In May of 1994, Ratliff Enterprises' Arkansas ice manufacturing plant was damaged by a fire and an explosion. An ammonia filter on an icemaker had ruptured accidentally, causing liquid ammonia to escape, vaporize, and enter the icemaker's electrical control panel. The ammonia vapors ignited when they reached the panel's circuitry. The resulting fire and explosion caused severe damage and the plant closed for months.
American Employers provided Ratliff with commercial property and boiler and machinery policies containing a real property coverage limit of $330,000.00 and $500,000.00 for personal property. Ratliff submitted a claim for real property damage totaling $997,202.07 and for personal property damage in the amount of $1,622,740.68.
American Employers paid Ratliff the policy limits for the real and personal property damage but denied the boiler and machinery claim and business interruption claim on the ground that the policy excluded coverage for damage resulting from fire or explosion ensuing from damage to covered equipment, i.e., the ice maker. Ratliff sued American Employers in the Jefferson County, Arkansas Chancery Court for breach of contract under the boiler and machinery policy to recover the damages to the plant and for the business loss.
The policy language at issue read:
Coverage.
We will pay for direct damage to Covered Property caused by a Covered Cause of Loss.
1. Covered Property
Covered property, as used in this Coverage Part, means any property that:
a. You own; or
b. Is in your care, or custody and for which you are legally liable.
2. Covered Cause of Loss
A covered cause of loss is an "accident" to an "object" shown in the Declarations. An "object" must be in use or connected ready for use at the location specified for it at the time of the "accident".
B. Exclusions
We will not pay for:
4. Other exclusions
Loss caused by or resulting from:
a. An explosion. However, we will pay for loss caused by or resulting from an explosion of an " object" of a kind described below and only to " objects" covered by this insurance and as described as an Object Definition endorsement..
b. Fire or explosion that occurs at the same time as an "accident" or that ensues from an "accident". With respect to any electrical equipment forming a part of an "object", this exclusion is changed to read:
Fire or explosion outside the "object" that occurs at the same time as an "accident" or ensues from an "accident" ...
We will not pay for any loss excluded above even though any other cause or event contributes concurrently or in any sequence to the loss.
"Accident" is defined in the policy as a sudden and accidental breakdown of the "object" or part of the "object." When the breakdown occurs, it must manifest itself by physical damage to the "object" that requires repair or replacement.
American Employers moved for summary judgment, arguing that coverage for the damage resulting from the explosion and fire was excluded. Ratliff cross-moved, arguing that the exclusion did not apply because it was ambiguous. The Chancellor denied American Employer's motion and reserved decision on the cross-motion.
The case proceeded to trial, where the Chancellor found in favor of American Employers on both points of coverage as a matter of law on the ground that the boiler and machinery exclusion clearly precluded coverage for property damage resulting from fire or explosion outside equipment that occurred at the same time as, or ensued from, a sudden and accidental equipment breakdown. In addition, the Chancellor found that there was no overlap of coverage between the boiler and machinery policy and the real and personal property policy and that there was no covered business loss.
The Arkansas Court of Appeals affirmed and the state's Supreme Court granted Ratliff's petition for review. A three justice majority agreed with the Chancellor's finding that the boiler and machinery exclusion was clear and held that the exclusion applied because the damage to Ratliff's plant as a whole resulted from a fire and explosion that in turn resulted from the ignition of ammonia vapors by an improperly functioning electrical panel.
In support of its position that coverage was excluded, the majority cited a Massachusetts federal court decision, Preferred Mutual Ins. Co. v. Travelers Companies, 955 F. Supp. 9 (D. Mass. 1997), aff'd, 123 F.3d 136 (1st Cir. 1997). In Preferred Mutual a fire occurred in a condominium's boiler room. The plaintiff, Preferred Mutual, paid for the entire loss under its all-risk policy. The defendant, Travelers, provided boiler and machinery coverage. Preferred Mutual sued Travelers for reimbursement of monies paid for the loss. The federal district and circuit courts agreed that coverage was excluded under the Travelers policy, which read in pertinent part:
Loss caused by or resulting from:
a. Fire or combustion explosion that occurs at the same time as an "accident" or that ensues from an "accident". With respect to any electrical equipment forming a part of an "object" this exclusion is changed to read:
Fire of explosion outside the "object" that occurs at the same time as an "accident" that ensues from an "accident".
The court noted also that under the "Exclusions" section of the Travelers policy, Travelers "will not pay for any loss or damage caused 'directly or indirectly' for any of the reasons specified 'regardless of any other cause or event that contributes concurrently or in any sequence to the loss.'"
Interpreting this language, the Massachusetts court held that the Travelers policy clearly intended to exclude coverage for damage caused by a fire that occurs at the same time as, or ensues from, a sudden and accidental breakdown of a boiler or part of a boiler, including accessory equipment. Also, the federal court specified that with respect to electrical equipment forming part of an "object," the policy excluded coverage "for fire or explosion that occurs outside the 'object.'"
The Ratliff majority relied on the reasoning in Preferred Mutual to find that coverage for Ratliff's claim under the boiler and machinery policy was excluded because, in its opinion, the American Employers exclusion was not susceptible to more than one reasonable interpretation. The Ratliff majority held that Ratliff's business loss was excluded under the policy as well.
In dissent, Justices Brown and Glaze gave insurers food for thought. Justice Brown described American Employers' boiler and machinery exclusion as "highly questionable" because it does not specify "whether the fire or explosion must originate outside the 'object' for the exclusion to apply, or merely occur outside the object." Commenting on the majority's reliance on Preferred Mutual, he noted that the Massachusetts courts failed to address the ambiguity question. Justice Brown stated that the exclusions in both the Travelers and American Employers' policies could be read to deny coverage for explosions or fires that start outside the "object." Commenting on the effects of the majority's holding, Justice Brown wrote, "we do a disservice to insureds generally because we perpetuate the use of this dubious language. As a result, insurance companies can now foist this confusing and muddled exclusion on insureds with the full weight of precedent behind them."