2007 CONSTRUCTION LAW UPDATE

Transcription

1 2007 CONSTRUCTION LAW UPDATE Chapter 4: LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION: THE NO OCCURRENCE MYTH Construction Law Library ASPEN Publishers REPRINTED WITH PERMISSION BY ASPEN PUBLISHERS, INC.

2 CHAPTER 4 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION: THE NO OCCURRENCE MYTH Edmund M. Kneisel Elliot A. Fus 4.01 INTRODUCTION 4.02 OVERVIEW OF KEY CGL POLICY TERMS 4.03 THE OCCURRENCE ISSUE DEBATE AMERICAN GIRL V. KVAERNER [A] American Girl Debunks the No Occurrence Myth [B] Strict Construction of the Occurrence Clause: Kvaerner 4.04 THE OCCURRENCE CONCEPT: SHOULD THE OUTCOME BE DETERMINED BY THE UNDERLYING ACT OR BY THE DAMAGE IT CAUSES? 4.05 THE PCOH COVERAGE AND THE OCCURRENCE ISSUE 4.06 SUMMARY OF CONCEPTS GOVERNING CGL COVERAGE FOR FAULTY CONSTRUCTION 4.07 CONCLUSION 1

3 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION INTRODUCTION For more than thirty years, insurance companies have offered and sold to contractors various forms of liability coverage that contractors hope and expect will insure against liability arising out of occurrences of property damage or bodily injury during and after the construction period. Injury to persons typically occurs relatively soon after the injury-causing event. Property damage may be either instantaneous or delayed, and often occurs after the project is complete. As discussed more fully below, commercial general liability ( CGL ) policies typically contain exclusions, often referred to as business risk exclusions, barring damage to the insured s own work or products. The business risk exclusions are a particular concern to general contractors, because a general contractor s work typically is construed to include the entire project. As a result, to provide more protection for contractors (and to sell more policies), carriers began to offer so-called broad form property damage (BFPD) extensions that limited the work exclusion to that particular part of any property... upon which operations are being performed by or on behalf of the insured at the time of the property damage... 1 In 1986 and afterwards, following the guidance of the Insurance Services Office ( ISO ), many carriers totally revamped their CGL forms to both incorporate the BFPD language and to add additional, products-completed operations hazard ( PCOH ) coverage. When PCOH coverage is available and when a subcontractor negligently performs construction work on the project, a general contractor should have full coverage for all damages caused by the subcontractor s negligence, even if the damaged property would otherwise be considered to be part of the general contractor s overall work. Despite these policy additions, for which an additional premium typically is charged, carriers have continued to resist coverage for property damage claims arising out of the insured s defective work. Indeed, when the PCOH coverage cannot be triggered, either because the damage occurred during the course of construction and not after completion or because a subcontractor was not at fault, 2 CGL coverage may not be available absent loss of use of other property arising out of a sudden and accidental physical injury to or destruction of the named insured s products or work... after such products or work have been put to use This language is an exception to the impaired property exclusion, which bars coverage for impaired property. Impaired property is defined as, tangible property... that cannot be used or is less useful as a result of the policyholder s defective work, if such property can be restored to use by [t]he repair, replacement... or... removal of such work. 4 The sudden and 1 Commercial Liability Insurance at IV.D.3, 4, IV.T.27 (International Risk Mgmt. Inst., Inc. 2006). The International Risk Management Institute, Inc. ( IRMI ) publishes a treatise and commentary containing an excellent discussion of the evolution of the CGL policy form over the years. 2 The subcontractor exception to the exclusions for claims for damage to the contractor s work, which otherwise might bar coverage for all damage to the project itself, is quoted in the text accompanying note 12, infra and is discussed more fully in 4.03[A] below. 3 Commercial Liability Insurance, supra, at IV.T Id. at V.T.42. According to the IRMI treatise, the exclusion should be applied to claims resulting from design error or failure to perform and should not apply in situations where physical injury occurs because the damaged property cannot be restored to use. Id. at IV.E.12. 2

4 CONSTRUCTION LAW UPDATE accidental exception restores coverage for loss of use damages caused by defective work (even the work of the insured party) if (a) the faulty work causes physical damage; (b) the faulty work causes loss of use of other property; and (c) the event causing the damage occurred after completion and was sudden and accidental. When defective workmanship causes an explosion, fire, collapse of a building or bridge, or similar obvious disaster, most courts and many carriers find little difficulty in concluding that the damages in question are insured. 5 However, if the loss is less obvious, especially when it occurs or worsens over time, such as when water intrusion through defective siding or a defective roof results in formation of mold or other damage to the interior of the structure, courts are more reluctant to find coverage. Some courts conclude that claims against contractors, especially when pursued in a case alleging breach of contractual warranties, cannot constitute insured claims because construction of a substandard home or other facility in breach of a construction contract is simply an uninsurable, economic loss. Other courts, focusing on the business risk exclusions, rule that extending coverage for damage caused by faulty workmanship would effectively convert a CGL policy into a performance bond. 6 Still other courts adopt an even broader bar of coverage for construction defects by holding that defective construction cannot be deemed a fortuitous occurrence covered by a CGL policy, regardless of whether or not the flawed construction causes physical damage to insured property. The recent ruling of the Pennsylvania Supreme Court in Kvaerner Metals Div. of Kvaerner United States, Inc. v. Commercial Union Ins. Co. 7 is a classic example of an opinion that seems to exalt form over substance in relation to the occurrence issue, even when the complaint in question alleged actual physical damage to tangible property. The absence of a specific allegation in the underlying complaint that the damage was caused by an accidental, fortuitous event was fatal to coverage in that case. While there may be other valid reasons for denying coverage when the only damaged property is the work of the insured, especially when such damage occurs during the course of construction, reliance on the occurrence language of a CGL policy as the basis for denying coverage is simply wrong. There is no sound public-policy reason to construe this terminology narrowly when construction-related damage is at issue; application of this narrow construction of the occurrence concept to other types of liability claims would effectively overrule a consistent line of cases holding that even intentional misconduct can give rise to coverage, if the results of that conduct are not expected or intended from the standpoint of the insured. Extending the no occurrence myth to bar coverage for claims within a CGL policy s PCOH coverage is especially inappropriate. A ruling denying coverage based on the proposition that a construction flaw cannot be deemed an accidental occurrence within the PCOH coverage would nullify the coverage the insured contractor purchased and expected to receive. In 5 See, e.g., Minergy Neenah LLC v. Rotary Dryer Parts, No. 05-C-1181, 2006 WL , at *2 (E.D. Wis. Sept. 21, 2006) (finding occurrence and denying CGL carrier s motion for summary judgment on issue of coverage where fire occurred during replacement of steam tubes in an industrial dryer, causing damage to other parts of the dryer). 6 See discussion at notes 37 and 39 and accompanying text, infra A.2d 888 (Pa. 2006). 3

