Second Circuit Holds Ambiguity of Phrase “Caused Only By” Permits Coverage Where Uncovered Perils Contribute to Property Damage

Darren S. Teshima, Harry J. Moren and Alison K. Roffi | March 23, 2016

Imprecise usage of the word “only” in policy language may create ambiguities favorable to policyholders. The Second Circuit recently agreed with policyholders that their homeowners’ policy, which insured for property damage involving the collapse of a part of a building “caused only by one or more of the following” specifically named perils, provided coverage so long as a collapse was caused by one of the enumerated perils, regardless of whether a non-enumerated peril also contributed to the collapse. In an unpublished opinion, the Court rejected the insurer’s interpretation, which the district court had accepted, that coverage was limited to collapses exclusively caused by one of the enumerated perils.

The Court found not only that both interpretations of the plain language were reasonable, which should lead to a resolution of the ambiguity in the policyholder’s favor, but further determined that several considerations supported the homeowners’ interpretation. First, the Court explained that under settled New York case law on insurance contracts, the word “caused” implicates the concepts of proximate causation: if a covered peril is the predominant cause of the loss, the concurrent operation of a non-covered peril will not defeat coverage. (See our recent coverage of the Fifth Circuit’s application of the concurrent-cause doctrine under Texas law.) The policy did not indicate any intent to override this established rule by drafting reasonably clear language. Moreover, the Court pointed out that the insurer obviously knew how to draft language to that effect because another provision in the same policy included a so-called “anti-concurrent cause” claims, which excluded certain perils from coverage “regardless of any other cause or event contributing concurrently.” Additionally, the Court observed that it would be reasonable for a homeowner whose home collapsed predominantly due to a listed peril to expect coverage.

The Court also dismissed the insurer’s contention that the charge from the district court to the jury was proper because the jury instructions used the same “caused only by” language as the policy. Rather, the Court found that the actual use of that phrase in the jury instructions either improperly altered the phase’s context from that in the policy or else preserved the ambiguity and impermissibly relegated the task of contract interpretation to the jury.

This decision reinforces…

To finish reading this article

Getting to the Bottom of Construction-Related Defects

David P. Amori | Claims Management | January 2016

The forensic engineering assignment typically has a scope of work that begins with something to the effect of “determine the cause of the observed damage to the….” Often this includes an inspection and analysis to determine if the observed damage is related to a particular event. For example, an assignment might ask a forensics professional to determine if the hailstorm on June 1 caused functional hail-related damage to a roof. Or, it might ask to delineate the structural fire-related damage.

In some cases, however, the damage being investigated is attributable to the method of construction or the omission or deviation from a generally accepted practice. This would constitute a construction-related defect. In some policies, this is excluded and, therefore, is not pursued in the investigation unless the policyholder is the contractor or if subrogation opportunities exist.

The phrase “ construction-related defect ” might conjure images of a window installed backwards or a roof drain emptying into a sink. As silly as these may sound, they are just as real as the struggle to find skilled, competent craftsmen. There was a time when working in the construction trades would be a lifetime endeavor. One might start his career carrying water, graduate to mixing mortar, then eventually laying stone. That was a time when labor was relatively inexpensive and the limited opportunities drove people into a lifelong investment in the trades. It also was a time when it would take 40 years to build a church. Needless to say, today’s bigger, cheaper, faster world is not as accommodating to the lifelong craftsmen. Although they exist, skilled craftsmen are few and far between and, therefore, the occasional backward window or missing flashing events do occur. More often than not, however, the construction-related defect is born before ground is broken and the first brick is laid.

Construction-related defects or omissions stemming from the procurement process can be just as frequent, if not more so, than the skill-related defects. Typically when a building is constructed, a general contractor (GC) is hired to build it according to project documents. Seldom does the GC perform all of the required work on the project. Instead, most of it is subcontracted to several trades. On a simple project, a warehouse with little office space and a few bathrooms could include 30 different subcontracts for items such as concrete, steel, floor finishes, paint, mechanical systems, and so on.

