The present economy is arguably the most challenging in recent memory for the residential and commercial construction industries. There is, however, a welcome bit of good news for general contractors and builders in much of the mid-Atlantic who are faced with added costs associated with repairing damage to their projects caused by the defective work of subcontractors. Although the cost of replacing a subcontractor’s deficient workmanship is generally not a covered loss under language standard to most commercial general liability policies (CGLs), for the second time in less than three years the Fourth Circuit has held that, where a subcontractor also causes damage to other non-defective components of a project, the resulting losses may be covered.  

The court’s most recent decision amply illustrates the danger that a subcontractor’s defective performance can pose to the rest of a construction project. In Stanley Martin Cos. v. Ohio Cas. Group, No. 07-2102, ---F. App’x---. 2009 WL 367589 (4th Cir. Feb. 12, 2009), Stanley Martin, a residential construction contractor, hired a subcontractor to supply wooden trusses and gypsum firewalls for 24 duplex townhouses that Stanley Martin was building in Gaithersburg, MD. Id. at *1. Unbeknownst to Stanley Martin, and contrary to the subcontractor’s express warranty, the trusses were infiltrated by mold growth that spread to the firewalls and other parts of the townhouses. Following protracted litigation, Stanley Martin eventually incurred over $1.7 million to remediate the resulting damage. Id.  

Stanley Martin then sought indemnification for this loss under an umbrella CGL policy it had purchased from Ohio Casualty. The policy, which was governed by Virginia law, covered losses from property damage resulting from any “occurrence,” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Id. This definition of “occurrence” was limited by a standard exclusion for “any property damage … to ‘your work’ arising out of it or any part of it,” but which covered circumstances where “the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor….” Id.  

Ohio Casualty denied Stanley Martin’s claim, on the grounds that under Virginia law, the subcontractor’s defective work could not constitute an “occurrence” under the CGL policy. Stanley Martin sued in the Eastern District of Virginia, which granted summary judgment to Ohio Casualty. The district court’s decision was based primarily on its view of the definition of “occurrence” under Virginia law. Id. at *2. Under Virginia law, an “occurrence” for coverage purposes can only include “faulty workmanship that results in bodily injury or property damage to property other than the insured’s work,” on the grounds that the insured’s own defective workmanship cannot be considered “unexpected” by an insured. Id. at *2. In an earlier case, the Fourth Circuit applied this reasoning to uphold a denial of coverage for losses incurred in repairing a subcontractor’s defective work, reasoning that, like a general contractor’s own performance, the deficient performance of a subcontractor could not be considered sufficiently “unexpected” to constitute an “occurrence.” See Travelers Indemnity Co. of America v. Miller Building Corp., 142 F. App’x 147, 149 (4th Cir. 2005). The Miller court reached its conclusion notwithstanding the presence of a subcontractor exception to the relevant exclusion similar to that in the policy Stanley Martin purchased, on the grounds that “an exclusion does not provide coverage,” and therefore an exception to an exclusion cannot “restore” coverage. Id. at 149- 150. The Eastern District of Virginia relied primarily on Miller to hold that Stanley Martin was responsible for the entire cost of remediating the damage caused by its subcontractor’s mold-infiltrated trusses. See Stanley Martin, 2009 WL 367589, at *2.  

The Fourth Circuit reversed, relying in part on a 2006 published case that calls into question the continuing validity of at least part of the Miller result. In French v. Assurance Co. of America, 448 F.3d 693 (4th Cir. 2006), the court considered a coverage claim under Maryland law by assignees of a general contractor arising out of extensive property damage caused by defective exterior siding installed on a home by a subcontractor. Id. at 697. Interpreting a CGL policy with both “occurrence” language and a “your work” exclusion similar to those at issue in both Miller and Stanley Martin, the French court held that, while a subcontractor’s defective work was not sufficiently unexpected to be an “occurrence,” the same could not be said for any resulting damage to the nondefective work of the general contractor. Id. at 703-04. In French this meant that damage to the walls and structure of the home in question resulting from years of moisture seeping in from the exterior was potentially covered. Id.  

Following French, the Fourth Circuit held in Stanley Martin that under Virginia law the plain language of the Ohio Casualty policy might require Ohio Casualty to cover “any mold damage that spread beyond the defective trusses and the gypsum fire walls to nondefective components of the townhouses” because such damage would be “an unintended accident, or an occurrence that triggered coverage….” 2009 WL 367589 at *4. The Fourth Circuit rejected Ohio Casualty’s attempt to distinguish French by arguing that the moisture seepage in that case was a “new” occurrence whereas the mold damage beyond the trusses represented only “further deterioration of already defective work,” holding that such a distinction would be contrary to the “broad and inclusive” definition of “occurrence.” Id. at *3. The court also held that any attempt to use Miller to read the subcontractor exception to the standard “your work” exclusion out of the policy “misses the mark.” Id. at *3 n.2. Such an exception does not “create” coverage, the court noted; rather, it “lends insight into the baseline definition of ‘occurrence’” and reaffirms that an insured general contractor cannot seek recovery for damage caused by its own faulty workmanship, notwithstanding the contractor’s ability to recover for damage caused by the faulty workmanship of a subcontractor. Id.

Ultimately, cases such as Stanley Martin and French reaffirm the basic black letter insurance principle that to exclude certain types of damage from coverage, policies must do so expressly, particularly where there is a broadly-worded insuring clause. Of course, the line between what constitutes a subcontractor’s actual defective work versus resulting damage to non-defective components of a project is far from clear in many cases, as the Stanley Martin court itself recognized when it remanded for further proceedings. See 2009 WL 367589 at *4.  

In the very least, it is imperative that in the event of defective performance by a subcontractor, builders and general contractors carefully track remediation costs and prepare scope documents that identify damage to work other than that of the subcontractor at fault.