Insurance Coverage of Defective Workmanship By William H. Tate Travelers v. Moore and a Developing Split of Authority Inconsistent application of the law from jurisdiction to jurisdiction is likely to continue until the question of fortuity is squarely confronted by the courts. The Tennessee Supreme Court s decision in Travelers Indem. Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302 (Tenn. 2007) ( Moore ), which represented a significant shift in Tennessee law, appears now to have also solidified a split among state courts concerning whether a defective workmanship claim, standing alone, is an occurrence under commercial general liability policies. This article will explain the rationale behind the departure by examining the example of Tennessee in depth, from the mid-1970s to the Tennessee Supreme Court s decision in Moore, as well as some key cases that have critiqued this emerging, minority approach as represented by Moore. Tennessee s Example Tennessee follows the general insurance law rule that exceptions, exclusions and limitations in policies of insurance are to be most strongly construed against the insurer. Travelers Ins. Co. v. Aetna Cas. & Surety Co., 491 S.W.2d 363, 367 (Tenn. 1973). Tennessee further follows the basic rule of contracts that a written agreement, in case of doubt as to the meaning thereof, [will] be interpreted against the party who has drawn it. Id. Further, it has long been William H. Tate is a partner with Howard Tate Sowell Wilson Leathers & Johnson, PLLC, in Nashville, Tennessee, where his practice focuses on business litigation, construction, insurance coverage of construction disputes, and surety law. He is also a Rule 31 mediator. the rule in Tennessee that in construing an insurance policy, uncertainties or ambiguities must be construed strongly against the insuror and in favor of the insured. Id. In the Tennessee Supreme Court case Vinsant Elec. Contractors v. Aetna Cas. & Sur. Co., 530 S.W.2d 76 (Tenn. 1975), the court interpreted a CGL policy that excluded coverage for property upon which operations were being performed on behalf of the insured at the time of the property damage. This interpretation of the operations exclusion, exclusion (j)(5) of the CGL policy, in Vinsant was the first in a line of cases that courts in other states followed. The Tennessee Supreme Court found no coverage in Vinsant. In Vinsant, an electrical contractor was engaged to mount two circuit breakers, and during these operations one of its workman inadvertently deposited or dropped a socket wrench in such manner that it came in contact with two buss bars producing phase to phase contact and a shortage which caused the entire switchboard to burn and blow up. Id. at 76. In addressing the operations exclusion, the Tennessee Supreme Court wrote: Our concern is limited to the meaning of the phraseology, that particular part of any property upon which operations are being performed. This, of course, 44 n For The Defense n June 2010 2010 DRI. All rights reserved.
is a question of fact and its determination will vary with the fact and circumstances of each particular case. Under the factual situation in this particular case, we hold that the switchboard, in its entirety, or as a unit, is that particular part of the property upon which operations are being performed. Id. at 77. In 1979, the Tennessee Supreme Court again addressed a CGL policy in Vernon Williams & Son Construction, Inc. v. Continental Ins. Co., 591 S.W.2d 760 (Tenn. 1979). In Vernon Williams, a prior lawsuit had determined that concrete work had not been properly designed or performed, resulting in a severely cracked floor, which rendered a building unusable. The court relied and quoted heavily from Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 (N.J. 1979). In its holding the Tennessee Supreme Court ruled as follows: We are convinced that the standard comprehensive general liability policy does not provide coverage to an insuredcontractor for a breach of contract action grounded upon faulty workmanship or materials, where the damages claimed are the cost of correcting the work itself. The [complaint] involved that character of claim only, and thus there was no coverage and no duty upon the insuror to defend. Moore, discussed below, has distinguished Vernon Williams and the business risk doctrine. In 1990, the Tennessee Court of Appeals decided Blaylock & Brown Constr., Inc. v. AIU Insurance Co., 796 S.W.2d 146 (Tenn. Ct. App. 1990). In Blaylock, the court dealt with these facts: [A] structural defect in the construction of the house which resulted in substantial damage to the building. Primarily, the structural defect was related to inadequate support of the concrete determined that the cause of the problem was a fracture in a drain pipe caused by incorrect post hole placement or floor supports, which was part of the work performed by Mr. Willie Jones who [the contractor] contends is a concrete subcontractor and who [the insurance company] contends is an employee of [the contractor.] Id. at 147 48. The Blaylock case involved a broad-form, comprehensive liability endorsement with respect to the completed operations hazard, which appeared to broaden coverage to property damage to work performed by the named insured, arguably not excluding work performed by a subcontractor, rather than the replaced Exclusion O, which excluded property damage to work performed by or on behalf of the named insured, arguably providing less coverage and excluding work of a subcontractor. The contractor in Blaylock had placed great reliance on Fireguard Sprinkler Systems v. Scottsdale Insurance, 864 F.2d 648 (9th Cir. 1988), a case of first impression in the Ninth Circuit in which the court held that a CGL policy had intended to cover losses caused by the work of subcontractors. As stated by the court in Blaylock, Fireguard interpreted the deletion in the exclusion to mean that the policy will not cover damage to work Fireguard performed, but will cover damage to work the subcontractors performed. Blaylock at 150. However, the court in Blaylock cited Vernon Williams & Sons, discussed earlier, as follows: Our Supreme Court held that a claim limited to remedying faulty workmanship or materials does not constitute injury to or destruction of tangible property. Id. at 763. The Court also held, following Weedo v. Stone-E-Brick, Inc., that the risk intended to be insured by a comprehensive general liability policy is faulty workmanship and materials which cause a tort liability to persons other than those to whom contractual obligation of workman- like performance is due. Id. at 152. In Blaylock, the property owner had sued the contractor, Blaylock, for breach of contract, breach of warranty, and negligence, finding the facts factually identical to Vernon Williams & Sons, to hold as follows: We are, therefore, constrained to agree that the coverage for property damage provided by the standard comprehensive general liability policy does not extend to coverage to an insured- contractor for a breach of contract action such as this. Id. at 152 53. The Blaylock court then cited with approval several authorities, including Bor- Son Building Corp. v. Employers Commercial Union, 323 N.W.2d 58 (Minn. 1982), which stated that The risk intended to be insured is the possibility that the goods, products or work of the insured, once relinquished or completed, will cause bodily injury or damage to the property other than to the product or completed work itself. The Moisture penetration, premature deterioration, and mold due to windows that a subcontractor had improperly installed, constituted an unforeseeable accident, an occurrence, and property damage. coverage is for tort liability for physical damage to others and not for contractual liability of the insured for economic loss because the product or completed work is not that for which the damaged person bargained. Blaylock at 153 (citing Bor-Son at 63). In conclusion, Blaylock seemed to ignore whether the work was performed by the contractor or a subcontractor and instead, based its holding on the distinction between the contractor s contractual liability for economic loss, which was not covered under the policy, as opposed to the contractor s tort liability for physical damage, which potentially was covered. However, the holding in Blaylock may have been significantly undermined by the holding in Travelers v. Moore, which is discussed below. In 1994, the Tennessee Supreme Court rendered a decision in St. Paul Fire & Marine Ins. v. Torpoco, 879 S.W.2d 831 (Tenn. 1994). In that decision, the court quoted with approval language from American Policyholders Ins. Co. v. Cumberland Cold Storage Co., 373 A.2d 247 (Me. 1977), as follows: For The Defense n June 2010 n 45
[I]n the overwhelming majority of jurisdictions the obligation of a liability insurance company to defend an action brought against the insured by a third party is to be determined solely by the allegations contained in the complaint. Accordingly, if the allegations in the underlying tort actions in the instant case are within the risk insured against Several other jurisdictions have not followed Tennessee s departure from prior CGL caselaw. and there is a potential basis for recovery, then American must defend, regardless of the actual facts or the ultimate grounds on which liability to the injured parties may be predicated. In any event, the pleading test for determination of the duty to defend is based exclusively on the facts as alleged rather than on the facts as they actually are. Torpoco at 835 (emphasis added). In Standard Fire Insurance Co. v. Chester- O Donley & Associates, Inc., 972 S.W.2d 1 (Tenn. Ct. App. 1998), the Tennessee Court of Appeals conducted a thorough review of the standard CGL policy. Judge Koch wrote a