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Faulty Construction Coverage Disputes (Part 2 of 2)
Differing Judicial Approaches to “Rip and Tear” Damages and “Legally Obligated to Pay as Damages” Disputes Surrounding Non-Litigated Faulty Workmanship Claims:
Part I of this article, published in the December 2021 issue of For The Defense, examined the current legal landscape in defective construction coverage disputes given an increasing judicial willingness to depart from long standing prior precedent to hold that faulty workmanship claims involving subcontractor work can satisfy the threshold occurrence requirement in CGL policies.
This article appeared in DRI: For the Defense Magazine, January 2022
Understanding the analytical framework that courts use to resolve these disputes will help insurers and their counsel predict the likely outcome of a wide array of litigated and non-litigated defective coverage claims. In addition to examining the approach taken to the initial “occurrence” determination under policies that include the subcontractor exception to the “your work” exclusion, Part I of this article addressed the importance of examining whether the faulty workmanship claims satisfy the “property damage” requirement in the insuring agreement in instances when the relief sought by the claimant is confined to the costs incurred to bring the work into conformity with the project specifications and/or contract requirements.
Against the backdrop of the preceding discussion, Part II of this article examines two recurring issues that coverage counsel need to be mindful of in the defective construction scenario because they receive far less judicial attention; namely (a) differing judicial approaches to claims concerning “rip and tear” damages sustained in the course of correcting faulty workmanship; and (b) an insurer’s potential ability to challenge the insured’s ability to satisfy the “legally obligated to pay as damages” requirement in the insuring agreement in instances when the insured seeks coverage for costs incurred to correct faulty workmanship outside the litigation context.
Differing Judicial Approaches to Disputes Over the Availability of Coverage for Rip & Tear Damages
In many jurisdictions, there is very little guidance regarding the insurer’s obligation to afford coverage for costs and/or damages sustained when faulty workmanship necessitates the removal and/or destruction of non-defective property and/or work performed by other contractors. In the jurisdictions which have examined this issue, courts take differing approaches to the availability of coverage for “rip and tear” damages. Given the unsettled and divergent approaches taken to this recurring issue around the country, some commentators have recommended that “rip and tear,” “get to” or “access” costs should not be treated as a separate category of damages for purposes of the coverage determination. Instead, the availability of coverage for these costs should depend upon whether the policy affords coverage for the core claims asserted against the insured.
Under this analytical framework, if the claims asserted against the insured are covered because its allegedly faulty workmanship and/or products caused resulting or consequential property damage to something other than the insured’s own work, then all costs associated with repairing or replacing that resulting property damage, including any so-called “rip and tear” costs, would be covered.
On the other hand, if the insured’s faulty workmanship or products did not cause any resulting or consequential property damage, then the insurer would not be required to afford coverage for any of the costs incurred to remove or replace the faulty workmanship or components.
As one commentator has noted, “[m]uch depends . . . on whether or not the property damage to the defective work is covered. Generally speaking, if there is no covered property damage there already, the ‘rip and tear’ damage is not covered either.” Scott C. Turner, Insurance Coverage of Construction Disputes, §6:20 (November 2013). Another commentator has summarized the case law as follows:
Another issue that has been litigated with some frequency is whether the CGL policy provides coverage for the costs to rip out otherwise non-defective work in order to repair defects in the insured’s work. While at first glance the case law across the country seems to be mixed, a careful look at the fact patterns discussed in the cases suggests a prevailing view. In particular, the majority view can be summed up as follows: the costs to rip out otherwise non-defective work in order to repair otherwise non-covered defective work is not “property damage,” but the costs to rip out non-defective work in order to repair covered “property damage” is considered damages because of “property damage” and is covered. The rationale of many of these decisions is that the nature of the repairs cannot create coverage if none exists.
Lee H. Shidlofsky, Deconstructing CGL Insurance Coverage Issues in Construction Cases, 9 No. 2 Journal of the Am. College of Construction Lawyers (August 2015). See also, Rawls, “Do CGL Policies Cover ‘Rip and Tear’ Expenses?” Insurance Risk Management Institute Circular (March 2011).
