Coverage for Construction Defects Caused by Subcontractor Work

Amanda M. Leffler | Brouse McDowell | September 12, 2017

The Ohio Supreme Court has held that claims for the cost to repair an insured’s own defective work are not covered because they “are not claims for ‘property damage’ caused by an ‘occurrence’ under a [CGL] policy.” See Westfield Ins. Co. v. Custom Agri Sys., Inc., 2012-Ohio-4712. In its decision, however, the Court approved of prior Ohio case law which held that consequential damages arising from a policyholder’s defective work generally are covered by CGL policies. Since Custom Agri, insurance practitioners and courts in Ohio have generally agreed that:

  • Repair and replacement of a policyholder’s own defective work is not “property damage caused by an occurrence” and is not covered by standard CGL policies; and,
  • Consequential damages to property other than the policyholder’s work is “property damage caused by an occurrence” and may be covered by a standard CGL policy depending upon the applicability of the policy’s exclusions and conditions.

Importantly, the Custom Agri Court did not address whether a typical CGL policy would provide coverage for the repair or replacement of defective work performed by the policyholder’s subcontractors. A recent decision from one of Ohio’s appellate courts suggests that defective work performed by a policyholder’s subcontractors may be covered, regardless of whether the subcontractor’s work caused any consequential damages.

In 2008, Ohio Northern University contracted with Charles Construction Services (CCS) to construct a hotel and conference center. Ohio Northern Univ. v. Charles Constr. Servs., Inc., 2017-Ohio-258 (3rd Dist.). CCS retained several subcontractors to complete the work. After construction was completed, Ohio Northern discovered significant water intrusion and related damages, as well as serious structural defects, and brought suit against CCS.

CCS tendered the claim to its insurer, Cincinnati Insurance Company, which argued that it had no obligation to defend or indemnify CCS. Cincinnati contended that, under Custom Agri, property damages arising from defective work could neverconstitute an occurrence, regardless of who performed the work. In response, CCS argued that Custom Agri was inapplicable because almost all of the work at issue had been performed by subcontractors, not by CCS, and because CCS had purchased products-completed operations coverage which applied to the defective construction claims arising from the work of its subcontractors.

The trial court granted summary judgment to Cincinnati, but the Third District Court of Appeals reversed. In finding in favor of CCS, the appellate court analyzed the “Damage to Your Property” and “Damage to Your Work” exclusions, which expressly preserved coverage for damaged work or damages arising from faulty work if (1) the work was performed by a subcontractor, and (2) the damage occurred after construction was completed. The appellate court correctly noted that if it were to adopt Cincinnati’s interpretation of the policy, it would render these provisions meaningless. The court found that, at a minimum, the provisions created an ambiguity that must be resolved in favor of the policyholder. Thus, the appellate court held that Cincinnati had a duty to defend and indemnify CCS.

Interestingly, though not analyzed by the appellate court, even if the work at issue had been performed by CCS and not its subcontractors, the damages alleged by Ohio Northern would have required that Cincinnati defend CCS and indemnify at least a portion of any award against it. This is because Ohio Northern asserted claims not only for the repair and replacement of defective work, but also for consequential damages arising from such work. As noted above, the Supreme Court in Custom Agri cited with approval prior lower court opinions, which held that CGL policies cover such claims for consequential damages. Insurers and policyholders in Ohio continue to test the scope of the Ohio Supreme Court’s decision in Custom Agri. As in any case involving complex coverage analysis, policyholders should consider retaining experienced coverage counsel to assist in the claim process so as to best position their claim for coverage.

Fourth Circuit Finds No Bad Faith for Delay in Investigating Construction Defect Claim

James W. Bryan | Nexsen Pruet | September 12, 2017

Construction defect claims often include coverage disputes spiced with allegations of bad faith designed to turn up the heat on the insurer. The Fourth Circuit, in its review of one such recent North Carolina case, held while the insured prevailed on its contract claim, there was no bad faith. Delay, without other, aggravating factors is not enough to establish the malice or reckless indifference to consequences necessary to reach the level of bad faith. Westchester Surplus Lines Ins. Co. v. Clancy & Theys Construction Co., 683 Fed.Appx. 259 (4th Cir. 2017).

