“Rip-and-Tear Damages” In Construction: A Roadmap For Coverage Where None Existed?

Ashley Veitenheimer | Kane Russell Coleman Logan | May 22, 2019

The insuring agreement in most commercial general liability policies states that the carrier “will pay those sums that the insured becomes legally obligated to pay as damages because of…’property damage’ to which this insurance applies.” In addition, most policies exclude coverage for the defective work of the named insured. Questions have arisen, however, as to whether and when there is coverage for damages commonly known as “rip-and-tear,” which are those damages caused to other property by the necessity of removing, replacing, and correcting defective work.

Prior to 2015, Texas law held that rip-and-tear damages were covered if there was underlying covered property damage in the first instance. See Lennar Corp. v. Markel Amer. Ins. Co., 413 S.W.3d 750 (Tex. 2013). That all changed with U.S. Metals v. Liberty Mutual Ins. Group, Inc., 490 S.W.3d 20, 22 (Tex. 2015). In U.S. Metals, the Court appears to hold that damages are covered even when they are not “because of” property damage, leading to vexing issues for the insurance carrier regarding when the duty to defend is triggered and whether rip-and-tear costs are covered when they are not “because of” property damage.

In U.S. Metals, U.S. Metals sold ExxonMobil 350 flanges for use in constructing diesel units. When ExxonMobil conducted post-installation testing, it discovered that several flanges leaked and did not meet industry standards such that it was necessary to replace them to avoid the risk of explosion. For each flange, this process involved stripping the temperature coating and insulation (which were destroyed in the process); cutting the flange out of the pipe; removing the gaskets (which were also destroyed in the process); grinding the pipe surfaces smooth for re-welding; replacing the flange and gaskets; welding the new flange to the pipes; and replacing the temperature coating and insulation. 

After ExxonMobil sued U.S. Metals and the parties settled, U.S. Metals sought indemnification from its insurer. On appeal, the parties disputed whether the installation of the faulty flanges physically injured the diesel units.  The Court noted that “the installation of the leaky flanges…can certainly be said to have injured – harmed or damaged – the diesel units by increasing the risk of danger from their operation and thus reducing their value.” However, no physical injury resulted because ExxonMobil replaced the flanges in order to avoid the risk of such injury.

The Court concluded that the diesel units were physically injured in the process of replacing the flanges because the flanges were welded to the pipes, and the removal process “necessitated injury to tangible property, and the injury was unquestionably physical.”  That tangible property was the original welds, coating, insulation, and gaskets. Because the diesel units were restored by replacing the flanges, they were impaired property to which Exclusion M applied.[1] Id. But it also concluded that the insulation and gaskets were destroyed in the process and replaced such that Exclusion M did not apply. Therefore, the Court held that these rip-and-tear costs, were covered because the items were physically injured and constituted “property damage.”

After U.S. Metals was decided, the Western District of Texas issued an opinion illustrating the problems the holding created. In Travelers Lloyds Ins. Co. v. Cruz Contracting of Texas, LLC, the Western District relied on the U.S. Metals holding to conclude that rip-and-tear damages were covered. 2017 WL 5202891 (W.D. Tex. Sept. 7, 2017). There, Cruz, the subcontractor, was hired by D & D to install utility systems, which were later discovered to be faulty. D & D alleged that, in order to replace the sewer system installed by Cruz, it had to tear out and redo roadways, curbs, and parkways.

Based on U.S. Metals, the court found that D & D suffered property damage in the form of rip-and-tear damages “to access faulty equipment installed by an insured…”. The problem with this conclusion is that no damages “because of” property damage existed prior to the rip-and-tear process being undertaken. Rather, as the court concedes, the adjoining utility work was “not physically disturbed by Cruz’s defective work” but was “rendered useless by the defective work.” Consequently, the court apparently relied upon the loss of use as the trigger for the insurer’s duty to defend.

