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Defining Business Risk Exclusions

Business risks exclusions include four separate provisions of essentially every standard contractor’s general liability (CGL) insurance policy on the market: Damage to Property, Damage to Product, Damage to Work and Impaired Property. However, the phrase “business risks” appears nowhere in the standard commercial general liability insurance policy, but the four exclusions that collectively are known by that name have misled many courts into believing the CGL policy does not cover risks that arise from a policyholder’s business, particularly the business of construction.  Even a determined effort to understand the exclusions can go awry; they jump from one provision to another and back again, tracing exceptions through definitions that reference still other definitions and exceptions.

The Damage to Property exclusion states the insurance does not apply to “[t]hat particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations,” nor does it apply to “[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 to this for property damage included in the Products-Completed Operations Hazard.  That is, if damage falls within the Products-Completed Operations Hazard,” then the damage to property exclusion simply does not apply.

The Products-Completed Operations Hazard is set forth in the “Definitions” section of the CGL policy.  If bodily injury or property damage occurs away from premises the contractor owns or rents and arises from the contractor’s faulty workmanship or product, then the damage is covered under the Products-Completed Operations Hazard.  In plain English, the provision covers damage caused by a contractor’s own faulty construction or workmanship once the work is complete (e.g., after the contractor delivers the fully constructed building to the owner).

When read together, the Damage to Property exclusion and the products-completed operations hazard coverage combine to exclude claims arising from only one infrequent circumstance: Where faulty workmanship by either the general contractor or its subcontractors cause property damage while the building is under construction.  Once the project is complete and has either been put to its intended purpose or turned over to its owner, the Damage to Property exclusion ceases to apply.

The Damage to Your Product exclusion says, simply, that it does not cover “‘Property damage’ to ‘your product’ arising out of it or any part of it.”  “Your product” is a defined term in the policy.  The definition excludes “real property.”  That is, the Damage to Your Product exclusion does not exclude coverage for damage to real property.  The policy does not define the term “real property,” but its common and accepted meaning includes land, structures firmly attached to the land, and fixtures incorporated into the structure.  The segregation of “real property” from the scope of this exclusion shows that it was never intended to apply to the business of building contractors.  The “Damage to Your Product” exclusion should never apply to construction projects, whether in progress or completed.

Thus, one of the four “business risks” exclusions applies only to damage that occurs while a building is actually under construction and the other does not apply to buildings at all.

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.’”  “Your work” means (1) “Work or operations performed by you or on your behalf;” and (2) “Materials, parts or equipment furnished in connection with such work operations.”  This exclusion also has an exception. This exclusion “does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”

A recent decision of the Supreme Court of Connecticut explained the Damage to Your Work exclusion as follows: “When read together, the ‘your work’ exclusion and the ‘subcontractor exception’ eliminate coverage for property damage caused by an insured contractor’s work, but restore coverage for property damage caused by a subcontractor’s work.”  Capstone Bldg. Corp. v. American Motorists Ins. Co. , No. 18886, 2013 WL 2396276, at *10 (Conn. June 11, 2013).  The vast majority of claims against general contractors are those allegedly caused by the faulty work of a subcontractor, not by the work of the general contractor/insured.

The final business risks exclusion is the Impaired Property exclusion.  This one is the most difficult of the four to follow and understand.  Fortunately, for the reasons that follow, its most common application is to defective manufactured products and usually not to construction-defect cases.  The exclusion applies to “‘Property damage’ to ‘impaired property’ or property that has not been physically injured, arising out of:  1) A defect, deficiency, inadequacy or dangerous condition in ‘your product’ or ‘your work,’ or 2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.”

The exclusion precludes coverage for defects, deficiencies, etc., in “your product.”  Remember “your product” excludes “real property.”  The first clause of the exclusion therefore will never apply to damage arising out of a defect or deficiency in the construction of a building.  The first clause also precludes coverage for defects, deficiencies, etc., in “your work.”  Recall that “your work” does not apply to the allegedly faulty workmanship of a subcontractor.  So far, then, the Impaired Property exclusion does not exclude anything in the construction context that has not already been excluded by the other three business risks exclusions, which is not very much at all.

The second clause is potentially problematic.  It may eliminate claims that the general contractor or its subs failed to comply with contract documents and specifications.  Yet, the definition of impaired property saves much of the coverage that might otherwise be excluded by this clause.

Impaired property means “tangible property, other than ‘your product’ or ‘your work,’ that cannot be used or is less useful because: a. It incorporates ‘your product’ or ‘your work’ that is known or thought to be defective, deficient, inadequate or dangerous; or b. You have failed to fulfill the terms of a contract or agreement.”  Because of this definition, the Impaired Property exclusion applies only to claims of economic loss–that is, a “loss off use” of an otherwise pristine and undamaged building.  For this exclusion to apply, the claim by the owner must be akin to the following: “I cannot open for business and use my otherwise perfectly good building because you, general contractor, incorporated into my building a product of yours or work that you did.  If not for your product or your work, I could use my building and I would be open for business.”  The exclusion does not apply to claims of physical damage.  If there is any claim that the building or its component parts are physically damaged, the exclusion does not apply.  Claims of pure economic loss, without any physical injury whatsoever to the property, are quite rare in construction-defect cases.

Most state supreme courts have held that faulty workmanship can be accidental and, therefore, covered by liability insurance.  Except in the relatively few outlier states where the courts have held that faulty workmanship can never be a covered occurrence, the typical judicial rationale for concluding that a claim for faulty workmanship is not covered usually lies in the application (or often the misapplication) of one or more the business risks exclusions.  But a careful review of each of them shows that their scope is really very narrow.