Imagine a situation in which a commercial tenant keeps valuable inventory in a rented space, but because the property owner did not properly maintain the roof of the building, unforeseen water intrusion destroys the tenant’s inventory. Is the landlord covered under his standard form commercial general liability (CGL) policy if that tenant sues for damages?
This issue—whether property damage caused by defective construction work constitutes an accidental “occurrence” under the insurance policy—has been frequently litigated in recent years. The outcome of that coverage issue is largely dependent on which state’s substantive law applies.
This is because a majority of jurisdictions have found that defective or faulty workmanship can constitute an “occurrence” under standard form CGL insurance policies. A minority of jurisdictions, on the other hand, have found that construction defect claims do not, and cannot, give rise to an accidental “occurrence” within the meaning of the CGL insurance policy, and these jurisdictions therefore bar coverage for such construction defect claims.
This article explores this interplay by first contrasting the rationales of both the majority and minority views. It then discusses a recent decision from the Pennsylvania Superior Court, Pennsylvania Manufacturers Indemnity Co. v. Pottstown Industrial Complex LP,[] which clarified and expanded Pennsylvania law to permit certain types of claims related to defective or faulty workmanship under Pennsylvania law.
At least 30 states have determined that construction defects, in one form or another, can constitute “occurrences” under a standard CGL policy.[] Some states have done this through legislative acts. In Arkansas, for example, the legislature passed a statute[] to supersede an Arkansas Supreme Court decision[] that concluded damages due to faulty workmanship are “foreseeable” and, therefore, not covered. The Colorado legislature likewise amended its statute to provide that when “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.”[]
Other states have expanded coverage through case law. The New Jersey Supreme Court, for example, held in Cypress Point Condo Ass’n v. Adria Towers, LLC, that consequential damages caused by a subcontractor’s defective workmanship are “property damage” caused by an “occurrence” under a standard form CGL policy.[] In that case, the plaintiff (a condominium association) brought an action against the developers and various subcontractors for “roof leaks and water infiltration” that allegedly caused, “among other things, damage to steel supports, exterior and interior sheathing and sheetrock, and insulation, to [the plaintiff’s] common areas, interior structures, and residential units (‘the consequential damages’).”[] The plaintiff also sued the developers’ insurers seeking a declaration that their CGL policies covered the plaintiff’s losses resulting from the developers’ construction. The trial court granted summary judgment in favor of the developers’ insurers, concluding that faulty workmanship did “not constitute an ‘occurrence’ and that the consequential damages caused therefrom were not ‘property damage’ under the terms of the policies because the damage arose entirely from faulty work performed by or on behalf of the developer.”[]
On appeal, the Appellate Division of the Superior Court of New Jersey reversed. In doing so, the appellate court distinguished two prior New Jersey cases,[] relied on by the trial court in finding for the insurers, and found that the “unintended and unexpected consequential damages [to the common areas and residential units] caused by the subcontractors’ defective work constitute ‘property damage’ and an ‘occurrence’ under the [CGL] polic[ies].”[] The New Jersey Supreme Court then affirmed the Appellate Division’s ruling based on the same reasoning.[]
This line of reasoning—that construction defects are “occurrences” so long as the property damage was not expected or intended by the policyholder—is seen throughout the case law in states that have permitted policyholders to bring claims for construction defects.[] The states that have declined coverage, on the other hand, have generally determined that construction defects cannot constitute an “occurrence” under a standard form CGL policy because construction defects are not “accidents” and thus not “occurrences.”[]
But even among those states that find coverage exists, the scope of that coverage varies considerably. Some states have determined that both the defective workmanship itself and the damage caused by it can constitute a covered occurrence.[] In Mutual Insurance Co. v. American Girl, Inc.,[] for instance, the Wisconsin Supreme Court rejected the insurer’s position against coverage, finding that damage to a warehouse caused by faulty site-preparation advice of the soil-engineering subcontractor was “property damage” caused by an “occurrence” under the CGL policy.[]
Several states have taken a more restrictive approach, holding that construction defects can be occurrences but only to the extent that property other than the defective work itself was damaged. In Capstone Building Corp. v. American Motorists Insurance Co., for example, the Connecticut Supreme Court found that coverage extended only to damage caused to other portions of the property, not to the faulty workmanship itself.[]
Practitioners therefore must be mindful that considerable variation exists on this coverage issue, even within a particular state’s jurisprudence. In that regard, one must be closely attuned to what state’s law applies, as that determination may be dispositive. In addition, practitioners must also be aware of any additional policy exclusions because, even if a state has determined that damage arising from a construction defect can constitute an “occurrence,” other policy exclusions may still eliminate coverage. Indeed, as the Appellate Division of the New Jersey Superior Court reasoned in Cypress Point Condominium Ass’n, Inc. v. Adria Towers, L.L.C., merely “concluding that plaintiff met the definitions of ‘property damage’ and ‘occurrence’ under the policy does not automatically mean that insurance coverage exists.”[] Rather, the court must still examine whether other “business risk” exclusions (e.g., the “Your Work” exclusion) would otherwise exclude coverage.[]
