Inside this Issue

A1 - Federal Court in Tennessee Holds Insurer Responsible Under CGL Policy For Defending Contractor Against Negligence Claims
A2 - Shifting Sands beneath the Economic Loss Doctrine in Washington
A3 - Contractual Liability Exclusion Bars Coverage for Breach of Contract Claim against Contractor by a Third Party
A4 - Defective Work of Subcontractor Covered under Prime Contractor CGL Policy

Article 1

Federal Court in Tennessee Holds Insurer Responsible Under CGL Policy For Defending Contractor Against Negligence Claims

When an owner asserts a claim of negligent construction against a general contractor, the general contractor may seek to have its insurer provide a defense to the claims (i.e., pay for an attorney) under its commercial general liability (“CGL”) policy and, if the general contractor is found to have been negligent, to pay the judgment. As addressed in the recent case, Forrest Construction, Inc. v. The Cincinnati Insurance Co., 728 F. Supp. 2d 955 (M.D. Tenn. 2010), whether the insurer is obligated to provide coverage under a CGL policy will depend upon the specific allegations of negligence and whether the general contractor self-performed the allegedly negligent work.

In Forrest Construction, the general contractor commenced work on a residential home, but abandoned the project before finishing the work. The homeowner took over the project, discovered that the general contractor’s “work was not done in a workmanlike manner and was done negligently,” and asserted negligence claims against the general contractor.

The general contractor informed its insurer of the claim and requested that the insurer provide the general contractor a defense to the homeowner’s claims of negligence. The insurer denied the general contractor’s claim on the grounds that the complaint alleged that the general contractor negligently installed the foundation and that the CGL policy did not insure against defects in the general contractor’s own work. After incurring substantial attorneys’ fees in defending against the homeowner’s negligence claims, the general contractor filed suit against its insurer for breach of the terms of the CGL policy.

After reviewing the CGL policy in question and the negligence claims asserted by the homeowner against the general contractor, the United States District Court for the Middle District of Tennessee determined that the insurer should have paid for an attorney to defend the general contractor against the owner’s negligence claims.

The court began its analysis by restating the general law surrounding insurance policies; that is, an insurer must provide a defense to its insured “when the underlying complaint alleges damages that are within the risk covered by the insurance contract and for which there is a potential basis for recovery.” The court further observed that “any doubt as to whether the claimant has stated a cause of action within the coverage of the policy is resolved in favor of the insured.”

Generally, a CGL policy broadly identifies the scope of the policy’s coverage; then, identifies certain “exclusions” to the scope of the policy’s coverage; and, finally, identifies certain “exceptions” to those “exclusions.” In the instant case, the court found that the CGL policy in question excluded from coverage any damage to the general contractor’s work, commonly referred to as the “your work” exclusion. The “your work” exclusion serves to preclude a general contractor from recovering under its insurance policy for damage to its own work.

The court also found that, as an exception to the “your work” exclusion, the CGL policy provided coverage to the general contractor where the “damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” In other words, where the work was performed by a subcontractor (as distinguished from work self-performed by the general contractor), the CGL policy would provide the general contractor insurance coverage for damage to its own work.

In Forrest Construction, the court had to determine whether the CGL policy afforded the general contractor coverage under the subcontractor’s work exception to the “your work” exclusion. The court looked to the homeowner’s specific allegations of negligence. Specifically, the homeowner alleged that the general contractor had “recklessly constructed the foundation or recklessly caused to be constructed the foundation,” resulting in cracking to the foundation and damage to other parts of the house.

The insurer argued that the homeowner’s negligence claim fell within the “your work” exception to the CGL policy, as the homeowner alleged that the general contractor had constructed the foundation. Accordingly, the insurer reasoned that the CGL policy did not provide coverage to the general contractor for the homeowner’s negligence claims.

The court rejected the insurer’s argument, reasoning that, because the homeowner alleged that the general contractor may have “caused” the foundation to be constructed and because “the usual way a contractor would ‘cause’ certain work to be performed…is to hire a subcontractor,” the “your work” exclusion did not apply to the homeowner’s claims. The court held that, because the homeowner alleged that the general contractor may have subcontracted the foundation work, the “your work” exclusion did not apply and that the insurer was obligated to pay for the general contractor’s defense to the homeowner’s claims.

