By Aaron F. Mandel and Stevi A. Siber-Sanderowitz, Sedgwick New York
Last year, we examined the different approaches states have adopted to resolve whether defective construction by itself is an “occurrence” within the meaning of liability insurance policies. See Is Defective Construction Work an “Occurrence”? The Answer Isn’t So Concrete, Insurance Coverage Law Report (May 2013). Since then, a number of states either have seen their highest courts depart from precedent by concluding that such claims satisfy the “occurrence” requirement, or have sought to pass legislation requiring liability policies to define “occurrence” to include faulty construction work. Below is a summary of these developments, as well as a recommendation on how to address this trend.
The trendsetter appears to have been the West Virginia Supreme Court’s decision in Cherrington v. Erie Insurance Property & Casualty Co., 745 S.E.2d 508 (W. Va. 2013). As previously reported on the Insurance Law Blog, that case involved a lawsuit arising out of defects at a newly constructed residential project. Only the project itself suffered damage, and the builder’s liability insurer denied coverage on the ground that, among other reasons, allegations of defective construction do not constitute an “occurrence.” This position aligned with several prior West Virginia Supreme Court decisions. Ignoring precedent and stare decisis, the Cherrington court overhauled West Virginia law and held that the term “occurrence” in general liability policies includes defective construction. The court reasoned that, by defining “occurrence” to mean “an accident,” all damages or injuries unintentionally caused by an insured fall within a liability policy’s insuring agreement. The court supported its conclusion by noting that the “your work” exclusion implied damage to the insured’s work must be within the insuring agreement. Otherwise, the exclusion would be meaningless.
Taking Cherrington’s lead, the North Dakota Supreme Court in K&L Homes, Inc. v. American Family Mutual Insurance Co., 829 N.W.2d 724 (N.D. 2013), also reversed course and held that defective construction may constitute an “occurrence” provided that the insured did not expect or intend the faulty work and resulting damage. There, homeowners claimed their homes were damaged because of substantial shifting caused by improper footings and inadequately compacted soil under the homes’ footings and foundations. After examining the standard general liability form’s drafting history and surveying cases nationwide, the court concluded that defective construction could qualify as an “occurrence” under the builder’s liability policy if the builder did not intend or expect the faulty work and the “property damage” was not anticipated or intentional. Although the North Dakota Supreme Court previously had held that faulty or defective workmanship standing alone is not an “occurrence,”¹ the K&L Homes court explained its decision by noting that previous case law incorrectly distinguished between defective construction that damages only the insured’s work, and defective construction that damages a third-party’s work or property. The court found there is nothing in the definition of “occurrence” which supports differentiating between the two types of damage.
Not to be outdone by its sister courts in West Virginia and North Dakota, the Alabama Supreme Court earlier this year reversed a decision less than six months old, and held that defective construction can qualify as an “occurrence” under a liability policy. Specifically, in Owners Insurance Co. v. Jim Carr Homebuilder, LLC, the Supreme Court of Alabama held that an insured hired to build a house was not entitled to coverage for “property damage” or “bodily injury” (i.e., mental anguish) resulting from the insured’s defective construction. No. 1120764, 2013 WL 5298575 (Ala. Sept. 20, 2013) (“Jim Carr I”). On rehearing, the court withdrew its opinion in Jim Carr I and replaced it with a new decision that held defective construction could constitute a covered “occurrence” under a general liability policy if the damage was unintended. Owners Ins. Co. v. Jim Carr Homebuilder, LLC, No. 1120764 (Ala. March 28, 2014) (“Jim Carr II”). As the court explained, “the fact that the cost of repairing or replacing faulty workmanship itself is not the intended object of the insurance policy does not necessarily mean that, in an appropriate case, additional damage to a contractor’s work resulting from faulty workmanship might not properly be considered ‘property damage’ ‘caused by’ or ‘arising out of’ an ‘occurrence.’” Because the policy did not define an “occurrence” in terms of the ownership or character of the property damage, the court concluded there was no basis for distinguishing between damages to the insured’s work and damage to third-party work.