5 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.02 considering these issues, it is important at the outset to review the key coverage provisions of a typical CGL form, as promulgated by the ISO in OVERVIEW OF KEY CGL POLICY TERMS As noted above, when faced with, claims of construction-related property damage caused by flawed workmanship, carriers typically will invoke what courts have characterized as the business risk exclusions to restrict or bar all coverage for the claim. The decision of the Wisconsin Supreme Court in American Family Mut. Ins. Co. v. American Girl, Inc., 8 contains an excellent discussion of the business risk exclusions, which generally bar coverage for property damage to the work of the named insured. In particular, exclusion (j)(6) often is invoked to bar coverage for property damage to... that particular part of any property that must be restored, repaired or replaced because your work was incorrectly performed on it. 9 The CGL policy form broadly defines your work to include: a. Work or operations performed by you or on your behalf;. Your work includes: a. Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of your work This exclusionary language significantly limits coverage for the work of a general contractor, including any work performed on behalf of the general contractor by a subcontractor. However, exclusion (j)(6) does not apply to property damage included in the products completed operations hazard. 11 While coverage for damage claims within the products completed operations hazard usually is specified in the declarations of the policy and also generates an additional premium charge, there is no specific section of the CGL form that actually explains what is being insured. Rather, in classically confusing fashion, the only mention of PCOH coverage is in the policy declarations. The PCOH is also mentioned in the exclusion section of the policy and is explained in the policy definitions; but in contrast to policy provisions covering bodily injury or personal injury, property damage, and advertising injury, there are no specific policy provisions that clearly extend coverage to claims for damages within the scope of the PCOH definition. Applicability of such coverage must be determined by a multi-step review of the base policy provisions granting coverage, the PCOH definition, the policy exclusions, and any applicable exceptions to the policy exclusions. Review of the CGL form confirms that the PCOH coverage is designed to restore whatever coverage otherwise is available by eliminating the business risk exclusions if the insured defendant is the general contractor and if the insured is sued for damage caused by a negligent subcontractor s work N.W.2d 65 (Wis. 2004). American Girl is discussed more fully in 4.03[A] below. 9 Id. at Id. at Id. 4

6 CONSTRUCTION LAW UPDATE The PCOH is mentioned as an exception to exclusion (j), quoted above, and also in a more broadly worded work exclusion (1), which reads as follows: This insurance does not apply to: (1) property damage to your work arising out of it or any part of it and included in the products-completed operations hazard. 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. 12 The PCOH itself is in turn described in the definitional section of the policy to include: [A]11 bodily injury and property damage occurring away from premises you own or rent and arising out of your product or your work except: (1) Products that are still in your physical possession; or (2) Work that has not yet been completed or abandoned. However, your work will be deemed completed at the earliest of the following times: (a) When all of the work called for in your contract has been completed. (b) When all of the work to be done at the site has been completed if your contract calls for work at more than one site. (c) When that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor working on the same project. Work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed. 13 This definition, while not in the sections of the CGL form expressly granting coverage, provides that the PCOH coverage is triggered when insured bodily injury or property damage occurs away from the owned premises of the insured, i.e., at construction projects owned by third parties. Also, the definition specifies that all property damage 12 Id Commercial Liability Insurance, supra at IV.T See Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 825 A.2d 641, (Pa. Super. Ct. 2003) (quoting CGL form), rev d, 908 A.2d 888 (Pa. 2006), as discussed below. 5

7 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.02 causally related to or arising out of the insured s work or products is covered by the PCOH, so long as the product or work is no longer in the care, custody, or control of the named insured. The PCOH coverage is triggered when damage attributable to a subcontractor s work occurs after completion of the insured contractor s project work and after the complete or partial turnover of the project to the owner, i.e., when the work has been put to its intended use. Ongoing warranty or punch list and maintenance work does not bar application of the PCOH coverage. While some carriers (and courts) will disagree, the CGL policy exclusion barring coverage for your product should not apply to construction work because the exclusion is intended to apply only to manufacturers and other entities that produce products rather than service companies such as general contractors.... [T]he current definition... contains a clear exception of real property. A building constructed by a contractor is... not the contractor s product but rather the contractor s work. 14 Thus, the principal concern of the typical general contractor who is sued for constructionrelated damages should be whether the your work exclusions apply. Under the plain language of the CGL policy, neither of the exclusions in subparts (j)(6) and (1) of the CGL form apply when the damage in question occurs after completion of the project and when the damaged work either arises from or was performed on behalf of the insured by a subcontractor. As ruled in American Girl, courts that apply a straightforward reading of the subcontractor exception have consistently recognized that the revisions to the CGL policy form adopted in 1986 restore otherwise excluded coverage for damage to construction projects caused by subcontractor negligence. 15 Cases, such as Weedo v. Stone-E-Brick, Inc., 16 applying policy language that existed before the ISO added the subcontractor exception to the CGL form in 1986, are no longer persuasive. The Weedo line of cases should not be followed in disregard of the basic rules of policy interpretation applied in most jurisdictions that exclusions in a CGL policy are to be narrowly construed and that policy ambiguities should be resolved in favor of finding coverage. Coverage under a CGL policy is not triggered unless there is actual property damage within the scope of the base insuring agreement. While there is some variation in the definitions of property damage commonly used, the definition adopted by the ISO in 14 1 Commercial General Liability Ins. Co., supra, at V.D.202 (emphasis in original). Your Product is defined as goods or products other than real property, manufactured, sold, handled, distributed or disposed of by: You.... Id. at IV.T.139. This definition would seem to apply to a materialman or supplier of a materialman but not to a contractor who merely installs a defective product as part of its work. See Underwriters at Interest v. SCI Steel Con, 905 F. Supp. 441 (W.D. Mich. 1995). But see American Home Assurance Co. v. AGM Marine Contrs., Inc., 467 F.3d 810 (1st Cir. 2006) (applying products exclusion to floating docks because the real property exception did not apply) N.W.2d at A.2d 788 (N.J. 1979). Weedo is one of the most commonly cited cases addressing damage for construction flaws; however, the case was decided almost thirty years ago; it construed a CGL form that is now more than thirty years old; and it did not address the PCOH coverage now contained in most CGL forms that provide such coverage. 6

