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Faulty Construction Coverage Disputes (Part 1 of 2)
To aid insurers and their coverage counsel in navigating the shifting terrain of faulty workmanship coverage disputes, this two-part article examines the following topics:
- The crucial interplay between the threshold insuring agreement requirements and the insurance policy’s potentially applicable exclusions;
- The analytical framework applied in significant recent court decisions addressing faulty workmanship coverage disputes;
- Differing judicial approaches to coverage disputes concerning “rip and tear” or “get to” damages sustained when repair measures necessitate the destruction, removal, and/or replacement of other nondefective property; and
- Practical challenges that arise when the insured endeavors to remedy faulty workmanship disputes without the need for litigation.
This article appeared in DRI: For the Defense Magazine, December 2021
Understanding the Crucial Interplay Between the Threshold Insuring Agreement Requirements and Potentially Applicable Policy Exclusions in Faulty Workmanship Coverage Disputes
In a significant number of faulty workmanship coverage disputes, the eventual outcome turns on whether the indemnity coverage determination is governed by the occurrence and property damage requirements in the policy’s threshold insuring agreement or by the applicability of one or more specific policy exclusions. If the insured can satisfy the policy’s threshold insuring agreement requirements, it is often difficult for the insurer to establish that one or more specific policy exclusions eliminates or restricts the availability of indemnity coverage for the faulty workmanship. Consequently, given the “tug of war” between the insurer and the insured’s efforts to carry their respective burdens of proof regarding the insuring agreement requirements and potentially applicable exclusions, counsel need a firm handle on the approach courts take in the governing jurisdiction to the interplay between the insuring agreement and exclusionary provisions to provide their client with informed advice regarding the availability of indemnity coverage for the matter at hand.
Battles over the interplay between these provisions loom particularly large in situations involving subcontracted work because of the difficulties courts encounter in attempting to reconcile the subcontractor exception in the “Damage to Your Work” exclusion with the “traditional view” that faulty workmanship does not constitute an “occurrence.” The standard form “Damage to Your Work” Exclusion states in relevant part that coverage is not afforded for “‘Property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard’” with the caveat that “[t]his 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 always, the applicable policy language must be closely reviewed because some insurers offer policies that provide some coverage for property damage caused by the named insured’s own work while others delete the subcontractor exception to strengthen the “your work” exclusion.
When afforded an opportunity to evaluate the availability of coverage for faulty workmanship claims under “modern” policy forms with the subcontractor exception, a significant number of courts have endorsed a pro-coverage approach that deems the threshold occurrence requirement satisfied. Over the past few years, several courts have re-examined the interplay between the threshold insuring agreement requirements and the applicable policy exclusions and have concluded that prior precedent involving pre-1986 versions of the standard ISO CGL policy that omitted the subcontractor exception to the “your work” exclusion should not govern the outcome of the dispute before them. When afforded an opportunity to evaluate the availability of coverage for faulty workmanship claims under “modern” policy forms with the subcontractor exception, a significant number of courts have endorsed a pro-coverage approach that deems the threshold occurrence requirement satisfied.
The Michigan Supreme Court’s Skanska Decision
In a closely watched dispute, the Michigan Supreme Court endorsed the position taken by an increasing number of courts around the country that deems the “occurrence” requirement satisfied when a subcontractor’s unintentionally faulty work damages the named insured’s work product (or other third-party property) in Skanska USA Building Inc. v. M.A.P. Mech. Contrs, Inc., 505 Mich. 369 (2020). Skanska concerned a dispute over a construction manager’s entitlement to coverage for approximately $1.5 million in repair costs incurred to remedy subcontractor’s faulty workmanship on a medical center renovation project. Relying on prior precedent, the trial court upheld the insurer’s denial on the grounds that the absence of damage to anything beyond the insured’s own work prevented it from satisfying the occurrence requirement. After noting that prior precedent, including Hawkeye-Security Ins. v. Vector Construction Co., 185 Mich. App. 369 (1990), concerned prior policy forms, the Michigan Supreme Court concluded that the continued adherence to the position that faulty workmanship, standing alone, does not qualify as an “occurrence” would render superfluous the subcontractor exception to the “your work” exclusion in the 1986 CGL form.
