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Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 1 of 9 Page ID #:141

1 HAROLD P. REICHWALD, ESQ. (CSBN 85274)


MANATT, PHELPS & PHILLIPS, LLP
2 11355 W. Olympic Boulevard
Los Angeles, California 90064
3 Tel: (310) 312-4000
Fax: (310) 312-4224
4
JEFFREY M. COHON, ESQ. (CSBN 131431)
5 HENRY NICHOLLS, ESQ. (CSBN 126129)
KRISTINA S. KELLER, ESQ. (CSBN 161946)
6 COHON & POLLAK, LLP
1999 Avenue of the Stars, Suite 1100
7 Los Angeles, California 90067
Tel: (310) 231-4470
8 Fax: (310) 231-4610
9 Attorneys for Plaintiff
MERIDIAN TEXTILES, INC.
10
11 UNITED STATES DISTRICT COURT
12 FOR THE CENTRAL DISTRICT OF CALIFORNIA
13 WESTERN DIVISION
14
)
15 MERIDIAN TEXTILES, INC., a California ) CASE NO. CV 06-4766 CAS (JCx)
corporation, )
16 ) PLAINTIFF MERIDIAN TEXTILES, INC’S
Plaintiff, ) PRE-TRIAL BRIEF RE COVERAGE
17 ) UNDER DEFENDANT INDEMNITY
vs. ) INSURANCE COMPANY OF NORTH
18 ) AMERICA’S MARINE INSURANCE
INDEMNITY INSURANCE COMPANY OF ) POLICY FOR “RISK OF PHYSICAL LOSS”
19 NORTH AMERICA, a Pennsylvania )
corporation, and Does 1 through 50, inclusive, ) Trial Date: March 25, 2008
20 )
Defendant. )
21 ______________________________________ )
22
23 Pursuant to the District Court’s Final Pretrial Conference Order, Plaintiff Meridian Textiles, Inc.
24 submits the following brief on the issue of whether coverage under IICNA’s marine insurance policy
25 for “risk of physical loss” requires an actual physical loss as a condition precedent to coverage or
26 whether the negative perception of the insured’s goods’ condition by the market is the “functional
27 equivalent” of damage of a material nature or an alteration in physical composition.
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________________________________________________________________________________
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 2 of 9 Page ID #:142

1 I. BACKGROUND
2 1. Business of Meridian Textiles, Inc.
3 Plaintiff Meridian Textiles, Inc. (“Meridian”) was formed in 1981 to produce high quality cloth
4 for major international clothiers. For the past quarter century, Meridian has scoured the globe for the
5 finest yarns and threads necessary to produce its high quality products. It is Meridian’s custom to buy
6 yarn from overseas and to have the material safely stored at warehouses around Los Angeles County
7 until the yarn is ready to be knitted or woven into cloth for later use by its domestically and
8 internationally recognized customers. Meridian’s customers have come to expect and trust that
9 Meridian will care for its yarn, select reliable knitters and produce first quality fabric from that yarn.
10 Over time, Meridian has ordered large volumes of yarn and drop-shipped most of its inventory
11 and stored it at Novelty Knits located at 2664 E. Del Amo Boulevard in Carson, California. In addition
12 to storing yarn for its customers, Novelty Knits takes orders from its clients to use the stored yarn to knit
13 fine fabrics.
14 2. The Marine Open Ocean Cargo Policy Issued to Meridian Textiles, Inc.
15 On or about March 1, 2004, Indemnity Insurance Company of North America (“Defendant”)
16 issued a Marine Open Ocean Cargo Policy to Meridian for the policy period March 1, 2004 through
17 March 1, 2005. Defendant’s marine policy, among its other coverages, included, through Endorsement
18 No. 2, a Warehouse Endorsement. The Warehouse Endorsement
19 3. The Fire at Novelty Knits
20 On December 31, 2004 at approximately 10:00 a.m. a fire broke out in the warehouse at Novelty
21 Knits incinerating a portion of Meridian’s stored product and damaging the rest.
22 4. The Insurance Claim
23 On January 4, 2005, Meridian submitted its claim for the loss of its entire inventory located
24 at Novelty Knits. Defendant investigated the loss by engaging an “expert” who determined that the vast
25 majority (90%) of the yarn was undamaged. On October 3, 2005, Defendant made a payment to
26 Meridian in the amount of $376,952.00, representing Defendant’s purported adjustment of Meridian's
27 loss claim. This sum was accepted by Meridian without prejudice to its claim for the policy limit of
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 3 of 9 Page ID #:143