This, in turn, raises the pivotal issue of when the alleged property damage actually occurs. In other words, since there was no “property damage” prior to the tear-out and replacement of Cruz’s work – there was merely faulty work (which is typically excluded from coverage) – when did the “covered” property damage occur? The court’s opinion states that the property damage “occurred when the utility systems installed by Cruz failed testing, rendering them inoperable and unusable.”. Although the court relies upon Don’s Buildingfor this proposition, this is a rather questionable conclusion because there was no property damage prior to the damage caused in accessing the faulty work.[2]

Take as an example pipe work that is performed before pouring a concrete floor. No damage exists at the time the pipes are installed; however, there is later discovered a leak in one of the connections that requires replacement. If suit is filed merely alleging that the pipe was faulty and that the concrete needed to be torn out, is this sufficient to trigger a duty to defend in Texas because the rip-and-tear is in itself property damage? And, if so, does the insurer for the connection supplier owe a duty to defend the entire lawsuit when the concrete flooring, pipes, and other building components are damaged in an effort to repair and replace the connection? If that is the case, almost every suit for construction defects may plead a covered claim because it will involve rip-and-tear costs.

Equally confounding it the issue of “when is the occurrence.” If the rip-and-tear is itself the “property damage,” then can an insured create its own trigger for defense by alleging that the installation was improperly performed and required the rip-and-tear damages to replace the faulty connection? These are the questions created by the holding in U.S. Metals that have yet to be answered, but the Cruz holding certainly got this issue wrong. That is because U.S. Metals clearly identifies when the occurrence is:

We have further held that, for purposes of a duty to defend under an occurrence-based policy period, damage due to faulty workmanship “occurs” not at the time the damage manifests (when it is discovered or discoverable) nor when the plaintiff is exposed to the agent that will eventually cause the damage (when it is installed, presumably). Rather, under a straightforward reading of the policy, we concluded that “[o]ccurred means when damage occurred, not when discovery occurred.” Since a defective product that causes damage is not an occurrence until the damage actually happens, it would be inconsistent to now find that a defective product that does notcause damage is nevertheless an occurrence at the time of incorporation.

Cruz, however, held that the “occurrence” happened when the utility systems failed testing without any related property damage. This is one example of the myriad of questions created by the U.S. Metalsholding, relied upon by the Cruz court, and the lower courts’ application of the ruling, which may create the potential for a huge shift in coverage law as to when the duty to defend is triggered.

Citations

[1] Exclusion M denies coverage for damages to impaired property, which is defined as property that can be “restored to use by the…replacement” of the faulty flanges. Id.

[2] Interestingly, the Southern District relied upon U.S. Metals to conclude that rip-and-tear damages are covered when the utility of component parts is destroyed “[a]s a consequence of their having been encased in bad concrete.” See Lauger Cos., Inc. v. Mid-Continent Cas. Co., 2017 WL 8677353 (S.D. Tex. Aug. 2, 2017). This creates the same problems as Cruz and gives rise to the same concerns of when the duty to defend is actually triggered.

The 10th Circuit Correctly Construes “That Particular Part” Narrowly

David Smith | Farella Braun & Martel | April 12, 2019

We do not often write about coverage opinions from jurisdictions as far away as Oklahoma; however, a recent case from the Federal Tenth Circuit looked at one of our favorite topics and came out with a much better reasoned opinion than recent decisions from the Ninth Circuit.

I’ve written before on the topic of the meaning of “that particular part” as the phrase is used in exclusions j (5) and j(6) of the Commercial General Liability (“CGL”) policy.  The “j” exclusions exclude coverage for damage to certain property.  Specifically, the j (5) and (6) exclusions state that the insurance does not apply to:

(5)    That particular part of real property on which you or any contractors or subcontractors working directly indirectly on your behalf are performing operations, if the “property damage” arises out of those operations; or

(6)    That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.

The part of these exclusions that some courts consistently get wrong is the meaning of the phrase “that particular part.”  In particular, in June 2017 I wrote about the way the Ninth Circuit (supposedly applying California law) has on several occasions ignored the insurance industry’s own explanation of the meaning of the phrase “that particular part” and applied the exclusion to the entire project a contractor was working on.