Forrest Construction is illustrative of the importance of understanding the coverage afforded by a contractor’s CGL policy. While a standard CGL policy will not ordinarily provide coverage for a contractor’s own defective work, depending upon the specific claim(s) asserted against the contractor, the insurer may be responsible for furnishing a defense to the contractor. After paying premiums to an insurer year-afteryear, the prudent contractor may wish to consider filing a claim under its CGL policy when faced with a defective construction claim.

About the Author: Katz & Stone, L.L.P, Attorneys at Law, 8230 Leesburg Pike, Suite 600, Vienna, VA 22182, 703-761-6179, info@katzandstone.com; http://www.KatzandStone.com. This is a nationally recognized construction law firm.

This article is published in ConstructionRisk.com Report, Vol. 13, No.6 (Jun 2011).

Article 2

Shifting Sands beneath the Economic Loss Doctrine in Washington

See similar articles: Economic Loss Doctrine

For more than a decade, design professionals in Washington have been able to rely upon the economic loss doctrine as a bulwark against many third party claims and certain types of negligence claims from their clients. However, two recent Washington State Supreme Court decisions have created great uncertainty about the future of the economic loss doctrine in this state. As a consequence, design professionals are advised to re‐evaluate their risks of claims in the near term. These cases have created great uncertainty. Indeed, in the first two weeks since their issuance, we have seen opposing parties in two of our active cases assert that the economic loss doctrine is now dead and gone in Washington. It is plain that counsel for owners, contractors and other potential third party claimants will closely look for opportunities to bring negligence claims against design professionals that previously had been barred. Likewise, given the confusing nature of these decisions, there will very likely be a lack of predictability at the trial court level as various judges try to figure out whether the economic loss doctrine still exists and if so, in whatever form, how is it applied under this “independent duty” analysis. No doubt some courts will conclude the doctrine is indeed gone and perform its own independent duty analysis to reach its own conclusions as to whether a tort claim may lie against a design professional.

Background

The economic loss doctrine (ELD) is a policy adopted by the courts to determine the parameters for assessing claims that may be asserted in either tort or contract. The doctrine has evolved over the past few decades to the form we know today. It was originally conceived of and applied in the context of consumer protection cases, but was subsequently applied in other areas of the law, including, and specifically, construction law. Various states accept the doctrine, and Washington has been among those with a long ‐‐ and strong ‐‐ history of recognizing the ELD with a particular emphasis in enforcing it in the construction arena.

Courts have historically considered the nature of claimed damages ‐‐ whether the damages are purely “economic” in nature or whether they involve injury to persons or other property ‐‐ in deciding the proper boundaries for tort and breach of contract claims. In Washington and most other jurisdictions recognizing the ELD, when the damages sought are essentially economic in nature (i.e., lost profits, cost overruns, project delays) and the parties have allocated the risk of economic loss in their contracts, the courts have held that only a breach of contract claim is permitted; as a consequence, only a party in contractual privity may recover from the party alleged to be at fault. On the other hand, when a claim involves an injury to a person or damage to other property, any injured party may assert a tort claim, such as professional negligence, against the responsible party, regardless of whether any contractual relationship exists between the two.

By way of differentiating “economic” damages from those that are not, one early court considering a consumer product safety claim used the hypothetical of a consumer who has purchased a defective lawn mower to illustrate how the economic loss rule should work. In this hypothetical, if the lawn mower doesn’t work because it fails to mow the grass, or if the engine malfunctions and is ruined, the consumer has lost the benefit of the bargain in purchasing the faulty equipment and may sue the store that sold the lawnmower for breach of contract; the consumer, however, is barred from suing the manufacturer (with whom the purchaser had no contract at all) in tort for negligently building the machine. Why? Because damage that is limited to only the thing itself, and which is the subject of the seller/ purchaser contract, is “economic” damage; and as a matter of policy, economic damage is compensable only through a breach of contract claim.

