8.7.1 Applicable Exclusions

• Jurisdiction: Arizona

Commercial general liablity policies do not provide coverage for what are typically called "business risks." Business risks involve losses that are the normal, frequent, or predictable consequences of doing business and that should be controlled and managed by the insured's management personnel. In the words of one commentator:

It is not the function of the CGL policy to guarantee the technical competence and integrity of business management. The CGL policy does not serve as a performance bond, nor does it serve as a warranty of goods or services. It does not ordinarily contemplate coverage for losses which are a normal, frequent or predictable consequence of the business operations. Nor does it contemplate ordinary business expense, or injury and damage to others which results by intent or indifference.

The essence of insurance is risk sharing. If rates are to be predictable and affordable by the mass of policyholders, the sharing of risk must be substantially limited to those risks which are beyond the effective control of the insured and which are not likely to occur frequently or as a normal and inherent consequence of the business operation.

"Business risks," then, are those risks which management can and should control or reduce to manageable proportions; risks which management cannot effectively avoid because of the nature of the business operations; and risks which relate to the repair or replacement of faulty work or products. These risks are a normal, foreseeable and expected incident of doing business and should be reflected in the price of the product or service rather than as a cost of insurance to be shared by others.^[362]

Commercial general liability insurance policies are not intended to guarantee or warrant the insured's work, because this would convert the policy into a performance bond. The Minnesota Supreme Court enunciated this point in Knutson Construction Co. v. St. Paul Fire & Marine Insurance Co.,^[363] where the court observed:

An analysis of the issue commences with the considerations of the elementary insurance principals. In exchange for the payment of a premium, an insurer assumes certain risks that otherwise would be the obligation of the insured. In order to have predictable and affordable insurance rates, the insurer's assumptions of risk are usually limited to those beyond the "effective control" of the insured. That principal applies to the CGL insurance policy.

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[T]he contractor . . . has a contractual business risk that he may be liable to the owner resulting from failure to properly complete the building project itself in a manner so as to not cause damage to it. This risk is one the general contractor effectively controls and one which the insured does not assume because it has no effective control over those risks and cannot establish predictable and affordable insurance rates . . . Unlike the surety on a performance bond, a CGL insurer has no recourse against a contractor for the employment of defective materials or shoddy workmanship on the project site.^[364]

The Arizona Court of Appeals made a similar observation in United States Fidelity & Guaranty Corp. v. Advance Roofing & Supply Co.,^[365] In that case, the court considered the question whether defective workmanship constituted an "occurrence," as defined by the insured's business risk policy. USF&G had issued a CGL policy to Advance Roofing & Supply Co. A coverage question arose out of a contract that had been entered into between Advance Roofing and Villa West IV Homeowners' Association, pursuant to which Advance Roofing contracted to replace the roofs of all 250 units in a housing complex governed by the homeowners' association. The homeowners' association sued Advance Roofing, alleging that Advance Roofing breached its contract by only replacing 40 roofs out of the total 250 roofs contracted for, and that the work performed on the 40 roofs was faulty and defective. Advance Roofing tendered the lawsuit to USF&G for a defense and coverage. USF&G denied the claim. USF&G argued, in part, that no occurrence had taken place that resulted in property damage. Advance Roofing argued that the faulty workmanship was itself an occurrence within the policy definition.^[366] The complaint filed by Advance Roofing did not explicitly allege property damage, but did allege faulty workmanship. This raised a question whether the damages resulting from faulty workmanship were property damage. Advance Roofing argued that the faulty workmanship constituted an occurrence and, therefore, there was coverage under the policy. In reviewing this argument, the court recognized that there were some authorities that appeared to conclude that the mere showing of faulty work was sufficient to bring a claim for resulting damages (of whatever nature) within policy coverage. However, the court rejected these authorities:

In our opinion, these authorities disregard the fundamental nature of a comprehensive general liability policy of the type involved in this litigation, and ignore the policy requirement that an occurrence be an accident. If the policy is construed as protecting a contractor against mere faulty or defective workmanship, the insurer becomes a guarantor of the insured's performance of the contract, and the policy takes on the attributes of a performance bond. We find these authorities unpersuasive.

In our opinion, the better reasoned authorities hold that mere faulty workmanship, standing alone, cannot constitute an occurrence as defined in the policy, nor would the cost of repairing the defect constitute property damages.^[367]

The court indicated that the complaint did not explicitly allege property damage and only alleged faulty workmanship. A reasonable interpretation of the Advance Roofing case would lead to the conclusion that faulty workmanship is not covered under the policy with respect to damage that may be caused to the product or work itself. Costs to repair the faulty workmanship would not be covered, although property damage to property other than the insured's work may be covered.^[368]

While never specifically ruling on the issue, the court in Advance Roofingimplies that if the faulty workmanship causes damage to other property rather than to the work itself or if there is damage caused to the work other than the defective workmanship, this could constitute an occurrence. In distinguishing one case cited by the insured in Advance Roofing, the court observed that "the settling of a building as a result of faulty workmanship...