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Insurance Coverage for Subcontractors’ Faulty Work

The question of whether and when a contractor can obtain insurance coverage for damage caused by a subcontractor’s faulty work has been fought out in a state-by-state basis in courts across the country.

In July, the New Jersey Appellate Division and the 3rd Circuit each addressed this issue. The Appellate Division came out strongly for coverage in Cypress Point Condominium Association, Inc. v. Adria Towers, L.L.C No. A-2767-13T1, __ N.J. Super. __ (App. Div. July 9, 2015). The 3rd Circuit, in The Travelers Property Casualty Company of America v. USA Container Co. No. 14-3685 (3d Cir. July 10, 2015), moderated its past strong rejection of coverage for subcontractors’ faulty work, certifying the question to the New Jersey Supreme Court while acknowledging that various jurisdictions have reached very different decisions on this question. If the New Jersey Supreme Court finds coverage, it could help tip the balance nationally on this highly contested issue

Coverage for Consequential Damages Stemming from Faulty Work

The decision in Cypress involved an all too familiar fact pattern: Faulty construction work caused water infiltration into a condominium development. In Cypress, the faulty workmanship was performed by subcontractors and caused damage to common areas and individual units, including damage to drywall, insulation, wall finishes and flooring. The general contractor that hired the subcontractors sought coverage under its commercial general liability policies “for consequential damages caused by the subcontractors’ defective work.”

The Cypress court found that the cases on which the insurance company relied to deny coverage, Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979), and Firemen’s Insurance Co. of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (App. Div. 2006), did not govern. First, both cases involved situations where the sole damage was poor workmanship, not resultant consequential property damage. Second, both cases involved different policy language than the insurance policy at issue in Cypress.

The Cypress court held that consequential damage to the common areas and unit owners’ property constituted “property damage” and an “occurrence” as defined by the insurance policy. The court explained that consequential damage was not the cost incurred to repair the defective work, but rather “those additional damages to the common areas of the condominium building and the unit owners’ property.” The court held that “[t]he consequential damages are therefore not the cost of correcting the defective work . . . but rather the cost of curing the ‘property damage’ arising from the subcontractors’ faulty workmanship.” The court found that there was a fundamental difference between the cost of correcting the poor workmanship itself, as compared to third-party consequential damage that resulted from the faulty workmanship.

A New Look at Old Policies

The Cypress court analyzed the 1986 ISO form policy, and found cases, including Weedo and Firemen’s, which construed the 1973 ISO form, inapplicable. Both Weedo and Firemen’s analyzed the 1973 standard commercial general liability form, or 1973 ISO form, which did not include a “significant exception” to the “your work” exclusion. However, in 1986, the standard exclusion language was changed by adding a “subcontractor 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.” The court held that “the addition of the subcontractor’s exception is of critical importance when determining whether the subcontractors’ faulty workmanship causing consequential damages amounts to ‘property damage’ and an ‘occurrence’ under the policy.” The court reasoned that the introduction of the subcontractor exception supports a finding that a subcontractor’s faulty workmanship, which caused consequential damage, would constitute “property damage” and an “occurrence.”

On to the New Jersey Supreme Court

For its part, the 3rd Circuit now seems unsure of how to apply and interpret the “your work” exclusion as applied in Weedo. In 2010, the court ruled in Pennsylvania National Mutual Casualty Insurance Co. v. Parkshore Development Corp., 403 Fed. Appx. 770 (3rd Cir. 2010), that when the damages consist of the cost to repair and replace defective work and materials, there was no occurrence. In USA Container, the 3rd Circuit is revisiting that finding. USA Container concerned a corn syrup distributor that hired USA Container Co. to transfer the product. USA Container Co. subcontracted the work, and the subcontractor ultimately damaged the corn syrup after failing to follow proper protocol. USA Container Co. notified Travelers of the claim and Travelers denied coverage, asserting there was no “occurrence.” In certifying the question to the state Supreme Court, the 3rd Circuit acknowledged the wealth of cases nationally that have analyzed similar facts and issues, and reached different holdings.

Coverage Clarified

The Cypress court held that the insuring agreement was triggered, although it did not reach the issue as to whether insurance coverage would ultimately exist (i.e., whether other policy exclusions would bar coverage). The court also did not address whether coverage exists for the subcontractor’s work, as opposed to consequential damages from that work. Still, the Appellate Division already has relied on Cypress in two subsequent cases. The opinions are nearly verbatim. Belmont Condominium Association, Inc. v. Arrowpoint Capital Corporation, No. A-4187-12T4, 2015 N.J. Super. Unpub. LEXIS 1749 (App. Div. July 21, 2015); Bob Meyer Communities, Inc. v. James R. Slim Plastering, Inc., No. A-5581-12T1, 2015 N.J. Super. Unpub. LEXIS 1754 (App. Div. July 21, 2015).

The Appellate Division has now made it clear that consequential property damage resulting from a subcontractor’s poor workmanship does constitute “property damage” and an “occurrence,” and is covered by liability insurance. Yet Cypress, like USA Container, may ultimately be settled by the New Jersey Supreme Court. If coverage is found in both cases, New Jersey will join the ranks of several states–including Florida, Illinois and Minnesota–that have clarified this longstanding point of dispute.

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