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People
Who Live In Glass Houses: The Recurring Issue of Construction Defect Claims And Insurance
Coverage
Periodical: Defense Research Institute
Date: April 5-8, 1998
I.
INTRODUCTION
Property owners continue to file construction-related claims
and lawsuits against contractors, developers, architects, designers,
subcontractors, material suppliers, and anyone remotely related to a
real property construction project (collectively
"contractors") almost as routinely as new buildings are
constructed. As new and
old theories of liability are advanced against insured contractors,
the issue of whether insurance coverage is available for defense or
indemnification of such claims or suits against these policyholders is
repeatedly raised . Contractors
want their insurers to shield them from claims that are based on the
contractors' alleged faulty workmanship. Insurers of the contractors, however, want to preclude or
limit coverage for such claims when the claim at issue is or was a
risk within the control of the contractor policyholder.
Assume, for example that a newly constructed glass house loses
several of its glass panels, one of which strikes a pedestrian.
The owner may bring several causes of action against the
contractor. Each cause of action, in turn, may raise questions regarding
the scope of coverage under the contractor's commercial general
liability ("CGL") policy.
Will insurance provide a defense or indemnity to the contractor
when the owner of the glass house files a suit seeking damages for
either injuries sustained by the pedestrian (and paid by the owner) or
damages incurred by the owner to repair the glass house?
Contractors and insurance carriers continue to dispute whether
insurance coverage is available for construction defect claims.
As a consequence, courts continue to confront the issue of
whether CGL policies grant or preclude coverage for construction
defect claims.
As a general rule, a court’s coverage analysis often
addresses the issue of coverage for construction defect claims based
upon whether the loss at issue is a natural or predictable consequence
of the contractor policyholder’s everyday business risks and
operations, or whether the loss at issue was truly unanticipated.
If a loss falls within the control of the contractor, such as
glass panels falling from a house due to faulty workmanship, courts
are generally reluctant to find coverage since the purpose of the CGL
policy is not to act as a warranty of the contractor’s work.
If a loss is outside the control of the contractor, however,
such as a glass panel falling and striking a pedestrian, courts are
more inclined to find coverage.
This paper examines a variety of issues related to insurance
coverage for construction defect claims under standard CGL policy
language. This
paper primarily focuses on whether certain construction defect claims
fit within the basic coverage grant of a CGL policy and, if so,
whether any policy exclusions are applicable.
II.
GENERAL LIABILITY INSURANCE AND PROPERTY INSURANCE.
A.
GENERAL LIABILITY
INSURANCE
The typical policy purchased by a
contractor is a Comprehensive or Commercial General Liability ("CGL")
policy. These policies
generally are written pursuant to forms provided by the
Insurance Services Office ("ISO") and obligate the insurer
to defend and/or indemnify the policyholder contractor for claims
against it alleging "bodily injury" or "property
damage" that are the result of an "occurrence."
The insuring coverage grant usually obligates the insurer to
pay "all sums" the insured becomes legally obligated to pay
as damages because of bodily injury or property damage caused by an
occurrence. This grant of
insurance coverage, however, is subject to several coverage exclusions.
An "occurrence," discussed infra,
is generally defined as "an accidental event . . . including
continuous or repeated exposure to substantially the same general
harmful conditions."
"Property Damage" is defined to
include "physical injury to or destruction of tangible property .
. . or loss of use of tangible property which has both been physically
injured or destroyed." "Bodily
Injury" usually requires actual injury to a person’s body (as
opposed to mere emotional distress).
The purpose of CGL policies, contrary to some contractors’
hopes, is to require the contractor to absorb "its own
replacement and repair losses while the insurer takes the risk of
injury to the property of others." Western Employers Ins.
Co. v. Arciero & Sons, Inc. 146 Cal. App. 3d 1027, 1031, 194
Cal. Rptr. 688, 690 (1983). If
insurance companies absorbed the risk of faulty workmanship, there
would be no incentive for contractors to make certain work is
performed correctly. The
seminal California case on the purpose of CGL coverage stated:
The
risk of replacing and repairing defective materials or poor
workmanship has generally been considered a commercial risk which is
not passed on to the liability insurer.
Rather liability coverage comes into play when the insured’s
defective materials or work cause injury to property other than the
insured’s own work or products
.
. . ." This distinction is significant.
Replacement and repair costs are to some degree within the
control of the insured. They
can be minimized by careful purchasing, inspection of materials,
quality control and hiring practices.
If replacement or repair costs were covered, the incentive to
exercise care or to make repairs at the least possible cost would be
lessened since the insurance company would be footing the bill for all
scrap."
Maryland Casualty Co. v. Reeder, 270 Cal. Rptr. 719, 722 (1990) citing
Stewart Macaulay, Justice
Traynor and the Law of Contracts, 13 Stan. L. Rev. 812, 825-826
(1961).
In one of the leading cases to address insurance coverage in
the construction defect context, the Minnesota Supreme Court stated:
An analysis of the issue commences with the consideration of
elementary insurance principles.
In exchange for the payment of a premium, an insurer assumes
certain risks that otherwise would be the obligation of the insured.
In order to have predictable and affordable insurance rates,
the insurers’ assumptions of risk are usually limited to those
beyond the "effective control" of the insured.
That principle applies to the CGL insurance policy.
The contractor . . . has a contractual business risk that he
may be liable to the owner resulting from the failure to properly
complete the building project itself in a manner so as to not cause
damage to it. This risk is one the general contractor effectively controls
and one which the insurer does not assume because it has no effective
control over those risks and cannot establish predictable and
affordable insurance rates. . . .
Unlike the surety on a performance bond, a CGL insurer has no
recourse against a contractor for the employment of defective
materials or shoddy workmanship on the construction project.
Knutson Constr. Co. v. St. Paul Fire & Marine Ins. Co., 396 N.W.
