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Construction Defect Coverage

Defective Work as Occurrence: "The Song Remains the Same"

Patrick Wielinski | July 29, 2016

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During the first half of 2016, more courts have issued opinions as to whether property damage arising out of defective workmanship is an "occurrence." True to form, these cases demonstrate that confusion reigns through the ongoing amalgamation of intentional acts, torts, contracts, and other concepts that have little place in the determination of "occurrence."

For the last several decades, courts throughout the United States repeatedly (some would say too often) have wrestled with the issue of whether defective work is an "occurrence" under a commercial general liability (CGL) policy. The first half of 2016 has been no exception. Unsurprisingly, courts deciding this issue have not yet reached a broad consensus as to what constitutes an occurrence. Instead, courts in various states continue to reach differing conclusions based on the application of the laws of the states where those courts sit, illustrating the effect of choice of law between the various states and producing uncertainty for insured contractors, particularly those that do work in multiple states.

Despite the fact that decisions emerged earlier this year that provide some clarity as to the scope of insurance coverage available for construction defects, insureds will still need to engage in a case-by-case analysis in their respective jurisdictions to determine whether and to what extent property damage arising out of defective work constitutes an occurrence.

Defective Workmanship Is Now an Occurrence in Montana

In Employers Mut. Cas. Co. v. Fisher Builders, Inc., 383 Mont. 187, 371 P.3d 375 (2016), the Montana Supreme Court admitted that its prior analyses of the occurrence issue had been inconsistent, and it clarified that objectively unintended or unexpected consequences resulting from an insured's intentional acts may constitute an "accident" and, therefore, an occurrence under a CGL policy. The case arose after a deck collapsed during the insured contractor's construction work on a home.

In the trial court, the court rejected the homeowner's argument that the term "accident" may include intentional conduct with unintended results and granted summary judgment in favor of the insurer on the basis that the insured's conduct was intentional and, therefore, was not an occurrence under the insured's CGL policy, regardless of whether the insured intended the consequences or not. On appeal, the Montana Supreme Court abrogated its previous analysis of the occurrence issue in Blair v. Mid-Continent Cas. Co., 167 P.3d 888 (Mont. 2007) on the basis that its analysis was incomplete, even though the result that the court reached (i.e., that there was no occurrence) was correct.

In Blair, the court previously determined that the insured's deliberate removal of gravel was not an occurrence under his liability policy because the intentional excavation was not accidental, regardless of whether the resulting damage claimed by his neighbors was intended or not. The Fisher court noted that Blair was decided solely on the basis that the insured's conduct was intentional and that, in Blair, it had failed to consider whether the consequences of the insured's intentional acts were objectively intended or expected from the insured's standpoint. Therefore, because the district court had applied the Blair analysis to the occurrence issue in Fisher, the Montana Supreme Court remanded the case so that the district court could apply the correct standard in determining whether the deck collapse was caused by an occurrence under the insured's policy.

Resulting Damage to Other Work Is Now an Occurrence in Iowa

The Iowa Supreme Court recently sought to clarify its stance on the occurrence issue. It found that property damage to defective work itself is not an occurrence, but property damage to other property constitutes an occurrence. In National Sur. Corp. v. Westlake Invs., LLC, 2016 Iowa Sup. LEXIS 71 (Iowa June 10, 2016), the Iowa Supreme Court held that property damage caused by a subcontractor's defective work may constitute an occurrence under 1986 edition CGL policy forms. The court primarily relied on the subcontractor exception to Exclusion l, the "your work" exclusion, in finding that water damage to an apartment complex caused by a subcontractor's defective installation of building wrap and flashings was an occurrence under the developer's CGL policy.

The court also noted that its holding was supported by the history of revisions to the CGL policy form and Insurance Services Office, Inc. (ISO), guidance as to the purpose of those revisions and by recent decisions from other states' supreme courts interpreting CGL insurance policies with the subcontractor exception to the "your work" exclusion, in the context of water damage caused by defective work.

Defective Work Is Still Not an Occurrence in Kentucky

The opinion of the Kentucky Court of Appeals in Acuity v. Martin/Elias Props., LLC, 2016 Ky. App. Unpub. LEXIS 237 (Ky. Ct. App. Mar. 25, 2016), seems to have laid to rest any reliance insureds may have had on a footnote from the Kentucky Supreme Court's opinion in Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W.3d 69 (Ky. 2010), where the Kentucky Supreme Court appeared to have left open the possibility that damage to third-party property may be an occurrence.

The insured in Acuity made this precise argument, which the Kentucky Court of Appeals dismissed as a misreading of the analysis in Cincinnati. The court reasoned that an occurrence is an accident, which is an unintended and fortuitous event. Because the insured subcontractor had control and contracted to construct a new foundation under the entire home, the subcontractor's defective work on the home's foundation, which caused extensive structural damage to the home, was not unintended or fortuitous (i.e., it was not an accident). Therefore, the insured subcontractor's faulty work was not an occurrence.

What Is Happening in Illinois?

The approach that Illinois courts have generally used when faced with the occurrence issue is that only property damage to third-party property is an occurrence. Under this approach, the scope of an occurrence as to property damage arising out of defective work is severely limited, particularly for insured general contractors. This is because the entire project, by definition, is considered to be the insured general contractor's work.

At the same time, this approach also limits coverage to a general contractor for the work of its subcontractor when the subcontractor's work is defective and that defective work causes damage to other nondefective work. Because the nondefective work is not third-party property, there may be no coverage for the damaged nondefective work. Therefore, under this approach, courts generally find that there is an occurrence only under limited circumstances (i.e., where property damage to third-party property is caused by the insured's defective work).

