Cover Me: The Subcontractor Exception to the Your [Completed] Work Exclusion
April 2007
One of the most contested provisions of the
commercial general liability (CGL) policy is the provision excluding coverage
for property damage to the insured's completed work. In 1986 Insurance Services
Office, Inc. (ISO), revised the standard CGL policy form to include an exception
to this exclusion if a subcontractor performed the work for the insured. This
revision has become heavily litigated.
by R. Steven
Rawls and Rebecca Appelbaum
Butler Pappas
Weihmuller Katz Craig, LLP
Most jurisdictions considering this exclusion and its exception apply the
plain language of the policy to find coverage for property damage to the insured's
completed work if a subcontractor performed the work.
The standard ISO policy form designates the exclusion for the insured's completed
work as exclusion (l) (and we refer to it that way in this article). Non-ISO
CGL policies also contain this exclusion, as do excess and umbrella policies,
although excess and umbrella policies often omit the subcontractor exception.
Standard CGL Policy Language
- Exclusion (l) states that the insurance policy 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.
Exclusion (l) is one of several standard CGL policy exclusions often called
the business risk exclusions. The business risk exclusions "are designed to
exclude coverage for defective workmanship by the insured builder causing damage
to the construction project itself." Sapp v. State Farm
Fire & Cas., 486 S.E.2d 71, 74 (Ga. App. 1997). The business risk exclusions
(j) through (n) preclude coverage generally for property damage to the work
of the insured. American Farm Mut. Ins. v. American
Girl, Inc., 673 N.W.2d 65, 81 (Wis. 2004).
The scope of the business risk exclusions varies widely from one jurisdiction
to another. Several factors govern each jurisdiction's interpretation of the
policy language upon the facts presented. As one court has explained, "where
the alleged occurrence involves the builder's risk exclusion ... the alleged
occurrence and the builder's risk issues are so intertwined that they must be
analyzed together...." Custom Planning & Dev., Inc.
v. American Nat'l Fire Ins., 606 S.E.2d 39, 42 (Ga. App. 2004). In this
article, though, we've limited our discussion to the issues surrounding the
interpretation and application of the subcontractor exception to exclusion (l).
The Business Risk Doctrine
Exclusion (l) precludes coverage for "property damage" to the insured's work
arising after a construction project is finished and in the owner's possession. Lennar Corp. v. Great Am. Ins., 200 S.W.3d 651,
670 (Tex. App. 2006). The exception raises the issue of whether it modifies
the business risk doctrine to provide coverage for faulty work, ordinarily not
covered, when performed by a subcontractor. See
e.g., J.S.U.B., Inc. v. U.S. Fire Ins.,
906 So. 2d 303 (Fla. App. 2005), rev. granted,
925 So. 2d 1032 (Fla. 2006) (reviewing the precise issue of whether the exception
to the exclusion provides coverage for the general contractor for property damage
arising out of the work performed by a subcontractor).
The business risk doctrine emerged from a comparison of the "two types of
risk undertaken by the insured-contractor." Thommes
v. Milwaukee Mut. Ins., 641 N.W.2d 877, 881 (Minn. 2002). The first is
the business risk borne by the contractor to replace or repair defective work
to make the building project conform to the agreed contractual requirements. Grinnell Mut. Reins. v. Lynne, 686 N.W.2d 118,
124 (N.D. 2004)(citation omitted). The second is the risk that the defective
or faulty workmanship will cause injury to people or damage to other property.
The former is not covered by the CGL policy pursuant to the business risk exclusions.
The latter is covered because of the potentially limitless liability associated
with it; this risk is precisely the type of risk covered by CGL policies. Weedo v. Stone E. Brick, Inc., 405 A.2d 788,
791 (N.J. 1979).
The courts applying the business risk doctrine note that "a CGL policy is
not a performance bond and is not intended to protect a contractor's business
risk to replace or repair defective work that does not conform to the agreed
contractual requirements." ACUITY v. Burd & Smith Constr.,
Inc., 721 N.W.2d 33, 40 (N.D. 2006). Thus, "the CGL policy excludes coverage
for damage sustained by a part of an insured's work due to his own ‘incorrect'
work." Minery Neenah LLC v. Rotary Dryer Parts, Inc.,
2006 WL 2711808, 3 (E.D. Wis. 2006). These exclusions "are intended to provide
coverage for tort liability, but not for contract liability of the insured for
loss because the product or completed work was not that for which the other
party bargained." Grinnell at 124.
The majority of jurisdictions considering the effect of the subcontractor
exception conclude that this exception has modified the traditional business
risk doctrine to no longer exclude coverage for faulty work performed by a subcontractor. Lennar at 672. Courts reason that the contractor
can control its own performance but cannot necessarily control a subcontractor's
performance. Lennar at 675 n.29 (citingFireguard
Sprinkler Sys., Inc. v. Scottsdale Ins., 864 F.2d 648, 653-4 (9th Cir.
1988)).
