Back to the Exclusions—The "Subcontractor" Exception
May 2001
The "your work" exclusion of the CGL policy,
together with its "subcontractor" exception, are the source of great contention
in construction defect cases. This article looks at the question of whether
coverage exists for property damage arising out of work or materials supplied
by other than a traditional subcontractor.
by Patrick
J. Wielinski
Cokinos, Bosien &
Young
Previous commentaries in this space have focused on the insuring agreement
and the occurrence requirement as applied to defective work claims under commercial
general liability (CGL) insurance policies. While these issues have garnered
much attention recently, coverage for many claims is still determined pursuant
to the exclusions in the CGL policy, some of which are tailored to the construction
industry.
The "Your Work" Exclusion
Such an exclusion is Exclusion (l), the "your work" exclusion, together with
its "subcontractor" exception. Exclusion (l) states that the insurance does
not apply to:
"Property damage" to "your work" arising out of it or any part of it
and included in the "products-completed operations hazard."
This exclusion does not apply if the damaged work or the work out of
which the damage arises was performed on your behalf by a subcontractor.
The operation of the "your work" exclusion can be fairly straightforward.
For example, in one of the more in-depth treatments of the exclusion, O'Shaughnessy v Smuckler Corp., 543 NW2d 99 (Minn
App 1996), pet. for rev. denied (Minn 1996), the court upheld coverage for an
insured general contractor for property damage arising out of defective work
performed by subcontractors on a home. The court noted that the subcontractor
exception narrowed the scope of the "business risk doctrine" to allow an insured
coverage for property damage to its own work where that property damage arises
out of work performed by the insured's subcontractor. In that way, an insured
general contractor still retains the risk for the exposure it controls, property
damage for its own defective work.
What Is a Subcontractor?
Nevertheless, despite this apparently straightforward application, issues
can arise as to the scope of the subcontractor exception. Particularly, courts
have addressed questions as to whether a particular party on a construction
project constitutes a "subcontractor" for purposes of a general contractor's
coverage for defective work arising out of that party's work. For example, is
the supplier of a component of the construction work to be considered a subcontractor?
What about a design professional? Not unexpectedly, insurers tend to define
the term "subcontractor" more narrowly than do insured contractors.
The leading case on this issue is National Union
Ins. Co. of Pittsburgh, Pa. v Structural Systems Technology, Inc., 964
F2d 759 (8th Cir 1992), affirming 756 F Supp 1232 (ED Mo 1991). In that case,
a tower collapsed due to defects in prefabricated steel rods. The insured general
contractor argued that the manufacturer and supplier of the rod was a subcontractor
so as to fall within the exception to the "your work" exclusion of its CGL policy.
The court reviewed the contract between the insured and the supplier, which
required it to provide, fabricate, galvanize, and deliver to the site all materials
per certain design and manufacturing specifications. The court held that since
the insured contracted with the supplier to fabricate specially designed steel
rods for the transmission tower, the exception to the exclusion applied, adopting
a construction most favorable to the insured.
The court's conclusion that a supplier is essentially equivalent to a subcontractor
for purposes of the exception to Exclusion (l) is in line with the definition
of "your work" contained in the policy which includes "work or operations performed
by you [the named insured] or on your behalf; and materials, parts or equipment
furnished in connection with such work or operations." Since the named insured's
work includes materials, parts or equipment furnished in connection with that
work, defective materials, parts, or equipment furnished to the named insured
by a supplier should be indistinguishable from defective work or operations
performed for the named insured by a subcontractor. This is especially true
when it is recalled that the subcontractor exception amounts to a limitation
on the business risk doctrine for work or materials not actually performed or
supplied by the named insured, but by its subcontractors.
A more recent case is Transportes Ferreos de Venezuela
II C.A. v NKK Corp., 239 F3d 555 (3rd Cir 2001). In that case, a boom
collapsed, damaging an ore tanker. In denying coverage for the claim, the insurer
relied on a professional services exclusion and the "your work" exclusion, contending
that both the design and the manufacture of the "rod-eye" component of the boom
cylinder was defective. That component was manufactured by a third party for
the named insured.
Under the "your work" exclusion, the court stated that the policy provided
coverage if the accident arose from a defect caused by the third party's manufacture
of the rod-eye. On the other hand, if the failure arose out of a design defect,
coverage would be excluded under the professional liability exclusion. Finding
the record unclear as to whether the collapse was due to a design or manufacturing
defect, the court remanded the case to the trial court, specifically stating
that if the failure arose out of a manufacturing defect, coverage would be provided
under the policy.
