Clearing up CGL confusion

Is defective workmanship covered?


This is the second in a series of articles addressing commercial general liability insurance. The first article, "Are you covered?" was published in the October issue, page 48.

Although contractors have been purchasing commercial general liability (CGL) insurance policies for many years, confusion remains as to whether CGL insurance policies cover claims based on faulty or defective workmanship. The confusion is because language in CGL policies and overly broad statements in some court decisions overlook key factors in determining whether there is insurance coverage.

To help eliminate the confusion, you should know what to expect from your CGL insurance carrier when a claim alleging defective workmanship is made against your company.

Exclusions

If a claim for defective workmanship pertains only to the cost of repairing or replacing the insured contractor's defective work and no other damages, standard CGL insurance policies do not apply. Therefore, if a lawsuit filed against your company seeks only to recover the cost to reroof or repair a defectively installed roof system or the difference between the building's value with the defective roof system compared with its value had the roof system been installed properly, you should not expect your CGL carrier to defend or pay the claim.

The cost to repair or replace a defective roof system is not covered because CGL policies contain several exclusions referred to as business risk exclusions that exclude "your work" and "your work product." Also, the difference in a building's value because of a workmanship defect is not covered because CGL policies cover bodily injury and property damages and not pure economic losses.

A statement that defective workmanship is not covered by CGL insurance is an example of an overly broad statement that leads to confusion and misunderstanding. If this statement refers only to the cost of repairing or replacing defective workmanship of the insured contractor, the statement is correct.

As succinctly stated by the New Jersey Supreme Court in the 1979 case Weedo v. Stone-E-Brick Inc., CGL policies do "not cover an accident of faulty workmanship but rather faulty workmanship which causes an accident."

As explained by the Maryland Court of Special Appeals, faulty workmanship is not covered by CGL insurance but property damage or bodily injury resulting from defective workmanship will trigger CGL coverage.

Therefore, if a person is injured by your defective workmanship (a poorly adhered shingle slides off a roof and injures a bystander, for example) or there is property damage resulting from your defective workmanship (leakage occurs through inadequately adhered roofing materials, damaging ceilings, carpets or walls), a CGL insurance policy should apply.

Determining coverage

The broad statement that CGL insurance policies do not cover contract or warranty claims and that only negligence or tort claims are covered also is inaccurate. As discussed in our previous article, the CGL language affording coverage does not mention or distinguish between contract and tort claims.

If a building owner or general contractor initiates a lawsuit against you seeking to recover damages based on an allegation of defective work, first determine whether you have insurance coverage applicable to the suit. Whether your insurance carrier has a duty to defend the suit and whether there is insurance coverage to pay for a claim will depend primarily on the damages the building owner seeks to recover.

The coverage portion of CGL insurance policies requires the insurer to pay "sums that the insured becomes legally obligated to pay as damages because of 'bodily injury' or 'property damage'" caused by an "occurrence" that took place during the period the insurance policy was in effect.

CGL policies also state an insurer has the right and duty to defend suits seeking bodily injury or property damage caused by an occurrence. The insurance carrier's "right and duty" to defend a lawsuit for bodily injury or property damage requires it to pay for the defense of a suit that includes those damages and gives it the right to select the attorney to defend the insured.

Because CGL policies also contain numerous exclusions from coverage, not all claims for bodily injury or property damage caused by an occurrence will be covered.

For instance, if asphalt spillage leads to a claim for bodily injury or property damage, the pollution exclusion in CGL insurance policies may negate coverage. However, you still might have insurance coverage if the claim fits within an exception to an exclusion.

Cases

There have been court cases in every state considering whether CGL insurance covers claims for defective workmanship. In almost all cases, the same CGL policy language is examined. Because the basic insuring agreement states a CGL policy covers claims for bodily injury and property damage caused by an occurrence, the first issue courts commonly address is whether there has been an occurrence.

CGL policies define an occurrence as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions."

Because CGL policies do not define "accident," courts refer to dictionary definitions or definitions developed in previous cases. Although precise definitions vary and may contribute to different outcomes, the common concept when courts discuss whether there has been an accident or occurrence in the context of a CGL insurance policy is whether the incident in question was unexpected or unintended.

Confusion has resulted because courts often state defective workmanship is not an occurrence and contract claims do not satisfy the occurrence criteria for CGL coverage. Most claims against construction contractors arise from contractual relationships and are based on a claim that a contractor's workmanship did not comply with the contract.

