Construction Defect Insurance Claims

Defective Construction Claims: Where Breach of Warranty and Covered Occurrences Merge or Divide

Jill Berkeley
March 21, 2014

In the construction industry, every owner, general contractor and subcontractor understands the necessity to include the cost of insurance in bids, contracts and proposals. Each also invests a fair amount of time in crafting appropriate insurance specifications, requirements and provisions in its contracts. Some, but not all, follow through and make sure that the insurance that is issued complies with the specifications. Many supply certificates of insurance, or work with brokers to provide documentation to meet their contractual obligations.

When tragic personal injury or catastrophic property damage occurs, construction industry entities are quick to involve their insurers, whether it's workers compensation, general liability, builders risk, wrap up policies, or professional liability. But when warranty claims are made for defective construction or work, the construction industry often fails to recover the benefit of the insurance they have procured.

This paper will explore the gap between performing contractual warranty work and utilizing insurance to fund repairs and remediation of property damage. It will review some of the most recent case law and statutory actions to deal with defective construction claims. The divergence in how different jurisdictions respond to similar factual situations creates frustration and complexity in pursuing insurance recovery. Some general principles and recommendations for how to proceed will be suggested, as a means to increase utilization of insurance as an asset in dealing with.

The Warranty Claim

You are the risk manager of a company that works as a general contractor. The company regularly hires sub-contractors to perform trade work. The contracts with the company's customers contain standard indemnity and insurance provisions. After the work is complete, but before the warranty period is over, a customer calls to say it has noticed some of the electrical circuits keep shorting out. The customer has had five instances in which electrical appliances on those circuits have failed and had to be replaced.

Scenario One: The project manager writes up the claim as an electrical wiring
problem. He hires workers to remove the finished walls, rip out the circuit, rewire
and re-finish the walls. Customer had to shut down his adjacent garage business
for two weeks while repairs to the area were done. The project manager sends an
invoice for the costs incurred to perform the repairs to the electrical contractor, who
never pays.

Scenario Two: The project manager reports back at the weekly safety meeting
that two of the circuits keep breaking and he noticed a “burning smell” near the
circuit breaker box.

You, as the risk manager, immediately make a note, “have broker give notice to
CGL insurer.” You contact the project manager and have him document the costs
associated with the repair and replacement of the customer‟s appliances. You
arrange for the insurance adjuster to visit the project. You submit a claim making
note of the following facts:

1. Notice was given in the warranty period and the company is legally
obligated to repair.
2. Notice was given to the insurer promptly.
3. Evidence of electrical shorts and surges exists.
4. Some indication that shorts have caused burnouts.
5. Customer's property was damaged.
6. Customer lost revenue during repair period.
7. Repairs to work other than the electrical system were required.
8. Electrical work was done by subcontractor.

The purpose of this comparison between Scenarios One and Two suggests that a warranty claim can be covered by a CGL policy, if contractors are aware that a few minor details can make or break coverage. Being aware of what questions to ask or what facts can be a “red flag” may often trigger coverage for what could seem like a typical warranty claim. Here's a checklist for consideration:

1. Did something happen? Notice the difference between an electrical circuit that does not work versus an electrical circuit that shorted out an appliance.
2. Did any tangible object suffer damage?
3. Did the non-conforming work become inoperable, so that it or some other work could not be used?
4. Who performed the work?
5. Who owned the property that was damaged or not working?
6. Did the customer/third party incur any expense or lose any revenue due to the non-working or damaged object?
7. Did repair involve more than a replacement of the damaged or non-conforming work?

If any of these questions are answered affirmatively, contractors may have a covered claim and should give notice to the CGL insurer optimally before the defective work is repaired. Giving notice and providing the insurer with an opportunity to investigate can go a long way to establishing coverage, rather than overcoming the obstacles of having to reconstruct the failure, the necessary repairs, and the costs. Once the insurer is in the picture, the contractor‟s broker, risk manager or attorney can deal with the insurance principles and case law discussed below.

When Is A Defective Construction Claim Covered?

Starting with general principles of insurance under a commercial general liability policy, the loss must fit within the Insuring Agreement, not be subject to any exclusions, and the insured must have met all conditions. In order to be entitled to a defense or coverage, a defective construction claim must meet five separate components, as follows:

1. the Insured must be legally obligated to pay
2. damages because of property damage
3. caused by an occurrence
4. where the damage is to property other than the ongoing work of the insured
5. unless the work was performed by subcontractors.

There are a few other important elements required, such as giving adequate notice, not making any voluntary payments, not admitting liability without consent of the insurer, and meeting general cooperation obligations.

Each of these components is defined in the policy and case law and may be interpreted differently depending upon the specific facts of the claim. Taking each of these components separately, the construction industry insured or claimant can better understand whether the claim made is covered. These principles will be illustrated by recent case law. The case law will also be used to answer some basic recurring questions.

Is Insured “Legally Obligated To Pay” Or Secure Insurer's Consent?

All too often, in defective construction claims, the general contractor is approached directly by the owner or its customer to “make right” any defects in the work. Project managers or supervisors in the field often accept responsibility for repairs without considering whether to notify the risk manager, broker or inside counsel to analyze whether the repair of the defective work might trigger insurance coverage. However, the insured never questions whether it is legally obligated to perform the repair. After all, the general contractor stands behind its work and will often acknowledge when work has been defectively performed.

