Failure to Fulfill Protective Safeguards Endorsement Defeats Fire Claim
Barry Zalma
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In Frankenmuth Mutual Insurance Company v. Fun F/X II, Inc. and Cao Enterprises II, LLC, No. 22-1933, United States Court of Appeals, Seventh Circuit (February 28, 2023) the insurer rejected a fire claim because the named insured knew, and didn’t tell Frankenmuth, that the sprinklers in his warehouse had no water, a breach of a material condition precedent of the policy.
Fun F/X II, Inc. and Cao Enterprises II, LLC (collectively “FUN”) sought insurance coverage after a warehouse fire. The relevant insurance policy issued by appellee Frankenmuth Mutual Insurance Company provides that it does not cover losses if prior to the fire the policy holder knew of a suspension or impairment in an automatic sprinkler system yet failed to notify Frankenmuth of the issue. Based on this policy exclusion, the district court granted summary judgment for Frankenmuth.
UNDISPUTED FACTS
FUN is a costume and theatrical supply retailer that stored its inventory in a warehouse in South Bend, Indiana owned by Cao Enterprises II, LLC. Victor Cao is the sole member of Cao Enterprises II, LLC and the sole stockholder of FUN. Cao purchased the warehouse in 1999. It then had a Functional sprinkler system with a working supply of water. Cao replaced the sprinkler heads around 2004 and hired inspection companies for routine system testing. In 2016, an inspector from Legacy Fire Protection found no problems.
When the same inspector returned on September 28, 2017, the sprinkler system had no water pressure. The inspector notified Cao, and the two called South Bend Water Works immediately. On November 15, 2017, Cao spoke with the city fire inspector to try to solve the problem.
Cao never heard from any water works personnel and did nothing else to check whether the water was in fact restored. No one ever told Cao the source of the problem, let alone that the problem was fixed.
The next year, a different employee from Legacy Fire Protection performed the annual inspection in the warehouse. Cao was not present for that September 2018 inspection and was not notified of any problems.
THE FIRE
A fire destroyed the warehouse and all of its contents on July 26, 2019. FUN claimed losses exceeding $7 million. The sprinkler system still did not have any water flowing to it. After the fire, the source of the problem was discovered: "The city apparently had cut and capped the pipe supplying the sprinkler system in April 2017 when the building next door was demolished. Cao was told that the worker cutting the pipe incorrectly believed the FUN warehouse was being demolished as well."
Frankenmuth Mutual Insurance Company’s policy contained an exclusion providing that Frankenmuth “will not pay for loss or damage caused by or resulting from fire if, prior to the fire, you: 1. Knew of any suspension or impairment in any protective safeguard listed in the Schedule above and failed to notify us of that fact.” The referenced schedule listed automatic sprinkler systems as protective safeguards.
It was undisputed that Cao never notified the insurer after he learned in September 2017 that the sprinkler system lacked a working water supply. It is also undisputed that no one ever told Cao before the fire that the water flow had been restored.
Frankenmuth sued seeking a declaratory judgment that it did not owe insurance coverage to FUN for losses from the fire. FUN asserted a counterclaim for breach of the insurance policy. The district court granted summary judgment in favor of Frankenmuth based on the policy’s notice-of-impairment exclusion. The court found the sprinkler system had no water flowing to it-and that FUN, through Cao, knew of this impairment yet failed to notify Frankenmuth.
ANALYSIS
Insurance policies are generally construed using familiar contract analysis rules and the interpretation is often a question of law. Where the policy language is unambiguous, plain meaning controls.
The protective safeguards endorsement is clear and easy to apply to the facts at hand. Cao admits that he knew there was no water flowing to the sprinkler system on at least two occasions: the September 2017 inspection and his November 2017 communications with the city fire inspector. He admits that no one ever told him that water flow had been restored. Cao also admits that he never told Frankenmuth about this lack of water flow.
The sprinkler system’s function was to deliver water in the event of fire. When Cao learned that there was no water in the system, he learned that there was a “suspension or impairment in” the system and needed to report the problem to Frankenmuth if he wanted to keep the fire insurance in effect. Since there is no genuine factual dispute on the decisive question that FUN knew of a suspension or impairment in the sprinkler system prior to the fire and failed to report that problem to Frankenmuth. Cao had knowledge in September and November of 2017 that the system had no water flowing to it yet never reported that impairment to Frankenmuth.
ZALMA OPINION
The protective safeguards endorsement created a condition precedent to recovery of indemnity under the policy. Since the insured knew there was no water flowing to the sprinkler system and did not tell his insurer of the fact, the seven million dollar loss was not covered by the policy. FUN and Cao are not without a remedy. The City cut off his water supply negligently and he may sue to recover his loss because of its negligence.
(c) 2023 Barry Zalma & ClaimSchool, Inc.
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Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business. He is available at http://www.zalma.com and [email protected]
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Happy Law Day
ZIFL – Volume 30, Issue 9 – May 1, 2026
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THE SOURCE FOR THE INSURANCE FRAUD PROFESSIONAL
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Zalma’s Insurance Fraud Letter (ZIFL) continues its 30th year of publication dedicated to those involved in reducing the effect of insurance fraud. ZIFL is published 24 times a year and is written by Barry Zalma.
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Post number 5347
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In Mohammed Ali Khalili v. State Farm Lloyds, No. 14-25-00611-CV, Court of Appeals of Texas (April 30, 2026) Khalili maintained a State Farm Lloyds homeowners insurance policy for decades. In 2008 he filed a roof-damage claim; State Farm paid him to replace the entire roof (shingles and gutters). Khalili never replaced the roof and repeated his claim.
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In 2021 he filed a second roof claim. State Farm’s inspectors found the roof “very old” with extensive non-storm-related damage. The claim was denied because (1) the damage did not exceed the deductible and (2) State Farm had already paid for a full roof replacement.
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