Inclusion of a London Engineering Group (LEG) exclusion in builders risk policies has become more popular in the United States, particularly with larger construction projects. But, there have been no published court cases in the United States that interpret the meaning of this exclusion. A very recent decision on LEG-3 changes that and provides insight for insurers, insurance practitioners, and construction project stakeholders.
The purpose of this article is to provide information on a LEG-3-related court decision that was published on September 29, 2023. The case is South Capitol Bridgebuilders v. Lexington Ins. Co., No. 21-cv-1436, 2023 U.S. Dist. LEXIS 176573 (D.D.C. Sep. 29, 2023).
The London Engineering Group introduced three LEG defects exclusions in 1996 to foster insurance industry consistency, while allowing insurers latitude to provide the breadth of coverage they desire. LEG-1 is an outright (total) defects exclusion. LEG-2 excludes the cost that would have been incurred to rectify a defect prior to the damage taking place. And LEG-3 is the least restrictive of the LEG exclusions. The LEG-3 exclusion allows coverage for the defective damaged property but excludes the cost of improvements of materials, workmanship, designs, plans, or specifications.
The LEG-3/96 exclusion was slightly amended in 2006 to include a reference to patent detrimental change.
A "patent defect" is a deficiency that is apparent by reasonable inspection.
This exclusion appears below, and the 2006 change is in bold text for ease of identification. Builders risk insurers and their underwriters can choose to use the 1996 or 2006 LEG versions or create their own defects exclusion wordings (which many have).
Model "Improvement" Defects Wording
The Insurer(s) shall not be liable for
All costs rendered necessary by defects of material workmanship design plan or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification.
For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification.
South Capitol Bridgebuilders v. Lexington Ins. Co.
South Capitol Bridgebuilders ("Contractor") was a joint venture composed of Archer Western Construction, LLC, and Granite Construction Company. It was hired to build a new Frederick Douglass Memorial Bridge in Washington, DC.
The design of the bridge to be constructed included cast-in-place concrete substructure elements and a composite deck supported by three steel arches on each side of the bridge. The arches were supported on concrete abutments on the east and west sides of the Anacostia River and on two concrete V-shaped piers in the river. Various concrete pours occurred during August/September 2019. For the concrete pours involving the abutments and V-piers, the concrete had to set before the formwork could be removed. After the formwork was removed in August/September 2019, the Contractor discovered areas of porosity in the concrete (known as "honeycombing") in the south and north legs of the West Abutment, South V-Pier 1, and North V-Pier 1. Construction was stopped. It was determined that there was damage to the bridge due to the honeycombing. This damage resulted in a decrease in the weight-bearing capacity of the bridge and support structures.
The Contractor had secured a builders risk policy from Lexington Insurance Company for the period from July 13, 2017, until January 1, 2022. This policy included a LEG-3 Defect Extension (Endorsement #009). The Contractor submitted its physical damage claim to the insurer on October 24, 2019. Following its investigation, in a letter dated April 9, 2020, the insurer denied coverage for the claim. The Contractor commenced litigation on July 22, 2020, and alleged breach of contract and bad faith against the insurer.
Insurer's Reasons for Claim Denial
During its investigation, the insurer engaged DeSimone Consulting Engineers (DCE) to investigate and report on the nature and cause of the defects in the bridge components. DCE issued a report concluding that the concrete honeycombing resulted from workmanship issues, including inadequate vibration during placement, resulting in poor consolidation of the concrete (vibration techniques are usually employed to eliminate the chance of honeycombing). The insurer denied coverage for two reasons: (1) the absence of direct physical damage, and (2) the terms of the LEG-3 Defect Extension precluded coverage.
Lack of Direct Physical Damage
The builders risk insuring agreement provided coverage for "direct physical loss or damage to insured property." The insurer contended that, in order to sustain direct physical loss of or damage, the insured property must be in an initial satisfactory state and then changed by some external event into an unsatisfactory state. The Contractor noticed that the affected abutments and piers were defective upon removing the formwork. These defective components were never placed into use or incorporated into nondefective components of the bridge and never caused damage to any other property. Therefore, the insurer concluded that no other part of the bridge incurred direct physical loss or damage as a result of the defects.
