When accidental losses, damages, or destruction of property occur during the course of construction, coverage may be afforded under both a commercial general liability (CGL) policy and a builders risk policy. When both policies are potentially triggered, which policy should respond and in what order? This article discusses coverage under CGL and builders risk policies, their interplay, and explores best practices in managing casualty during construction when both policies are potentially triggered.
Commercial General Liability (CGL)
Commercial general liability insurance protects the insured party from injuries it may cause to other people or property. Accordingly, a CGL policy is “third-party insurance” in that it protects the insured from claims made against the insured by other parties who have suffered loss or damage for which the insured is responsible. To comprehend the actual coverage afforded under the standard CGL policy form, the reader must conduct a three-prong analysis: (1) is the insuring agreement triggered; (2) if yes, does an exclusion or condition apply, and (3) if an exclusion applies, is there an exception to the exclusion? To accomplish the above three steps, the policy reader must analyze the meaning of multiple words and phrases such as “occurrence,” “accident,” “property damage,” “bodily injury,” “your work,” “expected or intended,” etc.
Coverage under a CGL can be written on either an occurrence or a claims-made form, but the occurrence form is preferred and used most of the time. The most commonly used occurrence form is the CG 00 01 published by the Insurance Services Office (ISO).
The insuring agreement of the CGL policy spells out specifically what the policy covers. The insuring agreement is broken down into five subparagraphs (a. through e.) and includes six defined terms (bodily injury, property damage, suit, occurrence, employee, and coverage territory) and various specific limitations/requirements, all of which act to limit the coverage initially provided.
In simple terms, the insuring agreement provides coverage for the insured’s legal liability arising out of bodily injury and tangible property damage for an occurrence during the policy period. An occurrence is defined as an “accident” which includes continuous or repeated exposure to the same general harmful condition. Under a “claims-made” policy, the insuring agreement is not triggered by an occurrence, but is triggered by a claim asserted against the insured during the policy period.
While the insuring agreement under any policy form is drafted in a broad manner, the scope of coverage under all policies is then narrowed by “exclusions” and “definitions.” The CGL policy as authored by ISO has attempted to limit coverage for damage arising out of construction defects. Accordingly, during construction, most damage occurring will not likely be covered because of the exclusions within the policy that embody the well-established business risk doctrine. These business risk exclusions are designed to exclude coverage for defective workmanship by the contractor causing damage to the work itself. The principle behind the business risk exclusions is based upon the distinction made between the two kinds of risk incurred by a contractor.
The first kind of business risk borne by the contractor is the risk of having to replace or repair defective work to make the building or project conform to the agreed contractual requirements. In the presence of the business risk exclusions, it is clear that this type of risk is not covered by the CGL policy. The second risk incurred by a contractor is the risk that defective or faulty workmanship may cause injury to people or damage to other property. As the liability associated with this risk is potentially limitless, it is the type for which the CGL coverage is contemplated. Below is a brief summary of relevant business risk exclusions and other exclusions which tend to limit coverage during the course of construction.
Damage to Product (exclusion l.)
The “your product” exclusion eliminates coverage for property damage to the insured’s own products (not real property), which may include the insured’s materials and supplies. Stated differently, this exclusion is designed to exclude coverage for damage to an insured’s product arising out of a defect with that product.
Damage to Your Work (exclusion l.)
Perhaps the most hotly contested exclusion is the exclusion for damage to “your work.” This exclusion performs the lion’s share of the labor in eliminating coverage for losses arising from a contractor’s poor workmanship in a completed operations context. The “your work” exclusion essentially excludes coverage for property damage to the insured’s work after it has been completed where the damage arises out of the work itself. By specific exception, the exclusion does not apply if the work that is damaged or that causes the damage was done on behalf of the insured by a subcontractor.
Damage to Property (exclusion j.(1), j.(5) and j.(6))
Exclusion j.(1) is commonly referred to as the “owned property” exclusion and eliminates from coverage property damage to all property owned by the insured.
Exclusion j.(5) eliminates from coverage property damage to that particular part of real property on which the insured (or the insured’s subcontractor) are performing operations if the damage arises out of the operations. The phrase “are performing operations” has a present-tense connotation; and those courts that have had the opportunity to address this exclusion have interpreted it to apply only to ongoing operations and not to completed operations. Because exclusion j.(5) is restricted to the damage to “that particular part” of the property that needs correction because of the defective work, j.(5) does not apply to consequential damage to other parts of the project which are not defective.
Exclusion j.(6) applies to faulty workmanship in order to restrict coverage on risks that are typically covered by business risk insurance. Specifically, exclusion j.(5) eliminates from coverage that particular part of property on which the insured (or the insured’s subcontractor) are performing operations if the damage arises out of the operations. Similar to exclusion j.(5), j.(6) is only applicable during construction, as it specifically excepts from the exclusion property damage included in the products completed operations hazard. However, unlike j.(5), exclusion j.(6) does not exclude the work that a subcontractor performs for the insured.
