9th Circuit to Interpret Meaning of “Direct Supplier” In Context of a Commercial Property Loss Claim

Commercial property insurance policies often include damages sustained by a “direct supplier.” As an example, an insured that sells motorcycles, might rely on a particular motor cycle part supplier to provide parts used in their motorcycles. If the motorcycle part supplier sustains a loss, it could impact the insured’s business.

Not all commercial policies, however, define “direct supplier.” Different industries do business differently, and the question arises: When the term “direct supplier” is not defined in a commercial insurance policy, how should the term be interpreted, and should insurers and the courts be required to apply an industry specific definition to meet the insured’s reasonable expectations?

A forthcoming decision by the 9th Circuit Court of Appeals will address this issue in a claim filed by DirecTV.

According to DirecTV’s October 2014, complaint against Factory Mutual Insurance Company, (“FM”), monsoons in 2011 flooded two factories in Thailand run by Western Digital. DirecTV said it selected Western Digital as the exclusive supplier for hard drives used in its digital video recorders.

Under DirecTV’s FM all risk commercial property insurance policy, it had coverage for both property damage and business interruption losses. Such coverage extended to losses occurring at all insured locations, including any location “of a direct supplier, contract manufacturer or contract service provider to [DIRECTV].”

After DirecTV submitted a preliminary claim for an estimated $20 to $25 million in damages from the flood, FM requested copies of any written contracts between DirecTV and Western Digital, according to the complaint. DirecTV responded that it did not have a contract with Western Digital but that that didn’t matter because the policy doesn’t require it to have written contracts with its direct suppliers.

FM denied DirecTV’s claim for coverage. Although FM acknowledged a “direct working relationship” between DirecTV and Western Digital, it cited the lack of a contractual relationship between the two companies as the sole basis for denying coverage, according to the complaint.

U.S. District Judge Dean D. Pregerson ultimately sided with FM, granting the insurer’s motion for summary judgment after finding that “DirecTV never received anything from Western Digital” directly, and that Western Digital was not a “direct supplier.”1

DirecTV has appealed the decision on the grounds that the decision incorrectly concluded that because the hard drive disks that DirecTV has made by Western Digital pass through an intermediary assembler before reaching DirecTV, that Western Digital is not a “direct supplier.”

DirecTV argues that the trial court’s reliance on the fact that the hard drives are first sent to the assemblers for incorporation into the digital video recorders before they are sent to DirecTV does not affect the direct supplier relationship it has with Western Digital. Further, DirecTV argues that nothing in the insurance policy specifies that DirecTV must receive components directly from a supplier for that supplier to be a “direct supplier.”

DirecTV argues in its opening appellate brief that “[a]t the very least, based on the lack of guidance in the policy, the industry understanding of the phrase, the various definitions applicable to the phrase and the context of DirecTV’s loss, DirecTV’s interpretation of ‘direct supplier’ as including Western Digital is reasonable.” According to DirecTV, the lower court erred by failing to consider that “direct supplier,” is a technical phrase that’s long been used in the supply chain industry, and should be considered synonymous with a “customer-controlled component supplier.” That is exactly what Western Digital is. The trial court did not consider any industry-specific definition because there was no evidence that FM had any particular knowledge of DirecTV’s industry when it issued the policy.

DirecTV contends that “as an insurer of risks in the electronics supply chain industry, [FM] is presumed to know the trade usage of such phrases — a presumption that is reinforced by FM’s decades long insurance relationship with DirecTV.” DirecTV also points out that even if the trade usage of the phrase were ignored, though, the plain meaning of “direct supplier” still describes DirecTV’s relationship with Western Digital because the two interact directly on numerous issues, including the development and design of the hard disk drives, their quality and how they are priced.

DirecTV’s position is that “[u]nder these circumstances, it would be objectively reasonable, if not expected, for an individual at DirecTV, when asked ‘who is your direct supplier of [hard drives],’ to respond ‘Western Digital’ — not the set-top box assemblers that merely aggregate components at the direction of DirecTV.”

It will be interesting to see how the 9th Circuit addresses and interprets this issue. On the one hand, it seems reasonable that if an insured, such as DirecTV, regularly relies on a particular business to supply component parts used and incorporated into its products, then such a business entity should be considered a direct supplier, whether or not there is a written contract between the two, and regardless of whether the parts get incorporated directly by DirecTV, or through a 3rd party at DirecTV’s direction.

On the other hand, if DirecTV’s relationship with Western Digital was truly attenuated because (1) DirecTV had no financial agreement with Western Digital, (2) DirecTV had its financial agreement with other suppliers, and (3) the other suppliers had the contractual obligation to provide DirecTV with the hard drives, then the question becomes that if, as a result of Western Digital’s property loss, DirecTV’s business was negatively impacted, should DirecTV be forced to turn to its contractual supplier for its losses instead of recovering under its own commercial insurance policy? Most business contracts contain provisions intended to address scenarios when a party is unable to perform. If DirecTV’s contractual supplier was unable to perform (i.e., provide the hard drives) because of Western Digital’s property loss, then there might be an argument that DirecTV should be forced to turn to its contractual supplier, DirecTV’s contractual supplier should turn to Western Digital (or its commercial insurance policy), and Western Digital should in turn look its own commercial insurer. Such a result may properly allocate the risk and loss in the way the parties had initially intended via their contractual arrangements.

The 9th Circuit decision may provide commercial businesses, insurance brokers, and policyholder advocates with greater insight into how to address the issue.


1Directv v. Factory Mut. Ins. Co., No. 14-08673, 2016 WL 386021 (C.D. Cal. Feb. 1, 2016).

 

Source: http://www.propertyinsurancecoveragelaw.com/2016/08/articles/commercial-insurance-claims/9th-circuit-to-interpret-meaning-of-direct-supplier-in-context-of-a-commercial-property-loss-claim/

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