Construction defect litigation: courts' fragmented rationales regarding coverage for contractor's faulty workmanship.

• Author: Friedlander, Lisa C.

In Boston, Massachusetts, the Central Artery Tunnel Project, also known as the "Big Dig," is considered an engineering marvel. Designers and contractors encountered many challenges including adverse soil conditions, confined work spaces, and proximity to office towers and historical buildings, while trying to construct an underground expressway beneath an elevated highway. After fourteen years of construction, an estimated cost of 14.6 billion dollars, and hundreds of leaks in the tunnel walls, accusations of construction defects naturally arose. Construction defect claims are no stranger to public construction contracts. Different courts and jurisdictions have taken varied approaches regarding faulty workmanship coverage under a Commercial General Liability ("CGL") policy. (1) The Big Dig contractors and subcontractors should be concerned with their potential liability under a CGL policy because courts have failed to supply a universal interpretation of liability under these policies. How can they truly understand what their CGL policy coverage encompasses when widespread disagreement exists among the courts?

1. INTRODUCTION

   Some contractors confronted with a claim of faulty workmanship by their customers are shocked to discover that there is no coverage for faulty workmanship under their CGL policy. (2) Such a discovery leaves many experienced builders wondering why they even purchased the insurance policy. (3) How can a contractor understand what the limits of his coverage are under his CGL policy when there is widespread disagreement among the courts? (4)

   Insurance coverage disputes regarding construction defects are a rapidly growing area of controversy in the insurance industry. (5) Courts have interpreted policy coverage language differently; therefore, parties often attempt to present precedent from other jurisdictions that support their position. (6) Consequently, this has resulted in additional litigation. (7)

   Over the past fifteen years, litigation involving defects in construction has exploded. (8) The enormous cost of this litigation has impacted homeowners, contractors, insurance companies and state legislatures, among others. (9) Accordingly, inferior quality construction resulted in a financial burden on society, as well as complex and expensive insurance coverage litigation. (10)

   A Commercial General Liability policy covers the liability exposures of a business that are not specifically excluded under that policy. (11) The range of coverage encompasses product liability, completed operations, premises and operations, and independent contractors. (12) Disagreement exists, however, among lawyers, policyholders and courts regarding the extent of insurance coverage available to contractors under a CGL policy. (13)

   A central question in the disagreement regarding coverage is whether a construction defect is considered "property damage" and an "occurrence," as defined in a CGL policy, terms essential to the trigger of policy coverage. (14) The CGL policy defines "occurrence," a condition precedent of policy coverage, as "an accident," and the definition of "occurrence" includes "property damage" which is not expected or intended by the insured. (15)

   This note will explore construction defect cases, specifically examining three recent state supreme court decisions that demonstrate jurisdictions' various rationales regarding CGL coverage. (16) Part II will provide a brief overview of the relevant history of Commercial General Liability insurance and the CGL policy. (17) Part III will focus on three recent state supreme court decisions involving construction defect actions in Wisconsin, South Carolina and Nebraska which examined the meaning of an "occurrence." (18) Part IV will compare the court's differing approaches in reaching their conclusions, particularly involving exceptions and exclusions in the CGL policy. (19) Part V will conclude that it is time for the United States Supreme Court to decide the relevant standard to be applied in construction defect litigation cases. (20)

2. HISTORY AND CHARACTERISTICS OF THE "CGL" POLICY WITH RESPECT TO CONSTRUCTION DEFECT CLAIMS

   In general, liability insurance is commonly referred to as third-party insurance because the insurer, on the insured's behalf, is obligated to pay directly a third-party claimant who is injured by conduct of the insured.21 Accordingly, the insurer's duty to pay does not run directly to the insured. (22) Fundamentally, the insurer indemnifies its insured for any liability the insured may have to the injured party by reimbursing the injured party on behalf of the insured. (23) Determining whether or not coverage exists under the CGL policy involves a two-step process: first, the insured must show that the policy covers his loss; second, in order to avoid coverage, the insurer must show specific policy language that excludes the insured's loss. (24)