Within the past five years, the supreme courts of Florida, Kansas, Nebraska, New Hampshire, North Dakota, South Carolina, Tennessee, Texas and Wisconsin have considered whether a claim based on defective workmanship and including alleged property damage other than to the insured's work would constitute an occurrence.

In each case, courts ruled there would be CGL insurance coverage; therefore, the CGL insurers had a duty to defend the claims. In some cases, courts ruled defective workmanship itself could constitute the occurrence. But in most cases, courts ruled the event leading to the property damage, such as water leaking through a window or walls cracking because of an improper building foundation, was the occurrence.

In its June 2008 decision in Auto-Owners Insurance Co. v. Pozzi Window Co., the Florida Supreme Court affirmed its view that "faulty workmanship that is neither intended nor expected from the standpoint of the contractor can constitute an 'accident' and, thus, an 'occurrence' under a post-1986 CGL policy."

Defining an "accident" as used in CGL policies as "an unforeseen or unexpected event," the Tennessee Supreme Court also concluded defective workmanship may constitute an "occurrence" in its March 2007 decision in The Travelers Indemnity Co. of America v. Moore & Associates Inc.

The Tennessee court said determining whether an accident has occurred under the terms of a CGL policy requires the court to determine whether damages would have been foreseeable had the insured properly completed the work. Assuming the work was performed properly, a subsequent injury or damage resulting from defective workmanship qualifies as an occurrence or accident.

The Supreme Court of Texas in its August 2007 decision in Lamar Homes Inc. v. Mid-Continent Casualty Co. stated whether an insured's faulty workmanship was intended or accidental depends on a case's facts and circumstances. As long as the insured's defective work was not intentional, the insured's defective workmanship that causes bodily injury or property damage will meet the occurrence requirements.

Relying on an earlier Texas decision and citing a 1999 decision of the 5th U.S. Circuit Court of Appeals in Federated Mutual Insurance Co. v. Grapevine Excavation Inc., the Supreme Court of Texas ruled "the terms 'accident' and 'occurrence' include damage that is the 'unexpected, unforeseen or undesigned happening or consequence' of an insured's negligent behavior, including claims for damage caused by an insured's defective performance or faulty workmanship."

In addition, courts in Alabama, Alaska, Arkansas, California, Colorado, Georgia, Illinois, Indiana, Kentucky, Louisiana, Maryland, Michigan, New Jersey, New York, North Carolina and Oregon have ruled the incidence of resultant damages constitutes an occurrence.

In the 2007 case Webster v. Acadia Insurance Co., the New Hampshire Supreme Court ruled a roofing contracting company was entitled to have its CGL policy provide a defense to a claim.

The case arose from a contract between the Winnisquam Regional School District and a roofing contracting company that was retained to install a new metal roof system over an existing roof system on a middle school. The new roof system was attached to the building using metal clips.

Several years after the roof system's construction, the school district discovered structural deficiencies in the roof system and buckling and bowing of the gymnasium's purlins, causing the gymnasium to be closed. The school district filed suit against the roofing contracting company. The roofing contracting company called upon its insurer, Acadia Insurance, Westbrook, Maine, to defend the suit. It denied the request.

The roofing contracting company subsequently filed suit against the insurer to recover its defense costs. Acadia Insurance denied coverage on the grounds that the school district's suit was a claim for defective workmanship and there was no occurrence or property damage. Because the school district's suit contained allegations pertaining to the purlins, which were not part of the roofing contracting company's work, the court found Acadia Insurance had a duty to defend the suit.

In ruling there had been an occurrence, the New Hampshire Supreme Court said an accident, when determining whether the CGL policy had been met, means "circumstances, not necessarily a sudden and identifiable event, that were unexpected or unintended from the standpoint of the insured." The court said the unexpected physical damage to the purlins gave rise to an occurrence under the terms of the CGL policy's insurance requirement.

Many state supreme courts have issued rulings concluding that when property damage results from defective workmanship, the occurrence requirement is met and there is CGL insurance coverage. These rulings indicate that though faulty workmanship is not itself an occurrence, the key to determining whether there is an occurrence is whether there is resulting damage that was not intentionally caused by the insured.

For example, in the 1982 case United States Fidelity and Guaranty Co. v. Bonitz Insulation Co. of Alabama, the Supreme Court of Alabama ruled property damage resulting from roof leaks constitutes an occurrence for CGL purposes.

