CGL Exclusions May Impact Coverage for Occurrences Involving Defective Work
October 2009
It has been over a year since this column
described caselaw developments addressing whether a construction defect meets
the definition of "occurrence" in the standard commercial general liability
(CGL) policy. (See Defective Construction
as an Occurrence.) Many of those cases were decided in 2007–2008, and the
highest courts of several states upheld that a construction defect is considered
an occurrence.
by Patrick
J. Wielinski
Cokinos, Bosien
& Young
This line of cases1 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 that certain exclusions in the CGL policy, particularly the
"your work" exclusion with its exception for property damage arising out of
subcontractor work, support that conclusion.
The development of the caselaw has not been quite as dramatic over the past
year. However, one recent case provides some indication as to how courts may
now approach the issue of CGL coverage for property damage arising out of construction
defects. That case is Auto Owners Ins. Co., Inc. v.
Newman, 2009 WL 2851211 (S.C. Sept. 8, 2009) (Newman
II).
Background of South Carolina Law: L-J and
Newman I
Newman II must be placed in context to fully
appreciate the potential impact of the opinion. Newman
II is actually the second opinion on rehearing of
Auto Owners Ins. Co. v. Newman, 2008 WL 64856
(S.C. Mar. 10, 2008) (Newman I). That opinion
overturned L-J, Inc. v. Bituminous Fire & Marine Ins.
Co., 621 S.E.2d 33 (S.C. 2005), a prior, though short-lived opinion of
the South Carolina Supreme Court. There, it was held that damage to a roadway
due to cracking caused by a subcontractor's work was not an occurrence under
the insured contractor's policy since the only damage was to the road, the insured
contractor's work.
That opinion caused considerable controversy among federal courts in South
Carolina in the context of construction defect lawsuits. Therefore, barely 3
years later, the Supreme Court of South Carolina revisited the issue of construction
defect as occurrence in Newman I. In that case,
the court specifically answered a certified question from those struggling federal
courts as to whether damage to other nondefective portions of the construction
project due to water infiltration constitutes an occurrence of property damage
under a general contractor's CGL policy.
The court answered "Yes" to that question in Newman
I. That case involved defective stucco work performed by the insured
homebuilder's subcontractor. The defective stucco allowed water to seep into
the home, causing damage to its framing and exterior sheathing. The court held
that there had been an "occurrence" of "property damage" caused by the subcontractor's
defective work. The court further determined that damage to rough carpentry,
windows and doors, thermal and moisture protection, and interior and exterior
finishes demonstrated the existence of underlying water damage to the home due
to the defectively applied stucco. Therefore, the court upheld coverage for
those elements of damage.
It should be noted that the court's reasoning in
Newman I relied on the definitions of "occurrence" and "property damage"
in the standard CGL policy. On their face, neither of those definitions makes
any distinction in terms of "accident" or "physical injury to tangible property"
as to whether the insured's defective work damages other work. In other words,
the distinction between the defective portion of the work, the repair and replacement
of which under Newman I does not constitute an
occurrence of property damage, and damage to other work, viewed by the court
as an occurrence of property damage, might better be made based on the property
damage exclusions in the policy. While the court supported its holding with
a discussion of the "your work" exclusion, and the exception to that exclusion
for subcontractor work; nevertheless, based on the language of the policy itself,
the result could have been reached without the limitations engrafted by the
court on the "occurrence" and "property damage" definitions.
However, in a more controversial holding, the court in
Newman I determined that since the scope of the
underlying moisture damage could neither be assessed nor repaired without first
removing the entire stucco exterior, the CGL policy provided coverage for the
replacement of the defective stucco itself, as a cost associated with remedying
the other property damage that resulted from an "occurrence." This aspect of
the Newman I opinion, together with the other
pronouncements on the definition of occurrence, were reheard and reconsidered
in Newman II.
Auto-Owners Ins. v. Newman II: Be Careful
What You Ask For
In Newman II, the South Carolina Supreme Court
was asked to reconsider its holding in Newman I.
In seeking rehearing, the insurer argued that, based on
L-J v. Bituminous, there was no "occurrence"
within the terms of the CGL policy. Once again, the court disagreed and upheld
its prior holding that the negligent application of stucco by the subcontractor
resulted in an "occurrence" of water intrusion, causing "property damage" to
the home and covered under the CGL policy. However, the court reiterated that
the subcontractor's negligent application of the stucco did not, in and of itself,
constitute an "occurrence" since it was a claim for faulty workmanship itself.