As grounds for rejecting Amerisure’s contention that “mere unanticipated damage” does not involve the degree of “fortuity” required to satisfy the occurrence requirement because it does not involve an “accident” “over which the insured has no control,” the Michigan Supreme Court characterized this position as “an overly stingy reading of the word “accident.” Id. at 381–82.
In rejecting Amerisure’s argument that an “occurrence” requires evidence of damage to something other than the insured’s own work, the court stated that “the policy does not limit the definition of ‘occurrence’ by reference to the owner of the damaged property.” Id. at 382. As the court explained, an insured’s ability to satisfy the “occurrence” requirement by pointing to subcontractor’s faulty workmanship does not prevent the insurer from invoking potentially applicable exclusions to contest the availability of coverage. Id. at 384.
In response to the argument that “interpreting the policy to cover faulty subcontractor work essentially converts the policy into a performance bond,” the court explained that the determination that CGL “coverage may overlap with a performance bond is not a reason to deviate from the most reasonable reading of the policy language.” Id. at 385.
Given the foregoing, the Michigan Supreme Court declared that Hawkeye will be “cabined” to only apply to pre-1986 CGL policies.
The New Jersey Supreme Court’s 2016 Cypress Point Decision
In 2016, the New Jersey Supreme Court handed policyholders a big win with its departure from the seminal Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979), decision that courts and insurers routinely invoke in support of the contention that faulty workmanship does not qualify as an occurrence. Specifically, in Cypress Point Condominium Association, Inc. v. Adria Towers, L.L.C., et al., 226 N.J. 403 (2016), the New Jersey Supreme Court held that rainwater penetration into a condominium complex due to a subcontractor’s faulty workmanship qualified as the “occurrence” requirement in the general contractor’s CGL policy. The court also held that coverage that would otherwise have been precluded by the “your work” exclusion was restored by the subcontractor exception. To support its seismic departure from Weedo and its progeny, the Cypress Point emphasized the importance of two revisions to the 1986 ISO form; namely (a) the expanded “occurrence” definition that includes the “continuous or repeated exposure to substantially the same general harmful conditions” language; and (b) the addition of the subcontractor exception to the “your work” exclusion. The court also emphasized that its prior decisions did not directly address the interplay between the occurrence requirement and the subcontractor’s exception to “your work” exclusion.
The New Jersey Supreme Court also distinguished Weedo by noting that it did not address the property damage requirement in the insuring agreement because the insurer relied on the business risk exclusions for its position. Additionally, Weedo addressed the availability of coverage for repair costs, rather than consequential damages from subcontractor faulty workmanship.
After distinguishing Weedo, the Cypress Point court pointed to a “strong recent trend” in decisions elsewhere, which afforded coverage for unexpected consequential damages caused by faulty workmanship under policies with the 1986 ISO language.
Against this backdrop, the court applied a three-step analysis to the general contractor’s request for coverage for consequential water damage attributed to subcontractors’ faulty workmanship. As the first step, the court concluded that the insuring agreement’s threshold “property damage” requirement was readily satisfied by the association’s allegations of mold growth and common area damages.
Treating the “occurrence” requirement as the second step of its analysis, the court defined the term “accident” in the 1986 ISO “occurrence” definition as “encompass[ing] unintended and unexpected harm caused by negligent conduct.” A more complicated issue was whether faulty work by a subcontractor—as opposed to a general contractor—could constitute an “occurrence.” Addressing this issue, the court rejected the insurers’ argument that consequential property damage from subcontractor’s faulty workmanship is a foreseeable business risk. Rejecting the premise that a breach of contract can never establish an “occurrence,” the New Jersey Supreme Court held that unexpected consequential damage from subcontractor faulty workmanship, including damage to otherwise nondefective property, qualifies as an “accident” and thus an “occurrence.”
As the final aspect of its three-step inquiry, the court examined the applicable policy exclusions. Acknowledging that the pre-1986 version of the “your work” exclusion would have eliminated coverage, the court held that coverage was restored by the subcontractor’s exception in the ISO 1986 CGL form. Citing to decisions elsewhere, the court noted that insurers can amend their policies to eliminate coverage for consequential damages from subcontractor faulty workmanship if they do not want to cover that risk.
