Expert Commentary

Coverage Triggers for Construction Defect Claims

This is the first in a series of articles dealing with construction defect claim fundamentals. In it, we address the trigger of coverage in construction defect claims. The stage will then be set for the second article covering principles of allocation of damages to specific policies and, in some cases, to the insured.

Construction Defect Coverage
July 2020

For the purpose of this article, we are going to assume that the construction-defect-caused damage is a covered occurrence and qualifies as property damage as defined in the Insurance Services Office, Inc. (ISO), commercial general liability (CGL) policy.

The Construction Defect Claim

Let's start with a couple of working definitions. Construction defect is a failure of the construction to perform in an intended or expected way. This failure to perform can, but not necessarily, cause physical injury to the work itself and/or other property or work. Construction defects include defects in design, faulty work, defective building products/material, and various types of soil failure and can be characterized as a breach of a contractual obligation or a breach of a duty outside of a contract. They can be discovered as early as during construction or can go undetected for many years until symptoms appear.

A construction defect claim is a claim for damages (money) arising out of a defect in construction, including design, workmanship, and materials. The defect can, but not necessarily, cause damage (or physical injury) to the work itself, to other work or property, or to both. The construction defect may cause no damage at all but still result in a claim for damages.

In either case of damage or no damage, it is common in the construction defect world for the defect and/or damage to manifest (become apparent and discoverable) or be discovered sometime after the initial construction or installation. It remains latent, or hidden, for a time. Insurance coverage will depend on the type of "trigger of coverage" employed in a specific jurisdiction.

At the outset, it is important to distinguish manifestation from discovery. While discovery can be concomitant with manifestation, it doesn't have to be. A roof leak, for example, can occur over a period of time in a second-floor closet, damaging the drywall, but not be discovered until after the damage begins.

In the CGL occurrence form, property damage must occur during the policy period. (Contrast this with the claims-made policy, wherein the activating event is when the claim is first made subject to a retroactive date, which is the date on or after which the property damage must occur.)

Trigger of Coverage

"Trigger" is a term of art used by legal and insurance practitioners that you will not find in the CGL policy. Useful and convenient, it simply describes how and when coverage is activated.

Most of the time, there is no controversy. The cause (occurrence) and effect (property damage) are definite in both time and place, and both are readily apparent. It is simple to pinpoint when the property damage occurred, and it is when the property damage occurs that triggers coverage, not when the work is done, for example, in a construction defect claim.

But, in the case of latent damage, the effect may not become apparent until sometime after the work is completed, so the timing of the property damage is unclear, and the controversy begins. Furthermore, latent property damage can be characterized by a continuous and progressive process (and practically indivisible if there are multiple causes). This is the rule and not the exception in the construction defect claim world. Even experts cannot agree on when property damage exactly occurs.

The trigger of coverage analysis requires an examination of the underlying facts and the law in a particular jurisdiction. It is a challenge to determine when property damage and bodily injury occur, and how, in continuous damage/injury claims. Various creative and convenient trigger theories have developed to determine not only when the damage/injury occurs to satisfy the insuring agreement provisions and the definitions of property damage, bodily injury, and occurrence in the CGL policy but also to allocate or apportion financial responsibility in an equitable manner (will be covered in a future article). Not only are different theories found among the states, but also which theory is applied in a given state is fact-sensitive and depends on the characteristics of the underlying cause and damage.

The impetus for these theories actually preceded the proliferation of construction defect claims. Asbestos and environmental claims provided fertile ground for controversies concerning when injury and damage actually occur, so these trigger theories evolved in an attempt to defuse such controversies. The premise is that, because it is sometimes virtually impossible to determine when the damage occurred, to assume that it occurred continuously and in equal amounts over a period of time is not unreasonable.

The Theories

The manifestation trigger theory holds that the policy in effect at the time that the property damage becomes apparent, either subjectively or objectively, is activated. A subjective manifestation occurs when the property damage actually becomes apparent and is discovered. On the other hand, an objective manifestation is one in which the property damage should have become apparent and discovered. For example, an inadequately designed foundation on expansive soil (i.e., soil that expands and contracts) will start to fail before the symptoms become apparent and eventually are discovered. In either case, only one policy is triggered.

The exposure trigger theory requires that all policies in effect during the period that the property is exposed to the harmful, damage-causing agent be activated. Consequently, more than one policy can be triggered.

The continuous injury trigger theory, the broadest trigger, begins with the time of the defective work through to when the work manifests or is discovered, and possibly beyond. More than one policy is triggered.

The injury-in-fact theory stays true to the policy requirement that only property damage that occurs during the policy period is covered, whether detectable or not. In the context of latent, continuous, and progressive damage, more than one policy can be triggered.

Nevertheless, while useful, these theories are not definitive and do not relieve the claim professional of carefully considering the defect/damage process. Whether a particular trigger theory should apply in the first place depends on the underlying facts and the prevailing case law in the specific jurisdiction.

