1012-00003 · Stonefield Logistics Group · Analysis

preliminary-coverage-assessment-memo.docx DOCUMENT Litigation

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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT

TO: Howard Bellamy, Responsible Partner

FROM: Andrew Fitzpatrick, Lead Associate; Naomi Petersen, Associate

DATE: February 20, 2024

RE: Preliminary Coverage Assessment — Stonefield Logistics Group Inc. v. Meridian Surety & Indemnity Company; Policy No. IML-TX-0039821-2023

MATTER NO.: 1012-00003

I. Executive Summary

Calderwood & Harkness LLP was engaged on February 5, 2024, by Stonefield Logistics Group Inc. ("SLG"), a Texas corporation headquartered at 2900 Petroleum Tower Boulevard, Suite 400, Midland, TX 79701, to evaluate its coverage claim under Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023 (the "Policy") issued by Meridian Surety & Indemnity Company ("Meridian"), an Ohio-domiciled stock insurance company (NAIC No. 28471), rated A (Excellent), Financial Size Category IX by A.M. Best. The engagement was authorized by SLG's Vice President of Risk Management, Dale Engstrom, with the concurrence of SLG's Chief Financial Officer, Leah Tran.

On November 17, 2023, SLG suffered a catastrophic warehouse fire at its Midland Facility, specifically in Warehouse Building C located at 4501 East County Road 130, Midland, TX 79706 (the "Midland Facility"). The fire destroyed Building C and its contents, including approximately $4,780,000 in customer freight that was in SLG's care, custody, and control at the time of the loss. The fire is believed to have originated in the building's main electrical distribution panel, and the Building C wet-pipe automatic sprinkler system, while it did activate, provided only limited suppression capability due to a significant deficit in municipal water-supply pressure on the night of the fire.

On January 22, 2024, Meridian issued a formal denial of SLG's coverage claim. Meridian's denial letter, signed by Vice President of Claims Patricia Ng, invoked two policy exclusions: Exclusion 4(f), which pertains to improper storage of cargo, and Exclusion 4(k), which pertains to the insured's failure to maintain fire protection, detection, or suppression systems. Meridian retained the Houston-based law firm of Kessler, Brandt & Howe LLP as outside coverage counsel in connection with its denial.

This memorandum presents our preliminary assessment of Meridian's denial. Based on the facts and documents available to us at this early stage, we conclude that both exclusions invoked by Meridian are likely inapplicable and that Meridian's denial contains significant procedural and substantive weaknesses that can be exploited in negotiation or litigation. In particular, we note that Exclusion 4(f) was not raised in Meridian's initial Reservation of Rights letter dated December 4, 2023, and appears to have been added to the denial approximately seven weeks later without adequate investigation — a fact that may give rise to extracontractual liability under the Texas Insurance Code.

We recommend that SLG retain an independent forensic fire investigation firm — specifically, Ridgeline Forensic Consultants LLC of Dallas, Texas — to conduct a comprehensive origin-and-cause investigation of the November 17, 2023 fire. The forensic report will be essential to confirming the electrical origin of the fire, evaluating the sprinkler system's performance under actual water-pressure conditions, and verifying the cargo segregation layout within Building C at the time of the loss. Once the forensic report is received, we recommend preparing a comprehensive coverage opinion memorandum for SLG, followed by a formal demand letter to Meridian.

The net claim amount at issue is $4,530,000, calculated as the total cargo loss of $4,780,000 less the $250,000 per-occurrence self-insured retention under the Policy. This amount is well within the Policy's $5,000,000 per-occurrence limit, and the $10,000,000 annual aggregate limit is unimpaired, as SLG has made no prior claims during the current policy period.

II. Background — The Insured and the Policy

A. Stonefield Logistics Group Inc.

Stonefield Logistics Group Inc. is a mid-market intermodal freight brokerage, trucking, and transload/warehousing company operating primarily across the Permian Basin and surrounding regions. SLG currently maintains fourteen terminals across Texas, New Mexico, and Oklahoma, and its core business specializes in Permian Basin oilfield supply-chain logistics, including the transportation, transloading, and warehousing of pipe, proppant, completion chemicals, heavy equipment, and other oilfield materials.

SLG's executive team includes Marcus D. Stonefield, Chief Executive Officer and founder; Leah Tran, Chief Financial Officer; and Dale Engstrom, Vice President of Risk Management. Mr. Engstrom serves as our primary point of contact at SLG for purposes of this engagement and has been responsive and cooperative in providing the documents and information reviewed in this memorandum.

For fiscal year 2023, SLG reported revenue of approximately $187.4 million and EBITDA of approximately $29.1 million. The company employs approximately 1,100 individuals across its terminal network. SLG is a privately held company; approximately 72% of its equity is owned by Irongate Capital Partners, LP, a Delaware limited partnership (Managing Partner: Carolyn Reeves), through Irongate Industrial Partners Fund IV, LP, a private equity fund that acquired its controlling stake in SLG in August 2019. SLG's Federal Employer Identification Number is 84-3291057.

The Midland Facility, where the loss occurred, is one of SLG's largest and most active terminals. The facility comprises multiple warehouse buildings, open-air storage yards, and a transload rail siding. Warehouse Building C, the building destroyed in the November 17, 2023 fire, was a pre-engineered metal building of approximately 32,000 square feet, constructed in 2011. It was used for the indoor storage of customer freight, primarily casing pipe, completion chemicals, downhole tools, and miscellaneous oilfield supplies.

B. The Meridian Policy

The Policy at issue is an Inland Marine Cargo Legal Liability Policy, the relevant terms of which are summarized as follows:

The Policy's insuring agreement provides coverage on an all-risks basis for "all risks of direct physical loss or damage to cargo in the care, custody, or control of the Insured arising out of or in connection with the Insured's transportation, warehousing, or transloading operations," subject to the Policy's terms, conditions, exclusions, and endorsements. This broad insuring agreement is typical of inland marine cargo legal liability policies placed for logistics and warehousing operators and is designed to protect the insured against liability to cargo owners for loss or damage to their goods while in the insured's possession.

The Policy was placed by SLG's longstanding insurance broker, Calvert & Strauss Insurance Brokers, Inc. ("Calvert & Strauss"), located at 3700 Buffalo Speedway, Suite 520, Houston, TX 77098. SLG's account executive at Calvert & Strauss is Jason Muñoz. Calvert & Strauss facilitated SLG's initial notice of loss to Meridian and assisted with the preparation and submission of the sworn proof of loss.

Meridian Surety & Indemnity Company is an Ohio-domiciled stock insurance company, NAIC No. 28471, with its principal offices at 600 Scioto Crossing, Suite 1200, Columbus, OH 43215. Meridian is rated A (Excellent), Financial Size Category IX by A.M. Best, indicating strong financial stability and claims-paying ability. Meridian writes inland marine, surety, and specialty casualty lines on a nationwide basis.

C. Key Policy Exclusions at Issue

Two Policy exclusions are at issue in connection with Meridian's denial of coverage. The operative language of each exclusion is as follows:

Exclusion 4(f) — Improper Storage:

"This Policy does not cover loss or damage resulting from the Insured's storage of cargo in a manner inconsistent with the shipper's written storage instructions or applicable industry standards for the type of cargo involved."

Exclusion 4(k) — Failure to Maintain:

"This Policy does not cover loss or damage caused by or resulting from the Insured's failure to maintain fire protection, detection, or suppression systems in the facility where cargo is stored, in accordance with applicable codes and manufacturer specifications."

As discussed in detail below, these two exclusions differ in their structure and operation. Exclusion 4(f) is triggered by storage that is "inconsistent with" shipper instructions or industry standards — a compliance-based exclusion. Exclusion 4(k), by contrast, contains express causation language ("caused by or resulting from"), requiring not merely a failure to maintain but a demonstrable causal connection between the maintenance failure and the loss. This distinction is significant to our analysis.

D. Notice and Proof-of-Loss Provisions

The Policy contains standard notice and proof-of-loss provisions in Section 8:

Section 8(a) requires the Named Insured to provide written notice to the insurer "as soon as practicable, but in no event later than thirty (30) days after the Insured becomes aware of any loss or damage which may give rise to a claim under this Policy."

Section 8(c) requires the Named Insured to submit a sworn proof of loss "within ninety (90) days after the date of loss," containing a detailed statement of the cargo destroyed or damaged, the circumstances of the loss, and the amount claimed.

SLG complied with both provisions. SLG's notice of loss was submitted within days of the November 17, 2023 fire, facilitated by Calvert & Strauss, and was received by Meridian well within the 30-day contractual notice period. SLG's sworn proof of loss was submitted on February 1, 2024 — 76 days after the date of loss — within the 90-day contractual deadline. The sworn proof of loss was prepared with the assistance of Whitlock & Associates, Certified Public Accountants, P.C. (Engagement Partner: Sandra Whitlock, CPA, CFF), located at 4200 South Loop 250 West, Suite 100, Midland, TX 79703. Ms. Whitlock is a Certified in Financial Forensics credential holder with extensive experience in cargo loss quantification.

There is no dispute between the parties regarding the timeliness of SLG's notice of loss or sworn proof of loss. Meridian has not raised any notice-related defense, and we do not anticipate that any such defense could be credibly asserted on these facts.

III. The Loss Event — November 17, 2023 Fire

A. Factual Summary

On November 17, 2023, at approximately 2:14 a.m. CST, a fire broke out in Warehouse Building C at SLG's Midland Facility. The fire appears to have originated in the area of the Building C main electrical distribution panel, a Square D Model QED-2 unit that was installed when Building C was constructed in 2011. The Square D Model QED-2 is a widely used low-voltage switchboard designed for commercial and industrial applications. At this preliminary stage, the precise mechanism of electrical failure has not been determined, but the Midland Fire Department's preliminary incident report identifies the area of origin as the vicinity of the main electrical distribution panel.

The Midland Fire Department was dispatched to the Midland Facility at approximately 2:17 a.m., following an automated alarm notification from the building's fire alarm system. Fire units arrived on scene at approximately 2:31 a.m. By that time, the fire had progressed substantially through the warehouse interior. Firefighting operations continued for over two hours, and the fire was declared contained at approximately 4:45 a.m. Despite suppression efforts, Building C was declared a total structural loss. The fire caused extensive damage to the building's structural steel framing, roof assembly, and exterior metal cladding, rendering the building unsalvageable.

The Building C wet-pipe automatic sprinkler system, which was NFPA 13 compliant at the time of its installation in 2011, did activate during the fire. However, the system provided only limited suppression capability. Preliminary investigation indicates that this limited performance was primarily attributable to a significant deficit in municipal water-supply pressure on the night of the fire. The Building C sprinkler system was designed to operate at a minimum supply pressure of 52 psi, consistent with the hydraulic calculations prepared at the time of installation. However, the actual municipal water-supply pressure at the Midland Facility on the night of the fire was approximately 36 psi — a deficit of approximately 16 psi, or roughly 31% below the system's design parameter. At 36 psi, the sprinkler heads that activated would have delivered significantly reduced flow rates, resulting in inadequate suppression density over the fire area.

The cause of the low municipal water pressure on the night of the fire has not yet been definitively determined. Possible contributing factors include concurrent high-demand drawdowns on the municipal water system, infrastructure limitations in the municipal water distribution network serving the eastern Midland industrial corridor, or other factors within the control of the City of Midland's water utility. Regardless of the cause, the municipal water-pressure deficit was entirely outside SLG's control and unrelated to SLG's maintenance of the sprinkler system itself.

No fatalities or serious injuries resulted from the fire. Two SLG employees who were on the overnight shift at the Midland Facility at the time the fire broke out evacuated safely and were not injured. One Midland firefighter sustained a minor injury during suppression operations and was treated and released at the scene.

B. Cargo Destroyed — Quantification

The sworn proof of loss prepared by Whitlock & Associates, under the supervision of Engagement Partner Sandra Whitlock, CPA, CFF, values the total cargo destroyed in the Building C fire at $4,780,000. The loss is broken down by cargo owner and type as follows:

The cargo values reflected in the sworn proof of loss were derived from the applicable warehouse receipts, bills of lading, shipper invoices, and replacement cost quotations, as compiled and verified by Whitlock & Associates. Meridian has not, to date, disputed the quantum of the loss; its denial was based entirely on the applicability of the two exclusions discussed in this memorandum.

