COVERAGE ISSUES FOR CONSTRUCTION DEFECT CLAIMS

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COVERAGE ISSUES FOR CONSTRUCTION DEFECT CLAIMS

• David L. Brown
• Pinto Coates Kyre Brown, PLLC
• 3203 Brassfield Road
• Greensboro, NC 27410
• Phone [phone]
• Fax [phone]
• www.pckb-law.com
• dbrown_at_pckb-law.com

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North Carolina Single-Family Building Permits
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2006 New Privately-Owned Residential Building
Permits
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COMMERCIAL GENERAL LIABILITY COVERAGE
FORMInsuring Agreement

• We will pay those sums that the insured becomes
  legally obligated to pay as damages because of
  bodily injury, property damage, to which
  this insurance applies.
• a. This insurance applies only
• (1) To bodily injury or property damage
• (a) that occurs during the policy period
  and
• (b) that is caused by an occurrence.

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COMMERCIAL GENERAL LIABILITYCOVERAGE
FORMDefinitions

• Occurrence means an accident, including
  continuous or repeated exposure to substantially
  the same general harmful conditions.

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COMMERCIAL GENERAL LIABILITYCOVERAGE
FORMDefinitions

• Property Damage means
• Physical injury to tangible property, including
  all resulting loss of use of that property. All
  such loss of use shall be deemed to occur at the
  time of the physical injury that caused it or
• Loss of use of tangible property that is not
  physically injured. All such loss of use shall
  be deemed to occur at the time of the
  occurrence that caused it.

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COMMERCIAL GENERAL LIABILITYCOVERAGE
FORMExclusions

• This insurance does not apply to
• Damage To Property
• 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

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COMMERCIAL GENERAL LIABILITYCOVERAGE
FORMExclusions

• This insurance does not apply to
• Damage To Property
• Property damage to
• (6) That particular part of any property that
  must be restored, repaired or replaced because
  your work was incorrectlyperformed on it.
• Paragraph (6) of this exclusion does not apply
  to property damage included in the
  products-completed operations hazard.

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COMMERCIAL GENERAL LIABILITYCOVERAGE
FORMExclusions

• This insurance does not apply to
• l. Damage To Your Work
• 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.

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PRO-INSURED CASES
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Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242
S.W.3d 1, (Tx. 2007)

• Facts
• Homeowners sued their builder (Lamar) for
  problems that they attributed to defects in their
  foundation.
• Lamar forwarded the lawsuit to its insurer
  seeking a defense and indemnification under a CGL
  policy.
• The insurer refused to defend under the theory
  that the construction errors harmed only Lamar's
  own product.
• Holding
• Coverage The builder's allegedly defective
  construction or faulty workmanship in building
  the house foundation was an occurrence, and the
  resulting cracks in sheetrock and stone veneer
  were property damage.

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Lamar Homes, Inc. v. Mid-Continent Cas.
Co.,(continued)

• We conclude that allegations of unintended
  construction defects may constitute an accident
  or occurrence under a CGL policy and that
  allegations of damage to, or loss of use of, the
  home itself may also constitute property damage
  sufficient to trigger the duty to defend under a
  CGL policy.
• (emphasis added)

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U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d
871, 32 Fla. L. Weekly S811 (Fla. 2007)

• Facts
• Insured general contractor brought a declaratory
  judgment action against its insurer, asserting
  that its CGL policy provided coverage for damage
  to homes it constructed caused by its
  subcontractors use of poor soil and improper
  soil compaction and testing.
• Holding
• Coverage The subcontractors' defective soil
  preparation, which general contractor did not
  intend or expect, was an occurrence, and the
  resulting structural damage to the completed
  homes was property damage under the CGL policy.

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U.S. Fire Ins. Co. v. J.S.U.B., Inc.,(continued)

• Citing with approval the following language
• Although defective construction may
  constitute an occurrence, the insurer
  indemnifies the insured only for resulting
  property damage arising after the project is
  completed. In contrast, a performance bond is
  broader than a CGL policy in that it guarantees
  the completion of a construction contract upon
  the default of the general contractor. . . .
  Consequently, allowing coverage for some
  property damage resulting from defective
  construction does not transform a CGL policy into
  a performance bond and require a CGL carrier to
  pay anytime an insured fails to complete, or
  otherwise comply with, its contract.