8 CONSTRUCTION LAW UPDATE the 1973 standard CGL form is typical. Under that definition, insured property damage includes: (1) physical injury to or destruction of tangible property, which occurs during the policy period, including the loss of use thereof at any time resulting therefrom, or (2) loss of use of tangible property which has not been physically injured or destroyed provided such loss of use is caused by an occurrence during the policy period. 17 Other forms of CGL policies, such as the policy at issue in the recent Kvaerner decision, contain a somewhat more limited definition of property damage, referring to [p]hysical injury to tangible property, including all resulting loss of use of that property. CGL policies also include a separate provision emphasizing the need for proof of a covered occurrence: B. This insurance applies to bodily injury or property damage only if: (1) The bodily injury or property damage is caused by an occurrence that takes place in the coverage territory... (2) The bodily injury or property damage occurs during the policy period Various definitions of the word occurrence have been employed over the years by the insurance industry. A typical definition defines the term as meaning an accident, including continuous or repeated exposure to substantially the same or general harmful conditions. 19 Some policies define the term accident and others do not, but courts typically agree that the consequences resulting from the act causing injury or damage must be unexpected and unintended to constitute an accident. 20 The Kvaerner court, relying upon the dictionary definition of the word accident, concluded that the unexpected/unintended language in the definition implies a degree of fortuity that is not present in a claim for faulty workmanship. 21 As a result, applying what the court considered to be the majority rule, the Pennsylvania Supreme Court concluded that the 17 1 Commercial General Liability Insurance, supra, at IV.T Id. at V Id. At V.L However, as noted above, even intentional acts may be deemed covered by a CGL form if the consequences of those acts were not specifically intended by the named insured. See Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, (2d Cir. 1995) (adopting subjective standard as to whether injury is expected or intended), opinion modified on denial of reh g, 85 F.3d 49 (2d Cir. 1996). See also Fireman s Fund Ins. Cos. v. Ex-Cell-0 Corp., 750 F. Supp. 1340, 1350 (E.D. Mich. 1990) (subjective standard under Michigan law); Queen City Farms v. Cent. Nat l Ins. Co., 882 P.2d 703, 714 (Wash. 1994) (also adopting subjective standard); Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 73 (1996) ( If coverage is lost for damage which a prudent person should have foreseen, there would be no point to purchasing a policy of liability insurance. ) A.2d at

9 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.02 definition of accident required to establish an occurrence under the policies cannot be satisfied by claims based on faulty workmanship. 22 A broad application of the Kvaerner analysis, applying what truly should be considered a no occurrence myth when applied to physical property damage caused by faulty construction, would effectively nullify CGL coverage for most construction-related claims under the typical form of policy purchased by a general contractor. Proper analysis of the scope of CGL coverage available should depend upon several factors and not only on a narrow reading of the occurrence language. First, one should consider the timing of the occurrence at issue. Did the damage occur during the course of construction? If so, the your work exclusions quoted above might bar entirely or limit coverage for course of construction damage. Second, if the damage occurred after completion, was it caused by the unintended and unexpected acts of a subcontractor? If so, the works exclusions are eliminated, and the PCOH coverage should be triggered. Finally, did the faulty workmanship of the subcontractor cause post-completion physical damage to insured property or loss of use of such property within the definition of property damage in the CGL form? 23 If so, coverage should be available. From a public policy standpoint, there is no reason to refuse to insure against construction-related property damage merely because the occurrence at issue destroys or lessens the value of the owner s completed home or project, as opposed to damaging property owned by a person who is not a party to the construction contract. Property damage coverage provided by the CGL form should not be nullified by an overly restrictive interpretation of the policy based on application of the no occurrence myth. 22 Id. at 899. This statement seems sweeping even encompassing faulty workmanship that damages property other than the insured s work (e.g., an explosion that destroys a neighboring building). As discussed below, however, other portions of Kvaerner suggest that damage to another property may be covered. 23 Coverage for diminution in value of a project damaged by faulty construction under the loss of use provisions of a CGL form is discussed in Edmund M. Kneisel & Jeffrey A. Hannah, Insurance for Financial Loss Caused by Defective Construction: Loss of Use and Diminution of Value as Covered Property Damage, Construction Law Update (Neal J. Sweeney ed., 2001). 8