In 2019, the Superior Court of Pennsylvania[] issued its opinion in Pennsylvania Manufacturers Indemnity Co. v. Pottstown Industrial Complex LP, which clarified and expanded on its earlier decisions and found that construction defects can be “occurrences” but only to the extent that property other than the defective work itself was damaged.[]
Prior to Pennsylvania Manufacturers Indemnity, the two leading Pennsylvania state court decisions insurers have relied on to deny coverage for faulty workmanship were Kvaerner Metals Division of Kvaerner U.S., Inc. v. Commercial Union Insurance Co.,[] and Millers Capital Insurance Co. v. Gambone Brothers Development Co.[]
Kvaerner involved alleged damage to a coke oven battery after one of its subcontractors had allowed the roof of the battery to be grouted too early, resulting in its inability to withstand unexpected “monsoon rains.”[] The plaintiff thus sought “either the amount that it will cost to replace the Coke Oven Battery, or the difference in value between the defective Coke Oven Battery that it received and the Coke Oven Battery that [Kvaerner] warranted that it would deliver.”[] Based on those facts, the Pennsylvania Supreme Court held that there was no allegation of an “occurrence” that could trigger CGL insurance coverage because the CGL policy defined “occurrence” as “an accident” and, further, faulty workmanship that damaged only the work product that the defendant supplied does not constitute an accident.[] To rule otherwise, the court reasoned, would convert a CGL policy into a performance bond guaranteeing the insured’s work.[]
The second seminal case, Gambone Brothers, involved claims that the insured’s faulty workmanship damaged the project on which the insured worked, not claims for damages to other property completely distinct from and unconnected to the insured’s contract.[] There, the plaintiff sought damages for “defective stucco exteriors, windows, and other artificial seals” that later “manifested themselves” as water damage “to the interior of the larger product—in this case, the home interiors.”[] Despite these differences in property damages, the trial court granted the insurer’s motion for summary judgment and the Pennsylvania Superior Court affirmed. In doing so, the Superior Court reaffirmed Kvaerner, explaining “the terms ‘occurrence’ and ‘accident’ in the CGL policy at issue contemplated a degree of fortuity that does not accompany faulty workmanship.”[] The appeals court also reasoned that “natural and foreseeable acts, such as rainfall, which tend to exacerbate the damage, effect, or consequences caused ab initio by faulty workmanship also cannot be considered sufficiently fortuitous to constitute an ‘occurrence’ or ‘accident’ for the purposes of an occurrence based CGL policy.”[]
The Superior Court clarified and expanded on Kvaerner and Gambone Brothers in its most recent decision, Pennsylvania Manufacturers Indemnity Co.[] In contrast to Kvaerner and Gambone Brothers, Pennsylvania Manufacturers Indemnity Co., involved a commercial landlord-tenant dispute. In the underlying action, the tenant alleged that, on at least four occasions between July 2013 and June 2016, the leased premises flooded during rainstorms, destroying inventory worth over $700,000.[] The tenant further alleged “that the water entered the premises due to roof leaks, that [the landlord] was responsible under the lease for keeping the roof ‘in serviceable condition and repair,’ and that the floods were caused by [the landlord’s] failure to properly maintain and repair the roof.”[]
After receiving notice of the tenant’s suit, the landlord’s insurer filed a declaratory judgment action, seeking a determination that there was no coverage under its CGL policy issued to the landlord. Thereafter, the trial court granted the insurer’s motion for judgment on the pleadings, concluding that allegations of inadequate roof repairs were claims for faulty workmanship and thus were not covered under the holdings in Kvaerner and Gambone Brothers.
On appeal, the Superior Court reversed, holding that the tenant had alleged a covered “occurrence” under the landlord’s CGL policy. The Superior Court distinguished Kvaerner and Gambone Brothers, pointing out that those cases precluded the finding of an “occurrence” only where the “insured’s faulty workmanship damaged the insured’s product or the project on which the insured worked, not claims for damages to other property completely distinct from and unconnected to the insured’s contract.”[]
The court found support for its decision in the reasoning in Indalex Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania.[] There, the court concluded that “personal injury or an event that damaged other property” (e.g., property unconnected to the insured’s contract), caused by faulty work could constitute an “occurrence” for purposes of coverage under a CGL policy.[] More specifically, the court reasoned that because “the Underlying Action alleges damage to other property, [the tenant’s] inventory stored on the premises, caused by a distinct event, flooding, and seeks damages for the destruction of that other property, not for the cost of repairing or replacing the defective item that [the landlord] supplied, the inadequate roof,” the flooding could constitute an “occurrence” for purposes of providing coverage.[]
As noted at the outset, whether policyholders will be able to assert claims for construction defects will largely depend on which state’s law governs and the specific facts of any given dispute. Insurers and insureds are thus well advised to carefully examine their respective state’s laws and conduct an analysis of their specific needs and the risks to which they may be exposed.