   The purpose of a general liability policy is to safeguard the insured from liability for personal injury or property damage to a third party that could be caused by the insured's products or services. (25) A common misconception, especially among those with insurance coverage, is that the purpose of liability insurance is to provide for the repair or replacement of the insured's poorly constructed product, or to perform the service correctly. (26) Coverage is excluded in these circumstances because a contractor or subcontractor would receive duplicate payment. (27) These duplicate payments would include a payment from the customer to a contractor for work completed, and another payment from the insurance company to repair or replace the deficiencies in its poorly constructed product. (28) Another policy reason that liability insurance is not for the repair or replacement of a faulty product or service is that the responsibility and obligation of the contractor or subcontractor to perform the project in a workmanlike fashion would be diminished. (29) Essentially, the contractor or subcontractor's incentive to provide a quality product would be eliminated. (30)

   Furthermore, liability coverage is "not a replacement for a warranty or a guaranty of the performance to be given to the insured's customer." (31) For example, in Travelers Indemnity Co. v. Miller Building Corp. (32), the United States Court of Appeals for the Fourth Circuit concluded that the building owner's claim against the builder for recovery for the cost to correct the builder's faulty workmanship was not within the scope of the insurance policy because faulty workmanship is not considered "property damage." (33) To be considered "property damage," the property must have been undamaged previously. (34) Comparatively, defective construction was never undamaged. (35)

   Coverage disputes involving construction defects are often further complicated because some contractors do not have a full understanding of the coverage of a CGL policy. (36) In general, CGL insurance includes coverage for "damage caused by a contractors faulty work," not for the expense for repair or replacement of the actual faulty work. (37) That the CGL policy does not cover the repair or replacement of faulty work often is surprising to contractors as these costs are often the most significant exposures and expenses at issue in construction disputes. (38)

   In the United States, CGL insurance policies traditionally are "occurrence" based, as opposed to other liability policies, such as Directors and Officers and Professional Liability, which are "claims-made". (39) Through the "occurrence" based CGL policy, the insurer is obligated to pay or defend claims, whenever they are made, resulting from an incident that occurred during the policy time period. (40) The insurer is obliged to defend and indemnify claims if an "occurrence" based liability policy was in force when the alleged bodily injury or property damage occurred. (41)

   The CGL insurer has two major duties to the insured, the duty to indemnify for settlements and judgments within the coverage granted, and the duty to provide defense for the policyholder. (42) In every state, insurers have a duty to provide defense if the complaint against the insured even suggests facts which could potentially bring the claim within the policy's coverage grant. (43) All claims or suits alleging that the insured caused property damage or bodily injury, even those encompassing certain intentional acts, lead to the possibility that the insurer will incur defense costs. (44) The duty to defend feature of the CGL policy is exceptionally significant to policyholders challenged with circumstances such as "product liability [including asbestos], environmental, construction defects, intellectual property or any other potentially covered claim" where defense costs may considerably exceed policy limits. (45)

   Although coverage is generally narrow, construction defect claims are a financial drain on insurers. (46) Construction defect claims are particularly costly because of CGL coverage's broad "duty to defend" the insured, and because litigation typically involves multiple parties. (47) To avoid these enormous defense costs and waste of financial resources, insurance companies often contribute to settlements regardless of whether their insured is actually liable or whether the policy clearly provides coverage. (48) In the examination of construction defect controversies, most not resolved through settlement, it is evident that complex and expensive insurance coverage litigation impacts multiple stakeholders, including policyholders, insurers, lawyers, the court system and society. (49)

3. RECENT SUPREME COURT DECISIONS INVOLVING CONSTRUCTION DEFECTS

   Since 2004, the supreme courts of Wisconsin, Nebraska, and South Carolina have each addressed questions of coverage under a CGL policy regarding claims of faulty workmanship. (50)

   1. American Family Mutual Insurance Co. v. American Girl, Inc.

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