10 4.03[A] 2007 CONSTRUCTION LAW UPDATE 4.03 THE OCCURRENCE ISSUE DEBATE AMERICAN GIRL V. KVAERNER [A] American Girl Debunks the No Occurrence Myth As might be expected from the commentary above, courts in the fifty states have adopted numerous approaches in reviewing construction defect/faulty workmanship claims. Some, such as Kvaerner, seem to adopt what amounts to a bright line (or perhaps blind eye) approach by holding that damages to the project caused by a constructionrelated flaw, whether based on a design deficiency or work-related negligent construction, are not covered because faulty workmanship is not an occurrence under a CGL policy. Such an approach avoids having to review the multiple, arguably confusing and ambiguous clauses that must and should be considered in the typical case, as illustrated by the analysis conducted by the American Girl court in Wisconsin. This case addresses damages caused by soil subsidence, a classic example of a non sudden and accidental occurrence of property damage caused by flawed construction. In American Girl, the general contractor (the insured party) had relied on the advice of its subcontractor regarding site preparation work. Faulty soil engineering work by the subcontractor led to excessive settlement of the soil after completion of the warehouse building, causing the foundation to sink, with resulting cracking and buckling of the building. Eventually the warehouse was condemned and had to be torn down. The construction work was completed in 1994; the subsidence became a problem in 1995; and by 1997, the building foundation had sunk by a foot, damaging steel supports, the concrete floor, and sewer lines. The ongoing problems caused the building to be dismantled in late 1999 or early Not surprisingly, the warehouse owner sued the general contractor under the construction contract; and the contractor in turn sought coverage from its CGL carriers by filing a lawsuit seeking a declaration that its potential liability to the owner was insured. On appeal from the lower court s ruling that an exclusion in the policy for the assumption of liability by contract barred coverage, the Wisconsin Supreme Court undertook a thorough review of the history of the CGL policy form, going back to The court noted that a proper coverage analysis requires a multi-step review, including (1) examining the insured s claim to determine whether it fit within the grant of coverage in the policy; (2) examining the policy exclusions to see which ones, if any, apply; and (3) determining whether any exception to an otherwise applicable exclusion would restore the liability protections provided by the base grant of coverage. Reviewing the standard CGL language (quoted above) extending coverage for any occurrence of property damage within the coverage territory, the court first addressed the issue of whether the economic loss doctrine barred coverage for the loss because the warehouse owner s underlying arbitration claim sought relief in contract rather than in tort. Noting that the economic loss doctrine, as a remedies principle, would determine how a loss can be recovered as between the contracting parties (the N.W.2d at

11 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.03[A] owner and contractor), the court assumed that the doctrine would bar a tort recovery here. However, the court decided that the economic loss doctrine did not bar coverage for the liability the builder incurred. The American Girl court noted that the contractor and owner had allocated their risks through contractual warranty provisions and that the contractor in turn insured against that risk where subcontractor fault gives rise to liability under the warranty The court rejected the carriers argument that claims seeking remedies for breach of contractual warranties can never be covered by a CGL policy, noting that there is nothing in the basic coverage language of the current CGL policy to support any definitive tort/contract line of demarcation for purposes of determining whether a loss is covered by the CGL s initial grant a coverage. 26 Citing cases, such as Weedo, suggesting that CGL coverage should be limited to tort liability for physical damage and not contractual liability for economic loss, the American Girl court rejected such broad generalizations as inconsistent with the basic coverage language of the CGL form. 27 Turning to the occurrence issue, the court also rejected the proposition that a loss actionable as a breach of contract can never be an insured occurrence, ruling as follows: The CGL policy s basic coverage language does not distinguish between losses actionable in tort and losses actionable in contract. As we have noted, the definition of occurrence in the CGL policy does not refer to the legal category of the claim; there is no language limiting the term to those occurrences that are actionable only in tort. While an insured s breach of contract/breach of warranty liability will often fall with the business risk exclusion... it does not categorically fall outside the policy definition of occurrence. 28 Because courts (and policies) typically define an accidental occurrence as something happening as a result of carelessness, unawareness, ignorance or a combination of causes and producing an unfortunate result, the Wisconsin court had little trouble concluding that the site engineer s negligence leading to the excessive subsidence was not intentional and hence was accidental and not barred by a separate exclusion for expected or intended property damage. 25 Id. at 75 n Id. at The court noted that Weedo and an earlier Wisconsin case, Bulen v. West Bend Mut. Ins. Co., 371 N.W.2d 392 (Wis. Ct. App. 1985), focused on the business risks exclusions rather than the basic grant of coverage in a CGL policy and hence should not be construed as holding that losses actionable as breaches of contract cannot be CGL occurrences... Id. 28 Id. at n.6. Indeed, the court noted that [t]he term tort does not appear in the CGL policy. Id. at 77. Taking a practical (and pro-policyholder) view of the rules of insurance contract construction, the court concluded that if the initial coverage grant excluded all coverage for contractual liability claims, the business risks exclusions are entirely unnecessary, as those exclusions specifically apply to liability claims for damage to the insured s own work or product. Such claims typically are asserted in a breach of contract lawsuit relying on the terms of the applicable construction contract, not in tort. Id at 78. See also note 76, infra. 10

12 4.03[A] 2007 CONSTRUCTION LAW UPDATE The American Girl court also had little trouble disposing of the argument that an exclusion for contractually assumed liability barred all coverage for the subsidence damage claim. Citing cases from Michigan, Utah, West Virginia, and the Fifth Circuit, the court agreed with those rulings that have held that the contractually-assumed liability exclusion refers to a specific contractual assumption of liability by the insured as exemplified by an indemnity agreement. 29 Overruling a previous Wisconsin case that had adopted an overly broad interpretation of the exclusion and consistent with its occurrence analysis, the court ruled that the exclusion did not apply because the underlying claim for breach of contractual warranties did not seek recovery under a thirdparty indemnification or hold harmless agreement. Addressing the business risk exclusions, the court first noted that the foundation and soil engineering activities of the general contractor and the soils engineer plainly fell within the definition of your work, as used in the possibly applicable exclusions (j) and (1). As a result, the court had to decide whether the subcontractor exception in the PCOH coverage applied because the soil engineering subcontractor was at fault. Citing the fact that the subcontractor exception had been added to the 1986 CGL form in response to requests of general contractors who wanted protection for damage claims arising out of the work of their subcontractors, the American Girl court noted that since 1986, courts in Wisconsin and in other jurisdictions have consistently recognized that the 1986 CGL revisions restored otherwise excluded coverage for damage caused to construction projects by subcontractor negligence. 30 The court also rejected the proposition (often invoked by CGL carriers) that an exception to an exclusion, such as the subcontractor exception, cannot create coverage, ruling as follows: This interpretation of the subcontractor exception to the business risk exclusion does not create coverage where none existed before.... There is coverage under the insuring agreement s initial coverage grant. Coverage would be excluded by the business risk exclusionary language, except that the subcontractor exception to the business risk exclusion applies, which operated to restore the otherwise excluded coverage. 31 Interestingly, one of the cases in other jurisdictions that the American Girl court cited with approval was the lower court opinion in Kvaerner, 32 recently overruled by the Pennsylvania Supreme Court. As a result, it is appropriate to return to that case to determine how and why the outcome there differed so much from the ruling in Wisconsin. 29 Id. at Id. at Id. at Kvaerner Metals Div. of Kvaerner U.S., Inc v. Commercial Union Ins. Co., 825 A.2d 641 (Pa. Super. Ct. 2003), rev d, 908 A.2d 888 (Pa. 2006). 11