Westchester involved a dispute over insurance coverage for a general contractor’s liability for defective design of a building foundation. A joint venture, in which Clancy was a partner, was hired to construct a mid-rise student housing building in Raleigh, North Carolina. In September 2011, after construction was well under way, a portion of the building began to lean, damaging other portions of the building. The owner demanded a remedy that would result in no risk to it, or its lender. Following agreement on a repair plan, the joint venture initiated a mediation process with potentially responsible subcontractors seeking allocation of the $14.4 million repair costs. This resulted in agreement that 10.5 million would be paid on behalf of subcontractors, leaving the remaining damages to be absorbed by the joint venture. Clancy sought reimbursement of its share from Westchester under general and professional liability policies.

Upon receiving the owner’s demand for repair in September 2011, Clancy notified Westchester of the potential claim. Clancy was unable to contact the Westchester representative assigned to the claim who, unbeknownst to Clancy, had left the employ of Westchester. After about a month, Clancy established contact with another Westchester employee assigned to the claim. After providing all of the communications between Clancy and the owner, Westchester was silent for another two months. As Clancy pressed for a coverage determination, Westchester requested an accounting of costs and a copy of the joint venture agreement, all of which Clancy provided. Eventually, in May 2012, Westchester informed Clancy it believed its policy did not cover Clancy’s obligations for the construction damages but it was not issuing a formal denial of coverage. Indeed, three months later, Westchester stated it was still investigating the coverage issue. In September, 2012, Clancy complained of Westchester’s year long delay and threatened suit. In response, Westchester filed its action for a declaratory judgment that its policy afforded no coverage. Clancy counterclaimed alleging Westchester’s breach of contract and tortious breach of contract based upon Westchester’s failure to timely investigate, failure to timely issue a coverage opinion, failure to properly defend, failure to assist in mitigating damages, and failure to indemnify for covered losses. Clancy also alleged Westchester acted in willful, wanton disregard of its duty to defend and indemnify, entitling Clancy to extra-contractual damages.

In May 2014, the district court denied summary judgment for either party on the contract dispute but entered summary judgment for Westchester on Clancy’s claim for bad faith tortious breach of contract, finding “in order to recover for tortious breach of an insurance contract, an insured must show that the refusal to pay on the insurance contract was based not on honest disagreement or innocent mistake, but rather on ‘malice, oppression, willfulness and reckless indifference to consequences.’”

The district court concluded

Though there is much dispute present in the record regarding when and whether Clancy notified Westchester of a claim against it, the record does not support that Westchester acted with malice, oppression, or a reckless indifference to consequences. Where courts have found that a refusal to settle an insurance claim was an act of bad faith there has been ample evidence to show not only delay in investigation but also other aggravating factors such as the offer of a woefully low settlement amount, reliance on estimation of damage and repairs submitted by a clearly unqualified professional, and evidence that the insurance company “stirred up hate and discontent” against its insured by making false accusations regarding the insured’s participation in the loss…While the record certainly reflects that Westchester does not think Clancy is entitled to indemnity and defense, Clancy has not demonstrated the presence of sufficient aggravating factors, nor an opinion that Westchester’s actions were not reasonable or appropriate within industry practices, and summary judgment in favor of Westchester is appropriate on Clancy’s tortious breach of contract claim.

A year later, in a bench trial as to the remaining issues, the district court found Westchester owed Clancy coverage for its portion of the loss, less its deductible, plus applicable interest. Westchester appealed and Clancy cross- appealed. The Fourth Circuit affirmed the bench trial judgment on the contract claim, rejecting Westchester’s argument that the joint venture’s liability was separate and distinct from the liability of each of its members. As to the bad faith claim based upon delays in Westchester’s investigation, the Fourth Circuit concluded summary judgment in favor of Westchester was proper, relying on North Carolina law requiring, “malice, oppression, willfulness [or] reckless indifference to consequences” in order to establish tortious breach of contract.

