What’s in the Policy?

Deconstructing the CGL policy for construction-defect claims

March 17, 2021 Photo

Construction-defect claims often yield confusion over the available insurance coverage. Owners typically require their contractors to obtain commercial general liability (CGL) insurance as part of the construction contract and expect their contractors’ insurers to provide coverage when disputes arise over the contractor’s work.

On the other hand, insurers do not intend for standard CGL policies to insure against a contractor’s known business risks, such as the risk of the contractor’s poor performance of its work. This article provides insurers with an overview of the standard CGL policy to utilize when evaluating insurance coverage in construction-defect claims.

The most important language in the CGL policy is the insuring agreement. The standard CGL policy only provides coverage if a claim alleges “bodily injury” or “property damage” caused by an “occurrence” that takes place within the policy period. “Occurrence” is usually defined as “an accident, including continuous or repeated exposure to substantially the same general, harmful conditions.” “Accident” is not a defined term in a standard CGL policy. However, courts generally define the term as a fortuitous event. For example, Alabama adopts Black’s Law Dictionary’s definition of accident, which is “[a]n unintended or unforeseen injurious occurrence; something that does not occur in the course of events or that could not be reasonably anticipated.” Nationwide Mut. Fire Ins. Co. v. David Grp., Inc., 294 So. 3d 732, 735 (Ala. 2019).

Is There an “Occurrence”?

States differ on whether faulty work is an occurrence or not. Generally, most states fall into one of three categories: A small number of states hold faulty work is never an occurrence. On the opposite end of the spectrum, other states hold faulty work is an occurrence as long as the contractor did not intend to cause the resulting damage. Most states are in the middle and hold faulty work that causes damage to other work or property is an occurrence.

In most states, resolution of whether a construction-defect claim constitutes an occurrence depends on whether the insured’s faulty work resulted in damage to other work or property. If the claim simply alleges the insured’s work was faulty or defective, that is not enough to constitute an occurrence in most states. However, a claim alleging the insured’s faulty work resulted in damage to other work or property will likely be sufficient to constitute an occurrence. For example, if the insured contractor negligently installed a roof that leaks and causes damage to other parts of the building, the claim alleges an “occurrence.”

Did the Injury Occur Within the Policy Period?

Construction-defect claims often do not arise until after the work is completed. Therefore, it is important to determine when the defect occurred for the purposes of determining whether the property damage took place during the policy period or not. Once again, states differ dramatically on how courts determine when the property damage took place, so it is critical to ensure the proper state law is considered when evaluating coverage. Generally, states fall into one of four analytical camps on this issue:

Exposure theory—The policy or policies in place at the time of the exposure to the conditions that cause the property damage are triggered. Thus, allegations of continuous and repeated exposure to conditions (e.g., water intrusion) might implicate more than one policy.

Manifestation theory—Occurrence takes place when the actual damage becomes apparent or identifiable.
Continuous trigger theory—All policies in effect from the date of the construction of the latent defect through the date of discovery are triggered.

Injury-in-fact theory—Absent specific policy language to the contrary, property damage under a CGL policy occurs when actual physical damage to the property occurs—not when the damage was or could have been discovered.

Is There “Property Damage”?

Assuming the construction-defect claim will be considered an occurrence and it occurred during the policy period, the next step is to determine if the claim presents potentially covered damages or not. Property damage is defined in a standard CGL policy as either: (a) physical injury to tangible property, including all resulting use of that property; or (b) loss of use of tangible property that is not physically injured. Similar to the occurrence analysis, if the property that is damaged or defective is the work product of the insured, that is not considered to be property damage in most states.

However, damage caused by the insured’s faulty work to property other than the insured’s work may constitute property damage. [See, e.g., Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A.3d 961, 973, 979-81 (Conn. 2013), which found that “‘[p]hysical injury to tangible property’ would not include construction deficiencies unless they damage other, nondefective property”].

Two of the more common issues that arise in the context of disputes over the definition of property damage include whether economic damages are property damage, and whether costs of removing and replacing faulty work that is incorporated into the work or products of others (also called “rip-and-tear damages”) are property damage.

While there is a fairly consistent body of case law holding that purely economic losses are not property damage, some courts have permitted coverage for economic losses directly tied to the physically injured property. For example, in American Home Assurance Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986), the owner of the John Hancock Building in Boston sued the manufacturer and supplier of defective glass curtain wall panels. The curtain-wall failure caused the glass panels to systematically pop out of the framing components and shatter onto the pavement below. The owner’s damages included lost profits. The 1st Circuit held these economic losses were covered by the policy. The court viewed the economic losses as consequential damages because of physical injury to tangible property. Therefore, it is important to determine whether the consequential economic damages may be covered in the governing jurisdiction.