While the business risk exclusions are designed to limit coverage for defective workmanship by the contractor, coverage is available during the course of construction for certain property damage. Specifically, when defective work causes damage and resulting loss to other non-defective property, coverage may be afforded. Accordingly, both a CGL and a builders risk policy may be triggered to respond to loss during ongoing operations.
Builders risk is a kind of property insurance, providing first-party coverage for fortuitous loss during the course of construction. It is often referred to as “course of construction” insurance because it usually only remains in effect during construction and expires when construction is completed and the project is first used or occupied.
Builders risk typically covers the building or structure under construction and materials, fixtures, supplies, machinery, tools, and the equipment to be used in the construction. It may also provide coverage for temporary structures, scaffolding, worksite trailers, landscaping, and excavation work. It also provides some coverage for work to be incorporated in the structure, but stored offsite. Coverage can be extended to include property of others to which the insured may be liable, and soft costs, loss of rents, and delayed opening costs.
Typically, either the owner or the general contractor is responsible for procuring the builders risk policy. Regardless of who is responsible for arranging the coverage, builders risk policies typically include as named insureds all project participants, including the project owners, contractors, subcontractors, and others involved in the project. This is because all such participants have an insurable interest in the construction project. As a general rule, however, suppliers of materials are not commonly named, nor are architects or engineers. Since an insurer cannot generally subrogate against its insured, the naming of all project participants on the policy protects the project participants by preventing the builders risk insurer from attempting to subrogate against any project participant.
Unlike the CGL policy, builders risk policies are not standardized. While the Insurance Services Office does offer builders risk forms, those forms are rarely used because they provide less coverage than most insurers’ manuscript forms. Specifically, ISO’s forms are limited to site-specific coverage, whereas broader coverage is typically required for a project, for example, coverage for materials and equipment in storage off site or while such property is in transit. No matter what form is used, almost all builders risk policy forms provide coverage under one of two basic formats: “all-risk” or “named peril” coverage.
All-risk policies, the most common type used, insure against all risks of direct physical loss or damage to insured property except those risks that are specifically excluded. It is important to keep in mind, however, that the label “all-risk” is essentially a misnomer. All-risk policies are not “all loss” policies. All-risk policies contain express written exclusions and implied exceptions which have been developed by the courts over the years. A cause of loss that is not specifically mentioned but is nonetheless not covered under builders risk is a loss that is non-fortuitous. To be covered a loss must be fortuitous, this is it must occur unexpectedly or without known cause. This requirement is referred to as the “fortuity doctrine” and protects insurers from having to pay for losses arising from undisclosed events that existed prior to coverage, as well as events caused by the same during the policy period. In short, in order to establish coverage under an all-risk policy, the insured must show an insurable interest and the fortuitous loss of covered property.
In contrast, a named peril policy insures against direct physical loss or damage to covered property or to insured property where the loss is caused by any of the specifically named perils or causes of loss. The enumerated perils insured against typically include, among others, fire, lightning, windstorm, hail, explosion, riot, strikes, civil commotion, aircraft, vehicles, smoke, leakage from fire protection systems, vandalism, and malicious mischief.
Exclusions/Perils not Insured
In general the exclusion section to a builders risk policy is divided into three sections, each having multiple subparts. The first part identifies causes of loss that directly or indirectly impact the covered property. These losses are excluded regardless of any other cause or event contributing concurrently or in any sequence in a chain of events that contribute to the loss and are often referred to as the broad exclusions. This wording is intended to exclude coverage if a covered cause of loss contributed to the loss. However, each exception typically has exceptions to the chain of events conditions. Examples of excluded causes of loss under part one typically include: (1) ordinance or law, (2) earth movement, (3) government action, (4) nuclear hazard, (5) utility services, (6) war and military action, (7) water, i.e., flood or subsurface water, and (8) fungus, wet rot, dry rot and bacteria.
Part two excludes coverage for loss or damage caused by or resulting from certain enumerated causes or events. Unlike part one, part two is typically silent as to concurrent causation and may be referred to as limited exclusions. Examples of excluded causes of loss under part two typically include: (1) delay, loss of use or loss of market, (2) agricultural smudging and industrial operations, (3) wear and tear, (4) rust, fungus and other hidden or latent defects, (5) settling or cracking, (6) mechanical breakdown, (7) explosion of steam boilers, (8) continuous water seepage, (9) freezing liquids, (10) dishonest acts, (11) voluntary parting, (12) rain, snow, ice or sleet, (13) collapse, (14) pollution, and (15) neglect.
Finally, part three excludes coverage for loss or damage caused by or resulting from certain enumerated causes or events. However, if a covered cause of loss ensues, then the loss or damage caused by the covered cause of loss is covered. Examples of excluded causes of loss under part three typically include: (1) weather conditions, (2) acts or decisions of governmental body, (3) faulty design, specifications, workmanship, repair, construction, renovation, remodeling, grading, and compaction, (4) material used in construction, and (5) discharge of pollutants.
Losses on construction projects often arise from a combination of forces. Some builders risk policies specifically exclude coverage in cases of multiple or concurrent causation. If the policies or exclusion do not address the issue of multiple causes, often the courts will be asked to decide this issue. The court decisions are divided on how to resolve the question of coverage in light of concurrent causation. At least one court has held that if at least one cause is not excluded, coverage exists.