The Tenth Circuit’s Black & Veatch Corp. v. Aspen Insurance (UK) Ltd. 2018 Decision (Predicting New York Law)
In a dispute that led to an unsuccessful petition for certiorari review by the United States Supreme Court, the Tenth Circuit Court of Appeals relied on many of the same considerations cited in Cypress Point when it reversed summary judgment for two excess insurers in Black & Veatch Corp. v. Aspen Insurance (UK) Ltd., 882 F. 3d 952 (10th Cir. 2018), cert. denied, Aspen Ins. (UK) Ltd. v. Black & Veatch Corp., 139 S. Ct. 151, 2018 U.S. LEXIS 4415 (U.S. Oct. 1, 2018).
To predict the correct outcome of the dispute under New York law, the Tenth Circuit reviewed decisions that examined pre-1986 ISO forms, the history of revisions to the standard ISO forms, including the addition of the subcontractor exception in the 1986 form, and recent decisions by state supreme courts around the country. In concluding that the policy’s threshold “occurrence” requirement was satisfied by Black & Veatch’s payment of more than $225 million to repair and replace faulty components installed by subcontractors in power plant reactors, the Tenth Circuit emphasized that a contrary conclusion would render the subcontractor exception in the “your work” exclusion and the policy’s j(5) and (6) exclusions for damage to “that particular part” of project on which the insured’s operations are being performed as mere surplusage.
After reviewing the changes to the ISO forms between 1973 and 1986, the Tenth Circuit concluded that the post-1986 version “has covered the cost of property damage to (1) completed projects, when the damage is due to subcontractor’s faulty work, and (2) ongoing work, when faulty workmanship damages property other than ‘that particular part’ on which the contractor or subcontractor was working at the time the damage occurred.”
The Tenth Circuit noted that its “occurrence” determination was consistent with the strong trend among state supreme court decisions around the country, pointing to “near unanimity” in post 2012 decisions that “construction defects can constitute occurrences and that contractors have coverage under CGL policies at least for the unexpected damage caused by defective workmanship done by subcontractors.” Id. at 996.
The Iowa Supreme Court’s National Surety Corp. v. Westlake Investments LLC Decision
A few months before the New Jersey Supreme Court’s departure from its seminal Weedo decision in Cypress Point, the Iowa Supreme Court also veered away from prior precedent in National Surety Corp. v. Westlake Investments, LLC., 880 N.W.2d 724 (Iowa. 2016). Affirming a $12.5 million jury verdict for the insured property owner’s assignee, the court held that “defective workmanship by an insured’s subcontractor may constitute an occurrence under the ‘modern’ version of the standard-form CGL policy which includes the subcontractor exception to the ‘your work’ exclusion.” Id. at 744.
Emphasizing the need to examine the policy as a whole, the court stated that the occurrence determination could not be made in a vacuum without evaluating the subcontractor exception in the “your work” exclusion and other limiting language added to other exclusions in the 1986 ISO CGL policy form. As the court explained, “although exceptions and exclusions cannot ‘create coverage that otherwise is lacking’ under an insuring agreement, they offer insight into whether coverage exists under an insuring agreement by shedding light on what the terms it contains mean.” Id. at 738.
Through this analytical approach to the interplay between the insuring agreement requirements and the policy exclusions, the court concluded that:
A reasonable ordinary person who read the modern standard-form CGL policy containing the subcontractor exception to the “your work” exclusion in its entirety would believe it covered defective work performed by the insured’s subcontractor unless the resulting property damage was specifically precluded from coverage by an exclusion or endorsement. [citations omitted.] Accordingly, we interpret the insuring agreement in the modern standard-form CGL policy as providing coverage for property damage arising out of defective work performed by an insured’s subcontractor unless the resulting property damage is specifically precluded from coverage by an exclusion or endorsement. In addition, we conclude the defective work performed by the insureds’ subcontractors falls within the definition of “occurrence” in the insuring agreement appearing in the [primary] policy. Id. at 740.