Once again, the court supported its decision as being in accord with the intent
behind other exclusions in the policy, primarily the subcontractor exception
to the "your work" exclusion. Thus, as far as these issues, the opinion in
Newman II somewhat expanded on, but also reiterated,
the reasoning of the court in Newman I.
Expected or Intended Exclusion
Despite this revisiting of the issues from Newman
I, the South Carolina Supreme Court in Newman
II also addressed the applicability of two exclusions in the CGL policy.
In that connection, Auto Owners, the insurer, argued that even if the subcontractor's
negligent application of stucco resulted in an occurrence under the CGL policy,
coverage for the resulting property damage was nevertheless barred by Exclusion
a, the expected or intended injury exclusion. That exclusion provides that the
insurance does not apply to property damage that is "expected or intended from
the standpoint of the insured."
Auto Owners contended that damages awarded by the arbitrator that related
to the framing and exterior sheathing of the home were not covered under the
CGL policy because a construction professional expects substantial moisture
intrusion from defective stucco to result in these types of damages. Once again,
the court reiterated that in the absence of any contrary evidence, it would
be unreasonable to believe that the insured homebuilder expected or intended
its subcontractor to perform negligently. Therefore, the insured contractor
did not expect or intend the resulting property damage either, citing
Lamar Homes v. Mid-Continent Cas., 242 S.W.3d
1 (Tex. 2007) (a deliberate act, performed negligently, is an accident if the
effect is not the intended or expected result; that is, the result would have
been different had the deliberate act been performed correctly).
Therefore, the court rejected the argument based on the expected or intended
injury exclusion, that argument being essentially a restatement of arguments
rejected by the courts listed above as to the foreseeability of property damage
arising from defective workmanship.
The Sistership Exclusion
In Newman II, Auto Owners also argued that
even if the damage to the home constituted an occurrence of property damage,
the CGL policy did not cover the cost of replacing and repairing the defective
stucco itself as an incidental cost to repairing the damage to other property.
The court agreed with this argument, observing that the standard CGL policy
grants the insured broad liability coverage for property damage which is then
narrowed by a number of exclusions. Each exclusion in the policy is to be read
and applied independently of any other exclusion. Since the subcontractor exception
preserved coverage for property damage that would otherwise be excluded as the
named insured's work, the court pointed to another exclusion that barred coverage
for damage to the defective workmanship itself.
Specifically, the court relied on Exclusion n, the recall of products, work
or impaired property exclusion, traditionally known as the "sistership exclusion,"2
that states that there is no coverage for damages claimed for any loss,
cost, or expense incurred as a result of the loss of use, withdrawal,
recall, inspection, repair, replacement, adjustment, removal, or disposal of
the insured's product, work, or impaired property in the event such is
withdrawn or recalled from the market or from use because of a known or
suspected defect, deficiency, inadequacy, or dangerous condition in it.
The court appeared to deemphasize
the products recall aspects of the exclusion, and it may be arguable whether
the exclusion applies to the repair of property damage to a single home or construction
project. Nevertheless, the court's reliance on this exclusion indicates a greater
propensity to move beyond the "construction defect as occurrence" argument and
to apply the property damage exclusions in the policy to determine coverage.
In other words, the courts appear to have heeded a primary argument made by
insured contractors and their trade organizations that unexpected and unintended
construction defects that cause physical injury to tangible property constitute
"occurrences" and "property damage," and that resort must be made to the policy
exclusions to fully interpret the scope of coverage provided for these risks
under the CGL policy.
Conclusion
While the South Carolina Supreme Court's reliance on the sistership exclusion
is an instance of "be careful what you ask for, you may just get it," the court
justified its reliance on that exclusion as an acknowledgment that a claim solely
for economic losses resulting from faulty workmanship is part of an insured's
contractual liability which a CGL policy is not intended to cover, citing back
to L-J v. Bituminous. Nevertheless, as caselaw
applying CGL exclusions is becoming more developed, it is hoped that more consistent
results will be obtained as to the standardized provisions. Perhaps consistent
application of standardized provisions will result in more uniform treatment
of insurance coverage for construction defects, unlike the widely disparate
results that characterized the analysis of "construction defect as occurrence."
Time will tell.
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