We all make them (even if we don't admit to them). Mistakes, that is.
It's just a matter of what, when, and how. Lives can be defined by a
mistake (without always having the benefit of errors or omissions insurance).
Take Fred Merkle, for instance. Almost 100 years later, he is still remembered
for one misjudgment, just one mistake that will be forever known as the Merkle
Boner.
With two out in the last of the ninth, and the score tied against the
Chicago Cubs, New York Giant's Fred Merkle stood on first base. His
teammate, representing the winning run and the National League pennant, waited
at third. The hitter promptly singled, driving in the winning run and clinching
the pennant for the Giants! Or so Fred Merkle thought.
As the celebration began, he went from first base to the dugout, never
touching second base. An alert Cub player fought through the crowd, retrieved
the ball and jumped up and down on second, getting Merkle out by a force play
and nullifying the run. The game was declared a tie and had to be replayed—and
the Giants lost the replayed game and the pennant to the Cubs in 1908. At the
ripe old age of 19, Fred Merkle had made a mistake—and cost his team a World
Series berth.1
An Occurrence
What could the Merkle Boner possibly teach us about the commercial general
liability (CGL) insurance policy? For starters, while it certainly was a lapse
in judgment, Fred Merkle neither intended nor expected to be put out at second
base (or lose the game and the pennant). It was an accident—the prime element
of an "occurrence" as defined in the CGL policy. Are all mistakes
(i.e., accidents) covered by the CGL?
Bodily Injury
An occurrence first must result in either property damage or bodily injury
for the CGL to respond. While there reportedly was a great deal of mental
anguish by many fans and players (including Fred Merkle), no one was physically
harmed by the play. No bodily injury resulted.
Property Damage
The owners of the Giants certainly lost significant revenues because the
Polo Grounds (the Giants' home field) would not host the World Series that
year. However, property damage requires more than just the loss of revenue or
unexpected additional costs. Property damage requires physical injury
to tangible property and the consequential loss of use of the damaged
property. Property damage also includes the loss of use of tangible property
that is not physically injured.
The Polo Grounds was neither physically damaged (physical injury to tangible
property) nor somehow unfit for playing baseball (loss of use of tangible
property not physically injured) as the result of Fred Merkle's play. As no
property damage had occurred, there is no coverage in the CGL, despite a
mistake that was truly an accident.
Faulty Work
What about mistakes that involve "faulty work"? Is "faulty
work" covered by the CGL? It depends—but today there is a strong trend
toward interpreting "occurrence" to include property damage resulting
from faulty work.
Faulty work can be loosely defined as any type of operation performed,
including materials, parts, or equipment that is part of the work,
which is done incorrectly. It might be something that is installed, repaired,
built, or maintained in a manner that falls below generally recognized
standards of quality or fails to meet representations or warranties. Even
failing to provide instructions or warnings can make it faulty work.
Faulty Work as an Occurrence
Background. Whether faulty work is an occurrence is a
threshold matter as respects CGL coverage. If faulty work is not an occurrence,
the CGL will not apply. The CGL Coverage A insuring agreement responds only to
bodily injury or property damage caused by an occurrence. For several
decades, insurers have contended that faulty work is not accidental in nature
if the resulting property damage is to the work itself as such damage is a
foreseeable business risk—and thus not property damage caused by an
occurrence.
The seminal case on faulty workmanship was the New Jersey Supreme Court case
of Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 (NJ 1979)—opining
"The consequences of not performing well is part of every business
venture; the replacement or repair of faulty goods or works is a business
expense to be borne by the insured-contractor.…" Id. at 239.
Although the Weedo court was actually addressing business risk in
the context of the exclusions found in the Insurance Services Office,
Inc. (ISO), 1973 comprehensive general liability policy, the Weedo
principles2 soon morphed into something far more
expansive. Faulty work was never an occurrence because any resulting
damage to the work was foreseeable and thus not accidental.3 Further, any such damage could not be property damage as the
CGL policy only provided coverage for damage to the property of third
parties. Finally, coverage for property damage to completed work would
turn the CGL into a performance bond.
