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An insurance dispute arose when the commercial general liability (CGL) insurance company refused to defend a suit by a prime contractor against an inspection firm (SLT, Inc.) that it had hired to inspect and approve shop welds of pipe sections that were brought to the construction site for installation. Large pipe sections were purchased by the contractor from a fabricator (Progressive Fabricators, Inc.) located in St. Louis for use at a hydroelectric plant in California. SLT was to inspect the welds before the pipe sections were shipped by the fabricator to California.

SLT tendered defense of the suit to its CGL carrier, Liberty Mutual which declined to defend on the basis that the losses alleged in the complaint were not covered “property damage” and, in any event were excluded under the policy’s “impaired property” exclusion. SLT settled its case with Esicorp (the successor to the original prime contractor) for over $2 million. As part of this settlement agreement, SLT agreed to give Esicorp $125,000 in cash plus transfer to Esicorp its rights to file a lawsuit against Liberty Mutual alleging bad faith breach of its contractual duties to defend and indemnify.

In the trial court, Esicorp obtained a judgment against Liberty Mutual. On appeal the appellate court affirmed the judgment and agreed that Liberty Mutual had breached its duty to defend SLT in the underlying suit. The policy promised to indemnify SLT for non-excluded “property damage” caused by an “occurrence.” The policy defined property damage as “physical injury to tangible property, including all resulting loss of use of that property.” Esicorp’s complaint had alleged that as a result of SLT’s failure to discover defective welds in the pipes, the pipes were brought to the project and installed. When it was discovered during installation that the welds were defective, the owner suspended further work and required Esicorp to re-examine all the shop welds and repair rejectable defects.

In reviewing the responsibilities of Liberty Mutual, the appellate court explained that an insurance company has two distinct duties. The first is to defend the insured in any lawsuit seeking damages that would be covered losses. The second duty is to indemnify the insured for covered losses. The duty to defend is broader than the duty to indemnify. If the complaint against the insured alleges facts that give rise to a claim potentially within the policy’s coverage, the insurer has a duty to defend.

In the Liberty Mutual policy, coverage was to be provided for property damage that was defined as “physical injury to tangible property, including all resulting loss of use of that property.” The court concluded that “it was reasonably apparent to a liability insurer from these allegations that “property damage” to the pipe system, and perhaps to surrounding project property and equipment, would likely result from this type of on-site repair operation. Thus, while “most of the damages alleged in Esicorp’s complaint appeared to be economic losses, not covered property damage” the complaint included allegations giving rise to a claim “potentially within the policies’ coverage.” The duty to defend was thereby triggered.

The case goes on from here to describe in greater detail the extent of the insurance company duty, including whether it can be held liable for more than the policy limit, and how to ascertain liability when the underlying damages arise out of some combination of covered and non-covered claims. Esicorp, Inc. v. Liberty Mutual Insurance Company, 193 F.3d 966 (8th Cir, 1999).

Risk Management Note: It is interesting how the decision of this case contrasts with that of the court in Laquila Construction, Inc. v. Pinnacle Concrete Corp. v. Travelers Indemnity Company of Illinois, discussed above. Here the court concluded that allegations of potential property damage resulting from defective inspection services of SLT could potentially be covered under the CGL policy. In contrast, the court in Esicorp found no potential coverage under a policy where repairs were conducted before the defective materials could fail and thereby cause damage to other property.

What is not explained in the court’s analysis is how there could be any potential coverage under a CGL policy for what appears to be allegations of negligence by a professional services provider. Generally, errors and omissions insurance that is afforded by professional liability policies would be more appropriate to cover negligent acts, errors and omissions in the performance of professional services. Even where there are professional liability endorsements in CGL policies, those policies will not provide coverage for purely economic damages – there must first be actual property damage or bodily injury.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 1, No. 4 (Apr 2000).

Copyright 1999, ConstructionRIsk.com, LLC