LIABILITY FOR CONSTRUCTION DEFECTS MAY BE
COVERED UNDER COMMERCIAL GENERAL LIABILITY INSURANCE POLICIES
As we have
written before, the construction industry is plagued by numerous construction defect
claims, property damage claims and personal injury claims. See our posts:
Rotted exterior wall due to
defective flashing installation
To repair
and defend these property damages and construction defects it costs billions of
dollars. Certainly the builder/owner/contractor/sub
does bear this liability. The question
then becomes: is any of that covered by
the CGL?
CGL was intended to be Third Party coverage
The most
common means of insuring against property damage at a construction site is
through "first party" coverage, e.g., builder's
risk insurance. From what we have seen,
the overwhelming majority of the builders do carry builders insurance. Protection of owners, developers, contractors
and subcontractors against third party claims (claims by parties other than the
parties to the contract, for example, claims by an adjacent property owner or
claims by injured employees of the contractor against the owner) is the subject
of CGL policies. CGL insurance
is thus commonly considered to be third party insurance.
Due to the
mounting construction defect claims by innocent third party homeowners who
purchased defective homes, builders, contractors, etc. have sought to utilize
CGL policies as first party insurance to cover property damage occurring at the
construction site due to defective products and/or negligently performed work
and/or damages that became apparent after the work was completed. See for example the picture below showing a
crack in the foundation wall seven years after the home was built.
Crack in the wall we discovered after the home was built and
purchased by the homeowner. Is the CGL
insurer liable for defense and indemnity costs?
The
insurers have sought to exclude from the coverage of CGL policies so-called
"business risks", those risks thought generally to be under the
control of the insured (contractor or subcontractor) and which are not regarded
as fortuitous in nature. The insurers argue
that the CGL policy covers "accidental" property damage but does not
cover uninsurable business risks. The
insurance industry has resisted insuring contractors for property damage caused
by "business risks" within the contractor's control. This is similar to a standard homeowners’
insurance where the insurer will pay for water damage caused by a sudden and
accidental release of water from defective equipment, but will not pay for
damage that is caused by negligence, or lack of maintenance, or failure to
reduce the damage, and so on.
Big Coverage Decisions in 2013 and 2014
In 2013 and
this year, a number of very important commercial general liability (CGL)
coverage questions have been handed down by various jurisdictions across the
country interpreting a number of provisions found in the CGL policies.
The
litigation issues between the insurer and the insured really come down to
this:
·
What is an
uninsurable business risk (that is typically not covered by a standard CGL
policy unless it was contracted for) and what was an accidental or fortuitous
risk that in general is covered by a CGL policy.
As you can
imagine, this is a fact-based question.
Insurers basically have been arguing that everything that a contractor
does is a business risk or that the contractor or owner assumed a liability or
risk in a contract and thus uninsurable.
Recently, a number of courts throughout the United States have tried to
address the issue as to what is an assumed business risk and what is standard
duty of care.
The courts ruled that if a developer or
general contractor does not assume liability in a contract or agreement,
then a CGL policy provided coverage to its insured for liability it incurred
for alleged breaches of its contract with a third party. In Travelers Property
Casualty Co. of America v. Peaker Services, Inc., July 22, 2014, Michigan
appeals court agreed with Peaker that the contractual liability exclusion
applied only in instances where the insured assumed the liability of another,
and did not apply here
At issue is
the contractual liability exclusion that exists in the standard CGL
policies. As you know, just the defense
costs in these construction defect cases can run into $200,000 or more. If include the liability, then we are talking
here about some really high numbers. So
naturally would try to avoid defense or indemnification if they can. The way to do it of course is to file a
declaratory action and to argue that CGL excludes contractual liability. As is always the case, these cases are very
fact specific and document specific. So,
be careful what you write in the contracts you are negotiating, because it may
very well come back and bite you in the bottom; the bottom line that is.
The General
Liability coverage form excludes contractual liability as follows:
2. Exclusions.
This
insurance does not apply to:
b.
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:
(1)
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.
So basically contractual liability is excluded unless the agreement
falls under the definition of an “insured contract”.
In Travelers Property
Casualty Co. of America v. Peaker Services, Inc., July 22, 2014, Michigan
appeals court agreed with Peaker that the contractual liability exclusion
applied only in instances where the insured assumed the liability of another,
and did not apply here. The court also
found unpersuasive Travelers’ contention that by failing to apply the
contractual liability exclusion, the trial court had expanded the scope of the
policy to include contract claims when the policy was meant to be limited to
potential tort liability.
