The Year of the Occurrence: 2007 Defective Construction Insurance Cases
in Review
February 2008
The past year, 2007, saw the issuance of a
number of significant court opinions from key states as to the issue of whether
damage attributable to defective construction is covered under the commercial
general liability (CGL) insurance policy. Those opinions centered around whether
damage to a construction project meets the definitions of "occurrence" and "property
damage" in the policy.
by Patrick
J. Wielinski
Cokinos, Bosien
& Young
These cases resulted from a questionable interpretation of the CGL policy
that denies 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. The major purpose of this argument has
been to avoid the coverage preserved for defective work claims under the carefully
drafted property damage exclusions by rewriting longstanding law on occurrence
and property damage. In 2007 these efforts met with little success, particularly
as to the efforts to avoid the coverage preserved under the subcontractor exception
to exclusion (l), the "your work" exclusion.
This column will summarize those developments that culminated in very recent
opinions rendered in late December, and which have already carried into 2008.1
Notable 2007 Opinions
Following are the important holdings of the year, in chronological order.
Tennessee
The year 2007 started with an opinion from the Tennessee Supreme Court in
March rejecting the "defective work is not an occurrence" argument in
Travelers Indem. Co. of Am. v. Moore & Assocs., Inc.,
216 S.W.3d 302 (Tenn. 2007). There, the court rejected the insurer's argument
that defective work installed pursuant to a contract is foreseeable and not
an occurrence. Rather, the court found 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 damages could not be
determined under an assumption that the windows would be installed improperly.
Therefore, the insured could not have foreseen the water penetration if the
windows had been properly installed.
Texas
In August 2007, an eagerly awaited opinion from the Supreme Court of Texas
was rendered on the defective construction as occurrence and property damage
issues. The court did not disappoint the construction industry in
Lamar Homes, Inc. v. Mid-Continent Cas. Co.,
239 S.W.3d 236 (Tex. 2007). The court answered three certified questions from
the U.S. Court of Appeals for the Fifth Circuit, holding that the existence
of an occurrence depends on whether the property damage is unexpected or unintended
from the standpoint of the insured, and not whether the ultimate remedy is in
contract or tort. In addition, the economic loss rule is a liability defense,
not a test for insurance coverage. Moreover, where a defect causes physical
injury to tangible property, it is not mere economic loss, but property damage
as defined in the CGL policy.
Having resoundingly rejected the occurrence and property damage arguments
of the insurer, the court went on to address the applicability of exclusions
in the policy. 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, 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. In construing the subcontractor
exception to the "your work" exclusion, the court rejected the notion that the
subcontractor exception creates coverage, finding rather that it reinstates
coverage that would otherwise be excluded under that exclusion.
Arizona
The result in Lamar Homes v. Mid-Continent
was followed in Arizona less than a month later in September 2007, when the
Arizona Supreme Court denied review of the court of appeals opinion in
Lennar Corp. v. Auto-Owners Ins. Co., 151 P.3d
538 (Ariz. App. 2007). In that case, the court held that damage to homes caused
by defective site preparation by the insured homebuilder's subcontractors constituted
an occurrence, and that the CGL policy covers the natural consequences of negligent
construction. The court then 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 builder's subcontractors.
Florida
Late December saw yet another refusal to accept the no occurrence and property
damage position in a high profile case in U.S. Fire
Ins. Co. v. J.S.U.B., Inc., 2007 WL 4440232 (Fla. Dec. 20, 2007). There,
the Florida Supreme Court reversed prior Florida caselaw that had been read
to hold that providing CGL insurance coverage for defective work was against
public policy. Rather, the court held that unexpected and unintended property
damage to a number of homes arising out of the faulty site preparation by a
subcontractor constituted an "occurrence" of "property damage," as defined in
the insured general contractor's CGL policy. The court rejected arguments based
on the purported distinction between tort and breach of contact claims for purposes
of CGL coverage, also refusing to recognize the applicability of the economic
loss rule to support such a distinction.
In addition, the Florida Supreme Court went on to recognize the applicability
of the subcontractor exception to exclusion (l), the "your work" exclusion,
by upholding coverage for the insured builder for the property damage to homes
caused by inadequate site preparation performed by a subcontractor. The court
also rejected the argument that to apply the exception would create coverage
through an exclusion, concluding that to uphold coverage under the CGL policy
would not convert it into a performance bond.
Unfortunately, on the same day, Florida clouded the issue in the companion
case to U.S. Fire v. J.S.U.B., on a certified
question from the Eleventh Circuit Court of Appeals, in
Auto-Owners Ins. Co. v. Pozzi Window Co., 2007
WL 4440389 (Fla. Dec. 20, 2007). Consistent with its opinion in
U.S. Fire v. J.S.U.B., the court found an "occurrence"
arising out of the unexpected defects in the installation of windows on a custom
home. Nevertheless, the court denied coverage to the insured homebuilder for
damages arising out of the defective installation of the windows by a subcontractor.
The damages included water intrusion into the interior of a home, as well as
damage to the windows themselves, but the court held that the installation of
the defective windows themselves did not involve "physical injury to tangible
property."
