Expert Commentary

When an Occurrence Is Not an Occurrence: Faulty Construction Is Not an "Occurrence"

Kentucky law holds that faulty construction does not fit within the definition of "occurrence" in a commercial general liability (CGL) insurance policy.


Claims Practices
December 2011

When a contractor was sued by the owner of a home it built, it sought defense and indemnity from its CGL insurer because the negligence was that of a subcontractor. The CGL insurer refused to defend, and the contractor sued in U.S. District Court in McBride & McBride Constr., LLC v. Acuity, A Mutual Ins. Co., No. 5:10–CV–173 (W.D. Ky. Dec. 8, 2011). Acuity moved for summary judgment, claiming, among other things, the lack of fortuity, the unwritten exclusion in all insurance policies.

Background

In September 2005, McBride contracted with Gary and Holly Holder for the purchase and sale of a house located in McCracken County, Kentucky. McBride constructed the house. During the course of construction, McBride subcontracted with Jimmy Smith Concrete to lay the footer and basement for the property. After taking possession of the property, the Holders experienced several issues related to the differential settlement of the house.

The Holders sued McBride and Jimmy Smith Concrete in McCracken Circuit Court. In the Holders' state court complaint, they alleged that "the property had been constructed in a deficient and substandard manner." The Holders asserted that McBride breached the contract when it "sold the property to plaintiffs with knowledge of numerous construction defects that did, in fact, materially impair the fitness of the property for use as a residence." The Holders further asserted violations of the Kentucky Building Code, negligence, breach of the implied warranty of habitability, and fraud.

At the time the complaint was filed, Acuity insured McBride under a CGL policy. McBride demanded a defense under the policy. Acuity denied coverage for the Holders' claims and declined to defend McBride in the state court action. McBride appealed.

The Policy

The CGL policy contained a provision stating that the insurance applies to bodily injury and property damage only if caused by an occurrence taking place during the policy period. An accident is defined as "including continuous or repeated exposure to substantially the same general harmful conditions."

What Is an Occurrence?

In its motion for summary judgment, Acuity maintained that the faulty workmanship alleged in the Holders' complaint was not an "occurrence" and therefore not covered under the CGL policy. McBride contended that consequential property damage to other nondefective portions of the work resulting from the faulty workmanship of a subcontractor did constitute an occurrence.

Under Kentucky law, like almost every state, an insurer's duty to defend its insured is broader than its duty to indemnify. In this case, Acuity refused to defend McBride in the underlying state court action, arguing that the Kentucky Supreme Court's decision in Cincinnati Ins. Co. v. Motorist Mut. Ins. Co., 306 S.W.3d 69 (Ky. 2010), mandated a conclusion that the Holders' claim of faulty workmanship did not constitute an occurrence. McBride argued that, despite the court's holding in Cincinnati Ins., consequential property damage to other nondefective portions of the work resulting from the faulty workmanship of a subcontractor did constitute an occurrence; therefore, coverage was owed for at least a portion of the claims asserted against it in the underlying state court action.

Duty To Indemnify

The Kentucky Supreme Court, in Cincinnati Ins., addressed the issue of whether a claim of defective construction against a home builder constitutes an occurrence under a CGL policy. The Kentucky Supreme Court ultimately found that the faulty workmanship claim was not covered by the CGL policy because faulty workmanship does not constitute an occurrence.

Essential to a determination of what constitutes an accident is the issue of control encompassed in the doctrine of fortuity. A fortuitous event is one that is beyond the power of any human being to bring to pass or is within the control of third persons. This conclusion ensures that ultimate liability falls to the person who performed the negligent work instead of the insurer. It will also encourage contractors to choose their subcontractors more carefully instead of having to seek indemnification from the subcontractors after their work fails to meet the requirements of the contract.

The Kentucky Supreme Court's decision controlled, holding that faulty workmanship on its own is not an "occurrence" under a CGL policy. The policy can never afford coverage to McBride for the claims of the Holders if there were no fortuitous event. The fact that the work on the foundation was performed by a subcontractor of McBride may not change the conclusion.

It appears as if a general rule exists whereby a CGL policy would apply if the faulty workmanship caused bodily injury or property damage to something other than the insured's allegedly faulty work product. In other words, although a CGL policy does not provide coverage for faulty workmanship that damages only the resulting work product, the policy does provide coverage if the faulty workmanship causes bodily injury or property damage to something other than the insured's work product.

Unfortunately for McBride, the facts of the case did not present a claim that would fall within such a rule because the alleged damage caused by the subcontractor was to McBride's work product and not to another's property.

For the foregoing reasons, the court held that McBride was not entitled to a defense because the faulty workmanship alleged by the Holders was not an occurrence under the CGL policy issued by Acuity.

The Subcontractor Exception

The Kentucky court noted in a footnote a general rule that did not apply to the McBride case, that courts of other states have found a "subcontractor exception" despite the majority rule that faulty workmanship is not an "occurrence" under the standard CGL policy. These courts conclude that CGL policies do provide coverage for property damage to the contractor's nondefective work caused by a subcontractor's faulty work. See:

  • French v. Assurance Co. of Am., 448 F.3d 693 (4th Cir. 2006) (applying Maryland law)
  • Greystone Constr., Inc. v. National Fire & Marine Ins. Co., 2011 U.S. App. LEXIS 22053 (10th Cir. 2011) (applying Colorado law)
  • Crossman Cmtys. of N.C., Inc. v. Beazer Homes Inv. Corp., 2011 S.C. LEXIS 277 (Aug. 22, 2011)
  • Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 104 P.3d 997 (Kan. 2005)
  • American Family Mut. Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004)

The South Carolina Supreme Court came to this conclusion by determining that the expansion of the definition of "occurrence" to include "continuous or repeated exposure to the substantially the same general harmful conditions" created an ambiguity that must be construed against the insurer. Crossman Cmtys., 2011 S.C. LEXIS, at *10. Other courts have found a subcontractor exception by determining that the "your work" exclusion would be meaningless if damage to a contractor's nondefective work product were not covered in the first place. French, 448 F.3d, at 705–06; Lee Builders, 104 P.3d, at 1005; Greystone Constr., 2011 U.S. App. LEXIS 22053 at *13.

The "your work" exclusion in CGL policies excludes coverage for property damage to "your work" or to "work performed by you." However, the exclusion generally does not apply "if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor."

Conclusion

Insurance under a CGL insurance policy for people in the construction business is often difficult, and the interpretation of the policies is harder than the interpretation of most policies because of the situations that bring about litigation against builders. In this case, although the court recognized the subcontractor exception, it found that it did not apply because the damage caused by the defect only applied to the work of the general contractor.

To find coverage for McBride, the plaintiffs needed to allege or prove that the defects caused bodily injury to them or property damage to something other than the work.


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.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More