New Jersey decided to take a different tack in addressing the “occurrence” issue. On November 25, 2013, New Jersey State Assemblyman Gary Schaer introduced Bill No. A4510, which would have required liability policies issued, renewed, or delivered in New Jersey to define “occurrence” to include damages resulting from faulty workmanship.² According to the bill’s interpretive statement, it required that “occurrence” be defined to address “both accidents and faulty workmanship” in order to remedy New Jersey case law that “varied in their holdings as to whether damage from faulty workmanship is accidental in nature and therefore within the definition of an occurrence.”³ Although the bill recently died in committee, its introduction demonstrates a continuing trend in states seeking to legislate the “occurrence” issue. Laws addressing the “occurrence” issue are already on the books in Colorado, Arkansas, South Carolina, and Hawaii. See, e.g., Col. Code § 13-20-808; Ark. Code § 23-79-155; S.C. Code § 38-61-70; Haw. Stat. § 431:1-217.
The foregoing cases and proposed legislation demonstrate states’ willingness to compel liability insurers to cover risks they have not traditionally insured. The foundation for this traditional rule is sound: an insured can prevent damage to its own work simply by performing its work correctly. In contrast, the reasoning behind compelling liability insurers to cover damage to an insured’s own work is shaky. For example, courts concluding that defective construction work is covered under liability policies because there would otherwise be no reason for those policies to include the “business risk” exclusions ignore that construction defect claims often involve damage to an insured’s work and other third-party property. The exclusions protect the insurer from having to insure uncovered damage (to the insured’s work) while preserving coverage for the covered damage (to the third-party property). In other words, the “business risk” exclusions actually confirm that liability policies are not intended to cover damage to an insured’s work as opposed to suggesting that damage is covered in the first instance.
Despite the weak reasons courts and legislatures have cited to in compelling liability insurers to cover faulty workmanship,it is doubtful those courts and legislatures will revert back to leaving defective workmanship claims outside the realm of liability policies. In that case, how should liability insurers respond?
Although case law and statutes declaring that defective construction qualifies as an “occurrence” within the meaning of liability policies generally leaves the policies’ “business risk” exclusions intact, we previously offered three potential responses in our earlier “Occurrence”? article: (1) including more specific policy exclusions that eliminate coverage for “property damage” to an insured’s own work; (2) charging higher premiums for policies issued to entities engaged in the construction industry and/or issuing policies only in excess of significant self-insured retentions; or (3) refusing to issue policies to parties that perform construction work. These options have drawbacks: higher premiums would be passed along to project owners and developers (which would unnecessarily increase construction costs), significant self-insured retentions could limit the pool of insureds capable of performing construction work to only those that could absorb them (thus decreasing competition), and no longer affording liability coverage for construction projects may cause the construction industry to come to a screeching halt.
Absent a statute or declared public policy prohibiting insurers and their insureds from doing so, a fourth option could be that insurers specify in policies that defective construction is not an “occurrence.” This would be the insurance equivalent of Newton’s third law (for every action, there is an opposite and equal reaction).
Limiting whether and to what extent faulty workmanship qualifies as an “occurrence” under liability policies would provide the greatest benefit to all involved: not only would that preserve the intent of liability policies to respond only to third-party injuries caused by defective construction (such as a steel beam falling on a car or a crane collapsing onto an adjacent building), it would keep liability policy premiums down by ensuring damages to construction projects caused by faulty workmanship are addressed through traditional channels – namely, sureties.
¹ ACUITY v. Burd & Smith Constr., 721 N.W.2d 33 (N.D. 2006).
² The proposed bill, however, noted that it was not intended to restrict or limit the “business risk” exclusions commonly found in liability policies. In the ISO Form, the “business risk” exclusions include Exclusion j. (Damage to Property), Exclusion k. (Damage to Your Product), Exclusion l. (Damage to Your Work), and Exclusion m. (Damage to Impaired Property or Property Not Physically Injured).
³ Specifically, the bill cited to Pennsylvania National Mutual Casualty Insurance Co. v. Parkshore Development Corp., 403 Fed. App’x 770 (3d Cir. 2010) (applying New Jersey law and holding that a subcontractor’s faulty work that resulted in damage to the insured general contractor’s work was not an “occurrence”), and Fireman’s Insurance Co. of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (N.J. App. Div. 2006) (holding that faulty workmanship was not “property damage” caused by an “occurrence” under a typical general liability policy).