Trending. The Weedo court's decision was based
on an older CGL policy that did not include a subcontractor exception to the
"your work" exclusion. Applying the "intent" of the parties
regardless of the actual policy wording has begun to give way to a more
complete analysis of the CGL policy wording—including consideration of the fact
that the ISO 1986 CGL coverage form was quite different in scope when compared
to the ISO 1973 CGL policy:
State supreme courts that have considered the issue since 2012 have
reached "near unanimity" that construction defects can
constitute occurrences and contractors have coverage under CGL policies for
the unexpected damage caused by defective workmanship of subcontractors
[citation omitted].
Black & Veatch v. Aspen Insurance (UK), LTD,
882 F.3d 952 (10th Cir. 2018)
Most of these state supreme court's opinions are based on
today's CGL policy wording rather than relying on outdated notions
of what is an occurrence in the CGL policy. This includes full consideration of
the "your work" exclusion and the subcontractor exception to that
exclusion as well as ISO's express intent found in a 1986
Circular4 that "confirmed that the 1986
revisions to the standard CGL policy … specifically covered damage … caused by
a subcontractor's work after the insured's operations are
completed."5 This change by ISO was apparently
in response to "demands of the policyholder community and the view of
insurers that the CGL [policy] was a more attractive product that could be
better sold if it contained this coverage."6
With focus on the entire CGL policy, taken as a whole, conclusions as to
whether faulty work is an occurrence necessarily shifted:
The subcontractor exception does not create coverage. Only the basic
insuring agreement can do that. But the subcontractor exception informs our
understanding of an "occurrence" based on New York's rule that
we should read the insurance policy as a whole and avoid interpretations that
render provisions meaningless.
Black & Veatch v. Aspen Insurance (UK), LTD, 882 F.3d
952 (10th Cir. 2018)
Property Damage Exclusions
As already noted, for the CGL (Coverage A) to be triggered, bodily injury or
property damage must result from an occurrence. In addition, regardless of when
the occurrence happens, the bodily injury or property damage resulting from the
occurrence must take place during the policy period. The phrase found in the
insuring agreement "to which this insurance applies" lets us know
that coverage limitations and exclusions will follow.
Presuming a claim for faulty work is considered property damage caused by an
occurrence (see the above discussion), we need to examine a series of property
damage exclusions to determine the extent of coverage found in the ISO
CGL policy for faulty work (1986 and later editions). Unfortunately, the
wording of these exclusions is a little arcane, resulting in not only
significant misunderstandings but also grounds for coverage disputes. How the
exclusions apply to faulty work is best explained by some examples.
Our Players
For the purposes of our examples, we have Great Big General Contractor, Inc.
(we'll call it GBGC) and Not So Big Subcontractor, Inc. (we'll call it
NSBS). Of course, we are talking about construction or contracting operations.
At the outset, it is important to define a couple of terms to avoid confusion.
(All definitions come from Black's Law
Dictionary, 7th edition).
- Contractor—One who contracts to do work or provide
supplies to another.
- General Contractor—One who contracts for completion of
the entire project, including purchasing all materials, hiring and paying
subcontractors, and coordinating all work. Also termed original contractor or
prime contractor.
- Subcontractor—One who is awarded a portion of an
existing contract by a contractor, especially a general contractor.
Example One—That Particular Part of Real Property (j. (5))
"Property damage" to:
(5) That particular part of real property on which you or any
contractors or subcontractors working directly or indirectly on your behalf
are performing operations, if the "property damage" arises out of
those operations;
GBGC is engaged by the owner to repair portions of a sprinkler system in an
older industrial building. In its haste to finish the job, GBGC snaps a pipe
when tightening it with the wrong type of equipment. The broken pipe falls and
breaks other pipes already installed by GBGC, tripping the sprinkler system.
Portions of the building are extensively damaged by the water.
The owner makes claim against GBGC for damage to the sprinkler system as
well as water damage to the rest of the building. As GBGC has incorrectly
performed its work, some may consider this to be faulty work.
