By their nature, defective work claims are often hotly contested. Even relatively simple claims cause confusion, resulting in inconsistent court opinions. This article examines the problem and suggests a comprehensive approach to determining the applicability of coverage to these claims.
Defective construction materials have given rise to many complex claims in recent years. Consider the Sarabond claims, asbestos, and PVC plumbing cases. More recently, exterior insulation finish system (EFIS) and mold claims have confounded both insured contractors, and their insurers alike. A myriad of coverage issues—trigger, existence of property damage, allocation—all swirl around these claims. However, even the most complex of construction defect claims must be analyzed according to the traditional elements of a claim: legal obligation, occurrence, property damage, insured's work exclusion, impaired property exclusion, etc.
Defective work claims are made even more complex when it is considered that as to each of these elements, there is a considerable disagreement between insurers and insureds. This makes every defective workmanship claim, even one that appears straightforward, hotly contested. The result is that relatively simple claims continue to cause confusion, resulting in inconsistent opinions among courts, even those within the same jurisdiction. Particularly, confusion over basic issues involving occurrences arising out of the performance of defective work continue to render even the most straightforward claim complex.
An example of a recent case resulting in confusion is Hartrick v Great American Lloyds Ins. Co., 2000 WL 1159603 (Tex App—Houston [1st Dist] Aug. 17, 2000). In that case, the insured homebuilder, Claremont, built a home in 1991 and sold it to its original owners, who in turn sold it to Hartrick and Cathey (collectively, "Hartrick") in 1993. After discovering structural problems and defects in the house's poured slab foundation, Hartrick sued Claremont, alleging causes of action for negligence, violation of the Texas Deceptive Trade Practices Act (DTPA), and breach of implied warranties of good and workmanlike construction and suitability for habitation. Great American, the insurer, defended Claremont pursuant to a commercial general liability (CGL) insurance policy issued on the 1993 edition Insurance Services Office, Inc. (ISO), form. The jury answered "No" to the negligence and DTPA claims, but "Yes" on the breach of warranty claims, awarding Hartrick $145,000 in damages.
Hartrick obtained a turnover order under Texas procedure requiring Claremont to assign its rights to its insurance policy to Hartrick. Great American denied coverage for the defective workmanship verdict based on the definitions of "property damage" and "occurrence" in its policy. The trial court in the declaratory judgment action granted Great American's motion for summary judgment and denied Hartrick's motion. Hartrick appealed.
In any defective workmanship case the precise nature of the property damage is critical. In that connection, Hartrick claimed that the foundation of the house had failed completely because Claremont did not properly prepare the soil or clear the land. The foundation was of inadequate compressive strength, was not sufficiently thick, and had no supporting piers. As a result, there was widespread damage to the home. A key fact, which is lost in the court's opinion, is that the clearing of the lot and the foundation work—the work that was claimed to be faulty—was performed by Claremont's subcontractor.
It is difficult not to label this as a "garden variety" completed operations claim for which a general contractor such as Claremont should have coverage. This is because of the exception to the "your work" exclusion in Exclusion (l) of the standard ISO policy. That exclusion states that the insurance does not apply to property damage arising out of the insured's work or any part of it and included in the products-completed operations hazard, unless the damaged work or the work out of which the damage arises was performed on the insured's behalf by a subcontractor. 1 A straightforward application of the exception to Exclusion (l) should have led to the conclusion that Hartrick was entitled to coverage for the property damage to the home arising out of the foundation subcontractor's work. Inexplicably, the Hartrick opinion makes no mention of the exception to the insured's work exclusion for work performed for the insured by a subcontractor.
The court of appeals in Hartrick never reached the exception to Exclusion (l); rather, it decided the case on the basis of the definition of "occurrence" in the policy. In other words, it decided that the insured contractor was not entitled to coverage since there was no occurrence. In reaching this conclusion, the court borrowed from Mid-Century Ins. Co. v Lindsey, 997 SW2d 953 (Tex 1999), a case involving injuries to the occupant of a car after a child discharged a shotgun stored in a gun rack in an adjacent pickup truck. The issue there was whether the discharge constituted an "accident" for purposes of underinsured motorist benefits under an automobile policy.
The court held that an injury is accidental if, from the viewpoint of the insured, it is not the natural and probable consequence of the action or occurrence which produced the injury. In other words, an injury is accidental if the injury could not reasonably be anticipated by the insured or would not ordinarily flow from the action or occurrence that caused the injury.