After application of the $250,000 per-occurrence self-insured retention, the net claim amount payable under the Policy is $4,530,000. This amount is within the Policy's $5,000,000 per-occurrence limit and, because no prior claims have been made during the April 1, 2023 – March 31, 2024 policy period, the $10,000,000 annual aggregate limit is entirely unimpaired.

It should be noted that the physical damage to Warehouse Building C itself, estimated at approximately $1,350,000, is covered under a separate commercial property insurance policy and is not at issue in this matter. The present analysis is limited to SLG's claim for the cargo loss under the Meridian Policy.

IV. Procedural History of the Claim

A. Notice and Reservation of Rights

As noted above, SLG timely notified Meridian of the loss in late November 2023. The notice was transmitted through SLG's insurance broker, Calvert & Strauss, and was received by Meridian within the 30-day notice period prescribed by Section 8(a) of the Policy.

On December 4, 2023, Meridian issued a Reservation of Rights letter to SLG, acknowledging receipt of SLG's notice of loss and advising that Meridian was investigating the claim and reserving all of its rights under the Policy. The Reservation of Rights letter was prepared by Meridian's Senior Claims Examiner, Brian Woolf, and was issued under the authority of Vice President of Claims Patricia Ng. The letter was sent to SLG's VP of Risk Management, Dale Engstrom, with a copy to Jason Muñoz at Calvert & Strauss.

Significantly, the December 4, 2023 Reservation of Rights letter cited only Exclusion 4(k) (Failure to Maintain) as a potential basis for denial of coverage. The letter referenced SLG's obligation to maintain fire protection systems in accordance with applicable codes and stated that Meridian was investigating whether the Building C sprinkler system had been properly maintained at the time of the fire. The Reservation of Rights letter did not reference Exclusion 4(f) (Improper Storage) or raise any concern regarding the manner in which cargo was stored within Building C.

The Reservation of Rights letter was issued 17 days after the date of loss, well within the 30-day notice window under the Policy. There is no issue with respect to the timeliness of Meridian's reservation of rights.

B. The Denial — January 22, 2024

On January 22, 2024, Meridian issued a formal coverage denial letter, addressed to Dale Engstrom at SLG, with copies to Jason Muñoz at Calvert & Strauss. The denial letter was signed by Patricia Ng, Vice President of Claims, and was prepared with the involvement of Meridian's outside coverage counsel, Kessler, Brandt & Howe LLP ("KBH"), located at 1401 McKinney Street, Suite 2800, Houston, TX 77010. The lead partner at KBH handling the matter is Victoria Kessler; she is assisted by associate Samuel Okonkwo.

The denial letter invoked two exclusions as the basis for Meridian's denial of SLG's claim:

1. Exclusion 4(f) (Improper Storage): Meridian alleged that SLG stored casing pipe and completion chemicals in the same warehouse bay, in violation of the shipper's written storage instructions and in contravention of OSHA 29 CFR 1910.106 segregation requirements for the storage of flammable and combustible liquids. Meridian contended that this co-storage constituted storage "in a manner inconsistent with the shipper's written storage instructions or applicable industry standards" within the meaning of Exclusion 4(f).

2. Exclusion 4(k) (Failure to Maintain): Meridian alleged that SLG failed to maintain the Building C sprinkler system in accordance with applicable codes and manufacturer specifications, citing the fact that the last annual full-flow inspection of the sprinkler system (per NFPA 25 § 5.3.2) was performed on September 14, 2022, and was not repeated by September 14, 2023 — creating an alleged lapse of over two months at the time of the November 17, 2023 fire. Meridian contended that this lapse constituted a failure to maintain fire suppression systems "in accordance with applicable codes and manufacturer specifications" within the meaning of Exclusion 4(k).

The denial letter did not dispute the timeliness of SLG's notice of loss or sworn proof of loss, nor did it challenge the quantum of the cargo loss as stated in the sworn proof of loss. Meridian's denial rests entirely on the applicability of the two cited exclusions.

C. Significant Procedural Observation — Late Addition of Exclusion 4(f)

A critical weakness in Meridian's position is the procedural irregularity surrounding the invocation of Exclusion 4(f). As noted above, the December 4, 2023 Reservation of Rights letter cited only Exclusion 4(k) as a potential basis for denial. Exclusion 4(f) was raised for the first time in the January 22, 2024 denial letter — approximately seven weeks after the Reservation of Rights letter was issued.

This late addition raises serious questions about the adequacy of Meridian's pre-denial investigation. An insurer that identifies a potential exclusion basis only after issuing its Reservation of Rights letter — and does so for the first time in the denial itself — suggests either that the insurer failed to conduct a thorough initial investigation or that the additional exclusion was added as a post hoc justification for a denial that may have been driven by other considerations. In either case, this procedural posture creates vulnerability for Meridian.

Under Texas law, an insurer has an affirmative duty to conduct a reasonable investigation of a claim before denying it. The Texas Insurance Code § 541.060(a)(7) prohibits an insurer from "refusing to pay a claim without conducting a reasonable investigation with respect to the claim." The late addition of Exclusion 4(f), apparently without the benefit of a physical inspection of the warehouse layout or a review of the SDS classifications for the Cantera chemicals, may constitute a violation of this statutory duty.

Furthermore, under Texas law, an insurer's failure to include a coverage defense in its Reservation of Rights letter may, under certain circumstances, result in waiver or estoppel with respect to that defense, particularly where the insured was prejudiced by the omission. While Texas courts have not adopted a blanket waiver rule for omitted reservation-of-rights defenses, the failure to timely assert a coverage defense is a relevant factor in evaluating the insurer's good faith and the overall reasonableness of its claim-handling conduct. See Members Mut. Ins. Co. v. Cutaia, 476 S.W.2d 278 (Tex. 1972) (discussing insurer's duty to timely assert coverage defenses).

This issue should be developed in full in our comprehensive coverage analysis and should feature prominently in any demand letter or litigation strategy.

V. Preliminary Analysis of Exclusion 4(f) — Improper Storage

A. Meridian's Position

In its January 22, 2024 denial letter, Meridian contends that SLG stored casing pipe and completion chemicals in the same warehouse bay within Building C, in violation of two standards: (1) the shipper's written storage instructions, and (2) OSHA 29 CFR 1910.106, which governs the storage and handling of flammable and combustible liquids. Meridian asserts that the co-storage of these materials constituted storage "in a manner inconsistent with the shipper's written storage instructions or applicable industry standards" under Exclusion 4(f), thereby triggering the exclusion and barring coverage for the entire loss.

Meridian's denial letter does not identify which shipper's instructions were allegedly violated, nor does it specify the particular provision of OSHA 29 CFR 1910.106 that Meridian contends was breached. The letter states generally that "the co-storage of casing pipe and completion chemicals in the same warehouse bay is inconsistent with industry standards for the segregation of flammable materials" and cites OSHA 29 CFR 1910.106 without further elaboration.

B. Preliminary Assessment — Exclusion Likely Inapplicable

Based on the information and documents available to us at this stage, we believe that Exclusion 4(f) is likely inapplicable for the following reasons.

1. SLG's Warehouse Layout. SLG's Warehouse Layout Plan, Revision 7, dated June 2023 (the most current revision prior to the fire), designates separate and distinct storage zones within Building C for different categories of cargo. Specifically, the Warehouse Layout Plan provides for the following allocation of storage bays:

• Bays 1–4: Casing pipe and tubular goods

• Bays 5–8: Tools, equipment, and miscellaneous freight (providing a 40-foot physical buffer zone between the pipe storage bays and the chemical storage bays)

• Bays 9–12: Chemical pallets and containerized liquids

This layout is designed to maintain physical separation between casing pipe (a non-flammable steel product) and completion chemicals, with a substantial buffer zone of approximately 40 feet occupied by intermediate-category cargo. The layout is consistent with prudent warehousing practices and is responsive to the general principle of segregating dissimilar materials.

Dale Engstrom, SLG's VP of Risk Management, has confirmed in our initial interviews that this layout was maintained at the time of the fire and that no casing pipe was stored in the chemical bays, nor were any chemical pallets stored in the pipe bays. Mr. Engstrom stated that SLG's warehouse personnel were trained on the Warehouse Layout Plan and that compliance with the designated bay assignments was enforced through SLG's warehouse management system, which tracks the bay location of each cargo lot.

While Mr. Engstrom's representations are credible and consistent with the documentary evidence we have reviewed, we recognize the importance of independent corroboration. The physical layout of Building C at the time of the fire should be confirmed through forensic mapping by a qualified fire investigator, which is one of the objectives of the proposed engagement of Ridgeline Forensic Consultants LLC (discussed in Section X below).

2. Nature of the Chemicals — Class IIIB Combustible Liquids. A critical flaw in Meridian's invocation of Exclusion 4(f) is its apparent mischaracterization of the chemicals stored in Building C. Meridian's denial letter refers broadly to "completion chemicals" and implies that these materials are "flammable" substances subject to the segregation requirements of OSHA 29 CFR 1910.106. However, a review of the Safety Data Sheets ("SDS") for the Cantera Chemical Supply Co. completion chemicals stored in Building C at the time of the fire reveals that these materials are classified as Class IIIB combustible liquids under the National Fire Protection Association (NFPA) and OSHA classification system.

Class IIIB combustible liquids are defined as liquids with a flash point at or above 200°F (93°C). The Cantera completion chemicals stored in Building C had a flash point exceeding 200°F, as documented in the applicable SDS sheets. This classification is significant because OSHA 29 CFR 1910.106 — the very standard cited by Meridian — draws clear and intentional distinctions between different classes of flammable and combustible liquids. The segregation requirements found in § 1910.106(d)(5)(iii) apply to flammable liquids (Classes IA, IB, and IC, with flash points below 100°F) and to combustible liquids stored at or above their flash points. Class IIIB combustible liquids stored at ambient temperature — which is the condition that existed in Building C — do not trigger the specific segregation requirements upon which Meridian relies.

Meridian's invocation of OSHA 29 CFR 1910.106 thus appears to conflate flammable liquids with Class IIIB combustible liquids — a legally and technically significant distinction that undermines the factual foundation of its Exclusion 4(f) argument. If Meridian's adjusters or coverage counsel did not review the SDS sheets for the Cantera chemicals before invoking this exclusion, that failure would further support our contention that Meridian failed to conduct a reasonable investigation before denying the claim.

3. Shipper Instructions. Meridian's denial letter alleges that SLG stored cargo "in a manner inconsistent with the shipper's written storage instructions" but does not identify which shipper's instructions were allegedly violated. Our review of the available shipper instructions has focused on Cantera Chemical Supply Co., the owner of the completion chemicals stored in Building C.

Cantera Chemical Supply Co.'s written storage instructions, which accompanied the cargo at the time of delivery to SLG's warehouse, required "segregation from incompatible materials per SDS." The SDS sheets for the Cantera completion chemicals identify "incompatible materials" as strong oxidizers, strong acids, and strong bases. Steel casing pipe is not identified as an incompatible material on any of the applicable SDS sheets. Accordingly, the storage of casing pipe in separate bays (Bays 1–4) within the same building as the Cantera chemicals (Bays 9–12) does not appear to violate Cantera's written storage instructions.

Moreover, as discussed above, the casing pipe and the chemicals were stored in physically separate areas of the warehouse, with a 40-foot buffer zone (Bays 5–8) between them. This arrangement is consistent with both the Cantera storage instructions and general industry practice for the warehousing of Class IIIB combustible liquids.

We note that we have not yet obtained and reviewed the complete set of shipper instructions for all cargo stored in Building C at the time of the loss. This is an outstanding information need identified in Section IX below. It is possible that one or more shippers provided storage instructions that were more restrictive than Cantera's, and we need to confirm compliance with all applicable shipper instructions before finalizing our analysis.

C. Preliminary Conclusion on Exclusion 4(f)

Based on the information currently available, Exclusion 4(f) does not appear to apply to the November 17, 2023 loss. The Cantera completion chemicals and the Permian Wellhead Services casing pipe were stored in separate bays within Building C, separated by a 40-foot buffer zone, consistent with SLG's Warehouse Layout Plan. The OSHA provision cited by Meridian (29 CFR 1910.106) is inapplicable to Class IIIB combustible liquids stored at ambient temperature, and the shipper's written storage instructions do not require segregation from steel pipe.

However, we emphasize that this conclusion is preliminary and is subject to two important caveats: (1) the warehouse layout at the time of the fire must be independently confirmed through forensic mapping, and (2) the complete set of shipper storage instructions for all cargo in Building C must be obtained and reviewed. These steps are incorporated into our recommended next actions.