When presented with a request for coverage for “rip and tear” damages, insurers need to determine if courts in the applicable jurisdiction have taken a position regarding this emerging issue. As the following representative decisions illustrate, the differing outcomes to disputes over the availability of “rip and tear” damages derives to a large extent from the approach courts in the particular jurisdiction take to the availability of coverage for faulty workmanship claims generally. In jurisdictions which deem the insuring agreement requirements satisfied by faulty workmanship claims, at least when the claimant alleges some degree of resulting property damage, most courts readily agree to afford coverage for “rip and tear” damages.
Decisions Denying Coverage for Rip & Tear Damages
In the following decisions, courts upheld the denial of coverage for liability imposed upon the insured for costs incurred to remove non-defective property to gain access to and replace faulty workmanship. In Regional Steel Corp. v. Liberty Surplus Ins. Corp., 226 Cal.App.4th 1377, 173 Cal.Rptr.3d 91, 93–94 (2014), the court upheld the insurer’s denial of coverage for costs incurred to tear out non-damaged concrete encasing seismic tie hooks that the building inspector rejected as inadequate. In so holding the court relied upon the rule that the incorporation of a faulty component does not give rise to covered “physical injury to tangible property” unless the product causes physical injury to other property. Id. at 101–02.
In Palm Beach Grading, Inc. v. Nautilus Ins. Co., 434 Fed. Appx. 829, 831 (11th Cir. 2011), the Eleventh Circuit Court of Appeals upheld an insurer’s denial of coverage for “rip and tear” costs incurred to repair defective piping that did not cause any covered property damage.
In Desert Mountain Props. Ltd. Partnership v. Liberty Mut. Fire Ins. Co., 236 P.3d 421, 441– 42 (Ariz. App. 2010), the court held that costs incurred in “getting to” an alleged defect was not covered because the “expense of removing or repairing non-defective property . . . is characterized as a cost of repairing the defect. The removal or destruction of non-defective property required to repair poorly compacted soil is not damage caused by the poorly compacted soil. Rather, it is damage caused by the repair of the poorly compacted soil. Therefore, because the cost of repairing the defect is not recoverable under a CGL policy in Arizona,” the costs incurred to access the defect was likewise not covered.
Decisions That Afford Coverage for Rip & Tear Damages
In upholding the insured’s right to obtain coverage for these “rip and tear” costs, the court differentiated between the non-covered costs incurred to replace the defective pool and covered cost incurred to remedy the resulting property damage. In the following jurisdictions, courts have directed insurers to afford coverage for liability imposed upon the insured for costs incurred to remove non-defective property to gain access to and repair or replace faulty workmanship.
In U.S. Metals, Inc. v. Liberty Mut. Group, Inc., 490 S.W.3d 20 (Tx. 2015), reh. denied, 2016 Tex. LEXIS 689 (Tx. June 17, 2016), the court took the approach, which several commentators have criticized, of analyzing the availability of coverage for “rip and tear” damages as a stand-alone type of damages rather than treating it as the covered or non-covered consequence of the underlying liability imposed upon the insured. Specifically, in U.S. Metals, the insured’s product, flanges, were incorporated into diesel units used by oil refineries. The flanges leaked but the problem was discovered before the leaks caused resulting property damage. To replace the faulty product, the oil refineries had to remove undamaged materials and property surrounding the insured’s product. The court held that the incorporation of the faulty component did not qualify as covered “property damage” because the leaking flanges did not cause any physical injury to tangible property. Rather than end its inquiry with the determination that the claims against the insured were not covered because its product did not cause any resulting property damage, the Texas Supreme Court directed the insurers to afford coverage for the costs incurred to remove the defective flanges based upon its conclusion that “the fix necessitated injury to tangible property, and the injury was unquestionably physical.” Id. at 28.