In this case, the city of Midfield, Ala., filed suit against the roofing contracting company for breach of contract because the company failed to perform the roof system installation in a good and workmanlike manner and follow specifications. The roof leaked for several years and eventually had to be replaced. In addition to the cost of the replacement roof system, the suit included damage to ceilings, walls, carpets and the floor as a result of water leaks that persisted during several years.

The roofing contracting company's insurance carrier denied coverage on the grounds there was no occurrence or accident. The Supreme Court of Alabama disagreed, ruling that when there was property damage resulting from roof leaks, there was an occurrence. The fortuity aspect of an accident was met because the roofing contracting company did not expect or intend for the roof system to leak; therefore, it was an accident.

The court pointed out that had the only damage been to the roof system, the CGL business risk exclusions would deny coverage.

However, the court concluded: "[W]e think there can be no doubt that, if the occurrence or accident causes damage to some other property than the insured's product, the insured's liability for such damage becomes the liability of the insurer under the policy."

The persistent leaks fit within the policy definition that an occurrence is an "accident, including continuous or repeated exposure to substantially the same or general harmful conditions."

When seeking to deny CGL coverage, insurance carriers argue that defective workmanship and breach-of-contract claims are not occurrences and a claim including property damages resulting from defective workmanship should not be covered because such damages are not accidental but rather are the natural and ordinary consequence of defective workmanship.

Although there are many court decisions agreeing that defective workmanship by itself is not an occurrence, courts generally have rejected insurers' arguments when there is other property damage. One notable exception is a December 2007 decision of the intermediate appellate court in Pennsylvania in Millers Capital Insurance Co. v. Gambone Brothers Development Co.

In this case, the Superior Court of Pennsylvania ruled faulty workmanship is not an occurrence because faulty workmanship is not an accident, relying on a 2006 decision of the Supreme Court of Pennsylvania, Kvaerner Metal Division of Kvaerner U.S. Inc. v. Commercial Union Insurance Co.

In Kvaerner Metal Division of Kvaerner U.S. Inc. v. Commercial Union Insurance Co., the Supreme Court of Pennsylvania ruled, as have other courts, that when a lawsuit does not seek any damages beyond the insured's work or work product and alleges defective workmanship, there is no CGL coverage because defective workmanship is not an occurrence.

In support of its conclusion, the Supreme Court of Pennsylvania stated: "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."

Although the Supreme Court of Pennsylvania's decision is not unusual because the damages alleged in the suit pertained only to a piece of defective equipment furnished by the insured contractor, the Superior Court of Pennsylvania's decision in Millers Capital Insurance Co. v. Gambone Brothers Development Co. is unusual because damage to property other than the insured's work was alleged in that case.

The claims against Gambone Brothers Development, Norristown, Pa., included homeowners' claims for water damage through allegedly defective vapor barriers, windows, roofs and stucco exteriors based on breach of contract, breach of warranty, negligence, fraud and other legal theories. Gambone Brothers Development argued the resulting water damage constituted an occurrence.

Noting rainfall is a natural and foreseeable event that exacerbates the consequences of faulty workmanship, the court ruled damage to a home's interior caused by rainfall that seeps through faulty home exterior is not a fortuitous event that triggers insurance coverage. Finding the occurrence requirement was not met, the court concluded there was no CGL insurance coverage despite the allegations of property damage.

Currently, the Supreme Court of Pennsylvania is deciding whether to hear the case on appeal. If you conduct business in Pennsylvania, check with your insurance producers and carriers to ascertain whether you will be provided with insurance coverage, including a defense, for claims for property damage or bodily injury based on alleged faulty workmanship.

Know your coverage

CGL insurance policies do not cover claims based on allegations of defective workmanship if the damages sought are limited to repair or replacement of the insured contractor's work or work product. Such claims are expressly excluded from coverage as a result of the "your work" and work product exclusions in CGL policies.

In addition, many court decisions state such claims do not meet the occurrence requirement of CGL policies. However, if a suit, whether based on an alleged breach of contract or negligence, includes a claim for bodily injury or property damage, your CGL policy should be responsive. The occurrence requirement should be met by the act, event or incident that is the immediate cause of the property damage or bodily injury.

Just as a bodily injury claim resulting from roofing materials that were inadequately attached would be covered by CGL insurance, a property damage claim resulting from inadequately attached roofing materials that allowed water to enter the building and caused property damage also should be covered. In each of these cases, it is the detachment of the roofing material or water passing through the roofing material and the resultant effect, not the original defective installation, that is fortuitous and would constitute an occurrence for CGL purposes.

Jared W. Heald is an attorney and Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.

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