If, on the other hand, the defective lawnmower explodes and not only damages itself, but also injures someone, or damages other property besides the lawnmower, then as a matter of policy, the consumer may sue in tort for the negligent construction of the machine. Moreover, the consumer may sue both the seller and the manufacturer, even absent any contract between the consumer and manufacturer. The policy is commonsensical: injuries that include bodily harm or damage to other property properly fall within the basic duty we all have to each other to use reasonable care in our dealings.

This same analysis has been applied to the construction industry in Washington and many other states. Contracts are intended to address the financial expectations of the parties; accordingly, a remedy pursuant to contract is the proper means by which to address disputes about purely economic issues. However, when a construction project results in damage to persons (i.e., injured worker or third party) or other property (i.e., neighboring property damage), then the courts permit a tort claim to be asserted to protect those interests.

Consequently, for purely economic losses, third parties, such as contractors not in contractual privity with a design professional, have been barred from asserting tort claims. Moreover, even a party in privity with a design professional, such as a project owner, can only bring a breach of contract claim when the damages at issue are economic in nature. So, for example, in the traditional “design‐bid‐build” model, where an architect has a contract with an owner, who in turn has a contract with the builder, the builder is barred from asserting a claim directly against the architect for economic damages, such as undue delay or cost overruns. Likewise, in such contracts, the owner in privity with the architect is limited to contractual remedies only ‐‐ the owner is barred from pursuing a tort claim for economic losses.

The policy rationale behind the ELD makes sense especially in the construction industry. Typically in this area of commerce, sophisticated parties have negotiated an agreement which allocates risks and rewards fairly and knowingly. The contract between parties creates a legal relationship to each other that makes risks more predictable and, thus, reasonably quantifiable. In one of Washington’s leading cases, Berschauer/ Phillips Constr. Co. v. Seattle School Dist. No. 1, decided in 1994, the state Supreme Court went to great lengths to specifically endorse this policy for the construction industry as a means of achieving the goals of reasonable risk allocation, price certainty and greater commercial security for parties to construction projects.

It was this very certainty that for several years has provided design professionals both stable predictability in contracts and, equally important, an effective shield in litigation from certain tort claims brought by owners and contractors alike.

What has changed?

In November, the Washington Supreme Court issued decisions in two cases: Eastwood v. Horse Harbor Foundation, Inc., et al, and Affiliated FM Insurance Co. v. LTK Consulting Services, Inc. Both cases address the economic loss doctrine in Washington. At best, these cases have significantly muddied the waters about how this doctrine will work going forward; at worst, these cases raise serious questions of whether the doctrine even exists anymore.

Much of the confusion is created by the fact that neither case contains a decision by the majority of the court; each is a “plurality” decision. Thus, there are questions about the extent to which these decisions will be precedent for subsequent cases and how these cases will be applied by the lower courts. In Eastwood, the “lead” opinion was joined by only two other justices; another opinion was signed by four justices, and concurred only in the result but not the analysis of the lead opinion; and the third opinion was signed by two justices, but concurred in part and dissented in part with the lead opinion. In Affiliated FM, there was a similar split of 2‐4‐3. Collectively, these varied plurality opinions present a fractured and unclear jumble of views about the reach and effect of the ELD in Washington going forward.

The first problem for design professionals now in evaluating their risks is that there is no clear rule to rely upon. Second, it appears from reading the various opinions that a majority of the court believes that Washington should no longer use the economic loss doctrine, but should apply a different test, known as the “independent duty” rule (discussed below). Finally, notwithstanding the plurality opinions and the ostensible rejection of the ELD, what is both hopeful, yet confusing, is that the court did not reverse any of the previous cases that had applied the economic loss doctrine specifically in the construction area.

As a consequence, we are left with two decisions that purport to substantially alter the ELD in Washington, yet don’t disturb previous ELD decisions.

