Courts across the country have struggled with the issue of whether CGL policies provide coverage for faulty workmanship. The Supreme Court of South Carolina is no exception. Confronted with this issue for the third time in recent years, the court in Crossman Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Corp., No. 26909, 2011 S.C. LEXIS 2 (S.C. Jan. 7, 2011), clarified and partially overruled its previous thinking on the issue and held that coverage for faulty workmanship under a CGL policy requires a separate, fortuitous event that results in third-party property damage.
Harleysville Mutual Insurance Company ("Harleysville") issued a standard-form CGL policy to the developers of a series of condominium projects. The projects suffered from numerous construction defects, primarily to the exteriors of the condominiums, which resulted in interior water damage and prompted homeowners to sue the developers for negligence, breach of express and implied warranties, unfair trade practices, and breach of fiduciary duty. After settling with the homeowners, the developers sought and were denied coverage by Harleysville, forcing the developers to file a declaratory judgment action. The trial court determined the homeowners' claim fell within the definition of "occurrence" and found coverage. On appeal, the Supreme Court of South Carolina reversed.
The court noted the "intellectual mess" created by the differing approaches courts have used in analyzing coverage for property damage stemming from faulty workmanship. The majority rule with regard to faulty workmanship is that claims of poor workmanship, standing alone, are not occurrences that trigger coverage under a CGL policy. Courts adopting this rule typically do so based on one of two reasons: (1) faulty workmanship that causes damage only to an insured's work product constitutes economic loss, which is a business risk and not covered "property damage"; or (2) faulty workmanship is not fortuitous, and any resulting damages are a natural and ordinary consequence of the faulty work and therefore not accidental. The Crossman court acknowledged that a "seemingly incongruent" feature of the majority rule is to provide coverage where faulty workmanship results in injury to persons or to property of third parties.
On the other hand, under the minority rule, damage flowing from faulty workmanship constitutes an occurrence, regardless of whether only the insured's product is injured or a third party's property is injured, as long as the insured did not intend or expect the resulting damage. The court recognized that both rules are subject to criticism, with courts applying the majority rule stating that the minority rule transforms the policy into a performance bond, and courts applying the minority rule pointing out that the majority rule is illogical because it makes the definition of "occurrence" depend on which property is damaged.
Having examined the majority and minority rules, the court also reviewed its jurisprudence on the issue. In L-J, Inc. v. Bituminous Fire and Marine Insurance Co., 621 S.E.2d 33 (S.C. 2005), the court considered whether property damage to an insured's work product alone, caused by faulty workmanship, constituted an occurrence. In that case, the court held that because faulty workmanship is not something typically caused by an accident or by exposure to the same general harmful conditions, there was no occurrence and no coverage. A few years later, in Auto Owners Insurance Co., Inc. v. Newman, 684 S.E.2d 541 (S.C. 2009), the court found that third-party property damage resulting from faulty workmanship did arise from an occurrence, without considering whether an accident occurred.
The Crossman court acknowledged that it erred in failing to consider whether the property damage in Newman resulted from an accident and held instead that a CGL policy provides coverage for third-party property damage only if it results from a fortuitous event. The developers in Crossman, the court found, failed to carry this burden because they did not show that the damage at issue resulted from an occurrence; rather, the damage-water intrusion and damage to the interiors of the condominiums-was a direct result and the natural and expected consequence of faulty workmanship to the exteriors of the units.
The court further clarified that L-J does not stand for the proposition that a CGL policy will never provide coverage where faulty workmanship causes damage to non-defective components of a project; instead, it is the presence or absence of a separate occurrence that determines coverage. In so holding, the Crossman court joined the ranks of courts that have limited coverage to policyholders even where faulty workmanship causes damage to third-party property.