In a subsequent decision that cited favorably to U.S. Metals, the Western District of Texas Federal District Court directed the insurer to afford coverage for “rip and tear” costs attributed to the need to remove a roadway to access and correct a subcontractor’s faulty utility work in Travelers Lloyds Ins. Co. v. Cruz Contracting of Texas LLC, No. 5:16-CV-759-DAE, 2017 WL 5202891 (W.D. Tex. Sept. 7, 2017). In Pennsylvania Nat. Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish, 790 F.3d 1173 (11th Cir. 2015) (Alabama law), the Eleventh Circuit Court of Appeals directed the insurer to afford coverage for costs incurred to remove and replace shingles to repair water damage to a roof deck and ceiling caused by the insured roofing contractor’s faulty workmanship. As the court explained in arriving at this determination, “If the [owner] had removed and replaced the shingles solely to repair [the insured contractor’s] faulty workmanship in installing them, then the cost would not be covered under the Policy. But here, the cost of removing and replacing the shingles is covered because these tasks necessarily had to be undertaken to repair the damaged gypsum deck.” Id. at 1181.
In Carithers v. Mid-Continent Cas. Co., 782 F.3d 1240, 1173 (11th Cir. 2015) (Florida law), the insurer appealed from the trial court’s determination that the insured contractor was entitled to coverage for a judgment entered against it in an action brought by homeowners to recover their costs incurred to correct faulty workmanship to a balcony to remedy resulting damage to an adjacent garage. On appeal, the Eleventh Circuit addressed the need to distinguish between non-covered costs incurred to remedy faulty workmanship and costs incurred to repair covered property damage. Applying this distinction, the Eleventh Circuit, applying Florida law, held that the insurer was required to cover the costs incurred to remove and replace the improperly constructed balcony, because the balcony had to be replaced to repair the covered resulting damage to the garage.
In Big-D Construction Corp. v. Take it for Granite Too, 917 F. Supp. 2d 1096 (D. Nev. 2013), the court was asked to evaluate the availability of coverage for costs incurred when the property owner decided to remove the stucco substrate on the exterior of a building to eliminate safety risks presented by falling stone tiles attributed to the use of an inadequate adhesive. After concluding that policy’s occurrence and property damage requirements were satisfied by the unexpected falling of the stone tiles, which sustained damage when they hit the ground, the court rejected the insurer’s argument that the decision to remove the non-defective stucco substrate and reinstall all of the tiles to avoid safety issues constituted non-covered “rip and tear” damages.
In concluding that the policy afforded coverage for the “rip and tear” costs incurred in removing the stucco, the court made the following findings regarding the existence of evidence of covered mage caused by the faulty work:
However, the actual stone tiles that fell from the building and hit the ground were physically injured. Therefore, the damage to each stone tile that fell is property damage. Additionally, the safety measures taken to prevent future property damage or bodily injury caused by additional falling stone tiles are property damage. This would include the removal, scaffolding, and any other safety measures taken to prevent future bodily injury or property damage. Big–D also has presented evidence that the stucco substrate was physically injured upon the removal of the stone tiles, and is therefore property damage caused by the stone tiles falling.
Id 9–10. In affording coverage for costs incurred to remove and replace non-defective, third-party work in Colorado Pool Sys., Inc. v. Scottsdale Ins. Co., 317 P.3d 1262, 1271 (Colo. Ct. App. 2012), the court concluded that the “rip and tear” costs were incurred to repair covered damages caused by the insured’s installation of a defective pool. In upholding the insured’s right to obtain coverage for these “rip and tear” costs, the court differentiated between the non-covered costs incurred to replace the defective pool and covered cost incurred to remedy the resulting property damage.
In Indian Harbor Ins. Co. v. Transform, LLC, No. C09-1120 RSM, 2010 WL 3584412 at *5–6, No. C09-1120 RSM (W.D. Wash. Sept. 8, 2010), the court held that although “[p]ure workmanship defects are not considered accidents or ‘occurrences,’” “rip and tear” damages qualify as covered third-party damages resulting from insured’s defective work.
