Expert Commentary

"Defective Construction as Occurrence" 2007: Too Close To Call

The first article in this series on insurance coverage for defective work appeared on IRMI.com 7 years ago. It discussed a disturbing trend among some courts to accept a relatively new interpretation of the standard CGL insurance policy. It developed into a more detailed book, Insurance for Defective Construction.


Construction Defect Coverage
May 2007

Based on the definition of "occurrence," that interpretation is used to deny 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. This novel interpretation ignores the coverage preserved for defective work claims under the carefully drafted property damage exclusions1 by focusing the definition of "occurrence."2

The past 18 months have seen the issuance of a number of opinions on the issue of "defective construction as occurrence." The disputes between insureds and insurers have become more heated, and the judicial resolution has resulted in ongoing and disparate results. Little forward progress seems to have been made in this regard, despite the ongoing gyrations of insurers, insureds, and their lawyers, alike.

The unusual amount of litigation as to the definition of occurrence is somewhat understandable in that it corresponds to the increasing amount of ongoing construction defect litigation before the courts. The "defective construction as occurrence" issue involves relatively high stakes, since if insurers succeed on their argument, the coverage intended to be preserved under the property damage exclusions in the standard CGL policy for certain types of defective workmanship claims will be virtually stolen away.

The following is a description of recent cases organized according to whether they favor the insurer, the insured, or take a middle ground approach. Several of these cases are currently on appeal and, of course, the result of those cases is still uncertain.

Pro-Insurer View: Breach of Contract

These cases deny coverage and adopt the insurer's view that defective construction is not an occurrence. Taken to their extreme, this line of cases stands for the proposition that faulty or defective workmanship that damages the subject matter of the contract—that the insured contractor has agreed to construct—is foreseeable and cannot be an occurrence. These cases focus on the intentional nature of the act of construction, rather than the expected or intended nature of the property damage resulting from performing it defectively.

Pennsylvania

Kvaerner Metals v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006). The faulty work by an insured contractor that constructed a coke battery resulting in damage to the battery itself was not an accident under the contractor's CGL policy. The faulty workmanship claims simply did not present the degree of fortuity contemplated by the ordinary definition of accident.

South Carolina

L-J, Inc. v. Bituminous Fire & Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005). This case was heralded as a major victory for the regional insurers touting the "defective work is not an occurrence" argument and has been the subject of much commentary. In that case, the court held that the premature cracking in roadwork due to the negligence of a subcontractor was not an occurrence, since the only damage done was to the road, the insured's own work product itself. However, other courts have been hesitant to apply the L-J reasoning.

For example, in Okatie Hotel Group v. Amerisure Ins. Co., 2006 WL 91577 (D.S.C. Jan. 13, 2006), 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 nondefective work, there is an occurrence; upholding coverage for a claim involving water intrusion damage to the interior of a hotel resulting from other defective work. Okatie Hotel represents something of a "middle ground" approach that is more fully discussed below. The issue of "defective workmanship as occurrence," and the determination of the South Carolina Supreme Court in L-J v. Bituminous, has spawned a raft of litigation in the federal courts of South Carolina.

The court in Okatie Hotel was the first of several courts to limit the scope of L-J v. Bituminous, but other courts have refused to do so. SeeBituminous Cas. Corp. v. Altman Builders, Inc., 2006 WL 2137233 (D. S.C. July 28, 2006), in which the court invoked Dante's The Divine Comedy (Inferno) to admonish contractors seeking coverage for defective work to "abandon hope, all ye who enter here," in light of L-J v. Bituminous. Some of these cases are on appeal to the Fourth Circuit, so the issue appears to be far from decided under South Carolina law despite the sweeping holding in L-J.

Pro-Insured View: Unintended and Unexpected Nature of Property Damage

Those courts that uphold coverage for the insured contractor, thus finding an occurrence, tend to emphasize the unexpected and unintended nature of the property damage. In other words, while they recognize that the installation of the work is intentional, the defective result and resulting property damage is not expected or intended, and falls within the definition of occurrence.

