Defective Construction as an Occurrence: Witnessing the 'Occurrence' Farewell
Tour?
April 2008
As described in previous articles in this
column, Insurance
Law: Construction Defect, 2007 saw the issuance of a number of much-publicized
opinions on the subject of defective construction as an occurrence, mostly from
the highest courts of several states. Those courts rejected the arguments of
some insurers that damage to a construction project arising out of the performance
of defective work in breach of the insured's contract is foreseeable and therefore
does not meet the definitions of "occurrence" and "property damage" in the commercial
general liability (CGL) insurance policy.
by Patrick
J. Wielinski
Cokinos, Bosien
& Young
Similar results are being reached by courts in 2008. Those 2007–2008 cases
include:
- Travelers Indem. Co. of Am. v. Moore & Assocs.,
Inc., 216 S.W.3d 302 (Tenn. 2007)
- Lamar Homes, Inc. v. Mid-Continent Cas. Co.,
242 S.W.3d 1 (Tex. 2007)
- Lennar Corp. v. Auto-Owners Ins. Co.,
151 P.3d 538 (Ariz. App. 2007)
- U.S. Fire Ins. Co. v. J.S.U.B., Inc.,
2007 WL 4440232 (Fla. Dec. 20, 2007)
- Auto-Owners Ins. Co. v. Pozzi Window Co.,
2007 WL 4440389 (Fla. Dec. 20, 2007)
- Aten v. Scottsdale Ins. Co., 511 F.3d
818 (8th Cir. 2008)
The most recent in this line of cases is Auto Owners
Ins. Co., Inc. v. Newman, 2008 WL 648546 (S.C. Mar. 10, 2008).
This line of cases is remarkable for its consistent adherence to the policy
language in determining that unexpected and unintended property damage to a
construction project is an accident within the definition of occurrence,
and going on to apply the exclusions in
the policy. Of those exclusions, the courts primarily addressed the "Your Work"
exclusion, together with its exception for property damage arising out of subcontractor
work for the insured.
Considered together, these cases not only establish a clear trend, but amount
to something of a "farewell tour" as to the "no occurrence for breach of contract"
argument. As stated, most of these cases were described in my February 2008
article, 2007 Defective Construction
Insurance Cases, but the newly issued opinion of the South Carolina Supreme
Court in Auto Owners v. Newman warrants additional
discussion. In fact, so far, it is the most important date or gig on the "Farewell
Occurrence Tour." It is also a harbinger of perhaps another tour of various
jurisdictions, the "Property Exclusion Reunion Tour," in that the parties to
insurance disputes will now refocus on the applicability of exclusions in the
policy since the existence of "occurrence" and "property damage" as to construction
defects in appropriate cases has now been reaffirmed.
The L-J v. Bituminous Fallout
The "breach of contract as no occurrence" argument has had no more checkered
history than in South Carolina. By way of background, in 2005, the South Carolina
Supreme Court issued a much-publicized opinion, L-J,
Inc. v. Bituminous Fire & Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005).
That opinion was pointed to by many as spelling the end of CGL coverage for
property damage arising out of defective construction. In that case, the court
held that damage to a roadway due to cracking caused by a subcontractor's work
was not an occurrence since the only damage was to the road, the insured contractor's
work.
Despite that pronouncement, federal district courts in South Carolina continued
to certify questions to the South Carolina Supreme Court as to whether its holding
in L-J v. Bituminous applied to deny coverage
for numerous claims involving property damage to other parts of a building caused
by continuous exposure to moisture which results from faulty workmanship.
That same issue was addressed by the federal district court in
Okatie Hotel Group, LLC v. Amerisure Ins. Co.,
2006 WL 91577 (D.S.C. Jan. 13, 2006), where the court determined that
L-J v. Bituminous stood 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. In Okatie, the
court ultimately upheld coverage for a claim involving water intrusion damage
to the interior of a hotel resulting from defective work.
The question certified by these courts to the Supreme Court of South Carolina
was whether damage to other nondefective portions of a construction project
due to water infiltration constitutes an occurrence of property damage under
a general contractor's CGL policy. Pending the answer of the certified question,
the various federal cases were stayed.
The Auto Owners v. Newman Case
The certified question was answered by the South Carolina Supreme Court in
mid-March 2008, in Auto Owners Ins. Co. v. Newman.
That case was hand-picked by the court pursuant to South Carolina procedure,
essentially for purposes of answering the certified question from the federal
courts.
The case involved defective stucco work performed by the insured homebuilder's
subcontractor. Specifically, defective stucco application by a subcontractor
allowed water to seep into the home, causing severe damage to the home's framing
and exterior sheathing. Relying on the plain language in the policy, the South
Carolina Supreme Court found there had been an "occurrence" of "property damage"
caused by the subcontractor's defective work. The Auto
Owners v. Newman case is quite remarkable in that it severely limited
and effectively abrogated the prior opinion of the South Carolina Supreme Court
in L-J, Inc. v. Bituminous, in which the court,
less than 3 years earlier, had held to the contrary.