In Clear, LLC v. Am. & Foreign Ins. Co., No. 3:07-cv-00110 JWS, 2008 WL 818978 (D. Alaska March 24, 2009), the court upheld the insured’s right to coverage for settlement costs incurred to resolve claims concerning work performed to remove and replace non-defective work to remedy resulting damages caused by faulty workmanship. As the court explained, “making repairs to covered property damage necessarily includes the costs involved in removing and replacing other materials to gain access to the damaged property[.]”
In Mut. of Enumclaw Ins. Co. v. T & G Constr., Inc., 199 P.3d 376, 385 (Wash. 2008), the court concluded that coverage was afforded for costs incurred to remove and replace poorly installed siding because this work was required to correct covered water intrusion damage. See also, Riverfront Landing Phase II Owners’ Ass’n v. Assurance Co. of Am., No. C08-0656RSL, 2009 WL 1952002 (W.D. Wash. July 6, 2009) (insurer required to cover cost to remove and repair insured’s faulty work to ‘get to’ and repair consequential damages).
In Limbach Co. LLC v. Zurich Am. Ins. Co., 396 F.3d 358, 365 (4th Cir. 2005), the court directed the insurer to afford coverage for costs incurred to remove and replace undamaged concrete encasing a leaking pipe, because the insured’s faulty installation of the pipe caused resulting damage to landscaping. Because the damage to the landscaping was covered, the costs incurred to remove and replace the non-damaged concrete were a covered consequence of the need to remedy third-party property damage caused by the insured’s faulty workmanship.
In DeWitt Constr. Inc. v. Charter Oak Fire Ins. Co., 307 F.3d 1127 (9th Cir. 2002), the insured subcontractor drilled concrete piles into the ground to serve as a building’s foundation. Remediation of the insured’s allegedly faulty construction of the piles necessitated the removal and reinstallation of other subcontractors’ non-defective work. In directing the insurer to afford coverage for the costs incurred in connection with the removal of the non-defective work, the court held that, under Washington law, the initial faulty workmanship qualified as an “occurrence,” and the resulting damage to the other subcontractors’ work constituted covered “property damage.” Id. at 1134.
The DeWitt court also rejected the insurer’s reliance on the policy’s impaired property exclusion based upon the determination that the “destroyed work of other subcontractors was not merely impaired, nor was it restored to use.” Id. at 1135.
Navigating Coverage Disputes When Efforts are Made to Resolve Faulty Workmanship Claims Without Formal Litigation
Given how often insurers are called upon to afford coverage for payments made or work performed to resolve faulty workmanship disputes without the need for litigation, it is somewhat surprising to see how rarely these issues are squarely addressed in reported decisions concerning faulty workmanship coverage disputes. In contrast to the widespread attention given to the swinging pendulum over the treatment of faulty workmanship as an “occurrence.” A recurring source of conflict in the faulty construction arena that is too often overlooked concerns the insurer and insured’s respective rights and obligations when the contractor requests coverage for costs incurred to correct allegedly faulty workmanship without the need for formal litigation.
For various reasons, including warranty obligations and efforts to preserve reputations and valued business relationships, contractors often attempt to work out disputes with project developers and owners over alleged construction deficiencies by undertaking corrective measures without the need for formal litigation. When the contractor asks the insurer to assist it in paying for the projected costs of the remedial measures without an adjudication of the insured’s asserted liability for covered and non-covered damages, the insurer faces some difficult decisions.
On the one hand, it may be helpful for the insurer to work cooperatively with the insured to arrive at a solution that will eliminate the need for costly litigation. If the insurer agrees to assist the insured in paying for the costs of required remedial measures, it may be in better position to evaluate the alleged deficiencies and the existence of covered property damage. By working cooperatively with the insured, the insurer may also have the ability to resolve the overall dispute on more favorable terms than would prove the case if the parties engaged in prolonged litigation.