The LEG-3 Defect Extension endorsement replaced Exclusion C. in the builders risk policy. Exclusion C. read: "Fault, defect, error, deficiency or omission in design, plan or specification, unless direct physical loss or damage by an insured peril ensues and then this policy will cover for ensuing loss or damage only." It should be noted that the LEG-3 Defect Extension did not replace Exclusion B. in the builders risk policy: "Faulty or defective workmanship or materials, unless direct physical loss or damage by an insured peril ensues and then this policy will cover for such ensuing loss or damage only."
The LEG-3 Defect Extension in the builders risk policy is as follows. This is the same exclusion as the LEG-3/06 exclusion above, except commas were added throughout.
All costs rendered necessary by defects of material workmanship, design, plan, or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification.
For the purpose of this policy and not merely this exclusion, it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, design, plan, or specification.
The insurer contended that the LEG-3 Defect Extension did not apply to the claim for two major reasons.
First, the last paragraph of the LEG-3 Defect Extension stated that insured property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, design, plan, or specification. The insurer reasoned: "Thus, the requirement of the Policy's Insuring Agreement, has not been met" and "the abutments and V-piers were simply defective construction."
Second, the insurer concluded that "the LEG-3 Extension makes clear that should damage … occur to any portion of the Insured Property containing any of the defects, the excluded cost is the cost incurred to improve the original material workmanship design plan or specification. The defective abutments and V-piers were never incorporated into any other portion of the bridge. Accordingly, all costs associated with rectifying these defects were merely for the purpose of bringing the defective components in conformity with the contract required."
Court's Findings and Reasoning
Even though this case was in the US District Court, District of Columbia, the parties agreed that Illinois insurance law governed.
The Damage Alleged by Contractor Was Unambiguously within the Scope of Coverage
The builders risk policy at issue insured against "all risks of direct physical loss of or damage to insured property." The abutments and piers were "insured property" under the policy. "Damage" was not defined in the policy. As a result, the court considered dictionary definitions, including Black's Law Dictionary: "loss or injury to person or property" or "any bad effect on something." The court concluded that the decreased weight-bearing capacity of the bridge was surely an injury or, at the very least, a bad effect on the bridge and its support structures.
The court contrasted Exclusion B. in the "Perils Excluded" section of the builders risk policy with the LEG-3 Defect Extension. It concluded that Exclusion B. implies that "faulty or defective workmanship" can cause "loss, damage, or expense" because the lead into Part B—Exclusions is very broad. ("This policy shall not pay for loss, damage or expense caused directly or indirectly by any of the following.") As respects the LEG-3 Defect Extension, the court concluded that "caused by" language in the builders risk policy language differs from the "solely by virtue of the existence" language in the LEG-3 Defect Extension. The LEG-3 Defect Extension does not suggest that property cannot be damaged if there were defects in material workmanship somewhere in the causation chain. However, defects in material workmanship in and of themselves are insufficient to constitute damage. In this case, the Contractor did not seek reimbursement solely for its defective workmanship.
Lastly, the court considered the "parties' intent" and "overall purpose of the contract" (builders risk policy) in assessing the meaning of "damage." The builders risk policy is "all risk" in nature. One risk inherent to a job like this one is damage from errors of workmanship. The insurer was aware that it was agreeing to insure issues that arose during construction of the bridge.
Insurer's Case Law Fails To Establish That the Damage Alleged by the Contractor Was Not Covered
The insurer argued that the insured property must be altered—not merely defectively constructed—to constitute physical loss or damage. No property was altered because the honeycombed concrete components were defective from the moment they were made. Further, the insurer argued that incorporation of defective components into a larger project does not constitute damage under Illinois law.
The court disagreed with the insurer because (1) a change that resulted in a reduction in the weight-bearing capacity of a bridge was an "alteration" to that bridge, and (2) the authorities the insurer cited were inapposite.
