Faulty Workmanship "Occurrences"
Two Steps Forward, One Step Back For General Contractors
Carl A. Salisbury
July 26, 2013
Judges get plenty of practice interpreting contracts. Why, then, do they so frequently get it wrong?
The last several months have been good ones for policyholders who happen to be general contractors. In April, the North Dakota Supreme Court took the unusual step of overruling one of its own prior decisions to find that faulty workmanship can constitute a covered “occurrence” (that is, construction defects can be “accidental”) under standard comprehensive general liability policies.
In June, the West Virginia Supreme Court of Appeals did the North Dakota court one better. It overruled three of its own prior precedents to reach the same conclusion. The Supreme Courts of Connecticut and of Georgia have also ruled within the past two months that faulty workmanship can be covered by a general contractor’s commercial general liability policy.
South Carolina has followed its own circuitous route to the conclusion that contractors have coverage for defective construction claims. In Crossman Communities of North Carolina Inc. v. Harleysville Mut. Ins. Co., 395 S.C. 40, 717 S.E.2d 589 (2011), the South Carolina Supreme Court ruled that faulty workmanship can never be a covered “occurrence” under a CGL policy, and, therefore, the initial grant of coverage in a CGL policy precludes both a defense and indemnity for general contractors facing liability claims for construction defects.
Despite intense pressure from the insurance lobby, the South Carolina Legislature passed a law that essentially overruled Crossman and declared that the definition of “occurrence” includes faulty workmanship.
After passage of the new law, the South Carolina Supreme Court reconsidered, and overruled, its prior
decision in Crossman. In doing so, the court joined 17 other state Supreme Courts that have considered the issue squarely and concluded that construction defects can be covered by CGL policies. Then, last
week, the South Carolina Supreme Court took a significant step backward.
In Bennett & Bennett Constr. Inc. v. Auto Owners’ Ins. Co. (S.C. 2013), the South Carolina high court
interpreted two exclusions that insurance carriers frequently cite in an effort to exclude construction
defect claims from coverage. The first is an exclusion that says that the policy does not cover “property
damage” to “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.”
Notice that the exclusion is written in the present tense: “are performing operations.” The correct interpretation of this exclusion, of course, is that it applies only during the construction process. It never applies to a completed project.
This is also because another clause in the CGL policy, the “products-completed operations hazard”
provision makes it clear that there is coverage for faulty workmanship once a project is completed and
has been put to its intended use. Courts are supposed to read insurance policies as a whole to give
effect to all provisions in the contract.
Courts are also supposed to apply exclusions in coverage strictly and narrowly. If there is any reasonable interpretation of an exclusion that would result in its not being applicable to a particular set of facts, that’s the interpretation the court must use. So the question is: Was the project in the Bennett case still under construction at the time the damage claim arose — in which case the exclusion arguably applied — or had it been completed and put to its intended use, in which case the contractor was entitled to coverage for the damage?
Bennett & Bennett, the general contractor on a house construction project, hired M&M to replace an exterior stucco finish on a home with a brick face. M&M did the work, declared it complete and invoiced Bennett & Bennett for the job.
Upon inspection, Bennett & Bennett discovered that M&M had done a sloppy job of installation and had left some dried mortar on the face of the brick. The general contractor directed the subcontractor to come back and fix the problem. In doing so, M&M hired a subcontracting company that made a further hash of things. It attempted to power wash the brick with an acid solution and, in the process, removed the decorative finish of the brick.
Bennett & Bennett, displeased, directed M&M to remove the brick and start over, whereupon M&M stopped taking Bennett’s phone calls. So, Bennett & Bennett did the work itself and sued M&M for the damage. After obtaining judgment, Bennett & Bennett sued M&M’s CGL carrier for coverage.
Several things become clear. First, the project was plainly completed when M&M turned it over to the homeowner after the initial installation. Second, although the subcontractor came back to try to repair the damage caused by the initial installation, the project was still complete at that point. M&M was not still installing the brick; it was attempting to repair a defect that existed to the previously completed installation.
The standard form products-completed operations hazard coverage provision speaks to precisely this kind of situation. It says, “Work that may need … repair, correction or replacement, but which is otherwise complete, will be treated as completed.”
Sometimes, it is hard to figure out whether the facts of a case either apply or do not apply to a policy provision. Here, however, it is hard to imagine that a provision could be written in a way that would make it any more clear than it was in this case that the project should have been “treated as complete” and therefore covered.
The brick face was up on the house. M&M had packed up its trowels and wheelbarrows and scaffolding. Its employees had presumably moved on to other jobs. It had invoiced the general contractor for heaven’s sake. The need for “repair, correction or replacement” of its work did not make the project less than complete.
On the contrary, the policy itself said that under these circumstances, work was no longer “being
performed” on the project. The only thing that was being done was “repair, correction or replacement”
of the work on the already completed project.
As if this were not enough, the court unnecessarily proceeded to interpret — and misapply — a second exclusion as well. This one is a provision commonly known as the “sistership” exclusion. The term comes from coverage in the airline industry. When an airplane is known to suffer from a defect that may affect its airworthiness, the airline industry typically grounds all similar planes — the “sister” ships — until the defect can be inspected and, if necessary, repaired.
The cost to fix the damage, if any, to the original ship that first manifested the defect will be covered. The cost to ground and repair all the other ships will not. Thus, the sistership exclusion is quite universally known to apply only to the costs incurred by a manufacturer to recall its goods from the market.
In fact, the insurance industry’s own interpretation of this exclusion makes it clear that it applies only to product recall situations. The exclusion says that it applies when a policyholder’s “work … is withdrawn … from use … because of a known or suspected defect, deficiency, inadequacy, or dangerous condition in it.”
The South Carolina court’s decision made the sistership exclusion swallow up all of the coverage for
property damage provided by the “products-completed operations hazard” provision where a
contractor has to go back to a completed project to “repair, correct or replace.”
Insurance policy interpretation, generally speaking, should not be especially difficult for a court. There are well-settled rules to assist in the task. Coverage provisions are supposed to be interpreted generously in favor of the insured. Exclusions are supposed to apply narrowly. Ambiguity favors coverage.
Very frequently, the people who draft the policies on behalf of the insurance industry have, themselves, put out publications that declare the intent of a policy provision. Nevertheless, courts have, in the past, been getting construction-defect coverage questions resolved correctly only in fits and starts.
Recently, the record of getting it right has improved substantially. If only courts could get it right all the time instead of doing what the Supreme Court of South Carolina did: taking two steps forward and one step back.
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SOURCE: www.kilpatricktownsend.com