On the other hand, if the faulty workmanship has not caused any resulting property damage, the insurer may be reluctant to afford coverage for the remedial measures for several reasons. Depending upon the factual circumstances surrounding the matter at hand, the insurer may want to avoid taking inconsistent positions regarding the availability of coverage for comparable faulty workmanship disputes in the same jurisdiction and/or with the same insured. In addition, when reviewing available information regarding the alleged deficiencies and proposed remedial measures, the insurer may question the insured’s responsibility for the asserted deficiencies and/or the reliability of the projected costs for the proposed corrective measures. Moreover, even if the insurer is prepared to participate in efforts to achieve a pre-litigation resolution of a faulty workmanship dispute, it may want to ensure that other responsible parties and their insurers pay their fair share of any agreed upon resolution. In weighing these considerations, the insurer needs to evaluate its ability to rely upon the following policy provisions and defenses to contest the availability of indemnity coverage for costs incurred by the insured to resolve a dispute without an adjudication of its asserted liability:
- The insured’s obligation to satisfy the threshold “legally obligated” requirement in the insuring agreement; and
- The insured’s obligation to comply with the no voluntary action/payment and no direct action provisions in the policy’s conditions section.
Given how often insurers are called upon to afford coverage for payments made or work performed to resolve faulty workmanship disputes without the need for litigation, it is somewhat surprising to see how rarely these issues are squarely addressed in reported decisions concerning faulty workmanship coverage disputes.
Without attempting to provide a comprehensive overview of the differing approaches courts have taken to these issues, this article addresses a handful of recent decisions that examine the coverage defenses that come into play when an insurer is asked to afford coverage for costs incurred to resolve faulty workmanship disputes without an adjudication of the insured’s asserted liability.
In Glasswerks LA, Inc. v. Liberty Ins. Co., No. CV 20-10428-VAP-PDx, 2021 U.S. Dist. LEXIS 46882 (C.D. CA. March 10, 2021), the court granted the insurers’ motion to dismiss an insured’s claimed entitlement to obtain coverage for a $1.2 million dollar settlement that it entered into to avoid litigation over its supply of defective window panels for a construction project. As grounds for its dismissal with prejudice of the coverage action, the court relied upon prior California decisions that supported the insurer’s position that formal “suit” was a precondition the imposition of a duty to defend.
Aided by a better understanding of the current approach courts around the country take to these recurring disputes, coverage counsel can also assist their insurer clients in making informed and proactive decisions about their available litigation and settlement options in potentially high-exposure faulty workmanship claims.to remedy the resulting property damage. The insured’s appeal from the dismissal order is now pending before the Ninth Circuit Court of Appeals in docket No. 21-55303. Based upon the issues set forth in the parties’ Briefs, the Ninth Circuit will also have the opportunity to address the parties’ dispute over whether insured’s entry into a written settlement agreement with the project general contractor and subcontractor satisfies the “legally obligated to pay as damages” provision in the applicable CGL Policy.
In Salvati v. American Ins. Co., 855 F. 3d 40 (1st Cir. 2017), an insured entered into a settlement agreement to eliminate its potential exposure to liability in a lawsuit filed by an individual injured in a serious job-site accident. The excess insurer denied coverage for the lawsuit based upon, inter alia, the employer liability exclusion in its policy. After some years of litigation, and an unsuccessful mediation effort (which the excess insurer attended), the plaintiff and the insured entered into a settlement that allowed the plaintiff to recover the $1 million limit of the insured’s primary policy and pursue assigned claims against the excess insurer in exchange for a full release of claims. The written settlement agreement entitled the plaintiff to recover a “total payment of $6,000,000” if it could establish the insured’s entitlement to coverage under the excess policy. The settlement agreement stipulated that its enforceability was not contingent on the ultimate availability of excess coverage.
To comply with statutory requirements concerning the settlement of claims for workers compensation benefits, the parties sought and obtained court approval of the settlement agreement before dismissing the underlying action without a formal adjudication and/or entry of a stipulated judgment.