13 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.03[B] [B] Strict Construction of the Occurrence Clause: Kvaerner Comparison of the lower court s ruling in Kvaerner with the ruling of the Pennsylvania Supreme Court is instructive. The Superior Court, as the intermediate court of appeals in Pennsylvania, reversed the trial court s underlying ruling granting summary judgment on the no occurrence ground. The claim at issue arose out of a design/build contract between Kvaerner and Bethlehem Steel for construction of a Coke Oven Battery. Kvaerner had subcontracted the design of the battery and related start-up work to a subcontractor; but apparently Kvaerner did most, if not all, of the actual construction work. After quoting the key provisions of the CGL form, including the business risk exclusions relied upon by the defendant carriers, the Superior Court noted that the policy issued by National Union had included a PCOH endorsement that the trial court had not even considered in light of its no occurrence ruling. The Superior Court agreed that, since the entire battery was the work of the insured general contractor, the business risk exclusions would bar all coverage unless there is an endorsement to the policy restoring coverage for the battery Kvaerner argued that torrential rains and improper adjustment of tie rods during heating of the battery after it had been placed in service had caused deformation of the battery roof and that such damage was insured as covered property damage. As a result, Kvaerner argued that the PCOH endorsement applied and covered Bethlehem s claims for damage to Kvaerner s non-defective completed work... and... for any defective work performed on behalf of Kvaerner by its subcontractor To support its position, Kvaerner relied on an expert report explaining that premature grouting of the battery, resulting apparently from the fault of the subcontractor, had caused some of the damage at issue. While the appellate court noted that there was a dispute over whether the battery had been completed when this damage occurred, the court ruled that the nature of the damage at issue, its timing, and its cause were disputed issues of fact that had to be resolved at trial and not by summary judgment. Rejecting the contention that Bethlehem s breach of contract allegations could not be deemed an occurrence that triggered CGL coverage, the Superior Court ruled as follows: In the instant case, the damage at issue is not the absence of the grout or the size of the grout spaces but the deformation of and deflection of the brick work, tie rods and roof of the battery which occurred after the battery was placed in use. Whether that damage was caused in whole or in part by the torrential rains... or by some other event during the heatup of the battery, we are not hesitant to conclude that the physical damage to the battery constituted an occurrence for which the policies provide coverage UNLESS otherwise precluded by one of the exclusions set forth in the policy A.2.d at Id. at Id. at 654 (emphasis in original). In reaching this conclusion, the Superior Court relied on commentary explaining that insurance carriers who argue that defective construction is not an occurrence do nothing 12

14 4.03[B] 2007 CONSTRUCTION LAW UPDATE As noted above, the Pennsylvania Supreme Court disagreed. After discussing the trial court s no occurrence ruling and the various arguments of the parties about the impact of the alleged torrential rains and applicability of the PCOH coverage for acts of Kvaerner s subcontractor, the Kvaerner court relied upon the so-called four corners rule, which requires the scope of a carrier s obligations under a CGL policy to be determined solely by the allegations of the underlying complaint. Noting that the Superior Court had examined materials, such as expert reports, not referenced in the Bethlehem complaint, the Pennsylvania Supreme Court ruled as follows: The Superior Court erred in looking beyond the allegations raised in Bethlehem s Complaint to determine whether National Union had a duty to defend Kvaerner and in finding that the Battery s damages may have been the result of an occurrence. In doing so, it departed from the wellestablished precedent of this Court requiring that an insurer s duty to defend and indemnify be determined solely from the language of the complaint against the insured. 36 As noted above, the court then determined that a claim for flawed construction alleged in a case brought to recover for breach of contract cannot be deemed to be based on an accidental occurrence because faulty workmanship does not have the requisite degree of fortuity. necessary to trigger coverage. The court suggested that the only type of construction risk covered by a CGL policy would be one in which the work or product actually malfunctioned and caused physical damage to property other than the work itself. Citing with approval the South Carolina Supreme Court s ruling in L-J, Inc. v. Bituminous Fire and Marine Ins. Co., the Kvaerner court concluded: [A] CGL policy may provide coverage where faulty workmanship caused bodily injury or damage to another property, but not in cases where faulty workmanship damages the work product alone [citation omitted]. To permit coverage in such instance would convert CGL policies into performance bonds, which guarantee the work, rather than like an insurance. policy, which is intended to insure against accidents. 37 The outcome in Kvaerner is flawed. The court cited American Girl as an example of the minority view on the occurrence issue, but made no reference to cases applying what it concluded was the majority rule, other than L-J, Inc. As discussed below, the strong trend of authority, which focuses on the entire policy language and the purpose and history of the PCOH provisions, finds coverage for property damage to the insured general contractor s work when a subcontractor is at fault. If broadly construed, the more than... rehash the business risk doctrine, whose success depends entirely on courts ignoring the actual language of the CGL policy. Id. at 653 (quoting James D. O Connor, What Every Construction Lawyer Should Know About CGL Coverage for Defective Construction, 21 Constr. Law. 15, 17 (Winter 2001)). The court also quoted at length from the decision of the intermediate appellate court of South Carolina (later reversed by the South Carolina Supreme Court) in L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 567 S.E.2d 489 (S.C. Ct. App. 2002), rev d, 621 S.E.2d 33 (S.C. 2005) A.2d at Id. at (citing L.J., Inc., 621 S.E.2d at 36-37). 13