1 $1,000,000. The $376,952.00 figure reflected the Defendant’s view that the vast majority (90%) of the
2 yarn did not actually sustain physical damage.
3 Indeed, in reliance on the expert’s conclusion, Defendant’s coverage counsel wrote a letter dated
4 August 7, 2006 in which he argued that Meridian was not entitled to additional compensation “because
5 the policy was written only to ‘cover against all risk of physical loss or damage from any external cause
6 . . .’ and this language limits Meridian’s right to recover only for yarn which actually sustained physical
7 damage.”
8 In response, Meridian informed Defendant in writing that the correct interpretation of the
9 foregoing policy provision was to extend coverage to Meridian’s goods which actually sustained
10 physical damage and to those goods which sustained the functional equivalent of damage of a material
11 nature, including the adverse perception of the insured’s goods by the market. Stated differently, once
12 the fact of the yarn’s exposure to smoke, heat, water, fire and mold were disclosed to putative buyers,
13 Meridian’s customers would never purchase fabric or any resulting finished product made from the
14 yarn. In short, the yarn essentially could be used for shoe laces and casket linings.
15 There is no dispute between the parties that the market for fabric produced from first quality
16 yarn would not accept fabric produced from Meridian’s yarn which had been warehoused at the Novelty
17 Knits location on the day of the fire event. Meridian sold the balance of the yarn located at Novelty
18 Knits, which was not incinerated in the fire, to the secondary yarn market at a “salvage” price.
19 II. LEGAL ANALYSIS
20 Plaintiff’s review of the relevant authority discloses that the only case in the United States
21 which addresses the coverage issue presently before the court under analogous facts and under
22 analogous policy language is the decision of Customized Distribution Services v. Zurich Insurance
23 Company, 373 N.J. Super. 480, 862 A.2d 560 (2004).
24 Customized was a declaratory judgment action by a warehouseman under a Commercial Inland
25 Marine policy containing a Warehouseman's Liability form. The claim arose from the mis-rotation of
26 a dated beverage product. Because of a mis-rotation by the warehouse, some containers were shipped
27 out of turn with expiration dates exceeding the freshness window promised by the manufacturer. As
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 4 of 9 Page ID #:144

1 a result, the manufacturer was forced to sell the product to secondary markets at a lower price; however,
2 the manufacturer could not establish that the product’s material or chemical composition had been
3 altered by improper handling at the warehouse.
4 In reversing summary judgment for the insurer, the Appellate Court determined that the policy
5 phrase “risk of direct, physical loss” did not require an actual physical loss, only a risk of such loss,
6 such that the coverage was ambiguous and applied even in circumstances where there was no actual
7 physical loss. The Court expressly held that the insurer’s use of the term “risk” supported the view that
8 the policy did not require actual physical damage. Id at 488.
9 The Court pointed out that the product change was not to its chemical composition, but in how
10 the product was perceived by the manufacturer’s customers, specifically as a result of an undue passage
11 of time. The Appellate Court held that such change is the “functional equivalent of damage of a
12 material nature or an alteration in physical composition.” As such, the Court held that “the presence
13 of the term “risks” in Zurich’s policy means that an actual material change in the product is not a
14 requisite for the triggering of coverage.” Id at 489.
15 As pointed out by Defendant’s coverage counsel, the policy at issue in the instant case covers
16 “all risk of physical loss or damage from any external cause.” Defendant’s use of the term “risk” in its
17 Marine policy– like the insurer’s use of the term “risk” in the Marine policy at issue in Customized,
18 compels an identical outcome in this case. Again, there is no dispute between the parties that in the
19 current circumstances the subject yarn could not be sold as “first rate” or “first quality” due to the fire
20 event. As set out above, the facts in the present action mirror the facts and argument in the Customized
21 decision.
22 It is expected that Defendant ACE will argue that the Customized decision is distinguishable
23 from the present case because it involves third-party, rather than first-part coverage. This conclusion
24 is a misreading of the Customized decision. Review of that decision discloses that the coverage
25 purchased by the insured Customized Distribution Services ("CDS") was a Commercial Inland Marine
26 Policy containing a Warehouseman's Liability form. Separately, CDS was also issued a Commercial
27 General Liability policy and, as the court pointed out, the Warehousman’s Liability coverage of the
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 5 of 9 Page ID #:145