In addition, insureds argue that there is no distinction between damages for breach of contract or tort, either in the insuring agreement of the CGL policy, or in the definition of occurrence. Whether the property damage results from breach of contract is immaterial so long as there has been unexpected or unintended property damage to the project. The following cases set out the view advocated by insureds—that unexpected and unintended property damage caused by defective construction is an occurrence, and in general, resort must be had to the exclusions to determine the precise scope of coverage.

Arizona

Lennar Corp. v. Auto-Owners Ins. Co., 2007 WL 152099 (Ariz. App. Jan. 23, 2007) petition for review filed. Damage to homes caused by defective site preparation by the insured homebuilder's subcontractors constituted an occurrence, and the CGL policy covered the natural consequences of negligent construction. The court 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 insured builder's subcontractors.

Tennessee

Travelers Indem. Co. of Am. v. Moore & Assocs., Inc., 2006 WL 4099997 (Tenn. March 7, 2007). The court rejected the insurer's argument that defective work installed pursuant to contract is foreseeable and not an occurrence. Rather, 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 the damages could not be determined under an assumption that the windows would be installed improperly, and the insured could not have foreseen water penetration if the windows had been properly installed. The court went on to apply the subcontractor exception to Exclusion (l), the your work exclusion, to uphold coverage for the insured general contractor for property damage resulting from the water penetration caused by the faulty workmanship of its window installer.

Middle Ground: Damage to Other Work

While the pro-insurer argument requires a departure from the policy language, so does a middle ground view that is emerging. In that middle ground, while generally holding that defective work in and of itself is not an occurrence, courts nevertheless find coverage for other nondefective portions of the work that are damaged by the defective work. In other words, there is no occurrence if the damage is restricted to the defect itself, but damage to other work, even work performed by the insured contractor pursuant to its contract, is covered. This position imports a requirement for damage beyond the work itself into the occurrence language in the CGL policy, a requirement that is not found in that language. In that manner, it leaves coverage on the table that would otherwise be preserved through consideration of the exclusions.

For example, under the language of the subcontractor exception to the your work exclusion, the policy provides coverage for even the defective portion of a subcontractor's work. Such would not be the case under the middle ground, since there would be no occurrence for that portion of the property damage.

South Carolina.Okatie Hotel Group v. Amerisure Ins. Co., 2006 WL 91577 (D. S.C. Jan. 13, 2006). See the discussion of this case above in connection with L-J v. Bituminous.

The Map: Impossible To Project

The following map illustrates the current state of the law among the 50 states and the District of Columbia. It illustrates the effect, on a national basis, of the cases set out above, as well as prior and existing opinions on the issue. This map, together with a matrix summarizing the cases addressing the issue of defective work as occurrence and the treatment of the property damage exclusions in the 50 states, is available as an update of the online edition of the author's book, Insurance for Defective Construction, Second Edition, available on IRMI Online. The maps and matrix will be periodically updated online to maintain the currency of the material.

Current State of the Law Map 2007

In states such as Florida, Texas, and Minnesota where the occurrence issue is on appeal, not even the likes of Wolf Blitzer or Dan Rather can project whether these states will end up in the blue or the red column. Much to the chagrin of insured contractors and those who would honor the policy wording, this race is just too close to call. Hopefully there will be no hanging chads after the dust settles.


1Those exclusions include the "your work" exclusion, Exclusion (l), which contains an exception preserving coverage for property damage to, or arising out of, work of the named insured’s subcontractors subsequent to completion, and the operations and the faulty work exclusions, Exclusions (j)(5) and (6), that exclude coverage only for the "particular part" of damage to real property upon which the insured is performing operations or that must be repaired or replaced because the work was performed incorrectly.

2The complex issues surrounding this approach have been the subject of other columns by this author on IRMI.com, including Defective Work as an Occurrence (July 2000); More on Defective Work as an Occurrence (November 2000); Even More on Defective Work as an "Occurrence" (October 2002); The New Business Risk Rationale (Part One) (December 2003); The New Business Risk Rationale (Part Two), December 2003; Recent Caselaw Applying the Subcontractor Exception: Too Little Too Late? (August 2004); Sore Knees: Recent Caselaw Ignoring the Subcontractor Exception (November 2004); and Trying to Reconcile the Irreconcilable: Making Sense of Recent Caselaw on Occurrence (December 2005.)


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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