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Travelers Indem. Co. v. Moore Assoc., Inc.,
216 S.W.3d 302 (Tenn. 2007)

• Facts
• Insurer brought a declaratory judgment action
  against the insured construction company, seeking
  a declaration that it had no duty to defend or
  indemnify under a CGL policy for a property
  owners demand for arbitration alleging faulty
  window installation by subcontractor.
• Holdings
• Coverage
• The alleged water penetration from faulty
  installation was an accident and, thus, an
  occurrence.
• the alleged damage was property damage because
  it is not limited to faulty workmanship.
• The Your Work exclusion did not apply due to
  subcontractor exception.

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Travelers Indem. Co. v. Moore Assoc., Inc.,
(continued)

• The Court reasoned that
• An occurrence is defined as an accident,
  which we hold is an event that is unforeseen by
  the insured. Because the insured could not
  have foreseen the water penetration had the work
  been completed properly, we conclude that the
  water damages were the result of an
  occurrence. In addition, we hold that claims
  alleging only damages for replacement of a
  defective component or correction of faulty
  installation do not allege property damage.
  Because the damages alleged . . . are not
  limited to faulty workmanship, we conclude that
  property owner has alleged property damages.
  

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PRO-INSURER CASES
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WM. C. Vick Construction Co. v. Penn. Nat. Mut.
Cas. Ins. Co., 52 F. Supp.2d 569 (E.D.N.C. 1999)

• Facts
• Contract entered into wherein Vick Construction
  Company was to construct an addition to a
  building.
• Subcontractor is hired to perform roofing work,
  including the installation of a waterproofing
  system.
• After continuous leaking problems are discovered,
  it is determined that waterproofing system is
  installed upside-down and therefore did not
  adhere to concrete.
• Building owner sues Vick Construction Company for
  costs of replacing the waterproofing membrane.

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WM. C. Vick Construction Co. v. Pennsylvania Nat.
Mut. Cas. Ins. Co. (continued)

• Holding
• No coverage.
• No property damage Language in policy
  requires that property allegedly damaged has to
  have been undamaged or uninjured at some previous
  point.
• No occurrence Defective workmanship does not
  fall within meaning of accident as required by
  the definition of occurrence.
• Work Product exclusions apply to bar coverage
  Work Product of a general contractor is entire
  construction project.

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Production Systems, Inc. v. Amerisure Insurance
Co., 167 N.C. App. 601, 605 S.E.2d 663, disc.
review denied, 359 N.C. 322, 611 S.E.2d 416 (2005)

• Facts
• PSI was under contract to design, construct and
  install two oven feed line systems.
• PSI and its subcontractors failed to property
  install certain components of the system.
• The defective components damaged other parts of
  the system, resulting in damages including the
  cost to repair and the loss of use of the system.
• Holding
• No coverage. The Court found that the damage
  sought did not fall within the definition of
  property damage.

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Production Systems, Inc. v. Amerisure Insurance
Co. (continued)

• As its reasoning, the Court stated
• The term property damage in an insurance
  policy has been interpreted to mean damage to
  property that was previously undamaged, and not
  the expense of repairing property or completing a
  project that was not done correctly or according
  to the contract in the first instance. (emphasis
  in original)
• Accordingly, the Court found that
• Property damage does not refer to repairs to
  property necessitated by an insureds failure to
  properly construct the property to begin with.

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Kvaerner Metals Div. of Kvaerner U.S., Inc. v.
Commercial Union Ins. Co., 589 Pa. 317, 908 A.2d
888 (Pa. 2006)

• Facts
• Insured coke battery builder brought action
  against CGL insurer for declaratory judgment that
  it was entitled to both a defense and indemnity
  in suit by steel company which alleged that the
  battery built by the insured was damaged and
  did not meet the contract specifications and
  warranties, or the applicable industry standards
  for construction.
• Holding
• No Coverage The builders alleged faulty
  workmanship was not accident and, therefore, was
  not an occurrence.