VI. Preliminary Analysis of Exclusion 4(k) — Failure to Maintain

A. Meridian's Position

Meridian's denial letter contends that SLG failed to maintain the Building C sprinkler system in accordance with applicable codes and manufacturer specifications, as required by the Policy. Specifically, Meridian alleges that the annual full-flow test of the sprinkler system, required by NFPA 25, Standard for the Inspection, Testing, and Maintenance of Water-Based Fire Protection Systems, § 5.3.2, was last performed on September 14, 2022, and was not repeated by September 14, 2023. Meridian asserts that this created a lapse of more than two months at the time of the November 17, 2023 fire and constitutes a failure to maintain fire suppression systems "in accordance with applicable codes" within the meaning of Exclusion 4(k).

NFPA 25 § 5.3.2 requires an annual full-flow test of wet-pipe sprinkler systems, which involves flowing water through the system's main drain to verify that water supply and system components are functioning within design parameters. The purpose of the annual full-flow test is to confirm that the water supply is adequate and that no obstructions or other conditions have developed that would impair system performance. Meridian's position is that the 14-month interval between the September 14, 2022 test and the date of the fire (November 17, 2023) constitutes non-compliance with this annual testing requirement.

B. Preliminary Assessment — Exclusion Likely Inapplicable

We believe that Exclusion 4(k) is likely inapplicable for several independent reasons, any one of which may be sufficient to defeat Meridian's defense.

1. SLG's Compliance with NFPA 25 Quarterly Inspections. While the annual full-flow test was overdue at the time of the fire, SLG maintained full compliance with the quarterly visual inspection requirements of NFPA 25 § 5.2.1 throughout the relevant period. Quarterly visual inspections are a separate and independent maintenance requirement under NFPA 25, requiring the building owner or operator to visually inspect sprinkler system components — including control valves, piping, sprinkler heads, and gauges — on a quarterly basis.

SLG performed quarterly visual inspections of the Building C sprinkler system on the following dates:

• December 15, 2022

• March 20, 2023

• June 12, 2023

• September 8, 2023

All four quarterly inspections during the relevant period were timely performed and documented. The inspection reports, which we have reviewed, indicate that no deficiencies were observed during any of the quarterly inspections. This demonstrates that SLG maintained an active and ongoing maintenance program for the Building C sprinkler system and did not neglect or abandon its maintenance obligations.

The fact that SLG was current on its quarterly inspections is relevant to the interpretation of Exclusion 4(k). The exclusion bars coverage for loss "caused by or resulting from the Insured's failure to maintain fire protection, detection, or suppression systems … in accordance with applicable codes." NFPA 25 prescribes a comprehensive maintenance program that includes multiple categories of inspections and tests at varying frequencies — weekly, monthly, quarterly, annually, and at five-year and ten-year intervals. A reasonable reading of Exclusion 4(k) does not require perfect, simultaneous compliance with every element of the NFPA 25 maintenance schedule at all times; rather, it contemplates a systemic or material failure to maintain fire protection systems. SLG's consistent compliance with the quarterly inspection program demonstrates that it was actively maintaining the sprinkler system, even though one element of the maintenance schedule — the annual full-flow test — was temporarily overdue.

2. Annual Full-Flow Test — Scheduled but Not Yet Performed. The circumstances surrounding the delayed annual full-flow test further undercut Meridian's Exclusion 4(k) defense. The annual full-flow test was last performed on September 14, 2022, by Lone Star Fire Protection Inc. ("Lone Star FP"), a licensed fire protection contractor based in Midland, Texas, which SLG had retained for sprinkler system testing and maintenance services.

A new full-flow test was initially targeted for October 2023, consistent with the approximate anniversary of the prior test. However, SLG was unable to schedule the test for October 2023 due to a scheduling backlog at Lone Star FP. The backlog was attributable to increased demand for fire protection inspection and testing services in the Midland area during the second half of 2023, driven by the expansion of industrial and oil-and-gas-related warehouse and storage facilities in the Permian Basin region.

SLG did not simply allow the annual test to lapse without action. On August 28, 2023 — well in advance of the September 14, 2023 anniversary — SLG executed a written engagement letter with Lone Star FP confirming an appointment for a full-flow test inspection of the Building C sprinkler system scheduled for November 20, 2023. This appointment was just three days after the November 17, 2023 fire.

The significance of this fact cannot be overstated. SLG took affirmative, documented steps to schedule the annual test in a timely manner. The delay was attributable entirely to the third-party contractor's scheduling constraints, not to any neglect or indifference on SLG's part. SLG's conduct demonstrates exactly the kind of good-faith maintenance effort that Exclusion 4(k) is designed to incentivize. An insured that proactively schedules a required inspection and is prevented from completing it on the precise anniversary date by circumstances beyond its control should not be penalized by the loss of coverage, particularly where — as here — the delayed inspection bears no causal relationship to the loss.

We should obtain corroborating documentation from Lone Star FP confirming the scheduling backlog and the November 20, 2023 appointment date. This is identified as an outstanding information need in Section IX below.

3. Causation Requirement — Exclusion 4(k) Language. Perhaps the most significant weakness in Meridian's Exclusion 4(k) defense is the exclusion's express causation requirement. Unlike Exclusion 4(f), which is triggered by storage "inconsistent with" specified standards (a compliance-based formulation), Exclusion 4(k) requires that the loss be "caused by or resulting from" the insured's failure to maintain fire protection systems. This is a causation-based exclusion that demands a demonstrable nexus between the alleged maintenance failure and the loss.

Under well-established Texas law, the insurer bears the burden of proving that an exclusion applies, including the burden of proving any causation element contained in the exclusion's language. See Drayton Insurance. v. Hudson Energy Co., 811 S.W.2d 552, 555 (Tex. 1991) ("When an insurer relies on an exclusion to deny coverage, the insurer has the burden of proving the exclusion applies."). This burden is on Meridian, and it is a substantial one on the facts of this case.

Preliminary indications are that the fire originated in the main electrical distribution panel — a Square D Model QED-2 unit — and not in any component of the sprinkler system or fire protection infrastructure. The fire's cause appears to be an electrical fault, entirely unrelated to the condition or maintenance of the sprinkler system. Accordingly, the delayed annual full-flow test did not "cause" the fire.

The remaining question is whether the delayed annual test "resulted in" the loss — that is, whether a timely annual full-flow test would have revealed a condition that, if corrected, would have prevented or materially reduced the loss. On the facts currently available, this argument is exceptionally weak for Meridian. The sprinkler system did activate during the fire, demonstrating that the system was functional and responsive to the fire condition. The system's ineffectiveness was attributable not to any deficiency in the sprinkler system itself but to the inadequate municipal water-supply pressure — approximately 36 psi actual versus the 52 psi design parameter. Even a system that had been subjected to a full-flow test on September 14, 2023, would have experienced the same water-pressure deficit on the night of the fire, because the deficit was caused by conditions in the municipal water supply system that were entirely outside SLG's control.

An annual full-flow test, by its nature, measures the water supply available at the time of the test. It is not a predictive instrument that guarantees future water-supply adequacy. If the municipal water pressure was adequate at the time of a hypothetical September 2023 full-flow test but was deficient on the night of the November 2023 fire, the test would not have prevented or mitigated the loss. The causal chain that Meridian would need to establish — from the delayed test, to a hypothetical discovery of a system deficiency, to a hypothetical correction that would have prevented the loss — is speculative at best and fails on the undisputed fact that the primary suppression failure was caused by inadequate municipal water pressure.

We recognize that a complete causation analysis requires an independent expert forensic report. Specifically, we need a qualified fire protection engineer to evaluate whether a fully code-compliant sprinkler system, operating at the design pressure of 52 psi, would have been capable of suppressing or materially containing the fire. If the answer is that even a fully pressurized system would have been overwhelmed by the fire (depending on the fire's growth rate and the sprinkler system's design density relative to the actual fire load), then Meridian's causation argument fails entirely. This analysis is within the proposed scope of the Ridgeline engagement discussed in Section X.

C. Preliminary Conclusion on Exclusion 4(k)

Exclusion 4(k) does not appear to apply on the facts currently available. SLG maintained full compliance with its quarterly inspection schedule, proactively scheduled the annual full-flow test through a written engagement with Lone Star Fire Protection Inc., and was prevented from completing the test on the precise anniversary date solely by the contractor's scheduling backlog. More fundamentally, the fire's apparent origin in the electrical distribution panel and the sprinkler system's inadequate performance due to a municipal water-pressure deficit — a condition entirely outside SLG's control — both undercut any causal link between the delayed annual test and the loss.

Independent forensic investigation is essential to solidify this conclusion. The Ridgeline engagement should specifically address: (a) confirmation of the fire's origin and cause; (b) analysis of the sprinkler system's actual performance on the night of the fire, including the impact of the water-pressure deficit; and (c) whether a fully code-compliant system operating at design pressure would have controlled or suppressed the fire under the conditions that existed on November 17, 2023.

VII. Potential Extracontractual Claims Under the Texas Insurance Code

In addition to the contractual coverage claim under the Policy, the circumstances of Meridian's denial give rise to potential extracontractual claims under the Texas Insurance Code. We address these potential claims below on a preliminary basis. A more thorough analysis will be included in the comprehensive coverage opinion to be prepared upon receipt of the forensic report.

A. Chapter 541 — Unfair Settlement Practices

The Texas Insurance Code Chapter 541 prohibits unfair methods of competition and unfair or deceptive acts or practices in the business of insurance. Section 541.060 identifies specific unfair settlement practices, including:

• § 541.060(a)(2): failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim with respect to which the insurer's liability has become reasonably clear;

• § 541.060(a)(3): failing to promptly provide to a policyholder a reasonable explanation of the basis in the policy, in relation to the facts or applicable law, for the insurer's denial of a claim or offer of a compromise settlement of a claim;

• § 541.060(a)(7): refusing to pay a claim without conducting a reasonable investigation with respect to the claim.

Meridian's late addition of Exclusion 4(f), raised for the first time in the January 22, 2024 denial letter after having been omitted from the December 4, 2023 Reservation of Rights letter, may constitute a violation of one or more of these provisions. The Exclusion 4(f) ground appears to have been raised without adequate investigation. Specifically, Meridian does not appear to have conducted a physical inspection of the warehouse layout to determine whether casing pipe and chemicals were actually stored in the same bay, nor does Meridian appear to have reviewed the SDS classifications for the Cantera completion chemicals to determine whether those chemicals were properly classified as flammable liquids subject to the OSHA segregation requirements cited in the denial letter. The denial letter's factual assertions regarding co-storage and OSHA non-compliance appear to be assumptions, not conclusions supported by investigation.

If Meridian's denial is determined to be wrongful and its investigation inadequate, SLG may be entitled to recover actual damages, treble damages under Tex. Ins. Code § 541.152(b) (available where the insurer's conduct was committed "knowingly"), and reasonable and necessary attorney's fees under § 541.152(a)(1). These potential remedies significantly increase Meridian's exposure and provide substantial leverage for SLG in any settlement negotiation.

B. Chapter 542 — Prompt Payment of Claims

The Texas Insurance Code Chapter 542, Subchapter B (the "Prompt Payment of Claims Act") imposes specific deadlines on insurers for the acknowledgment, investigation, and payment of insurance claims. Under § 542.056(a), an insurer that receives all items, statements, and forms reasonably requested and required under § 542.055 must notify the claimant in writing of its acceptance or rejection of the claim not later than the 15th business day after the date the insurer receives all required items. This deadline may be extended to 45 days if the insurer notifies the claimant that it needs additional time and provides specific reasons. See § 542.056(d).

SLG submitted its sworn proof of loss on February 1, 2024. Meridian denied the claim on January 22, 2024 — before the sworn proof of loss was even submitted — which raises additional questions about the adequacy of Meridian's investigation. However, even assuming that the statutory clock under Chapter 542 began running on February 1, 2024 (the date of the sworn proof of loss), the 15-business-day deadline for acceptance or rejection would fall in late February 2024, and the extended 45-day deadline would fall in late March 2024.

If Meridian's denial is ultimately determined to be wrongful, statutory penalty interest of 18% per annum begins to accrue under Tex. Ins. Code § 542.060 on the date the claim was required to be paid. Based on our preliminary calculation, the accrual trigger date is approximately April 29, 2024, taking into account the maximum statutory extension periods and required processing time.