Based on this definition, the Hartrick court concluded, "Lack of compliance with implied warranties, i.e., promises implied as a matter of law ... are not accidental, but result from not doing what one must do. By not doing what it had to do, Claremont could reasonably anticipate injury to Hartrick...." The court continued that because Claremont was responsible for the damages and could reasonably foresee them, it did not become legally obligated to pay damages because of an accident under the terms of the policy. Claremont was, therefore, not entitled to indemnity for the judgment entered against it.
The court reached this decision even though the jury had specifically found that the breach of warranty was not intentional, reckless, or knowing. The jury instruction on that issue stated that "knowing" was defined as an "actual awareness of the conduct constituting a failure to comply with a warranty." The jury did not agree. Apparently, the insurer managed to convince the court that the breach of an implied warranty is akin to a misrepresentation, so that as an intentional tort, misrepresentation cannot constitute an occurrence.
The court relied on cases involving intentional conduct to support its holding, including the following cases.
The court also relied on Argonaut Southwest Ins. Co. v Maupin, 500 SW2d 633 (Tex 1973), a case involving an intentional trespass by a contractor.
There are two problems with this analysis. First, cases interpreting whether intentional acts constitute occurrences should not have applied to this claim in light of the jury's failure to find intentional or knowing conduct on the part of the insured contractor. Second, under these circumstances, the Hartrick opinion is out of step with the current statement of Texas law on this issue in Federated Mut. Ins. Co. v Grapevine Excavation, Inc., 197 F3d 720 (5th Cir 1999).
In that case, the U.S. Fifth Circuit Court of Appeals, applying Texas law, noted that there are two lines of Texas cases construing the definition of "occurrence." One line of cases, epitomized by the Argonaut v Maupin case relied on in Hartrick, involves intentional torts that are not occurrences. The second line of cases involves damage arising out of alleged negligent conduct that is considered occurrences under Texas law. Based on the jury's finding that Claremont's breach of warranty was not accompanied by intentional, reckless, or knowing conduct, the Hartrick opinion more appropriately falls within the negligent conduct line of cases.
The Hartrick case illustrates the dangers of relying on an occurrence analysis to determine the existence of insurance coverage for unintended property damage arising out of an insured contractor's performance of its contract. The unintended results of breaches of warranty have traditionally been covered under a liability policy [Bundy Tubing Co. v Royal Indemnity Co., 298 F2d 151 (6th Cir 1962)]. In contrast, where a contractor intends to breach its warranty or its contract, the property damage is not an occurrence [Bituminous Cas. Corp. v Bartlett, 240 NW2d 310 (Minn 1976) (contractor intentionally installs chipped and damaged bricks out of plumb, contrary to contract specifications)]. Hartrick did not involve an intentional breach of warranty or contract.
The structure of the CGL policy itself makes it clear that unintended property damage resulting from a contractor's performance of its contract is a covered occurrence, unless excluded by the policy. Such exclusions in the policy include Exclusion j.(5) (insured's operations); j.(6) (faulty workmanship), (l) (insured's work), and (m) (impaired property). Each of these exclusions would be unnecessary if an insured contractor's installation of defective work is a per se nonoccurrence.
In fact, many of the construction defect cases cited by the court in Hartrick actually involved the application of exclusions, including the following.
In each of these cases, the court regarded defective work giving rise to unintended property damage as an occurrence. Curiously, the Hartrick opinion contains no citation to Mid-United Contractors, Inc. v Providence Lloyds Ins. Co., 754 SW2d 824 (Tex App—Fort Worth 1988, writ ref'd n.r.e.), a case in which a Texas court applied the 1973 work performed exclusion, the equivalent to Exclusion (l) of the current CGL forms and including the subcontractor exception, to uphold coverage for an insured for property damage arising out of the defective workmanship of its subcontractor.
The CGL policy recognizes that defective workmanship, under the proper circumstances, certainly under the facts of Hartrick, constitutes an occurrence. It is then up to the insurer, or the court, to apply the property damage exclusions. If the analysis stops at the definition of "occurrence," assuming that property damage arising out of defective construction work in breach of a contract or warranty is naturally foreseeable, and not intended or unexpected, many claims, including the claim addressed by the court in Hartrick, will be denied.
Certainly, some of those claims, such as those involving damage only to the insured's own work, may nevertheless be denied based on the exclusions. On the other hand, claims involving damage to property other than the insured's own work or defective work by subcontractors may not be excluded. In any case, insured contractors deserve an analysis of claims that goes beyond an overly broad application of the definition of "occurrence" and which considers the exclusions in the policy.
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.
For a more complete discussion of completed operations coverage for property damage arising out of a subcontractors' defective work, see Chapter 11 of