Liability insurance provides coverage against accidents. If defective work is accidental, then maybe liability insurance will cover claims for property damage arising from defective work. But should it? This is one of the most debated issues in construction law. Courts in different states have ruled both ways. Some courts are adamant that insurance shouldn’t cover damage caused by defective work. Over the last ten years, however, the majority of courts that have considered the issue have decided yes, defective work is an accident. While this trend is favorable for contractors, it’s not the end of the story. Liability insurance policies begin with a broad grant of coverage and then list numerous exclusions that substantially reduce what, in fact, only appeared to be a broad grant of coverage. Some of these exclusions are then tempered by exceptions that give back some of the coverage taken away by the exclusion. In this article, we’ll discuss the structure of liability insurance policies, the current state of the accident debate, and the coverage hurdles that remain even in the majority of states that follow the recent trend.
Contractors buy commercial general liability insurance to protect themselves from claims for personal injury and property damage. Coverage for personal injury caused by defective work is rarely an issue. Property damage is another story, and that is what this article will focus on. Most CGL policies begin with the following language or something similar:
We will pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies.
This broad coverage is then immediately limited by the following:
This insurance applies to bodily injury and property damage only if:
1) The bodily injury or property damage is caused by an occurrence.
CGL policies define property damage as either physical injury to tangible property or loss of use of tangible property that is not physically injured. Most CGL policies define occurrence as an accident, including continuous or repeated exposure to substantially the same general harmful conditions. The policies don’t define accident. If a contractor or subcontractor seeks liability coverage for damage caused by defective work, the first two questions are: is there property damage and, if so, was the property damage caused by an occurrence/accident? If the answer to both questions is yes, then it is necessary to look at any applicable exclusions and exceptions. If the answer to either is no, that is the end of it. Of the two preliminary coverage questions, the occurrence/accident issue has received by far the most attention.
Defective Work Not An Accident
Before 2004, it was probably the majority view that liability insurance was not intended to cover claims for breach of contract, and that defective work could not therefore be an occurrence. This is still the law in Oregon, which the Oregon Supreme Court has explained as follows:
We do not need to definitely define ‘accident’; however, we do hold that ‘accident’ has a tortious connotation. Damage solely caused by failure to perform a contract is not recoverable in tort. A tort is a breach of a duty created by law and not necessarily by the agreement of the parties. * * * Damage caused by the negligent performance of a contract can in certain instances be recoverable in tort. * * * This is because by contract the parties have entered into a relationship in which the law requires, apart from any obligation assumed by contract, that the obligor act with due care. For example, if a physician contracts to treat a patient and treats the patient negligently, he is liable in tort because the law, apart from contract, imposes a duty upon the physician to treat patients with due care. * * * [However], [d]amages caused by a failure to perform ‘amount to mere breaches of contract, for which no tort action will lie.’ ”
Oak Crest Construction Co. v. Austin Mutual Insurance Co., 998 P.2d 1254 (Or. 2000) quoting Kisle v. St. Paul Fire & Marine Insurance, 495 P.2d 1198 (1972).
In Oak Crest, the contractor had claimed the cost of repainting cabinets after its subcontractor’s original paint job failed to cure. There was no argument that the subcontractor’s defective paint job was intentional. Nor was it argued that the cabinets were not damaged by the uncured paint. Nevertheless, because the subcontractor had not committed a tort, there was no occurrence. Many courts would now say that Oregon’s position is based on public policy rather than the language of the standard CGL insurance policy.
Another, now minority, position focuses on the concept of fortuity. The Pennsylvania Supreme Court explains this idea as follows:
The National Union CGL policies do not provide a definition for “accident.” Words of common usage in an insurance policy are construed according to their natural, plain, and ordinary sense. . . . We may consult the dictionary definition of a word to determine its ordinary usage. Id. Webster’s II New College Dictionary 6 (2001) defines “accident” as “[a]n unexpected and undesirable event,” or “something that occurs unexpectedly or unintentionally.” The key term in the ordinary definition of “accident” is “unexpected.” This implies a degree of fortuity that is not present in a claim for faulty workmanship.
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We hold that the definition of “accident” required to establish an “occurrence” under the policies cannot be satisfied by claims based upon faulty workmanship. Such claims simply do not present the degree of fortuity contemplated by the ordinary definition of “accident” or its common judicial construction in this context.
Kvaerner Metals Division of Kvaerner U.S., Inc. v. Commercial Union Fire Insurance Co., 908 A.2d 888 (Pa. 2006).
In Kvaerner, the contractor built a brick coke oven for Bethlehem Steel. The ovens roof was damaged because a subcontractor grouted the bricks in the roof too early. As in Oregon, the Pennsylvania court does not appear to have thought that Kvaerner’s subcontractor intended to damage the coke oven by grouting too early. While the majority of courts would now say that Pennsylvania’s fortuity requirement is based on policy and not the definition of accident, courts in Kentucky, Ohio, and Nebraska also rely on a fortuity analysis to hold that defective work cannot be accidental. Courts that employ the fortuity analysis do tend to recognize coverage where faulty workmanship causes damage to property other than contractor’s work. This distinction based on results, rather than the nature of the contractor’s actions, has been rejected in the majority of cases decided in the last 15 years.
