CGL Policy Coverage Definitions and Exclusions Applicable to Construction Defect Claims
The typical CGL policy coverage language obligates the insurer to “pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily  injury’ or ‘property damage’ to which [the] insurance applies.” The policy will typically go on to state that it applies only if the bodily injury or property damage is caused by an “occurrence.” Further, an “occurrence” is typically defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The term “accident” is often undefined, and thus is afforded its ordinary meaning by courts when applied to the policy. See e.g., Westfield Ins. Co. v. Custom Agri Sys., 2012-Ohio-4712, 133 Ohio St. 3d 476, 979 N.E.2d.
Therefore, courts evaluating whether construction defects constitute an occurrence covered by CGL policies often focus on whether such defects could reasonably be considered an accident, or whether they were ordinary business risks outside the scope of the unintended or unusual risks CGL are meant to insure against. As one would expect, courts across the country have reached differing conclusions, some of which are discussed below.
Even in states where courts hold that construction defects are a covered occurrence, however, courts still must grapple with the application of several policy exclusions insurers claim foreclose coverage for construction defect claims. Thus, even if there is a grant of coverage by the policy’s insuring language, the policy’s exclusions may remove that coverage. Some of the most common exclusions relied upon by insurers when arguing against coverage for construction defect claims are:
· Exclusion j. Damage to Property.
(5) That particular part of real property on which you or any contractors of subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations; or
(6) That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.
* * *
Paragraph (6) of this exclusion does not apply to “property damage” included in the “products-completed operations hazard.”
· Exclusion k. Damage to Your Product. “Property damage” to “your product” arising out of it or any part of it.”
· 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.
As discussed below, in many states, application of these exclusions will frequently turn on a similar analysis as to whether there is a covered occurrence. Further, a clearly-defined scope of work for each component part of the project may preserve coverage even in light of these exclusions.
State Courts Are Divided on Coverage
State courts differ on what types of construction defect claims are covered from state to state, and sometimes even within those states. While the policy language that is being interpreted in these cases is generally uniform, the paths taken to finding (or not finding) coverage are varied and often factually dependent. Cases determining whether defective construction constitutes an occurrence generally result in one of three outcomes:
1. Construction defects are covered occurrences. Some courts hold that both the defective work itself, and resulting property damage stemming from the defective work, can be a covered occurrence. For example, in Cherrington v. Erie Ins. Prop. & Cas. Co., 231 W.Va. 470, 483, 745 S.E.2d 508 (2013) the West Virginia Supreme Court reversed prior precedent by holding that defective workmanship “causing bodily injury or property damage is an ‘occurrence’ under a policy of commercial general liability coverage.” Similarly, in K & L Homes, Inc. v. American Family Mut. Ins. Co., 829 N.W.2d 724, 736 (N.D. 2013), the North Dakota Supreme Court held that faulty workmanship may constitute an occurrence “if the faulty work was ‘unexpected’ and not intended by the insured, and the property damage was not anticipated or intentional, so that neither the cause nor the harm was anticipated, intended, or expected.” See also Sheehan Constr. Co. v. Cont'l Cas. Co., 935 N.E.2d 160, 171 (Ind.2010). (Finding that where the defective work is done “without intention or design” it may constitute an occurrence in and of itself).
While these courts have construed the standard CGL policy language to provide a broad grant of coverage for construction defect claims, they still apply the exclusionary language discussed above to the particular facts of each case. Therefore, even in these states, coverage may be restricted by application of these exclusions.
2. Construction defects are occurrences only when the defect causes damage to property other than to the defective work itself. Most courts find that an occurrence exists only where some property other than the defective work itself has been damaged. Those courts are often split on whether non-defective work of the insured contractor is covered, with some courts finding damage to non-defective work of the insured to be an “occurrence” and others requiring third-party property damage (i.e., a defective roof causing damage to personal property within a dwelling).
For example, in Taylor Morrison Servs. v. HDI-Gerling Am. Ins. Co., 293 Ga. 456, 460, 746 S.E.2d 587 (2013), the court held that the definition of occurrence did not require reference to the “identity of the person whose property or work is damaged thereby,” finding that damage to non-defective work of the insured was sufficient to meet the definition. Similarly, in U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d 871, 890 (Fla.2007, the court found coverage where a subcontractor’s foundation work on a home damaged the insured contractor’s completed, and otherwise non-defective, work on the home. See also, Capstone Building Corp. v. Am. Motorists Ins. Co., 308 Conn. 760, 787 (2013) (holding that the CGL policy “covers claims for property damage caused by defective work, but not claims for repair of the defective work itself.”).
Other courts differentiate between damage to the work of an insured and damage to third-party property, finding that only the third-party damage constitutes an unexpected or unforeseen liability. The Supreme Court of Pennsylvania’s decision in Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 589 Pa. 317, 334, 908 A.2d 888 (2006) illustrates this line of reasoning. The Kvaerner court found that claims for damage to the insured’s own work do not “present the degree of fortuity contemplated by the ordinary definition of ‘accident’,” and stated that to hold otherwise would be to convert the insurance policy into a performance bond. Similarly, the Northern District of New York has found that damage to any work of the insured, even non-defective work, is an expected consequence of faulty workmanship and therefore not an “accident” or “occurrence.” Rosewood Home Builders, LLC v. Nat'l Fire & Marine Ins. Co., N.D.N.Y. No. 1:11-CV-1421 (LEK/RFT), 2013 U.S. Dist. LEXIS 45374, at *12 (Mar. 29, 2013) (analyzing New York law).