lengthy and well- reasoned opinion for the court following a long line of cases from many jurisdictions. He cited many Tennessee cases regarding the general construction of CGL policies. This is the leading case in Tennessee at the present time. The court addressed the issue of estoppel to deny coverage, stating that Chester- O Donley and Clark & Associates also assert that Standard Fire should be estopped to deny coverage because a claim consultant told them that he believed that the policy might cover Highland Rim s claim that it had to perform substantial work on the mechanical system and Clark & Associates claim for lost income. We find little merit with this argument for two reasons. First, 46 n For The Defense n June 2010 an insurer s duties to defend and indemnify arise from the terms of its policy, not from later statements of its agents. See Kentucky Farm Bureau Mut. Ins. Co. v. Cann, 590 S.W.2d 881, 883 84 (Ky. Ct. App. 1979). Second, we have determined as a matter of law that Standard Fire s policy does not cover any of Clark & Associates claims. Chester- O Donley at 13 (emphasis added). In Chester- O Donley, the court found that Standard Fire s policy provided no coverage for Chester- O Donley, making it clear that CGL policies only provided indemnification for damages as a result of tort liability to a third party [and] are not intended to cover the insured s contractual liability for economic loss because its work was not that for which the damaged person bargained. Id. at 6 7. As the court stated, CGL policies do not cover economic loss without some sort of physical injury to tangible personal property that is not owned by the insured or that is not part of the insured s work. Id. at 8; see also, Miele v. Zurich U.S., 98 S.W.3d 670, 673 74 (Tenn. Ct. App. 2002) (finding that claims for an insured s willful and intentional violations of the Tennessee Consumer Protection Act were not covered under a policy that excluded bodily injury or property damage) and Assurance Co. of America v. Continental Development & Const., Inc., 2009 WL 1616760 (M.D. Tenn. 2009) (involving a jury finding of actual fraud through an intentional misrepresentation and an expected or intended policy exclusion.) With respect to property damage, the court specifically stated that Additional construction expenses, lost profits, or diminution in value of the project caused by the insured s defective work are the sort of economic losses that do not fit within the definition of property damage. Id. at 9. In Chester- O Donley, the insured was an HVAC subcontractor, Chester- O Donley, who was counter- sued by two parties for $1.4 million dollars for its defective work and the replacement of the entire ductwork system in a commercial building, fraudulent misrepresentations, and loss of income. The court found no coverage for either counterclaim: The definition of property damage in Standard Fire s policy limits the policy s coverage to physical injury to tangible property and to the loss of use of tangible property other then the insured s work that has not been physically injured. The impaired property exclusion in Standard Fire s policy narrows the lossof-use coverage by excluding loss-ofuse claims based solely on the insured s failure to provide the work or products called for in the contract. When read together these provisions exclude coverage when there has been no physical injury to tangible property other than the insured s work. Standard Fire, 972 S.W.2d at 12 (emphasis added). In many construction lawsuits, the suing party does not allege that a third person or party bears liability. Instead, suing parties often allege that they suffered economic losses resulting from breach of contract or breach of warranty to fix the work. Until Moore, these losses were clearly not covered under the CGL policy, as the court held in Standard Fire. Id. Moore In 2007, the Tennessee Supreme Court decided Travelers Indem. Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302 (Tenn. 2007). In this case the Tennessee Supreme Court affirmed the trial court s grant of summary judgment, holding that Travelers had a duty to defend Moore under a CGL policy. Justice Holder, writing on behalf of the court, stated the issues as 1) whether an insured contractor s defective workmanship may constitute an occurrence under the terms of the insuring agreement of a commercial general liability policy; 2) whether damages resulting from faulty workmanship are property damage ; and 3) whether damages to the insured contractor s work are excluded from coverage if those damages are caused by the faulty workmanship of a subcontractor. Moore, 216 S.W.3d at 304. The court concluded that defective workmanship may constitute an occurrence and that damage caused by faulty workmanship is property damage. Finally, the court held that the faulty workmanship of a subcontractor was not excluded from coverage.