In the eyes of the Third Circuit in the Transportes
Ferreos v NKK Corp. case, the key distinction was whether the defective
rod-eye was supplied by a third party, not whether that third party was a subcontractor
or a supplier. It made no effort to distinguish between suppliers and subcontractors
for purposes of application of the exception to the "your work" exclusion.
Similar reasoning was employed by the court in First
Texas Homes, Inc. v Mid-Continent Cas. Co., 2001 U.S. Dist. LEXIS 2397
(ND Tex March 7, 2001), a case in which the insured homebuilder sought coverage
for property damage to a home arising out of a defective foundation. One of
the exclusions relied on by the insurer was the "your work" exclusion. The petition
in the underlying lawsuit alleged that an engineer negligently designed or was
involved in the design of the foundation of the house. Moreover, an affidavit
of the insured established that the engineer was hired to design the foundation
of the home. Since the design was alleged to be defective and was performed
by a third party hired to design the foundation, the court held that the subcontractor
exception applied so that, consequently, the "your work" exclusion was inapplicable.
Is the Subcontractor's Work Defective?
The cases discussed above demonstrate that as long as a third party, whether
subcontractor or supplier, is responsible for the defect out of which the property
damage arises, the subcontractor exception to the "your work" exclusion will
be applied. This was not the case in Collett v Insurance
Co. of the West, 64 Cal App 4th 338, 75 Cal Rptr 2d 165 (1998). In that
case, the insured general contractor brought suit against its CGL insurer seeking
coverage for the cost of repairing the retaining wall in a residential development.
Per the requirements of the contract with the developer, the insured hired a
special inspector to verify and report to the project structural engineer that
the walls were being constructed according to strict specifications. Unfortunately,
the retaining wall failed subsequent to completion.
In denying coverage to the insured contractor, the CGL insurer relied on
the "your work" exclusion. In response, the insured contractor contended that
the term "subcontractor" should be interpreted in its broadest sense so as to
include the inspector hired by the contractor, citing National Union Fire Ins. v Structural Systems Technology,
discussed above.
The California Court of Appeals recognized National
Union v Structural Systems as a "broad interpretation of subcontractor,"
but stated that even under that broad view, an "inspector" was not a "subcontractor."
The court said that while the inspector may have failed to catch defects in
the retaining walls, he did not put them there. Rather, the defective retaining
walls were the insured's own work. Under this view, the rationale behind the
subcontractor exception to the "your work" exclusion simply does not apply since
the insured's own work constitutes its own business risk.
Suppliers as Subcontractors under the Law
The cases that have addressed this issue all seem to agree that so long as
the defect arises out of either work or materials supplied by a third party
which contracted with the insured, the "your work" exclusion will not apply.
This result, in addition to being supported as an exception to the business
risk doctrine for the work or materials of the third parties, is also in keeping
with traditional construction law, which makes little differentiation between
a supplier and a subcontractor.
In that connection, see Crow-Williams, I v Federal
Pacific Electric Co., 683 SW2d 523 (Tex App—Dallas 1984, no writ). In
that case, a contractual waiver of subrogation as to builders risk insurance
coverage extended to "subcontractors and sub-subcontractors." After a fire caused
by a defective bus duct system supplied to the electrical subcontractor, the
builders risk insurer claimed that the supplier was not a "subcontractor" or
"sub-subcontractor" as set out in the waiver of subrogation. The court rejected
this argument, holding that the word "subcontractor" was not ambiguous and that
it had an ordinary meaning. In the ordinary sense of the word, a subcontractor
includes an entity in the position of an electrical supplier, a materialman.
Arguments for Coverage
Based on the above, coverage for property damage arising out of work or materials
supplied by other than a traditional subcontractor is supported by the following
arguments:
- The definition of "your work" in the policy includes materials, parts,
or equipment furnished as part of it.
- The fact that the defective materials are furnished by a third party
supplier and were not fabricated by the named insured supports the limited
exception to the business risk doctrine for labor and materials provided
by third parties and not the insured itself.
- In terms of defective work, there is little distinction between a subcontractor
and a supplier under traditional construction law.
So long as the property damage arises out of a lower tier's work, materials,
or design, an insured contractor has a strong argument for application of the
subcontractor exception to the "your work" exclusion.
This commentary updates and supplements the discussion contained
in Chapter 11 of
Insurance for Defective
Construction: Beyond Broad Form Property Damage Coverage, published
by IRMI and authored by Mr. Wielinski.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.