Monday, May 11, 2015

A High Bar for Lumber Liquidators

CNBC reports that Lumber Liquidators’ insurance companies are refusing to cover its liability for the sale of toxic flooring materials:

Lumber Liquidators has filed suit, claiming that the insurance companies should pay the legal bills and liability claims for the laminate flooring it sold. It stopped selling the flooring in question last week because of concerns that the product has unreasonably high levels of formaldehyde, a potentially harmful poison. The specific legal questions about insurance coverage are difficult and technical and must be left for lawyers and judges to work out; however, I am skeptical of Lumber Liquidators’ legal position on this issue.

First, there is the question of coverage in general. Lumber Liquidators admits it never had a product liability policy, the insurance policy that would normally cover claims of harm from defective products. Instead, it had commercial general liability policies with several insurance companies. A general liability policy might or might not cover product liability, and if so, it is a limited form of coverage. It isn’t meant to cover a business acting in the capacity of a manufacturer or importer. That’s what the product liability policies are for. Lumber Liquidators is said to be the exclusive U.S. source of the Chinese-made flooring in question, and if that is so, it will be very difficult for it to establish that it wasn’t effectively involved in either manufacturing or importing the flooring. If it turns out that Lumber Liquidators was the importer in any practical sense, or if it had any say in the way the product was made, the insurance companies are correct in denying coverage, and they will be able to have the cases thrown out.

The second issue has to do with intentionality. Insurance does not cover damages resulting from the intentional sale of a bad product. If Lumber Liquidators was cutting costs by intentionally sourcing a product with bizarrely high levels of formaldehyde, that would be a criminal act, and insurance legally cannot cover criminal acts of any kind. Lumber Liquidators disclosed a week ago that federal agents searched two of its facilities in September as part of a criminal investigation, and more recently, it was notified that the company will face criminal charges. Unless the criminal charges turn out to be unrelated, courts might very well order insurance companies to withhold any payments to Lumber Liquidators until the criminal case is resolved.

The mere fact that Lumber Liquidators is filing suits against nine insurance companies is cause for skepticism. Why would it have nine liability insurance companies and not just one or two? When a business is piling up as much liability coverage as it can find, it may be a sign that it knows it has done something wrong.

It is the retailer that filed the suits against the insurance companies, so it is the retailer that has to prove its case. It will have to answer questions and turn over its internal documents, and they will have to demonstrate that the company reasonably believed that the flooring products in question were reasonably safe. That argument won’t stand up if documents show the kind of corporate thinking that tries to wish problems away. All in all, Lumber Liquidators has a difficult case to try to make.