The question of whether the insured is “legally obligated” to pay for the damages caused by its work, therefore, is an issue raised by the insurer, after the work has been done, claiming that the repair was “voluntary” and reflects an assumption of an obligation beyond what the contract or the law would require. In Lennar Corp. v. Markel American Ins. Co., 413 S.W.3d 750 (Tex. 2013), the insured recognized that the exterior insulating finishing system (“EIFS”) used in its homebuilding projects was defective and established a program to remove the EIFS, repair the damage and replace the exterior with concrete stucco. At trial, the insurer argued that because Lennar offered remediation to homeowners with damaged houses who would never have sought redress had Lennar left them alone, coverage was excused. The jury did not find Markel's position convincing or that Lennar's remediation program was anything other than a reasonable approach to a serious problem. Markel‟s position was that had Lennar stonewalled the homeowners, fewer repairs would have been made. The jury resolved that as a question of fact, finding that the settlements Lennar entered into established its legal liability and unmistakably limited its liability had it not performed the repairs.

Contrast Lennar's approved remediation plan with the course that the insured general contractor followed in West Bend Mutual Ins. Co. v. Arbor Homes LLC, 703 F.3d 1092 (7th Cir. 2013). As characterized by the court as “the biggest mistake a plumber can make: he forgot to connect the home's drainage system to the city's sewer,” the Seventh Circuit affirmed the district court‟s denial of coverage based on the homebuilder‟s failure to obtain the insurer's consent before settling. When the aggrieved homeowners demanded that the homebuilder furnish them with a new home, the homebuilder requested that the plumber place its insurer on notice of the homeowners' potential claims. Meanwhile, the homebuilder negotiated a settlement, which it believed the plumber communicated to its insurer. Hearing nothing from the insurer in response, the homebuilder mistook the insurer's silence for acquiescence to the terms of the
settlement. In reality, the insurer never consented to the settlement and subsequently denied coverage under the voluntary payments condition in the policy.

What Is An Occurrence?

This question is often answered by the statement: “Faulty workmanship is not an occurrence, but property damage caused by faulty workmanship is the occurrence.” Courts will also conclude that damage is not caused by an occurrence because the property damage is the insured's own work. Neither of these approaches really answers what constitutes an occurrence.

All true coverage analysis should begin with the policy language. The standard CGL policy defines an “occurrence” simply as “an accident, including continuous or repeated exposure to substantially the same, general harmful conditions.” Courts that begin here correctly conclude “an occurrence can arise where faulty workmanship causes unforeseen or unexpected damage to property.” Taylor Morrison Services v. HDI Gerling, 746 S.E.2d 587, 590 (Ga. 2013). Nothing in the definition of an occurrence requires damage to the property or work of someone other than the insured. Id. at 589. Whether property damage was to the named insured‟s work, whether it was caused by a subcontractor's work, or whether it was to completed work, it has no place in the analysis of whether there was an occurrence. “The sounder analytical approach is to avoid
conflating the several requirements of the insuring agreement and the exclusions, and instead to let each serve its proper purpose. (citations omitted).” Id. at 592.

The Supreme Court of North Dakota, in K&L Homes v. American Family Ins. Co., 829 N.W.2d 724 (N.D. 2013), overruled prior precedent that held property damage caused by faulty workmanship is a covered occurrence “to the extent the faulty workmanship causes bodily injury or property damage to property other than the insured‟s work product.” It found that "there is nothing in the definition of „occurrence‟ that supports that faulty workmanship that damages the property of a third party is a covered occurrence but faulty workmanship that damages the work of the named insured is not an occurrence." K&L Homes, at 736. The court concluded that “faulty workmanship may constitute an 'occurrence' if the faulty work was „unexpected‟ and not intended by the insured, and the property damage was not anticipated or intentional, so that neither the cause nor the harm was anticipated, intended, or expected.” Id. at 736.

In Capstone Bldg. Corp. v. American Motorists Ins. Co., 67 A.3d 961 (Conn. 2013), the Supreme Court of Connecticut recognized as an issue of first impression whether a CGL policy would cover defective work as an occurrence. The court noted the significant split in decisions of other jurisdictions. It was convinced by the line of decisions finding coverage, which it felt was more persuasively reasoned. See Appendix for cases finding coverage.

The Capstone court correctly began with the policy language. In prior cases, Connecticut courts held that the term “accident” was to be construed in its ordinary meaning as an “unexpected happening” or “something that happens unexpectedly without design.” As applied to defective construction, it found that the mere fact that defective work is in some sense volitional does not preclude it from coverage. “A deliberate act, performed negligently, is an accident if the effect is not the intended or expected result; that is, the result would have been different had the deliberate act been performed correctly,” citing Lamar Homes v Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007). After concluding that faulty workmanship can be an occurrence, the court
acknowledged that conclusion was only the first step. It then turned to the property damage requirement of the insuring agreement.

One recent case provides an excellent example of when faulty construction constitutes an occurrence. In Maxum Ind. Co. v. Jimenez, 734 S.E. 2d 499 (Ga. App. 2012), the court started with the definition of an occurrence as establishing that faulty workmanship that causes unforeseen or unexpected damage to other property constitutes an occurrence. After construction of a dormitory, a pipe burst, which caused property damage to several units. The costs to repair the property damage caused by the faulty plumbing work was clearly covered. Jimenez did not expect or intend for his piping to burst or to cause damage. The court acknowledged that the correct analysis started with the policy language.