In the ensuing coverage action, the excess insurer argued that “its duty to indemnify was not triggered by the Settlement Agreement because only a judgment can ‘legally obligate’ a party to pay ‘damages.” The trial court agreed, and granted the excess insurer’s motion for summary judgment, based upon its determination that “there was never any legal determination of liability” because ‘no judgment entered against the Underlying Defendants’. . . ”.
While affirming the entry of summary judgment for the excess insurer on appeal on other grounds summarized below, the First Circuit rejected the insurer’s argument that its policy only required it to afford indemnity coverage for liability imposed upon the insured via a court-ordered judgment. In rejecting this argument, the First Circuit started its analysis with the observation that the undefined term “damages” does not “signify the need for a court judgment.” The court then examined specific excess policy provisions which supported its determination that “the requisite ‘legal obligat[ion]’ to pay ‘damages’ can arise from either a court judgment or a settlement agreement that is wholly contractual in nature.” Id. at 45.
In concluding that the policy’s “legally obligated” requirement was satisfied by the insured’s entry into a binding settlement agreement, the First Circuit pointed to the insurer’s statement in the policy’s conditions section that a “‘settlement [by the insured] requires our prior written authorization.” As the court explained, “[s]uch a requirement of prior approval makes sense only if settlements could trigger [the excess carrier’s] duty to indemnity.” Id. at 46. In support of this determination, the First Circuit also pointed to the insured’s duty to cooperate in the “investigation or settlement of any claim, or the defense of any insured against any ‘suit’ . . .”
After concluding that the policy’s legally obligated requirement could be satisfied by the insured’s assumption of liability in a written settlement agreement, the First Circuit affirmed the entry of summary judgment for the excess insurer on alternate grounds. Focusing on specific language in the insuring agreement, the First Circuit held that the settlement agreement “did not trigger the [excess insurer’s] duty to indemnify because it did not legally obligate the Underlying Defendants to pay anything beyond the $1 million available through Western World’s primary policy.” When the insured agreed to assign its right to pursue claims against its excess insurer to the plaintiff, it did not assume an obligation to pay a “sum in excess of the Primary Insurance” as required to trigger the excess insurer’s indemnity coverage obligation. Id. at 48. While upholding the entry of summary judgment for the insurer, the First Circuit cautioned that the excess policy’s legally obligated requirement could have been satisfied by a settlement agreement reduced to a judgment, even if the parties entered into a separate agreement releasing the insured from liability.
An Arizona court also rejected an insurer’s contention that comparable policy language requiring a “legal obligation to pay” permitted it to deny coverage for remediation costs incurred to resolve a faulty workmanship dispute prior to the entry of a judgment against its insured in Desert Mountain Properties, L.P. v. Liberty Mutual Fire Ins. Co., 236 P. 3d 421 (Ariz. Ct. App. 2010). As the court explained in concluding that an insured developer was entitled to coverage for over $640,000 in remediation costs to correct soil settlement problems and repair cracks and other damage to the homes:
The language in the Liberty Mutual policies may be interpreted according to its plain and ordinary meaning, as one untrained in law or business would understand it. Reading the policies in that manner, a “legal obligation to pay” means any obligation enforceable by law, including, for example, an obligation created by statute, contract, or the common law. Once created, the obligation exists prior to and even in the absence of a suit to enforce it or a court order compelling performance. In short, although a court may enforce a legal obligation, in the usual case, no court action is required to create a legal obligation. For that reason, we conclude the better-reasoned rule is that the coverage for sums an insured becomes “legally obligated to pay as damages” may be triggered even in the absence of a civil lawsuit against the insured or a court order requiring the insured to make payment.
In contrast, the Third Circuit concluded that the “legally obligated” requirement requires the entry of a judgment against the insured in Permasteelisa CS Corp. v. Columbia Cas. Co., 377 Fed. App’x 260 (3rd Cir. 2010). In Permasteelisa, an insured subcontractor sought coverage for costs incurred to correct deficiencies in a decorative curtain wall installed on the exterior of a 43-story office tower constructed for Goldman Sachs. After being instructed to stop work on the project due to safety concerns presented by falling debris and materials attributed to problems with the grillwork on the curtain wall, Permasteelisa asked CNA to assist it in resolving the dispute pursuant to the terms of its contractor’s professional liability policy. After receiving the insured’s notice of a “potential claim,” CNA issued a response which reserved its rights and instructed Permasteelisa not to “admit liability . . . [or] say you’re going to do anything.” Facing pressure from the property owner and the general contractor, Permasteelisa agreed to perform remedial work to correct the problems at an approximate cost of $5.5 million.