15 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.03[B] above-quoted language would not only nullify the PCOH coverage, it would turn back the clock to periods before the modification of the CGL works exclusion to allow coverage for consequential property damage to nondefective work. This was accomplished by narrowing the work exclusion to the particular part of the work that causes the damage. As discussed in the next section of this chapter, many courts eschew a narrow construction of the occurrence language when faulty workmanship, such as defective installation of roofing, siding, and the like causes damage to other, nondefective parts of the structure (other work ). There may be some justification for strictly applying the four corners rule to deny coverage when there are no allegations of insured property damage and when the underlying complaint merely seeks recovery in contract for economic losses resulting from unsatisfactory, flawed work. However, it makes no sense to ignore the PCOH provisions and to adopt a pro-carrier view that effectively nullifies the coverage that the insured contractor purchased if (a) a subcontractor is at fault; (b) the subcontractor s negligent construction work caused physical damage to the project, 38 including damage to the subcontractor s (and hence the insured general contractor s) work; and (c) where the damage at issue occurs after completion of the work Perhaps because it was included in what Bethlehem characterized as a non-performance list rather than an itemization of physical damage to property, the Kvaerner court appears to have ignored allegations listing the following problems with the Battery: cracked paver bricks, shifting brickwork, deviation of centerlines of flue inspection reports, displacement of oven top brick, sheared/open joints in the roof brick, completely broken or shattered outer blocks, distortion and spalling of oven walls, and bowed tie rod housings. 908 A.2d at 891. These problems appear to describe significant, physical damage to the Battery; however, it is not clear if anything short of an actual explosion or fire or collapse of the ovens would have been considered accidental by the Pennsylvania Supreme Court. It is possible, however, that the court may have been influenced by the fact that Kvaerner had recovered proceeds from its builders risk and professional liability policies, which the court might have concluded were the only types of policies that should cover such risks. See id. at 899 n.11. Not all contractors have the economic resources to purchase project-specific builders risk policies for every project, and many smaller contractors and even larger ones that do not engage in design/build work do not have professional liability policies. That is why contractors purchase and insurance brokers sell CGL policies that include PCOH coverage. 39 It is equally nonsensical to express concern (as carriers often do) that application of the PCOH subcontractor exception to allow coverage for faulty construction work would convert a CGL policy into a construction bond. Again, most small projects, such as homebuilders projects, are not bonded. Moreover, unlike a CGL policy, bonds will cover a variety of non-accidental events, such as noncompletion of the work caused by the prime contractor s refusal or inability (perhaps as a result of insolvency) to complete the work. Unlike insurance, a bond is written on the basis of a credit evaluation, is underwritten with the expectation that no loss will occur, and provides the surety with a contractual right of indemnity against the contractor in the event of a loss. See Lennar Corp. v. Great Am. Ins. Co., 200 S.W.3d 651, 674 (Tex. Ct. App. 2006) ( a performance bond is broader than a CGL policy in that it guarantees the completion of a construction contract upon the default of the general contractor ); Fid. & Deposit Co. of Maryland v. Hartford Cas. Ins. Co., 189 F. Supp. 2d 1212, 1218 (D. Kan. 2002) ( a performance bond does not insure the contractor[,] runs to the benefit of the third party owner ); O Shaughnessy v. Smuckler Corp., 543 N.W.2d 99, 105 (Minn. Ct. App. 1996) ( A variety of deficiencies that do not constitute property damage may be covered by a performance bond, and not all deficiencies cause additional property damage. ). 14

16 CONSTRUCTION LAW UPDATE 4.04 THE OCCURRENCE CONCEPT: SHOULD THE OUTCOME BE DETERMINED BY THE UNDERLYING ACT OR BY THE DAMAGE IT CAUSES? As discussed above, to trigger coverage, there must be an occurrence of an accident within the policy period. An accident typically is defined as the happening of an unintended, unexpected event. Even an intentional act can be deemed an accident if the consequences of that act are unintended. The question remains, especially in construction cases, whether the focus should be on the consequences of the event, i.e., the damage it causes, or the nature and cause of the event itself. When the event (occurrence) at issue is negligent, faulty workmanship, a surprising number of courts, wedded perhaps to the Weedo business risks analysis, focus entirely on the consequences, ruling that negligent construction is an accidental occurrence only when it damages other property or work of third parties. The decision of the Supreme Court of Nebraska in Auto-Owners Ins. Co. v. Home Pride Cos. 40 is an example of a case holding that defective workmanship constitutes an occurrence only when it causes damage to property other than the insured s work. In Home Pride, owners of apartment buildings hired a contractor to install new shingles on the buildings roofs. The contractor subcontracted the roofing work to other companies, whose faulty workmanship allegedly damaged not only the roofs themselves, but also damaged the apartment buildings, which were not the work product of the insured roofing contractor. The court held that although a standard CGL policy does not provide coverage for faulty workmanship that damages only the resulting work product, if faulty workmanship causes bodily injury or property damage to something other than the insured s work product, an unintended and unexpected event has occurred, and coverage exists. 41 The Supreme Court of North Dakota arrived at the same conclusion in Acuity v. Burd & Smith Constr., Inc. 42 The Acuity court also found an occurrence where owners of an apartment building hired a contractor to replace a roof. A subcontractor allegedly failed to protect the building from rain, which damaged the interior of the building. Because the building was not part of the insured s work, the court found that the resulting damage caused by the negligent work was an insured occurrence. These cases illustrate that courts, perhaps even the Pennsylvania Supreme Court, will hold that faulty work can constitute an insured occurrence, but only if it causes damage to a third party s property. Such rulings suggest that damage to an insured general contractor s own work will not be considered an accidental occurrence, even if the damage occurs after project completion and results from a subcontractor s negligent N.W.2d 571 (Neb. 2004). 41 Id. at N.W.2d 33, 39 (N.D. 2006) ( property damage caused by faulty workmanship is a covered occurrence to the extent the faulty workmanship causes bodily injury or property damage to property other than the insured s work product ). 15

