In Capstone Building Corporation v. American Motorists Insurance Company, 308 Conn. 760 (June 11, 2013) (SC 18886), the Connecticut Supreme Court answered three questions of Connecticut insurance law certified from the Northern District of Alabama in a construction defect coverage suit.
Briefly, in June 2000, Capstone Development contracted with the University of Connecticut (UConn) to coordinate and supervise construction of a student housing complex. The project was completed in August 2001, and the project’s architect certified that it complied with the state building and fire safety codes. A few years later, UConn notified Capstone of alleged defects in the project. In response, Capstone sought defense and indemnification coverage from its commercial general liability (CGL) insurer.
The insurer disclaimed coverage for UConn’s claims, reasoning that: “As the liability at issue arises out of [Capstone Building’s] own work, including its role as general contractor and heating and plumbing installation, there can be no coverage for this matter for Capstone [Building] under the policy.”
A settlement was reached between Capstone and UConn, after which Capstone sued its CGL insurer in the Circuit Court of Jefferson County, Alabama, for breach of contract and bad faith. The suit was later removed to the U.S. District Court for the Northern District of Alabama, which certified three questions of Connecticut insurance law to the Connecticut Supreme Court, each of which is discussed below.
1. Whether damage to a project contracted to be built, which was caused by defective construction or faulty workmanship associated with the construction project, may constitute “property damage” resulting from an “occurrence,” triggering coverage under a commercial general liability insurance policy?
In deciding the first certified question, Connecticut’s high court held that defective construction or faulty workmanship that causes damage to nondefective property may constitute property damage resulting from an occurrence, thus triggering coverage under the CGL policy. The court also held that if the property damage is the result of an insured’s defective work, it is excluded from coverage by the “your work” exclusion; however, if the property damage was caused by a subcontractor’s defective work, it may be covered under the “subcontractor” exception to the “your work” exclusion.
Noting that this was an issue of first impression, the court applied standard insurance contract interpretation principles and held that because negligent work is unintentional from the point of view of the insured, it may constitute the basis for an “accident” or “occurrence” under the plain terms of the CGL policy. In determining whether this damage constitutes “property damage” under the standard CGL policy, the court found that, since the policy covers physical injury to third parties’ property, there is no reason to limit coverage to liability for harm to third parties.
The court did provide specific rulings on what constitutes policy-defined “property damage.” For example, the court held that the escape of carbon monoxide into the student housing complex, without more, is not property damage. In so ruling, the court reasoned that the gas “caused no physical, tangible alteration to any property” or any physical injury to the homeowners. The court also found that building-code violations, defective construction and poor quality control do not constitute “[p]hysical injury to tangible property, including all resulting loss of use of that property” unless they result in damage to other, nondefective property. Similarly, the court ruled that a claim for the cost of repairing or removing defective work – as opposed to a claim for damage caused by defective work – is not a claim for policy-defined “property damage.”
2. Can an insurer’s bad faith conduct in investigating an insurance claim provide a basis for a cause of action for bad faith under Connecticut law?
In determining whether the insurer's inaction during the investigation phase constitutes bad faith, the court held that no cause of action will lie based solely on the insurer’s failure to investigate because the insurance policy at issue provides that the decision of whether and how to investigate lies exclusively with the insurer.
In so ruling, the court reasoned that because the covenant of good faith and fair dealing only requires “that neither party [to a contract] do anything that will injure the right of the other to receive the benefits of the agreement,” it is not implicated by conduct that does not impair contractual rights; that is to say, conduct that does not impair the duty to defend or indemnify. The court found that in the first instance a discretionary investigation is often necessary to determine the existence of a duty to defend or indemnify under the policy; a bad faith action is properly addressed to the insurer’s conduct in depriving the insured of a defense or indemnity obligation, rather than the precedent, investigatory step.
3. Does Alderman v. Hanover Ins. Group, 169 Conn. 603 (1975), apply to pre-suit settlement cases wherein the insurer, under a commercial general liability insurance policy, wrongfully denies coverage, but where only some of the underlying claims should have been covered under the policy?
In Alderman, the issue was whether the insured is entitled to recover expenses incurred in settlement of a claim, where the insurer has wrongfully denied coverage and settlement is made by the insured before any suit has been instituted against the insured by the claimant. The Connecticut high court held that the insurer's unjustified breach entitled the plaintiff to recover the costs of investigation and legal fees incurred in the settlement of the claim against the plaintiff, in addition to the amount of the settlement. Here, the question was whether Alderman applies in the context of a pre-suit global settlement demand for covered and uncovered claims. The court held that the insurer’s duty is triggered when the demand is “sufficiently detailed for the defendant to discern whether the allegations … [are] within the scope of the plaintiff’s insurance coverage.”
Under Alderman, the court ruled that the insured need not prove actual liability for the settled claims, but rather that the settlement was reasonable in proportion to claims that, considered independently, the insurer had a duty to defend.
In keeping with this, the court found that the breaching insurer’s liability for reasonable costs should be limited to the portion of the settlement corresponding to claims for which the insurer had a duty to defend, when considered independently.
While the issues raised in Question 1 were evidently of first impression in Connecticut, the court’s ruling breaks no new ground; to the contrary, it is well within the mainstream of jurisdictions that have considered, in the context of construction defect claims, the insurability of faulty workmanship and repair costs and the scope and applicability of the “your work” exclusion and its “subcontractors” exception.
Regarding Question 2, the bad faith question, the court justifies its decision nixing bad faith claims for mere failure to investigate – absent some breach of duty to defend or indemnity – in part on ground that to rule otherwise would “open new avenues of litigation,” the costs of which “would be passed on to consumers under commercial general liability policies.” Yet, in dictum, the court appears to suggest that suits based on the mere failure to investigate would be proper under the Connecticut Unfair Insurance Policies Act (CUIPA) and the Connecticut Unfair Trade Practices Act (CUTPA) where the insured demonstrates a “general business practice” of inadequate investigation. Whether policyholders’ attorneys will file suits under CUIPA and CUTPA alleging a “general business practice” of inadequate investigations remains to be seen. Future decisions will presumably answer this question.
As for Question 3, the key “take-away” is as follows: Assessing the reasonableness of allocating the costs of settling pre-suit demands involving a mix of covered and uncovered claims is not a legal determination; to the contrary, it’s complicated, fact-sensitive inquiry, the resolution of which may require an evidentiary hearing. Indeed, the Capstone court concedes as much when it states, in dictum, “In the context of determining global settlements for more than one claim, the procedure may require a trial to determine the reasonable allocation of the settlement.” (Emphasis added.)