Each of these contracts has a very specific scope of work that makes up the payment mechanism for the subcontractor, and the devil (defect) is in the details. Who does the flashing—the rough carpenter or mason? Who makes the domestic water line connection at the building pad—the plumber or the utilities subcontractor? Critical details can be overlooked in the process, only to appear weeks, months, or years later after a particularly heavy rain or high-velocity wind event.

When a construction-defect investigation arises and the statute of limitations has not precluded a subrogation opportunity, there are some items that need to be secured:

  • Project documents: These typically include the drawings and specifications that outline how things should have been built. Also within this package will be references to dozens of other documents, namely, the building codes that were enforced at the time of construction.
  • Contracts: These should contain detailed scopes of work that delineate the responsibility of each subcontractor. Where two trades meet (at through-wall flashing, for example) is where guidance should be given on who is responsible for what. It typically would be incumbent upon the GC to perform work where there was a hole in the scope, provided that the work was part of the contractual project documents.
  • Construction-related correspondence: Especially interesting would be all of the architect supplemental instruction (ASI), requests for information (RFI), and change orders.

An RFI is initiated by the GC or a subcontractor to ask for additional details or if a conflict has been discovered. The ASI…

To finish reading this article

Insurance Insight – Texas Supreme Court Clarifies Extent of Coverage for Construction Defects under CGL Policies

Matthew T. Nickel, J. Stephen Berry and  Keith Moskowitz | Dentons | March 24, 2016

In a matter of first impression, the United States Court of Appeals for the Fifth Circuit certified four questions to the Texas Supreme Court arising from an insured’s claims that its liability for a refinery owner’s replacement costs and downtime damages is covered by its commercial general liability (CGL) policy. U.S. Metals, Inc. v. Liberty Mut. Grp., Inc., No. 14-0753, 2015 WL 7792557, at *1 (Tex. Dec. 4, 2015).

The insured supplied flanges for use in constructing refinery processing units. The flanges were welded to piping and then covered with a coating and insulation. However, the flanges leaked and had to be replaced, resulting in delayed operation of the units for several weeks. The refinery sued the insured for the cost of replacing the flanges and for damages for the loss of use of the units. The insured settled with the refinery and then sought indemnification from its CGL insurer.

The insurer denied coverage, and the insured sued in federal district court to determine its rights to a defense and indemnity under its CGL policy. Id. at *2. The insured argued the refinery’s property was physically injured by the installation of the flanges and also during the replacement process. Id. The court granted summary judgment in favor of the insurer. Id. On appeal, the Fifth Circuit certified to the Texas Supreme Court four questions that raise two issues: 1) whether property is physically injured simply by the incorporation of a faulty component with no manifestation of injury; and 2) whether property is restored to use by replacing a faulty component when the property is altered, damaged, and repaired in the process. Id. at *3.

In an opinion issued on December 4, 2015, the Texas Supreme Court concluded that the policy does not cover most of the damages claimed. Id. at *4. The court explained that all damages for which the insured claimed coverage arose out of the defective flanges, and thus exclusions for damages to “your product” and “impaired property” of the policy applied. Id. at *2. The policy excluded damage to property, or the loss of its use, if the property was not physically injured or if it was restored to use by replacement of the flanges. Id. Thus, the Texas Supreme Court noted that the existence and extent of coverage depended on whether the refinery’s property was 1) physically injured or 2) restored to use by replacing the flanges. Id.

In response to the Fifth Circuit’s certified questions, the Texas Supreme Court found that the installation of the faulty flanges alone did not physically injure the units. Id. at *6. The court reasoned that the policy covers “injury” but it does not cover every injury; it covers only “physical injury.” Id. at *4. Thus, the court suggested that if the increased risk of danger from the units’ operation by using installed, leaky flanges “amounted to physical injury within the meaning of the CGL policy, then it is difficult to imagine a non-physical injury.” Id. (emphasis in original). By only covering a “physical injury,” the policy suggests a difference with non-physical, non-covered injuries. “Otherwise, the requirement that injury be ‘physical’ would be superfluous.” Id. “[P]hysical injury requires tangible, manifest harm and does not result merely upon the installation of a defective component in a product or system.” Id. at *6. Essentially, had the flanges actually leaked in use and the leakage damaged other property, that would have been a physical injury, but mere incorporation of the defective flanges into the units was not.