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Kvaerner Metals Div. of Kvaerner U.S., Inc. v.
Commercial Union Ins. Co., (continued)

• We hold that the definition of accident
  required to establish an occurrence under the
  policies cannot be satisfied by claims based upon
  faulty workmanship. Such claims simply do not
  present the degree of fortuity contemplated by
  the ordinary definition of accident or its
  common judicial construction in this context. To
  hold otherwise would be to convert a policy for
  insurance into a performance bond. We are
  unwilling to do so, especially since such
  protections are already readily available for the
  protection of contractors.

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Mutual Ben. Group v. Wise M. Bolt Co., Inc.,
Civil Action No. WMN-01-4196 (D.Md. Sept. 29,
2008) (applying Maryland law)

• Facts
• Insurer sought a declaratory judgment that it did
  not have an obligation to indemnify its insured
  under a CGL policy for an arbitration award
  against its insured for damages arising from the
  insureds negligence in the construction of a
  house.
• Holding
• No Coverage (indemnity) Although the court had
  previously determined that the insurer had a duty
  to defend, the insurer did not have an obligation
  to indemnify the insured because the damages
  ultimately established related only to the house
  or the insureds contractual obligations to
  construct the house.

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Mutual Ben. Group v. Wise M. Bolt Co., Inc.,
(continued)

• Though the homeowners did allege unrelated
  and unexpected damages in the underlying action,
  ultimately Judge Alpert did not find for the
  homeowners as to these claims. Instead, the
  monetary award against the insured is based on
  damages related to the homeowners house and to
  the insureds contractual obligations to the
  homeowners. The insurers issued a general
  liability policy, not a performance bond. The
  repair and replacement damages award as a result
  of the insureds poor performance are simply a
  cost of doing business, not a component of the
  insurance objective of shifting risk.

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CONFUSION IN SOUTH CAROLINA
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L-J, Inc. v. Bituminous Fire and Marine Ins.
Co., 366 S.C. 117, 621 S.E.2d 33 (S.C. 2005)

• Facts
• Insurer brought a declaratory judgment action
  seeking a determination as to whether a CGL
  policy it had issued to L-J, Inc. covered damage
  caused by the faulty workmanship of L-J, Inc. and
  its subcontractors on a road construction project
• Holdings
• No Coverage As a matter of first impression,
  premature deterioration of roads as result of a
  contractors faulty workmanship is not caused by
  an occurrence.

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L-J, Inc. v. Bituminous Fire and Marine Ins. Co.,
(continued)

• The Court reasoned that
• We hold that the damage in the present case
  did not constitute an occurrence. If we were
  to hold otherwise, the CGL policy would be more
  like a performance bond, which guarantees the
  work, rather than like an insurance policy, which
  is intended to insure against accidents. A
  performance bond guarantees that the work will be
  performed according to the specifications of the
  contract by providing a surety to stand in the
  place of the contractor should the contractor be
  unable to perform as required under the contract.
  Consequently, our holding today ensures that
  ultimate liability falls to the one who performed
  the negligent work-the subcontractor-instead of
  the insurance carrier.

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Auto Owners Ins. Co., Inc. v. Newman, __ S.E.2d
__, 2008 WL 648546 (S.C., Mar. 10, 2008),
rehearing granted (Aug. 22, 2008)

• Facts
• Homeowners sued their builder alleging defective
  construction related to the installation of
  stucco siding, which they alleged had allowed
  water to seep into the home causing severe damage
  to the homes framing and exterior sheathing.
• Auto Owners sought a declaratory judgment that
  the damages were not covered under a CGL policy
  it had issued to the builder.
• Holdings
• Coverage
• Water intrusion and resulting damage was an
  occurrence.
• The subcontractor's exception to the Your Work
  exclusion applied to property damage resulting
  from water intrusion.
• The exclusion for damage expected or intended by
  the insured did not apply to damage resulting
  from subcontractors negligent work.
• Replacement of defective stucco was a cost
  associated with the repair of property damage
  covered under the policy.

