Connecticut Federal Court Construes Ambiguous Policy Exclusion in Favor of Coverage, but Rejects Bad Faith Claim

In A Priori Family Office LLC v. Valley Forge Insurance Co., the U.S. District Court for the District of Connecticut found the undefined term “surface water” in an all-risk insurance policy’s water exclusion ambiguous, so construed coverage in favor of the insured but found the insured failed to present evidence demonstrating the insurer engaged in bad faith.

The insured, A Priori, suffered a loss after heavy rainfall flooded a roof terrace and water entered the insured’s office under the terrace door. Among relying on other exclusions, the insurer denied coverage based on the policy’s water exclusion, which precludes coverage “for loss or damage caused directly or indirectly by … ‘Flood,’ surface water, waves, tidal waves, overflow of any body of water, or their spray, all whether driven by wind or not.” It argued that the rainwater became “surface water” because it pooled on the third-floor terrace before entering the building.

The parties disputed whether water must be on the ground’s surface to constitute “surface water.” The insured cited case law holding that “surface water” generally includes water from precipitation “flowing on the ground outside of any defined channel.” Conversely, the insurer cited a First Circuit decision applying Massachusetts law that held that pooled water on an artificial surface constituted surface water. However, the court noted that the Massachusetts Supreme Judicial Court, in Zurich American Insurance Co. v. Medical Properties Trust Inc., had recently rejected the First Circuit decision and found there were “two different reasonable interpretations of the term ‘surface waters.’”

The court found both parties presented a reasonable interpretation of “surface water” and referenced multiple decisions that had either disagreed about the definition of the term or explicitly found it ambiguous. Therefore, the court construed the term in favor of coverage and held the water exclusion did not apply.

The insured also asserted a bad faith claim, alleging the insurer failed to conduct a proper investigation into the claim and only vaguely explained its denial of coverage. The court found the insurer had “an ‘arguably justifiable reason,’ albeit incorrect, for denying coverage.” Further, the court found the insurer had relied upon information provided by the insured in conducting its investigation of the claim. Because the insured failed to demonstrate the insurer had acted with dishonest purpose or moral obliquity in denying coverage, it granted the insurer’s motion for summary judgment and dismissed the bad faith claim.