Faulty Work and the CGL
July 2005
We all make them (even if we don't admit to
them). Mistakes, that is. It's just a matter of what, when and how. Lives can
be defined by a mistake (without always having the benefit of errors or omissions
insurance). Take Fred Merkle, for instance. Almost 100 years later, he is still
remembered for one misjudgment, just one mistake that will be forever known
as the Merkle Boner.
by Craig
F. Stanovich
Austin &
Stanovich Risk Managers, LLC
With two out in the last of the ninth, and the scored tied against the Chicago
Cubs, New York Giant's Fred Merkle stood on first base. His teammate, representing
the winning run and the National League pennant, waited at third. The hitter
promptly singled, driving in the winning run and clinching the pennant for the
Giants! Or so Fred Merkle thought.
As the celebration began, he went from first base to the dugout, never touching
second base. An alert Cub player fought through the crowd, retrieved the ball
and jumped up and down on second, getting Merkle out by a force play and nullifying
the run. The game was declared a tie and had to be replayed—and the Giants lost
the replayed game and the pennant to the Cubs in 1908. At the ripe old age of
19, Fred Merkle had made a mistake—and cost his team a World Series berth.1
An Occurrence
What could the Merkle Boner possibly teach us about the commercial general
liability (CGL) insurance policy? For starters, while it certainly was a lapse
in judgment, Fred Merkle neither intended nor expected to be put out at second
base (or lose the game and the pennant). It was an accident—the prime element
of an "occurrence" as defined in the CGL policy. Are all mistakes—i.e., accidents—covered
by the CGL?
Bodily Injury
An occurrence first must result in either property damage or bodily injury
for the CGL to respond. While there reportedly was a great deal of mental anguish
by many fans and players (including Fred Merkle), no one was physically harmed
by the play. No bodily injury resulted.
Property Damage
The owners of the Giants certainly lost significant revenues because the
Polo Grounds (the Giants' home field) would not host the World Series that year.
However, property damage requires more than just the loss of revenue or unexpected
additional costs. Property damage requires physical
injury to tangible property and the
consequential loss of use of the damaged property. Property damage also includes
the loss of use of tangible property that is not
physically injured.
The Polo Grounds was neither physically damaged (physical injury to tangible
property) nor somehow unfit for playing baseball (loss of use of tangible property
not physically injured) as the result of Fred Merkle's play. As no property
damage had occurred, there is no coverage in the CGL, despite a mistake that
was truly an accident.
Faulty Work
What about mistakes that involve "faulty work?" Is "faulty work" covered
by the CGL? It depends—a definite maybe.
Faulty work can be loosely defined as any type of operation performed, including
materials, parts, or equipment that is part of
the work, which is done incorrectly. It might be something that is installed,
repaired, built, or maintained in a manner that falls below generally recognized
standards of quality or fails to meet representations or warrantees. Even failing
to provide instructions or warnings can make it faulty work.
Property Damage Exclusions
As already noted, for the CGL (Coverage A) to be triggered, bodily injury
or property damage must result from an occurrence. In addition, regardless of
when the occurrence happens, the bodily injury or property damage resulting
from the occurrence must take place during the policy period. The phrase found
in the insuring agreement "to which this insurance applies" lets us know that
coverage limitations and exclusions will follow.
Presuming a claim for faulty work is considered property damage caused by
an occurrence (occasionally a big leap), we need to examine a series of property
damage exclusions to determine the extent
of coverage found in the Insurance Services Office, Inc. (ISO), CGL policy for
faulty work (December 2004 edition). Unfortunately, the wording of these exclusions
is a little arcane, resulting in not only significant misunderstandings but
also grounds for coverage disputes. How the exclusions apply to faulty work
is best explained by some examples.
Our Players
For the purposes of our examples, we have Great Big General Contractor, Inc.
(we'll call it GBGC, Inc.), and Not So Big Subcontractor, Inc. (we'll call it
NSBS, Inc.). Of course, we are talking about construction or contracting operations.