However, the Supreme Court did find that the units were physically injured in the process of replacing the flanges because they were welded to pipes; as a result, the flanges had to be cut out, pipe edges resurfaced, and new pipes put in. Id. Thus, repair costs and damages for the downtime were “property damage” covered unless a certain exclusion in the policy—Exclusion M—applied. Id. Exclusion M denied coverage of damages to impaired property, defined by the policy as property that could be “restored to use by the . . . replacement” of the faulty flanges. Id.

The Supreme Court concluded that the units were restored to use by replacing the flanges and were therefore impaired property to which Exclusion M would apply. Id. at *7. Tangentially, the insulation and gaskets destroyed in the process were not restored to use—they were replaced—and therefore did not constitute impaired property to which Exclusion M applied. Id.

Admittedly, “the result in this case has a perverse aspect to it.” Id. at *6. Essentially, since a defective product that causes damage is not an occurrence until the damage actually happens, if the refinery had been negligent or even reckless, and an explosion had occurred, the insured would not be denied coverage for want of “physical injury.” Id. However, because the refinery exercised care and caution, preventing any actual “physical injury,” the insured was not entitled to indemnity for the costs of remedying the installation of the faulty flanges. Id.

Several associations of contractors and insurer groups have argued…

To finish reading this article

Georgia Supreme Court Holds Pollution Exclusion Applicable to Lead Paint Injury

Traub Lieerman Straus & Shrewsberry LLP | March 22,2 016

In its recent decision in Georgia Farm Bureau Mut. Ins. Co. v. Smith, 2016 Ga. LEXIS 245 (Ga. Mar. 21, 2016), the Supreme Court of Georgia had occasion to consider whether under Georgia law, the pollution exclusion applies to a bodily injury claim arising out of ingestion of lead paint.

Georgia Farm Bureau (“GFB”) issued a general liability policy to the landlord of a private rental house. The landlord was named as a defendant in a lawsuit alleging that a child tenant suffered injury as a result of ingesting paint chips containing lead. GFB contended, among other things, the claim was barred by its policy’s pollution exclusion which applied to bodily injury claims arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of “pollutants” at or from any premises owned or occupied by any insured. The policy defined the term “pollutants” as:

… any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.

While the trial court initially granted summary judgment in GFB’s favor, the Georgia Court of Appeals reversed, concluding that lead-based paint was not a pollutant for the purpose of the exclusion. In so doing, the Court of Appeals distinguished the Supreme Court’s decision in Reed v. Auto-Owners Ins. Co., 284 Ga. 286 (2008), which held the pollution exclusion applicable to an underlying claim involving the indoor release of carbon monoxide.

In considering the issue, the Georgia Supreme Court noted that while the pollution exclusion was originally drafted to apply to environmental contamination, the language was revised in the 1980s to encompass non-environmental pollution claims. The Court further observed that while some jurisdictions have continued to limit the pollution exclusion to traditional environmental harms despite these changes in the exclusion, Georgia courts have not applied such a limitation, as reflected in the Reed decision.

The Court further observed that the proper analysis for determining whether a particular constituent is a “pollutant” is not to look to the “purpose and historical evolution” of the pollution exclusion, but instead to look to the plain language of the terms. With this frame of reference, the Court concluded that lead-based paint is a “pollutant” and that as such, the pollution exclusion was applicable to the underlying claim.

Finding “Common Ground” in a Site Conditions Clause

Lisa Andrezejewski | Robinson & Cole | March 23, 2016

I recently attended an ABA conference in Newark, New Jersey in which the theme was “Finding Common Ground in Drafting and Negotiating Design Clauses” in construction contracts.  One of the speakers presented a segment regarding differing site conditions in which he articulated the major risks that differing site conditions present to both owners and contractors and the potential impact of an “unfavorable” drafting of this clause.  His presentation laid the “groundwork” (pun intended) for the challenges of owners and contractors in finding “common ground” (yep, another bad play on words) in the site conditions contract clause.