The Supreme Court of Mississippi in Architex Assn. v Scottsdale, 27 So.3d 1148 (Miss. 2010) also recognized the confusion in conflicting opinions of courts because the initial analysis of whether faulty workmanship constitutes an occurrence does not focus on the policy language. “Faulty workmanship, defective or non-conforming work, may be accidental, intentional or neither. The facts must be examined to determine whether the complaint of property damage was proximately caused by breach of a recognizable duty and whether that breach was accidental or intentional, or whether the property damage was caused by neither. The court must determine whether the unexpected and unintended property damage resulted from the insured‟s work.” Id. at 1161.
In Cherrington v. Erie Ins. Property & Cas. Co., 745 S.E.2d 508 (W.Va. 2013), the Supreme Court of West Virginia overruled prior precedent to join what it deemed a majority of jurisdictions that concluded CGL policies provide coverage for defective work as an occurrence. See Appendix for cases citing majority rule.

What Is Property Damage?

All too often, a court addressing a defective construction claim concludes that no property damage was the result of the defective construction. If the court had focused its review on the policy language as it applied to the facts, it would have to acknowledge that, in reality, tangible property was actually damaged. The courts, however, erroneously conclude that no property damage occurred because the damage was only to the work of the insured.

In the defective construction claim, the claimant alleges changes to the physical condition of the named insured's work, e.g., warping of window installations, cement spalling, or insulation damaged by intrusion of water. Those allegations qualify as damage to tangible property. A conclusion that there is no property damage is erroneous. What more correctly should follow after the examination of the insuring agreement elements is an application of the policy exclusions. Damage to the work of the named insured is still property damage, but it may not be covered due to the application of the named insured‟s work exclusion.

In K&L Homes v. American Family Ins. Co., 829 N.W.2d 724 (N.D. 2013), the court acknowledged that damage to the insured's work is still property damage. Although the insured constructed the entire home, the homeowner noticed cracks, unevenness and shifting in the foundation. The house suffered damage of substantial shifting caused by improper footings and inadequately compacted soil under the footings and foundations. The court concluded that the damage suffered by the home fell within the definition of “property damage,” as “physical injury to tangible property.”

In Capstone, the court in turning to whether property damage occurred, recognized that there was no consensus on the meaning of the term “property damage” in the context of claims for defective work. As a threshold matter, however, it confirmed that there was no basis in the language to assert that property damage could only exist if a third party's property was damaged. It noted that the definition of property damage and the insuring agreement did not differentiate between damage to the insured's work and damage to other property. In reviewing the allegations of the complaint, the court noted that UConn had alleged the project suffered water damage, mold damage, cracked piping and structural problems, which clearly involved property damage. The alleged defects also included building code violations and poor quality control. Those alleged defects did not constitute physical injury to tangible property. Similarly, the escape of carbon monoxide, without more, did not constitute property damage.

Once the court acknowledged that there were elements of property damage, it then turned to whether the repair of the defective work would constitute covered damage. It made the distinction, as do other courts, that there is a difference between a claim for the costs of repairing or removing defective work, which is not a claim for property damage, and a claim for the costs of repairing damage caused by the defective work, which is a claim for property damage. The policy clearly contemplates coverage for repairs to nondefective property stemming from physical injury to tangible property or loss of use caused by defective work stemming from an occurrence including consequential costs for the necessary repairs and remediation. (Capstone, at 982)

In Lennar Corp. v. Markel American Ins. Co., 413 S.W.3d 750 (Tex 2013), the court examined whether the cost of repairs undertaken by Lennar was covered as damages because of property damage. The court concluded that under no reasonable construction of the insuring agreement could the cost of investigating the damage in order to repair it not be considered to be “because of” the damage. Since each of the homes for which Lennar sought to recover remediation costs was actually damaged, the cost to locate the damage, which was hidden from sight, would be covered. The court thus rejected Markel‟s argument that removal of the EIFS was merely “preventive.” Furthermore, since the damage to each home began during construction and continued until it was repaired, all because of water trapped in walls by EIFS applied to wood-frame construction, the policy covered Lennar‟s total remediation costs. (Lennar, at 758)

In Cherrington v. Erie Ins Property & Cas. Co., 745 S.E.2d 508 (W.Va. 2013), the court identified the following as property damage: an uneven concrete floor on the home's lower level; roof leaking that damaged the ceiling, walls, and chimney joint; wood components that directly touch the soil; settlement that produced a sagging support beam and numerous cracks in the home‟s walls and partitions; and various other items requiring repair, including systems for water diversion, roof seams, flashing, caulking, and paint.

Can A Complaint Based On Breach Of Contract Be Covered?

In many different contexts, one encounters a basic misunderstanding about what coverage a commercial general liability policy offers. Starting with the basic premise of the coverage grant, any potential liability must be tested against the elements of CGL coverage, not by the label that the cause of action bears.