2d 229, 233-234 (Minn. 1986).
B. THE "BROAD FORM "
ENDORSEMENT AND ITS INCORPORATION INTO THE 1986 POLICY FORM
Insurers initially offered a broad
form property damage endorsement
as a package that, in effect, provided policyholders, including
contractors, with expanded coverage.
The broad form endorsement proved a popular addition to CGL
converage. Eventually,
the endorsement was dismantled and incorporated piecemeal into the
1986 general liability coverage forms.
Several changes were made in the 1986 CGL forms based on the
broad form endorsement that did not previously exist in the 1973 CGL
forms. The primary
changes were made in definitions and exclusions.
These changes, in turn, often impact on whether coverage will
be available to a contractor for construction defect claims.
Although these changes in policy language have now been in
existence for ten years or more, it is not unusual to see a contractor
tender coverage under a 1973 form, especially when a delayed injury
claim is at issue. Consequently,
any coverage analysis or policy interpretation should include
consideration of whether a 1973 or 1986 form is being utilized (or a
broad foam endorsement), and the policy language differences and
issues relevant thereto. These changes are discussed further, infra.
C.
PROPERTY INSURANCE
A property insurance contract, as
distinguished from general liability insurance, is a contractual
relationship in which the insurer agrees to indemnify a policyholder
in the event a designated property experiences a covered loss. Several persons or entities may have an insurable interest in
the designated property at the same time, e.g.,
property owner, mortgagee, or tenants.
Property insurance policies generally insure either (1)
"all risks" of physical loss unless perils are specifically
excluded; or (2) "named perils" such as losses from
specifically identified causes, e.g., fire or earthquake. The
property insurer covering the insured risk when property damage first
manifests itself is generally the insurer solely responsible for the
loss, even if property damage continues after the insurer’s policy
expires. See, e.g., Prudential-LMI Commercial Ins. Co. v. Sup. Ct. (Lundberg),
51 Cal. 3d 674, 679, 274 Cal. Rptr. 387, 404 (1990); Allstate Ins. Co. v. Quinn Constr. Co., 713 F. Supp. 35 (D. Mass.
1989), opinion vacated, 784
F. Supp. 927 (D. Mass. 1990); Cohen
v. North American Life and Casualty Co., 150 Minn. 507 (Minn.
1921); Jackson v. State Farm
Fire & Cas. Co., 108 Nev. 504 (Nev. 1992).
Coverage under an "all risk" policy is generally
determined by the policy exclusions.
Coverage under a "named perils" policy primarily
focuses on whether the cause of the loss was an identified peril, e.g.,
fire or earthquake--and if it was, only then are policy exclusions
relevant. See, e.g., Garvey v. State
Farm Fire & Cas. Co., 48 Cal. 3d 395, 406, 257 Cal. Rptr. 292,
298 (1989).
Courts have determined that when a third party’s negligence
(such as a contractor’s faulty workmanship) is the cause of damage
to a policyholder’s property it is a "risk of physical
loss" and, consequently, is covered under an "all risk"
policy unless expressly excluded from coverage.
Garvey, 48 Cal. 3d at
408. A "named
insured" policy, however, does not
cover a third party’s negligence unless such a risk was specifically
identified on the policy. The
effective difference is that an insurer has the burden to prove
coverage is excluded under the "all risk" policy while the
insured has the burden to prove a loss was caused by a specifically
identified risk and fits within a coverage grant of a "named
perils" policy. Garvey
at 406; Strubble v. United Servs. Auto. Ass’n, 35 Cal. App. 3d 498, 504,
110 Cal. Rptr. 828, 831 (1973).
While coverage under property
insurance can vary from policy to policy, property policies generally
contain numerous exclusions. These
exclusions, in turn, often preclude coverage for construction defects
claims. Such exclusions
include, but are not limited to, (1) "Earth Movement," (2)
"Contractor Negligence," (3) "Deterioration,"
"Inherent Vice," "Latent Defect," and "Wear
and Tear,"(4) "Faulty Workmanship or Materials," (5)
"Underground Water," (6) "Seepage and Leakage,"
(7) "Pollution," and (8) "Enforcement of an
Ordinance." See Croskey and Kaufman,
California Practice Guide: Insurance Litigation, sections 7:1442 et
seq. (TRG 1995). Because
property insurance often contains exclusions for claims related to
construction defects, the property insurance policyholder often has no
choice but to pay its own damages or seek to recover its damages from
the contractor it deems responsible for the damages at issue.
The contractor, in turn, will often forward that claim to its
own liability insurer.
III.
DOES A CONSTRUCTION DEFECT CONSTITUTE AN
"OCCURRENCE"?
The CGL policy generally provides that it
will "pay on behalf of the insured all sums which the insured
shall become legally obligated to pay as damages because of . .
.property damage to which this insurance applies, caused by an
occurrence." An
"occurrence" is defined as ". . .an accident, including
injurious exposure to conditions which results, during the policy
period, in bodily injury or property damage neither expected nor
intended from the standpoint of the insured. . . ."
Often, a claim against a contractor does not allege property
damage, but rather seeks damages for breach of contract resulting from
the contractor’s faulty workmanship.
Further, in many instances in which property damage is alleged
it has not become apparent until after
a contractor’s policy of insurance has expired and the contractor
has either new insurance or no insurance.
These examples illustrate the question of whether there has
been an "occurrence" and, if so, what year(s) of CGL
insurance is obligated to respond to the claim i.e., what policy is "triggered."
A.
IS THERE PHYSICAL INJURY TO TANGIBLE PROPERTY?
CGL policies typically provide coverage
for "property damage" that occurs during the policy period.
Property damage is defined to include physical injury to,
destruction of, or the loss of use of tangible
property. Often, the
allegations against a policyholder contractor do not reference or
allege tangible property damage during an insurer's policy period.
