Recent decisions from the U.S. Courts of Appeal for the Tenth and Second Circuits have partially overturned a longstanding rule against coverage for faulty workmanship under commercial general liability policies. The rule, known as the “fortuity doctrine,” was based on insuring clauses that provided coverage only for claims arising out of an “occurrence,” and which defined “occurrence” to mean “accident.” For many years, courts held that claims based on the insured’s faulty workmanship did not arise out of an “accident,” and so were not covered by CGL policies. In Greystone Const., Inc. v. National Fire & Marine Ins. Co., 661 F.3d 1272, 1289 (10th Cir. 2011), and in Scottsdale Ins. Co. v. R.I. Pools, Inc., No. 11-3529-cv (2d Cir. Mar. 21, 2013), the policies also contained “your work” exclusions, which barred coverage for damage arising out of the insureds’ own work, but which were subject to exceptions for work performed by subcontractors. In both cases, the Courts of Appeals held that the exception indicated an intention to bring the faulty workmanship of a subcontractor within the scope of an “occurrence.” (This blog provided a detailed report on those cases here.)

In Greystone, the Tenth Circuit remanded the case for further proceedings. Last month, in Greystone Const., Inc. v. National Fire & Marine Ins. Co., No. 07–cv–00066–MSK–CBS (D. Colo. March 31, 2013), the district court put additional meat on the bones of the subcontractor exception. It awarded summary judgment to the policyholder, and directed the insurer to reimburse the policyholder’s defense costs, despite an express exclusion for claims arising out of “operations performed . . . by . . . subcontractors.”

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 Insurer, National Fire, refused to provide a defense, and it refused to indemnify the insured when it settled the homeowners’ claims. On remand, National Fire cited Endorsement M to the contractor’s policy, which expressly precludes coverage for property damage “arising out of operations performed for you by . . . subcontractors,” unless the subcontractors satisfied certain conditions, including (i) agreeing in writing to indemnify the insured and (ii) maintaining separate liability insurance. The insurer argued that the subcontractors in this case had not satisfied those conditions, and, therefore, that coverage was excluded.

The district court, applying Colorado law, held that, in determining whether an insurer has a duty to defend under a CGL policy, a court may not consider any facts that are not alleged in the complaint in the underlying action. (The lone exception to this rule, the court found, is where the insured’s complaint contains allegations made in bad faith.) Because the homeowners’ complaints “fail[ed] to state allegations regarding whether the . . . subcontractors did or did not satisfy the four-part exception that would allow coverage,” Nation Union could not rely on Endorsement M to extinguish its duty to defend.

The court also rejected National Union’s argument that Endorsement M established the absence of a duty to indemnify. It noted that the exclusion applies to “operations performed for [the insured] by . . . subcontractors,” whereas the insuring clause states that the policy covers claims arising out of the “your work,” and the policy defines “your work” as “work or operations performed by you or on your behalf.” Consequently, it held that there must be some “work” performed by a subcontractor that is within the scope of the insuring clause, while outside the scope of the “operations” to which the exclusion applies. Because National Union had not established that the work at issue in this case fell within the meaning of “operations,” the court denied the insurer’s motion for summary judgment on the issue of its duty to indemnify.