Insurance companies routinely – and incorrectly in many states – deny coverage for construction defects cases by arguing that construction defect claims do not allege covered occurrences and, even if they do, various exclusions eliminate coverage. Before engaging in ex-tended disputes over these coverage denials, business insureds should carefully scrutinize the complaint for alternative grounds for coverage. A recent insurance coverage case arising out of a lawsuit between a resi-dential buyer and seller, USAA Casualty Insurance Co. v. McInerney, demonstrates the favorable impact of an alternative claim on coverage. The court in McInerney required the insurance company to defend a home seller from the home buyer’s lawsuit because the complaint alleged negligent misrepresentation, even though the complaint also alleged admittedly non-covered claims.
This case arose out of problems with a leaking basement in Illinois. The sellers’ home disclosure in-formed the buyer of flooding or reoccurring leakage problems in the basement that had been corrected by new drains and landscaping. The sellers also disclosed that "[o]n rare occasions, we have experienced slight seepage." Less than a year after the sale closed, the basement sustained water infiltration, flooding, and mold growth that rendered the basement uninhabitable and allegedly constituted far more than "slight seepage." The buyers sued the sellers, claiming that the sellers negligently misrepresented the potential for basement flooding. The buyers also alleged breach of contract, violation of the Residential Real Property Disclosure Act, and fraudulent misrepresentation. The buyers claimed that the flooding damaged their house and per-sonal belongings, and also caused mold-related illnesses.
The sellers submitted the buyers’ lawsuit to their liability insurer, but the insurer denied coverage and instead sued the sellers to obtain a ruling on coverage. The insurer argued that the complaint did not allege an occurrence, and, even if it did allege an occurrence, the occurrence was excluded from coverage because it resulted from intentional acts or arose from the sales contract. The sellers did not dispute the insurer’s inten-tional acts and contract exclusion defenses, but argued that the buyers’ claim for negligent misrepresentation was a covered occurrence not excluded under the policy.
The Illinois appellate court held that a negligent misrepresentation claim is not excluded from coverage as long as the insured did not expect or intend the injury. The court held that the complaint alleged an occurrence by alleging negligent misrepresentation and that the relevant exclusions did not eliminate that coverage. The complaint alleged an occurrence because the damage arguably was not expected or intended. The contract exclusion did not bar coverage because the disclosure report was not a contract and the buyers’ lawsuit sought compensatory damages rather than contract-based relief.
Thus, the court seized on a single count – negligent misrepresentation – as the grounds for requiring the insurer to defend the entire case against the home seller. As the court explained, "if the underlying complaint against the insured contains several theories of recovery and only one of the theories is potentially covered, the insurer must still defend the insured [and] may become obligated to defend against causes of action and theories of recovery that the policy does not actually cover."
Construction defect complaints allege many alterna-tive theories of recovery and one of those may be an "occurrence" (although many insurers may contest the point). Although insureds and insurers typically battle over exclusions to coverage, such as the "your work" and "faulty workmanship," exclusions, alternative bases for coverage may be available that avoid these disputes. Business insureds facing construction defect claims should search for alternative bases for coverage in com-plaints asserted against them. A single allegation, such as one for negligent misrepresentation, can be sufficient to trigger coverage for a claim that, from the insurer’s perspective, is otherwise uninsured.