Specifically, actions against contractors
often only allege causes of action for negligent misrepresentation,
breach of fiduciary duty and breach of CC&Rs, or may simply seek
equitable indemnity or declaratory relief.
However, these actions do not assert physical injury to,
destruction of, or loss of use of tangible property.
The gravamen of these actions is that the policyholder or
contractor made various misrepresentations to the property owner and
failed to perform various obligations, resulting in economic damage to
the plaintiff. Consequently,
the property damage coverage in a CGL policy generally does not apply
to such claims.
Interpreting similar language defining
"property damage," the California Court of Appeal has held:
Strictly economic losses like lost
profits, loss of good will, loss of the anticipated benefit of the
bargain and loss of an investment do not constitute damage or injury
to tangible property covered by a comprehensive general liability
policy.
Allstate
Ins. Co. v. Interbank Financial Services, 215 Cal. App. 3d 825, 830, 264 Cal. Rptr. 25
(1989). See
also, Giddings v. Industrial Indemn. Co., 112 Cal. App. 3d 213,
169 Cal. Rptr. 278 (1980) (suits alleging banking and securities law
violations as well as waste and misappropriation did not involve
"property damage" within the meaning of the policy); Devin
v. USAA, 6 Cal. App. 4th 1149, 8 Cal. Rptr. 2d 263 (1992), review
denied (negligent misrepresentation with respect to the sale of a
house caused only a non-tangible pecuniary loss).
Further, California decisions have
concluded that the cost of repairing or replacing a defective
component of construction does not constitute "property
damage" under a CGL policy.
St. Paul Fire &
Marine Ins. Co. v. Coss, 80 Cal. App. 3d 888 (1978); Rafiero
v. American Employers Ins. Co., 5 Cal. App. 3d 799 (1970); Hamilton
Die Cast, Inc. v. U.S.F.&G., 508 F. 2d 417 (7th Cir. 1975).
Other courts have similarly concluded that claims not
identifying actual damage to tangible property do not constitute an
occurrence. See, e.g., USF&G v.
Advance Roofing & Supply Co., 788 P. 2d 1227, 1231 (Ariz.
1989) (a breach of contract action is not an occurrence since it does
not constitute "property damage"); New
Hampshire Ins. Co. v. Vierira, 930 F. 2d 696, 698 (9th Cir. 1991)
(actual physical injury to a third party is required to qualify as
"property damage"; diminution in value and economic loss,
including the cost to repair faulty workmanship, is not sufficient).
Liability coverage may come into play,
however, when the insured's defective materials or work causes injury
to property other than the
insured's own work or products, e.g.,
where the defect has caused either physical injury to or the loss of
use of tangible property. Geddes and Smith, Inc. v. St. Paul Mercury Indemnity Co., 51 Cal. 2d
558, 334 P. 2d 381 (1959) and Maryland
Casualty Co. v. Reeder, 270 Cal. Rptr. 719 (1990) ("Reeder").
Reeder, for example,
involved a lawsuit against a contractor and developer alleging
construction defects in a condominium project and in which general
liability policies had been issued to the contractor and developers.
Reeder involved three
underlying complaints. In
the first complaint the
plaintiffs alleged that their condominium was "suffering from
severe cracks in the walls and settling of the slab"; in the
second complaint the plaintiffs alleged that their units "have
been damaged to the extent that they are rendered valueless"; and
in the third complaint, the homeowners' association alleged that the
soil subsidence had caused "cracking and separation in the
concrete floor slabs, foundations, retaining wall, interior and
exterior walls and ceilings, and exterior concrete patio areas and
walkways at affected Condominium Units and Common Areas."
The homeowner's association also alleged that the roofing
system had failed "causing rainwater and moisture to penetrate
the roofs, causing damage to the building structures and the contents
of the affected Condominium Unit living spaces."
Based on those allegations, the Reeder
court held that while inferior workmanship itself is not property
damage, where the effect itself has caused physical injury to property
or the loss of its use, there is insurance coverage.
The court stated:
[W]e have allegations of physical harm to
the tangible property. As
we have seen, the homeowners and their association have alleged soil
subsidence has cracked concrete floor slabs, foundations, retaining
walls, interior and exterior walls and ceilings and exterior concrete
patio areas. Moreover
failure of the roofing system has allegedly allowed rainwater to
damage building structures and the contents of living areas.
Thus, like the claimants in Geddes,
the homeowners and their association have gone beyond allegations that
defects in materials and workmanship exist at the project.
221
Cal. App. 3d at 970-971.
The issue of whether property damage
exists may also arise in the context of a defective product being
incorporated into tangible property. In short, some courts have concluded that this can constitute
"property damage." Tobi
Eng’g, Inc. v. Nationwide Mut. Ins. Co., 574 N.E. 2d 160, 163
(Ill. App. Ct. 1991). Generally, coverage for the incorporation of defective
products into tangible property is determined not on the basis of the
existence of the defect (which usually is not covered), but rather by
whether consequential damages exist as a result thereof.
Fresno Economy Import
Used Cars, Inc. v. USF&G, 142 Cal. Rptr. 681 (1977) (defective
head gasket in automobile is not property damage even though policy
had no physical injury requirement;
no other part of automobile was damaged by defective part); Hamilton
Diecast, Inc. v. USF&G, 508 F. 2d 417 (7th Cir. 1975)
(incorporation of defective component does not constitute property
damage since there was no harm to other parts).
B.
WHEN DOES PROPERTY DAMAGE RESULT?
CGL policies require that in order for an
occurrence resulting in property damage to be covered the property
damage must result "during the policy period."
Property damage, however, often occurs after the policy period
has expired, but is the result of acts committed during the policy
term. In construction
defect cases, this leads to the issue of whether
property damage occurred during the policy term and,
consequently, which policy year(s) are required to respond (or are
"triggerred") by a claim against a policyholder.
