J. Kent Holland, Jr.
Where a contractor and its subcontractor allegedly performed defective work while repairing and replacing a roof on an apartment building allowing extensive water damage to the interior of the building while the work was in progress, a court held that the “your work” exclusions only excluded coverage for repairing or replacing the defective roof but did not exclude coverage for other property damage to the building. The principal issue addressed by the court involved how to define “work product” – in particular whether it was the entire apartment building or only the roof that the contractor was actually performing work on. Another issue was whether the “contractual liability” exclusion of the policy would bar coverage since work was performed under a contract between another contractor and the owner which had been assigned to become a subcontract to the Insured prime contractor.
In the case of Acuity Mutual Insurance Company v. Burd & Smith Construction, (2006 ND 187), the Supreme Court of North Dakota considered facts quite different from those in the cases where the only damage alleged was damage to the actual construction work itself (e.g., a concrete slab poured improperly). In this case, a building owner contracted with Burd & Smith to replace a roof. The essence of their complaint against the contractor was that it failed to exercise reasonable care in replacing the roof – in particular failing to secure the premises against water damage from rainstorms, and that the interior of the building was damaged and two tenants sustained property damage as well. The owner sued for breach of contract. In a separate action, Acuity, the insurance company filed a declaratory judgment action seeking a declaration by the court that the CGL policy did not provide coverage for the Owner’s damages in the underlying action.
On counter motions for summary judgment, the trial judge granted judgment for the Owner, concluding that damages to the apartment building were covered by the policy and that the various exclusions did not bar coverage.
The state supreme court affirmed the trail court decision, with slight modification. On the issue of whether the claim arose out of “contractual liability” and was therefore excluded from coverage by the contractual liability exclusion, the court explained that the exclusion was not intended to apply to every claim merely because arising out a contractual agreement. The “contractual liability” exclusion of the policy reads as follows:
“Contractual Liability. Bodily injury or property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages: (a) That the insured would have in the absence of the contract or agreement; or (2) Assumed in a contract or agreement that is an insured contract, provided the bodily injury or property damage occurs subsequent to the execution of the contract or agreement.”
Acuity argued that the Owner’s claims were grounded in breach of contract and were not within the scope of coverage provided under the CGL policy. Acuity argued in particular that the contractual liability provision excludes coverage of any potential liability of the Insured based on a contract ratification theory whereby the prime contractor ratified the contract of another contractor to make it a subcontract under its own prime contract. In rejecting that argument, the court quoted another decision in which it had previously said: “The key to understanding this exclusion, and its very important exception, is the concept of liability ‘assumed’ by the insured,” and “In the CGL policy and other liability policies an ‘assumed’ liability is generally understood and interpreted by the courts to mean the liability of another which one ‘assumes’ in the sense that one agrees to indemnify or hold the other person harmless therefor.” Since there was no evidence of liability arising out of an indemnity provision in the contract at issue, the court held that the “contractual liability” exclusion did not exclude coverage for the claimed damages.
On the issue of whether the claim was excluded from coverage by the property damage exclusions for defective work, the court distinguished between damages occurring to the insured’s work product or project itself and damage to property other than the work product or project. Quoting from a previous decision, the court explained the intent and purpose of the exclusions so clearly that rather than attempt to paraphrase the court’s explanation, it is quoted here verbatim as follows:
“The exclusions from coverage for property damage . . . are generally referred to as ‘business risk’ exclusions, and are designed to exclude coverage for defective workmanship by the insured causing damage to the project itself. The principle behind such exclusions is based on the distinction made between two kinds of risk incurred by a contractor . . . . The first is the business risk borne by the contractor to replace or repair defective work to make the building project conform to the agreed contractual requirements. This type of risk is not covered by the CGL policy, and the “business risk” exclusions in the policy make this clear. The second is the risk that the defective or faulty workmanship will cause injury to people or damage to other property. Because of the potentially limitless liability associated with this risk, it is the type for which CGL coverage is contemplated. “While it may be true that the same neglectful craftsmanship can be the cause of both a business expense of repair and a loss represented by damage to persons and property, the two consequences are vastly different in relation to sharing the cost of such risks as a matter of insurance underwriting. . . . The risk intended to be insured is the possibility that the goods, products or work of the insured, once relinquished or completed, will cause bodily injury or damage to property other than to the product or completed work itself, and for which the insured may be found liable. The insured, as a source of goods or services, may be liable as a matter of contract law to make good on products or work which is defective or otherwise unsuitable because it is lacking in some capacity. This may even extend to an obligation to completely replace or rebuild the deficient product or work. This liability, however, is not what the coverages in question are designed to protect against. The coverage [applicable under the CGL policy] is for tort liability for . . . [injury to persons and damage to other property] and not for contractual liability of the insured for economic loss because the product or completed work is not that for which the damaged person bargained.”
The court went on to state that this quoted decision well explains the concept that a CGL policy is not intended to insure business risks that are the normal, frequent, or predictable consequences of doing business and which businesses can control and manage. “A CGL policy does not insure the insured’s work itself; rather, it insures consequential damages that stem from that work…. As a result, a CGL policy may provide coverage for claims arising out of tort, breaches of contract, and statutory liabilities as long as the requisite accidental occurrence and property damage are present.” As its bottom line in this case, the court held that “property damage caused by faulty workmanship is a covered occurrence to the extent that the faulty workmanship causes bodily injury or property damage to property other than the insured’s work product.”
The exclusions in this case, when read in their entirety, said the court, only excluded coverage for repairing or replacing the defective roof but did not exclude coverage for other property damage to the building.
About the author: Kent Holland is a construction lawyer located in Tysons Corner , Virginia , with a national practice representing design professionals, contractors and project owners. He is principal of ConstructionRisk, LLC, providing insurance risk management services and construction risk management services, including but not limited to, advice to insurance underwriters; guidance to those procuring insurance; change order and claim preparation, analysis and defense; contract preparation; contract review and contract negotiation. Mr. Holland 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. 9, No. 6.