1 Commercial Inland Marine Policy was purchased for the following reason: “CDS obtained the WL
2 coverage to fill the gap created by the ‘care, custody, and control exclusion’ contained in the CGL
3 policy.” Id at 486. Hence, the Marine policy was intended to cover exactly these kind of risks.
4 The Commercial Inland Marine policy with the Warehouseman's Liability form is first party
5 property coverage extended through the Warehouseman's Liability form to cover property of the insured
6 or of others, stored at the CDS warehouse facilities. This is nearly identical to the coverage provided
7 to Meridian Textiles by the Warehouse Endorsement of Defendant’s Marine Policy N00898843. The
8 fact that the damaged property was property of another in the custody of the insured (as in CDS), rather
9 than the insured’s own property (as in the present circumstances), would not change the character of
10 the coverage as first-party coverage.
11 Under California law, the ambiguity in the policy language found by the New Jersey Superior
12 Court, which again represents nearly identical policy language and facts to the present case, would lead
13 to an interpretation consistent with Meridian’s reading of the relevant policy provision as set out below.
14 The rules for interpreting contracts, including insurance policies, are set forth in the California
15 Civil Code. Contract interpretation is governed for the most part by the mutual intentions of the parties
16 at the time the contract is formed (§1636 and §1647). This intent is to be inferred, if possible, from the
17 written terms of the contract. (§1639). These terms are to be given their ordinary and popular meaning
18 unless the parties both intend them to have a technical or special meaning. (§1638 and §1644). If
19 ambiguity remains after that, the terms will be interpreted against the party who drafted the contract.
20 (§1654). AIU Ins. Co. v. FMC Corp. (1990) 51 Cal. 3d 807. See, St. Paul Mercury Ins. v. Frontier
21 Pacific Ins. Co. (2003) 111 Cal. App. 4th 1234.
22 These standards were refined in AIU and the California Supreme Court’s subsequent rulings in
23 Bank of the West v. Superior Court (1992) 2 Cal. 4th 1254 and Bay Cities Paving & Grading, Inc. v.
24 Lawyers Mutual Insurance Company (1993) 5 Cal. 4th 854. Essentially, the court has directed that a
25 three part test be used. First, the mutual intent of the parties should be derived from the written terms
26 of their contract, if possible. If not, a court should next look the objectively reasonable expectations
27 of the insured at the time of contracting. Finally, if any remaining ambiguity cannot be answered
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 6 of 9 Page ID #:146

1 through these steps should it be resolved in favor of the insured. See, Cooper Co. v. Transcontinental
2 Ins. Co. (1995) 31 Cal. App.4th 1094.
3 The analysis of the New Jersey Superior Court clearly demonstrates that the objectively
4 reasonable expectations of the insured at the time of contracting would have been that the term “risk”
5 meant that the policy did not require actual physical damage, but only the risk of actual physical
6 damage. Defendant’s use of the term “risk” in its own policy must be given a meaning separate and
7 apart from the balance of the phrase, “physical loss or damage from any external cause.” To ignore the
8 word “risk” would effectively re-write the policy to provide the more limited coverage that Defendant
9 seeks to impose at this late date. At a minimum, the entire phrase represents the kind of ambiguity
10 which must be resolved in favor of the insured.
11 Lastly, although the Customized court based its decision in part on ambiguity in the policy
12 language, the court also stated,
13
14 “…the trial court erred in finding that the misrotation was not a direct physical
15 loss … for coverage to apply, it was not necessary that the product's material or
16 chemical composition be altered. The bottles of Splash could have broken and
17 the product then would have been damaged even though its chemical
18 composition remained unchanged. The loss certainly would have been covered.
19 The same is true if the product remained undamaged and uncontaminated, but
20 a leak or fire at the warehouse damaged the labeling or bottling of the product.
21 In neither of these instances does the term ‘physical’ require or contemplate that
22 the material composition of the product itself be changed or affected.” Id. at
23 487.
24
25 Interestingly, there is no dispute between the parties that some of the boxes containing the
26 subject yarn showed water stains form the loss event, but the yarn within the boxes was excluded from
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 7 of 9 Page ID #:147

1 coverage by Defendant based upon the argument that such a condition did not represent actual physical
2 damage to the yarn within the boxes.
3 It is expected that ACE will rely in support of its denial of coverage on the unreported decision
4 of Columbiaknit, Inc. v. Affiliated FM Insurance Co. (D.Or. 1999) 1999 U.S. Dist. LEXIS 11873.
5 In Columbiaknit, the court, construing Oregon law, addressed when mold damage constitutes
6 a “direct physical loss” to property under an “all-risk” property insurance policy (not a marine policy
7 like the one here and in Customized). In Columbiaknit, rainwater entered the plaintiff's warehouse and
8 saturated some of the fabric and garments stored there. The plaintiff's “all-risk” property insurance
9 provided coverage for “direct physical loss of or damage to” covered property.
10 Plaintiff insured contended that the policy language “direct physical loss” was ambiguous in that
11 it raised a question as to whether damages must be “direct” or “physical.” Under that theory, if damages
12 need be only direct and not physical, the insured could recover for purely economic loss. The court
13 disagreed, finding the language unambiguous and, under Oregon law, not to cover consequential or
14 intangible damages such as depreciation in value.
15 It should be noted that although the decision in Columbiaknit was unfavorable to the insured,
16 it is readily distinguishable from the present case. First, the language policy at issue was not a
17 Commercial Inland Marine Policy, as in the Customized decision and in the policy at issue in the present
18 litigation before this Court, but rather, it was an “all-risk” property policy. Second, the court in
19 Columbiaknit failed to address how the use of word “risk” in the phrase “risk of physical loss or
20 damage,” might suggest that the policy did not require a physical loss, only a risk of such loss. The
21 evidence of this can readily be seen in the court’s discussion of ambiguity,
22
23 Plaintiff contends that the policy language “direct physical loss or damage to” is
24 ambiguous, in that it raises a question of whether damages must be “physical” or
25 “direct.” Id at 3.
26 ///
27 ///
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 8 of 9 Page ID #:148

