The so-called “business risk” exclusions in the standard Commercial General Liability policy are not models of clear drafting. But it’s surprising, nonetheless, how often courts simply cannot figure out how to apply them correctly even to a simple set of facts. The South Carolina Court of Appeals appears to be the most recent victim of business-risk-exclusion vertigo.
I have been having a quixotic dream recently. It will never come true, but it is worthy nevertheless. The dream is that I can convince everyone (courts, lawyers, insurance adjusters, brokers, circus performers — everyone) to stop using the phrase “business risk exclusions” when referring to the four provisions in a standard form CGL policy that exclude coverage for “Damage to Your Work,” “Damage to Property,” “Damage to Your Product,”and “Impaired Property.” And here’s why. First, the phrase “business risk” actually appears nowhere in the CGL policy. Second, there isn’t really any reasoned, special, conceptual connection between the things these four exclusions exclude and any of the things we would ordinarily consider a “risk” of doing business. Third, it seems clear that calling these provisions “business risk” exclusions has created an atmosphere of interpretive mischief that inspires courts to say things about the CGL policy that just aren’t so, such as: “the purpose of CGL policies is to cover risks of liability but not to insure the normal, frequent, or predictable consequences of doing business.”
That crabbed conception of what the CGL policy does and — more to the point – doesn’t do, certainly comes from some place other than the actual words and provisions of the policy. A prime suspect for the cause of this mischief, it seems to me, is that courts believe the CGL policy actually contains exclusions for the risks of doing business. After all, isn’t that what we call them?
Let’s be perfectly clear: the Comprehensive General Liability insurance policy was conceived, designed, written, marketed, and sold (often for a very substantial premium) precisely and expressly to “insure the normal, frequent, predictable consequences of doing business.” Just as it is a normal, frequent, predictable consequence of driving automobiles that a certain number of those automobiles will be involved in accidents that cause damage to property and injury to persons (when 45,000 people a year die on our highways, would anyone ever suggest that auto accidents are not a normal, frequent, predictable consequence of driving?), it is an equally normal, frequent, predictable risk of doing business that accidents will occur on the job that cause bodily injury or property damage. Auto liability policies cover auto accidents and CGL policies cover commerce-related accidents.
The four exclusions under discussion are most often applied to liabilities that arise from construction activities. The purpose here is not to conduct a thorough analysis of all four exclusions (for that analysis, check out Meditations on Exclusions in Coverage, or Defining Business Risk Exclusions). The focus, instead, is on just two of them and how, recently, the South Carolina Court of Appeals erroneously applied one and not the other to exclude coverage for a claim of faulty construction.
It seems clear that calling these provisions “business risk” exclusions has created an atmosphere of interpretive mischief.
It would have been helpful, as a threshold matter, if the Court in Precision Walls, Inc. v. Liberty Mut. Fire Ins. Co., Case No. 2013-000787 (S.C. Ct. of App. July 23, 2014)(get a copy here) had quoted the entire policy provision on which its decision was based. Then we would be able to tell if all of the language that was the subject of the Court’s analysis included the form language that appears in nearly all CGL policies. There are clues, however, in the opinion to suggest that the provision was in fact standard form. The part of the “Damage to Your Work” exclusion the Court did quote is identical to the form language of that part of the provision. Also, the Court cites several cases in support of its decision and notes that those cases interpreted “Your Work” exclusions that were the same as the exclusion in the policy at issue. A review of those other cases reveals that they involved the standard ISO-drafted (Insurance Services Office) forms. So it is safe to assume, without being absolutely certain, that the Precision Walls Court was dealing with the standard-form “Damage to Your Work” exclusion. Here’s what that provision says:
This insurance does not apply to:
“Property damage” to “Your Work” arising out of it or any part of it and included in the “products-completed operations hazard.’”
“Property damage” is a defined term. It means, “physical injury to tangible property or loss of use thereof.” “Your Work” is also defined. It means, “(1) Work or operations performed by you or on your behalf” or “(2) Materials, parts or equipment furnished in connection with such work or operations.” “Products-completed operation hazard” is separate coverage, usually included as part of a CGL package of coverages, that a policyholder can purchase for an extra premium. It insures against bodily injury or property damage that occurs after a contractor has finished the job, where the damage arises from the contractor’s faulty workmanship or breach of warranty. You have to put all these moving parts together to figure out the scope of the exclusion. The most important aspect of the exclusion, at least for purposes of the Precision Walls decision, is that the damage must be “included in the ‘products-completed operations hazard,’” or PCOH. So, what does that mean?