Most courts, however, use the “efficient proximate cause rule” to resolve coverage issues involving the concurrence of covered and excluded perils. The efficient proximate cause rule applies when two or more identifiable causes contribute to a single property loss, at least one of them covered under the policy and at least one of them excluded under the policy. Under this approach, which is the prevailing rule in a majority of jurisdictions, if multiple concurrent causes exist, and if the dominant or predominant cause is a covered peril, then coverage exists for the entire loss, even though other concurrent causes are not covered under the policy. If the dominant or predominant cause is an excluded peril, coverage would not exist for the entire loss, even though other concurrent causes are covered by the policy.
Ensuing loss provisions can appear vague and ambiguous as to their effect. However, many courts have found that the provisions are themselves clear and unambiguous. As one court noted, “[t]he ensuing loss clause may be confusing, but it is not ambiguous.” McDonald v. State Farm Fire & Cas. Co., 837 P.2d 1000, 1005 (Wash. 1992). Reasonably interpreted, the ensuing loss clause means that if one of the specified uncovered events takes place, any ensuing loss which is otherwise covered by the policy will remain covered. The uncovered event, itself, is never covered. As the exclusion for loss or damages caused by workmanship, repair, and construction, typically contains an ensuing loss provision, coverage for faulty workmanship may be extended under a builders risk policy. For example, if certain defective work (excluded) caused a collapse or a fire (covered event), then coverage would be afforded.
If a loss occurs during construction for which coverage may be afforded under both the builders risk and a CGL policy, certain steps can be taken to best maximize coverage and lessen the financial impact to the project and its participants.
Owner Procured or Project Specific Builder’s Risk
If there is a payout by the builders risk carrier, it could have a financial impact on future premiums. For that reason, a general contractor should first assess if exposure to additional premiums is applicable. As discussed above, builders risk may be purchased by either the owner or the contractor. If the owner bought the builders risk policy, there is no risk of financial impact in the form of increased premiums on the contractor. If the contractor bought the builders risk, then question whether the policy is project-specific.
Builder’s risk policies are usually project-specific, meaning they commonly cover only one project. If the builders risk is project specific, then any loss history will stay with the project and there is no financial impact to the contractor. Larger construction industry policyholders may buy “rolling” builders risk coverage which provides coverage for all of the insured’s projects under construction. If the contractor insured the project with a rolling builders risk policy, then any loss history will remain with the policy and the contractor may see increased premiums. If there is exposure to increased premiums, a contractor may want to explore having the loss adjusted under the CGL policy of a project participant that caused the subject loss, for example, a subcontractor.
Need for Quick Resolution
As discussed above, builders risk provides first-party property coverage. If there is a covered event, the builders risk carrier will typically issue payment in short order. Receiving insurance proceeds quickly is critical, especially if the contractor cannot front end the cost of repair.
Conversely, a CGL policy covers liability to third parties. When a CGL claim is made, the insured may dispute that they caused the loss or argue that other parties also contributed to the loss. The insured’s carrier may opt to defend their insured as opposed to merely tendering a check to cover the insured’s liability. Unless the insured clearly caused the subject loss, a payment by a CGL carrier will likely take much longer than a payment issued from the builders risk carrier.
Under the terms of many construction contracts, subcontractors are required to endorse their CGL policies to respond as the primary insurance for any loss arising out of the subcontractor’s work. At the same time, most construction contracts contain a mutual waiver of subrogation. If builders risk insurance pays for a loss, there will be no right of subrogation, regardless of the fact that subcontractor’s policy was supposed to respond as primary. This is important if the builders risk was procured by the contractor and is not project specific. In such a situation, the contractor will want to document any delay by the subcontractor’s carrier in the resolution of the claim and that the right to subrogate should not be enforceable in the current situation. While subrogation may still be waived if a payment is made by the builders risk carrier, the contractor has preserved arguments that the subcontractor should not be allowed to rely on the waiver of subrogation because of its breach for failing to insure for the loss on a primary basis.
Further complicating any preservation of subrogation rights is the fact that under most builders risk policies all project participants are generally insured, thereby preventing a carrier from subrogating against their own insured. It is good practice to have all project participants with an interest in the project named as insureds; however, it will likely close off any right of subrogation, even if adjustment of the claim under the subcontractor’s CGL is unreasonably delayed.
Even if the owner procured the builders risk and there is no financial risk to the contractor for tendering the loss to builders risk, any tender to builders risk may upset the owner. Contractors who desire to maintain a positive relationship with the owner should familiarize themselves with the owner’s policy before making a claim. Builders risk policies differ. To know whether a potential claim is covered, it is necessary to review the specific policy covering the project. If there is no coverage for a potential claim, there is no reason to tender the claim and risk negative relationships with the owner. That said, prior to abandoning a tender a full coverage analysis should be conducted by counsel.
In the end, each project is different and the coverage scenarios are endless. Prior to taking any action on either the builders risk or CGL, a contractor should always consult coverage counsel or its insurance broker.