Consistent with the recent trend, the court examined the drafting history of the 1986 revisions to the ISO CGL form, insurance industry efforts undertaken to alleviate general contractor concerns regarding their need for coverage for claims concerning subcontractor faulty workmanship, and recent pro-coverage decisions issued by other state supreme courts.
Based on these considerations, and its determination that none of its prior decisions squarely addressed the question of whether “defective work negligently performed by an insured’s subcontractor may constitute an occurrence covered by a modern standard-form CGL policy,” the Iowa Supreme Court concluded that the trial court correctly instructed the jury that “[d]efective construction work performed by the insured is not covered by the policy; however, defective construction work performed by subcontractors may be an ‘occurrence’ under the policy” when the insured does not expect the faulty work and resulting harms. Id. at 729.
Notably, three justices dissented based on their view that faulty workmanship should not be treated as an occurrence in the absence of evidence of a “sudden and unexpected event resulting in damage to a third party” irrespective of whether the work is performed by the insured or by a subcontractor. Id. at 746. The dissent also took issue with the majority’s reliance on language in the exclusions to “change the scope of coverage under the occurrence definition.” Id.
Other Recent Decisions That Afford Coverage for Faulty Workmanship Claims
Recent Florida and Colorado decisions underscore the difficulty insurers face when their coverage defenses turn on the applicability of one or more potentially applicable policy exclusions, rather than the threshold insuring agreement requirements.
In Owners Ins. Co. v. Bobby T., Inc., 2018 U.S. Dist. LEXIS 51901, No. 8:16-CV-3428-T27AAS (M.D. Fl., Mar. 28, 2018), the court granted a contractor defense coverage for claims for water penetration damages sustained after it carried out work to remedy moisture intrusion problems in the exterior stairs and breezeways of a condominium resort in Florida.
Faced with prior Florida precedent that deems the occurrence requirement satisfied by faulty workmanship claims, Owners Insurance based its denial on the Policy’s “your work” exclusion. Rejecting this argument, the court held that the insurer did not meet its burden of demonstrating that the entirety of the complaint allegations fell “solely and entirely within the exclusion” because it was “not clear that no other property was damaged” by the contractor’s allegedly faulty repairs. Similarly, in Auto-Owners Ins. Co. v. High Country Coatings, Inc., 261 F. Supp. 3d 1129 (D. Colo. 2017), the trial court granted an insured summary judgment regarding its entitlement to defense coverage for claims concerning repair costs incurred to correct the faulty installation of a floor coating system that failed on two occasions. The defense coverage determination turned on the insurer’s inability to establish that coverage was precluded by policy exclusions and/or the insured’s alleged prior knowledge of the likelihood of the floor failure because Colorado enacted a statute in May 2010 that presumes that “the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident [and therefore an occurrence] unless the property damage is intended and expected by the insured.” See, C.R.S §13-20-808.
With the occurrence requirement satisfied by this statutory presumption, the Colorado District Court rejected the insurer’s reliance on the policy’s “your work” and “your product” exclusions because the complaint alleged damage to the concrete slab. The court concluded that the impaired property exclusion did not defeat coverage because it can reasonably be interpreted to “apply only to instances where property has not been physically injured” and it does not apply to allegations of damage to physical property other than the insured’s own work.
Even when insurers do not have to overcome statutory or judicial presumptions that render the occurrence requirement satisfied, they will be hard-pressed to deny coverage for faulty workmanship claims in a significant number of jurisdictions if the complaint against the insured includes any allegation of potentially covered damage to something other than the insured’s own work and/or if the faulty workmanship is deemed a contributing cause of damages sustained in an unforeseen event beyond the insured’s control.
For example, in Capstone Bldg. Corp.v. Am. Motorists Ins. Co., 308 Conn. 760 (2013), the Connecticut Supreme Court held, in deciding a “first impression” issue on certified questions, that “defective workmanship can give rise to an ‘occurrence’” and “property damage” for purposes of satisfying the threshold insuring agreement requirements when the faulty work causes damage to other, nondefective property beyond the work itself.
Two Capstone entities served as the general contractor and project developer for the construction of a student housing complex at the University of Connecticut. Three years after the project completion, UConn discovered “elevated levels of carbon monoxide in several areas” of the housing complex and other alleged defects and deficiencies in Capstone’s work. Capstone’s insurer denied its request for coverage on the grounds, inter alia, that its liability arose out of its own work.