History of the Exception
Before 1976, the business risk exclusions precluded coverage for damages
arising out of the work of subcontractors. Many contractors were unhappy with
the unavailability of coverage because more projects were being completed using
subcontractors. American Girl, at 82. In response,
for an additional premium, insurers began offering the broad form property damage
(BFPD) endorsement in 1976. The BFPD endorsement deleted several portions from
the "business risk" exclusions and replaced them with more specific exclusions
that effectively broadened coverage. Among other changes, the BFPD narrowed
the "your work" exclusion and extended coverage for "property damage" to the
work of a subcontractor or "property damage" arising out of the work of a subcontractor. Lennar at 672. In 1986 the insurance industry
incorporated this aspect of the BFPD endorsement directly into the CGL policy
form by inserting the subcontractor exception into the "your work" exclusion.
Interpretation of the Subcontractor Exception
The majority of courts apply the exception to exclusion (l) to provide coverage
for "damages to the insured's own work that arise out of the work of a subcontractor." Wanzek Constr., Inc. v. Employers Ins. of Wausau,
667 N.W.2d 473, 478-9 (Minn. Ct. App. 2003). In doing so, these courts either
apply the plain language of the policy or explain that caselaw interpreting
the business risk doctrine within the context of the pre-1986 policy form no
longer applies because that form did not contain the exception. See e.g., Lennar at 672-3.
The opponents of coverage argue that an exception to an exclusion cannot
create coverage where none exists. See e.g., Lassiter Constr., Inc. v. American States Ins.,
699 So. 2d 768 (Fla. App. 1997); see alsoReliance
Nat'l Ins. v. Hatfield, 228 F.3d 909 (8th Cir. 2000). Responding to this
argument, courts find that the exception to the exclusion merely "restore[s]
otherwise excluded coverage." French v. Assurance Co.
of Am., 448 F.3d 693, 706 (4th Cir. 2006). The exception does not create
coverage because the policy initially granted such coverage under the insuring
agreement. The business risk exclusions exclude this coverage but the exception
restores the initially granted, but subsequently excluded, coverage. SeeAmerican Girl at 83-4.
Responding to the argument that applying the exclusion to provide coverage
for faulty subcontractor work turning the CGL policy into a performance bond
or making the general contractor the de facto surety for incorrect subcontractor
work, Travelers Indem. Co. of Am. v. Moore & Assoc.,
Inc., 2005 WL 2293009 (Tenn. App. 2005), explained:
- [w]e realize that under our holding a general contractor who contracts
out all the work to subcontractors, remaining on the job in a merely supervisory
capacity, can ensure complete coverage for faulty workmanship. However,
it is not our holding that creates this result: it is the addition of the
new language to the policy. We have not made the policy closer to a performance
bond for general contractors, the insurance industry has.
Moore & Assoc. at 9.
Trends
Several jurisdictions continue to adhere to the position that faulty completed
work is not an occurrence and thus not within the insuring agreement of the
CGL policy. See e.g., Amin Realty, LLC v. Travelers Prop. Cas., 2006
WL 1720401, 7 (E.D.N.Y. 2006). These jurisdictions similarly find that faulty
completed subcontractor work also fails to trigger the insuring agreement, primarily
because, once the work is turned over to the owner, the general contractor has
accepted the subcontractors' work and incorporated it into its own finished
product. SeeKnutson
Constr. v. St. Paul Fire & Marine Ins., 396 N.W.2d 229 (Minn. 1986),
and Tucker Constr. v. Michigan Mut. Ins., 423
So. 2d 525 (Fla. App. 1982).
Courts taking this position do so by finding that faulty work, causing damage
only to the work itself, and not to third-party property, is not an accident,
within the definition of occurrence, but rather the failure of the contractor
to complete the work in a workmanlike manner as bargained-for in the construction
contract. Amin at 6. However, the trend in recent
decisions considers the defective work of a subcontractor (i.e., improper installation
of the windows) an accident from the standpoint of the general contractor insured. SeeTravelers Indem.
of Am. v. Moore & Assoc., 2006 WL 4099997 (Tenn. 2007). This is "because
the acts were not done with the intent or expectation of causing damage or injury." National Eng'g & Contacting v. U.S. Fid. & Guar. Co.,
2004 WL 1103993, 5 (Ohio App. 2004).
As courts continue to find coverage, the insurance industry has responded
by drafting an endorsement to the CGL policy which eliminates the exception
to exclusion (l). Endorsement CG 22 94 10 01 simply states that exclusion (l)
is deleted and replaced by an identical exclusion (l) without the subcontractor
exception. The endorsement effectively returns the available coverage under
the general contractor's CGL policy for faulty completed work to that which
existed prior to the 1976 creation of the BFPD: none.
Conclusion
Although not all jurisdictions have addressed the issue, the majority of
those that have find that the insured general contractor or developer's CGL
policies cover faulty completed subcontractor work. In response, insurers are
adding endorsements to the policies that eliminate the subcontractor exception.
Given the concerns prompting the creation of the broad form property damage
endorsement, judicial interpretation of the policy language, and usage of the
endorsement eliminating the subcontractor exception, the issue of whether the
general contractor's CGL policy covers faulty completed subcontractor work is
far from settled.
Contributing author
Rebecca C. Appelbaum is a senior associate
practicing in the area of third-party coverage at the firm of Butler Pappas
Weihmuller Katz Craig, LLP.
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