Exclusion j. (5) eliminates from coverage property damage to that particular
part of real property on which GBGC is performing operations if the
damage arises out of the operations. In this example, the property damage did
arise from GBGC's operations—the damage happened while GBGC was
actually repairing the sprinkler system. But what is the meaning of
"that particular part of real property"? Clearly, the portions of the
building damaged by the water cannot be considered to be that particular part
of the real property on which GBGC was working. Thus, property damage coverage
would apply to all portions of the building damaged by the water.
Conversely, damage to the pipe that snapped is excluded—it was the negligent
tightening of the pipe that caused it to snap. But what about the other
portions of the sprinkler systems already repaired by GBGC that were damaged
when the broken pipe fell. While not universally held, the other pipes of the
sprinkler system are generally not considered to be "that
particular part" upon which GBGC was actually performing operations when
the property damage occurred. Therefore, GBGC would have coverage for the cost
of replacing the pipes damaged by the falling pipe.
Example Two—Cost of Replacing Property Because of Faulty Work (j. (6))
"Property damage" to:
(6) That particular part of any property that must be restored, repaired
or replaced because "your work" was incorrectly performed on
it.
The state hires GBGC to resurface portions of the highway. The work involves
removing the existing surface and laying bituminous concrete (asphalt) over the
"grooved" pavement. Unfortunately, GBGC scrapes away far too much,
accidentally scraping way most of the compacted gravel that is the base of the
highway. The resurfacing project quickly becomes a disaster—the new asphalt
being applied by GBGC crumbles into small pieces only hours after the roller
passes over it. The project is quickly halted, and the state brings a claim
against GBGC for the cost of replacing the compacted gravel base.
Exclusion j. (6) expressly excludes damage to the highway base—the compacted
gravel—as it is property that must be replaced or repaired because GBGC's
work was incorrectly performed on it. GBGC has no CGL coverage for the claim by
the state.
Another Example
Here is another example of exclusion j. (6) that more clearly distinguishes
it from exclusion j. (5). GBGC is engaged by the Steamship Authority to perform
repair work on the ship's steam turbines, specifically to inspect and
replace the turbine blades. After completing the inspection and replacing some
blades on one of several turbines to be serviced, a marine contractor engaged
by the Steamship Authority, NSBS tests the turbine. Because a few of the blades
were not securely installed by GBGC, the testing causes some of these blades to
break apart, rendering the turbine useless. The Steamship Authority makes claim
against GBGC for the cost of replacing the damaged turbine blades.
As the turbine blades are not likely be considered real property,
exclusion j.(5) would not apply. Exclusion j. (6) excludes property damage to
"that particular part of any property," thus eliminating
coverage for GBGC for the cost of replacing the blades. The damage to the
blades was a result of work incorrectly performed by GBGC on the blades,
necessitating their replacement.
It is important to note that exclusion j. (5) applies only if the damage
occurs during the operation. Exclusion j. (6) eliminates coverage for damage
during as well as after the some portions of the work are finished, provided
the work does not fall into the "products-completed operations
hazard." Further, the exclusions apply whether the work was done directly
by GBGC's employees or was performed on behalf of GBGC by a subcontractor
engaged by GBGC. (See Broad Form Property Damage—A Look Back.)
Example Three—Damage to Your Work (Exclusion l.)
"Property damage" to "your work" arising out of it
or any part of it and included in the "products-completed operations
hazard".
This exclusion does not apply if the damaged work or the work out of
which the damage arises was performed on your behalf by a
subcontractor.
GBGC is hired by the state to put in the new ramp for the highway. The
project involves site preparation, such as excavation, grading, and compaction,
as well as laying down the compacted gravel base and the proper layers and
thickness of bituminous concrete to meet state highway standards.
GBGC completes the project and it is put to its intended use—the ramp is
open to all traffic. But 3 weeks after completion, the highway ramp begins to
cave in and crumble. The state investigates and finds that the earth was not
properly compacted and the depth of compacted gravel base put down was
inadequate. The base and the earth under the base of the highway had collapsed,
resulting in the crumbling of the bituminous concrete. In short, the work
performed was faulty. The state subsequently sues GBGC for the cost of
completely rebuilding the highway ramp.