After reaching a $2 million settlement agreement with UConn, the Capstone entities filed separate actions against its insurer, AMICO, in Alabama state court for breach of contract and bad faith. Following the removal of the actions to federal court on diversity grounds, the court submitted three certified questions to the Connecticut Supreme Court in Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 2011 U.S. Dist. LEXIS 172237, No. 2:08-cv-00513-RDP (N.D. Ala. May 2, 2011).
The first certified question asked if faulty workmanship damage to a project “may constitute ‘property damage’ resulting from an ‘occurrence,’ triggering coverage under a CGL policy?” Answering this “first impression” question in the affirmative, the Connecticut Supreme Court rejected AMICO’s argument “that defective construction lacks the element of ‘fortuity’ necessary for an accident.” Commenting that insurance policies “are designed to cover foreseeable risk, including negligent acts,” the court held that faulty work can satisfy the requirements of the insuring agreement if it is unintentional from the point of view of the insured and it damages other nondefective property or work.
Turning to the “property damage” requirement, the court acknowledged that the standard CGL policy definition does not “differentiate between damage to the contractor’s work and damage to other property,” but concluded that “defective work, without more, is not ‘property damage’ within the meaning of the policy.” To support its determination that faulty work does not satisfy the “property damage” requirement unless it damages nondefective components, the court reasoned that a contrary result would “render the policy’s requirement for ‘[p]hysical injury to tangible property’ meaningless.” Drawing this distinction, the court emphasized that the insuring agreement “contemplate[s] coverage for repairs to nondefective property stemming from ‘[p]hysical injury to tangible property’ or ‘loss of use’ caused by defective work stemming from an occurrence, including consequential costs for the necessary repairs and remediation.”
Next addressing the “your work” exclusion, the court concluded that the subcontractor exception restores coverage for property damage to the insured’s own work from subcontractor faulty workmanship.
In rejecting the oft-cited argument that allowing coverage for “defective workmanship inappropriately turns the commercial general liability policy into a performance bond,” the court stated that “overlapping coverage does not negate a commercial general liability policy’s express terms. ‘The . . . policy covers what it covers. No rule of construction operates to eliminate coverage simply because similar protection may be available through another insurance product.’” Id. (quoting Lamar Homes, Inc. v. Mid-Continent Casualty Co., 242 S.W.3d 1, 10 (Tex. 2007)). See also, MTI, Inc. v. Empire Ins. Co., 913 F. 3d 1245 (10th Cir. 2019) (applying Oklahoma law, rejected insurer’s argument that CGL policy would effectively be converted into performance bond if insured contractor was afforded coverage for settlement costs incurred to remedy faulty workmanship damage).
In another decision that highlights the crucial interplay between the subcontractor exception to the “your work” exclusion and the threshold insuring agreement requirements, the Second Circuit Court of Appeals reversed the entry of summary judgment for the insurer in Scottsdale Insurance Co. v. R.I. Pools Incorporated, 710 F.3d 488 (2nd Cir. 2013), based upon its determination that the Connecticut federal district court’s decision did not afford sufficient weight to the subcontractor exception.
Recent Decisions That Adhere to the Position that Faulty Workmanship Claims Do Not Satisfy the Threshold Occurrence Requirement
In a shrinking number of jurisdictions, insurers can still point to recent decisions that subscribe to the “traditional” position that faulty workmanship claims lack the degree of fortuity required to satisfy the threshold occurrence and/or property damage requirements in the CGL insuring agreement.
For example, the Eighth Circuit relied upon the “foreseeability” rule in permitting an insurer to deny coverage for a counterclaim that sought to recover costs incurred to remedy the faulty design and construction of a grain storage and distribution facility in American Family Mutual Ins. Co. v. Mid-American Grain Distributors, LLC, 958 F. 3d 748 (8th Cir. 2020).