17 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.04 work. 43 Thus, if the insured contractors in Home Pride and Acuity had been constructing new buildings and had been responsible for the building interiors as well as their roofs, the courts might have applied the no occurrence myth to bar all coverage. There may be justification for such an outcome when the occurrence at issue takes place during the course of construction. The PCOH coverage cannot be triggered by accidental property damages that occur during construction, and the business risks exclusions typically will apply to bar or significantly limit any CGL coverage for course of construction losses. However, coverage for such losses should be denied based on application of the exclusions, not based on the no occurrence myth. Focusing only on the results of the negligent act as the basis for resolving the occurrence issue would lead to contradictory outcomes when the same inadvertent errors in constructing a faulty roof cause property damage. The same, unintentional acts of negligence in installing a faulty roof are at issue, whether those acts cause physical damage to third party property or only damage the insured s work. However, the same negligent workmanship is deemed an accidental occurrence in one case, but not in the other. Logic should compel a consistent outcome when the same conduct causes physical damage to tangible property that arises out of faulty workmanship. The Fourth Circuit Court of Appeals recently examined this issue under Maryland law in French v. Assurance Co. of America. 44 In French, the plaintiff home owners hired a contractor to build a home clad with a synthetic stucco ( EIFS ) system. A subcontractor installed the EIFS system. Five years after the completion of construction, plaintiffs discovered extensive moisture and water damage to the otherwise nondefective structure and walls of their home resulting from the defective cladding of the exterior of their home with EIFS. 45 The plaintiffs sued the contractor for damages incurred in correcting the defective EIFS system and in repairing the resulting damage to the interior of the homes. The underlying suit was then settled, with plaintiffs taking a $450,000 confession of judgment from the contractor. Plaintiffs also received an assignment of the contractor s rights to sue two carriers that insured the contractor under 1986 ISO CGL policies. Plaintiffs, as the contractor s assignees, sued the insurance companies for the $450,000 settlement. The federal district court granted summary judgment to the carriers. Relying on a Maryland Court of Special Appeals decision, the district court ruled that the damage at issue was expected or intended-from the standpoint of the insured. 46 On appeal, the Fourth Circuit affirmed in part and reversed in part the district court s ruling. 43 Cf. Kvaerner, 908 A.2d at F.3d 693 (4th Cir. 2006). 45 Id. at Id. at 699 (applying Lerner Corp. v. Assurance Co. of Am., 707 A.2d 906 (Md. Ct. Spec. App. 1998)). In Lerner Corp., the insured developer and construction manager had sold a building that contained latent defects in the stone façade. The Maryland court affirmed summary judgment for the carriers, holding that the plaintiffs liability for repairing the defective façade did not result from the happening of an accident but rather from the failure to satisfy a contractual obligation and that no occurrence was present. Again, the outcome of this case might be justified, assuming the PCOH subcontractor exception to the your work exclusion did not apply, but using the no occurrence analysis as a basis for denying coverage is flawed. 16

18 CONSTRUCTION LAW UPDATE Citing the same case, Lerner Corp., relied upon by the district court, the Fourth Circuit concluded that the EIFS defects did not constitute an accident, and therefore, not an occurrence. 47 However, the court decided that Lerner Corp. did not bar coverage for water intrusion through the defective EIFS that had damaged the interior of the plaintiffs homes. Citing American Girl, the Fourth Circuit held that the moisture intrusion into the non-defective structure and walls of the Frenches home was an accident, and therefore, an occurrence. 48 The court emphasized that the portions of the home that were ultimately water-damaged were defect-free at the time that construction was completed. Thus, coverage for such damage does not act as a source of warranty for contractually provided workmanship. 49 Rather, the court held that damage to otherwise nondefective parts of the home was covered, just as if the EIFS system had fallen outwardly onto an automobile or inwardly onto a painting hanging on an interior wall. 50 While the French court cited the American Girl case, it felt constrained by previous Maryland authority to distinguish damage to the defective work itself (the EIFS siding) from damage to other, nondefective work (the interior of the homes). Such a distinction is simply not warranted where the same, negligent conduct of a subcontractor damages the work of the general contractor. The plain language of the subcontractor exception eliminates the your work exclusion entirely when the damaged work or the work out of which the damage arises was performed... by a subcontractor. 51 As ruled in American Girl, when subcontractor negligence triggers the PCOH coverage, the PCOH exception to the your work exclusion restores all coverage for the property damage at issue. In effect, the outcome in French simply applies the BFPD coverage for damage to property other than the particular part of the property out of which the damage arises. Such rulings ignore the additional coverage provided by the PCOH coverage when a subcontractor is at fault. Cases such as French that find coverage for faulty workmanship that damages nondefective work allow for more CGL coverage than cases, such as Kvaerner or Weedo or Home Pride, that appear to bar coverage unless the defective work causes a roof shingle to fall on someone s head, for example, or otherwise damages a third person s property. Nevertheless, cases that base their outcomes on analysis of the occurrence or no occurrence issue, rather than on analysis of the policy exclusions and any applicable exceptions to those exclusions ignore proper rules of policy interpretation, leading to unexplainable, sometimes contradictory results. Several courts have gone to great lengths in finding a covered occurrence when damage to nondefective property is caused by incorporation of defective workmanship into other parts of the same property. Recent cases in Ohio illustrate the fine lines of distinction that some courts draw in finding coverage for some losses and not for others. For instance, in Stansley Group v. Fru-Con Constr. Corp., 52 Stansley provided cement to Fm-Con for the construction of pylons for a bridge. Two pylons did not meet strength 47 Id. at Id. at Id. at Id. 51 The subcontractor exception is quoted in full in the text accompanying note 12, supra. 52 No. 3:05 CV 7023, 2006 U.S. Dist. LEXIS 67718, at *2 (N.D. Ohio Sept. 21, 2006). 17