Exclusion l. eliminates coverage for property damage to "your
work" arising out of it or any part of it. In order for the exclusion to
apply, the work has to be included in the "products-completed operations
hazard." Does this exclusion apply to the cost of rebuilding the highway
ramp?
There is no question that the highway ramp was the work of GBGC. And since
the cause of the damage (the highway crumbling is property damage) resulted
from the work itself (inadequate compaction of the earth and gravel base), the
damage to the highway did "arise" out of the work.
But unlike the prior exclusions j. (5) and j. (6), this exclusion only
applies if the work that caused the damage is included within the
"products-completed operations" hazard.
The CGL policy contains three measures of when work is considered
completed—and thus included within the products-completed operations hazard.
One such measure is that the work at the jobsite has been put to its intended
use by the owner. In the above example, the state has opened the highway to the
public. GBGC's work has been put to its intended use, and thus its work now
falls squarely within the products-completed operations hazard.
Based on the above, GBGC has no coverage for the cost to replace the highway
ramp. The work is faulty, and insurance is not meant to pay for the cost of
fixing work not properly done. The cost of fixing faulty work is seen as a
business expense or business risk.
Important Exception—Damage to Your Work
As is the tendency, the above "no coverage" conclusion has been
reached without determining all the facts and, most importantly, without
examining the entire exclusion. All too often, insurers cite exclusion (l) in
either a denial letter or reservation of rights letter and completely leave
out any mention of the exception to the exclusion.
This exclusion is limited—it does eliminate coverage for the cost of
repairing "your work" ("your work" does include operations
performed on your behalf), but does not apply if the following occurs.
- The damaged work or the work out of which the damage
arises was performed on your behalf by a subcontractor.7
Subcontractor Exception
A closer look at the facts of the above ramp work reveals that the GBGC,
Inc., subcontracted to NSBS, Inc., the site preparation—the excavation,
grading, compaction, and laying down the compacted gravel base. GBGC operations
were to put down the layers of bituminous concrete.
As the damage to GBGC's work (bituminous concrete) arose out
of work performed on behalf of GBGC by a subcontractor (the improperly
compacted earth and gravel base), GBGC has coverage for the cost of replacing
the bituminous concrete.
In addition, as the damaged work (the damaged work here is the
collapsed base) was also performed on GBGC's behalf, GBGC has coverage for
the cost of properly compacting the soil and properly installing the compacted
gravel base.
In short, using the above fact scenario, exclusion (l) does not apply to
GBGC at all—full coverage for the damage to all work performed is granted
by the exception to the exclusion. As the cause of the damage to GBGC's
work was due to a subcontractor's work, GBGC has coverage for its own work.
Further, GBGC also has coverage for damage to the subcontractor's work.
Another Example
What if the facts were reversed—GBGC performed the highway site work:
excavation, grading, laying, and compaction of the gravel base—and
subcontracted to NSBS the application of the layers of the bituminous concrete?
Assume the same reason for the damage—GBGC did not properly compact the earth
and the gravel base, which later collapsed.
The exception still applies—but a little differently. GBGC would
not have coverage for the cost of replacing the gravel base as the
damage to GBGC's work did not arise out of the work performed by a GBGC
subcontractor. However, the damage to the bituminous concrete (the damaged
work) was performed on GBGC's behalf by a subcontractor, and thus the cost
of replacing the bituminous concrete is covered by GBGC's CGL policy.
Example Four—Impaired Property or Property Not Physically Injured—Exclusion
(m.)
"Property damage" to "impaired property" or property
that has not been physically injured, arising out of:
(1) A defect, deficiency, inadequacy or dangerous condition in
"your product" or "your work"; or
(2) A delay or failure by you or anyone acting on your behalf to perform
a contract or agreement in accordance with its terms.
This exclusion does not apply to the loss of use of other property
arising out of sudden and accidental physical injury to "your
product" or "your work" after it has been put to its
intended use.