In addition, Pennsylvania remains in the forefront of jurisdictions that routinely uphold coverage denials based upon the determination that faulty workmanship does not qualify as an occurrence, even when it causes consequential property damage. In Union Ins. Co. v. Selective Ins. Co. of America, 2018 U.S. Dist. LEXIS 154359, No. 17-2674 (E.D. Pa. Sept. 11, 2018), two insurers contested their respective coverage obligations concerning a condominium association’s faulty workmanship claims against a façade subcontractor. Specifically, Union Insurance took issue with Selective’s withdrawal from their defense funding agreement approximately two years after it undertook the subcontractor’s defense under a reservation of rights. As grounds for its entry of summary judgment for Selective, the court concluded that faulty workmanship does not constitute an occurrence under well-settled Pennsylvania law.
Applying Pennsylvania law, the Third Circuit also upheld an insurer’s denial of coverage for faulty workmanship claims asserted against a subcontractor by a condominium association in Lenick Construction, Inc. v. Selective Way Ins. Co., 737 Fed. Appx. 92 (3rd Cir. 2018). Pointing to prior precedent, including Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Insurance, 908 A.2d 888 (Pa. 2006), the Third Circuit reiterated that faulty workmanship claims do not qualify as an occurrence under Pennsylvania law, even when the faulty workmanship causes damages to areas beyond the insured’s own work.
Over the past several years, courts in Alabama, Illinois, Kentucky, New Hampshire, and Ohio also declined to depart from the proposition that faulty workmanship claims do not involve the fortuity required to satisfy the threshold occurrence requirement in a number of proinsurer decisions over the preceding year or so.
For example, in Nationwide Mut. Fire Ins. Co. v. David Grp., Inc., 294 So. 3d. 732 (Ala. 2019), the Alabama Supreme Court reversed the judgment entered in favor of homeowners who sued the contractor who built their homes to recover for asserted construction defects. Pointing to the absence of any evidence of damage to anything beyond the contractor’s work, the court reaffirmed its view that faulty workmanship, standing alone, does not qualify as an “occurrence.” As the court explained, this “concept is consistent with the idea that the purpose of a CGL policy is to protect the insured contractor from tort liability, not to insulate it from its own faulty work.”
In Ohio N. University v. Charles Construction Services, 120 N.E. 3d 762 (2018), the University sought coverage for approximately $6 million in costs incurred to remedy water penetration damage to a luxury hotel/conference center facility. Supported by several amici curiae, the contractor argued that the PCOH coverage it purchased for an added premium afforded it with coverage for unexpected defects discovered after the completion of construction. Charles Construction also argued that its use of subcontractors distinguished this dispute from Westfield Ins. Co. v. Custom Agra Sys. Inc., 979 N.E.2d 269 (Ohio 2012), a decision that upheld an insurer’s denial of coverage for faulty workmanship claims concerning the insured’s own work.
Acknowledging that its “reasoning in this case contrasts with recent decisions of other courts” in other jurisdictions, the Ohio Supreme Court concluded that “[r]regardless of any trend in the law,” it needed to base its decision on the plain language of the CGL policy. From that perspective, the court held that it did not matter if the faulty workmanship claims were asserted against a general contractor or its subcontractor or whether the insured had purchased PCOH coverage.
In Martin/Elias Properties, LLC v. Acuity, 544 S.W.3d 639 (Ky. 2018), an owner hired a contractor to renovate a historic townhouse. During basement renovations, the entire structure began to sag, risking an imminent collapse. The owner sued the contractor and its insurer, following its denial of coverage. While the coverage action remained underway, the contractor filed for bankruptcy protection and disappeared. Relying on the view that the policy should cover unexpected damage to areas beyond the contractor’s own work, the trial court upheld the denial of coverage for the basement damage while permitting the owner to obtain coverage for the damage to the rest of the Townhouse.