The biggest question, however, was whether Travelers had a duty to defend the insured contractor against a claim for water penetration resulting from the faulty workmanship of the window subcontractor, which caused damage to the contractor s work. Moore Facts The insured, Moore, was the general contractor for the construction of a hotel in Houston, Texas. Moore hired a subcontractor to provide and install windows. The demand for arbitration alleged negligent installation resulting in water and moisture penetration, which in turn has caused pervasive premature deterioration of/and damage to other components of the interior and exterior wall structure, and some room finishes and fixtures. Mold was also found in some locations and some windows were removed for mold and damage remediation. On cross motions for summary judgment, the trial judge held that Travelers had a duty to defend the demand for arbitration and reserved the issue of the duty to indemnify. The Court s Analysis in Moore The Tennessee Supreme Court began its analysis by reviewing the case law described above, including Chester- O Donley, 972 S.W.2d 1. The Tennessee Supreme Court attempted to square its decision with Vernon Williams, 591 S.W.2d 760, and Weedo, 405 A.2d 788, stating that these two opinions were based upon the exclusions in the respective CGLs, rather than in the insuring agreement. The court concluded that neither Weedo nor Vernon Williams is relevant to the determination of whether there has been an occurrence under the terms of the insuring agreement again. The Court Revised the Law and Definitions of Occurrence and Accident Interestingly, the Moore court stated that the meaning of occurrence in a modern CGL is a matter of first impression for this Court. The opinion attempted to distinguish the long- standing opinion Gassaway v. Travelers Insurance Co., 439 S.W.2d 605, 608 (Tenn. 1969), but did not attempt to distinguish the facts in Gassaway. Gassaway held that the insured contractor s failure to disclose its negligent installation of an underground storm drain, which leaked water and caused foundation settlement and property damage, was reasonably foreseeable and not an accident. The Moore court reached a different conclusion: We therefore conclude that the term accident as used in the CGL in this case means an unforeseen or unexpected event. Furthermore, we consider foreseeability from the perspective of the insured. See Gassaway, 439 S.W.2d at 608 09. Therefore, the policy in this case provides coverage to any property damage caused by an event that was not foreseeable to Moore, including continuous exposure to substantially the same generally harmful conditions. Moore, 216 S.W.3d at 308 A New Definition of Property Damage Again, in defining property damage, the court distinguished Vernon Williams because its result was based on the CGL s exclusions. Citing a California case, St. Paul Fire & Marine Ins. Co. v. Coss, 145 Cal Rptr. 836 (Cal. Ct. App. 1978), which described damage to a finished product, a car, due to a car crash caused by a defective tire, as property damage, and comparing the water penetration in its case to a car crash caused by a defective tire, the Moore court held that the claim in question was not limited to faulty workmanship and alleged property damage. The Court s Analysis of the Your Work Exclusion The policy in Moore contained the standard Exclusion L as follows: Exclusion L. Damage to Your Work 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. The Tennessee Supreme Court concluded that the entire hotel met the definition of your work because the entire construction project was performed by Moore or by subcontractors on Moore s behalf. The court concluded that all damages to the hotel initially were excluded by the your work exclusion, but also that work performed by a subcontractor fall outside the exclusion and are covered under the CGL. Id. at 309. The Court s Conclusion in Moore In summarizing its conclusion, the court wrote: An occurrence is defined as an accident, which we hold is an event that is unforeseen by the insured. Because Moore could not have foreseen the water penetration had the work been completed properly, we conclude that the water damages were the result of an occurrence. In addition, we hold that claims alleging only damages for replacement of a defective component or correction of faulty installation do not allege property damage. Because the damages alleged by Hilcom are not limited to faulty workmanship, we conclude that Hilcom has alleged property damages. Finally, we hold that damages to the insured contractor s work are not excluded from coverage if those damages are caused by the faulty workmanship of a subcontractor. To the extent that Hilcom alleges damages resulting from the faulty workmanship of a subcontractor, we conclude that these damages are not excluded from coverage. We therefore hold that Hilcom has alleged an occurrence resulting in property damage, that the alleged damages are not excluded from coverage, and that Travelers has a duty to defend Moore. Id. at 309 (emphasis added). This was a very important decision, and, as indicated earlier, represents a shift in Tennessee law. It is difficult to distinguish Gassaway s facts. Drainage can leak and windows can leak. Therefore, relying on Gassaway is questionable, and Gassaway s definition of a fortuitous accident has also been diluted. Moreover, Moore did not discuss Blaylock, 796 S.W.2d 146, and paid little attention in its holding to the distinction between contractual liability and tort liability. In Moore, the court held that moisture penetration, premature deterioration, and mold due to windows that a subcontractor had improperly installed, constituted an unforeseeable accident, an occurrence, and property damage. The Tennessee Supreme For The Defense n June 2010 n 47