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Auto Owners Ins. Co., Inc. v. Newman,(continued)

• The Court reasoned that
• As a matter of pure contract interpretation,
  we hold that the CGL policy covers the damage
  resulting from the negligent acts of the
  subcontractor in this case. On this matter, a
  brief history of CGL policies is instructive. A
  CGL policy in the home construction industry is
  designed to cover the risks faced by homebuilders
  when a homeowner asserts a post-construction
  claim against the builder for damage to the home
  caused by alleged construction defects.

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EXCLUSION DAMAGE TO WORK PERFORMED BY
SUBCONTRACTORS ON YOUR BEHALFCG 22 94 10 01

• Exclusion l. of Section I Coverage A Bodily
  Injury And
• Property Damage Liability is replaced by the
  following
• 2. Exclusions
• This insurance does not apply to
• l. Damage To Your Work
• "Property damage" to "your work" arising out of
  it or any part of it and included in the
  "products-completed operations hazard".

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Strategic Issues Going Forward

• Choice of Law
• Operations Loss v. Products-Completed Operations
  Hazard
• Nature of Alleged Damage
• Damages from water intrusion (more likely to be
  covered), or
• Failure to meet Code/contract provisions (less
  likely to be covered)
• Was Faulty Work Performed by a Subcontractor?
• Trigger of Coverage
• A Applicable Endorsements
• B Allocation with other insurers and/or insured

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COMMERCIAL GENERAL LIABILITY COVERAGE
FORMAdditional Insured Endorsement

• WHO IS AN INSURED (Section II) is amended to
  include as an insured the person or organization
  shown in the Schedule as an insured but only with
  respect to liability arising out of your
  operations or premises owned by or rented to you.

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COMMERCIAL GENERAL LIABILITY COVERAGE
FORMBlanket Additional Insured Provision

• WHO IS AN INSURED (Section II) is amended to
  include as an insured any person or organization
  for whom you are performing operations when you
  and such person or organization have agreed in
  writing in a contract or agreement that such
  person or organization be added as an additional
  insured on your policy. Such person or
  organization is an additional insured only with
  respect to liability arising out of your ongoing
  operations performed for that insured.

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INSURERS VIEW

• The Additional Insured endorsement covers the
  Additional Insured for the Additional Insureds
  vicarious liability for the actions of the Named
  Insured. No significant new risk is assumed.
  That is why nominal, if any, premium is charged
  for the Additional Insured endorsement.

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POLICYHOLDERS VIEW

• The Additional Insured endorsement provides a
  broad grant of coverage for any liability of the
  Additional Insured arising out of the Named
  Insureds presence on the job site. This element
  of risk transfer is at the heart of why the
  Additional Insured endorsement is required of
  subcontractors and vendors.

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Pulte Home Corp. v. American Southern Ins. Co.,
185 N.C. App. 162, 647 S.E.2d 614 (2007)

• Facts
• Pulte Homes hired TransAmerica as a subcontractor
  to frame houses in Breckenridge subdivision in
  Wake County.
• TransAmerica obtained an additional insured
  endorsement to its policy with American Southern,
  naming Pulte Homes.
• Pulte Homes was sued by an employee of a
  TransAmerica subcontractor for severe injuries
  suffered when he fell off roof. Claim against
  Pulte was for failure to provide safety devices.
• American Southern refused to defend or indemnify
  Pulte Homes.

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Pulte Home Corp. v. American Southern Ins. Co.,
(Continued)

• Policy Language
• WHO IS AN INSURED (Section II) is amended to
  include as an insured Pulte Home Corporation
  but only with respect to liability arising out of
  TransAmericas operations . . . .

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Pulte Home Corp. v. American Southern Ins. Co.,
(Continued)

• Holding
• Coverage for additional insured rests on whether
  there was a causal nexus between Pulte Homes
  liability and TransAmericas operations.
  Coverage existed for Pulte Homes independent
  acts of negligence, not just for its vicarious
  liability for torts of named insured.

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Implications of Holding

• In construction defect cases, is the general
  contractor covered as an Additional Insured under
  the subcontractors liability policy for the
  general contractors failure to supervise since
  there would be a causal nexus between the
  subcontractors operations and the general
  contractors liability? If so, Other Insurance
  clauses become critical.