However, in Allied Prop. & Cas. Ins. Co. v. Metro N. Condo. Ass'n, 2016 U.S. Dist. LEXIS 43952 (N.D. Ill. Mar. 31, 2016), the federal district court for the Northern District of Illinois took this approach to an extreme in finding that the faulty window installation work of a subcontractor, which caused damage to common elements of a condominium building on which the subcontractor did not work, was not an occurrence because water infiltration that damaged the rest of the building was the natural and ordinary consequence of a subcontractor's defective window installation.

The alleged damage to the common elements of the condominium building in that case amounted to damage to third-party property, which should have resulted in a finding of coverage for the costs of repairing those common elements. However, the court bucked precedent when it determined that defective work was not an occurrence because the damage caused by the defective work was not accidental (i.e., it was not a fortuitous or unintended event). It should be no surprise that the court's decision has been appealed, and the case is currently pending before the 7th Circuit Court of Appeals.

Breach of Contract Claims Are Not an Occurrence in Arkansas

The Arkansas Supreme Court's opinion in Columbia Ins. Grp. v. Cenark Project Mgmt. Servs., 2016 Ark. 185 (2016), was issued in response to two certified questions from the federal district court for the Eastern District of Arkansas that related to property damage arising out of faulty workmanship as an occurrence. However, the court declined to answer the certified questions on the basis that the questions were moot. Instead, the court stated that it was reaffirming its position that CGL policies do not cover breach of contract claims, citing Essex Ins. Co. v. Holder, 261 S.W.3d 456 (Ark. 2007).

The court took this position based on the underlying plaintiff property owners' allegations against the insured contractor where the property owners claimed that the insured's failure to construct earthwork pads for the foundations of the owners' lake houses in accordance with the plans and specifications caused the foundations and other structures within the houses to crack and to separate. The court held that these allegations did not involve faulty workmanship. Rather, the court stated that the property owners' claims were for breach of contract, and CGL policies do not cover breach of contract claims. The court also noted in a footnote that Arkansas Code § 23–79–155 was inapplicable because the owners' claims arose before the effective date of the statute.

Why the Chicken Crossed the Road: to Further Weaken Weedo

A year ago, the Appellate Division of the New Jersey Superior Court issued its opinion in Cypress Point Condo. Ass'n, Inc. v. Adria Towers LLC, 441 N.J. Super. 369, 118 A.3d 1080 (App. Div. 2015), wherein it cast serious doubt on years of New Jersey precedent by limiting the application of the business risk doctrine found in Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 (N.J. 1979).

In Cypress Point, the court held that unintended and unexpected consequential damages caused by a subcontractor's defective work constitute property damage caused by an occurrence under an insured developer's CGL insurance policy. In reaching its decision bucking Weedo, the court pointed out that the older Weedo decision focused on exclusions in the 1973 edition ISO CGL policy that no longer appear in the modern CGL policy, the modern CGL policy form defined occurrence differently than the policy in Weedo, and the Weedo policy did not have a subcontractor exception to the "your work" exclusion. Not surprisingly, the insurers appealed the court's ruling, which has been argued earlier this year and is currently pending before the New Jersey Supreme Court.

In the interim, in Phibro Animal Health Corp. v. National Union Fire Ins. Co. of Pittsburgh, 2016 N.J. Super. LEXIS 97 (App. Div. July 14, 2016), the Appellate Division of the New Jersey Superior Court recently reiterated that "the business risk doctrine" relates only to the exclusions to coverage contained in a CGL insurance policy and should not be read into the general insuring clauses of those policies.

The court held that damage to chickens in the form of stunted growth due to ingestion of a drug manufactured by the insured animal product manufacturer was an occurrence under the insured's CGL and umbrella policies. In reaching this conclusion, the court stated that Weedo did not control the court's interpretation of the insuring agreement in the insured's policies because the Weedo court did not adjudicate the meaning of occurrence and did not apply the business risk doctrine to the insuring agreement; rather, the Weedo court interpreted the business risk exclusions in the 1973 edition ISO policy form, which defined occurrence differently than the 2007 and 2009 ISO policy forms that were before the court in Phibro.

While it is tempting to regard this discussion of occurrence in Phibro as yet another nail in the coffin of Weedo, this issue will remain somewhat uncertain until the New Jersey Supreme Court issues its opinion in Cypress Point.

The More Things Change, the More They Remain the Same

As these cases from the last several months demonstrate, there is little consistency among jurisdictions when it comes to the occurrence issue. Nevertheless, the following points can be gleaned.

  • There is still a disparity of approaches among the states, with most applying one of the four general approaches: property damage to defective work is an occurrence; property damage to other property, including the insured's nondefective work, is an occurrence; only damage to third-party property arising out of defective work is an occurrence; and defective work is not an occurrence, whether due to considerations of breach of contract or foreseeability.
  • A particular state's approach may often change or even flip-flop because these cases often receive much attention from industry organizations that frequently file amicus curiae briefs in support of either the insured or the insurer. As a result, some courts may reverse longer, more entrenched principles of law on these issues. For these reasons, choice of law is critical for construction insureds, particularly contractors that do business in multiple jurisdictions.
  • The occurrence argument is often strengthened through arguments as to the significance of other policy provisions, particularly the subcontractor exception to the "your work" exclusion, which preserves coverage for a subcontractor's defective work if defective work is considered an occurrence. However, if defective work is never an occurrence, the subcontractor exception to the "your work" exclusion is meaningless.

Admittedly, the above conclusions have not changed much over the years as the occurrence issue winds its way through the courts. Therefore, the ebb and flow of the law on defective work as an occurrence, and the corresponding unpredictability that it breeds, seems to be the only constant year after year.


Amy Rauch, an associate in the DFW office of Cokinos, Bosien & Young, is a member of the policyholder practice group.

With deference to Jimmy Page and Robert Plant.

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