Eastwood v. Horse Harbor Foundation, Inc., et al

Eastwood involved a horse farm owner who leased a portion of his property to the defendant, a non‐profit organization that rescued and cared for abused horses. Over the course of the lease, the defendant allowed the leased premises to fall into substantial disrepair and unsanitary conditions. The plaintiff ultimately sued for breach of the lease and for violation of Washington’s “waste” statute, a legislatively‐created tort. The waste statute imposes a duty on tenants to avoid unreasonable and improper use of rented space resulting in a landlord suffering material damage to property. At trial, the court found the defendants liable for both breach of the lease (a contract) and the tort of waste; the court further found that the defendants were “grossly negligent” in committing waste. The defendants appealed the gross negligence finding.

Although neither party raised the issue at the trial, the Court of Appeals chose to apply the ELD to find that the plaintiff’s waste claim was barred. The appellate court reasoned that because the property damage was only to the thing itself ‐‐ the premises that was subject to a written lease ‐‐ the plaintiff’s tort claim for waste was barred. The court relied on the fact that the plaintiff was able to successfully bring its breach of contract claim under which it could recover damages.

On appeal to the Supreme Court, all three plurality opinions rejected the Court of Appeals’ application of the ELD under these facts. The “lead” opinion and one of the two concurring opinions argued that the blanket application of the economic loss rule to any case merely because of purely economic damages was improper and that a case‐by‐case analysis is more appropriate pursuant to the “independent duty rule.” The second concurring/dissenting opinion argued that it was unnecessary to go that far, because the tort of “waste,” as a legislative creation, cannot be barred by the economic loss doctrine, which is a judicial creation.

The key point from Eastwood worth noting is that between the lead opinion and the other concurring opinions, six of the nine justices supported application of the independent duty rule. As expressed in Eastwood, the independent duty rule would conceptually replace the economic loss doctrine regarding whether a tort claim may be brought by shifting the question from “whether damages are purely economic in nature” to “whether there is an independent tort duty to exercise due care outside of contractual obligations.” To accomplish this analysis, the Eastwood justices advocate that the courts apply on a case‐by‐case basis “considerations of logic, common sense, justice, policy and precedent.”

As mentioned above, what is both confusing, yet encouraging, is that the authors of the plurality opinions, who advocate applying “independent duty” analysis, actually discussed prior construction law cases where the ELD was applied as a bar to tort claims and nonetheless agreed that all of these cases were correctly decided. They also argued, however, that going forward, courts should not only not use the phrase “economic loss doctrine” and/or consider the nature of damages, but should apply an “independent duty” analysis to determine whether, regardless of contractual terms, a tort claim may properly lie.

Affiliated FM Insurance Co. v. LTK Consulting Services, Inc.

It is in Affiliated FM that Eastwood’s plurality endorsement of the independent duty rule is applied as a guiding principle.

The Affiliated FM case involved a fire on a crowded Seattle Monorail train in 2004 that necessitated a dramatic evacuation 50 feet above street level. No one was injured, but the monorail train sustained substantial damage. The lawsuit arising from this incident was brought by an insurance company that paid a property damage claim to the City (as owner of the monorail) and to a vendor. This vendor had contracted with the City to operate the monorail. Earlier, improvements and modifications to the monorail had been designed by the defendant engineer and these were alleged to have caused the fire. The vendor sought to recover lost profits from the engineer as a result of the monorail being out of service for repairs. The engineer asserted that because the damages were only to the thing itself (the monorail), and no person was hurt and no other property damaged, the vendor, who was not in privity with the engineer, was barred from asserting a professional negligence claim pursuant to the ELD.

This case was brought in federal court because the parties were based in different states. The federal trial court agreed with the engineer, applying Washington’s ELD, and dismissed the vendor’s negligence claim. The vendor appealed to the U.S. Ninth Circuit Court of Appeals, and that court elected to “certify” a question to the Washington Supreme Court, asking it to clarify how the ELD should work under these facts.