In its analysis of "occurrence," the court determined that the insurer's
argument that the property damage caused by the subcontractor's defective work
was foreseeable, and thus expected and intended since it arose out of the insured's
breach of contract, was "unreasonable" in that no insured homebuilder would
expect its subcontractor to perform negligently. Applying that common-sense
logic, the court affirmed the trial court's award of damages for
rough carpentry, windows and doors, thermal and moisture protection, and interior
and exterior finishes as demonstrating the existence of the underlying water
damage to the home resulting from the defectively applied stucco. In addition,
because this underlying moisture damage could neither be assessed nor repaired
without first removing the entire stucco exterior, the allowance for replacement
of the defective stucco was covered by the CGL policy as a cost associated with
remedying the other property damage that resulted from an "occurrence."
In Auto Owners v. Newman, the court also took
the opportunity to clarify its citation to High Country
Assoc. v. New Hampshire Ins. Co., 648 A.2d 474 (N.H. 1994), in its prior
L-J v. Bituminous opinion. In
L-J, the South Carolina Supreme Court used
High Country as an example of a case upholding
coverage where defective workmanship resulted in property damage. It regarded
the facts of High Country as setting out covered
property damage caused by continuous exposure to moisture to other work, rather
than simply a claim for the contractor's defective work that was outside the
scope of CGL coverage. Confusion over the citation to that case in
L-J was created because the facts of
High Country were substantially similar to those
in L-J, and also to the state and federal cases
involving water infiltration as discussed above.
In L-J, the South Carolina Supreme Court had
distinguished between "a claim for faulty workmanship versus a claim for damage
to the work product caused by the negligence of a third party," noting that
the latter would be covered under a CGL policy. In looking to clear up confusion
arising out of that aspect of L-J, the court
stated in Newman that, "given our analysis of
High Country in the L-J
opinion, it should be clear that this Court intended the 'third party' language
to refer to subcontractors who are not a party to the CGL policy between the
insurer and the contractor." Although the South Carolina court did not expressly
overrule L-J in Newman, this "clarification" represented an attempt to backtrack
from its prior holding that deprived many construction insureds of coverage,
contrary to the policy language.
It should be noted that the result in Auto Owners
v. Newman was achieved through reliance on the definitions of occurrence
and property damage, although neither of those definitions appears to make any
distinction, in terms of "accident," or "physical injury to tangible property,"
as to whether the insured's defective work damages other work. The same result,
and perhaps a result "truer" to the policy language, could have been achieved
through reliance on the exclusions, particularly the subcontractor exception.
The court discussed and relied on that exception in tandem with the definitions
of occurrence and property damage to achieve essentially the same result.
The Property Damage Exclusion Reunion Tour
As evidenced by the above discussion, the judicial trend in many jurisdictions
appears to be the rejection of the theories previously utilized by insurers
to deny coverage in construction defect insurance disputes, such as the breach
of contract versus tort distinction and the economic loss rule, none of which
have any basis in the policy language itself. Instead, those courts tasked with
determining coverage issues are now focusing again on the actual terms of the
policy, including the policy exclusions. As such, momentum for a Property Damage
Exclusion Reunion Tour is building. Below are some of the more noteworthy opinions
issued in 2007–2008 in which various courts construed and applied property damage
exclusions in disputes involving defective workmanship, either as a part of
the Reunion Tour, or sometimes as the closing act on a double bill on the Occurrence
Farewell Tour after the existence of an occurrence had been upheld.
For example, in Lamar Homes, Inc. v. Mid-Continent
Casualty Co., 242 S.W.3d 1 (Tex. 2007), the court traced the expanded
coverage provided under the CGL policy for certain business risks, recognizing
the effect of the broad form property damage (BFPD) endorsement which culminated
in the insertion of the subcontractor exception into exclusion (l), the your
work exclusion, into the CGL policy in 1986. By incorporating the subcontractor
exception into the your work exclusion, the insurance industry specifically
contemplated coverage for property damage caused by a subcontractor's defective
performance.
Similarly, in U.S. Fire Ins. Co. v. J.S.U.B., Inc.,
2007 WL 4440232 (Fla. Dec. 20, 2007), the Florida Supreme Court recognized the
applicability of the subcontractor exception to exclusion (l), the your work
exclusion, by upholding coverage for the insured builder for property damage
to homes caused by inadequate site preparation performed by a subcontractor.
The Florida Supreme Court rejected the argument that to apply the exception
would create coverage through an exclusion. It also concluded that to uphold
coverage under the CGL policy would not convert the policy into a performance
bond.