On appeal, the intermediate appellate court and the Supreme Court of Kentucky concluded that the trial court erred when it arrived at a “Solomon” outcome that differentiated between the areas that were, directly and indirectly, damaged by the contractor’s faulty work. In concluding that “none of the structural damage qualified as an accident triggering coverage as an occurrence,” the Kentucky Supreme Court held that the insured cannot establish the degree of fortuity required to satisfy the occurrence requirement when it exercises control over any aspects of construction work that cause foreseeable damage to any components of the property under construction. Applying what it described as an “intent and control” test to the occurrence determination, the court held that the analytical focus should not be on whether the contractor intended to cause damage. Instead, the coverage determination should be based upon “whether the damage resulted from the actions purposefully taken by the contractor or those working under the contractor’s control.” In Fletch’s Sandblasting & Painting, Inc. v. Colony Ins. Co., 2017 WL 2455040, No. 15-cv-490-PB (D. N.H. June 6, 2017), the court concluded that faulty workmanship claims against a subcontractor did not satisfy the occurrence requirement and coverage was defeated in any event by the policy’s “your work” exclusion. Granting the insurer summary judgment, the court concluded that claims did not seek to recover for any resulting property damage beyond the costs incurred to redo faulty workmanship. The New Hampshire Supreme Court reaffirmed its view that CGL policies do not afford coverage for foreseeable consequence of poor workmanship because they are designed to insure against fortuitous, unanticipated events that cause resulting property damage.
Recent Decisions That Highlight the Importance of Examining the Property Damage, as well as the Occurrence, Requirement in the Insuring Agreement
Even in jurisdictions that treat faulty workmanship as an occurrence, insurers may retain the ability to challenge insured’s ability to satisfy the “property damage” requirement in the insuring agreement if the request for coverage concerns costs incurred to correct faulty workmanship rather than repair costs for resulting property damage. As shown by the following decisions, a significant number of courts maintain the view that a CGL policy should not “cover purely economic loss for the repair or replacement of defective work” because these are essentially “contractual damages” that the insured should be required to absorb. Courts that take this approach carefully differentiate between claims that concern damage to third-party property and claims that seek to recover economic costs incurred to correct faulty workmanship.
Certain Underwriters at Lloyd’s, London v. Metropolitan Builders, Inc., 158 N.E.3d 1084 (Ill. App. Ct. Dec. 18, 2019), is instructive in this regard. This dispute concerned the conversion of three adjacent properties into a single-family dwelling. While the work remained underway, an adjoining wall collapsed as a consequence of the general contractor’s alleged failure to ensure the structural integrity of the properties during the renovation process. Following the collapse, the City of Chicago directed the owner to demolish the structures.
After paying the owner approximately $1.8 million dollars for demolition and construction costs, the owner’s insurer filed a subrogation lawsuit against the GC. The GC’s insurer (Lloyds) sought a declaration regarding its right to deny coverage based upon its contention that the subrogation action did not satisfy the policy’s “property damage” or “occurrence” requirement because it only sought to recover economic losses stemming from faulty work. The trial court agreed, granting Lloyds summary judgment.
On appeal, the appellate court agreed with the view that a CGL policy does not serve as a source of coverage for economic losses incurred to correct faulty workmanship in the absence of any resulting damage to third party property:
‘[C]omprehensive general liability policies *** are intended to protect the insured from liability for injury or damage to the persons or property of others; they are not intended to pay the costs associated with repairing or replacing the insured’s defective work and products, which are purely economic losses. [Citations omitted.] Finding coverage for the cost of replacing or repairing defective work would transform the policy into something akin to a performance bond.’ Id. at *34.
After addressing its view that faulty workmanship, standing alone, does not constitute an “occurrence,” the court turned to the “property damage” requirement in the insuring agreement. Noting that “property damage” is broadly defined as “physical injury to tangible property, including all resulting loss of use of that property,” the court opted to go “beyond the mere textual meaning of the [defined] phrase” to focus on the purpose served by the property damage requirement in the insuring agreement. Id. at *59. As the court explained:
when the “property” that is alleged to be “damaged” in the underlying lawsuit against the construction contractor is merely the contractor’s work product, then in essence the only damage is the disappointed commercial expectations of the property owner, and the damages alleged are purely economic losses for the cost of repair and replacement of the contractor’s work product or for the property’s diminution in value. In those instances, we have held that no “property damage” was alleged to trigger coverage under the CGL policy. Id. at *60.