The majority of decisions that have considered when property
damage results under first party property insurance policies have
concluded that it is when property damage "manifests"
itself. See
Property Insurance discussion, supra.
The issue is less clear when CGL policies are at issue in the
construction defect claim context.
Courts have reached a variety of
conclusions that identify what CGL policy or policies must either
defend or indemnify a policyholder when construction defects are
unidentifiable for several years.
It may take years, for example, for certain defects, such as an
improperly constructed building that consequently experiences a
cracked foundation, to become appreciable or manifest themselves.
Most recently, the California Supreme Court addressed this
issue in the context of an insurer’s duty to defend a third party
environmental contamination claim and found that "property damage
that is continuous or progressively deteriorating throughout severally
policy periods is potentially covered by all policies in effect during
those periods." Montrose
Chemical Corp. v. Admiral Ins. Co., 10 Cal. 4th 645, 655, 42 Cal.
Rptr. 2d 324, 913 P. 2d 878 (1995), modified
at 11 Cal. 4th 219
(1995). In Montrose,
the California Supreme Court stated that the CGL insurance at issue:
.
. . unambiguously provides potential coverage for the continuous and
progressively deteriorating bodily injury and property damage alleged
to have occurred during Admiral’s policy periods.
Turning
to the express language, Admiral contracted with Montrose to "pay
on behalf of the insured all sums which the insured shall become
legally obligated to pay as damages because of . . .bodily injury, or
. . . property damage to which this insurance applies, caused by an
occurrence . . . ." "[P]roperty
damage to which this insurance applies" is defined in Admiral’s
policies as "(1) physical injury to or destruction of tangible
property which occurs during the policy period, including the loss of
use thereof at any time resulting therefrom. . . . "Bodily injury" to which the insurance applies is
defined as "bodily injury, sickness or disease sustained by any
person which occurs during the policy period, including death at any
time resulting therefrom.
Courts in other jurisdictions, as well as
pre-Montrose California
courts, have adopted a variety of other triggers in the property
damage context. In short,
courts throughout the country are not uniform in their trigger
theories and trigger decisions may vary depending not only on the type
of insurance at issue, e.g.,
property or CGL insurance, but also based upon the type of delayed
injury case at issue, e.g., construction defect, asbestos, environmental.
See, e.g., Garriott Crop
Dusting Co. v. Superior Court, 221 Cal. App. 3d 783, 270 Cal. Rptr
678 (1990) (applying an exposure
trigger that requires each policy from the time of exposure to the damage-causing condition to respond to a
claim); Ohio Casualty Ins. Co.
v. Hartford Accident and Indem. Co., 1995 WL 217401 (1995) and Chemstar,
Inc. v. Liberty Mut. Ins. Co., 41 F. 3d 429 (9th Cir. 1995)
(applying a manifestation
trigger, discussed supra); USF&G
v. Warwick Dev. Co., 446 So. 2d 1021 (Ala. 1984) (applying an injury
in fact trigger, which triggers policies when actual damage occurs
to the property but usually does not trigger policies after
manifestation); American
Cyanamid Co. v. American Home Assurance Co., 30 Cal. App. 4th 969
(1994) (court analyzed triggers based on when wrongful
act was committed and
when there was an injury in fact).
In practical terms, the issue of when
property damage results is far from over.
The California decisions referenced above evidence that
reasonable judicial minds consistently differ about how this issue
should conclude even though the policy language may not differ from
one case to another. These
decisions also evidence that the issue of trigger may ultimately be
dependent upon whether it involves first party property insurance or
CGL insurance, and whether the facts at issue involve asbestos
claims, environmental claims, construction defect claims, or some
other type of third party property
damage or bodily injury. Moreover,
courts may provide separate triggers for the duty to defend (which
exists when there is a potential for coverage) and the duty to
indemnify (which exists only when a judgment has been entered that is
actually--as opposed to potentially--covered by the policy). In Insurance Company of
No. America v. National American Ins. Co. of Calif, 37 Cal. App.
4th 195, 205, 43 Cal. Rptr. 518, 24 (1995), for example, the
California Court of Appeal, in a post-Montrose
decision addressed the duty to indemnify
in the context of a progressive property damage case, and concluded:
"We must examine the date injury became
appreciable." (Emphasis
added).
IV.
CGL POLICIES AND CLAIMS FOR POOR WORKMANSHIP?
CGL policies are not intended to provide
coverage for claims of faulty workmanship asserted against a
contractor when the risk at issue is within the control of the
contractor. Based
thereon, insurers have made various efforts to make sure that coverage
for such faulty workmanship does not fall within the coverage grant of
a CGL policy or is expressly excluded from coverage.
This issue was crystallized in Maryland
Casualty Co. v. Reeder, 221 Cal. App. 3d 961, 270 Cal. Rptr. 719
(1990) ("Reeder")
review denied:
General liability policies . . . are not
designed to provide contractors and developers with coverage against
claims their work is inferior or defective . . . The risk of replacing
and repairing defective materials or poor workmanship has generally
been a commercial risk which is not passed on to the liability
insurer. . . . Rather liability coverage comes into play when the
insured's defective materials or work causes injury to property other
than the insured's own work or products.
Id.,
221 Cal. App. 3d at 967 (citations omitted).
Similarly, in Weedo v. Stone-E-Brick, Inc, 405 A. 2d 788, 791-92 (N.J. 1979), the
New Jersey Supreme Court explained:
When a craftsman
applies stucco to an exterior wall of a home in a faulty manner and
discoloration, peeling, and chipping result, the poorly-performed work
will perforce have to be replaced or repaired by the tradesman or by a
surety. On the other
hand, should the stucco peel and fall from the wall, thereby causing
injury to the homeowner or his neighbor standing below or to a passing
automobile, an occurrence of harm arises which is the proper subject
of risk-sharing as provided by the type of policy before us in this
case. The happenstance
and extent of the latter liability is entirely unpredictable--the
neighbor could suffer a scratched arm or a fatal blow to the skull
from the peeling stonework. Whether
the liability of the businessman is predicated upon warranty theory,
or preferably or more accurately, upon tort concepts, injury to
persons or damage to other property constitute the risk intended to be
covered under the CGL.