At the outset, it is important to define a couple of terms to avoid confusion.
(All definitions come from Black's Law Dictionary,
7th ed.).
-
Contractor—One who contracts to do
work or provide supplies to another.
-
General Contractor—One who contracts
for completion of the entire project, including purchasing all materials,
hiring and paying subcontractors, and coordinating all work. Also termed
original contractor or prime contractor.
-
Subcontractor—One who is awarded a
portion of an existing contract by a contractor, especially a general contractor.
|
"Property damage" to:
(5) That particular part of real property on which you or any contractors
or subcontractors working directly or indirectly on your behalf are
performing operations, if the "property damage" arises out of those
operations;
|
GBGC is engaged by the owner to repair portions of a sprinkler system in
an older industrial building. In its haste to finish the job, GBGC snaps a pipe
when tightening it with the wrong type of equipment. The broken pipe falls and
breaks other pipes already installed by GBGC, tripping the sprinkler system.
Portions of the building are extensively damaged by the water.
The owner makes claim against GBGC for damage to the sprinkler system as
well as water damage to the rest of the building. As GBGC has incorrectly performed
its work, some may consider this to be faulty work.
Exclusion j. (5) eliminates from coverage property damage to that particular
part of real property on which GBGC is performing operations if the damage arises out of the operations. In this example, the
property damage did arise from GBGC's operations—the damage happened while GBGC was actually repairing the sprinkler system.
But what is the meaning of "that particular part of real property?" Clearly,
the portions of the building damaged by the water cannot be considered to be
that particular part of the real property on which GBGC was working. Thus, property
damage coverage would apply to all portions of the building damaged by the water.
Conversely, damage to the pipe that snapped is excluded—it was the negligent
tightening of the pipe that caused it to snap. But what about the other portions
of the sprinkler systems already repaired by GBGC that were damaged when the
broken pipe fell. While not universally held, the other pipes of the sprinkler
system are generally not considered to be
"that particular part" upon which GBGC was actually performing operations when
the property damage occurred. Therefore, GBGC would have coverage for the cost
of replacing the pipes damaged by the falling pipe.
|
"Property damage" to:
(6) That particular part of any property that must be restored, repaired
or replaced because "your work" was incorrectly performed on it.
|
The state hires GBGC to resurface portions of the highway. The work involves
removing the existing surface and laying bituminous concrete (asphalt) over
the "grooved" pavement. Unfortunately, GBGC scrapes away far too much, accidentally
scraping way most of the compacted gravel that is the base of the highway. The
resurfacing project quickly becomes a disaster—the new asphalt being applied
by GBGC crumbles into small pieces only hours after the roller passes over it.
The project is quickly halted, and the state brings a claim against GBGC for
the cost of replacing the compacted gravel base.
Exclusion j. (6) expressly excludes damage to the highway base—the compacted
gravel—as it is property that must be replaced or repaired because GBGC's work
was incorrectly performed on it. GBGC has no CGL coverage for the claim by the
state.
Another Example
Here is another example of exclusion j. (6) that more clearly distinguishes
it from exclusion j. (5). GBGC, Inc., is engaged by the Steamship Authority
to perform repair work on the ship's steam turbines, specifically to inspect
and replace the turbine blades. After completing the inspection and replacing
some blades on one of several turbines to be serviced, a marine contractor engaged
by the Steamship Authority, NSBS, Inc., tests the turbine. Because a few of
the blades were not securely installed by GBGC, the testing causes some of these
blades to break apart, rendering the turbine useless. The Steamship Authority
makes claim against GBGC, Inc., for the cost of replacing the damaged turbine
blades.
As the turbine blades are not likely be considered real property, exclusion j.(5) would not
apply. Exclusion j. (6) excludes property damage to "that particular part of any property," thus eliminating coverage
for GBGC, Inc., for the cost of replacing the blades. The damage to the blades
was a result of work incorrectly performed by GBGC on the blades, necessitating
their replacement.