On the one hand, the owner’s goal is to ensure that the design and the construction means and methods are compatible with the site conditions and that the site-related costs are captured in the project’s budget.  The Contractor’s goal is to ensure that its bid either incorporates a contingency to cover the risk of an unforeseen site condition or has assurances that the contract provides a mechanism to allow for reimbursement for the work.

No Clause, Contractor Bears All Risk, or Some Middle Ground?

Since the common law rule generally places the risk on the contractor, barring a material misrepresentation or material omission from the owner, the owner may elect to delete all site conditions clauses or draft a clause whereby the “contractor bear all risks.”  A contractor bears all risk clause would require that the contractor has exclusive site inspection obligations and provides a total disclaimer of information provided by the owner.  The effect of this approach, however, is that the contractor must bear the high cost of site investigations, with few if any, experienced resources available to conduct the testing, which needs to be completed within short bid time.  As a result, the contractor may be unlikely to conduct the testing, submit a bid with an arbitrary contingency amount or bear the risk and plan to submit change orders in the event a site condition problem arises.  This is an unfavorable situation for the contractor.  Additionally, under a “contractor bears all risks” approach, the owner should expect to bear the cost of the unknown in the form of higher bid pricing, which may result in a profit windfall for the contractor.

So, there is in fact some common ground between the owner and contractor on this issue.  Both the owner and the contractor wish to avoid costly, and time consuming site investigations and minimize economic inefficiencies.  Therefore, the owner and contractor are more likely to agree to include a differing site condition clause whereby the contractor is compensated for legitimately differing conditions, and the owner is relieved of bearing the cost of an unused contingency. 

Form Contract Clauses

The AIA, Consensus Docs and EJCDC form documents all contain risk shifting clauses for differing site conditions.  The ABA’s Second Edition of the Construction Contracts Book:  How to Find Common Ground in Negotiating the 2007 Industry From Contract Documentarticulates the frequently used differing site condition clauses among these form contracts.   Despite the differences among commonly used site condition clauses, the most popular provisions contemplate both Type I and Type II differing site conditions in an effort to balance risk among the parties.

Proving Type I and Type II Claims

To recover in Type I conditions, the contractor must establish that the conditions encountered differ from what was represented in the contract documents and that the contractor reasonably relied on this information.  The contractor must show that the conditions are:  1) subsurface or concealed; 2) physical in nature; 3) materially differ from the contract documents; and 4) the contactor reasonably relied upon this information.  A Type II condition focuses on conditions that are different from those normally expected in connection with the type of work being performed.  The contractor must show that it encountered an:  1) unknown physical condition; 2) of an unusual nature; and 3) which was different from those ordinarily encountered.  A Type II condition seeks a change based on the common law doctrine of mutual mistake, and is more difficult to prove than a Type I, and places a heavy burden on the contractor.  Unlike a Type I claim where the proof is a comparison with the contract documents, for Type II claims, the contractor must demonstrate a difference from what is “ordinarily encountered.”

Owner Risk-Shifting Alternatives

Since the owner is required to provide the contract documents, it would on first blush seem as though a contractor is well protected in Type I claims, however, in order to minimize risk, owners frequently include a contractor site inspection clause and/or disclaimer clause(s) to negate the owner’s responsibility for the accuracy of the site information provided or the exclusion of information.  The use of these clauses, thereby limits the contractors ability to prove that it “reasonably” relied on the contract documents for a Type I clause, and restricts a Type II claim for unknown or unusual site conditions to those not reasonably ascertainable by a visual inspection.  However, the enforceability of these clauses will depend on the specificity of the clause and whether or not it excludes reasonable reliance on the information contained in the contract documents.

Contractor Risk-Shifting Alternatives

In addition to the alternatives described above, which generally shift the owner’s risk to the contractor, the contractor may consider requiring high levels of specificity regarding what will be included and excluded from its site inspections.  In lieu of, or in addition to the modification of the site inspection or disclaimer clauses, the contractor may also consider adding a clause for the development of a Differing Site Conditions Contingency.  A contingency of a specified amount…

To finish reading this article