Unfortunately, courts have too often looked at the type of action alleged and concluded that the policy does not provide coverage because a breach of contract action is excluded by the contractual liability exclusion. Nothing could be further from the truth. Under the broad coverage grant of a CGL policy, an insured may be covered for any liability arising from a contractual liability. The policy language provides:

The company will pay on behalf of the insured all sums which the insured shall ecome legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies, caused by an occurrence.

A starting point for the analysis is understanding that a tort cannot be created from a breach of contract action by merely using the label “negligence.” The differences between the two types of actions are far more significant than labels and lead to a genuine basis for distinguishing between what can be covered and what is not.

In Ewing Constr. Co. v. Amerisure Ins. Co., 690 F.3d 628 (Tex. 2014), the Supreme Court of Texas recently analyzed whether a defective construction case triggered coverage. Shortly after construction was completed, “serious tennis court cracking and flaking problems began . . . and have continued since. Chunks of the court surfaces are coming loose. Flaking, crumbling, and cracking make the courts unusable for their intended purpose, competitive tennis events.” The owner claimed damages on both contractual and negligence theories of liability. Amerisure did not dispute that the alleged defects in the tennis courts occurred during the policy period and constituted “property damage” caused by an “occurrence” within the scope of the policy‟s insuring agreement.

The court, although answering the question of whether the contractual liability exclusion applied, had occasion to comment on the difference between the allegations of breach of contract and negligence.

The allegations that Ewing failed to perform in a good and workmanlike manner are substantively the same as its claims that Ewing negligently performed under the contract because they contain the same factual allegations and alleged
misconduct. We have defined “good and workmanlike” as “that quality of work performed by one who has the knowledge, training, or experience necessary for the
successful practice of a trade or occupation and performed in a manner generally considered proficient by those capable of judging such work.” Melody Home Mfg. Co. v. Barnes, 741 S.W.2d 349, 354 (Tex. 1987) (discussing the implied warranty
of good and workmanlike quality of services in connection with the repair of tangible goods). Negligence means the failure to use ordinary care, that is, failing to do that which a reasonable person or provider of the defendant's type would
have done under the same or similar circumstances. See 20801, Inc. v. Parker, 249 S.W.3d 392, 398 (Tex. 2008).

Based on these definitions, TMISD's claims that Ewing failed to perform in a good and workmanlike manner and its claims that Ewing negligently performed under the contract are substantively the same. See Coulson v. Lake L.B.J. Mun. Util. Dist., 734 S.W.2d 649, 651 (Tex. 1987) (“We are unable to discern any real difference between the District's claim that Coulson's efforts were not good and workmanlike and did not
meet the standards of reasonable engineering practice and its claim that Coulson was negligent in his performance of professional services.”). Ewing, at 632.

It is beyond question that a breach of contract is limited to the obligations that run between the parties to the contract to perform the “work” of a contract. One refers to the “corpus” of the contract, or the “res” or “thing” produced. If the contract is not performed adequately, or if the “corpus” of the contract is not delivered according to specifications, the injured party will be entitled to damages under the contract, the benefit of the bargain. These can include claims for inadequate value, repair and replacement costs, lost profits, and delay damages. These are termed “economic damages.” [See Figure 1 attached.] If in the course of performing a contract, one of the parties causes damage to property or persons outside the “corpus” of the contract, the third party will be entitled to all damages which were proximately caused by the breach of duty owed to that third party. These damages are defined in terms of bodily injury, property damage, pain and suffering, emotional distress, loss of consortium, and injury to reputation or noneconomic loss.

The Supreme Court of Alabama in Owners Ins. Co. v. Jim Carr Builder LLC, 2013 Ala. LEXIS 122, 2013 WL 5298575 (Ala. 9/20/13), emphasized the distinction in concluding that “faulty workmanship performed as part of a construction or repair project may lead to an occurrence if the faulty workmanship subjects personal property or other parts of the structure outside the scope of that construction or repair project (emphasis in original) "to continuous or repeated exposure to some other general harmful condition‟ and if, as a result of that exposure, that personal property or other unrelated parts of the structure are damaged.” “We 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.” Id. at 15.

The Seventh Circuit made the same pronouncement in Lagestee-Mulder, Inc. v. Consol. Ins. Co., 682 F.3d 1054 (7th Cir. 2012) when it cited the general rules: “Where the underlying suit alleged damage to the construction project itself because of a construction defect, there is no coverage. By contrast, where the complaint alleges that a construction defect damaged something other than the project, coverage exists… (cites omitted). In other words, to find coverage, “there must be damage to something other than the structure, i.e., the building.” Id. at 1057.

Therefore, in the course of distinguishing between what is a tort, what is a contract, what is property damage, and what is economic loss, there is a confluence of tort and contract concepts. This distinction is very strikingly demonstrated by two pairs of cases, one that involved a breach of contract action which ultimately was held not to trigger insurance coverage, and the other in which the court determined that property damage existed, and therefore a CGL policy applied.

The State of Illinois claimed economic losses arising from extreme heat in its new building due to an inadequate heating, ventilating, and air-conditioning (HVAC) system. It filed suit for breach of contract to provide thermal banks and failure to install equipment in conformance with contract specifications. It claimed that loss of productivity occasioned by illness of employees resulting from excessive temperatures should translate its breach of contract claim to a negligence claim for bodily injury. In two separate coverage actions, the appellate courts determined that the claims of the State were not on behalf of its employees, seeking recovery for damages sustained by them on account of their illness or other bodily injury. Furthermore, the courts held that allegations that the units failed to perform their anticipated function did not constitute physical injury to property. Diamond State Ins. Co. v. Chester-Jensen Co., 611 N.E.2d 1083 (Ill. App. 1993);
Bituminous Cas. Corp. v. Gust K. Newberg Construction Co., 578 N.E.2d 1003 (Ill. App. 1991).