On the net claim amount of $4,530,000, the 18% statutory penalty interest represents a significant financial exposure to Meridian — approximately $815,400 per year, or approximately $2,233 per day. This ongoing accrual provides a powerful incentive for Meridian to resolve the claim promptly if its denial is not well-founded, and it should be prominently featured in any formal demand letter.

C. Preliminary Assessment

The combination of a potentially wrongful denial of a $4,530,000 claim and the procedural irregularities in Meridian's claim-handling — particularly the late addition of Exclusion 4(f) without apparent investigation — provides meaningful leverage for SLG's demand. The availability of treble damages under Chapter 541 and 18% penalty interest under Chapter 542, in addition to the contractual claim itself, creates a total exposure for Meridian that substantially exceeds the face amount of the claim. These extracontractual claims should be developed in the comprehensive coverage opinion and should be expressly referenced in the formal demand letter, with appropriate specificity as to the factual and legal basis for each claim.

We note that extracontractual claims under the Texas Insurance Code require careful development and proof. While the facts currently available are supportive, a definitive assessment will depend in part on the results of the forensic investigation and on further investigation of Meridian's claim-handling process, including potentially the contents of Meridian's claim file. The decision of whether and when to seek production of Meridian's claim file — through informal demand or formal discovery — is a strategic question that we should discuss with Mr. Bellamy and the client.

VIII. Key Documents Reviewed to Date

In preparing this preliminary assessment, we have reviewed the following documents and materials:

1. Meridian Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023, including the full policy form, all endorsements, and the declarations page.

2. Meridian Reservation of Rights letter to Stonefield Logistics Group Inc., dated December 4, 2023, issued by Senior Claims Examiner Brian Woolf.

3. Meridian Coverage Denial letter to Stonefield Logistics Group Inc., dated January 22, 2024, signed by Vice President of Claims Patricia Ng.

4. Stonefield Logistics Group Inc. Sworn Proof of Loss, submitted February 1, 2024, prepared with the assistance of Whitlock & Associates, Certified Public Accountants, P.C. (Engagement Partner: Sandra Whitlock, CPA, CFF).

5. Stonefield Logistics Group Inc. Warehouse Layout Plan, Revision 7, dated June 2023.

6. Stonefield Logistics Group Inc. Quarterly Sprinkler Inspection Reports for Building C, dated December 15, 2022; March 20, 2023; June 12, 2023; and September 8, 2023.

7. Lone Star Fire Protection Inc. engagement letter from Stonefield Logistics Group Inc., dated August 28, 2023, confirming an inspection appointment for November 20, 2023.

8. Midland Fire Department Incident Report (preliminary), relating to the November 17, 2023 fire at 4501 East County Road 130, Midland, TX 79706.

9. Safety Data Sheets (SDS) for Cantera Chemical Supply Co. completion chemicals stored in Building C at the time of the fire.

10. Cantera Chemical Supply Co. written storage instructions for completion chemicals delivered to SLG's Midland Facility.

We have also conducted initial interviews with Dale Engstrom, SLG's VP of Risk Management, and Jason Muñoz, SLG's account executive at Calvert & Strauss Insurance Brokers, Inc. These interviews were conducted under the protection of the attorney-client privilege.

IX. Outstanding Information Needs

While the documents and information reviewed to date support a strong preliminary assessment of SLG's coverage position, several outstanding information needs must be addressed before we can issue a comprehensive coverage opinion. These needs are summarized below in order of priority.

1. Independent Forensic Origin-and-Cause Investigation. This is the most critical outstanding need. An independent forensic investigation is essential to establish, to a reasonable degree of scientific certainty, that the fire originated in the Building C main electrical distribution panel (Square D Model QED-2), to identify the specific mechanism of electrical failure, and to evaluate the sprinkler system's performance under the municipal water-pressure conditions that existed on the night of the fire. The forensic investigation should also address whether a fully code-compliant sprinkler system operating at design pressure (52 psi) would have prevented or materially mitigated the loss, given the fire's growth characteristics and the cargo fire load present in Building C.

2. Complete Shipper Storage Instructions. We need to obtain and review the complete set of written storage instructions for all cargo stored in Building C at the time of the loss — not just the Cantera Chemical Supply Co. instructions. If any shipper's instructions contained restrictions that SLG did not comply with, that fact could affect our analysis of Exclusion 4(f). Dale Engstrom should be asked to compile and produce these documents as soon as practicable.

3. Confirmation of Cargo Segregation at Time of Fire. While Dale Engstrom has confirmed that the Warehouse Layout Plan, Revision 7, was adhered to at the time of the fire, this representation should be corroborated through independent forensic mapping of the Building C layout as it existed at the time of the fire. Forensic mapping may be possible through analysis of the fire debris pattern, surviving warehouse management system records, security camera footage (if any), and interviews with SLG warehouse personnel who were familiar with the cargo layout.

4. Municipal Water-Pressure Records. We should obtain records from the City of Midland's water utility confirming the actual water pressure at or near the Midland Facility on November 17, 2023, and any history of low-pressure events in the eastern Midland industrial corridor. These records will be important in establishing that the sprinkler system's inadequate performance was attributable to the municipal water-supply deficit and not to any deficiency in the system itself.

5. Lone Star Fire Protection Inc. Records. We should obtain documentation from Lone Star Fire Protection Inc. confirming the scheduling backlog that prevented completion of the annual full-flow test prior to November 17, 2023, and corroborating the November 20, 2023 appointment date referenced in SLG's August 28, 2023 engagement letter. This documentation may include internal scheduling records, correspondence between Lone Star FP and SLG, and a statement from a Lone Star FP representative regarding the backlog.

6. Meridian's Claim File. We should consider whether and when to request production of Meridian's internal claim file, including all adjuster notes, correspondence, investigation reports, and communications with outside counsel (KBH). In the event of litigation, the claim file will be discoverable (subject to work-product and attorney-client privilege objections), and its contents may be probative of Meridian's good or bad faith in handling the claim. At this pre-litigation stage, a formal request for the claim file may be premature, but this is a strategic decision that we should discuss with Mr. Bellamy.

X. Recommendation — Retention of Ridgeline Forensic Consultants LLC

Based on the foregoing analysis, we strongly recommend that SLG retain Ridgeline Forensic Consultants LLC ("Ridgeline") to conduct an independent origin-and-cause investigation of the November 17, 2023 fire. Ridgeline is located at 9100 Sovereign Row, Suite 210, Dallas, TX 75247, and specializes in forensic fire and explosion investigation for commercial and industrial clients.

We recommend that the engagement be led by Dr. William Creech, P.E., CFEI, a principal at Ridgeline. Dr. Creech is a licensed Professional Engineer in the State of Texas and holds the Certified Fire and Explosion Investigator (CFEI) credential from the National Association of Fire Investigators (NAFI). He has extensive experience in industrial and warehouse fire investigations and has served as a testifying expert in numerous insurance coverage and subrogation matters in Texas state and federal courts.

The proposed scope of Ridgeline's engagement includes the following:

1. Fire origin and cause analysis: Determination of the precise origin and cause of the November 17, 2023 fire, including identification of the mechanism of failure in the Square D Model QED-2 electrical distribution panel.

2. Electrical distribution panel evaluation: Detailed forensic examination of the Square D Model QED-2 unit, including analysis of recovered components, arc mapping, and assessment of the panel's installation history, maintenance records, and known failure modes.

3. Sprinkler system performance assessment: Evaluation of the Building C wet-pipe automatic sprinkler system's performance during the fire, with specific attention to the impact of the municipal water-pressure deficit (36 psi actual vs. 52 psi design) on system efficacy. This assessment should include a determination of whether a fully code-compliant sprinkler system operating at design pressure would have been capable of suppressing or materially containing the fire, given the fire's growth characteristics and the cargo fire load present in Building C.

4. Forensic mapping of warehouse layout: Documentation and mapping of the Building C cargo layout as it existed at the time of the fire, to the extent determinable from physical evidence, surviving records, and witness interviews, for purposes of confirming compliance with SLG's Warehouse Layout Plan, Revision 7.

The engagement should be structured as a retention at the direction of counsel in anticipation of litigation, to ensure that Ridgeline's work product is protected by the attorney-client privilege and the work-product doctrine. The engagement letter should be issued by Calderwood & Harkness LLP (not by SLG directly), and all reports and communications should be directed to this firm.

Ridgeline has provided an estimated engagement fee of approximately $38,500 (fixed fee) for the scope described above. This estimate assumes one site visit of approximately two to three days, laboratory analysis of recovered electrical components, hydraulic modeling of the sprinkler system, and a written report. Additional costs may be incurred if testifying expert services are required in connection with future litigation, but those costs would be addressed under a separate engagement at that time.

We request authorization to proceed with the Ridgeline engagement promptly. Time is of the essence, as the fire scene — while secured — is subject to potential degradation of physical evidence, and the City of Midland may release the site for demolition and cleanup at some point in the future. Early forensic investigation will maximize the quality and completeness of the available physical evidence.

XI. Next Steps and Timeline

Based on the preliminary analysis set forth in this memorandum, we recommend the following action items and timeline:

1. Immediate (this week — week of February 19, 2024): Obtain authorization from Dale Engstrom and/or Howard Bellamy to retain Ridgeline Forensic Consultants LLC. Upon authorization, prepare and transmit the engagement letter to Dr. William Creech at Ridgeline, with appropriate privilege and work-product protections. Simultaneously, request that Dale Engstrom compile and produce the complete set of shipper storage instructions for all cargo stored in Building C at the time of the fire, and begin the process of obtaining municipal water-pressure records from the City of Midland and scheduling records from Lone Star Fire Protection Inc.

2. February – March 2024: Ridgeline conducts its site investigation at the Midland Facility, performs laboratory analysis of recovered electrical components, completes hydraulic modeling of the sprinkler system, and prepares its forensic report. We estimate approximately three to four weeks from the date of engagement for Ridgeline to complete its investigation and deliver a draft report for our review.

3. Upon receipt of the Ridgeline forensic report: Complete the comprehensive coverage opinion memorandum for delivery to SLG. The comprehensive coverage opinion will address in full detail: (a) the contractual coverage analysis under the Policy, including the insuring agreement and all potentially applicable exclusions; (b) the extracontractual claims available to SLG under Texas Insurance Code Chapters 541 and 542; (c) an assessment of litigation risk and potential outcomes; and (d) our recommended strategy for demand, negotiation, and, if necessary, litigation.

4. Following delivery of the comprehensive coverage opinion: Prepare and transmit a formal demand letter to Meridian. The demand letter should be addressed to Patricia Ng, Vice President of Claims, Meridian Surety & Indemnity Company, 600 Scioto Crossing, Suite 1200, Columbus, OH 43215, with a copy to Victoria Kessler at Kessler, Brandt & Howe LLP, 1401 McKinney Street, Suite 2800, Houston, TX 77010. The demand letter should demand payment of $4,530,000 (net of the self-insured retention) plus all applicable statutory remedies under the Texas Insurance Code, including 18% penalty interest under Chapter 542 and attorney's fees under Chapter 541. The demand letter should provide a specific response deadline (we recommend 30 days) and should clearly communicate that SLG intends to pursue litigation if the claim is not resolved.

5. Pending Meridian's response to the demand letter: Evaluate Meridian's response and determine the appropriate next steps. Options include: (a) negotiated settlement, if Meridian makes a reasonable offer; (b) mediation, which may be productive given the strength of SLG's position and Meridian's extracontractual exposure; or (c) direct filing of suit in state court (likely Midland County District Court or, alternatively, Harris County District Court), if Meridian refuses to engage in meaningful settlement discussions.

6. Budget note: Our current estimated fee budget for the pre-litigation phase of this engagement — through and including the forensic investigation, comprehensive coverage opinion, demand letter, and negotiation/mediation — is $175,000 to $225,000. This estimate includes Calderwood & Harkness attorney time, the Ridgeline forensic engagement ($38,500), and anticipated expenses. A separate litigation budget will be prepared if suit becomes necessary, and will be submitted to SLG and Irongate for approval before any litigation is initiated.