Let's go back to our first example, but change the facts a little. GBGC
installs a sprinkler system for the owner of a new office building. This time,
no pipes snap or break—there is no physical injury to tangible property.
However, it is discovered that the system has not been installed to building
code—the owner can replace portions of the sprinkler system to bring it up to
code, but only at considerable cost.
The owner makes claim against GBGC for the cost of replacing the incorrectly
installed portions of the sprinkler system and also for the loss of use of the
office building as the owner cannot obtain an occupancy permit until the
sprinkler system is installed to building code.
Impaired Property
From the viewpoint of GBGC, the owner's office building is
"impaired property." That is, the office building is less useful
because GBGC's work (the sprinkler system) is known to be inadequate (it
does not meet building codes), and the property can be restored to use by
replacing GBGC's work—bringing the sprinkler system up to code.
GBGC has no coverage for the cost of replacing or repairing the sprinkler
system as the sprinkler system itself, which is tangible property, has not been
damaged. Thus there is no property damage to GBGC's work—the sprinkler
system.
The improper installation of the sprinkler systems has, however, caused loss
of use of tangible property—the office building. The owner cannot collect rent
until the sprinkler system is installed to code. Even though the definition of
"property damage" in the CGL policy does include loss of use of
tangible property (even if not physically injured), exclusion (m.) expressly
eliminates coverage for any property damage to impaired property. As the office
is impaired property, GBGC has no coverage for the loss of use claim made by
the building owner.
Exception to Impaired Property
There is an exception to this exclusion. Assume that GBGC goes ahead and
replaces the appropriate parts of the sprinkler system, bringing it up to code.
The landlord is able to rent space to his tenants and collect rental income.
Unfortunately, 4 months after full occupancy, the main riser of the sprinkler
system suddenly cracks and needs to be replaced (no damage is done to any other
property). GBGC is found to have used defective piping materials—the reason the
riser cracked.
Because the cracked riser renders the building unusable as an office
building, the owner again makes claim against GBGC for loss of use—the tenants
are not required to pay the rent if damage to the building prevents them from
occupying their space.
Because the loss of use of the office building arose out of the sudden and
accidental physical injury to GBGC's work (the cracked riser), the
exception applies, and GBGC has coverage for this loss of use claim made by the
owner.
Conclusion
Faulty work can be covered by the CGL policy. In most instances, it is no
longer adequate for insurers to disregard the import of the "Damage to
Your Work" exclusion and the subcontractor exception to that exclusion by
asserting faulty work is never an occurrence in a CGL policy. Instead, properly
determining coverage requires a detailed understanding of precisely what
happened as well as a thorough understanding of how the property damage
exclusions (and their exceptions) apply. Too often, coverage is denied without
a good faith effort to ascertain the facts or by a less than careful reading of
the CGL policy. While it may be easier and more expedient to deny coverage
using buzz phrases, there has been a marked shift by a number of courts in how
CGL policies are interpreted for the purpose of determining coverage arising
out of a contractor's faulty workmanship. This trend is in favor of holding
that such claims may arise from an occurrence:8
The term "occurrence" is defined in the Owner's policy
simply as "an accident, including continuous or repeated exposure to
substantially the same general harmful conditions." If some portion of
the Owners policy seeks to affect coverage by reference to the nature or
location of the property damaged, it is not in the policy for coverage of
occurrences. The policy simply does not defined "occurrence" by
reference to such criteria.
Owners Ins. Co. v. Jim Carr Homebuilder, LLC, 157 So.3d 148 (Ala.
2014) at 155
For a state-by-state comparison of whether faulty work is an occurrence, and
you subscribe to IRMI's Construction Risk Management, see the
map of state positions on faulty workmanship as an
"occurrence."
To read more on the legal issues affecting insurance coverage for faulty
work and construction defects, see IRMI.com articles by Patrick J. Wielinski of Cokinos, Bosien & Young, and stay tuned for the fifth
edition of his book, Insurance for Defective Construction, due out this fall.