After reviewing several examples of this important distinction, the court summarized the “prevailing rule”:
to constitute “property damage” in these CGL policies with definitions like the one here, the property’s appearance must be altered in some measurable way, but it must also be property beyond that of the contractor’s work product. If the only property injured is the very project on which the contractor was working—the windows it installed or sealed, the wall it built, the house it erected— then the damages sought are merely economic losses stemming from disappointed commercial expectations. They are contractual damages for the cost of repair or replacement or to make the property owner whole for the diminution in the property’s value. And such damages are not recoverable in a CGL policy. But again, allegations of damage to property other than the project itself, requiring more than mere repair or replacement, constitute “proper damage” under the CGL policy. Id. at *65.
Based upon this distinction, the appellate court reversed summary judgment for Lloyds because the subrogation complaint contained allegations of resulting damage to the owner’s “personal property” that sufficed for purposes of triggering Lloyd’s defense obligation. Given its view that a CGL does not serve as a source of coverage for costs incurred to repair faulty work in the absence of resulting property damage, the court cautioned that its ruling did not alter Lloyd’s right to deny indemnity coverage.
In jurisdictions that recognize the need to examine the dual property damage and occurrence requirements in the insuring agreement, an insurer can still contest the availability of coverage for economic costs to correct faulty workmanship even if the occurrence requirement is deemed satisfied. Cowart v. Nautilus Ins. Co., 2019 U.S. Dist. LEXIS 8531, No. 4:17-cv-142 (S.D. Ga. Jan. 17, 2019), is instructive in this regard. Specifically, the insured’s ability to rely upon Taylor Morrison Services, Inc. v. HDI-Gerling American Ins. Co., 746 S.E.2d 587 (Ga. 2013), to satisfy the occurrence requirement did not insulate it from the insurer’s right to challenge its ability to satisfy the property damage requirement given the absence of any evidence of resulting property damage from the faulty workmanship.
As the Cowart court recognized, citing to Taylor Morrison, “[p]roperty or work that is inherently defective because it was produced by faulty workmanship cannot be said to have been ‘physically injured’ by the very faulty workmanship that brought it into being in the first place.” Consequently, Nautilus was entitled to deny coverage for claims brought against a contractor for costs incurred to remedy the faulty construction of a pool.
In Southern Owners Ins. Co. v. Gallo Building Servs., 2018 U.S. Dist. LEXIS 212961, No. 8:15-cv-01440-EAK-AAS (M.D. Fl. Dec. 18, 2018), the coverage determination also turned on the property damage, versus the occurrence, requirement in the insuring agreement and the potentially applicable business risk exclusions. Southern Owners concerned an insurer’s right to deny coverage for a lawsuit KB Homes filed against its insured and several other subcontractors to for an array of construction deficiencies in a 270-unit condominium development. Summary judgment was entered for Southern Owners when its insured defaulted.
After granting KB Homes’ motion to vacate the default, the court concluded that the property damage requirement was satisfied because of alleged damage to property beyond Gallo’s own work, coupled with loss of use damages stemming from KB Homes’ payment of relocation costs during repairs. Turning from the property damage requirement to the potentially applicable exclusions, the court rejected Southern Homes’ reliance on a “your work” exclusion that omitted the subcontractor exception. (The absence of the subcontractor exception was irrelevant because the entire project could not be deemed Gallo’s work given its subcontractor status). The court also rejected Southern Homes’ reliance on a narrowly written “exterior finishing and stucco exclusion.”
As the foregoing demonstrates, the initial defense coverage evaluation is often the opening skirmish in a battle over the extent and availability of indemnity coverage for faulty workmanship claims. Given the shifting approaches to the occurrence determination, insurers and their counsel need to monitor significant developments in the faulty construction coverage landscape so that they can proactively evaluate the wide array of scenarios presented by the faulty construction claims.
Building upon this examination of the pivotal interplay between the threshold “occurrence” and “property damage” insuring agreement requirements and the potentially applicable exclusions, Part Two of this article will examine differing judicial approaches taken to coverage disputes concerning “rip and tear” damages that occur when remedial efforts undertaken to correct faulty workmanship necessitate the destruction, removal, and/or replacement of nondefective property.
Part Two will also examine frequently overlooked issues that arise when an insured corrects faulty workmanship outside of the litigation context, including the insurer’s potential ability to challenge the insured’s ability to satisfy the “legally obligated to pay as damages” insuring agreement requirement and/or the policy’s “no voluntary” action or payment conditions.