Though an unpublished decision, Westchester reflects a North Carolina trend; delay-based extra-contractual claims in construction defect cases do not end well for the insured. The procedural history of Westchester demonstrates a common pattern and the court’s opinion demonstrates a frequent result.

Iowa Appellate Court Upholds Appraisal Award For Insured

Christina Phillips | Property Insurance Coverage Law Blog | August 20, 2017

Recently the Iowa Court of Appeals reversed the district court and upheld an approximate $1.4 million dollar appraisal award entered for the Walnut Creek Townhome Association.1

Walnut Creek’s thirty-six buildings had been damaged by a hail storm in August, 2012. Prior to that, however, the board had investigated issues with the shingles which turned out to be CertainTeed New Horizon shingles, known to have defects which caused cracking and crazing in the shingle applique and cause significant granular loss. Within a week of the hail storm, the association had the roofer conduct an inspection. The roofer concluded that he observed no hail impacts significant enough to warrant an insurance claim. Thereafter, the association had another roofer inspect the roof who concluded the roofs had hail damage and found eight to twelve hits per square. Ultimately, the association retained a public adjuster who similarly concluded the buildings had sustained hail damage and observed nine to eleven hits per square. Conversely, the insurer’s experts from Haag Engineering found that the damage observed was not consistent with hail damage and observed that the roofs were in poor condition. Depositors Insurance denied Walnut Creeks claim, excluding payment for the soft metals. Walnut Creek filed suit.

The court concluded that the parties could fully litigate whether all of the loss to the property resulted from a covered hail storm, but also stated that the appraisers and umpire must consider what damage was caused by hail and what was not. The appraisal proceeded and an award was entered for Walnut Creek in the approximate amount of $1.4 million. A couple of weeks later, a bench trial was held and the district court concluded that the appraisal was not binding or conclusive and dismissed Walnut Creek’s claims.

On appeal, the Iowa Court of Appeals concluded there was no reason to reject the appraisal award. Specifically, there was no reason to reject the appraisal panel’s determination of damage and possible causes. The structure of the appraisal award did not suggest fraud, mistake or malfeasance. As such, the court accepted the appraisal panel’s conclusions as to the amount of the loss and causation as binding.

The appellate court also concluded the district court erred in its application of the policy in light of the appraisal panel’s conclusion. In particular, the appellate court rejected the district court’s conclusion that the shingles contained a product defect that triggered deterioration—coverage excluded under (B)(2)—as it was inconsistent with the binding conclusion of the appraisal panel, which had specifically found that hail caused the damage. The court therefore reversed the judgment and ordered the district court to enter judgment in favor of Walnut Creek consistent with the appraisal panel’s award.
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1 Walnut Creek Townhome Association v. Depositors Ins. Co., 2017 WL 3077916 (Ct. App. Iowa, July 19, 2017).., 2017 WL 3077916 (Ct. App. Iowa, July 19, 2017).

Is the Retroactive Statute of Repose for Construction Defect Claims Constitutional?

Gregory King, Esq. adn Sarah J. Odia, Esq. | Nevada Lawyer | September 2017

With the February 24, 2015, enactment of Assembly Bill 125 (2015 Nevada Laws, Ch. 2), much has changed in the world of residential construction defect litigation. One of the most dramatic shifts has been the reduction of the statute of repose period for construction defect claims from a maximum of 12 years to six years from the date of substantial completion of a newly constructed improvement. Not only did AB125 dramatically shorten the statute of repose period, but it did it retroactively.

This begs the question of whether it is constitutional for the Legislature to retroactively shorten the time a plaintiff has in which to file lawsuit, especially for claims that had already accrued before AB125 went into effect. As it turns out, this is not the first time that the Nevada Legislature has enacted a retroactive statute of repose for construction defect actions. In fact, the Nevada Supreme Court has previously addressed the constitutionality of a retroactive statute of repose and has given the Nevada Legislature clear guidance on what is required to clear constitutional hurdles. Although the Nevada Supreme Court has not ruled on the constitutionality of AB125’s retroactive statute of repose, the statute appears to follow the guidelines that were set forth by the court decades ago.