In contrast to these “failure to perform” cases, liability for asbestos incorporated into buildings has received different treatment. The presence of health threatening, asbestos-containing products released over time has been found to have contaminated buildings, therefore constituting physical injury to tangible property. The damage was not the result of the failure of the asbestos to perform its contractual function as an insulator. Rather its detrimental impact was caused by a “wholly ancillary and coincidental phenomenon,” namely the diffusion of harmful fibers.

In USF&G v. Wilkin Insulation Co., 578 N.E.2d 926 (Ill. 1991), asbestos-related cost of repair and replacement was held to be more than merely economic damage. This symmetry between the insurance concept of physical injury to property and the tort concept of damage to property outside the “res” of the contract is noted in the companion case to Wilkin, Board of Education v. A.C.&S., Inc., 546 N.E.2d 580 (Ill. 1990). Although this case preceded the USF&G v. Wilkin analysis, the Illinois Supreme Court determined that a tort claim sounding in negligence and strict product liability against asbestos installers pleaded property damage for purposes of passing the costs of asbestos abatement onto those parties that manufactured, sold, and installed the asbestos. The
court rejected the claim that the parties suffered a claim for breach of contract only. The court concluded that the installation of asbestos sufficiently contaminated the building so that damage to property other than the defective product occurred. The claim was not that the asbestos failed to perform its function, i.e., insulate effectively, but that it deteriorated in a dangerous manner, was defective, toxic, and harmful.

Many commentators have noted that nothing in the insuring agreement of the CGL policy precludes coverage for breach of contract. A judgment or settlement imposing liability upon the insured, if based upon an accident resulting in bodily injury or property damage would certainly be a “sum that the insured became legally obligated to pay as damages because of bodily injury or property damage.”

Further support for the conclusion that a claim sounding in breach of contract may be covered is the fact that the standard CGL policy contains a “contractual liability” exclusion. If contractual liabilities were not potentially covered by the insuring agreement, there would be no need to have an exclusion to “take away” the coverage.

If one begins with the insuring agreement and the definition of an occurrence, the use of the word “accident” in its usual and common usage, and without more, conveys nothing about the nature of extent of the legal theory through which liability might arise from the happening of an event. The Taylor Morrison court noted only one important exception, i.e., to the extent that a theory of liability is absolutely and necessarily inconsistent with the notion of an “accident,” when the theory of liability and the idea of an accident are mutually exclusive. In addressing breach of contract or breach of warranty, however, the court concluded it is not inherently mutually exclusive to an accident, because generally speaking, breach of warranty imposes strict liability regardless of intent or culpability. “In many cases, faulty workmanship may cause a product or other work to amount to a breach of warranty for the product or work.... So, in many cases, an 'occurrence' might be found in the context of a claim for breach of warranty.” Thus, it is not the cause of action that determines whether the conduct is covered. The insuring agreement requires
that the occurrence, i.e., the faulty workmanship, must cause property damage which will only be found when the faulty workmanship causes physical injury to, or the loss of use of, nondefective property or work. “As such, it generally will only be a breach of a warranty of nondefective property from which coverage might arise, as liability for a breach of the warranty of the defective property would not involve 'damages because of' 'property damage' to the nondefective property.” Taylor, at 595.

Another case in which the insurer claimed that its policy did not provide coverage for the property damage suffered by the owner raised the defense that since the suit was for only contractual indemnity and breach of contract, the damages claimed were outside the scope of the policy's coverage for property damage arising out of tort liability. The court in Maxum Ind. Co. v. Jimenez, 734 S.E. 2d 499 (Ga. App. 2012) rejected the argument finding the insurer‟s attempt to characterize the underlying claim as involving only contractual damages for economic loss to be unavailing. It recognized that although the complaint set forth both a breach of contract claim and a tort claim, both claims were based upon defective workmanship and the resulting damage.

Despite this broad generalization, however, there is nothing in the basic coverage language of the current CGL policy to support any definitive tort/contract line of demarcation for purposes of determining whether a loss is covered by the CGL‟s initial grant of coverage. “Occurrence” is not defined by reference to the legal category of the claim. The term “tort” does not appear in the CGL policy. In American Family Mutual Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004), the court rejected the insurer‟s argument that breach of contract actions could not qualify as covered.

Indeed, this court has never held that the CGL insuring agreement only covers torts. In Doyle v. Engelke, 219 Wis. 2d 277, 580 N.W.2d 245 (1998), for instance, we decided a CGL coverage dispute involving a policy that used the term “event” instead of “occurrence,” but which defined “event” in exactly the same way that “occurrence” is defined in the CGL policy here. We took note of the “common, everyday meaning” of “accident:” “'an unexpected, undesirable event' or 'an unforeseen incident' which is characterized by a 'lack of intention.'” Id. at 289 (quoting The American Heritage
Dictionary of the English Language 11 (3d ed. 1992)). We also noted the ommonalities in the standard dictionary definitions of “accident” and “negligence,” and remarked that “[I]t is significant that both definitions center on an unintentional occurrence leading to undesirable results.” Doyle, 219 Wis. 2d at 289-90.

