The Battle Over Coverage for Construction Defects

• Jurisdiction: United States,Federal
• Citation: Vol. 16 No. 03
• Publication year: 2012

The Battle Over Coverage For Construction Defects

by Tred R. Eyerly

Introduction

A Commercial General Liability ("CGL") policy covers potential liability for property damage caused by an "occurrence," defined as an accident. For years, a debate has raged on whether a CGL policy provides coverage for construction defects. Some courts have determined that a construction defect is not an "occurrence" and therefore not covered under a CGL policy. Instead, these courts hold that a construction defect arises from an expected or intended act or from breach of contract, which are non-fortuitous events not covered by the policy.

A review of the historical development of the standard CGL policy suggests, however, that the policy's insuring agreement broadly grants coverage for "property damage" caused by accident, i.e., faulty workmanship. The scope of such coverage may be narrowed or even eliminated, not because of the absence of an "occurrence," but because exclusions in the policy negate coverage.¹As a result, a policy's "business risk" exclusions may limit or remove all coverage for construction defects.

The Evolution Of The CGL Policy And Its Business Risk Exclusions Confirm That Accidental Construction Defects Are "Occurrences"

The precursor of today's CGL policy originated in 1940. It has since undergone five principal revisions, most recently in 1986. See Am. Family Mut. Ins. Co. v. Am. Girl, Inc., 673 N.W.2d 65, 73 (Wis. 2004). Today, CGL policies are primarily drafted using standardized forms created by the Insurances Services Office, Inc. Id. at 73. The historical development of the CGL policy and the business risk exclusions suggest that construction defects typically arise from an "occurrence."

"Occurrence" Defined

Until 1966, the standard CGL policy provided coverage for liabilities arising out of injury or damage "caused by an accident." Use of the term "accident" created confusion regarding coverage for gradual, continuing harm culminating in bodily injury or property damage. Consequently, the insurance industry removed the "accident" language from the insuring agreement and replaced it with the broader term "occurrence." The standard definition of "occurrence" is, "an accident, including continuous or repeated exposure to conditions."

This language continues to be used in CGL policies today. Id. at 74.

Historical Development of The Business Risk Exclusions

At an early stage, broad exclusions canceled coverage for property damage arising out of construction work. Gradually, the "business risk exclusion" evolved. The business risk exclusions were commonly known as the "your work," "your product," and "your property" exclusions. Eventually, exceptions to the business risk exclusions preserved coverage for property damage caused by a subcontractor and property damage to completed projects.

"Your Work" and "Your Product" Exclusions

The 1973 standard CGL policy contained broad exclusions for damage to "your work," stating that the insurance did not apply:

(o) to property damage to work performed by or on behalf of the named insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.

United States Fire Ins. Co. v. J.S.U.B., 979 So. 2d 871, 878 (Fla. 2007) (emphasis added) (relying on 21 Eric Mills Holmes, Homles' Appleman on Insurance 2d, §129.1, at 7 (2002)) [hereinafter "Holmes"]. The "on behalf of " language was broadly interpreted to mean there was no coverage for damage to a subcontractor's work or for damage to the insured's own work resulting from a subcontractor's work. Sheehan Constr. Co. v. Cont'l Cas. Co., 935 N.E. 2d 160, 162-63 (Ind. 2010). Consequently, this provision was historically relied upon as a basis for excluding construction defect claims.

Enter the Broad Form Property Damage Endorsement

As a result of the "your work" exclusion, many contractors were left without coverage for construction defect claims. Id. at 163. In response, beginning in 1976, insurers offered contractors an endorsement known as the Broad Form Property Damage Endorsement ("BFPD Endorsement"), which effectively eliminated the "on behalf of " language and excluded coverage only for property damage to work performed by the named insured. Id. The BFPD Endorsement also replaced the old, 1973 CGL policy's exclusion (o) with more specific exclusions and differentiated between property damage that occurred before and after operations were completed. With regard to completed operations, the endorsement eliminated the exclusion for "work performed on behalf of the named insured." United States Fire Ins. Co., 979 So.2d at 879.

BFPD Endorsement Incorporated Into Exclusion (j)

In 1986, new provisions in the CGL policy incorporated and clarified the BFPD Endorsement. Coverage was excluded only for liability arising out of property damage that occurred while the construction work was in progress:

This insurance does not apply to:
. . . .

j. Damage to Property "Property damage" to:
. . . .
(5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the "property damage" arises out of those operations; or
(6) That particular part of any property that must be restored, repaired or replaced because "your work" was incorrectly performed on it.
Paragraph (6) of this exclusion does not apply to "property damage" included in the "products-completed operations hazard."²

(Holmes, §132.9, at 145, 153, quoted in United States Fire Ins. Co., 979 So.2d at 879). Consequently, the exclusion for faulty workmanship did not apply to work completed projects.

Subcontractor Exception to "Your Work" Exclusion, Exclusion (l)

The 1986 revisions to the CGL policy also added new exclusion (l), the "your work exclusion." The new exclusion only applied to property damage arising out of completed operations and did not apply to property damage arising out of work performed by subcontractors:

This insurance does not apply to:
. . .
l. Damage to Your Work "Property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard." This exclusion does not apply if the damaged work or the work out of which the damage arises was per formed on your behalf by a subcontractor.

United States Fire Ins. Co., 979 So.2d at 879 (quoting Holmes, §132.9, at 145, 152).

The basis for this 1986 revision has been explained as follows:

[T]he insurance and policyholder communities agreed that the CGL policy should provide coverage for defective construction claims so long as the allegedly defective work had been performed by a subcontractor rather than the policy-holder itself. This resulted both because of the demands of the policyholder community (which wanted this sort of coverage) and the view of insurers that the CGL was a more attractive product that could be better sold if it contained this coverage.

United States Fire Ins. Co., 979 So. 2d at 879 (quoting 2 Jeffrey W. Stempel, Stempel on Insurance Contracts §14.13 [D] at 14-224.8 (3d ed. Supp. 2007)).

The Business Risk Exclusions Define, But Do Not Create, Coverage

The business risk exclusions and their exceptions are valuable tools for determining the parameters of coverage. As one court has noted:

[t]he import of the "your work" exclusion and its subcontractor exception is not that the exclusion "creates" coverage. Rather, the import is that the exception lends insight into the baseline definition of "occurrence" from which parties and courts interpreting CGL policies should operate. If the definition of "occurrence" cannot be understood to include an insured's faulty workmanship, an exclusion that exempts from coverage any damage the insured's faulty workmanship

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