Construction Defect Case & Duty to Defend
Determining the Duty to Defend in a Construction Defect Case
Jack Levy
October 4, 2010
Claims Pointer: In a defective stucco case, the Oregon Court of Appeals holds for the first time that in evaluating an insurer’s duty to defend, a court may consider facts outside the complaint to determine whether a party is an insured under the policy. The Court also holds that there is coverage for construction defects resulting in third party property damage, and that chemical/physical change and labeling/relabeling exclusions in a vendor endorsement are ambiguous and therefore should be construed in favor of the insured.
Fred Shearer & Sons, Inc. v. Gemini Ins. Co., in the Court of Appeals of the State of Oregon (Case No. A136818, September 29, 2010).
Defendant Gemini Insurance Company (“Gemini”) insured TransMineral USA (“TransMineral”), a distributor of a stucco product. Plaintiff Fred Shearer & Sons, Inc. (“Shearer”) was hired by a contractor to apply the TransMineral stucco to the exterior of a home. The stucco allegedly cracked, causing leaking and mold, and the homeowners sued their general contractor who, in turn, sued Shearer and TransMineral. Shearer tendered the defense of the lawsuit to Gemini – TransMineral’s insurer – because the Gemini policy contained a blanket vendors endorsement which extended coverage to any person or organization that distributed or sold TransMineral’s products in the regular course of its business. Shearer was a vendor of TransMineral’s stucco product, operating under an exclusive agreement with TransMineral.
Gemini refused to defend Shearer, and Shearer filed an insurance coverage action to establish that Gemini had a duty to defend it in the homeowners’ action. The trial court granted summary judgment in Shearer’s favor, and Gemini appealed to the Oregon Court of Appeals.
The “Four-Corners” Rule
Before the Court of Appeals, Gemini first argued that it was impossible to tell from the pleadings in the underlying action, or the policy at issue, that Shearer sold or distributed the stucco product in the ordinary course of its business. Therefore Gemini asserted that, based upon Oregon’s longstanding “four-corners” rule, the facts alleged in the pleadings and policy were insufficient to show that Shearer was a covered insured and the complaint should have been dismissed.
The gist of the “four-corners” rule is that in determining whether an insurer has a duty to defend an insured in an action, the court will look only within the “four-corners” of each of two documents – the complaint and the insurance policy – and not beyond. If the facts alleged in the complaint do not provide a basis for recovery that could be covered by the policy, the insurer has no obligation to defend.
Reviewing the facts and pleadings before it, the Court held that while applying the “four-corners” rule makes sense in determining whether alleged conduct falls within the scope of coverage, there is no logical justification for limiting to the four-corners of the complaint a determination of a party’s status as an insured (which the Court called a preliminary question to whether conduct is covered.) The Court reasoned that pleadings generally contain only facts relevant to the merits of a case, and, since facts relevant to an insured’s relationship with its insurer may not be relevant to the merits of the case, such facts may not be contained in a pleading. Therefore, the Court held for the first time that the “four-corners” rule in duty-to-defend cases does not apply when the issue is whether a party is an insured under a policy, and, under those circumstances, the court may consider facts not alleged in the complaint.
Policy Exclusions
Next, Gemini argued that even if Shearer was an insured under the policy, certain exclusions operated to defeat coverage. Specifically, Gemini asserted that the policy contained a “work product” exclusion which excluded coverage of the “work product,” that is, damage to the stucco itself. Gemini maintained that since the homeowners did not plead damage “beyond the cost of replacing the faulty stucco” (i.e. the “work product”), the damage was not covered under the policy. In addition, Gemini argued that the exclusions for “any physical or chemical change in the product made intentionally by the vendor” and for “products which after distribution or sale by [TransMineral], have been labeled or relabeled or used as container, part or ingredient of any other thing or substance by or for the vendor” precluded coverage under the policy.
With regard to the “work product” exclusion, the Court held that in addition to the allegations of the cracking of the stucco itself, the complaint also referred to “leaking and mold.” And, although this reference was ambiguous as to whether the leaking and mold pertained only to the stucco or to other parts of the house as well, a reasonable reading of the complaint could bring some of those allegations within the coverage of the policy. In so holding, the Court suggested that there is coverage under general liability policies for damage to third party property (which is the first time an Oregon appellate court has squarely addressed the issue).
Finally, addressing the chemical/physical change and labeling/relabeling exclusions in the policy, the Court held that it was unclear whether the insured had to demonstrate that the property damage to the house arose out of the physical/chemical changing of the product or the labeling/relabeling of the product. And the Court further held that since there must be some nexus between the vendor's conduct as described in the exclusion and the alleged injury or damage for the exclusions to apply, these exclusions were ambiguous in their application and therefore had to be construed in favor of the insured.
Thus, looking outside the four-corners of the complaint and the policy, and construing the ambiguous exclusions in favor of the insured, the Court affirmed the trial court’s holding and held that Gemini had a duty to defend Shearer under the policy.