Unintentional Defective Work Is An Accident
One of the earliest cases to challenge the older policy driven decisions was American Family Mutual Insurance Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004). American Girl involved a design-build contract for a large distribution warehouse. Faulty soils engineering led, after the warehouse was occupied, to more than 18 inches of settlement causing the building to buckle. The warehouse was determined to be unsafe and was dismantled. The contractor made an insurance claim for the property damage caused by the settling. The insurance company opposed the claim, arguing that the owner’s breach of contract/breach of warranty claim could not give rise to an occurrence. The Wisconsin Supreme Court rejected the insurer’s argument explaining as follows:
American Family argues that because Pleasant’s claim is for breach of contract/breach of warranty it cannot be an “occurrence,” because the CGL is not intended to cover contract claims arising out of the insured’s defective work or product. We agree that CGL policies generally do not cover contract claims arising out of the insured’s defective work or product, but this is by operation of the CGL’s business risk exclusions, not because a loss actionable only in contract can never be the result of an “occurrence” within the meaning of the CGL’s initial grant of coverage. This distinction is sometimes overlooked, and has resulted in some regrettably overbroad generalizations about CGL policies in our case law.
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[T]here 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.
The court went on to note that an accident is an event or change occurring without intention or volition through carelessness, unawareness, ignorance, or a combination of causes and producing an unfortunate result. Since neither the soils engineer or the contractor intended the building to settle, the damage to the warehouse was caused by an accident. The court then went on to examine the exclusions and exceptions in the contractor’s policy.
During 2007, the Supreme Courts of Florida, United States Fire Insurance Co. v. J.S.U.B., Inc., 979 So.2d 871, Tennessee, The Travelers Indemnity Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302, and Texas, Lamar Homes, Inc. v. Mid-Continent Casualty Co., 242 S.W.3d 1, followed Wisconsin’s holding in American Girl. In 2013, they were joined by the Supreme Courts of Connecticut, Capstone Building Corp. v. American Motorists Insurance Co., 67 A.3d 961, Georgia, Taylor Morrison Services, Inc. v. HDI-Gerling America Insurance Co., 746 S.E.2d 587, North Dakota, K&L Homes, Inc. v. American Family Mutual Insurance Co., 829 N.W.2d 724, and West Virginia. In Cherrington v. Erie Insurance & Casualty Co., 745 S.E.2d 508, the West Virginia Supreme Court overruled its recent 2005 holding that “[b]ecause faulty workmanship claims are essentially contractual in nature, they are outside the risks assumed by a traditional commercial general liability policy.” The court explained its reversal as follows:
With the passage of time comes the opportunity to reflect upon the continued validity of this Court’s reasoning in the face of juridical trends that call into question a former opinion’s current soundness. It has been said that “[w]isdom too often never comes, and so one ought not to reject it merely because it comes late.”
In 2010, Colorado enacted a statute requiring its courts to “presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident unless the property damage is intended and expected by the insured.” Colo. Rev. Stat. § 13–20–808(3) (2010). In 2011, Arkansas enacted legislation requiring CGL policies sold in Arkansas to “contain a definition of ‘occurrence’ that includes: … Property damage or bodily injury resulting from faulty workmanship.” Ark. Code Ann. § 23–79–155(a)(2).
The Supreme Courts of Alabama and South Carolina have ruled that defective work can be an occurrence, but both courts hold that the defective work itself is not property damage. Owners Insurance Co. v. Jim Carr Homebuilder, LLC, 157 So.3d 148 (Ala. 2014); Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Co., 717 S.E.2d 589 (S.C. 2011). South Carolina has confirmed this interpretation by statute. S.C. Code Ann. § 38–61–70(B)(2) (2011).
Not all states have issued definitive decisions on this issue. Still the trend, both legislatively and in case decisions, is to find defective work not done intentionally to be accidental and, therefore, an occurrence for purposes of CGL insurance. This does not necessarily mean, however, that CGL insurance will always pay for property damage caused by defective work. Most CGL policies contain several business risk exclusions that specifically address defective work. The trend to find defective work accidental is not a trend to make CGL insurance pay for defective work. It is instead a trend to allow the terms of the CGL policy, rather than judicial policy, to determine whether property damage caused by defective work is covered. The business risk exclusions addressing defective work claims will be the subject of the next edition of this newsletter.
Property damage caused by defective work can expose contractors to substantial liability. Whether CGL insurance will cover that liability is dependent on both the terms of the contractor’s policy and the law of the state where the work is done. Prudent contractors will be very familiar with both.