This case gives credence to the old legal adage that “bad facts make bad law.” Most of the Supreme Court justices in this case were plainly troubled by the fact that a catastrophic tragedy had nearly occurred and were disinclined to consider barring a tort claim merely because the actual damages suffered were limited to the monorail. The lead opinion declared that because a fire broke out on the monorail allegedly because of bad engineering, it is appropriate for a third party not in privity with the engineer to be able to bring a tort claim for the lost business expectancy attributable to the engineer’s negligent work. The lead opinion’s logic is that because fires endanger the public and engineers should design to avoid fires, the engineer’s independent duty to protect the public from safety hazards gives rise, as a matter of policy, to a right to sue for negligence, even when the claimant is not suing about bodily injury, but because it lost money.

What’s a design professional to think?

These cases have created great uncertainty. Indeed, in the first two weeks since their issuance, we have seen opposing parties in two of our active cases assert that the economic loss doctrine is now dead and gone in Washington. It is plain that counsel for owners, contractors and other potential third party claimants will closely look for opportunities to bring negligence claims against design professionals that previously had been barred. Likewise, given the confusing nature of these decisions, there will very likely be a lack of predictability at the trial court level as various judges try to figure out whether the economic loss doctrine still exists and if so, in whatever form, how is it applied under this “independent duty” analysis. No doubt some courts will conclude the doctrine is indeed gone and perform its own independent duty analysis to reach its own conclusions as to whether a tort claim may lie against a design professional.

Although these recent decisions leave us with more questions than answers, we can predict that:

In cases involving serious personal injuries or the risk of serious personal injuries, the design professional will be found to have an “independent duty” and will be exposed to a negligence claim, either from a party in contract or from a third party.

In cases involving catastrophic damage to property other than the project itself, the design professional will be found to have an “independent duty” and will be exposed to a negligence claim, either from a party in contract or from a third party.

In cases involving damage to the project property, uncertainty will reign as to whether the design professional will be exposed to tort claims from a party with whom he/ she/it has contracted, in addition to the remedies and limitations in the contract, or from claims brought by a third party, especially the construction contractor.

Even in cases with purely economic damages, aggrieved third parties will contrive to articulate theories intended to implicate some “independent” duty by which a tort claim can be asserted which was previously barred in this state.

It is too early to tell if we now face a sea‐change in tort law exposure for design professionals.

We recommend that all firms review their insurance programs with these new risks in mind. This review should extend not only to the forms and policy limits of professional liability insurance, but also to available general commercial liability coverage that may be available from owners and contractors and for which design professionals can be named as “additional insureds.”

Design professionals should also be mindful of builder’s risk coverage and pay careful attention to subrogation clauses in these policies. The Affiliated FM case was actually a subrogation claim by a property carrier, who had paid on the property damage claim and then stood in the shoes of the vendor to bring the negligence claim against the engineer.

Design professionals should pay careful attention to all indemnity and other risk‐shifting clauses to be sure they comport with Washington law. This is especially true for limitation of liability and indemnity clauses.

Probably the best defense against these risks is to pay careful attention to quality assurance in all aspects of the work of the firm. Most negligence‐based claims can be avoided in the first place by instituting and maintaining the quality assurance/quality control practices and adhering to them.

About the Author: Terence J. Scanlan, Esq., is a partner in the law firm of Skellenger Bender, P.S., Rainier Tower, 1301 Fifth Ave, Suite 3401, Seattle, WA 98101, 206-623-6501, tscanlan@skellengerbender.com; www.skellengerbender.com. He is a nationally recognized construction lawyer.

This article is published in ConstructionRisk.com Report, Vol. 13, No.6 (Jun 2011).

Article 3

Contractual Liability Exclusion Bars Coverage for Breach of Contract Claim against Contractor by a Third Party

A general contractor under contract to the Dallas Area Rapid Transit Authority (DART) was sued by the owner of a building adjacent to the construction site, alleging that water damage was caused by the contractor’s negligent construction activities. In addition to suing for negligence, the building owner also sued the contractor for breach of contract, alleging that the contractor assumed liability for the damage under its contract with DART. The trial court granted summary judgment for the contractor on the negligence claim on the basis of governmental immunity that applied to the contractor as well as to the government. The breach of contract claim, however, was not dismissed and the contractor eventually settled the claim with the building owner for $6.175 million and then sought indemnity form its commercial general liability (CGL) carrier. In response to the contractor’s demand for indemnity, the CGL carrier responded that the breach of contract claim was not covered under the policy because the policy excluded coverage for contractual liability. On the contractor’s suit against the carrier to enforce coverage, the trial court granted summary judgment for the contractor, which was reversed by an intermediate appellate court and then affirmed by the Supreme Court of Texas in the case of Gilbert Texas Construction v. Underwriters at Lloyd’s London, 327 S.W3d 118 (Tex. 2010). The basis of the holding was that the breach of contract claim fell within the policy’s contractual liability exclusion.

