Over the past 2 decades, there has been a move away from using the traditional property damage exclusions as a basis to deny coverage for defective work claims to using the definitions of "occurrence" and "property damage," together with the insuring agreement. If an insurance coverage dispute escalates to the point of litigation, it more important than ever that the court remain focused on the language of the CGL policy before it.
Over the years the landscape of disputes over insurance coverage for defective work claims under commercial general liability (CGL) policies has been ever-changing. Some would say it has been ever-evolving. Twenty years ago, in the late 1970s and through the 1980s, the primary focus was on the working of the 1973 edition CGL policy's property damage exclusions, particularly the effect of the "broad form property damage endorsement" on the exclusions in the main body of the CGL policy.
Very broadly speaking, the work product and associated exclusions in the CGL policy have been historically ineffective in eliminating coverage for defective work claims. Generally, the significant revisions made in 1986 to the CGL forms have further weakened those exclusions as a basis for a denial of coverage for what many insurers regard to be "business risks" of the insured contractor.
Despite this, elaborately defined exclusions—such as Exclusion m., the "impaired property" exclusion—targeted specifically at such business risks have done little to affect basic coverage under the policy. This is largely because that Exclusion, in most instances, simply amounts to a restatement of basic concepts relating to the definition of "property damage."
In terms of insurance coverage disputes, this phenomenon has resulted in a de-emphasis of the traditional property damage exclusions as a basis to deny coverage for defective work claims. Rather, the focus is now on arguments based on the definitions of "occurrence" and "property damage," together with the insuring agreement. Those arguments include:
Whether claims involving breach of contract constitute occurrences under the policy
Whether the claims involve property damage as defined in the policy
Whether the insuring agreement provides coverage for claims which involve breach of contract
Arguments based on the applicability of the so-called work product exclusions become secondary in the event a claim does not survive a coverage defense based on one or more of these provisions.
It goes without saying that most defective work claims against contractors involve a breach of contract, largely because most contractors perform their services pursuant to written contracts with owners, developers, or other contractors. While many defective work claims may be framed against the contractor in terms of negligence or breach of warranty, most claims include allegations of breach of contract. In fact, in many claims brought by an aggrieved owner against a contractor, only breach of contract may be alleged.
On occasion, where defective workmanship has caused damage to an ongoing project, there may be no claim, or even demand, made by the owner on the contractor. Rather, in light of its contractual obligation to construct the project, the contractor repairs the damage, incurring the costs of doing so itself, turning to its insurer for coverage.
The contractor's insurer, however, may have difficulty finding coverage for that claim, even if there has been an occurrence of property damage as required under the CGL policy. Emphasis on the insuring agreement and definitions in the policy to deny coverage for claims which would otherwise survive analysis under the applicable exclusions significantly narrows the scope of coverage to an insured contractor.
Complicating this analysis is the occasional tendency of the courts to ignore the policy language for a "business risk" analysis. That is, the courts buy into the illusory belief that contractors should be able to control the quality of their work, even though that work may have been performed by one of many subcontractors on a complex construction project. Any defective work claim would therefore fall under the contractor's risk of doing business.
Overlaid on this "business risk rationale" is the parallel "CGL policy as de facto performance bond" argument that has been raised by insurers to deny defective work claims within the construction industry. The conversion of the CGL policy into a performance bond argument basically posits that defective workmanship is largely a performance issue and a breach of contract, which should implicate a performance bond-not a CGL policy. Of course, this analysis ignores the fact that many defective work claims involve classic occurrences of property damage.
The pyramid illustration below demonstrates this concept. The pyramid illustrates the basic steps in interpreting and analyzing coverage for a claim under a CGL policy.
"Outside the Policy" Considerations
At the base of the pyramid are policy defenses based on considerations other than policy language-the business risk and de facto performance bond arguments. Next, the insuring agreement, including the requirement that the insured be "legally obligated to pay as damages," is located near the base of the pyramid because the insuring agreement is intended to set out the very broadest statement of coverage under the policy.
That broad grant of coverage is then narrowed by the definitions of "occurrence" (with its accident and fortuity requirements) and "property damage" (with its physical injury to tangible property and loss of use requirements) at upper levels of the pyramid. This location shows how these definitions narrow the coverage provided in the insuring agreement.
Finally, the work and product exclusions applicable to a defective work claim are at the top of the pyramid. These exclusions are included to deny coverage for certain claims which, even though they may involve property damage caused by an occurrence for which the contractor is legally obligated, nevertheless are outside the intended coverage.
The pyramid illustrates that if coverage for defective work claims, or any other claim for that matter, is denied at the outset because of a wooden application of non-policy language arguments, the result is the denial of a greater number of claims, including claims which would otherwise be paid under the definitions and exclusions of the policy. Further, if a rule that a breach of contract liability does not constitute a covered "legal obligation" of the insured is applied, a greater number of claims than intended will be denied. This renders superfluous other portions of the policy, particularly the definitions of "occurrence" and "property damage," and the work product exclusions.
This makes the CGL policy of much less utility to a contractor, and those other parties on a construction project, such as the owner or developer, which depend on it to provide coverage for property damage arising out of the contractor's defective work. Similarly, if the definitions of "occurrence" and property damage are improperly relied on to deny coverage, then a greater number of defective work claims will be denied than under a more traditional analysis which relies on the property damage exclusions to eliminate coverage for a smaller number of these types of claims.
The bottom line is that if an insurance coverage dispute escalates to the point of litigation, a key consideration for the insured contractor is to ensure that the court remains focused on the language of the CGL policy before it, language that through its careful drafting may provide a contractor with a certain amount of coverage for property damage arising out of defective work. By maintaining that focus, the court should apply the language of the policy and not be guided by vague principles-principles which can lead to anomalous denials of what should otherwise be covered claims.
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