XII. Conclusion

Based on our preliminary analysis, SLG has a strong coverage claim under Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023. Both exclusions invoked by Meridian in its January 22, 2024 denial appear inapplicable on the facts currently available:

• Exclusion 4(f) (Improper Storage) is undermined by the warehouse layout evidence showing separate storage zones for pipe and chemicals with a 40-foot buffer, by the inapplicability of OSHA 29 CFR 1910.106 segregation requirements to Clas

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
TO: Howard Bellamy, Responsible Partner
FROM: Andrew Fitzpatrick, Lead Associate; Naomi Petersen, Associate
DATE: February 20, 2024
RE: Preliminary Coverage Assessment — Stonefield Logistics Group Inc. v. Meridian Surety & Indemnity Company; Policy No. IML-TX-0039821-2023
MATTER NO.: 1012-00003
I. Executive Summary
Calderwood & Harkness LLP was engaged on February 5, 2024, by Stonefield Logistics Group Inc. ("SLG"), a Texas corporation headquartered at 2900 Petroleum Tower Boulevard, Suite 400, Midland, TX 79701, to evaluate its coverage claim under Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023 (the "Policy") issued by Meridian Surety & Indemnity Company ("Meridian"), an Ohio-domiciled stock insurance company (NAIC No. 28471), rated A (Excellent), Financial Size Category IX by A.M. Best. The engagement was authorized by SLG's Vice President of Risk Management, Dale Engstrom, with the concurrence of SLG's Chief Financial Officer, Leah Tran.
On November 17, 2023, SLG suffered a catastrophic warehouse fire at its Midland Facility, specifically in Warehouse Building C located at 4501 East County Road 130, Midland, TX 79706 (the "Midland Facility"). The fire destroyed Building C and its contents, including approximately $4,780,000 in customer freight that was in SLG's care, custody, and control at the time of the loss. The fire is believed to have originated in the building's main electrical distribution panel, and the Building C wet-pipe automatic sprinkler system, while it did activate, provided only limited suppression capability due to a significant deficit in municipal water-supply pressure on the night of the fire.
On January 22, 2024, Meridian issued a formal denial of SLG's coverage claim. Meridian's denial letter, signed by Vice President of Claims Patricia Ng, invoked two policy exclusions: Exclusion 4(f), which pertains to improper storage of cargo, and Exclusion 4(k), which pertains to the insured's failure to maintain fire protection, detection, or suppression systems. Meridian retained the Houston-based law firm of Kessler, Brandt & Howe LLP as outside coverage counsel in connection with its denial.
This memorandum presents our preliminary assessment of Meridian's denial. Based on the facts and documents available to us at this early stage, we conclude that both exclusions invoked by Meridian are likely inapplicable and that Meridian's denial contains significant procedural and substantive weaknesses that can be exploited in negotiation or litigation. In particular, we note that Exclusion 4(f) was not raised in Meridian's initial Reservation of Rights letter dated December 4, 2023, and appears to have been added to the denial approximately seven weeks later without adequate investigation — a fact that may give rise to extracontractual liability under the Texas Insurance Code.
We recommend that SLG retain an independent forensic fire investigation firm — specifically, Ridgeline Forensic Consultants LLC of Dallas, Texas — to conduct a comprehensive origin-and-cause investigation of the November 17, 2023 fire. The forensic report will be essential to confirming the electrical origin of the fire, evaluating the sprinkler system's performance under actual water-pressure conditions, and verifying the cargo segregation layout within Building C at the time of the loss. Once the forensic report is received, we recommend preparing a comprehensive coverage opinion memorandum for SLG, followed by a formal demand letter to Meridian.
The net claim amount at issue is $4,530,000, calculated as the total cargo loss of $4,780,000 less the $250,000 per-occurrence self-insured retention under the Policy. This amount is well within the Policy's $5,000,000 per-occurrence limit, and the $10,000,000 annual aggregate limit is unimpaired, as SLG has made no prior claims during the current policy period.
II. Background — The Insured and the Policy
A. Stonefield Logistics Group Inc.
Stonefield Logistics Group Inc. is a mid-market intermodal freight brokerage, trucking, and transload/warehousing company operating primarily across the Permian Basin and surrounding regions. SLG currently maintains fourteen terminals across Texas, New Mexico, and Oklahoma, and its core business specializes in Permian Basin oilfield supply-chain logistics, including the transportation, transloading, and warehousing of pipe, proppant, completion chemicals, heavy equipment, and other oilfield materials.
SLG's executive team includes Marcus D. Stonefield, Chief Executive Officer and founder; Leah Tran, Chief Financial Officer; and Dale Engstrom, Vice President of Risk Management. Mr. Engstrom serves as our primary point of contact at SLG for purposes of this engagement and has been responsive and cooperative in providing the documents and information reviewed in this memorandum.
For fiscal year 2023, SLG reported revenue of approximately $187.4 million and EBITDA of approximately $29.1 million. The company employs approximately 1,100 individuals across its terminal network. SLG is a privately held company; approximately 72% of its equity is owned by Irongate Capital Partners, LP, a Delaware limited partnership (Managing Partner: Carolyn Reeves), through Irongate Industrial Partners Fund IV, LP, a private equity fund that acquired its controlling stake in SLG in August 2019. SLG's Federal Employer Identification Number is 84-3291057.
The Midland Facility, where the loss occurred, is one of SLG's largest and most active terminals. The facility comprises multiple warehouse buildings, open-air storage yards, and a transload rail siding. Warehouse Building C, the building destroyed in the November 17, 2023 fire, was a pre-engineered metal building of approximately 32,000 square feet, constructed in 2011. It was used for the indoor storage of customer freight, primarily casing pipe, completion chemicals, downhole tools, and miscellaneous oilfield supplies.
B. The Meridian Policy
The Policy at issue is an Inland Marine Cargo Legal Liability Policy, the relevant terms of which are summarized as follows:
The Policy's insuring agreement provides coverage on an all-risks basis for "all risks of direct physical loss or damage to cargo in the care, custody, or control of the Insured arising out of or in connection with the Insured's transportation, warehousing, or transloading operations," subject to the Policy's terms, conditions, exclusions, and endorsements. This broad insuring agreement is typical of inland marine cargo legal liability policies placed for logistics and warehousing operators and is designed to protect the insured against liability to cargo owners for loss or damage to their goods while in the insured's possession.
The Policy was placed by SLG's longstanding insurance broker, Calvert & Strauss Insurance Brokers, Inc. ("Calvert & Strauss"), located at 3700 Buffalo Speedway, Suite 520, Houston, TX 77098. SLG's account executive at Calvert & Strauss is Jason Muñoz. Calvert & Strauss facilitated SLG's initial notice of loss to Meridian and assisted with the preparation and submission of the sworn proof of loss.
Meridian Surety & Indemnity Company is an Ohio-domiciled stock insurance company, NAIC No. 28471, with its principal offices at 600 Scioto Crossing, Suite 1200, Columbus, OH 43215. Meridian is rated A (Excellent), Financial Size Category IX by A.M. Best, indicating strong financial stability and claims-paying ability. Meridian writes inland marine, surety, and specialty casualty lines on a nationwide basis.
C. Key Policy Exclusions at Issue
Two Policy exclusions are at issue in connection with Meridian's denial of coverage. The operative language of each exclusion is as follows:
Exclusion 4(f) — Improper Storage:
"This Policy does not cover loss or damage resulting from the Insured's storage of cargo in a manner inconsistent with the shipper's written storage instructions or applicable industry standards for the type of cargo involved."
Exclusion 4(k) — Failure to Maintain:
"This Policy does not cover loss or damage caused by or resulting from the Insured's failure to maintain fire protection, detection, or suppression systems in the facility where cargo is stored, in accordance with applicable codes and manufacturer specifications."
As discussed in detail below, these two exclusions differ in their structure and operation. Exclusion 4(f) is triggered by storage that is "inconsistent with" shipper instructions or industry standards — a compliance-based exclusion. Exclusion 4(k), by contrast, contains express causation language ("caused by or resulting from"), requiring not merely a failure to maintain but a demonstrable causal connection between the maintenance failure and the loss. This distinction is significant to our analysis.
D. Notice and Proof-of-Loss Provisions
The Policy contains standard notice and proof-of-loss provisions in Section 8:
Section 8(a) requires the Named Insured to provide written notice to the insurer "as soon as practicable, but in no event later than thirty (30) days after the Insured becomes aware of any loss or damage which may give rise to a claim under this Policy."
Section 8(c) requires the Named Insured to submit a sworn proof of loss "within ninety (90) days after the date of loss," containing a detailed statement of the cargo destroyed or damaged, the circumstances of the loss, and the amount claimed.
SLG complied with both provisions. SLG's notice of loss was submitted within days of the November 17, 2023 fire, facilitated by Calvert & Strauss, and was received by Meridian well within the 30-day contractual notice period. SLG's sworn proof of loss was submitted on February 1, 2024 — 76 days after the date of loss — within the 90-day contractual deadline. The sworn proof of loss was prepared with the assistance of Whitlock & Associates, Certified Public Accountants, P.C. (Engagement Partner: Sandra Whitlock, CPA, CFF), located at 4200 South Loop 250 West, Suite 100, Midland, TX 79703. Ms. Whitlock is a Certified in Financial Forensics credential holder with extensive experience in cargo loss quantification.
There is no dispute between the parties regarding the timeliness of SLG's notice of loss or sworn proof of loss. Meridian has not raised any notice-related defense, and we do not anticipate that any such defense could be credibly asserted on these facts.
III. The Loss Event — November 17, 2023 Fire
A. Factual Summary
On November 17, 2023, at approximately 2:14 a.m. CST, a fire broke out in Warehouse Building C at SLG's Midland Facility. The fire appears to have originated in the area of the Building C main electrical distribution panel, a Square D Model QED-2 unit that was installed when Building C was constructed in 2011. The Square D Model QED-2 is a widely used low-voltage switchboard designed for commercial and industrial applications. At this preliminary stage, the precise mechanism of electrical failure has not been determined, but the Midland Fire Department's preliminary incident report identifies the area of origin as the vicinity of the main electrical distribution panel.
The Midland Fire Department was dispatched to the Midland Facility at approximately 2:17 a.m., following an automated alarm notification from the building's fire alarm system. Fire units arrived on scene at approximately 2:31 a.m. By that time, the fire had progressed substantially through the warehouse interior. Firefighting operations continued for over two hours, and the fire was declared contained at approximately 4:45 a.m. Despite suppression efforts, Building C was declared a total structural loss. The fire caused extensive damage to the building's structural steel framing, roof assembly, and exterior metal cladding, rendering the building unsalvageable.
The Building C wet-pipe automatic sprinkler system, which was NFPA 13 compliant at the time of its installation in 2011, did activate during the fire. However, the system provided only limited suppression capability. Preliminary investigation indicates that this limited performance was primarily attributable to a significant deficit in municipal water-supply pressure on the night of the fire. The Building C sprinkler system was designed to operate at a minimum supply pressure of 52 psi, consistent with the hydraulic calculations prepared at the time of installation. However, the actual municipal water-supply pressure at the Midland Facility on the night of the fire was approximately 36 psi — a deficit of approximately 16 psi, or roughly 31% below the system's design parameter. At 36 psi, the sprinkler heads that activated would have delivered significantly reduced flow rates, resulting in inadequate suppression density over the fire area.
The cause of the low municipal water pressure on the night of the fire has not yet been definitively determined. Possible contributing factors include concurrent high-demand drawdowns on the municipal water system, infrastructure limitations in the municipal water distribution network serving the eastern Midland industrial corridor, or other factors within the control of the City of Midland's water utility. Regardless of the cause, the municipal water-pressure deficit was entirely outside SLG's control and unrelated to SLG's maintenance of the sprinkler system itself.
No fatalities or serious injuries resulted from the fire. Two SLG employees who were on the overnight shift at the Midland Facility at the time the fire broke out evacuated safely and were not injured. One Midland firefighter sustained a minor injury during suppression operations and was treated and released at the scene.
B. Cargo Destroyed — Quantification
The sworn proof of loss prepared by Whitlock & Associates, under the supervision of Engagement Partner Sandra Whitlock, CPA, CFF, values the total cargo destroyed in the Building C fire at $4,780,000. The loss is broken down by cargo owner and type as follows:
The cargo values reflected in the sworn proof of loss were derived from the applicable warehouse receipts, bills of lading, shipper invoices, and replacement cost quotations, as compiled and verified by Whitlock & Associates. Meridian has not, to date, disputed the quantum of the loss; its denial was based entirely on the applicability of the two exclusions discussed in this memorandum.
After application of the $250,000 per-occurrence self-insured retention, the net claim amount payable under the Policy is $4,530,000. This amount is within the Policy's $5,000,000 per-occurrence limit and, because no prior claims have been made during the April 1, 2023 – March 31, 2024 policy period, the $10,000,000 annual aggregate limit is entirely unimpaired.