In reaching its decision, the court stated that the exclusion was not limited to only liability assumed of another party, such as indemnity provisions of contracts whereby a contractor agrees to assume its client’s liability to a third party. Instead, the court held that the exclusion does not apply just to those situations in which the insured has assumed the liability of another. The contractual liability provision at issue in this case provided as follows:

Protection of Existing Site Conditions

a. The Contractor shall preserve and protect all structures ... on or adjacent to the work site....

b. The Contractor shall protect from damage all existing improvements and utilities (1) at or near the work site and (2) on adjacent property of a third party ... [and] repair any damage to those facilities, including those that are the property of a third party, resulting from failure to comply with the requirements of this contract or failure to exercise reasonable care in performing the work. If the Contractor fails or refuses to repair the damage promptly, [DART] may have the necessary work performed and charge the cost to the Contractor.

In this case, says the court, “the contractor settled its breach of contract count with the plaintiff after the trial court had granted judgment in the contractor’s favor on all other theories of liability besides the contractual one. Since the trial court had granted summary judgment as to everything else, the only claim that remained, according the Texas Supreme Court “fell within the policy’s contractual exclusion for purposes of determining [the insurance carrier’s] duty to indemnify.”

An exception to the exclusion for liability the contractor would have had in the absence of the contractual liability obligation was held to be inapplicable to get out from under the exclusion. There was simply no basis of the claim that was otherwise covered, said the court, in addition to the contractually assumed liability to be applicable. Because the tort claims against the contractor had been dismissed on the basis of sovereign (government contractor) immunity, “the only viable claim underlying [Contractor’s] settlement was for breach of contract. Gilbert asserts no other basis for its settlement than the breach of contract claim; thus, Gilbert’s settlement payment for which it seeks indemnity simply was not liability for damages it had apart from its contract with DART, as it must have been in order for the [ ] exception [to the exclusion] to apply.” For these reasons, the court held that the contractor was not entitled to coverage for the breach of contract claim brought by the third party building owner.

Comment: This case shows that the contractual liability exclusion in a policy may apply to exclude coverage for more than merely the indemnification provisions of a contract whereby a party agrees to assume liability that its client may have to a third party. This case is somewhat unique in that the breach of contract claim was not brought by the party that actually had a contract with the contractor (i.e., DART) but was instead brought by a third party with whom the contractor had no relationship whatsoever. That third party, building owner, argued that it was essentially an intended beneficiary of the contractual commitment that the contractor made with DART to “preserve and protect all structures … on or adjacent to the work site….” It is interesting to note that the court does not explain the legal theory on which the building owner argued that it was an intended beneficiary and directly entitled to enforce the contract obligations the contractor made to DART. That seems to this author like a critical element that should have been decided by the court before getting to the issue of how the contractual liability exclusion should be applied. But letting that question pass for the moment, I tend to agree with the court that the contractual liability exclusion can be read broader than just applying to indemnity obligations. But that will depend largely on how the language of the insurance policy is written. Some policies seem to contemplate that it only applies to indemnity obligations. Other policies contain broader language that might permit the carrier to deny coverage for a number of other obligations as well. So, be knowledgeable of the wording of the contractual liability exclusion in your policy. Also, be careful when negotiating contracts with clients that you don’t inadvertently run afoul of the contractual liability exclusion as the contractor was held to have done in this case.

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).

Article 4

Defective Work of Subcontractor Covered under Prime Contractor CGL Policy

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.

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ConstructionRisk.com Report (June 2011)