A case denying coverage based upon an exclusion is
Burlington Ins. Co. v. Steve's Ag Servs., Ltd.,
2007 WL 4357767 (9th Cir. Dec. 10, 2007) (applying Hawaii law). There, the court
held that exclusion j(6), the faulty workmanship exclusion, applied to deny
coverage to an insured contractor that logged state lands without a permit,
since the claim for the value of the timber taken constituted an effort to repair
and replace the insured's work within the meaning of the exclusion.
Another case is Bituminous Casualty Corp. v. Kenway
Contracting, Inc., 2007 WL 1790685 (Ky. June 21, 2007), in which the
court held that exclusions j(5) and j(6), the operations and faulty workmanship
exclusions, did not apply to a claim which arose out of the unintentional demolition
of an entire home when only the carport was to be demolished. Both exclusions
were ambiguous since the policy did not define the terms "that particular part
of real property" or "operations," and there was no allegation that any of the
work on the carport itself was faulty.
In Calcasieu Parish Sch. Bd. v. Lewing Constr. Co.,
Inc., 2007 WL 4322161 (La. App. 2007), the court found that despite its
previous finding of coverage, exclusion (k), the your product exclusion, or
exclusion (l), the your work exclusion, applied to bar coverage for property
damage to a floor installed in a school by the insured flooring subcontractor.
The court did not differentiate between whether the insured's installation of
the flooring was considered "your work" or "your product," but instead simply
held that one of those exclusions would apply to deny coverage.
In addition, in Mello Constr., Inc. v. Acadia Ins.
Co., 874 N.E.2d 1142 (Mass. App. Ct. 2007), the court applied exclusion
(j), the faulty workmanship exclusion, finding that because the entire project
was considered the insured general contractor's work, the "particular part"
distinction in the exclusion was irrelevant, and thus the exclusion applied
to bar coverage for the contractor's defective foundation work.
As discussed above, in Auto Owners Ins. Co., Inc.
v. Newman, 2008 WL 648546 (S.C. Mar. 10, 2008), the court recognized
that the 1986 revisions of the standard CGL policy to clarify that the exception
expanded liability coverage for property damage to a contractor's completed
work arising out of work performed by the subcontractor. In that connection,
the court found that coverage for damages arising out of the defective installation
of stucco by a subcontractor was preserved by the subcontractor exception in
this exclusion.
One of the early 2007 dates on the Property Exclusion Reunion Tour originated
with the Tennessee Supreme Court in Travelers Indem.
Co. of Am. v. Moore & Assocs., Inc., 216 S.W.3d 302 (Tenn. 2007). There,
the court applied the subcontractor exception to exclusion (l) 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.
As can be seen, it appears that the argument that defective workmanship arising
out of a breach of contract cannot be an occurrence under a CGL policy, which
was somewhat successful in previous years, has been increasingly rejected in
2007. Even in states where that view was adopted, such as South Carolina, the
courts appear to be reconsidering it.1
The rejection of this argument was not extremely surprising, since based
on the language of the policy itself and the notion that unexpected and unintended
property damage arising out of faulty workmanship constituted an occurrence
has been the majority rule for quite some time. In essence, the courts are simply
restoring order on this aspect of construction defect coverage. Due to its nature,
construction defect litigation invariably spawns considerable coverage litigation,
since insurance coverage drives the defense and payment of what are often relatively
large claims. That litigation should now shift back to the application of the
property damage exclusions, the portions of the policies where these issues
were traditionally and more properly addressed.
In keeping with the theme, construction insureds can expect the Property
Damage Reunion Tour to play to packed houses in numerous other venues. However,
as the property damage exclusion cases described above illustrate, reviews on
the Reunion Tour will be mixed. In other words, even though issues surrounding
"occurrence" and "property damage" may have receded, application of the relatively
complex exclusions to complex construction defect scenarios will still require
considerable time, attention, and creativity. At least for the time being, this
author will likely not need to get a new gig.
1Nevertheless, it must be kept in mind that the Farewell Occurrence
Tour has not reached all venues and the "breach of contract is no occurrence"
position is still the law in a number of states.
See, Kvaerner Metals
v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006);
Adair Group, Inc. v. St. Paul Fire & Marine Ins. Co.,
477 F.3d 1186 (10th Cir. 2007) (applying Colorado Law);
ACS Constr. Co. of Miss. v. CGU, 330 2F.3d 885
(5th Cir. 2003) (applying Mississippi law); Burlington
Ins. Co. v. Oceanic Design & Constr., Inc., 383 F.3d 940 (9th Cir. 2004)
(applying Hawaii law); Essex Ins. Co. v. Holder,
2008 WL 598160 (Ark. Mar. 6, 2008). A comprehensive survey of the caselaw on
these issues is beyond the scope of this column. For a matrix of the status
of the law on occurrence, property damage, and the major exclusions as applied
to construction defect insurance coverage throughout the 50 states, as prepared
and maintained by the author, see the
IRMI Online edition of the author's book,
Insurance for Defective Construction, Second Edition (2005), also available
on that same website.
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.