Doyle did not, however, equate the term “accident,” as used in the CGL policy, with negligence as a form of legal liability; we simply held that negligent acts were “accidental” within the meaning of the CGL's definition of “event.” Id. (“[W]e have
little trouble concluding that a reasonable insured would expect the Policy provision defining 'event' to include negligent acts.”) Doyle did not imply that there could never be CGL coverage unless the accidental “event” (here, “occurrence”) was actionable in tort as negligence.

Furthermore, contrary to American Family's suggestion, Wausau Tile did not establish a “generally accepted” rule that a breach of contract or warranty cannot be an “occurrence” for purposes of CGL coverage. In Wausau Tile, we concluded that certain tort claims between Wausau Tile and its cement supplier, Medusa Cement, were barred by the economic loss doctrine. Wausau Tile, 226 Wis. 2d at 247-254. Having disposed of the tort claims in the case, we briefly addressed Medusa's insurer‟s duty to defend the remaining contract/warranty claims, noting only that the issue of whether the alleged breach of contract or warranty was a covered “occurrence” under the insurer‟s policy was “undisputed.” Id. at 268-69. Here, unlike in Wausau Tile, the issue is disputed.

If, as American Family contends, losses actionable in contract are never CGL “occurrences” for purposes of the initial coverage grant, then the business risk exclusions are entirely unnecessary. The business risk exclusions eliminate coverage for liability for property damage to the insured‟s own work or product – liability that is typically actionable between the parties pursuant to the terms of their contract, not in tort. If the insuring agreement never confers coverage for this type of liability as an original definitional matter, then there is no need to specifically exclude it. Why would the insurance industry exclude damage to the insured's own work or product if the damage could never be considered to have arisen from a covered “occurrence” in the first place? Id. at 77.

Can Economic Damages Such As Delay Or Extra Expense Be Covered?

An analysis of whether consequential damages, such as loss of profits or diminution in value can be covered by a CGL policy demands that the analysis not resort to “labels” or general principles such as one can not recover economic damages in a tort cause of action. One recent case that serves as an excellent example of a coverage analysis finding that consequential damages that flowed from an occurrence constituted property damage caused by an occurrence. In Auto-Owners Ins. Co. v. Rhodes, 748 S.E.2d 781 (S.C. 2013), the insured was sued for damages arising out of the faulty construction of three outdoor advertising billboard signs after one of the signs fell across the interstate. The damages claimed included damage to the real estate owed by the contractor's
customer, loss of use of the signs, and lost income of his company due to the negligent design, fabrication, and erection of the signs, which led to the removal of the non-defective signs and the revocation of the permits to allow the erection. The court held that the loss of the two non-damaged signs and the consequential damages flowing therefrom were causally linked to the occurrence of the falling sign and thus constituted property damage caused by an occurrence.

What Is Ongoing Work Versus Completed Work?

In Brown v Concord Group Ins. Co., 163 N.H. 522, 44 A.3d 586 (2012), the Supreme Court of New Hampshire made the extremely important point often overlooked that the “your work” exclusion has two requirements. Not only must the damage be to the named insured's own work, but the damage must be to work that is completed, so that it falls within the “products-completed operations hazard.” Therefore, the definition of “your work” has a limitation in that it contemplates discrete jobs that have an endpoint. The impact of delineating between jobs was the basis for finding coverage for damage to the insured's previously completed work.

When Does The Policy Cover Damage To The Insured's Work If Caused By A
Subcontractor's Work?

It has recently been noted by the Supreme Court of North Dakota in K&L Homes v. American Family Ins. Co., 829 N.W.2d 724 (N.D. 2013) that faulty workmanship of a subcontractor fits within the definition of an occurrence under a CGL policy in a majority of state supreme courts. Currently, the majority of state supreme courts who have decided the issue of whether inadvertent faulty workmanship is an accidental “occurrence” potentially covered under the CGL policy have decided that it can be an "occurrence." See Appendix.

Furthermore, the insured‟s work exclusion might apply but for the subcontractor exception. Therefore, when a general contractor becomes liable for damage to work performed by a subcontractor – or for damage to the general contractor‟s own work arising out of a subcontractor‟s work – the subcontractor exception preserves coverage the "your work‟ exclusion would otherwise negate.” K&L Homes, at 737.

Cases in Wisconsin and in other jurisdictions have consistently recognized that the 1986 CGL revisions restored otherwise excluded coverage for damage caused to construction projects by subcontractor negligence. In Kalchthaler, the court of appeals concluded that “[t]he only reasonable reading of [the 1986 exception] is that it restores coverage for damage to completed work caused by the work of a subcontractor.” Kalchthaler, 224 Wis. 2d at 391.

The court of appeals‟ straightforward reading of the subcontractor exception to the business risk exclusion in Kalchthaler was buttressed by a similar holding in a case from Minnesota, O’Shaughnessy v. Smuckler Corp., 543 N.W.2d 99 (Minn. Ct. App. 1996), in which the Minnesota Court of Appeals found coverage for improper subcontractor performance that caused damage to a residential home project.