When analyzing the underlying facts, it is quite useful to create a chronology of construction events. When property damage occurs may not be known exactly, but a good chronology can help narrow down when property damage may have occurred. Specific dates and activities cannot only define the parameters of when property damage may have occurred, but they can also rule out when property damage definitely did not occur. A chronology generally, however, cannot determine how much property damage occurred at a particular point in time, only when property damage may have occurred.

For example, the date of the insured's construction contract, the dates of work (including completion and acceptance dates), the certificate of occupancy date, etc., should generally be available. These dates and the dates insurance coverage are available to the insured can aid in the establishment of a chronology that narrows down the triggered periods. The following simple chronology illustrates the point.

Date Activity/Event
5/1/24 Date of subcontract
8/1/24 Date insured's work completed/accepted
12/1/24 Certificate of occupancy issued
6/1/25–6/1/26 Insurer A policy
6/1/26 Insurer B policy begins
11/30/26 Water intrusion discovered
12/1/26 First documented complaints of water intrusion
6/1/27 Insurer B policy ends; Insurer C policy begins
12/1/27 Lawsuit filed
6/1/28 Insurer C policy ends

When does a construction defect cause property damage? Until property damage is discovered, has it occurred? A manifestation or discovery jurisdiction would say no. But the CGL policy requires that property damage occurs during the policy period. It does not say that the property damage has to be seen, heard, or discovered. So, it must be conceded that property damage can begin before it is discovered or becomes manifest. What does the law of a particular state say? In other words, while it is easy to conceptualize that property damage can begin the moment of the creation of the defect and continue undetected, it is necessary to determine when the law says the property damage occurred.

One cannot forget logic and common sense, however, when analyzing when the property damage occurred. For example, suppose a roof is installed, but flashing at the chimney is not. Three months later, water damage is discovered. The damage occurred before discovery, but did it occur during the entire 3 months? Suppose it did not rain for the first 2 months? Care must be taken to avoid being so mired in theories and legal concepts that logic and common sense are trumped by a tempting automatic, mechanistic approach to the availability of coverage.

Known Loss and Montrose

In a continuing/progressive property damage dynamic, when does the triggered period end? Is it when the defect and/or property damage manifests or is discovered? Or is it when the first complaints are documented? Or, is it when suit is filed?

In July 1995 (modified August 31, 1995), the California Supreme Court, in Montrose Chemical Corp. v. Admiral Ins. Co., 10 Cal. 4th 645 (Cal. 1995), provided an answer that turned the concept of fortuity on its head, compelling the insurance industry to respond with significant policy modifications.

The concept of fortuity is the cornerstone of insurance and its operation. Unless a loss is fortuitous, it is not insurable. Otherwise, those that knew a loss would occur or somehow influence the occurrence would buy insurance, and those who knew that a loss would not occur would not buy it. This "adverse selection" plays havoc with sound actuarial predictions. While a fortuitous loss is unpredictable, fortuitous losses collectively can be predicted utilizing the law of large numbers.

The Montrose case involved underlying environmental contamination claims and insurance coverage. In the underlying claims, a continuous trigger was applied. Given the dates of operations, the termination of which occurred before the first Admiral policy, and the manifestation of the contamination occurring before the Admiral policy—certainly no later than Montrose's receipt of the potentially responsible party (PRP) letter—it seemed reasonable that any trigger period should not extend beyond the date of the PRP letter. At that point, the loss became known and was not insurable.

However, citing the "loss-in-progress rule as codified in sections 22 and 250," the court ruled that the covered loss in question in a liability policy is legal liability and that known liability is what is insurable, not the receipt of a PRP letter. When liability is known occurs when liability is "established" with certainty.

… in the context of continuous or progressively deteriorating property damage … insurable under a … CGL policy, as long as there remains uncertainty about damage or injury that may occur during the policy period and the imposition of liability upon the insured, and no legal obligation to pay third party claims has been established, there is a potentially insurable risk.… Stated differently, the loss-in-progress rule will not defeat coverage for a claimed loss where it had yet to be established, at the time the insurer entered into the contract of insurance with the policyholder, that the insured had a legal obligation to pay damages to a third party in connection with a loss.

Montrose's receipt of the PRP letter prior to its purchase of Admiral's policies did not establish any legal obligation to pay damages.… The PRP letter did no more than formally place Montrose on notice of the government's asserted position and initiate proceedings that could result in subsequent findings and orders. Montrose *693.

The ruling's wide net captured construction defect claims and nullified the previously applicable manifestation trigger in such claims. The industry first reacted with a variety of so-called Montrose exclusions, and ISO subsequently amended the insuring agreement in the CGL policy.

The next question—and the subject of the next article—is how to allocate the damages during the entire triggered period.

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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