19 LIABILITY COVERAGE FOR DEFECTIVE CONSTRUCTION 4.04 requirements and had to be demolished and replaced. Fm-Con brought contract, warranty, and negligence claims against Stansley, and Stansley sought coverage from its CGL insurer. Not surprisingly, the insured and insurer disagreed regarding the coverage available. The carrier relied on a line of cases holding that faulty workmanship was not an occurrence because CGL policies do not insure an insured s work itself; rather, the policies generally insure consequential risks that stem from the insured s work. 53 Citing a different line of cases, the insured contractor argued that the term occurrence has a broader meaning than accident and that case law overwhelmingly indicates that allegations that a contractor failed to fulfill its duties in constructing or designing that which it had constructed, constitute an occurrence. 54 Citing still other cases, the district court suggested that a proper analysis should require review of the policy in its entirety, including the policy s exclusions and any exceptions to the exclusions. The court noted that in considering the business risk exclusions, courts had concluded that coverage should be denied where the damages claimed are the cost of correcting the work itself... [but] [i]f the damages are consequential and derive from the work the 55 insured performed, coverage generally will lie. The Fru-Con court, focusing on the perceived dichotomy between rejecting coverage for losses incurred in repairing the insured s work, as opposed to damages to other work, denied the parties cross-motions for summary judgment. The court ruled that resolution of the coverage issue would be determined by whether the damages were solely for defective workmanship or included collateral or consequential damages. 56 Construing exclusion (j)(6), the court decided that resolution of the coverage dispute required factual analysis of whether the defective concrete could be specifically identified and distinguished from nondefective workmanship. If substantially all the concrete used to construct the pylons was defective, (j)(6) would apply and free [the insurer] of any duty to defend on damages occurring during operations. 57 However, if the bad concrete was merely a defective component of the pylon structure, removal of the entire pylon, containing both good and bad concrete that could not be separated, would be collateral damage that triggered the CGL coverage. Concluding that [t]he destruction of the good concrete may constitute an unanticipated collateral consequence, 58 the court ruled that issues of fact on this question had to be resolved at trial. In another Northern District of Ohio decision, Acuity v. City Concrete L.L.C., 59 the court went one step beyond the Fru-Con analysis to reject claims for coverage for property damage caused by use of defective concrete in driveways. In Fru-Con, the 53 Id. at * Id. at *8. 55 Id. at * Id. at * Id. at * 16. The court did not consider any other exclusions or the PCOH exception to any such exclusions, noting that they only applied to completed operations and that the parties had agreed that the insured s work had not been completed before the pylon damages occurred. Id. at * 14 n Id. at * See Acuity v. City Concrete, L.L.C., No. 4:06CVO415, 2006 U.S. Dist. LEXIS at *13 (N.D. Ohio Oct. 17, 2006). Notably, City Concrete cites Stansley, but incorrectly states that the Stansley decision found no coverage. 18

20 CONSTRUCTION LAW UPDATE plaintiff general contractor on the bridge project sued its subcontractor who supplied the concrete used in constructing the failed pylons. It is not clear whether the insured in that case, who was the concrete supplier, actually had worked on the pylons, other than perhaps pouring the concrete. Nevertheless, because the plaintiff alleged damages as a result of breach of an implied warranty to perform in a workmanlike manner, the court treated the insured as a subcontractor on the project and concluded that the your work exclusions governed the outcome of the coverage dispute. 60 The result may differ if the insured is merely a materialman or supplier of a materialman who provides a defective product that is installed in the project. City Concrete is an example of a such a case. Applying the four corners approach, the court noted that the plaintiffs, including the contractor who had installed the driveways, had sued the insureds as the manufacturers of the concrete. There is no indication in the decision that the defendants actually did any work on the driveways. As a result, rather than consider the your work exclusions, the City Concrete court focused on the product exclusions. Because the complaints alleged damage caused by manufacture of the defective concrete and breach of defendants contractual duty to perform, the court ruled that claims for damages for the faulty driveways that are the product of Defendants[ ] own product, the concrete... are not covered by the CGL policy Addressing alleged collateral damage to the plaintiffs homes, the court also concluded that exclusion (m), the impaired property exclusion, barred all coverage for property damage or loss of use of the house (`impaired property ) that arises out of the defective concrete ( `your product ). 62 There is no discussion in the City Concrete case of the issue of whether the contractor who had installed the driveways might be covered by its CGL policy for claims by the homeowners. The outcome might have been different if coverage for the contractor had been at issue, and if the PCOH coverage could be triggered. 60 Fru-Con, supra 2006 U.S. Dist at *3. The concrete used for the pylons was in effect custom-made in accordance with the bridge builder s contract specifications calling for concrete with 10,000 psi compressive strength. Id. at *2. When custom-designed, non-standard equipment is supplied, especially when the supplier contracts directly with the general contractor to provide custom work, courts have ruled that the manufacturer/supplier is not merely a materialman, but can be deemed a subcontractor for purposes of the PCOH coverage. Limbach Co. LLC v. Zurich Am. Ins. Co., 396 F.3d 358, (4th Cir. 2005) (distinguishing a supplier of generic bricks who is merely a materialman from a supplier of custom manufactured steam pipe, who qualifies as a subcontractor for purposes of triggering the PCOH exception to the your work exclusion). Interestingly, Limbach applied Pennsylvania law and cited with approval the Superior Court s opinion in Kvaerner, supra. As a result, the Fourth Circuit s opinion, which does not address the occurrence issue, might be called into question in light of the Pennsylvania Supreme Court s ruling in Kvaerner, discussed above. 61 Id. at *19. There is no indication in the case that the concrete at issue was other than generic, as opposed to custom-made concrete. See note 60, supra. In any event, the plaintiffs had not alleged any workmanship claims against the concrete supplier. 62 Id. The court also concluded that the sudden and accidental exception to the impaired property exclusion, see discussion of impaired property at text accompanying note 4, supra, would not restore coverage because the occurrence at issue happened on delivery of the defective concrete to the work site and hence before the product had been put to its intended use, concluding as well that there were no allegations that the post-completion chipping, cracking or spalling [of the driveways] occurred suddenly. Id. at *22. 19