It should be noted that the physical damage to Warehouse Building C itself, estimated at approximately $1,350,000, is covered under a separate commercial property insurance policy and is not at issue in this matter. The present analysis is limited to SLG's claim for the cargo loss under the Meridian Policy.
IV. Procedural History of the Claim
A. Notice and Reservation of Rights
As noted above, SLG timely notified Meridian of the loss in late November 2023. The notice was transmitted through SLG's insurance broker, Calvert & Strauss, and was received by Meridian within the 30-day notice period prescribed by Section 8(a) of the Policy.
On December 4, 2023, Meridian issued a Reservation of Rights letter to SLG, acknowledging receipt of SLG's notice of loss and advising that Meridian was investigating the claim and reserving all of its rights under the Policy. The Reservation of Rights letter was prepared by Meridian's Senior Claims Examiner, Brian Woolf, and was issued under the authority of Vice President of Claims Patricia Ng. The letter was sent to SLG's VP of Risk Management, Dale Engstrom, with a copy to Jason Muñoz at Calvert & Strauss.
Significantly, the December 4, 2023 Reservation of Rights letter cited only Exclusion 4(k) (Failure to Maintain) as a potential basis for denial of coverage. The letter referenced SLG's obligation to maintain fire protection systems in accordance with applicable codes and stated that Meridian was investigating whether the Building C sprinkler system had been properly maintained at the time of the fire. The Reservation of Rights letter did not reference Exclusion 4(f) (Improper Storage) or raise any concern regarding the manner in which cargo was stored within Building C.
The Reservation of Rights letter was issued 17 days after the date of loss, well within the 30-day notice window under the Policy. There is no issue with respect to the timeliness of Meridian's reservation of rights.
B. The Denial — January 22, 2024
On January 22, 2024, Meridian issued a formal coverage denial letter, addressed to Dale Engstrom at SLG, with copies to Jason Muñoz at Calvert & Strauss. The denial letter was signed by Patricia Ng, Vice President of Claims, and was prepared with the involvement of Meridian's outside coverage counsel, Kessler, Brandt & Howe LLP ("KBH"), located at 1401 McKinney Street, Suite 2800, Houston, TX 77010. The lead partner at KBH handling the matter is Victoria Kessler; she is assisted by associate Samuel Okonkwo.
The denial letter invoked two exclusions as the basis for Meridian's denial of SLG's claim:
1. Exclusion 4(f) (Improper Storage): Meridian alleged that SLG stored casing pipe and completion chemicals in the same warehouse bay, in violation of the shipper's written storage instructions and in contravention of OSHA 29 CFR 1910.106 segregation requirements for the storage of flammable and combustible liquids. Meridian contended that this co-storage constituted storage "in a manner inconsistent with the shipper's written storage instructions or applicable industry standards" within the meaning of Exclusion 4(f).
2. Exclusion 4(k) (Failure to Maintain): Meridian alleged that SLG failed to maintain the Building C sprinkler system in accordance with applicable codes and manufacturer specifications, citing the fact that the last annual full-flow inspection of the sprinkler system (per NFPA 25 § 5.3.2) was performed on September 14, 2022, and was not repeated by September 14, 2023 — creating an alleged lapse of over two months at the time of the November 17, 2023 fire. Meridian contended that this lapse constituted a failure to maintain fire suppression systems "in accordance with applicable codes and manufacturer specifications" within the meaning of Exclusion 4(k).
The denial letter did not dispute the timeliness of SLG's notice of loss or sworn proof of loss, nor did it challenge the quantum of the cargo loss as stated in the sworn proof of loss. Meridian's denial rests entirely on the applicability of the two cited exclusions.
C. Significant Procedural Observation — Late Addition of Exclusion 4(f)
A critical weakness in Meridian's position is the procedural irregularity surrounding the invocation of Exclusion 4(f). As noted above, the December 4, 2023 Reservation of Rights letter cited only Exclusion 4(k) as a potential basis for denial. Exclusion 4(f) was raised for the first time in the January 22, 2024 denial letter — approximately seven weeks after the Reservation of Rights letter was issued.
This late addition raises serious questions about the adequacy of Meridian's pre-denial investigation. An insurer that identifies a potential exclusion basis only after issuing its Reservation of Rights letter — and does so for the first time in the denial itself — suggests either that the insurer failed to conduct a thorough initial investigation or that the additional exclusion was added as a post hoc justification for a denial that may have been driven by other considerations. In either case, this procedural posture creates vulnerability for Meridian.
Under Texas law, an insurer has an affirmative duty to conduct a reasonable investigation of a claim before denying it. The Texas Insurance Code § 541.060(a)(7) prohibits an insurer from "refusing to pay a claim without conducting a reasonable investigation with respect to the claim." The late addition of Exclusion 4(f), apparently without the benefit of a physical inspection of the warehouse layout or a review of the SDS classifications for the Cantera chemicals, may constitute a violation of this statutory duty.
Furthermore, under Texas law, an insurer's failure to include a coverage defense in its Reservation of Rights letter may, under certain circumstances, result in waiver or estoppel with respect to that defense, particularly where the insured was prejudiced by the omission. While Texas courts have not adopted a blanket waiver rule for omitted reservation-of-rights defenses, the failure to timely assert a coverage defense is a relevant factor in evaluating the insurer's good faith and the overall reasonableness of its claim-handling conduct. See Members Mut. Ins. Co. v. Cutaia, 476 S.W.2d 278 (Tex. 1972) (discussing insurer's duty to timely assert coverage defenses).
This issue should be developed in full in our comprehensive coverage analysis and should feature prominently in any demand letter or litigation strategy.
V. Preliminary Analysis of Exclusion 4(f) — Improper Storage
A. Meridian's Position
In its January 22, 2024 denial letter, Meridian contends that SLG stored casing pipe and completion chemicals in the same warehouse bay within Building C, in violation of two standards: (1) the shipper's written storage instructions, and (2) OSHA 29 CFR 1910.106, which governs the storage and handling of flammable and combustible liquids. Meridian asserts that the co-storage of these materials constituted storage "in a manner inconsistent with the shipper's written storage instructions or applicable industry standards" under Exclusion 4(f), thereby triggering the exclusion and barring coverage for the entire loss.
Meridian's denial letter does not identify which shipper's instructions were allegedly violated, nor does it specify the particular provision of OSHA 29 CFR 1910.106 that Meridian contends was breached. The letter states generally that "the co-storage of casing pipe and completion chemicals in the same warehouse bay is inconsistent with industry standards for the segregation of flammable materials" and cites OSHA 29 CFR 1910.106 without further elaboration.
B. Preliminary Assessment — Exclusion Likely Inapplicable
Based on the information and documents available to us at this stage, we believe that Exclusion 4(f) is likely inapplicable for the following reasons.
1. SLG's Warehouse Layout. SLG's Warehouse Layout Plan, Revision 7, dated June 2023 (the most current revision prior to the fire), designates separate and distinct storage zones within Building C for different categories of cargo. Specifically, the Warehouse Layout Plan provides for the following allocation of storage bays:
• Bays 1–4: Casing pipe and tubular goods
• Bays 5–8: Tools, equipment, and miscellaneous freight (providing a 40-foot physical buffer zone between the pipe storage bays and the chemical storage bays)
• Bays 9–12: Chemical pallets and containerized liquids
This layout is designed to maintain physical separation between casing pipe (a non-flammable steel product) and completion chemicals, with a substantial buffer zone of approximately 40 feet occupied by intermediate-category cargo. The layout is consistent with prudent warehousing practices and is responsive to the general principle of segregating dissimilar materials.
Dale Engstrom, SLG's VP of Risk Management, has confirmed in our initial interviews that this layout was maintained at the time of the fire and that no casing pipe was stored in the chemical bays, nor were any chemical pallets stored in the pipe bays. Mr. Engstrom stated that SLG's warehouse personnel were trained on the Warehouse Layout Plan and that compliance with the designated bay assignments was enforced through SLG's warehouse management system, which tracks the bay location of each cargo lot.
While Mr. Engstrom's representations are credible and consistent with the documentary evidence we have reviewed, we recognize the importance of independent corroboration. The physical layout of Building C at the time of the fire should be confirmed through forensic mapping by a qualified fire investigator, which is one of the objectives of the proposed engagement of Ridgeline Forensic Consultants LLC (discussed in Section X below).
2. Nature of the Chemicals — Class IIIB Combustible Liquids. A critical flaw in Meridian's invocation of Exclusion 4(f) is its apparent mischaracterization of the chemicals stored in Building C. Meridian's denial letter refers broadly to "completion chemicals" and implies that these materials are "flammable" substances subject to the segregation requirements of OSHA 29 CFR 1910.106. However, a review of the Safety Data Sheets ("SDS") for the Cantera Chemical Supply Co. completion chemicals stored in Building C at the time of the fire reveals that these materials are classified as Class IIIB combustible liquids under the National Fire Protection Association (NFPA) and OSHA classification system.
Class IIIB combustible liquids are defined as liquids with a flash point at or above 200°F (93°C). The Cantera completion chemicals stored in Building C had a flash point exceeding 200°F, as documented in the applicable SDS sheets. This classification is significant because OSHA 29 CFR 1910.106 — the very standard cited by Meridian — draws clear and intentional distinctions between different classes of flammable and combustible liquids. The segregation requirements found in § 1910.106(d)(5)(iii) apply to flammable liquids (Classes IA, IB, and IC, with flash points below 100°F) and to combustible liquids stored at or above their flash points. Class IIIB combustible liquids stored at ambient temperature — which is the condition that existed in Building C — do not trigger the specific segregation requirements upon which Meridian relies.
Meridian's invocation of OSHA 29 CFR 1910.106 thus appears to conflate flammable liquids with Class IIIB combustible liquids — a legally and technically significant distinction that undermines the factual foundation of its Exclusion 4(f) argument. If Meridian's adjusters or coverage counsel did not review the SDS sheets for the Cantera chemicals before invoking this exclusion, that failure would further support our contention that Meridian failed to conduct a reasonable investigation before denying the claim.
3. Shipper Instructions. Meridian's denial letter alleges that SLG stored cargo "in a manner inconsistent with the shipper's written storage instructions" but does not identify which shipper's instructions were allegedly violated. Our review of the available shipper instructions has focused on Cantera Chemical Supply Co., the owner of the completion chemicals stored in Building C.
Cantera Chemical Supply Co.'s written storage instructions, which accompanied the cargo at the time of delivery to SLG's warehouse, required "segregation from incompatible materials per SDS." The SDS sheets for the Cantera completion chemicals identify "incompatible materials" as strong oxidizers, strong acids, and strong bases. Steel casing pipe is not identified as an incompatible material on any of the applicable SDS sheets. Accordingly, the storage of casing pipe in separate bays (Bays 1–4) within the same building as the Cantera chemicals (Bays 9–12) does not appear to violate Cantera's written storage instructions.
Moreover, as discussed above, the casing pipe and the chemicals were stored in physically separate areas of the warehouse, with a 40-foot buffer zone (Bays 5–8) between them. This arrangement is consistent with both the Cantera storage instructions and general industry practice for the warehousing of Class IIIB combustible liquids.
We note that we have not yet obtained and reviewed the complete set of shipper instructions for all cargo stored in Building C at the time of the loss. This is an outstanding information need identified in Section IX below. It is possible that one or more shippers provided storage instructions that were more restrictive than Cantera's, and we need to confirm compliance with all applicable shipper instructions before finalizing our analysis.
C. Preliminary Conclusion on Exclusion 4(f)
Based on the information currently available, Exclusion 4(f) does not appear to apply to the November 17, 2023 loss. The Cantera completion chemicals and the Permian Wellhead Services casing pipe were stored in separate bays within Building C, separated by a 40-foot buffer zone, consistent with SLG's Warehouse Layout Plan. The OSHA provision cited by Meridian (29 CFR 1910.106) is inapplicable to Class IIIB combustible liquids stored at ambient temperature, and the shipper's written storage instructions do not require segregation from steel pipe.
However, we emphasize that this conclusion is preliminary and is subject to two important caveats: (1) the warehouse layout at the time of the fire must be independently confirmed through forensic mapping, and (2) the complete set of shipper storage instructions for all cargo in Building C must be obtained and reviewed. These steps are incorporated into our recommended next actions.
VI. Preliminary Analysis of Exclusion 4(k) — Failure to Maintain
A. Meridian's Position