AB125’s Retroactively Applied Repose Period for Construction Defect Claims

AB125 dramatically shortened the statutes of repose period for construction defect actions in Nevada. Under the previous statutes of repose, NRS 11.202 through 11.205, a claimant had from six to 12 years from the date of substantial completion of a property to file a construction defect action, depending upon the type of defect. Under the new statute of repose, a construction defect claimant has only six years from the date of completion of the property to file an action, regardless of the type of defect.

AB125 provides that the shortened statute of repose applies retroactively to all actions involving properties that were completed before the February 24, 2015, effective date of the act. The act does, however, provide an exception to its retroactive application. If a claim accrued prior to February 24, 2015, and if the corresponding action was commenced no later than February 24, 2016, then the new, six-year repose period does not apply to that action. Conversely, if a construction defect action was not commenced by February 24, 2016, the new, shortened repose period applies to that action, even if the claim accrued before AB125’s effective date. In other words, AB125 provided a claimant with a one-year grace period within which to file a lawsuit relating to his or her accrued claim, in order to avoid the effects of the new statute of repose.

Is it Constitutional to Apply a Limitations Period Retroactively?

The obvious question is whether it is constitutional for a legislature to retroactively reduce a limitations period, especially for persons who have already accrued claims. At first blush, this change may seem unfair. However, numerous courts throughout the country, and even the U.S. Supreme Court, have held that a party does not have a vested right in the time for the commencement of an action nor in the running of the statute of limitations prior to its expiration.1 These courts have found that it is constitutional for a legislature to retroactively reduce a limitations period, as long as a “reasonable” time is given for the commencement of an action before the new limitation period takes effect. These courts reason that a change in a limitations period merely effects a change in procedure, which is within the constitutional power of a legislature.

What is a “Reasonable” Grace Period?

Having established that it is constitutional for a legislature to enact a retroactive limitations period as long as a reasonable grace period is provided, we now turn to the question of what constitutes a “reasonable” grace period. Courts around the country have generally held that grace periods ranging from six months to a year are reasonable.2 The courts have generally deferred to the legislature as the judge of the reasonableness of the grace period, ruling that they will not interfere with the legislature’s judgment as to the reasonableness of the grace period unless it is so short that it is tantamount to a denial of justice.

Nevada’s History of Unconstitutional Statutes of Repose

AB125 is not the first retroactive statute of repose enacted by the Nevada Legislature. The Nevada Legislature has a history of failed attempts to enact a constitutional statute of repose for construction defect claims.

In 1983, the Nevada Supreme Court struck down the statute of repose for construction defect claims that was in effect at that time. The court held that the statute violated the equal protection and due process clauses of the state and federal constitutions, because it arbitrarily excluded certain owners and material suppliers from its protections.3 Thus, the statute of repose was unenforceable, void ab initio, afforded no protections and conferred no rights.

In response to this ruling, the Nevada Legislature enacted new statutes of repose later in 1983.4 The new statutes cured the equal protection and due process violations. Moreover, the Legislature attempted to apply these new statutes retroactively. This is where it ran into problems.

In Alsenz v. Twin Lakes Village, Inc., 108 Nev. 1117, 1122, 843 P.2d 834 (1992), the Nevada Supreme Court held that the 1983 statutes of repose could not be applied retroactively, because they did not provide a grace period. More specifically, the court held that in order for the 1983 statutes of repose to be applied retroactively, the statutes must afford a claimant a reasonable period of time in which to file an action, thereby avoiding the new repose period.

The result of the Alsenz ruling was that the 1983 statutes of repose could not apply retroactively to properties that were completed prior the statutes enactment. Moreover, the Nevada Supreme Court had already held that the pre-1983 statute of repose was unconstitutional and void. Accordingly, after the ruling in Alsenz, there was no statute of repose that could be applied to construction defect actions involving properties that were built prior to 1983! This left real estate developers and contractors exposed to a significant and indefinite risk of exposure for pre- 1983 properties.