Like the O’Shaughnessy court, the court in Kalchthaler recognized that the effect of the 1986 revision of the CGL could not be defeated by reliance upon broad judicial holdings interpreting pre-1986 policies that did not contain the subcontractor exception. “For whatever reason, the industry chose to add the new exception to the business risk exclusion in 1986. We may not ignore that language when interpreting case law decided before and after the addition. To do so would render the new language superfluous.” Kalchthaler, 224 Wis. 2d at 400.

Courts in other jurisdictions have reached the same conclusion when interpreting the post-1986 subcontractor exception or policy endorsements containing identical language. See Wanzek Constr., Inc. v. Employers Ins. of Wausau, 667 N.W.2d 473 (Minn. Ct. App. 2003); Kvaerner Metals v. Commercial Union Ins. Co., 825 A.2d 641 (Pa. Super. Ct. 2003); L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 567 S.E.2d 489 (S.C. Ct. App. 2002)(certiorari granted May 15, 2003); CU Lloyd's of Texas v. Main Street Homes, Inc., 79 S.W.3d 687 (Tex. Ct. App. 2002).

CGL policies unmistakably include coverage for defects in the insured's own work, if the insured's liability for defects turns on whether the subcontractor exception applies. Scottsdale v. R.I. Pools 710 F.3d 488, 492 (2nd Cir. 2013).

In Capstone, the court noted that if the property damage was to the insured's own work, one still had to determine whether the damage arose out of work performed on the insured's behalf by a subcontractor. Recognizing that when the damage arises out of an occurrence, the subcontractor exception restores coverage for property damage caused by a subcontractor's defective work.

CONCLUSION

Defective construction claims pose business challenges for the construction and insurance industries. Risk managers and claims professionals need to be aware that insurance is a valuable asset to use for repairs and remediation, as well as reimbursement to owners for delay and lost profits. Knowing what makes a warranty claim a covered claim will make the difference.

APPENDIX

Cases Citing The Majority Rule That CGL Policies
Provide Coverage For Defective Work As An Occurrence

American Empire Surplus Lines Ins. Co. v. Hathaway Dev. Co., Inc., 288 Ga. 749, 752, 707 S.E.2d 369, 372 (2011) (“[A]n occurrence can arise where faulty workmanship causes unforeseen or unexpected damage to other property.”). American Family Mut. Ins. Co. v. American Girl, Inc., 268 Wis. 2d 16, 673 N.W.2d 65 (2004) (concluding property damage resulting from subcontractor's defective work constituted an “occurrence” under CGL policy) (holding that damage to a
warehouse caused by soil settlement, which occurred because of a subcontractor's faulty site-preparation advice was accidental, not intentional or anticipated, and was an “occurrence” within the meaning of the CGL policies).

Architex Ass’n, Inc. v. Scottsdale Ins., 27 So. 3d 1148 (Miss. 2010) (holding the term “occurrence” cannot be construed in such a manner as to preclude coverage for unexpected or unintended “property damage” resulting from negligent acts or conduct of a subcontractor unless otherwise excluded) (“[T]he term "occurrence" cannot be construed . . . to preclude coverage for unexpected or unintended "property damage‟ resulting from negligent acts or conduct of a subcontractor[.]”).

Auto Owners Ins. v. Newman, 684 S.E.2d 541 (S.C. 2009) (holding that a subcontractor‟s negligent application of stucco to a home resulted in an “occurrence” under the CGL policy‟s grant of coverage for the resulting progressive property damage to the home), overruled by Crossmann Communities of N.C., Inc. v. Harleysville Mut. Ins., No. 26909, 2011 S.C. LEXIS 2, at *1 (S.C.
Jan. 7, 2011), withdrawn and substituted by 717 S.E.2d 589 (S.C. 2011) (adhering to the result in Newman).

Capstone Bldg. Corp. v. American Motorists Ins. Co 67 A. 3d 961, at *6 (Conn. June 11, 2013) (“[W]e conclude that defective workmanship can give rise to an “occurrence”[.]”).

Century Indem. Co. v. Hearrean, 120 Cal. Rptr. 2d 66, 98 Cal. App. 4th 734 (2002) (concluding that defective construction triggered coverage as an “occurrence” under CGL policy).

Columbia Mut. Ins. Co. v. Epstein, 239 S.W.3d 667 (Mo. Ct. App. 2007) (concluding defective workmanship constituted an “occurrence” under CGL policy).

Corner Constr. v. United States Fid. and Guar., 638 N.W.2d 887 (S.D. 2002) (holding that the CGL policy provided coverage for a general contractor's liability for property damage to the building as a result of the subcontractor's faulty workmanship, which was an “accident” resulting in property damage) (finding CGL policy provided coverage for subcontractors' faulty workmanship).

Fejes v. Alaska Ins., 984 P.2d 519 (Alaska 1999) (holding there was an “occurrence” and coverage for damages caused by a subcontractor's defective work on a septic system).

High Country Assocs. v. N.H. Ins., 648 A.2d 474 (N.H. 1994) (holding that actual damage to the structure of the condominium units by continuous exposure to moisture from defective construction resulted in an "occurrence" covered by the CGL policy).