In the construction context, PCOH coverage comes into play when either all of the contractor’s work has been completed under the contract, or the work has been substantially completed and the project has been put to its intended use. Work is also complete (and damage arising from it is therefore covered) when a part of the work “has been put to its intended use” by someone other than another contractor or subcontractor working on the same project. Interestingly, none of these things had yet happened in the Precision Walls case, but the Court applied the exclusion, nonetheless. [Incidentally, the "Damage to Your Work" exclusion has a very important exception that applies to most construction projects but not, unfortunately for Precision Walls, to this case: the exclusion "does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor."]
Precision Walls, Inc. was a subcontractor on a project to construct a building. It was hired to perform numerous tasks, including installing the insulation. It allegedly did this with a sealing tape product that, after installation but before the completion of a brick veneer wall covering, began to peal and separate. The general contractor’s masonry subcontractor had to demolish the wall and Precision had to replace the faulty insulation product. The general contractor then issued a change order that deducted the cost of the repair from Precision’s contract. Precision sued its insurance carrier for the cost of the damage.
The trial court entered judgment on behalf of the carrier under several theories and Precision appealed. The Court of Appeals affirmed solely on one issue. It found that the “Your Work” exclusion applied. There is no mention in the opinion of the requirement that the work be included in the PCOH nor is there any analysis of what it means to be included in the PCOH. Unless, however, the insulation work at issue was the very last task Precision had to complete in its contract — which is unlikely in light of the variety of tasks listed in its contract, as set out in the Court’s opinion — it is clear that its work was not completed and, therefore, did not fall within the provisions of the PCOH. Instead, the faulty work was performed while the building was still being constructed and before it had been turned over to its owner. Under these circumstances, the “Your Work” exclusion should not have applied.
If the Court reached the right conclusion but for the wrong reason, what does it matter? To policyholders and their counsel, it matters a great deal.
Notably, the Court could have reached the same conclusion — that is, a denial of coverage — if it had applied another exclusion that appears in CGL policies (and presumably appeared in this one). That is the exclusion for “Damage to Property,” which says that the insurance does not apply to “[t]hat particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations,” and to “[t]hat particular part of your property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” There is an exception to this for “property damage” included in the “products-completed operations hazard.”
In other words, the “Damage to Property” exclusion is the mirror-image of the “Damage to Your Work” exclusion. The “Damage to Your Work” exclusion applies when the work falls within the PCOH provision; the “Damage to Property” exclusion does not apply when the work falls within the PCOH provision. Unlike the “Damage to Your Work” exclusion, which excludes coverage for a contractor’s own work after the project is complete (but does not exclude coverage for damage arising from the work of a subcontractor), the “Damage to Property” exclusion applies while the construction project is in progress. Obviously, the project was still in progress in the Precision Walls case and it was the “Damage to Property” exclusion, not the “Your Work” exclusion, that was applicable under those circumstances.
If the Court reached the right conclusion but for the wrong reason, what does it matter? To Precision Walls, Inc., it probably doesn’t matter a whit. To other policyholders and their counsel, it matters a great deal, especially if they do construction work in South Carolina. Because now there is a decision of the Court of Appeals, which is binding on all trial courts in that state, that misinterprets the application of the “Damage to Your Work” exclusion. And the only way that it occurs to me to distinguish this decision, if you happen to be a policyholder lawyer with a similar case, is to observe that, since the opinion does not even mention the PCOH provision, perhaps the exclusion in Precision Walls was non-standard, after all. Or perhaps the policyholder did not have PCOH coverage. Since we cannot know the answer to these questions for sure, it would be best for future courts actually to interpret the policy in front of them correctly, without regard to what the Precision Walls court did with the potentially different coverage at issue in that case.
In the meantime, let’s all do our part to eliminate the phrase “Business Risk Exclusions” from the insurance lexicon.