Coverage for Construction Defects

Commercial general liability (“CGL”) policies typically require the insurance company to “pay those sums that the insured becomes legally obligated to pay as damages because of . . . ‘property damage’ to which this insurance applies.” But when is the insured contractor, subcontractor or developer “legally obligated?” Is it only when a suit is filed against the insured? What about when the insured settles before any lawsuit or administrative complaint is filed? The Arizona Court of Appeals recently answered these questions and others in Desert Mountain Properties Limited Partnership v. Liberty Mutual Fire Insurance Company, CA-CV 09-0802 (Aug. 3, 2010). In Desert Mountain, there was improperly compacted soil at a residential development, and the developer (Desert Mountain) conducted repairs even though the homeowners had not filed suit. The Court of Appeals rejected the California view that “legally obligated” under a CGL policy means that there is a court order requiring the insured to make some payments and held that Desert Mountain was “legally obligated” to make repairs relating to the soil settlement problems even in the absence of a lawsuit or court order requiring payment.    

The Court also rejected the insurance company’s argument that coverage was barred because the homeowners were seeking money pursuant to their contracts with Desert Mountain, and not under a tort theory. The Court reasoned that the phrase “legally obligated to pay” includes any obligation that is binding and enforceable, whether the obligation arises from a tort theory or a contract theory.

In addition, The Court addressed what is known as the “Broad Form Property Damage” endorsement, which excludes coverage for damage to property not owned or rented by the insured, the repair of which has been made or is necessary due to faulty workmanship. The Court found that the exclusion only applied to bar coverage for the defective property (i.e., the improperly compacted soil); it did not bar coverage for the damages to other property that resulted from the improperly compacted soil. Also, the Court found there was coverage for the costs Desert Mountain incurred to prevent possible future damage to nondefective property, provided that damage would have occurred during the policy period absent preventative measures.

Not surprisingly, Liberty Mutual Fire Insurance Company has petitioned the Arizona Supreme Court to review the Court of Appeals’ opinion. Only time will tell if the policyholder-friendly rulings in Desert Mountain will be affirmed. Quarles & Brady will continue to monitor the progress of this case and others affecting Arizona contractors and developers.