Where a commercial general liability (GCL) insurance carrier filed a declaratory judgment action against its insured contractor asking the court to declare that the carrier owed no defense or indemnification duty arising out of costs to repair water damage to homes caused by the faulty work of the contractor’s subcontractors, the court held that the coverage for subcontractor faulty workmanship was covered under the policy due to the subcontractor exception to the “your work” exclusion in the standard CGL policy.  In its opinion in this case, the court in Sheehan Construction Company v. Continental Casualty, 935 N.W.2d 160 (Indiana, 2010), the court provided a short, educational history of the standard ISO form for general liability, and explained that in the precursor to the current 1986 version of the policy, the standard form did not used to have a subcontractor exception for defective workmanship.  According to the court, contractors complained that they needed insurance to cover the damages they incur as a result of work defective performed by their subcontractors, and ISO revised the form in 1986 to provide the desired coverage by creating the current exception to the exclusion when the defects are caused by subcontractors rather than by the insured prime contractor itself.

Sheehan Construction Company, the insured under the CGL policy, was the general contractor for a housing project and hired subcontractors to actually build the houses.  Water leaks due to leaking windows caused fungus growth, decayed OSB sheathing, deterioration and decay of floor joists, and water damage to the interior of the home.  These problems were all due to defective work by the subcontractor which the court found “included lack of adequate flashing and quality caulking around the windows, lack of a weather resistant barrier behind the brick veneer to protect the wood components of the wall, improperly installed shingles, improperly flashed or sealed openings for the chimney and vents and inadequate ventilation in the crawl space.”

In response to the homeowner’s suit against the prime contractor, the prime tendered the claim to both its own CGL carrier as well as the carrier of the responsible subcontractor under which it was included as an “additional insured.”   Eventually this became a class action lawsuit by all the homeowners and the matter went to mediation that resulted in a settlement of $2.8 million.  The prime contractor’s carrier represented the contractor subject to a “reservation of rights” and participated in the mediation, but then subsequently filed a declaratory judgment action seeking a declaration that it was not obligated to indemnify the contractor.   Summary judgment was granted by the trial judge in favor of both the primary carrier as well as the additional insured carrier on ground that there was no damage ‘other than to the structural components of the homes themselves’ and thus there was no ‘occurrence’ or ‘property damage.’”

The policies contained substantially the same language as to what was covered as to bodily injury and property damages caused by an “occurrence.”  The term “occurrence” was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”   “Property damages” was defined to include “physical injury to tangible property, including all resulting loss of use of that property.”

As with all 1986 CGL standard ISO form policies, the two policies contained exclusions applicable to “damage to your work.”  The language of the exclusion reads as follows:

“This insurance does not apply to …   “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 performed on your behalf by a subcontract.”

Whether faulty workmanship fits with the insurance policies’ definition of “occurrence” was the first issue decided by the court, which stated:  “We align ourselves with those jurisdictions adopting the view that improper or faulty workmanship [constitutes] an accident so long as the resulting damage is an event that occurs without expectation or foresight.”   Although the term “accident” is not defined in the policies;

“this court has defined accident to mean ‘an unexpected happening without an intention or design.’[citation omitted].  Implicit in the meaning of ‘accident’ is the lack of intentionality.  The question presented is whether faulty workmanship is an accident within the meaning of a standard CGL policy…. [I]f the faulty workmanship is ‘unexpected’ and ‘without intention of design’ and thus not foreseeable from the viewpoint of the insured, then it is an accident within the meaning of a CGL policy.”

The court went on to further explain its logic for finding coverage as follows:

For an additional reason we find support for our conclusion that “accident” within the meaning of the CGL policies at issue in this case includes faulty workmanship. Although exclusionary clauses “do not grant or enlarge coverage,” [citation omitted], contract construction principles instruct us to read the pertinent provisions of insurance policies together…. As previously noted, the faulty workmanship on the Class members’ homes was performed by subcontractors that Sheehan-the general contractor-hired to do the work. The CGL policies include an exclusion for damage to “your work” and then narrow the exclusion by expressly declaring that it does not apply “if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” If the insuring provisions do not confer an initial grant of coverage, then there would be no reasons for a “your work” exclusion.

In reversing the summary judgment and remanding the case for further proceedings, the court held that if defective work is done unintentionally then it is an accident within the meaning of the policies and therefore subject to coverage under the policies.

Comment: This case is another of a growing body of case law holding that defective workmanship that was done by a subcontractor without intention or design is subject to coverage under the standard ISO form CGL policy as an “accident.”  As an interesting point, the court commented that ISO has issued an endorsement that some carriers use to specifically remove the subcontractor work exception to the exclusion such that defective work by either the prime or its subcontractor is excluded from coverage.  What is intimated, but not specifically stated by the court, is that this suggests that since the carriers chose not to use that narrowing endorsement the broader coverage was intended.   In an apparent effort to educate the reader as to the two sides of the argument, of whether there is coverage under the CGL policy for defective workmanship as an “accident”, the court cites decisions from about a dozen states holding that defective workmanship is not an “accident”, and decisions from approximately the same number of states holding that defective workmanship is an “accident” or “occurrence” that is covered under the CGL policy.  This can serve as a useful reference guide to the law of the various states with regard to CGL coverage for defective workmanship.

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. 13, No.6  (May 2011).

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