Expert Commentary

CGL Exclusions May Impact Coverage for Occurrences Involving Defective Work

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.


Construction Defect Coverage
October 2009

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.


1Those 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., 242 S.W.3d 1 (Tex. 2007)
  • Lennar Corp. v. Auto-Owners Ins., 151 P.3d 538 (Ariz. App. 2007)
  • U.S. Fire Ins. v. J.S.U.B., Inc., 979 So. 2d 871 (Fla. 2007)
  • Auto-Owners Ins. v. Pozzi Window, 984 So.2d 1241 (Fla. 2008)
  • Aten v. Scottsdale Ins., 511 F.3d 818 (8th Cir. 2008)

For a description of these cases, see prior articles in this series, Defective Construction as an Occurrence and 2007 Defective Construction Insurance Cases.

2The term "sistership exclusion" refers to the original underwriting intent behind the exclusion exemplified by the grounding of a fleet of airplanes, the "sisterships" of the single defective plane, because of a defect in that plane.


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.

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