In response to this conundrum, the Nevada Legislature passed Senate Bill 554 on July 9, 1993; it explicitly provided that the statutes of repose enacted in 1983 applied retroactively to pre-1983 improvements to real property. This time, the Nevada Legislature got it right by including a one-year grace period during which claimants could file actions for accrued claims. Thus, SB554 passed the constitutional litmus test provided by the Nevada Supreme Court for retroactively applied statutes of repose.5

AB125’s Retroactive Statute of Repose is Constitutional

Although the Nevada Supreme Court has not specifically ruled on the constitutionality of AB125’s retroactive statute of repose period, it does appear to pass constitutional muster because it provided claimants with a one-year grace period in which to file actions for accrued claims, thereby avoiding the effects of the shortened repose period. The one-year grace period is the exact same grace period that was provided under SB554, which the Nevada Supreme Court determined was constitutional.6 In fact, the relevant text of SB554 is identical to that of AB125’s retroactive statute of repose. Both acts specify that the statutes of repose will apply retroactively, and both provide one-year grace periods from the effective dates of the acts for claimants with accrued claims to commence actions.

It appears that the Nevada Legislature learned its lessons from its prior to attempts to enact retroactive statutes of repose and the Nevada Supreme Court’s rulings related thereto.

1. See, Saranac Land & Timber Co. v. Roberts, 177 U.S. 318, 323–24 (1900); Terry v. Anderson, 95 U.S. 628, 632–34 (1877); Liptak v. Diane Apartments, Inc., 167 Cal. Rptr. 440, 446 (Cal. Ct. App. 1980); Carlson v. Blatt, 105 Cal. Rptr. 2d 42, 45 (Cal. Ct. App. 2001).

2. See, Terry, 95 U.S. at 632–34 (noting that a nine-month period was reasonable); Saranac Land & Timber Co. v. Roberts, 177 U.S. 318, 323–24 (1900) (holding that a six-month period was reasonable); Brown v. Angelone, 150 F.3d 370, 373–75 (4th Cir. 1998)(holding that one year is reasonable); Curie v. Schon, 704 F. Supp. 698, 701 (E.D. La. 1989)(holding that a six-month period was reasonable).

3. State Farm v. All Electric, Inc., 99 Nev. 222, 660 P.2d 995 (1983).

4. The statutes of repose that were enacted in 1983 were the same statutes of repose for construction defect claims that were in effect prior to the 2015 enactment of AB125.

5. See, G and H Associates v. Ernest W. Hahn, Inc., 113 Nev. 265, 269, 937 P.2d 229 (1997).

6. Id.

Insurer Can’t Ax Loss In Construction Defect Coverage Battle

Jeff Sistrunk | Law 360 | August 30, 2017

A California appeals court on Wednesday upheld a lower court’s ruling after trial that American Safety Indemnity Co. had wrongly refused in bad faith to defend Pulte Home Corp. in a pair of lawsuits alleging construction defects at housing developments, finding that the insurer incorrectly interpreted key policy language and acted unreasonably.

Pulte, the developer of two San Marcos, California-area residential housing projects, was named an additional insured under liability policies that American Safety issued to a trio of subcontractors. When residents of the developments sued Pulte and others over alleged construction defects, the insurer denied the builder’s request for a defense, in part based on the position that the policies only extended additional insured coverage for claims relating to the subcontractors’ “ongoing operations,” not completed work.

A California state court rejected American Safety’s argument and sided with Pulte, saying the cited language created ambiguities regarding the potential for coverage of the construction defect suits, meaning the insurer was obligated to assume the builder’s defense.

In a published opinion issued Wednesday, a panel of the California Court of Appeal’s Fourth Appellate District affirmed the trial court’s decision on the defense issue, along with its finding that American Safety had acted in bad faith.

“Both sets of insureds could reasonably have expected that if the subcontractors had bought completed operations coverage for the work, it also applied to vicarious liability of the developer, if property damage problems appeared,” Judge Richard D. Huffman wrote for the panel.

However, the panel remanded the case for a recalculation of Pulte’s attorneys’ fees and corresponding punitive damages, holding that the lower court had improperly based its initial calculations on a new fee arrangement that the developer didn’t reach with its lawyers until trial.

The housing projects at issue were completed by 2006. In 2011 and 2013, two groups of residents sued Pulte for damages in separate suits alleging multiple construction defects at their respective developments, including deficiencies in the concrete and electrical work.