See
also, Biebel Brothers v. USF&G, 522 F. 2d 1207 (8th Cir. 1975)
(faulty workmanship is not a covered claim); Accord:
Stroup Sheet Metal v. Aetna,
223 S.E. 2d 885 (S.C. 1977).
A minority of courts have concluded
that claims for faulty workmanship may be covered by the CGL policy.
These decisions primarily rely on language in the 1973 CGL
policy language that excluded coverage for liability assumed by an
insured under contract which stated that it did not apply to "a
warranty of fitness or quality of the named insured’s products or
warranty that work performed by and on behalf of the insured will be
done in a workmanlike manner."
The minority position was that this exclusion was in conflict
with other exclusions related to the work product of the insured and,
consequently, created an ambiguity to be resolved in favor of the
insured. See,
e.g., Worsham Construction Co. v. Reliance Ins. Co., 687 P. 2d 988
(Colo. Ct. App. 1984); Baybutt
Construction Corp. v. Commercial Union Ins. Co., 455 A. 2d 914
(Me. 1983), overruled by Peerless Ins. Co.
v. Brennan, 564 A. 2d 383 (Me. 1989).
But see Weedo v. Stone-E-Brick, Inc., 405 A. 2d 788, 795 (N.J. 1979)
(critical of minority position on basis that exclusions bore no
relationship to each other); The 1986 CGL form eliminated the issue by
revising the contractual liability exclusion.
V.
EXCLUSIONS RELEVANT TO CONSTRUCTION DEFECT CLAIMS.
A.
BUSINESS RISK EXCLUSION
One of the most common bases for a
court to uphold a denial of coverage to a contractor for a
construction defect claim is the business risk exclusion.
Although several of the exclusions in the CGL policy are
collectively referred to as the Business Risk Exclusion, i.e.,
business risk exclusion, the performance exclusion, the sistership
exclusion, the work performed exclusion, and the care, custody and
control exclusion, none is specifically named as such.
The exclusion that is most often cited for excluding coverage
for a policyholder's business risks provides:
This
insurance does not apply:
To bodily injury or
property damage resulting from the failure of the named insured’s
products or work completed by or for the named insured to perform the
function or serve the purpose intended by the named insured, if such
failure is due to a mistake or deficiency in any design, formula,
plan, specifications, advertising material or printed instructions
prepared or developed by the insured; but this exclusion does not
apply to bodily injury or property damage resulting from the active
malfunctioning of such products or work;
The Minnesota Supreme Court in
addressing the need for a CGL policy to exclude business risks,
especially in a construction defect context, noted:
Even though an
examination of the CGL policies in this case . . . will reveal no
exclusions specifically designated as "business risk," in
insurance law the scope of the phrase is well understood. As explained in the Article by G.H. Tinker entitled
"Comprehensive General Liability Insurance--Perspective and
Overview,".
. . "‘Business risks,’ then, are those
risks which management can and should control or reduce to manageable
proportions; risks which management cannot effectively avoid because
of the nature of the business operations; and risks which relate to
the repair or replacement of faulty work or products.
These risks are a normal, foreseeable and expected incident of
doing business and should be reflected in the price of the product or
service rather than as a cost of insurance to be shared by others.
Knutson
Construction v. St. Paul Fire & Marine Ins. Co., 396 N.W. 2d
229, 235 (Minn. 1986). See
also, Heldor Industries v. Atlantic Mutual Ins. Co., 551 A. 2d
1001 (N.J. 1988) (business risk exclusion applies for claims to
damages to the insured’s own product or work, e.g.,
when the coping of a pool peeled off, coverage did not apply since
there was no claim for bodily injury or property damage); Sturla,
Inc. v. Fireman’s Fund Ins. Co., 684 P. 2d 960 (Pa. 1984)
(replacement of defective carpeting within the scope of the
exclusion); Bor-son v. Commercial Union, 323 N.W. 2d 58 (Minn. 1982) Central
Mutual Ins. Co. v. Del-Mar Beach Club Owners Assoc., 123
Cal. App. 3d 916 (1981); Indiana
Ins. Co. v. DeZutti, 408 N.E. 2d 1275 (Ind. 1980); B.A.
Green Construction Co. v. Liberty Mutual Ins. Co., 517 P. 2d 563
(Kan. 1973); Bulen v. Westbend
Mutual Ins. Co., 371 N.W. 2d 392 (Wis. 1985).
B.
WORK PERFORMED EXCLUSION
The 1973 "work performed"
exclusion in CGL policies typically provides that it excludes
coverage:
(1)
To property damage to work performed by or on behalf of the
named insured arising out of the work or any portion thereof, or out
of materials, parts or equipment furnished in connection therewith;
The 1986 CGL form modified this language
to exclude coverage for:
(1) Property damage to "your work" arising out of it or
any part of it and included in the "products completed operation
hazard." . . . this exclusion does not apply if the damaged work
or the work out of which the damage arises is performed on your behalf
by a subcontractor.
The work performed exclusion has also
been drafted to exclude coverage for:
Liability
for damage to real property arising out of work the insured was doing,
directly or indirectly, on that property;
Liability
for need of repairs to property because the insured's work on the
property was incorrectly performed.