Meridian's denial letter contends that SLG failed to maintain the Building C sprinkler system in accordance with applicable codes and manufacturer specifications, as required by the Policy. Specifically, Meridian alleges that the annual full-flow test of the sprinkler system, required by NFPA 25, Standard for the Inspection, Testing, and Maintenance of Water-Based Fire Protection Systems, § 5.3.2, was last performed on September 14, 2022, and was not repeated by September 14, 2023. Meridian asserts that this created a lapse of more than two months at the time of the November 17, 2023 fire and constitutes a failure to maintain fire suppression systems "in accordance with applicable codes" within the meaning of Exclusion 4(k).
NFPA 25 § 5.3.2 requires an annual full-flow test of wet-pipe sprinkler systems, which involves flowing water through the system's main drain to verify that water supply and system components are functioning within design parameters. The purpose of the annual full-flow test is to confirm that the water supply is adequate and that no obstructions or other conditions have developed that would impair system performance. Meridian's position is that the 14-month interval between the September 14, 2022 test and the date of the fire (November 17, 2023) constitutes non-compliance with this annual testing requirement.
B. Preliminary Assessment — Exclusion Likely Inapplicable
We believe that Exclusion 4(k) is likely inapplicable for several independent reasons, any one of which may be sufficient to defeat Meridian's defense.
1. SLG's Compliance with NFPA 25 Quarterly Inspections. While the annual full-flow test was overdue at the time of the fire, SLG maintained full compliance with the quarterly visual inspection requirements of NFPA 25 § 5.2.1 throughout the relevant period. Quarterly visual inspections are a separate and independent maintenance requirement under NFPA 25, requiring the building owner or operator to visually inspect sprinkler system components — including control valves, piping, sprinkler heads, and gauges — on a quarterly basis.
SLG performed quarterly visual inspections of the Building C sprinkler system on the following dates:
• December 15, 2022
• March 20, 2023
• June 12, 2023
• September 8, 2023
All four quarterly inspections during the relevant period were timely performed and documented. The inspection reports, which we have reviewed, indicate that no deficiencies were observed during any of the quarterly inspections. This demonstrates that SLG maintained an active and ongoing maintenance program for the Building C sprinkler system and did not neglect or abandon its maintenance obligations.
The fact that SLG was current on its quarterly inspections is relevant to the interpretation of Exclusion 4(k). The exclusion bars coverage for loss "caused by or resulting from the Insured's failure to maintain fire protection, detection, or suppression systems … in accordance with applicable codes." NFPA 25 prescribes a comprehensive maintenance program that includes multiple categories of inspections and tests at varying frequencies — weekly, monthly, quarterly, annually, and at five-year and ten-year intervals. A reasonable reading of Exclusion 4(k) does not require perfect, simultaneous compliance with every element of the NFPA 25 maintenance schedule at all times; rather, it contemplates a systemic or material failure to maintain fire protection systems. SLG's consistent compliance with the quarterly inspection program demonstrates that it was actively maintaining the sprinkler system, even though one element of the maintenance schedule — the annual full-flow test — was temporarily overdue.
2. Annual Full-Flow Test — Scheduled but Not Yet Performed. The circumstances surrounding the delayed annual full-flow test further undercut Meridian's Exclusion 4(k) defense. The annual full-flow test was last performed on September 14, 2022, by Lone Star Fire Protection Inc. ("Lone Star FP"), a licensed fire protection contractor based in Midland, Texas, which SLG had retained for sprinkler system testing and maintenance services.
A new full-flow test was initially targeted for October 2023, consistent with the approximate anniversary of the prior test. However, SLG was unable to schedule the test for October 2023 due to a scheduling backlog at Lone Star FP. The backlog was attributable to increased demand for fire protection inspection and testing services in the Midland area during the second half of 2023, driven by the expansion of industrial and oil-and-gas-related warehouse and storage facilities in the Permian Basin region.
SLG did not simply allow the annual test to lapse without action. On August 28, 2023 — well in advance of the September 14, 2023 anniversary — SLG executed a written engagement letter with Lone Star FP confirming an appointment for a full-flow test inspection of the Building C sprinkler system scheduled for November 20, 2023. This appointment was just three days after the November 17, 2023 fire.
The significance of this fact cannot be overstated. SLG took affirmative, documented steps to schedule the annual test in a timely manner. The delay was attributable entirely to the third-party contractor's scheduling constraints, not to any neglect or indifference on SLG's part. SLG's conduct demonstrates exactly the kind of good-faith maintenance effort that Exclusion 4(k) is designed to incentivize. An insured that proactively schedules a required inspection and is prevented from completing it on the precise anniversary date by circumstances beyond its control should not be penalized by the loss of coverage, particularly where — as here — the delayed inspection bears no causal relationship to the loss.
We should obtain corroborating documentation from Lone Star FP confirming the scheduling backlog and the November 20, 2023 appointment date. This is identified as an outstanding information need in Section IX below.
3. Causation Requirement — Exclusion 4(k) Language. Perhaps the most significant weakness in Meridian's Exclusion 4(k) defense is the exclusion's express causation requirement. Unlike Exclusion 4(f), which is triggered by storage "inconsistent with" specified standards (a compliance-based formulation), Exclusion 4(k) requires that the loss be "caused by or resulting from" the insured's failure to maintain fire protection systems. This is a causation-based exclusion that demands a demonstrable nexus between the alleged maintenance failure and the loss.
Under well-established Texas law, the insurer bears the burden of proving that an exclusion applies, including the burden of proving any causation element contained in the exclusion's language. See Drayton Insurance. v. Hudson Energy Co., 811 S.W.2d 552, 555 (Tex. 1991) ("When an insurer relies on an exclusion to deny coverage, the insurer has the burden of proving the exclusion applies."). This burden is on Meridian, and it is a substantial one on the facts of this case.
Preliminary indications are that the fire originated in the main electrical distribution panel — a Square D Model QED-2 unit — and not in any component of the sprinkler system or fire protection infrastructure. The fire's cause appears to be an electrical fault, entirely unrelated to the condition or maintenance of the sprinkler system. Accordingly, the delayed annual full-flow test did not "cause" the fire.
The remaining question is whether the delayed annual test "resulted in" the loss — that is, whether a timely annual full-flow test would have revealed a condition that, if corrected, would have prevented or materially reduced the loss. On the facts currently available, this argument is exceptionally weak for Meridian. The sprinkler system did activate during the fire, demonstrating that the system was functional and responsive to the fire condition. The system's ineffectiveness was attributable not to any deficiency in the sprinkler system itself but to the inadequate municipal water-supply pressure — approximately 36 psi actual versus the 52 psi design parameter. Even a system that had been subjected to a full-flow test on September 14, 2023, would have experienced the same water-pressure deficit on the night of the fire, because the deficit was caused by conditions in the municipal water supply system that were entirely outside SLG's control.
An annual full-flow test, by its nature, measures the water supply available at the time of the test. It is not a predictive instrument that guarantees future water-supply adequacy. If the municipal water pressure was adequate at the time of a hypothetical September 2023 full-flow test but was deficient on the night of the November 2023 fire, the test would not have prevented or mitigated the loss. The causal chain that Meridian would need to establish — from the delayed test, to a hypothetical discovery of a system deficiency, to a hypothetical correction that would have prevented the loss — is speculative at best and fails on the undisputed fact that the primary suppression failure was caused by inadequate municipal water pressure.
We recognize that a complete causation analysis requires an independent expert forensic report. Specifically, we need a qualified fire protection engineer to evaluate whether a fully code-compliant sprinkler system, operating at the design pressure of 52 psi, would have been capable of suppressing or materially containing the fire. If the answer is that even a fully pressurized system would have been overwhelmed by the fire (depending on the fire's growth rate and the sprinkler system's design density relative to the actual fire load), then Meridian's causation argument fails entirely. This analysis is within the proposed scope of the Ridgeline engagement discussed in Section X.
C. Preliminary Conclusion on Exclusion 4(k)
Exclusion 4(k) does not appear to apply on the facts currently available. SLG maintained full compliance with its quarterly inspection schedule, proactively scheduled the annual full-flow test through a written engagement with Lone Star Fire Protection Inc., and was prevented from completing the test on the precise anniversary date solely by the contractor's scheduling backlog. More fundamentally, the fire's apparent origin in the electrical distribution panel and the sprinkler system's inadequate performance due to a municipal water-pressure deficit — a condition entirely outside SLG's control — both undercut any causal link between the delayed annual test and the loss.
Independent forensic investigation is essential to solidify this conclusion. The Ridgeline engagement should specifically address: (a) confirmation of the fire's origin and cause; (b) analysis of the sprinkler system's actual performance on the night of the fire, including the impact of the water-pressure deficit; and (c) whether a fully code-compliant system operating at design pressure would have controlled or suppressed the fire under the conditions that existed on November 17, 2023.
VII. Potential Extracontractual Claims Under the Texas Insurance Code
In addition to the contractual coverage claim under the Policy, the circumstances of Meridian's denial give rise to potential extracontractual claims under the Texas Insurance Code. We address these potential claims below on a preliminary basis. A more thorough analysis will be included in the comprehensive coverage opinion to be prepared upon receipt of the forensic report.
A. Chapter 541 — Unfair Settlement Practices
The Texas Insurance Code Chapter 541 prohibits unfair methods of competition and unfair or deceptive acts or practices in the business of insurance. Section 541.060 identifies specific unfair settlement practices, including:
• § 541.060(a)(2): failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim with respect to which the insurer's liability has become reasonably clear;
• § 541.060(a)(3): failing to promptly provide to a policyholder a reasonable explanation of the basis in the policy, in relation to the facts or applicable law, for the insurer's denial of a claim or offer of a compromise settlement of a claim;
• § 541.060(a)(7): refusing to pay a claim without conducting a reasonable investigation with respect to the claim.
Meridian's late addition of Exclusion 4(f), raised for the first time in the January 22, 2024 denial letter after having been omitted from the December 4, 2023 Reservation of Rights letter, may constitute a violation of one or more of these provisions. The Exclusion 4(f) ground appears to have been raised without adequate investigation. Specifically, Meridian does not appear to have conducted a physical inspection of the warehouse layout to determine whether casing pipe and chemicals were actually stored in the same bay, nor does Meridian appear to have reviewed the SDS classifications for the Cantera completion chemicals to determine whether those chemicals were properly classified as flammable liquids subject to the OSHA segregation requirements cited in the denial letter. The denial letter's factual assertions regarding co-storage and OSHA non-compliance appear to be assumptions, not conclusions supported by investigation.
If Meridian's denial is determined to be wrongful and its investigation inadequate, SLG may be entitled to recover actual damages, treble damages under Tex. Ins. Code § 541.152(b) (available where the insurer's conduct was committed "knowingly"), and reasonable and necessary attorney's fees under § 541.152(a)(1). These potential remedies significantly increase Meridian's exposure and provide substantial leverage for SLG in any settlement negotiation.
B. Chapter 542 — Prompt Payment of Claims
The Texas Insurance Code Chapter 542, Subchapter B (the "Prompt Payment of Claims Act") imposes specific deadlines on insurers for the acknowledgment, investigation, and payment of insurance claims. Under § 542.056(a), an insurer that receives all items, statements, and forms reasonably requested and required under § 542.055 must notify the claimant in writing of its acceptance or rejection of the claim not later than the 15th business day after the date the insurer receives all required items. This deadline may be extended to 45 days if the insurer notifies the claimant that it needs additional time and provides specific reasons. See § 542.056(d).
SLG submitted its sworn proof of loss on February 1, 2024. Meridian denied the claim on January 22, 2024 — before the sworn proof of loss was even submitted — which raises additional questions about the adequacy of Meridian's investigation. However, even assuming that the statutory clock under Chapter 542 began running on February 1, 2024 (the date of the sworn proof of loss), the 15-business-day deadline for acceptance or rejection would fall in late February 2024, and the extended 45-day deadline would fall in late March 2024.
If Meridian's denial is ultimately determined to be wrongful, statutory penalty interest of 18% per annum begins to accrue under Tex. Ins. Code § 542.060 on the date the claim was required to be paid. Based on our preliminary calculation, the accrual trigger date is approximately April 29, 2024, taking into account the maximum statutory extension periods and required processing time.
On the net claim amount of $4,530,000, the 18% statutory penalty interest represents a significant financial exposure to Meridian — approximately $815,400 per year, or approximately $2,233 per day. This ongoing accrual provides a powerful incentive for Meridian to resolve the claim promptly if its denial is not well-founded, and it should be prominently featured in any formal demand letter.