For example, the insurance industry’s own text books give the example of a general contractor dropping a steel roofing beam during the construction of a steel-frame building. The dropped beam fell while being hoisted and “struck and damaged other steel components that had already been erected.” Because at the time the accident occurred the contractor was working on the beam that dropped, and not the other damaged building components, the damage to those building components was intended to be covered because it was not the “particular part” being worked on. Donald S. Malecki, et al., Commercial Liability Insurance and Risk Management, 95-96 (3d ed. 1995) (“No coverage applies to ‘that particular part’ of real property damaged while work is being performed on it. But, by inference, coverage does apply for damage to any other part of the property besides ‘that particular part’….”) (emphasis in original). A number of other industry writings support this analysis, including materials published by the drafters of the actual policy wording, the Insurance Services Office.

California law specifically allows the use of industry materials and resources to interpret insurance policies. See, e.g., Maryland Cas. Co. v. Reeder, 221 Cal. App. 3d 961, 973, n.2 (1990) (relying on industry publications to interpret the scope of exclusions in the 1973 CGL policy). Furthermore, California Courts of Appeal have already applied the exclusions narrowly. See, e.g., Pulte Home Corp. v. American Safety Indemn. Co., 14 Cal. App. 5th 1086 (2017); Global Modular, Inc. v. Kadena Pacific, Inc., 15 Cal. App. 5th 127 (2017).

Additionally, when a policy clause is ambiguous and capable of at least two reasonable interpretations, the court is supposed to construe the clause against the drafter – which in insurance contexts, is invariably in favor of coverage. This is true nationwide. See, e.g., Foster-Gardner, Inc. v. Nat’l Union Fire Ins. Co., 18 Cal. 4th 857, 869 (1998); Haworth v. Jantzen, 172 P.3d 193, 197 (Okla. 2006).

A recent case out of the Tenth Federal Circuit looked at the “that particular part” issue in a published opinion, MTI, Inc. v. Employers Insurance Company of Wausau, __ F.3d __, 2019 WL 321423 (10th Cir. 2019), applying Oklahoma law. MTI, a contractor, was hired to replace corroded anchor bolts and castings in a wooden cooling tower. The contractor removed the old bolts but was delayed in installing the new ones. High winds blew the cooling tower down while it was left unsupported.

MTI’s insurer, Wausau, denied MTI’s claim for the damage caused to the cooling tower and equipment inside, citing exclusions j (5) and j (6). MTI sued Wausau. Noting that the Oklahoma Supreme Court had not explicitly addressed the issue, the court looked at the way other jurisdictions had interpreted the clauses, finding that courts had ruled both ways (i.e., some courts held that the language restricted the exclusion’s application to only the part of a project being worked on; others applied it to the entire project).

Holding that both interpretations were reasonable, the MTI court held that the exclusions were ambiguous and thus must be construed against the insurer. The court also opined that the insured’s reasonable expectations would be for coverage for the cost of replacing the entire tower. While from a purist’s point of view it’s unfortunate that the MTI court did not look at the insurance industry resources, it nevertheless reached the right conclusion, adding to the majority of jurisdictions that interpret these exclusions narrowly. We can only hope that eventually the weight of opinion (together with California law) will sway the Ninth Circuit on this issue.

As an aside, the court also dismissed Wausau’s argument that providing coverage of the tower converted the CGL policy into a performance bond. This is a red herring argument often used by insurers. The court noted that a performance bond guarantees completion of a contract upon the contractor’s default, while a CGL policy spreads the contractor’s risk. The monetary values at issue underlined this point: the value of the contract was $46,000; the value of the damage was $1.4 million. A performance bond for such a project would not result in liability of this amount.

Ninth Circuit Finds Policy’s Definition of “Policy Period” Fatal to Insurer’s “Related Claims” Argument

Jason M. Taylor | Insurance Law Blog | March 27, 2019

Professional liability policies often include some form of a “related claims” or “related acts” provision stating that if more than one claim results from a single wrongful act, or a series of related wrongful acts, such claims will be treated as a single claim and deemed first made during the policy period in which the earliest claim was made.  These provisions can have significant implications on the applicable policy and policy limits, retroactive date issues, and whether such claims were first made and reported during a particular policy period.  Recently, the Ninth Circuit issued a stern reminder of how the particular policy language can effect, and in this case thwart, the intended scope of the carrier’s “related claims” provision.