Court specifically held that in this particular instance, due to the facts, as noted above, the subcontractor exception [to the your work exclusion] provides that any damages arising out of the work performed by a subcontractor fall outside the exclusion and are covered under the CGL. Id. at 309. Although the court did not fully address coverage and indemnification, the opinion stated in dicta that faulty workmanship by a subcontractor resulting in actual property damage to the work was covered. Split of Authority in Other Jurisdictions The Florida Supreme Court adopted Moore in United States Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871 (Fla. 2007). However, several other jurisdictions have not followed Tennessee s departure from prior CGL caselaw. In the Colorado decision General Security Indemnity Company of Arizona v. Mountain States Mutual Casualty Company, 205 P.3d 529 (Co. Ct. App.2009), the court reviewed the split that has developed among the various states regarding allegations of faulty workmanship and whether a defective workmanship claim, standing alone, is an occurrence under CGL policies. The Colorado court observed that a majority of jurisdictions have held that claims of poor workmanship, standing alone, are not occurrences that trigger coverage under CGL policies. The Colorado court cited cases collected by the Second Circuit interpreting Illinois, Iowa, Nebraska, Pennsylvania, and South Carolina law. See J.Z.G. Resources, Inc. v. King, 987 F.2d 98 (2d Cir. 1993); State Farm Fire & Cas. Co. v. Tillerson, 777 N.E.2d 986 (Ill. App. Ct. 2002); Pursell Constr., Inc. v. Hawkeye- Security Ins. Co., 596 N.W.2d 67 (Iowa 1999); Auto- Owners, Co. v. Home Pride Companies, Inc., 684 N.W.2d 571, 576 (Neb. 2004); Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 589 Pa. 317, 908 A.2d 888 (Pa. 2006); L J, Inc. v. Bituminous Fire & Marine Ins. Co., 366 S.C. 117, 621 S.E.2d 33 (S.C. 2005); See also the collection of cases at 9A Couch on Insurance 129:4. As stated in the General Security case, a corollary to the majority rule is that an accident and occurrence are present when consequential property damage has been inflicted upon a third party as a result of the insured s activity. General Security, 205 P.3d at 535. The court in General Security concluded that there was no basis to apply this corollary that an accident and occurrence are automatically present when defective construction happens. The General Security case listed the minority of jurisdictions, including Tennessee, which have held that the damage resulting from faulty workmanship can be considered an accident and thus a covered occurrence, as long as the insured did not intend the resulting damage. See Great Am. Ins. Co. v. Woodside Homes Corp., 448 F. Supp. 2d 1275 (D. Utah 2006); United States Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871 (Fla. 2007); Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 137 P.3d 486 (Kan. 2006); Travelers Indem. Co. v. Moore & Assocs., Inc., 216 S.W.3d 302 (Tenn. 2007); Lamar Homes, Inc. v. Mid- Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007); Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 268 Wis. 2d 16, 673 N.W.2d 65, 83 (Wis. 2004). The Colorado Court of Appeals in General Security criticized the minority rule, including the Moore decision, which had unconvincingly concluded that defective work is unforeseeable, and thus the property damage caused by defective work is an accident that constitutes an occurrence. General Security, 205 P.3d at 536 (citing United States Fire Ins. v. J.S.U.B., 979 So. 2d 871 (Fla.2007), and Moore, 216 S.W.3d 302 (Tenn. 2007)). The Colorado court precisely stated the problem, criticizing the minority of jurisdictions that do not address the reasoning of courts following the majority rule that an accident must be fortuitous. General Security, 205 P.3d at 536. Finally, the Colorado court in General Security highlighted the problem with departing from prior case law by noting that the minority rule resulted in improperly shifting the burdens of a subcontractor s poor workmanship from the contractor to the insurance company. Id. Pennsylvania has also addressed whether faulty workmanship constitutes an occurrence and has joined the majority of jurisdictions finding that faulty workmanship by itself is insufficient to invoke coverage. See Kvaerner Metals v. Commercial Union Insurance Co., 908 A.2d 888 (Penn. 2006). Apparently, in a case of first impression in Pennsylvania, in Kvaerner Metals the court held that faulty workmanship did not satisfy the occurrence requirement under the CGL policy. The court stated that such claims simply do not present the degree of fortuity contemplated by the ordinary definition of an accident or its common judicial construction in this context. To hold otherwise would be to convert a policy for insurance into a performance bond. Id. at 899. Moore was only a duty to defend case and, theoretically, only discussed coverage in dicta. Thus, in the context of an actual coverage case, the Tennessee Supreme Court and other jurisdictions need to address the fortuity problem and precisely address the criticisms of the minority rule embodied by cases such as Moore. The split of authority will continue until the courts squarely confront whether an accident must be fortuitous to result in coverage. 48 n For The Defense n June 2010