Pulte sought a defense from American Safety under liability policies issued to three of its subcontractors between 2003 and 2006, but the insurer declined on multiple grounds.

The policies provided the subcontractors coverage for claims tied to their “completed operations.” But American Safety asserted that Pulte was not entitled to that coverage because endorsements to the policies extended additional insured coverage to the developer only for liabilities arising out of the subcontractors’ work during ongoing operations. The insurer also pointed to several faulty workmanship exclusions.

Pulte sued American Safety in California state court in 2013, and the case proceeded to a two-phase bench trial after the court ruled that American Safety had a duty to defend under one of the policies. The first phase dealt with the insurer’s duty to defend under the remaining policies and Pulte’s claim that the insurer’s denials constituted bad faith.

The trial court found that the endorsement language cited by the insurer didn’t limit the developer’s coverage to claims pertaining to the subcontractors’ ongoing operations, and awarded Pulte over $455,000 in contractual damages and interest. Furthermore, the court held, Pulte showed that American Safety had acted in bad faith by engaging in a pattern of issuing additional insured endorsements and then using “every conceivable argument” to deny coverage.

In the second phase, the court granted Pulte about $500,000 in attorneys’ fees and court costs under the seminal California Supreme Court ruling of Brandt v. Superior Court, and also awarded punitive damages of the same amount.

American Safety raised a number of challenges on appeal. With respect to policy interpretation, the insurer again contended, among other things, that it had limited Pulte’s additional insured coverage to the subcontractors’ ongoing operations via the endorsement language.

But the Fourth Appellate District panel was unconvinced, opining that if American Safety had wanted to make clear to Pulte that it wouldn’t cover completed operations for the additional insured, it could have explicitly said so.

“These [additional insured endorsements] do not clearly restrict coverage to only ongoing operations, simply by linking the ongoing operations phrase to the ‘liability arising out of the work’ clause,” Judge Huffman wrote.

The appellate panel further held that the trial court had correctly ruled that American Safety’s denial of Pulte’s defense requests was in bad faith, and that the developer is entitled to punitive damages.

“In ruling that an award of punitive damages was justified, the trial court’s decision stated that American Safety had demonstrated its ‘pattern and practice’ of using every conceivable argument to deny coverage, whether the arguments are weak or strong, valid or invalid,” Judge Huffman wrote. “Such conduct showed the company was primarily protecting its own interests in refusing to defend its additional insureds in construction defect cases.”

American Safety also argued on appeal that the trial court’s calculation of Pulte’s “Brandt” fees — and, by extension, its punitive damages — was improper because Pulte had abruptly shifted during trial from a contingency fee arrangement with its lawyers to an hourly rate. Pulte has justified the change by asserting that it wanted to ensure that its counsel would receive the “full measure” of reasonable fees required to pursue the coverage action.

The panel expressed “serious concerns” that the change in Pulte’s fee arrangement was geared toward manipulating the Brandt calculation to the developer’s benefit. As a result, it sent the case back to the lower court to recalculate the Brandt fees and punitive damages based on Pulte’s original contingency arrangement.

Robert C. Carlson of Koeller Nebeker Carlson & Haluck, representing Pulte, told Law360 that “our client is pleased with the court’s decision as to the legal issues raised and think that it goes a long way to resolving uncertainties in the community with respect to a carrier’s obligation to defend additional insureds in construction defect litigation.”

An attorney for American Safety did not immediately respond to a request for comment Wednesday.

Judges Richard D. Huffman, Terry B. O’Rourke and William Dato sat on the appellate panel.

Pulte is represented by Robert C. Carlson, Sharon A. Huerta and Sarah P. Long of Koeller Nebeker Carlson & Haluck.

American Safety is represented by Gregory D. Hagen of Wilson Elser Moskowitz Edelman & Dicker LLP and Robert A. Olson and Gary J. Wax of Greines Martin Stein & Richland.

The case is Pulte Home Corp. v. American Safety Indemnity Co., case number D070478, in the California Court of Appeal, Fourth Appellate District, Division One