C. Preliminary Assessment
The combination of a potentially wrongful denial of a $4,530,000 claim and the procedural irregularities in Meridian's claim-handling — particularly the late addition of Exclusion 4(f) without apparent investigation — provides meaningful leverage for SLG's demand. The availability of treble damages under Chapter 541 and 18% penalty interest under Chapter 542, in addition to the contractual claim itself, creates a total exposure for Meridian that substantially exceeds the face amount of the claim. These extracontractual claims should be developed in the comprehensive coverage opinion and should be expressly referenced in the formal demand letter, with appropriate specificity as to the factual and legal basis for each claim.
We note that extracontractual claims under the Texas Insurance Code require careful development and proof. While the facts currently available are supportive, a definitive assessment will depend in part on the results of the forensic investigation and on further investigation of Meridian's claim-handling process, including potentially the contents of Meridian's claim file. The decision of whether and when to seek production of Meridian's claim file — through informal demand or formal discovery — is a strategic question that we should discuss with Mr. Bellamy and the client.
VIII. Key Documents Reviewed to Date
In preparing this preliminary assessment, we have reviewed the following documents and materials:
1. Meridian Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023, including the full policy form, all endorsements, and the declarations page.
2. Meridian Reservation of Rights letter to Stonefield Logistics Group Inc., dated December 4, 2023, issued by Senior Claims Examiner Brian Woolf.
3. Meridian Coverage Denial letter to Stonefield Logistics Group Inc., dated January 22, 2024, signed by Vice President of Claims Patricia Ng.
4. Stonefield Logistics Group Inc. Sworn Proof of Loss, submitted February 1, 2024, prepared with the assistance of Whitlock & Associates, Certified Public Accountants, P.C. (Engagement Partner: Sandra Whitlock, CPA, CFF).
5. Stonefield Logistics Group Inc. Warehouse Layout Plan, Revision 7, dated June 2023.
6. Stonefield Logistics Group Inc. Quarterly Sprinkler Inspection Reports for Building C, dated December 15, 2022; March 20, 2023; June 12, 2023; and September 8, 2023.
7. Lone Star Fire Protection Inc. engagement letter from Stonefield Logistics Group Inc., dated August 28, 2023, confirming an inspection appointment for November 20, 2023.
8. Midland Fire Department Incident Report (preliminary), relating to the November 17, 2023 fire at 4501 East County Road 130, Midland, TX 79706.
9. Safety Data Sheets (SDS) for Cantera Chemical Supply Co. completion chemicals stored in Building C at the time of the fire.
10. Cantera Chemical Supply Co. written storage instructions for completion chemicals delivered to SLG's Midland Facility.
We have also conducted initial interviews with Dale Engstrom, SLG's VP of Risk Management, and Jason Muñoz, SLG's account executive at Calvert & Strauss Insurance Brokers, Inc. These interviews were conducted under the protection of the attorney-client privilege.
IX. Outstanding Information Needs
While the documents and information reviewed to date support a strong preliminary assessment of SLG's coverage position, several outstanding information needs must be addressed before we can issue a comprehensive coverage opinion. These needs are summarized below in order of priority.
1. Independent Forensic Origin-and-Cause Investigation. This is the most critical outstanding need. An independent forensic investigation is essential to establish, to a reasonable degree of scientific certainty, that the fire originated in the Building C main electrical distribution panel (Square D Model QED-2), to identify the specific mechanism of electrical failure, and to evaluate the sprinkler system's performance under the municipal water-pressure conditions that existed on the night of the fire. The forensic investigation should also address whether a fully code-compliant sprinkler system operating at design pressure (52 psi) would have prevented or materially mitigated the loss, given the fire's growth characteristics and the cargo fire load present in Building C.
2. Complete Shipper Storage Instructions. We need to obtain and review the complete set of written storage instructions for all cargo stored in Building C at the time of the loss — not just the Cantera Chemical Supply Co. instructions. If any shipper's instructions contained restrictions that SLG did not comply with, that fact could affect our analysis of Exclusion 4(f). Dale Engstrom should be asked to compile and produce these documents as soon as practicable.
3. Confirmation of Cargo Segregation at Time of Fire. While Dale Engstrom has confirmed that the Warehouse Layout Plan, Revision 7, was adhered to at the time of the fire, this representation should be corroborated through independent forensic mapping of the Building C layout as it existed at the time of the fire. Forensic mapping may be possible through analysis of the fire debris pattern, surviving warehouse management system records, security camera footage (if any), and interviews with SLG warehouse personnel who were familiar with the cargo layout.
4. Municipal Water-Pressure Records. We should obtain records from the City of Midland's water utility confirming the actual water pressure at or near the Midland Facility on November 17, 2023, and any history of low-pressure events in the eastern Midland industrial corridor. These records will be important in establishing that the sprinkler system's inadequate performance was attributable to the municipal water-supply deficit and not to any deficiency in the system itself.
5. Lone Star Fire Protection Inc. Records. We should obtain documentation from Lone Star Fire Protection Inc. confirming the scheduling backlog that prevented completion of the annual full-flow test prior to November 17, 2023, and corroborating the November 20, 2023 appointment date referenced in SLG's August 28, 2023 engagement letter. This documentation may include internal scheduling records, correspondence between Lone Star FP and SLG, and a statement from a Lone Star FP representative regarding the backlog.
6. Meridian's Claim File. We should consider whether and when to request production of Meridian's internal claim file, including all adjuster notes, correspondence, investigation reports, and communications with outside counsel (KBH). In the event of litigation, the claim file will be discoverable (subject to work-product and attorney-client privilege objections), and its contents may be probative of Meridian's good or bad faith in handling the claim. At this pre-litigation stage, a formal request for the claim file may be premature, but this is a strategic decision that we should discuss with Mr. Bellamy.
X. Recommendation — Retention of Ridgeline Forensic Consultants LLC
Based on the foregoing analysis, we strongly recommend that SLG retain Ridgeline Forensic Consultants LLC ("Ridgeline") to conduct an independent origin-and-cause investigation of the November 17, 2023 fire. Ridgeline is located at 9100 Sovereign Row, Suite 210, Dallas, TX 75247, and specializes in forensic fire and explosion investigation for commercial and industrial clients.
We recommend that the engagement be led by Dr. William Creech, P.E., CFEI, a principal at Ridgeline. Dr. Creech is a licensed Professional Engineer in the State of Texas and holds the Certified Fire and Explosion Investigator (CFEI) credential from the National Association of Fire Investigators (NAFI). He has extensive experience in industrial and warehouse fire investigations and has served as a testifying expert in numerous insurance coverage and subrogation matters in Texas state and federal courts.
The proposed scope of Ridgeline's engagement includes the following:
1. Fire origin and cause analysis: Determination of the precise origin and cause of the November 17, 2023 fire, including identification of the mechanism of failure in the Square D Model QED-2 electrical distribution panel.
2. Electrical distribution panel evaluation: Detailed forensic examination of the Square D Model QED-2 unit, including analysis of recovered components, arc mapping, and assessment of the panel's installation history, maintenance records, and known failure modes.
3. Sprinkler system performance assessment: Evaluation of the Building C wet-pipe automatic sprinkler system's performance during the fire, with specific attention to the impact of the municipal water-pressure deficit (36 psi actual vs. 52 psi design) on system efficacy. This assessment should include a determination of whether a fully code-compliant sprinkler system operating at design pressure would have been capable of suppressing or materially containing the fire, given the fire's growth characteristics and the cargo fire load present in Building C.
4. Forensic mapping of warehouse layout: Documentation and mapping of the Building C cargo layout as it existed at the time of the fire, to the extent determinable from physical evidence, surviving records, and witness interviews, for purposes of confirming compliance with SLG's Warehouse Layout Plan, Revision 7.
The engagement should be structured as a retention at the direction of counsel in anticipation of litigation, to ensure that Ridgeline's work product is protected by the attorney-client privilege and the work-product doctrine. The engagement letter should be issued by Calderwood & Harkness LLP (not by SLG directly), and all reports and communications should be directed to this firm.
Ridgeline has provided an estimated engagement fee of approximately $38,500 (fixed fee) for the scope described above. This estimate assumes one site visit of approximately two to three days, laboratory analysis of recovered electrical components, hydraulic modeling of the sprinkler system, and a written report. Additional costs may be incurred if testifying expert services are required in connection with future litigation, but those costs would be addressed under a separate engagement at that time.
We request authorization to proceed with the Ridgeline engagement promptly. Time is of the essence, as the fire scene — while secured — is subject to potential degradation of physical evidence, and the City of Midland may release the site for demolition and cleanup at some point in the future. Early forensic investigation will maximize the quality and completeness of the available physical evidence.
XI. Next Steps and Timeline
Based on the preliminary analysis set forth in this memorandum, we recommend the following action items and timeline:
1. Immediate (this week — week of February 19, 2024): Obtain authorization from Dale Engstrom and/or Howard Bellamy to retain Ridgeline Forensic Consultants LLC. Upon authorization, prepare and transmit the engagement letter to Dr. William Creech at Ridgeline, with appropriate privilege and work-product protections. Simultaneously, request that Dale Engstrom compile and produce the complete set of shipper storage instructions for all cargo stored in Building C at the time of the fire, and begin the process of obtaining municipal water-pressure records from the City of Midland and scheduling records from Lone Star Fire Protection Inc.
2. February – March 2024: Ridgeline conducts its site investigation at the Midland Facility, performs laboratory analysis of recovered electrical components, completes hydraulic modeling of the sprinkler system, and prepares its forensic report. We estimate approximately three to four weeks from the date of engagement for Ridgeline to complete its investigation and deliver a draft report for our review.
3. Upon receipt of the Ridgeline forensic report: Complete the comprehensive coverage opinion memorandum for delivery to SLG. The comprehensive coverage opinion will address in full detail: (a) the contractual coverage analysis under the Policy, including the insuring agreement and all potentially applicable exclusions; (b) the extracontractual claims available to SLG under Texas Insurance Code Chapters 541 and 542; (c) an assessment of litigation risk and potential outcomes; and (d) our recommended strategy for demand, negotiation, and, if necessary, litigation.
4. Following delivery of the comprehensive coverage opinion: Prepare and transmit a formal demand letter to Meridian. The demand letter should be addressed to Patricia Ng, Vice President of Claims, Meridian Surety & Indemnity Company, 600 Scioto Crossing, Suite 1200, Columbus, OH 43215, with a copy to Victoria Kessler at Kessler, Brandt & Howe LLP, 1401 McKinney Street, Suite 2800, Houston, TX 77010. The demand letter should demand payment of $4,530,000 (net of the self-insured retention) plus all applicable statutory remedies under the Texas Insurance Code, including 18% penalty interest under Chapter 542 and attorney's fees under Chapter 541. The demand letter should provide a specific response deadline (we recommend 30 days) and should clearly communicate that SLG intends to pursue litigation if the claim is not resolved.
5. Pending Meridian's response to the demand letter: Evaluate Meridian's response and determine the appropriate next steps. Options include: (a) negotiated settlement, if Meridian makes a reasonable offer; (b) mediation, which may be productive given the strength of SLG's position and Meridian's extracontractual exposure; or (c) direct filing of suit in state court (likely Midland County District Court or, alternatively, Harris County District Court), if Meridian refuses to engage in meaningful settlement discussions.
6. Budget note: Our current estimated fee budget for the pre-litigation phase of this engagement — through and including the forensic investigation, comprehensive coverage opinion, demand letter, and negotiation/mediation — is $175,000 to $225,000. This estimate includes Calderwood & Harkness attorney time, the Ridgeline forensic engagement ($38,500), and anticipated expenses. A separate litigation budget will be prepared if suit becomes necessary, and will be submitted to SLG and Irongate for approval before any litigation is initiated.
XII. Conclusion
Based on our preliminary analysis, SLG has a strong coverage claim under Inland Marine Cargo Legal Liability Policy No. IML-TX-0039821-2023. Both exclusions invoked by Meridian in its January 22, 2024 denial appear inapplicable on the facts currently available:
• Exclusion 4(f) (Improper Storage) is undermined by the warehouse layout evidence showing separate storage zones for pipe and chemicals with a 40-foot buffer, by the inapplicability of OSHA 29 CFR 1910.106 segregation requirements to Clas

MEMORANDUM

MATTER NO.: 1012-00003

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