Unable to secure coverage from CNA, Permasteelisa sought coverage under an OCIP policy issued by Lexington. Lexington denied coverage based upon the absence of a “claim” as defined in its policy. When a subsequent arbitration action was resolved in Lexington’s favor, Permasteelisa filed a declaratory judgment action against CNA. Applying New Jersey law, the trial court entered summary judgment for CNA based on the determination that Permasteelisa could not satisfy the “legally obligated” requirement in the policy’s insuring agreement because it undertook the repairs without a judgment entered against it or a settlement agreement consented to by the insurer.
On appeal, the Third Circuit upheld the entry of summary judgment in CNA’s favor. As the court explained:
Given our duty to ascertain New Jersey law, we agree with the District Court that the starting point for this analysis is the trial court decision in Bacon [330 A.2d 389], the lone New Jersey case construing the policy phrase “legally obligated to pay.” . . . In Bacon, the court held that an insured becomes “legally obligated to pay” only after an entry of a final judgment establishing its liability. . . . As a federal court applying state law, we must not disregard the Appellate Division’s adoption of the holding and reasoning of Bacon unless we are convinced by other persuasive data that the highest court of the state would decide otherwise. After reviewing the parties’ contentions and the relevant case law, we predict that the New Jersey Supreme Court would neither overrule nor distinguish Bacon if confronted with the facts of this case. Accordingly, we conclude that the District Court did not err in applying Bacon to hold that, in the absence of a final judgment, Permasteelisa was not “legally obligated to pay” for the remediation of the curtain wall.
See also, 7A Couch on Ins. §103:14 (“[L]egal liability requires entry of a judgment against the insured so that the insured’s settlement of a claim without authorization from the insurer, or positive response to a demand for equitable relief does not amount to “legal liability” for which the insurer is responsible.”) In addition to evaluating the approach taken to the “legally obligated” requirement in the applicable jurisdictions, policyholders presented with demands to remedy alleged construction deficiencies also need to reach out to their insurers to request their agreement to forego reliance on the no voluntary payments and/or no action provisions in the policy’s conditions section to avoid compromising their potential right to coverage.
A typical voluntary payment clause provides “No insured will, except at that insured’s own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without [the insurer’s] consent.” To reinforce this requirement, most CGL policies also include a no-action clause which states an insured cannot sue the insurer for coverage “unless all of its terms have been fully complied with.” Some policies also include a provision stating that “settlement payments can be recovered only if the insurer itself has signed the settlement and release of liability.” As the following decisions demonstrate, these provisions offer insurers significant protections in the faulty construction arena.
In Travelers Property Casualty Co. v. Stresscon Corp., 370 P.3d 140 (Colo. 2016), an insured subcontractor sought coverage for settlement payments made pursuant to a settlement agreement entered into without its insurer’s knowledge or consent to secure the dismissal of an underlying action concerning a job site action. In contesting its obligation afford coverage for the settlement, Travelers argued that the insured violated the policy’s “no voluntary payments” clause by settling with the general contractor without notifying Travelers of the loss and without seeking Travelers’ consent to enter into the settlement. The insured prevailed at the trial and intermediate appellate level based in part on the court’s determination that Travelers could not demonstrate prejudice from the insured’s voluntary settlement.