It is important to note that exclusion j. (5) applies only if the damage
occurs during the operation. Exclusion j. (6) eliminates coverage for damage
during as well as after the some portions of the work are finished, provided
the work does not fall into the "products-completed operations hazard." Further,
the exclusions apply whether the work was done directly by GBGC's employees
or was performed on behalf of GBGC by a subcontractor engaged by GBGC.
|
"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.
|
GBGC is hired by the state to put in the new ramp for the highway. The project
involves site preparation, such as excavation, grading, and compaction, as well
as laying down the compacted gravel base and the proper layers and thickness
of bituminous concrete to meet state highway standards.
GBGC completes the project and it is put to its intended use—the ramp is
open to all traffic. But 3 weeks after completion, the highway ramp begins to
cave in and crumble. The state investigates and finds that the earth was not
properly compacted and the depth of compacted gravel base put down was inadequate.
The base and the earth under the base of the highway had collapsed, resulting
in the crumbling of the bituminous concrete. In short, the work performed was
faulty. The state subsequently sues GBGC for the cost of completely rebuilding
the highway ramp.
Exclusion l. eliminates coverage for property damage to "your work" arising
out of it or any part of it. In order for the exclusion to apply, the work has
to be included in the "products-completed operations hazard." Does this exclusion
apply to the cost of rebuilding the highway ramp?
There is no question that the highway ramp was the work of GBGC. And since
the cause of the damage (the highway crumbling is property damage) resulted
from the work itself (inadequate compaction of the earth and gravel base), the
damage to the highway did "arise" out of the work.
But unlike the prior exclusions j. (5) and j. (6), this exclusion only applies
if the work that caused the damage is included within the "products-completed
operations" hazard.
The CGL contains three measures of when work is considered completed—and
thus included within the products-completed operations hazard. One such measure
is that the work at the jobsite has been put to its intended use by the owner.
In the above example, the state has opened the highway to the public. GBGC's
work has been put to its intended use, and thus its work now falls squarely
within the products-completed operations hazard.
Based on the above, GBGC has no coverage for the cost to replace the highway
ramp. The work is faulty, and insurance is not meant to pay for the cost of
fixing work not properly done. The cost of fixing faulty work is seen as a business
expense or business risk.
Important Exception—Damage to Your Work
As is the tendency, the above "no coverage" conclusion has been reached without
determining all the facts and, most importantly, without examining the entire
exclusion. All too often, insurers cite exclusion (l) in either a denial letter
or reservation of rights letter and completely
leave out any mention of the exception to the exclusion.
This exclusion is limited—it does eliminate coverage for the cost of repairing
"your work" ("your work" does include operations performed on your behalf),
but does not apply if:
- the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.
Subcontractor Exception
A closer look at the facts of the above ramp work reveals that the GBGC,
Inc., subcontracted to NSBS, Inc., the site preparation—the excavation, grading,
compaction, and laying down the compacted gravel base. GBGC operations were
to put down the layers of bituminous concrete.
As the damage to GBGC's work (bituminous
concrete) arose out work performed on behalf of
GBGC, Inc. by a subcontractor (the improperly compacted earth and gravel
base), GBGC has coverage for the cost of replacing the bituminous concrete.
In addition, as the damaged work (the
damaged work here is the collapsed base) was also performed on GBGC's behalf,
GBGC has coverage for the cost of properly compacting the soil and properly
installing the compacted gravel base.
In short, using the above fact scenario, exclusion
(l) does not apply to GBGC, Inc. at all—full coverage for the damage
to all work performed is granted by the exception to the exclusion. As the cause
of the damage to GBGC's work was due to a subcontractor's work, GBGC has coverage
for its own work. Further, GBGC also has coverage for damage to the subcontractor's
work.
Another Example
What if the facts were reversed—GBGC performed the highway site work: excavation,
grading, laying, and compaction of the gravel base—and subcontracted to NSBS,
Inc., application of the layers of the bituminous concrete. Assume the same
reason for the damage—GBGC did not properly compact the earth and the gravel
base, which later collapsed.