Again, even though these cases may construe the CGL policies as containing a grant of coverage for certain construction defect claims, the court still must work through application of the policy’s exclusions to the facts before it.
3. Neither the construction defect nor the reasonably foreseeable property damage flowing from the defect constitute an occurrence. A few courts have found that no occurrence exists even where there has been resulting third-party property damage. Generally, these courts rely on the rationale that where the insured provides faulty workmanship, it is foreseeable that the faulty work could cause additional property damage. See H.E. Davis & Sons, Inc. v. N. Pac. Ins. Co., 248 F.Supp.2d 1079, 1084 (D. Utah 2002); but see Great Am. Ins. Co. v. Woodside Homes Corp., 448 F.Supp.2d 1275, 1281 (D.Utah 2006)( (finding coverage where a subcontractor’s work causes the damage).
In response to decisions limiting coverage for construction defect claims, some states have enacted statutes that require policy definitions to include “faulty workmanship” within the definition of “occurrence,” or require policy language to be interpreted as including certain construction defects within the definition of occurrence. See, e.g. Ark. Code Ann. § 23-79-155(a)(2) (2011) (“A commercial general liability insurance policy offered for sale in this state shall contain a definition of 'occurrence' that includes: . . . Property damage or bodily injury resulting from faulty workmanship.”); Colo. Rev. Stat. § 13-20-808(3) (2010) ("In interpreting a liability insurance policy issued to a construction professional, a court shall presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident unless the property damage is intended and expected by the insured."). Importantly, however, these statutes may not be retroactive to the issuance of the policy. See Greystone Constr. v. Nat'l Fire & Marine Ins. Co., 661 F.3d 1272, 1280 (10th Cir.2011)() (finding the statute did not apply retroactively to change the definition for policies entered into before its enactment).
Parties Continue to Test The Contours of these Decisions, Even in Jurisdictions Where the Law Appears to be Settled
Even where the law has seemingly been clarified by state court decisions, policyholders and insurers continue to battle over the application of these decisions to the particular facts of their case. This has led to inconsistent results in some jurisdictions. For example, two courts within the Northern District of Illinois recently issued decisions within months of each other reaching opposite conclusions on extremely similar facts. In Westfield Ins. Co. v. Nat'l Decorating Serv., Inc., 147 F. Supp. 3d 708, 717 (N.D. Ill.2015) the court held that property damage arose from an occurrence where the named insured, a subcontractor, supplied defective painting work that damaged other parts of the building project performed by the general contractor and others. However in Allied Prop. & Cas. Ins. Co. v. Metro N. Condo. Ass'n, No. 15 C 3925, 2016 U.S. Dist. LEXIS 43952, at *20 (N.D. Ill. Mar. 31, 2016), decided only four months later, the Northern District found no occurrence existed where subcontractors performed defective window and glazing work, which in turn led to property damage on other areas of the project. It is difficult to reconcile the holdings of these cases, which were both decided under Illinois law and presented similar policy language and facts to the court. (Both Westfield Ins. Co. v. Nat'l Decorating Serv., Inc. and Allied Prop. & Cas. Ins. Co. v. Metro N. Condo. Ass'n are currently pending on appeal to the U.S. Court of Appeals for the Seventh Circuit. Their eventual resolution may provide policyholders with some clarity.)
In addition to the West Virginia Supreme Court’s change of course in Cherrington, several decisions in the recent months demonstrate a growing trend towards finding at least some coverage for contractors. In National Surety Corp. v. Westlake Investments, LLC, 880 N.W.2d 724 (Iowa 2016), the Iowa Supreme Court held that defective workmanship of the insured’s subcontractor was covered by a CGL policy, citing a litany of recent cases in support of its holding. In ruling, the Court focused on the language of the “your work” exclusion in the policy, which excepted out work performed by a subcontractor, finding that the language would be superfluous if the policy was not otherwise applicable to defective subcontractor work. Id. at 740-41. Similarly, in Cypress Point Condo. Assn., Inc. v. Adria Towers, L.L.C., 226 N.J. 403, 143 A.3d 273 (2016), the New Jersey Supreme Court held that defective work of a subcontractor that caused water intrusion was a covered “occurrence” under a CGL policy.