Absent, a broad form endorsement or the
1986 modified language, the 1973 work performed exclusion
unambiguously eliminates coverage for the claims made by property
owners for damage to any part of the goods or services provided by or
on behalf of the named insureds, e.g.
the phrase "on behalf of" in a normal "work
performed" exclusion would apply to work performed by a
subcontractor on behalf of a named insured general contractor.
Maryland Casualty Co. v.
Reeder, 221 Cal. App. 3d 961, 971-972, 975 n.5, 270 Cal. Rptr. 719
(1990). See
also Maryland Casualty Co. v. Imperial Contracting Co., 212 Cal.
App. 3d 712, 723-24, 260 Cal. Rptr. 797 (1989); Western
Employers Ins. Co. v. Arciero & Sons, Inc., 146 Cal. App. 3d 1027, 1029, 194 Cal. Rptr. 688 (1983); Castigliola
v. Department of Community Development, 538 So. 2d 1139 (La. Ct.
App. 1989); Allen v. Lawton & Moore Builders, 535 So. 2d 779 (La. Ct. App.
1988); Tastigliola v. Department
of Community Development, 538 So. 2d. 1139 (La. Ct.App. 1989) (a
CGL policy is not intended to act as a substitute for a performance
bond). Saint
Johns Home Milwaukee v. Casualty Company, 434 N.W. 2d. 112 (Wis.
Ct.App. 1988) (CGL policy did not cover damages from contractor's
faulty construction of a brick wall).
Diamond Heights Homeowners Association v. National American Insurance
Company, 227 Cal. App. 3d 563, 571, 277 Cal. Rptr. 906, 910 (1991)
(the work performance exclusion is intended to bar coverage for claims
against a contractor based on the contractor's faulty work product).
Rafiero
v. American Employers' Ins. Co., 5 Cal. App. 3d 799, 85 Cal. Rptr.
701 (1970) supports that where there is no broad form endorsement the
CGL policy coverage does not apply to work performed by the named
insured or its subcontractors. In
Rafiero, the plaintiff
entered into a contract with Wentz Construction Company for the
construction of two separate apartment buildings.
Plaintiff contended that Wentz had either used unsuitable
materials or performed unworkmanlike construction.
Judgment was awarded to plaintiff for $13,4000.
Plaintiff then brought an action against American Employers
Insurance Co., Wentz's insurer, to recover the judgment.
The exclusion considered by the court was
for damage to property, "the restoration, repair or replacement
of which has been made or is necessary by reason of faulty workmanship
thereon by or on behalf of
the insured." The
court held that the insurance provided was not intended to indemnify the contractor (and through him the owner)
for direct damages resulting because the contractor furnished
defective materials or workmanship.
Thus, for example, Reeder
supports that the phrase "on behalf of" eliminates coverage
for work performed by contractors, subcontractors or architects for a
developer or general contractor if the exclusion is otherwise
applicable, i.e., if there
is no broad form endorsement. If
a policyholder desired broader protection that would cover the
negligent work of subcontractors it would be required to purchase the
broad form endorsement coverage which modifies the language of the
"work performed" exclusion.
In Reeder, for
example, the insureds argued that the broad form endorsement's
elimination of the phrase "on behalf of the named insured"
operated to provide coverage for claims arising out of work performed
by subcontractors that the developers and the contractor retained in
developing the project. The
court noted that the developers and contractor believed that the
claims made against them arose out of errors committed by soils
engineers, graders and roofing subcontractors, and they argued that
the policy provided them with coverage.
The Court of Appeal accepted the argument
and held that "the broad
form endorsement provides coverage for damage claims growing out
of services provided by subcontractors retained during development of
the condominium project." Reeder, 221 Cal.
App. 3d at 974 (emphasis added).
The court relied primarily upon the Ninth Circuit decision of Fireguard Sprinkler Systems v. Scottsdale, Inc., 864 F. 2d 648 (9th
Cir. 1988) (which held that the change in the work performed language
in the endorsement, i.e.,
the omission of "on behalf of," served to extend coverage to
faulty work done "on behalf of" the insured)
and rejected two Minnesota Supreme Court cases
that held to the contrary. Knutson
Construction v. St. Paul Fire & Marine Ins., 396 N.W. 2d 229
(Minn. 1986); and Bor-Son Bldg.
Corp. v. Employers Commercial Union Ins. Co., 323 N.W. 2d 58
(Minn. 1982).
In Knutson, the Minnesota Supreme Court held that the modification of
the work performed exclusion in the broad form endorsement did not
serve to extend coverage for claims of construction defects arising
from the work of subcontractors.
The Minnesota court concluded that the work of subcontractors
was integrally related and became part of the named insured's work
and, thus, the modified exclusion did not serve to preclude coverage.
In Bor-Son Bldg., the court found the effect a subcontractor's work
might have on a completed project was a business risk of the general
contractor which could not be passed on to a liability insurer by way
of a broad form endorsement.
C.
FAULTY WORKMANSHIP EXCLUSION
The faulty workmanship exclusion
typically precludes coverage for:
(4)
Personal property in the care, custody or control of the
insured;
(5)
That particular part of real property in 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; or
(6)
That particular part of any property that must be restored,
repaired or replaced because your "work" was incorrectly
performed on it.
In the 1973 CGL form the faulty
workmanship exclusion precluded coverage for:
. . .
property damage to work performed by or on behalf of the named
insured arising out of the work or any portion thereof, or out of
materials, parts or equipment furnished in connection therewith.
The intent of the faulty workmanship exclusion is to preclude
coverage for business risks within the control of the policyholder.
For example, in LISN,
Inc. v. Commercial Union Insurance Companies, 615 N.E. 2d. 650
(Ohio Ct. App. 1992), a policyholder was hired to replace certain
telephone cables with the understanding that it was not to disturb the
functioning cable. In the
process of performing the work, the policyholder harmed the
functioning cable and the claimant requested damages for
repair and replacement. The
court, however, found that because the policyholder incorrectly
performed the work coverage for the damage was precluded.
The portion of the exclusion that precludes coverage for
property in the "care, custody or control of the insured,"
subparagraph (4), has proven to be a source of litigation when
policyholders dispute that property was in their exclusive care,
custody or control. For
example, in Bituminous Casualty
Corp. v. Volcherson, 571 N.E. 2d. 256, 262 (Ill. Ct. App. 1991)
the court determined that the "mere performance of work within a
well bore" was not enough of an allegation to deny coverage for
well repairs. See also, Hartford
Casualty Company v. Cruse, 938 F. 2d 601, 604 (5th Cir. 1991)
(contractor's foundation work did not mean the contractor had control
of entire house).
The California Court of Appeal has summarized the purpose of
subparagraph (5) in its decision in Economy
Lumber Company v. Insurance Company of North America, 204 Cal.
Rptr. 135 (1984). In Economy Lumber,
the court was asked to interpret the exclusion when property damage
was the result of the installation of defective siding.
The court stated:
If we interpret
"that particular part of any property" under [the faulty
workmanship exclusion] to refer to the siding, coverage for the siding
is excluded by subparagraph (ii), "out of which any property
arises," and subparagraph (iii), because its "restoration,
repair and replacement" had been made necessary by faulty milling
on behalf of [the policyholder].
However, the property damage to the houses itself remains
covered.
If we were to
interpret "that particular part of any property" to refer to
the houses themselves, coverage for property damage to them would
still result. As the
supplier, [the policyholder] did not perform any workmanship on the
houses. The only
reasonable interpretation of the exclusion would be to hold it
applicable if [the policyholder] had itself performed work on the
houses, or if such work was done on its behalf.
Such is not the case.
We conclude,
therefore, that while there is no coverage for the defective siding as
such, the exclusion does not apply to the loss of value of the eight
houses for which there is policy coverage.
In addressing subparagraph (6), the Eighth Circuit Court of
Appeals in National Union Fire Insurance Company v. Structural Systems Technology,
Inc., 964 F. 2d 759 (8th Cir. 1992), explained:
Part (6) of the
exclusion is derived from the so called faulty workmanship exclusion
found in BFPD [Broad Form Property Damage] provisions.
However, it differs from the BFPD exclusion in that the current
version contains an exception stating that it does not apply to
property damage included in the product completed operation hazard.
This exception should avoid disputes, sometimes arising in
connection with BFPD claims, over whether the faulty workmanship
exclusion applies to completed work. As will be discussed later, exclusion (1) of the CGL coverage
form is the exclusion that addresses coverage for property damage to
completed work performed by or on behalf the named insured.
Based thereon, the court determined that the property at issue
was not excluded from coverage because of the completed operations
exception. This is
because the performance of repair work did not have an impact on
whether the structure was complete, and the other equipment
purportedly damaged and on which the policyholder was not working was
not precluded from coverage because the policyholder was not
performing work to restore, repair or replace that property.
D.
SISTERSHIP EXCLUSION
The sistership exclusion typically
provides that the CGL policy coverage does not apply:
To damages claimed
for withdrawal, inspection, repair, replacement, or loss of use of the
named insured products or work completed by or for the named insured
or of any property of which such products or work form a part, if such
product, work or property are withdrawn from the market or from use
because of any known or suspected defect or deficiency therein.
In Four City Dillon, Inc. v. Aetna Casualty & Surety Company, 852
F. 2d 168 (6th Cir. 1988), the court was asked to determine whether
this exclusion precluded coverage for defective panels that were
installed on homes. In
concluding that the exclusion did not preclude coverage, the court
explained that the exclusion would only apply to the extent the siding
panels were removed from the market.
See also, Atlantic
Mutual Insurance Company v. Judd Company, 380 N.W. 2d 122 (Minn.Ct.
App. 1985) (sistership exclusion does not preclude coverage for claims
brought by contractors against supplier of plumbing supplies for
damages necessitated by the removal of pipes); U.S.
Gympsum Co. v. Admiral Ins. Co., 643 N.E. 2d. 1226, 1247 (Ill.
Ct.Ap. 1995), appeal denied
(addressing "repair and replacement" exclusion); Wellington
III Associates v. Providence Builders Corp., No. CX-94-758, 1994
WL 523851, at *2 (Minn. Ct. App. 1994) (purpose of exclusions is to
preclude contractor from passing business risk of defective or faulty
work on to its insurer); Ryan Houses, Inc. v. Howe Indem. Co.., 647 A. 2d 939, 942 (Pa. Sup. Ct. 1994), appeal denied (exclusions ensure that policyholder "assume[s]
the risk of the quality of its product and its work.)
E.
PREMISES ALIENATED AND OWNED PROPERTY EXCLUSION
Another often-used basis for denial of a
property owner’s causes of action against a contractor for property
damage is the alienated premises and owned property exclusion.
This exclusion generally provides:
This insurance does not apply:
(k)
to property damage to
(1)
property owned or occupied by or rented to the insured,
(2)
property used by the insured, or
(3)
property in the care, custody or control of the insured or as
to which the insured is for any purpose exercising physical control; .
. . .
(4)
to property damage to premises alienated by the
named insured arising out of such premises or any
part thereof;
It is common for a contractor or
developer to own or to at one time
have
been the owner of a property at issue (before selling the property to
the current owner that subsequently files a claim against the
contractor or developer).
The intent of the owned property or
premises alienated exclusion is to preclude insurance coverage under a
CGL policy where the policyholder has neglected to repair property it
owns or, prior to its sell, has similarly neglected to identify or
repair defects in the property. Prudential--LMI
Commercial Insurance Company v. Reliance Insurance Company, 22
Cal. App. 4th 1508, 1512, 27 Cal.Rptr. 2d 841, 844 (1994).
Evaluating this principle, the Court in Reeder,
supra, specifically found that if a named insured owned property,
developed the property, and then sold (alienated) the property, that
the premises alienated exclusion precludes coverage.
Reeder, 221 Cal. App.
3d at 977.
Thus, the premises alienated exclusion, in conjunction with the
owned property, used by the insured, and the care, custody or control
exclusions, eliminates coverage for property damage to premises
alienated (or, by implication, owned, used, or in the care, custody or
control of the insured), if the damage arises out of such premises or
any part thereof. Central
Mutual Ins. Co. v. Del Mar Beach Club Owners Association, Inc.,
123 Cal. App. 3d 916, 928, 176 Cal. Rptr 895, 902 (1981) (items of
damage to property developed by the insureds and sold
(alienated) to the Owners Association were subject to the
exclusion provisions of the policies making coverage inapplicable to
the "product," "work" or "premises")
(emphasis added); Liberty
Building Co. v. Royal Indem. Co., 177 Cal. App. 2d 583, 587, 2
Cal. Rptr. 329 (1960). (The court stated that "[t]his Exclusion means that if
the insured becomes liable to replace or repair any 'goods or
products' or 'premises alienated'
or 'work completed' after the same has caused an accident because of a
defective condition, the cost of such replacement or repair is not
recoverable under the policy") (emphasis added); Rafeiro,
5 Cal. App. 3d at 808 (premises alienated exclusion precludes coverage
for construction defects related to premises
alienated by a named insured out of which the accident arises).
This application of the premises
alienated exclusion has been upheld by other jurisdictions, even where
the policy contained completed operations coverage. See, e.g., Rieder v.
Cherokee Insurance Company, 635 F. Supp. 699 (E.D. Pa. 1986) (affirmed
by 813 F. 2d 398 (3rd Cir. 1987)); Quality
Homes, Inc. v. Bituminous Casualty Corp., 355 N.W. 2d 746 (Minn.
1984); Taylor-Morley-Simon, Inc. v. Michigan Mutual Ins., 645 F. Supp. 596
(E.D.Mo. 1986), (affirmed by
822 F. 2d 1093 (8th Cir. 1987)); Gary
L. Shaw Builders v. State Automobile Mut. Ins. Co., 182 Ga. App.
220, 355 S.E. 2d 130 (1987); Gruol
Construction Co. Inc. v. Ins. Co. of North America, 11 Wash. App.
632, 524 P. 2d 427 (1974); Reliance
Ins. Co. v. Povia-Valentine Corp., 738 F. Supp. 523 (S.D. Ga
1990), (affirmed by 927 F.2d
614 (11th Cir. 1991)); Wilmington
Island Construction Co., Inc. v. Cincinnati Ins. Co., 179 Ga. App.
477, 347 S.E. 2d 308 (1986); Diamond
Shamrock Chemicals Co. v. Aetna Cas. & Surety Co., 231 N.J.
Super. 1, 554 A. 2d 1342 (1989); Summit
Assoc., Inc. v. Liberty Mutual Fire Ins. Co., 229 N.J. Super. 56,
65, 550 A. 2d 1235 (1988); Borden,
Inc. v. Affiliated FM Ins. Co., 682 F. Supp. 927, 930 (S.D. Ohio
1987), (affirmed by 865 F. 2d 1267 (6th Cir. 1989)).
When facts support that an owner or
developer owned and subsequently sold the property at issue to the
owner claiming loss, the alienated premises exclusion applies to
preclude coverage for property damage. In the event the contractor or developer still possesses an
ownership interest, uses, or has care, custody, or control of the
property at issue, the above analysis would also apply based on the
exclusions referencing the same.
It should be noted that the 1986 CGL
policy changed the alienated premises exclusion to exclude coverage
for claims for property damage to:
premises
you sell, give away, or abandon if the "property damage"
arises out of any part of those premises.
However,
this exclusion does not apply "if the premises are 'your work'
and were never occupied, rented or held for rental by you."
The intent of this modification appears to be to except from
the exclusion property that was built for resale.
See Croskey and Kaufman,
California Practice Guide: Insurance Litigation, Sections 7:1466 et
seq (TRG 1995).
F.
WORK PRODUCT EXCLUSION
CGL policies also
often contain an exclusion
for property damage due to the insureds' work product.
The policy typically provides:
This insurance does not apply:
to property damage to the named insured's
products arising out of such products or any part of such products;
The question arises of whether a
contractor’s entire project was the product
of the named insured, thus barring coverage for the property
damage claims, if any, under the exclusion.
California cases have rejected such a broad interpretation of
the "products exclusion."
Reeder, 221 Cal. App. 3d at 974-975. The Reeder court
discussed the cases considering the point and, following the Ninth
Circuit decision of Fireguard
Sprinkler Systems v. Scottsdale Inc., 864 F. 2d 648 (9th Cir.
1988) (applying Oregon law), held that coverage exists when services,
as opposed to discreet, tangible components, have caused injury.
The Reeder court
concluded that because the damages claimed in the underlying lawsuits
may have been caused by faulty services provided to the policyholders
by the subcontractors (not named as insureds in the policy), the
products exclusion did not apply as a matter of law.
Id.
Some courts have determined this exclusion will not apply to a
claim for a construction defect.
The reasoning behind these decisions is that a building or
structure does not qualify as a "product" as defined by a
CGL policy. Maryland Casualty
Company v. Reeder, 221 Cal. App. 3d. 961, 976, 280 Cal. Rptr. 719,
728 (1990) (products exclusion did not preclude coverage for claim
asserted against developer of condominium project).
See also, Fireguard
Sprinkler v. Scottsdale Insurance Company, 864 F. 2d 648 (9th Cir.
1988) (product exclusion was inapplicable when landslide occurred
after site was prepared for tank.
The court determined the wor |