The exception still applies—but a little differently. GBGC would not have coverage for the cost of replacing
the gravel base as the damage to GBGC's work did not arise out of the work performed
by a GBGC subcontractor. However, the damage to the bituminous concrete (the
damaged work) was performed on GBGC's behalf by a subcontractor and thus the
cost of replacing the bituminous concrete is covered by GBGC's CGL policy.
|
"Property damage" to "impaired property" or property that has not
been physically injured, arising out of:
(1) A defect, deficiency, inadequacy or dangerous condition in "your
product" or "your work"; or
(2) A delay or failure by you or anyone acting on your behalf to
perform a contract or agreement in accordance with its terms.
This exclusion does not apply to the loss of use of other property
arising out of sudden and accidental physical injury to "your product"
or "your work" after it has been put to its intended use.
|
Let's go back to our first example, but change the facts a little. GBGC installs
a sprinkler system for the owner of a new office building. This time, no pipes
snap or break—there is no physical injury to tangible property. However, it
is discovered that the system has not been installed to building code—the owner
can replace portions of the sprinkler system to bring it up to code, but only
at considerable cost.
The owner makes claim against GBGC for the cost of replacing the incorrectly
installed portions of the sprinkler system and also for the loss of use of the
office building as the owner cannot obtain an occupancy permit until the sprinkler
system is installed to building code.
Impaired Property
From the viewpoint of GBGC, the owner's office building is "impaired property."
That is, the office building is less useful because GBGC's work (the sprinkler
system) is known to be inadequate (it does not meet building codes), and the
property can be restored to use by replacing GBGC's work—bringing the sprinkler
system up to code.
GBGC has no coverage for the cost of replacing or repairing the sprinkler
system as the sprinkler system itself, which is tangible property, has not been
damaged. Thus there is no property damage to the GBGC's work—the sprinkler system.
The improper installation of the sprinkler systems has, however, caused loss
of use of tangible property—the office building. The owner cannot collect rent
until the sprinkler system is installed to code. Even though the definition
of "property damage" in the CGL policy does include loss of use of tangible
property (even if not physically injured), exclusion (m.) expressly eliminates
coverage for any property damage to impaired property. As the office is impaired
property, GBGC has no coverage for the loss of use claim made by the building
owner.
Exception to Impaired Property
There is an exception to this exclusion. Assume that GBGC goes ahead and
replaces the appropriate parts of the sprinkler system, bringing it up to code.
The landlord is able to rent space to his tenants and collect rental income.
Unfortunately, 4 months after full occupancy, the main riser of the sprinkler
system suddenly cracks and needs to be replaced (no damage is done to any other
property). GBGC is found to have used defective piping materials—the reason
the riser cracked.
Because the cracked riser renders the building unusable as an office building,
the owner again makes claim against GBGC for loss of use—the tenants are not
required to pay the rent if damage to the building prevents them from occupying
their space.
Because the loss of use of the office building arose out of the sudden and
accidental physical injury to GBGC's work (the cracked riser), the exception,
applies and GBGC has coverage for this loss of use claim made by the owner.
Conclusion
Faulty work can be covered by the CGL policy. Properly determining coverage
does require a detailed understanding of precisely what happened as well as
a thorough understanding how the property damage exclusions (and their exceptions)
apply. Too often, coverage is denied without a good faith effort to ascertain
the facts or by a less than careful reading of the CGL policy. Doctrines such
as "business risk" or "economic loss" as reasons for denial are not a substitute
for the plain meaning of the policy. While it may be easier and more expedient
to deny coverage using such buzz phrases, the public and the industry will be
better served by paying close attention to facts, coverage wording, and applicable
case law.
To read more on the legal issues affecting insurance
coverage for faulty work and construction defects, see IRMI.com articles by Patrick J. Wielinski of Cokinos, Bosien
& Young, and stay tuned for the second edition of his book, Insurance for
Defective Construction, due out this fall.
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.