In Greystone Const., Inc. v. National Fire & Marine Ins. Co., 661 F.3d 1272, 1289 (10th Cir. 2011), the U.S. Court of Appeals for the Tenth Circuit articulated an important rule for construing commercial general liability policies:

[A] CGL policy ‘begin[s] with a broad grant of coverage, w[hich is then limited in scope by exclusions. Exceptions to exclusions narrow the scope of the exclusion and . . . add back coverage. But it is the initial broad grant of coverage, not the exception . . . that ultimately creates (or does not create) the coverage sought.

But the court only honored the rule in the breach: It did not find that an exception to an exclusion created coverage the insuring clause did not, but it did rule that the exception made it necessary to construe the insuring clause more broadly than other courts had done. On that basis, it recognized a “subcontractor exception” to the general rule against liability coverage for claims based on faulty workmanship. Not every court agrees: Two months ago, in McBride v. Acuity, No. 12-5037 (6th Cir. Jan. 7, 2013), the Sixth Circuit declined to follow Greystone. But this month, in Scottsdale Ins. Co. v. R.I. Pools, Inc., No. 11-3529-cv (2d Cir. Mar. 21, 2013), the Second Circuit embraced the doctrine, without even acknowledging the anomaly of using an exception to an exclusion to modify the traditional meaning of an insuring clause.

Greystone and The Fortuity Doctrine

A typical CGL policy contains an insuring clause, in which it states that coverage is provided only for personal injury or property damage caused by an “occurrence,” and the definition of “occurrence” usually includes the word “accident.” Applying what is known as the “fortuity doctrine,” many courts have held that claims for damage caused by the faulty workmanship of the insured have not been caused by an “accident,” and so are not entitled to CGL coverage.

In Greystone, an insured contractor was sued by homeowners who claimed their house had suffered extensive damage from shifting soils, due to a subcontractor’s negligent design and construction of soil-drainage elements. The opinion in Greystone contains a lengthy discussion of cases discussing the fortuity doctrine, in which the court concludes that “a strong recent trend . . . interprets the term ‘occurrence’ to encompass unanticipated damage to nondefective property resulting from poor workmanship.” 661 F.3d at 1282.

Typical CGL policies also contain a “your work” exclusion, which expressly excludes coverage for damage arising out of the insured’s own work. In the 1980s, the standard “your work” exclusion also began to contain an exception for work performed by a subcontractor. The Tenth Circuit reasoned that this exception would be a “phantom” if there were no circumstances in which the policy’s coverage applied to workmanship. Consequently, as a second basis for its holding, it found that these developments indicated an intent on the part of insurers to include the faulty work of subcontractors within the definition of “occurrence.” Id. at 1289-90.

In other words, the court held that the longstanding meaning of the language of the insuring clause had been changed by the subcontractor exception to the “your work” exclusion.

The Sixth Circuit Doesn’t Quite Buy It

The facts in McBride v. Acuity were similar to those in Greystone, but the Sixth Circuit also cited conflicting authority that construed the subcontractor exception more narrowly—applying it only to damage caused to other properties, rather than to the property constructed by the policyholder. E.g., Travelers Indem. Co. v. Miller Bldg. Corp., 142 Fed.Appx. 147 (4th Cir. 2005). Predicting that Kentucky’s Supreme Court would adopt only this narrow version of the exception, the court ruled that the insured was not entitled to coverage. See also The Netherlands Ins. Co. v. Jeffries Construction, Inc., No. 3:10–CV–754 (W.D. Ky. Mar. 19, 2013).

The Door Opens Again

In 2006, R.I. Pools was in the business of installing pools, but it used subcontractors to supply concrete and shoot it into the ground. In 2009, 19 customers complained about cracking, flaking and deteriorating concrete. R.I.’s CGL policies from Scottsdale Insurance Company covered injury or damage that was “caused by an ‘occurrence’” and defined “occurrence” to mean “accident.” The policy also expressly excluded from coverage “’[p]roperty damage’ to ‘your work’ arising out of it or any part of it,” but the exclusion stated that it “[did] not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a sub-contractor.”

The fortuity doctrine has been settled law within the Second Circuit for 20 years, and the district court awarded summary judgment to the insurer in its action for declaratory judgment. Citing Jakobson Shipyard, Inc. v. Aetna Cas. & Surety Co., 961 F.2d 387 (2d Cir. 1992), the court held that a defect in workmanship may not be considered an “accident.”

The Second Circuit reversed, on the ground that the subcontractor exception in the Scottsdale policy made the case distinguishable from Jakobson. The court’s per curiam opinion reasoned that “[t]he district court’s analysis essentially read the subcontractor exception out of the policies.” In the view of the appellate court:

[T]he present polic[y] expressly provide[s] that in some circumstances the insured’s own work is covered [i.e., when that work is performed by a sub-contractor]. As coverage is limited by the policy to ‘occurrences’ and defects in the insured’s own work in some circumstances are covered, these policies . . . unmistakably include defects in the insured’s own work within the category of an ‘occurrence.’

This approach to contract interpretation is certainly defensible, since policies should be construed in a way that gives meaning to all of their terms. But it achieves that goal by concluding that the industry indicated its intent to change the meaning of “occurrence” by adding an exception to an exclusion in a different part of the policy. That is, at best, a debatable claim, with possible significance far beyond the fortuity doctrine.