When Travelers pursued a further appeal to the Colorado Supreme Court, it prevailed in establishing that Colorado law did not support the application of the prejudice rule to the policy’s “no voluntary payments” provisions. In support of this determination, the Colorado Supreme Court distinguished the no voluntary action condition from the policy’s reporting obligation which imposes affirmative duties on the insured. As the court explained in concluding that “the no-voluntary-payments clause of the contract at issue here actually goes to the scope of the policy’s coverage,” and remanding with instructions to vacate the jury verdict against Travelers:
Rather than a provision purporting to bar an insured from voluntarily making payments or incurring expense without the consent of the insurer, for the breach of which the insurer would be absolved of compliance with its obligations under the policy, the no-voluntary-payments provision makes clear that coverage under the policy does not extend to indemnification for such payments or expenses in the first place, and instead, the no-voluntary payments clause merely specifies that as uncovered expenses they will not be borne by the insurer.
Id. at 144.
In Perini/Tompkins Joint Venture v. Ace American Ins. Co., 738 F. 3d 95 (4th Cir. 2013), the Fourth Circuit affirmed the entry of summary judgment in favor of an insurer that relied on the no voluntary payment and no action provisions in its policy to deny coverage for a settlement agreement entered into without its knowledge or consent. This dispute concerned claims brought against the general contractor of a hotel and convention center development project in Maryland following the failure of a truss joint that impaired the structural integrity of an 18-story glass atrium. As it happened, a representative of the project’s OCIP insurer, ACE, was on site when the truss failed. Approximately two years later, the GC and project owner entered into a settlement agreement after litigating their respective claims against one another for a few months. The settlement agreement required the GC to provide the owner with a $26 million credit toward the final payment owed under the parties’ construction contract in exchange for the owner’s payment of $42 million.
Approximately six months after entering into the settlement, PTJV submitted its first request for coverage for the truss failure under the OCIP policy to the extent that its builder’s risk policy did not provide coverage. PTJV did not disclose the settlement in its notice of claim. Unaware of the settlement, ACE issued a reservation of rights that referenced the policy’s voluntary payment and no action clauses as grounds to deny coverage. Shortly thereafter, PTJV filed a declaratory judgment action against ACE.
Affirming the trial court’s allowance of ACE’s motion to dismiss, the Fourth Circuit Court of Appeals upheld its right to deny coverage based on the insured’s breach of its obligations under the voluntary payment and no action provisions. As the court noted, the “central issue in this appeal is whether the insured . . . can unilaterally settle a construction defect case . . . , present the settlement to its liability insurer as a fait accompli, and obtain indemnification despite its blatant breach of
clear and unambiguous policy provisions.” Responding “no” to that question, the court explained that the policy’s no-action clause clearly stated that the insured could not sue “unless all of its terms have been fully complied with.” The court also pointed to the insured’s disregard of the policy’s clear statement that coverage would only be afforded for a “settlement and release of liability” signed by ACE. The court also upheld ACE’s right to enforce the policy’s no voluntary payment condition which required the insured to obtain ACE’s consent before “voluntarily mak[ing] a payment, assum[ing] any obligation, or incur[ring] any expense.”
The court also rejected the insured’s attempt to challenge ACE’s denial based upon its asserted inability to establish actual prejudice stemming from the insured’s disregard of its obligations under these provisions. As the court explained, the Maryland statute cited by the insured only applies to late notice defenses, not to the insured’s obligation to comply with the policy’s no voluntary payment and no-action conditions precedent. Furthermore, even if the insured could establish a common law no prejudice requirement, the court noted that prejudice could be presumed as a matter of law. By unilaterally entering into a settlement without the insurer’s consent, PTJV prejudiced ACE’s right to investigate, defend, control, or settle the claim.
By gaining a better understanding of the analytical framework that courts use to resolve faulty workmanship coverage disputes under CGL policies in this two-part article, including the increased willingness to deem the “occurrence” requirement satisfied when subcontractors are responsible for the allegedly defective work, insurers and their counsel will both be better positioned to predict the likely outcome of a wide array of litigated and non-litigated defective coverage disputes. Aided by a better understanding of the current approach courts around the country take to these recurring disputes, coverage counsel can also assist their insurer clients in making informed and proactive decisions about their available litigation and settlement options in potentially high-exposure faulty workmanship claims.