"Defective Construction as Occurrence" 2007: Too Close To Call
May 2007
The first
article in this series on insurance coverage for defective work appeared
on IRMI.com 7 years ago. It discussed a disturbing trend among some courts to
accept a relatively new interpretation of the standard CGL insurance policy.
It developed into a more detailed book,
Insurance for
Defective Construction.
by Patrick
J. Wielinski
Cokinos, Bosien
& Young
Based on the definition of "occurrence," that interpretation is used to deny
claims involving defective work on the theory that the performance of defective
work that breaches the insured's contract is foreseeable and outside the coverage
grant of the CGL policy. This novel interpretation ignores the coverage preserved
for defective work claims under the carefully drafted property damage exclusions1 by focusing the definition of "occurrence."2
The past 18 months have seen the issuance of a number of opinions on the
issue of "defective construction as occurrence." The disputes between insureds
and insurers have become more heated, and the judicial resolution has resulted
in ongoing and disparate results. Little forward progress seems to have been
made in this regard, despite the ongoing gyrations of insurers, insureds, and
their lawyers, alike.
The unusual amount of litigation as to the definition of occurrence is somewhat
understandable in that it corresponds to the increasing amount of ongoing construction
defect litigation before the courts. The "defective construction as occurrence"
issue involves relatively high stakes, since if insurers succeed on their argument,
the coverage intended to be preserved under the property damage exclusions in
the standard CGL policy for certain types of defective workmanship claims will
be virtually stolen away.
The following is a description of recent cases organized according to whether
they favor the insurer, the insured, or take a middle ground approach. Several
of these cases are currently on appeal and, of course, the result of those cases
is still uncertain.
Pro-Insurer View: Breach of Contract
These cases deny coverage and adopt the insurer's view that defective construction
is not an occurrence. Taken to their extreme, this line of cases stands for
the proposition that faulty or defective workmanship that damages the subject
matter of the contract—that the insured contractor has agreed to construct—is
foreseeable and cannot be an occurrence. These cases focus on the intentional
nature of the act of construction, rather than the expected or intended nature
of the property damage resulting from performing it defectively.
Pennsylvania
Kvaerner
Metals v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006). The faulty
work by an insured contractor that constructed a coke battery resulting in damage
to the battery itself was not an accident under the contractor's CGL policy.
The faulty workmanship claims simply did not present the degree of fortuity
contemplated by the ordinary definition of accident.
South Carolina
L-J,
Inc. v. Bituminous Fire & Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005).
This case was heralded as a major victory for the regional insurers touting
the "defective work is not an occurrence" argument and has been the subject
of much commentary. In that case, the court held that the premature cracking
in roadwork due to the negligence of a subcontractor was not an occurrence,
since the only damage done was to the road, the insured's own work product itself.
However, other courts have been hesitant to apply the L-J reasoning.
For example, in Okatie Hotel Group v. Amerisure Ins.
Co., 2006 WL 91577 (D.S.C. Jan. 13, 2006), the court determined that L-J v. Bituminous stands for the proposition
that no occurrence exists if the damage is restricted to the defective work
itself. However, if the damage extends beyond the defective work to otherwise
nondefective work, there is an occurrence; upholding coverage for a claim involving
water intrusion damage to the interior of a hotel resulting from other defective
work. Okatie Hotel represents something of a
"middle ground" approach that is more fully discussed below. The issue of "defective
workmanship as occurrence," and the determination of the South Carolina Supreme
Court in L-J v. Bituminous, has spawned a raft
of litigation in the federal courts of South Carolina.
The court in Okatie Hotel was the first of
several courts to limit the scope of L-J v. Bituminous,
but other courts have refused to do so. SeeBituminous
Cas. Corp. v. Altman Builders, Inc., 2006 WL 2137233 (D. S.C. July 28,
2006), in which the court invoked Dante's The
Divine Comedy (Inferno) to admonish contractors seeking coverage for
defective work to "abandon hope, all ye who enter here," in light of L-J v. Bituminous. Some of these cases are on
appeal to the Fourth Circuit, so the issue appears to be far from decided under
South Carolina law despite the sweeping holding in L-J.