Another example of a jurisdiction where the law may require further clarification is Ohio. While the Ohio Supreme Court recently weighed in on coverage for construction defect claims in Westfield Ins. Co. v. Custom Agri Systems, the Court’s decision left lower courts to decide how to apply the decision to the innumerable fact patterns that arise in construction defect cases. Specifically, the Ohio Supreme Court held that the standard CGL policy language did not provide coverage for repair costs associated with damage to the insured’s own defective work. However, the court cited with approval a prior lower court decision which held that “[i]f the damages are consequential and derive from the work the insured performed, coverage generally will lie.” Custom Agri, supra at ¶13 (citing JTO, Inc. v. State Auto Mut. Ins. Co., 194 Ohio App.3d 319, 2011-Ohio-1452, 956 N.E.2d 328, ¶ 32-33 (11th Dist.). The court did not go on to state how this language may apply to the typical construction defect claim which results in damage to the insured’s non-defective work, or to work outside the insured’s own scope of work.
Thus, while case law has become more developed over the course of the last twenty years, there still remain questions as to the specific contours of each state’s body of case law.
Contractors Should Clearly Define the Scope of Work in Their Projects
With the state of the law still open to interpretation in many jurisdictions, a few decisions over the past several years underscore the importance of having a clearly defined “scope of work” that can be presented to the court in an effort to obtain coverage for construction defect claims. In Mid-Continent Cas. Co. v. JHP Dev., Inc., 557 F.3d 207 (5th Cir. 2009), the Fifth Circuit Court of Appeals, applying Texas law, held that two of the exclusions referenced above did not apply to the damages sought by plaintiff in the underlying construction defect litigation. Id. at 218. In that case, a contractor entered into an agreement with a developer for the construction of a condominium project. Id. at 210. The underlying suit alleged that the contractor failed to properly water seal certain portions of the building’s exterior, causing water intrusion that damaged the building’s interior walls, wiring, and flooring.
The contractor sought coverage under its CGL policy, which was denied by the insurer. The insurer then filed a separate declaratory judgement action in federal court. Id. at 211. Upon review, the Fifth Circuit noted that the insurer had abandoned its argument that there was no “occurrence” or “property damage” in light of Texas case law. Id. However, the insurer argued that exclusions j(5) and j(6) removed the claims from coverage. Id. The Fifth Circuit summarily dismissed the insurer’s argument in reliance upon exclusion j(5), holding that the exclusion only applied to property damage occurring while the contractor was actively working on the project, and not where there was “a total cessation of active construction work for the foreseeable future.” Id. at 213.
The court then examined exclusion j(6), excluding 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.” Id. at 214. The court, giving this exclusion its plain meaning, held that it applied only to those specific portions of the project where the defective work was performed by the insured, and not to “other damaged property that was either the subject of nondefective work by the insured or that was not worked on by the insured at all.” Id. at 215. (Emphasis added). The issue of whether and what portions of a contractor’s work were defective may be contested in any given case. However, through a clearly written scope of work, it should be easier for a contractor to prove which parts of the project were “not worked on by the insured at all,” thus maintaining coverage for damage caused to portions of the project outside the contractor’s scope of work. See also Acuity v. Soc'y Ins., 339 Wis.2d 217, 2012 WI App 13, 810 N.W.2d 812, ¶39 (finding scope of work to be a determining factor in deciding whether the “your work” exclusion applies to bar coverage).
Similarly, in National Decorating Serv., discussed above, the underlying construction dispute arose from construction of a condominium high-rise in Chicago. Id. at 711. The condominium association sued the project’s general contractor and its painting subcontractor for faulty workmanship on the project. The general contractor then asserted claims against the painting contractor, alleging that its faulty workmanship damaged the work of other contractors on the project, resulting in the peeling and cracking of drywall. The general contractor sought damages both for repairing the painting contractor’s work, and for repairing other portions of the project affected by this work. Both the general contractor and the painting contractor sought coverage under the painting contractor’s CGL policy – the painting contractor as the “named insured,” and the general contractor as an “additional insured.” Id. at 711-712.
In determining whether the insurer was obligated to provide a defense, the court noted that it “must examine the scope of the [painting contractor’s] work, as the Named Insured, when determining if there is “property damage” resulting from an occurrence.” Id. at 714. This analysis compelled a conclusion that “damage beyond the scope of the name insured’s work on the project at issue is ‘property damage’ resulting from an ‘occurrence.’” The court then held that damages to the building’s ceilings, drywall, and floors were beyond the painting contractor’s scope of work, and were covered damages based upon the court’s interpretation of “occurrence” in the policy. Id. at 717.
As these cases make clear, whether or not a contractor has coverage under a CGL policy may frequently turn on whether the contractor can clearly define the limits of its scope of work on the project. The more clearly defined, the more readily a court can review the damages being claimed in the underlying case to determine whether the damages are to the contractor’s own work, or to work for which the contractor was not responsible.
This evidentiary proof is equally valuable when confronting the exclusions frequently cited in these cases. For example, the exception to exclusion j(6), reinstating coverage for work performed by subcontractors, means that higher-tier contractors must clearly define what work they delegate to lower-tier subcontractors versus what work they are retaining for themselves. Policyholders that can present a court with a clearly defined scope of work have a higher likelihood of convincing a court that at least a portion of the damages sought against them in a construction defect case should be covered by their CGL policy.
P. Wesley Lambert, a partner, and JoZeff W. Geboyls, an associate, are with the Akron, Ohio, office of Brouse McDowell.