K & L Homes, Inc. v. American Family Mut. Ins. Co., 829 N.W.2d 724, 736 (N.D. 2013) (“We conclude faulty workmanship may constitute an „occurrence‟ if the faulty work was „unexpected‟ and not intended by the insured, and the property damage was not anticipated or intentional, so that neither the cause nor the harm was anticipated, intended, or expected.”).

Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 4 (Tex. 2007) (“We conclude that allegations of unintended construction defects may constitute an "accident' or "occurrence" under the CGL policy[.]”) (holding that a general contractor's defective construction or faulty workmanship in building a house foundation is an “occurrence” within the meaning of the CGL policy).

Lee Builders, Inc. v. Farm Bureau Mut. Ins., 137 P.3d 486 (Kan. 2006) (holding unforeseen and unintended damage from leaking windows installed by an insured‟s subcontractor was caused by an “occurrence”) (“The damage in the present case is an occurrence – an even more expansive coverage term than "accident" – because faulty materials and workmanship provided by [the]
subcontractors caused continuous exposure of the [property owner's] home to moisture. The moisture in turn caused damage that was both unforeseen and unintended.”).

Lennar Corp. v. Auto-Owners Ins. Co., 214 Ariz. 255, 262-64, 151 P.3d 538 (Ct. App. 2007) (finding that damages resulting from defective workmanship constitute an “occurrence” under CGL policy).

McKellar Dev. v. Northern Ins., 837 P.2d 858 (Nev. 1992) (holding soil compaction performed by subcontractors, which caused damage to buildings built by an insured, was an “occurrence” and covered under the Broad Form Property Damage endorsement).

Revelation Indus., Inc. v. St. Paul Fire & Marine Ins. Co., 350 Mont. 184, 206 P.3d 919 (2009) (deciding subcontractor's faulty product constituted an “event” so as to be covered by subject CGL policy) (holding property damage to an insured's products or completed work done for the insured by a subcontractor is an “accident” and the CGL policy provides coverage to the insured).

Sheehan Constr. v. Continental Cas. Co., 935 N.E.2d 160, modified 938 N.E.2d 685 (Ind. 2010) (on other grounds) (holding that faulty workmanship may constitute an “occurrence” if the resulting damage is an event that occurs without expectation or foresight) (“[F]aulty workmanship may constitute an accident and thus an occurrence [under a CGL policy].”), modified on other grounds, 938 N.E.2d 685 (Ind. 2010).

Travelers Indem. Co. of Am. v. Moore & Assocs., Inc., 216 S.W.3d 302, 308 (Tenn. 2007) (observing that “the [CGL] policy in this case provides coverage to any "property damage" caused by an event that was not foreseeable to [the insured], including continuous exposure to substantially the same generally harmful conditions” such as those resulting from the subcontractor"s defective work)
(holding that defective workmanship may constitute an “occurrence” under a CGL policy; damages caused by faulty workmanship are “property damage” and “damages resulting from the faulty workmanship of a subcontractor are not excluded from coverage”).

United States Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871, 888 (Fla. 2007) (“We hold 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.”) (holding that a subcontractor's defective soil preparation, which was neither expected nor intended from the standpoint of the general contractor, was an “occurrence” under the CGL policy and the structural
damage to the completed homes was property damage under the CGL policy). Wanzek Constr., Inc. v. Employers Ins. of Wausau, 679 N.W.2d 322 (Minn. 2004) (determining CGL policy provided coverage for faulty work of subcontractor) (holding damage to a swimming pool caused by a subcontractor was covered under a CGL policy).

Cases Citing The Minority Rule That CGL Policies
Provide Coverage For Defective Work As An Occurrence

Cincinnati Ins. v. Motorists Mut. Ins., 306 S.W.3d 69 (Ky. 2010) (holding a claim for poor workmanship in building a home does not involve the fortuity required to constitute an accident and is therefore not an “occurrence”).

Essex Ins. v. Holder, 261 S.W.3d 456 (Ark. 2008) (holding defective or incomplete construction, standing alone, that results in damage only to the work product itself is not an “occurrence” under the CGL policy).

Kvaerner Metals v. Commercial Union Ins., 908 A.2d 888 (Pa. 2006) (holding poor workmanship in the construction of a coke battery, resulting in the product not meeting contract specifications and warranties, was not an "occurrence" under the CGL policy language).

Oak Crest Constr. v. Austin Mut. Ins., 998 P.2d 1254 (Or. 2000) (holding costs for the repair of a subcontractor‟s deficient work did not arise from an accident under the CGL policy, but leaving open the question when there is damage to other property).

Town & Country Prop. v. Amerisure Ins., No. 1100009 and 1100072, 2011 WL 5009777, *1 (Ala. Oct. 21, 2011) (holding a subcontractor‟s faulty workmanship, standing alone, is not an “occurrence” under the CGL policy, but may be an “occurrence” if the faulty workmanship exposes personal property or other parts of the structure to continuous and repeated exposure to some other general harmful condition).

J. Randolph Evans & J. Stephen Berry, New Appleman on Insurance: Current Critical Issues in Insurance Law, on Construction Defect Coverage Law: Past, Present, and Future, § I-Appendix, at 1-31 (December 2008) [hereafter “New Appleman on Insurance”].

The content of this article is intended to provide general information and as a guide to the subject matter only. Please contact an Advise & Consult, Inc. expert for advice on your specific circumstances.

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