Pro-Insured View: Unintended and Unexpected Nature of Property Damage
Those courts that uphold coverage for the insured contractor, thus finding
an occurrence, tend to emphasize the unexpected and unintended nature of the
property damage. In other words, while they recognize that the installation
of the work is intentional, the defective result and resulting property damage
is not expected or intended, and falls
within the definition of occurrence.
In addition, insureds argue that there is no distinction between damages
for breach of contract or tort, either in the insuring agreement of the CGL
policy, or in the definition of occurrence. Whether the property damage results
from breach of contract is immaterial so long as there has been unexpected or
unintended property damage to the project. The following cases set out the view
advocated by insureds—that unexpected and unintended property damage caused
by defective construction is an occurrence, and in general, resort must be had
to the exclusions to determine the precise scope of coverage.
Arizona
Lennar
Corp. v. Auto-Owners Ins. Co., 2007 WL 152099 (Ariz. App. Jan. 23, 2007)
petition for review filed. Damage to homes caused by defective site preparation
by the insured homebuilder's subcontractors constituted an occurrence, and the
CGL policy covered the natural consequences of negligent construction. The court
applied the subcontractor exception to Exclusion (l), the "your work" exclusion,
to uphold coverage for the damage to homes caused by the defective site preparation
of the insured builder's subcontractors.
Tennessee
Travelers
Indem. Co. of Am. v. Moore & Assocs., Inc., 2006 WL 4099997 (Tenn. March
7, 2007). The court rejected the insurer's argument that defective work installed
pursuant to contract is foreseeable and not an occurrence. Rather, the alleged
water penetration from faulty window installation by the named insured's subcontractor
was unexpected and unforeseen, and thus, an "accident" and an "occurrence" within
the meaning of the CGL policy. Even though the water penetration could be the
natural consequence of improperly installed windows, the foreseeability of the
damages could not be determined under an assumption that the windows would be
installed improperly, and the insured could not have foreseen water penetration
if the windows had been properly installed. The court went on to apply the subcontractor
exception to Exclusion (l), the your work exclusion, to uphold coverage for
the insured general contractor for property damage resulting from the water
penetration caused by the faulty workmanship of its window installer.
Middle Ground: Damage to Other Work
While the pro-insurer argument requires a departure from the policy language,
so does a middle ground view that is emerging. In that middle ground, while
generally holding that defective work in and of itself is not an occurrence,
courts nevertheless find coverage for other nondefective portions of the work
that are damaged by the defective work. In other words, there is no occurrence
if the damage is restricted to the defect itself, but damage to other work,
even work performed by the insured contractor pursuant to its contract, is covered.
This position imports a requirement for damage beyond the work itself into the
occurrence language in the CGL policy, a requirement that is not found in that
language. In that manner, it leaves coverage on the table that would otherwise
be preserved through consideration of the exclusions.
For example, under the language of the subcontractor exception to the your
work exclusion, the policy provides coverage for even the defective portion
of a subcontractor's work. Such would not be the case under the middle ground,
since there would be no occurrence for that portion of the property damage.
South Carolina.Okatie
Hotel Group v. Amerisure Ins. Co., 2006 WL 91577 (D. S.C. Jan. 13, 2006).
See the discussion of this case above in connection with L-J v. Bituminous.
The Map: Impossible To Project
The following map illustrates the current state of the law among the 50 states
and the District of Columbia. It illustrates the effect, on a national basis,
of the cases set out above, as well as prior and existing opinions on the issue.
This map, together with a matrix summarizing the cases addressing the issue
of defective work as occurrence and the treatment of the property damage exclusions
in the 50 states, is available as an update of the online edition of the author's
book,
Insurance
for Defective Construction, Second Edition, available on IRMI-Online.com.
The maps and matrix will be periodically updated online to maintain the currency
of the material.
Display the Map
In states such as Florida, Texas, and Minnesota where the occurrence issue
is on appeal, not even the likes of Wolf Blitzer or Dan Rather can project whether
these states will end up in the blue or the red column. Much to the chagrin
of insured contractors and those who would honor the policy wording, this race
is just too close to call. Hopefully there will be no hanging chads after the
dust settles.
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.