In Attorneys Ins. Mut. Risk Retention Grp., Inc. v. Liberty Surplus Ins. Corp., 2019 WL 643442 (9th Cir. Feb. 15, 2019), the Ninth Circuit construed a “related claims” provision included in two consecutive lawyers professional liability policies. During both the 2009–2010 and 2010–2011 insurance policy periods, attorney J. Wayne Allen (“Allen”) was insured through his employer by Liberty Surplus Insurance Corporation’s (“Liberty”) professional liability insurance.  Third parties filed suit against Allen during the 2009–2010 policy period in a probate case, and a second, related civil suit during the 2010–2011 policy period.  

The 2010–2011 Policy was a “claims-made and reported policy,” which required that any claim made during the 2010–2011 policy period against the insured be reported during the 2010–2011 policy period. One provision limited Liberty’s liability for multiple related claims and provided, in relevant part:

Claims alleging, based upon, arising out of or attributable to the same or related acts, errors or omissions shall be treated as a single Claim regardless of whether made against one or more than one Insured. All such Claims, whenever made, shall be considered first made during the Policy Period or any Extended Reporting Period in which the earliest Claim arising out of such acts, errors or omissions was first made, and all such Claims shall be subject to the same Limits of Liability.

The earlier probate suit was not reported to Liberty until the second policy period.  When the civil suit was reported to Liberty (within the 2010-2011 policy period in which the claim was made), Liberty declined coverage for Allen in the civil action. Liberty argued that the “related claims” provision in the 2010–2011 Policy limited coverage so that if multiple claims regarding the same set of facts are made against an insured in multiple policy periods, the claims are all considered initially made during the policy period in which the first claim is made.  Here, Liberty argued that by virtue of the “related claims” provision, both the probate case and related civil suit were deemed to have been first made during the 2009-2010 Policy period, when the original probate suit was first made.  Further, because claims must be reported during the policy period in which they are made, Liberty asserted that it had no obligation to defend Allen against the civil action because he failed to report the earlier, related probate claim during the 2009–2010 policy period.  

The District Court rejected Liberty’s argument, and the Ninth Circuit affirmed.  The court’s analysis involved interpretation of one of the 2010–2011 Policy’s defined terms, “Policy Period.” In particular, the 2010–2011 Policy defined “Policy Period” as “the period from the Inception Date of this Policy to the Policy Expiration Date as set forth in the Declarations or its earlier termination date, if any.” The “Declarations” identified the policy period as from July 31, 2010 until July 31, 2011. According to the court, the specific definition of “Policy Period” within the 2010-2011 Policy precluded Liberty’s interpretation of the “related claims” provision.

The District Court reasoned that “[a]dopting Liberty’s interpretation would require the court to give different meanings to the same term used in the same policy, which would run afoul of the rules of contract interpretation.” Rather, the court held that the definition of “Policy Period” necessitated that the “related claims” provision be read to mean any relevant claims will be “considered first made during the Policy Period,” i.e., during the period from July 31, 2010, until July 31, 2011.  In other words,the specific policy language in the 2010-2011 Policy only applied to “related claims” made within the 2010-2011 Policy period and that such claims will be deemed made when the earliest of claims was made during that policy period only, and not the prior policy period.  The Ninth Circuit held that Liberty’s chosen definition of “Policy Period” may create an ambiguity in the meaning of the multiple related claims provision as a whole, but it nevertheless sided against Liberty as any ambiguities in an insurance policy are resolved against the insurer.

CGL Provides No Coverage for Damage to the Insured’s Work

Barry Zalma | Zalma on Insurance | March 22, 2019

Construction contracts are risk transfer devices. The owner shifts the risk of loss to the general contractor who shifts the risk of loss to subcontractors and all shift the risks of loss to their insurers. Commercial General Liability (CGL) policies agree to accept the risk of loss faced by those insured by the CGL for an “occurrence” happening during the policy period. It does not, however, provide coverage for the general costs of doing business.

In Skanska USA Building Inc. v. M.A.P. Mechanical Contractors, Inc., and Amerisure Insurance Company and Amerisure Mutual Insurance Company, