Less than two weeks apart, two appellate courts issued opinions analyzing whether faulty work claims are covered under commercial general liability policies, each reaching a different result. The United States Court of Appeals for the Third Circuit issued an unpublished opinion in Zurich American Insurance Company v. R.M. Shoemaker Company, No. 12-2268, 2013 WL 1224104 (3d Cir. Mar. 27, 2013). The Supreme Court of North Dakota issued an opinion in K&L Homes, Inc. v. American Family Mutual Insurance Company, No. 20120060, 2013 WL 1364704 (N.D. Apr. 5, 2013).
In R.M. Shoemaker, the Third Circuit, applying Pennsylvania law, affirmed the district court’s summary judgment order holding that a general liability insurer had no duty to defend or indemnify a policyholder in a lawsuit seeking damages resulting from faulty workmanship of the policyholder’s subcontractor. 2013 WL 1224104, at *4.
In R.M. Shoemaker, a New Jersey county hired the policyholder to construct an addition to a correctional facility. The county filed a lawsuit against the policyholder alleging that the policyholder, a construction firm, negligently supervised its subcontractor. The county further alleged that the policyholder’s negligence permitted the subcontractor to engage in willful misconduct, which resulted in “damage to both structural elements and personal property” at the correctional facility. The insurance policies provided coverage for property damage caused by an “occurrence.” The policies defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” 2013 WL 1224104, at *1.
The policyholder argued unsuccessfully that the dispute was governed by a Pennsylvania case where the court held that an insurer had a duty to defend insured parents against negligence claims seeking to hold the parents liable for damages resulting from a shooting rampage perpetrated by their child. See Donegal Mutual Ins. Co. v. Baumhammers, 938 A.2d 286, 293 (Pa. 2007). The Third Circuit held that “the crucial inquiry dictating whether a general liability insurer must defend its insured under an occurrence-based policy is whether an event was sufficiently fortuitous from the perspective of the insured to qualify as an ‘occurrence.’” Id. at 292. The court contrasted the shooting spree in Baumhammers, with the facts of the pending case; the shooting was “unexpected, undesigned and fortuitous,” not the “natural and expected result” of the parent’s negligence. 2013 WL 1224104, at *2. By contrast, it reasoned, faulty workmanship is not a fortuitous event, even if it occurs as a result of a contractor’s negligent supervision of its subcontractor. Id.
In reaching this conclusion, the federal court of appeals found controlling the Pennsylvania Supreme Court’s decision in Kvaerner Metals Division of Kvaerner U.S., Inc. v. Commercial Union Insurance Co., 908 A.2d 888 (Pa. 2006). The Kvaerner court held
the definition of ‘accident’ required to establish an ‘occurrence’ under the policies cannot be satisfied by claims based upon faulty workmanship. Such clams simply do not present the degree of fortuity contemplated by the ordinary definition of ‘accident’ or its common judicial construction in this context. To hold otherwise would be to convert a policy for insurance into a performance bond.
908 A.2d at 899.
By contrast, less than two weeks after the federal appeals court issued its decision in R.M. Shoemaker, the Supreme Court of North Dakota abrogated North Dakota precedent which held that faulty workmanship that causes property damage to the insured’s own product is not an accident and, accordingly, cannot constitute an “occurrence” under a commercial general liability policy. In K&L Homes,the North Dakota Supreme Court held instead 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.
2013 WL 1364704 at *10.
In K&L Homes, the owners of a newly-constructed home filed an arbitration claim against the policyholder, a builder. The homeowners alleged that the faulty workmanship of the policyholder’s subcontractor damaged the foundation of the house. The jury found that the builder breached its contract or implied warranty with the homeowners and awarded damages. Id. at *1.
The insurance policies in K&L Homes provided coverage for “property damage” caused by an “occurrence.” As in R.M. Shoemaker, the policies defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Id. at *3. In addition, the policy contained a “your work” exclusion with a “subcontractor exception.” Id at *3-4.
First, the court analyzed whether the faulty workmanship of the builder’s subcontractor constituted an “occurrence.” Id. at *4. The insurer argued that the North Dakota Supreme Court’s decision in ACUITY v. Burd & Smith Construction, Inc., 721 N.W.2d 33 (N.D. 2006), was dispositive. Id. at *8. In Burd & Smith, the court held that “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.” 721 N.W.2d at 39. The North Dakota Supreme Court in K&L Homes, however, concluded that the court in Burd & Smith incorrectly decided this issue, and overruled its prior decision. 2013 WL 1364704, *10. The court held that if neither the faulty work nor the property damage was expected or intended, then there may be an occurrence. Id. It reached this decision after surveying the law on this frequently litigated issue, analyzing the evolution of the business risk exclusions in commercial general liability policies, and discussing commentators’ analysis.
Next, the court analyzed whether the faulty workmanship resulted in “property damage.” The policies defined property damage as “‘[p]hysical injury to tangible property, including all resulting loss of use of that property’ and ‘[l]oss of use of tangible property that is not physically injured.’” Id. (alteration in original). The court determined that the damage alleged by the homeowner, including cracks, unevenness, and shifting of the home’s foundation, would meet the definition of “property damage.” The court further reasoned that if the “your work” exclusion, which excludes coverage for damage to the policyholder’s work, applied, the subcontractor exception would preserve coverage. Id.
The divergent views expressed by the courts in R.M. Shoemaker and K&L Homes suggest that litigation will persist on the question of whether, absent a pertinent exclusion, coverage exists under a commercial general liability policy for faulty workmanship of a policyholder’s subcontractor.