Insurer Fails To Demonstrate That an Exclusion Applies
The court found the LEG-3 Defect Extension to be ambiguous. It had this to say: "The LEG-3 Extension is ambiguous—egregiously so. To understand this, one need only attempt to read it. Lexington managed to squeeze in a run-on sentence, an undefined term, several mispunctuations, and a scrivener's error…. The Extension is internally inconsistent and bordering incomprehensible. SCB's [Contractor's] statement that the Extension is 'convoluted' is an understatement." In support of this, the court noted the following.
The parties disagree on the nature of the title of the "LEG-3 Defect Extension." The insurer argued it was an exclusion. The Contractor considered it to be a broadening of coverage. The court said they were both correct.
The LEG-3 Defect Extension replaced builders risk policy Exclusion C. However, the Contractor correctly pointed out that the LEG-3 Defect Extension addressed the subject matter of both Exclusion B and Exclusion C. As such, the court determined that the insurer made a scrivener's error and that the parties intended for LEG-3 to replace both Exclusions B and C.
The parties had competing arguments on what constitutes "damage" within the LEG-3 Defect Extension. The court determined that "damage" in the LEG-3 Defect Extension encompassed the Contractor's claim: honeycombing resulted in a reduction in the weight-bearing capacity of the bridge. This qualified as a detrimental change in the insured property, and the damage was "patent" in nature. The honeycombing was certainly visible to an onlooker.
The insurer argued that any repairs were "improvements" and excluded by the LEG-3 Defect Extension endorsement. The Contractor's interpretation of "improvement" was "making it better than originally planned." The court determined that to improve something "means to make a thing better than it would have been if it were not for defective work."
The court ruled that the LEG-3 Defect Extension was subject to more than one reasonable interpretation and was, therefore, ambiguous. The Contractor's reading was more plausible. Under Illinois law, the court must construe the LEG-3 Defect Extension against the drafter (the insurer) and in favor of coverage. The court held the insurer liable for breaching its builders risk policy.
Please understand that this legal decision is based on a fact pattern surrounding the loss and the specific terms of the builders risk policy, including the LEG-3 Defect Extension endorsement. Some insurers use LEG wordings verbatim. Others slightly alter the LEG wordings. Still others create modified wordings that may mimic LEG wordings but include additional requirements, conditions, or exclusions. Examples of the titles of endorsements with modified wordings include the following.
Extension for Repairing or Replacing Defective Covered Property (LEG-3) Endorsement
Amendment to Excluded Causes of Loss—Cost of Making Good
Faulty, Inadequate, or Defective Workmanship or Design Exclusion Amendment
Defects Exclusion—Betterment (LEG-3)
Faulty, Inadequate, or Defective Conditions and Cost of Making Good Changes
Modified Cost of Correcting or Making Good Exclusion
Amendment to Cost of Making Good Exclusion
If You Are an Insurer
Be careful how you label "LEG" endorsements. If a modified wording is used (see above), the endorsement should not contain "LEG."
Be very careful how your LEG endorsements interact with the balance of your builders risk policy. Inconsistencies will work in the insureds' favor.
If You Are an Insurance Broker
In developing insurance proposals or endorsements, do not use the term "LEG" unless a true LEG endorsement is used. If a proposal confirms inclusion of a LEG endorsement and a modified endorsement is included in the issued builders risk policy, that is an obvious problem.
Carefully compare the insurance proposal to the issued builders risk insurance policy. Mistakes and inconsistencies involving LEG wordings and the balance of terms of builders risk policies are far more common than one would think.
If a builders risk insurer agrees to provide a LEG endorsement, but imposes a sublimit, confirm there is wording in the builders risk policy to cover losses in excess of the sublimit (for instance, utilize a standard defects exclusion with an ensuing loss exception).
If You Are an Insured
Demand to have true LEG wordings. When LEG wordings were introduced in the United States, it was considered to be a very positive development. Stakeholders would better understand what is and what is not covered. In addition, consistent case law would develop over time.
In the current environment, know that obtaining a LEG-3 endorsement can sometimes be difficult. In addition, expect to pay more premium (about 10 percent of the base builders risk premium) and to have a higher deductible applicable to claims involving LEG-3.
If something is not clear to you, or if you have other questions, contact the insurance broker to get answers and alter coverage if needed.
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