Insurance Coverage for Defective Materials
When does a general contractor have insurance coverage for damage caused by defective materials from its supplier?
Earl K. Messer
August 18, 2011
Standard forms of commercial general liability insurance coverage for construction contractors exclude coverage for damage to that contractor’s work. It is commonly known as the “your work” exclusion to coverage. Many such policies also include an exception to this exclusion, however, if the defective or damaged work was completed by a subcontractor and not by the insured contractor.
Sometimes the issue arises as to what the term “subcontractor” means, for example, where a completed operations claim is caused by defective materials provided by a supplier to the general contractor. In that case, is the supplier of those materials a subcontractor under this exception? This seemingly technical issue is highly significant, as it can make all the difference whether the insured contractor has coverage or not, and whether the insurer will provide a defense or not, for a potentially large claim.
This question recently came before the United States Court of Appeals for the Sixth Circuit in Mosser Construction, Inc. v. The Travelers Indemnity Company, 2011 WL 2728213 (July 14, 2011). After a full discussion of Ohio law (the applicable law in the case), treatises on insurance, and other court decisions, the Sixth Circuit Court settled on the following standard. A supplier is a subcontractor when some combination of the following exists: (1) the supplier fabricated the materials to meet custom specifications; and (2) the supplier performed some on-site work.
In Mosser the supplier performed no on-site work, so the Court proceeded to determine whether it was a subcontractor looking only to the first prong of the standard. The general contractor had agreed to make improvements to a city’s water treatment plant. By purchase order, the GC then bought specified aggregate for required structural backfill from a supplier that manufactured this aggregate regularly and kept a supply in inventory. It turned out that the aggregate had gypsum in it, which leeched away after the building was built, causing the building to settle, thus damaging the GC’s other completed work.
The GC made a claim on its CGL policy and the insurer refused to provide a defense, contending that the GC had no coverage pursuant to the “your work” exclusion because the supplier was not a subcontractor. Although the trial court agreed with the insurer, the appellate court reversed, holding that the supplier was indeed a subcontractor because: (1) it manufactured the aggregate at its own facility with its own equipment; and (2) the PO identified the project for which the aggregate was specified. The Court refused to adopt the rule suggested by the GC that all material suppliers should be considered subcontractors and instead adopted the two-prong test discussed above.
In light of this decision, what proactive steps can a GC take to increase the likelihood it will have insurance coverage in the event materials it has purchased are found to be defective and cause significant harm to its completed project?
- As in the Mosser case, recite in the PO that the materials are being purchased for the specific project for which the GC has a contract.
- If feasible, have the supplier deliver and handle the materials at the site, thereby getting the supplier “on-site.”
- If possible, make sure the supplier has its own products liability insurance.
- Confirm that the GC’s policy has the subcontractor exception to the “your work” exclusion since that exception provides a very valuable expansion of coverage. Recently, some insurers have been removing it by endorsement, often using ISO form 22 94. Also, the exception often does not appear in umbrella and excess policies so the benefit may be limited to the primary layer of coverage.
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