The most striking development in coverage law in 2013 was the willingness of state high courts to correct prior mistaken precedent on their way to finding that faulty workmanship can be a covered “occurrence” under a construction contractor’s commercial general liability policy. In a six-week period, the North Dakota Supreme Court, the West Virginia Supreme Court of Appeal, and the Connecticut Supreme Court all brought themselves into line with the substantial majority of states on this coverage question. A recent decision by the United States Court of Appeals for the Sixth Circuit, applying Kentucky law, went in the opposite direction. Maybe it’s time for the Kentucky Supreme Court to take another look at the issue.
When can it fairly be said that a general contractor hires a sub-contractor with the expectation or intent that the sub-contractor will perform its work in a shoddy and negligent manner, exposing the general contractor to potential liability for construction defects and the property damage — not to mention the harm to the general contractor’s reputation — that usually results from faulty workmanship? The question answers itself: never. Recently, however, the Sixth Circuit answered the same question as follows: always.
In fairness we have to observe that federal courts are obliged by a rule called the Erie Doctrine to apply the law of the state in which the federal district court sits. In Liberty Mutual Fire Insurance Co. v. Kay and Kay Contracting LLC and MW Builders Inc., No. 12-5791, (6th Cir. Nov. 19, 2013) (download a copy from the “Opinions” section of the 6th Circuit website here), the Sixth Circuit was required to apply Kentucky law, which is currently unfavorable to policyholders in construction-defect coverage disputes.
In 2010, the Kentucky Supreme Court decided that a sub-contractor’s faulty workmanship on a construction project can never be accidental. That case was Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W.3d 69 (Ky. 2010) (get a copy here). There are lots of reasons why the Kentucky Supreme Court should follow the lead of the high courts of North Dakota and West Virginia and overrule Cincinnati v. Motorists.
When a judicial decision, like an argument, proves to have been based upon faulty premises, it is time to revisit the decision. The very first premise of the Cincinnati v. Motorists decision has proved false. The court observed that “The majority viewpoint, …, appears to be that claims of faulty workmanship, standing alone, are not ‘occurrences’ under CGL policies.” In fact, an overwhelming majority of state Supreme Courts that have considered the question have held that faulty workmanship can be (and usually is) accidental and, therefore, is a covered “occurrence.” To date, the following states’ high courts have squarely concluded that faulty workmanship can be a covered occurrence: Alaska, Connecticut, Florida, Georgia, Indiana, Kansas, Minnesota, Mississippi, Montana, Nevada, North Dakota, South Carolina, South Dakota, Tennessee, Texas, West Virginia, and Wisconsin. By contrast — and aside from the Supreme Court of Kentucky, itself — only the Supreme Courts of Arkansas, Hawaii, Illinois, New Hampshire, and Pennsylvania have concluded that a construction defect can never constitute a covered “occurrence.”
Notably, the legislatures of Arkansas, Colorado, Hawaii, and South Carolina have overturned contrary decisions by the courts of those states on this issue, placing them in the majority, as well. Thus, there are currently 20 states in which either the state high court or the state legislature (or both) have decided that faulty workmanship can be an occurrence. Only five state supreme courts, including Kentucky, have held otherwise.
What is more, five of the states that the Kentucky Supreme Court cited as supporting the denial of coverage for faulty workmanship now apply the opposite rule; specifically: Arkansas, Colorado, North Dakota, South Carolina, and West Virginia. In fact, the Cincinnati v. Motorists opinion expressly relies on a South Carolina decision that both the legislature and the Supreme Court of that state have since repudiated. Citing L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 366 S.C. 117, 621 S.E.2d 33 (2005), the Kentucky court observed, “we agree with the Supreme Court of South Carolina that refusing to find that faulty workmanship, standing alone, constitutes an ‘occurrence’ under a CGL policy ‘ensures that ultimate liability falls to the one who performed the negligent work … instead of the insurance carrier.’” In Crossman Communities of North Carolina, Inc. v. Harleysville Mut. Ins. Co., 395 S.C. 40, 717 S.E.2d 589 (2011), however, the South Carolina Supreme Court held that, in the context of a construction defect that caused progressive water damage to a condominium complex, the word “occurrence” in the standard CGL policy is ambiguous and, therefore, must be construed in favor of finding coverage for the contractor whose liability arose from the faulty workmanship.
In any event, to justify a decision that denies coverage to a policyholder on the ground that doing so ensures that the “ultimate liability falls to the one who performed the negligent work” is to gut the very purpose of all insurance coverage. As Justice Benjamin Cardozo said, a great many years ago, “To restrict insurance to cases where liability is incurred without fault of the insured would reduce indemnity to a shadow.” The entire reason liability insurance coverage exists in the first place is to protect us (and our victims) from the consequences of our own negligence.
The second faulty premise of the Cincinnati v. Motorists decision is that finding coverage in a CGL policy for faulty workmanship would transform the policy into a performance bond. This is a mistake a number of courts have made when determining the scope of coverage under a CGL policy. A performance bond protects the owner of the project from the default of the contractor. A CGL policy protects the contractor from the claims of third parties. They are two completely different kinds of contracts, covering completely different kinds of risks, for completely different parties. It may well be that, in some circumstances, the owner might recover under a performance bond and the contractor might recover under a CGL policy for the same faulty workmanship but such a circumstance would, in no way, effect the substitution of one policy for the other.
Finally, the Kentucky court analyzed the “fortuity” inherent in the meaning of the undefined word “accident” in a way that would eliminate all liability coverage if applied to claims other than construction defects. It said, “So focusing solely on whether Motorists [which stood in the shoes of the general contractor] intended to build a faulty house is insufficient. Rather, the court must also focus on whether the building of the … house was a chance event, beyond the control of the insured.” It is worth looking at that strange premise once more: the court must “focus on whether the building of the house was a chance event.”
Let’s try applying that premise to coverage for, say, a car accident. If my negligence in running a stop sign and denting a fellow motorist’s fender is to be covered under the Cincinnati v. Motorists logic, it would not be enough for the court to focus on whether I intended to run the stop sign. Rather, the court would have to focus on whether my driving the car in the first place was a “chance event.” This, of course, is not how insurance coverage works.
Peter Ustinov is credited with saying, “ Intelligent mistakes are the worst kind because so much thought has gone into them.” The intelligent mistakes that the court made in deciding Cincinnati v. Motorists are now, through the influence of stare decisis and the Erie Doctrine, replicating themselves in decisions such as Liberty Mutual Fire Insurance Co. v. Kay and Kay Contracting LLC and MW Builders Inc. Perhaps it is time for the Kentucky Supreme Court to do what it believed it was doing when it decided Cincinnati v. Motorists: bring itself into line with the majority rule by overturning that decision and finding that faulty workmanship can be a covered “occurrence” under a CGL policy.