1 There, the emphasis was on the words “physical” and “direct” whereas the focus in the
2 Customized case – and the focus here – is properly on the word “risk.” The term “risk” does not even
3 appear in the Columbiaknit discussion. Thus, the central ambiguity suggested in Customized was never
4 raised by the insured in Columbiaknit. For this reason alone, the reasoning in the Columbiaknit decision
5 should have little weight with this Court.
6 CONCLUSION
7 Based on the foregoing, Plaintiff Meridian Textiles, Inc. respectfully requests that the Court
8 follow the ruling in the decision of Customized Distribution Services v. Zurich Insurance Company, 373
9 N.J. Super. 480, 862 A.2d 560 (2004) and find that the phrase “risk of physical loss or damage” as used
10 in the subject policy, does not require actual physical damage, but covers the negative perception of the
11 condition of the insured ‘s goods by the market, where such negative perception is the “functional
12 equivalent of damage of a material nature or an alteration in physical composition.”
13 As noted by the parties at the Final Pretrial Conference, such a determination will greatly
14 simplify the trial of this case as the more time consuming and expert driven issue of the percentage of
15 actual physical damage will be rendered moot. Further, the resolution of this issue in Plaintiff’s favor
16 will likely lead to the prompt resolution of the entire dispute between the parties.
17 DATED: March 14, 2008 COHON & POLLAK, LLP
18 MANATT, PHELPS & PHILLIPS, LLP
19
20 /s/Jeffrey M. Cohon
By Jeffrey M. Cohon, Attorneys for Plaintiff
21 Meridian Textiles, Inc.
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”
Case 2:06-cv-04766-CAS-JC Document 35 Filed 03/14/08 Page 9 of 9 Page ID #:149

1 PROOF OF SERVICE
2 STATE OF CALIFORNIA, COUNTY OF LOS ANGELES
3 I am employed in the county of Los Angeles, State of California. I am over the age of 18 and
not a party to the within action; my business address is 1999 Avenue of the Stars, Suite 1100, Los
4 Angeles, California 90067.
5 On March 14, 2008, I served the foregoing document described as PLAINTIFF MERIDIAN
TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER DEFENDANT INDEMNITY
6 INSURANCE COMPANY OF NORTH AMERICA’S MARINE INSURANCE POLICY FOR
“RISK OF PHYSICAL LOSS” on the interested parties in this action:
7
x by placing the original x a true copy thereof enclosed in sealed envelopes addressed as
8 follows:
9 Neil S. Lerner, Esq.
Arun Dayalan, Esq.
10 Sands Lerner
12400 Wilshire Blvd., Suite 1300
11 Los Angeles, CA 90025
12 Robert C. Chiles, Esq.
Chiles and Prochnow, LLP
13 2600 El Camino Real, Suite 506
Palo Alto, California 94306-1718
14
x BY MAIL
15
x As follows: I am "readily familiar" with the firm's practice of collection and processing
16 correspondence for mailing. Under that practice it would be deposited with U.S. postal service on that
same day with postage thereon fully prepaid at Los Angeles, California in the ordinary course of
17 business. I am aware that on motion of the party served, service is presumed invalid if postal
cancellation date or postage meter date is more than one day after date of deposit for mailing in
18 affidavit.
19 Executed on March 14, 2008, at Los Angeles, California.
20 (State) I declare under penalty of perjury under the laws of the State of California that the above
is true and correct.
21
x (Federal) I declare that I am a member of the bar of this Court.
22
23 /s/Jeffrey M. Cohon
Jeffrey M. Cohon
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________________________________________________________________________________
Cohon & Pollak,
PLAINTIFF MERIDIAN TEXTILES, INC’S PRE-TRIAL BRIEF RE COVERAGE UNDER
LLP DEFENDANT INDEMNITY INSURANCE COMPANY OF NORTH AMERICA’S MARINE
INSURANCE POLICY FOR “RISK OF PHYSICAL LOSS”