GC Liability InsuranceMore Like This

Three Things to Know about Occurrence-Based Insurance

Until recently, North Dakota law stated faulty workmanship is never “accidental” and, therefore, a construction defect could never be a covered “occurrence” under Commercial General Liability (CGL) policies. In April, the North Dakota Supreme Court overturned that law, ruling that faulty construction can be accidental. On June 18, 2013, the West Virginia Supreme Court of Appeals did the same thing, overruling three prior cases on its way to holding that faulty workmanship can constitute a covered “occurrence.” On June 4, 2013, the Connecticut Supreme Court also found that CGL policies can cover damage from defective construction.

The clear trend nationwide is toward finding that claims of faulty workmanship can be covered under occurrence-based CGL policies. Judicial analysis of CGL policies in construction liability cases, which has at times been superficial and even sloppy, is becoming more careful and sound. Courts are now considering the impact of the 1986 revision of the CGL policy, which added a provision to broaden coverage of general contractors for the work of subcontractors. Judges are recognizing that nothing in the definition of “occurrence” in the CGL policy precludes coverage for construction defects. They are beginning to look at the drafting history of the 1986 CGL revision, which shows that the drafters intended to cover faulty workmanship.

Nevertheless, figuring out whether coverage exists for a particular claim can be tricky. Following are three things every contractor should know about coverage for construction defects. This discussion applies to the provisions in essentially all standard-form CGL policies.

1.  Whether there’s coverage depends on which state’s law applies. In our form of government, each state decides how to interpret insurance policies. Think of the 50 states as 50 countries with 50 different sets of laws. To be sure, the various state Supreme Courts often look to courts in other states for guidance when deciding novel issues. Nonetheless, some courts have found that faulty workmanship can be covered and others have found it cannot.

The following state Supreme Courts have concluded that faulty workmanship can constitute an “occurrence:” Alaska, Connecticut, Florida, Indiana, Kansas, Minnesota, Mississippi, Montana, Nevada, New Hampshire, North Dakota, South Carolina, South Dakota, Tennessee, Texas, West Virginia and Wisconsin. Three states have statutes that require CGL policies to cover faulty workmanship: Arkansas, Colorado and South Carolina. The following states have decisions on the books, some by intermediary courts of appeal, holding that faulty workmanship is not covered by CGL insurance: Alabama, Hawaii, Illinois, Iowa, Kentucky, Nebraska, New Jersey, North Carolina, Ohio and Pennsylvania. The bottom line is the value of a construction-defect claim turns on the same three factors that influence the value of real estate: location, location and location.

To complicate matters further, the various states have different choice-of-law rules that govern the law to be applied to a case. In some states, courts will apply the law of the place where the contract was made–usually the place where the insurance policy was delivered to the insured. In others, the law of the place where the injury or harm occurred will govern. In still others, courts apply a “center-of-gravity” approach to determine which state has the greatest interest in the outcome of the dispute. When potentially covered claims arise, contractors need immediate advice about choice-of-law issues, in the interest of avoiding an insurance fight under the law of a no-coverage state.

2.      In pro-coverage states, a finding that there was no “occurrence” requires proof the contractor intended to cause damage to the project. An “occurrence” is an “accident” that causes damage “neither expected nor intended from the standpoint of the insured.” CGL policies cover property damage or bodily injury “caused by an occurrence.” The focus is on whether the insured intended to cause the harm that resulted from the negligent act. One court correctly expressed the concept as follows: “The accidental nature of an occurrence is determined by analyzing whether the alleged wrongdoer intended or expected to cause an injury. If not, then the injury is accidental, even if the act that caused the injury is intentional.” Think of automobile insurance. Driving a car is intentional; denting someone’s fender usually is not. Insuring against the risk of denting a fellow motorist’s car is the reason we buy automobile insurance.

Common sense prescribes that it is the rare contractor who intends to cause harm to his own project. The West Virginia Supreme Court’s recent decision aptly expressed this fact as follows: “Nor can it be said that Pinnacle [the general contractor in that case] deliberately intended or even desired the deleterious consequences that were occasioned by its subcontractors’ substandard craftsmanship. To find otherwise would suggest that Pinnacle deliberately sabotaged the very same construction project it worked so diligently to obtain at the risk of jeopardizing its professional name and business reputation in the process.”

3.      Getting past the “occurrence” defense may be only half the battle. Even when a claim for faulty workmanship is a covered “occurrence,” insurance carriers seeking to deny coverage will cite the so-called “business risks” exclusions. When read together, these exclusions are confusing and difficult to navigate. They contain exceptions and references to other policy provisions that, themselves, reference additional clauses and definitions, back and forth throughout the policy in a merry chase. Consequently, courts sometimes apply them incorrectly. There are three “business risks” exclusions of concern: “Damage to Property,” “Damage to Your Product,” and “Damage to Your Work.” Although insurance carriers routinely attempt to apply them broadly, these exclusions are, in fact, quite narrow. Contractors should be wary whenever they see one in a coverage denial letter.

The “Damage to Property” exclusion eliminates coverage for “[t]hat particular part of your property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” There is an exception for “property damage” included in the “products-completed operations hazard.” The “products-completed operations hazard” provides coverage for damage caused by the insured’s faulty workmanship once the work is complete–for example, after the contractor delivers the constructed building to the owner. Because of this exception, the “Damage to Property” exclusion should not apply in most cases.

The “Damage to Your Product” exclusion does not cover “‘Property damage’ to ‘your product’ arising out of it or any part of it.” The policy definition of “your product” excludes “real property,” making it clear that this exclusion is not directed at the normal business activities of building contractors. Since “real property” includes land, structures firmly attached to the land and fixtures incorporated into the structure, the “Damage to Your Product” exclusion should never apply to completed construction projects.

The “Damage to Your Work” exclusion eliminates coverage for “‘Property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’” There is an exception to this exclusion as well if the damage or the work out of which the damage arises was performed by a subcontractor. In sum, if the building was complete at the time the faulty-workmanship claim was made, and if the claim arose from the work of a subcontractor, the business risks exclusions should never preclude coverage.

There is ample evidence that the standard CGL policy was intended to cover certain kinds of construction-defect claims. The Insurance Services Office, which is the insurance-industry trade association that drafted the CGL policy, published a circular on July 15, 1986 confirming the 1986 CGL revision “covered damage caused by faulty workmanship to other parts of work in progress; and damage to, or caused by, a subcontractor’s work after the insured’s operations are completed.”

As the recent cases in North Dakota and West Virginia demonstrate, the cause is not lost for coverage of faulty workmanship even in states where courts have previously held that construction defects are never accidental. It may take a resolute contractor armed with the right facts to change the law in one of the hold-out states such as Alabama, Kentucky or Pennsylvania. In states such as New Jersey, where no-coverage decisions have issued from lower courts, the law may change when the right cases reach those states’ high courts. In the meantime, the recent trends clearly favor finding coverage for claims of faulty workmanship. When insurers respond to such claims, contractors should not take “no” for an answer.