pipeline following the rupture that was the dominant and efficient cause of [the refinery’s] loss.”
The court did, however, go ahead and reject the insurers’ argument that certain policy exclusions apply even if the policy provided coverage on its face. The insurers argued that the exclusion for the “cost of making good . . . faulty workmanship” and the exclusion for “latent defect” applied. The court concluded that the refinery’s claimed financial loss from a business interruption was distinct and separate from the cost to make good the weld defect in the pipeline: “The ‘cost of making good’ must refer to the specific cost of replacing or repairing damaged property due to faulty workmanship and not to any contingent loss or consequential damages stemming from the faulty work.” Similarly, the court concluded that the misinterpretation of an anomaly did not render the anomaly a latent defect, which requires the defect to be one not discoverable upon careful inspection. This particular defect was discovered, it was just originally misidentified.