It should be noted that the facts before the court appeared to be indistinguishable
from the J.S.U.B. case in which the same court
upheld coverage and applied the subcontractor exception to exclusion (l). That
aspect of the case is the subject of a motion for rehearing currently pending
before the Florida Supreme Court in this case.
Momentum in 2008
Cases already addressing the issue this year include the following.
Minnesota
The momentum gained by construction insureds has already carried into 2008,
with the court's opinion in Aten v. Scottsdale Ins.
Co., 2008 WL 65595 (8th Cir. Jan. 8, 2008), applying Minnesota law. Relying
on O'Shaughnessy v. Smuckler Corp., 543 N.W.2d
99 (Minn. App. 1996), the Eighth Circuit Court of Appeals held that the defective
construction of a home, which led to water damage to that home, was an accident,
and thus an "occurrence." The court remanded the case to the trial court for
a determination as to whether the defective workmanship had been performed by
a subcontractor.
South Carolina
Even in states where the breach of contract approach has been accepted, such
as South Carolina, in L-J, Inc. v. Bituminous Fire &
Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005), there have been signs of
retrenchment. In that case, the S.C. Supreme 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, several federal district courts in South Carolina recently certified
the question as to whether the S.C. Supreme Court's holding in
L-J v. Bituminous applies to deny coverage for
property damage caused by continuous exposure to moisture which results from
faulty workmanship.
That same issue was addressed 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 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 non-defective work, there is an occurrence. In
Okatie, the court upheld coverage for a claim
involving water intrusion damage to the interior of a hotel resulting from defective
work.
The confusion in these cases resulted in the certification by the federal
courts of the issue of whether damage to other 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
by the South Carolina Supreme Court, the various federal cases have been stayed.
This stay is the result of an appeal before the S.C. Supreme Court,
Auto-Owners Ins. Co. v. Newman, 2002-C.P. 10-4390.
Oral arguments were heard in that case in early January 2008. It is expected
that the S.C. Supreme Court will issue a detailed opinion, particularly as to
the issue of resulting damages and the court's favorable citation to
High Ctry. Assoc. v. New Hampshire Ins. Co.,
648 A.2d 474 (N.H. 1994), in the L-J case, as
an example of a case upholding coverage where defective workmanship resulted
in property damage.
Confusion over the citation to that case in L-J
was created because the facts of High Country
are substantially similar to those in the other federal cases, that is, where
water infiltration causes damage to other nondefective portions of the work.
Nevertheless, under the strict holding of L-J,
the court there did not seem to be upholding coverage for such resulting damage.
At any rate, it is expected that the court's opinion in
Auto-Owners v. Newman may resolve these issues.
If resolved in favor of coverage, that finding would represent a departure from
the strict "breach of contract is not an occurrence" approach.
Other Pending Appeals
Other cases on the issue of defective work as occurrence and property damage
are currently pending in the following states:
Georgia
In Hathaway Dev. Co., Inc. v. Illinois Union Ins.
Co., No. 07-00118 (N.D. Ga. Oct. 4, 2007),
appeal pending, Case No. 07-15155 (11th
Cir.), the district court held that because the subcontractor intended to perform
work on an apartment complex, the damages arising out of that work did not constitute
an accident under the insured general contractor's CGL policy and Georgia law.
The case also considers the applicability of exclusions j(5) and j(6), the operations
and faulty workmanship exclusions.
Missouri
In St. Paul Fire & Marine Ins. Co. v. Building Const.
Ent., Inc., 484 F. Supp. 2d 1004 (W.D. Mo. 2007),
appeal pending, Case No. 07-2246 (8th Cir.),
the district court determined that property damage caused by a subcontractor's
substandard work on a governmental contract to construct the ducts on a training
facility for the Army Corps of Engineers was not an "accident," and thus not
an "occurrence" under the insured general contractor's CGL policy, since breaches
of contract are not considered accidents or occurrences under Missouri law.
Washington
Mid-Continent Cas. Co. v. Williamsburg Condo. Ass'n,
2006 WL 2927664 (W.D. Wash. Oct. 12, 2006), appeal
pending, Case No. 06-35977 (9th Cir.). In that case, the district court
determined that property damage to condominiums caused by the insured builder's
breach of contract or breach of warranties could not be regarded as an "occurrence,"
since such a breach is reasonably foreseeable.
The Scorecard
A map as to the current status of the law in all 50 states and the District
of Columbia illustrates the effect, on a national basis, of the cases discussed
above, as well as prior and existing opinions on the issue of defective work
as occurrence. The map, together with a matrix summarizing the cases addressing
the issue of defective work as occurrence and the treatment of the property
damage exclusions, is available as an update to the
IRMI Online edition of Insurance for Defective
Construction, Second Edition.
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 overwhelmingly rejected
in 2007. Even in states where that view was adopted, such as South Carolina,
the courts appear to be reconsidering it. 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—it has been the majority rule for quite
some time. In essence, the courts are simply restoring order on this aspect
of construction defect coverage. As a result, construction insureds can likely
expect more emphasis by insurers on the property damage exclusions as applied
to these claims, and a continuation of the effort to modify those exclusions
to reduce the scope of coverage available.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do 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.