Whether rip-and-tear damages constitute property damage is often fact intensive and dependent upon the governing state law. As a general rule, rip-and-tear damages are covered when it is necessary to remove the insured’s defective work in order to remediate damage to other property or work. [See, e.g., Penn. Nat. Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish, 790 F.3d 1173, 1181 (11th Cir. 2015) (Alabama law), which found that removal of the main roof to get to the gypsum deck was property damage because removal was necessary to remediate damage to “other property”]. If the insured’s work does not actually cause damage to other property or work, there should be no coverage for the removal of the insured’s faulty work in order to simply remediate it.

Is the Claim Excluded?

If it appears the construction-defect claim is covered, the next step is to determine if a policy exclusion applies. Known as “business-risk exclusions,” the CGL policy’s exclusions j. through n. are intended to exclude from coverage the contractual risk that the insured’s work or product will fail to live up to its expected performance and will require repair or replacement. The business-risk exclusions were designed to make the insured responsible for predictable and limited business risks. The exclusions that tend to be the most relevant in the construction-defect context are the “damage to property” exclusions, j(5) and j(6), and the “your work” exclusion, l.

Generally, exclusion j(5), often referred to as the “performing operations” exclusion, eliminates coverage for property damage to “that particular part of real property on which you [the insured] or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the ‘property damage’ arises out of those operations.” This portion of the exclusion was intended to apply to ongoing construction operations on real property. By way of illustration, this exclusion would preclude coverage for damage to a partially constructed roof if it collapsed while the insured roofing subcontractor was still working. This exclusion may not negate coverage for damage to other work, such as the floor joists resulting from the collapse.

Exclusion j(6), often referred to as the “faulty workmanship” exclusion, excludes coverage for property damage to “that particular part of any property that must be restored, repaired or replaced because ‘your work’ [the insured’s] was incorrectly performed on it.” For example, in Auto-Owners Insurance Co. v. Chorak & Sons, Inc., 2008 WL 3286986 (N.D. Ill. 2008), the insured was hired to replace sill plates on a home, which required it to raise the entire house. While the insured was raising the house, it fell off the foundation, resulting in damage to the home’s structure. The district court held the resulting damage was excluded by exclusion j(6) because the insured’s faulty work—the raising of the home—caused damage to the home. However, exclusion j(6) does not apply to damage that arises out of the insured’s completed operations. Exclusion j(6) will not apply if the property damage occurs after the insured completes its work.

The “your work” exclusion specifically excludes coverage for “‘property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’” In order for the “your work” exclusion to apply, the damage not only must be to “your work,” but also must be included in the products-completed operations hazard. Thus, this exclusion applies to the insured’s faulty work.

However, some states limit the scope of the “your work” exclusion when the insured has purchased product-completed operations hazard coverage. For example, the Alabama Supreme Court arrived at this conclusion regarding the “your work” exclusion in Jim Carr Homebuilder, 157 So. 3d at 157. Consequently, it is important to determine if the insured purchased products-completed operations hazard coverage and if the applicable state law limits the scope of the exclusion if that coverage was purchased.

CGL policies may also include other exclusions that limit coverage available for construction-defect claims. These include exclusions for mold or fungi, property damage arising from the use of exterior insulation and finish systems (EIFS) or stucco materials, and contract liability exclusions. Thus, reviewing the entire policy to adequately assess coverage for the construction-defect claim is essential.

Evaluating coverage in construction-defect claims can be a daunting task and implicate several aspects of the CGL policy. Courts have added to the confusion by trending toward expansive coverage for construction-defect claims and failing to provide bright-line rules. As a result, the best practice is to perform a careful and critical analysis of whether a construction-defect claim triggers coverage under the policy and whether any of the policy exclusions may limit or exclude coverage.

About The Authors
Multiple Contributors
Brandon J. Clapp

Brandon J. Clapp is an insurance and commercial litigation attorney with Swift Currie McGhee & Hiers LLP in Birmingham. brandon.clapp@swiftcurrie.com

Brian Richardson

Brian Richardson is a partner in the Birmingham office of Swift, Currie, McGhee & Hiers, LLP.  brian.richardson@swiftcurrie.com

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