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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