The appeals
court noted that while the Regents brought a breach of contract action, the
substance of the claim sounded in negligence because the Regents alleged that
Peaker breached “the prevailing industry standards and practices.” The court
repeated the prevailing rule that accompanying every contract is a common-law
duty to perform with ordinary care the thing agreed to be done, and a negligent
performance constitutes a tort as well as a breach of contract. Simply because
the Regents brought a breach of contract versus a tort action did not determine
whether coverage existed under the CGL policy. Rather, the policy’s grant of
coverage turned on whether the property damage arose from an “occurrence.” In
this case, Travelers made no argument regarding whether an occurrence had
caused the university’s property damage in this case. The judgment in favor of
Peaker was therefore affirmed.
Rotted exterior beam
Few months earlier, on January 27,
2014, the Texas Supreme Court Handed a Big Insurance Win to Construction
Industry in Ewing Constr. Co. v. Amerisure Ins. Co. , 690 F.3d 628, 633
(5th Cir.2012). The Ewing Construction Co. v. Amerisure
Insurance Co. saga began in 2008, when Ewing Construction entered into a
contract with a school district to build tennis courts. After Ewing completed construction, the
school district complained that the tennis courts were flaking, cracking and
crumbling, rendering them unusable. The
school district filed suit against Ewing, asserting claims for breach of
contract and negligence. Ewing tendered
the defense to its general liability carrier, Amerisure, which denied
coverage. Ewing sued Amerisure in
federal court in Texas, seeking a declaration that Amerisure had breached its
duties to defend and indemnify it in the school district’s suit. On cross motions for summary judgment, the
district court ruled in favor of Amerisure based on the contractual liability
exclusion. Ewing appealed to the Fifth
Circuit, which affirmed the district court in a 2-1 opinion. On rehearing, in an unusual turn of events,
the Fifth Circuit withdrew its opinion and sent the case over to the Texas
Supreme Court on certified questions:
- Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good and workmanlike manner, without more specific provisions enlarging this obligation, “assume liability” for damages arising out of the contractor’s defective work so as to trigger the Contractual Liability Exclusion.
In a
significant win for the construction industry, the Texas Supreme Court answered
the first question “no”. The Amerisure
CGL policy’s insuring agreement provided coverage for “property damage” during
the policy period caused by an “occurrence.”
Amerisure did not dispute that the school district’s claim fell within
the policy’s insuring agreement. Instead,
relying on the Texas Supreme Court’s opinion in Gilbert Texas Construction,
L.P. v. Underwriters at Lloyds, 327 S.W.3d 118 (Tex. 2010), Amerisure
contended that the policy’s contractual liability exclusion, which barred
coverage for liability Ewing assumed in a contract or agreement, applied.
Ewing
argued that the exclusion did not apply because it excepts liability for
damages the insured would have in the absence of the contract or
agreement. The court explained its
decision in Gilbert where the insured had made promises to pay for the
restoration of damages to third party’s property located outside to his
client’s work area. Ewing never made
such promises or accepted any more liabilities that would normally perform in a
typical construction job.
Ewing
argued that its agreement to construct the tennis courts in a good and
workmanlike manner did not enlarge
its obligation under the general law to comply with the contract’s terms and to
exercise ordinary care in doing so.
This is the key. Because its
express agreement to perform the construction in a good and workmanlike manner
did not add to its obligations, it thus was not an “assumption of liability”
within the meaning of the contractual liability exclusion. Importantly, Ewing did not add any language
in the agreement with the school district to assume more liabilities than under
its common law duty.
The
Texas Supreme Court, distinguishing Gilbert, agreed with Ewing,
concluding that the general contractor who agrees to perform its construction
work in a good and workmanlike manner, without
more (this is the key), does not enlarge its duty to exercise ordinary
care in fulfilling the contract, and thus does not “assume liability” for
damages arising out of its defective work so as to trigger the contractual
liability exclusion. In reaching its
decision, the court affirmed its holding in Lamar Homes, Inc. v.
Mid-Continent Casualty Co., 242 S.W.3d 1 (Tex. 2007), in which it held that
a claim for an insured’s faulty workmanship can qualify as an “occurrence”
under a CGL policy.
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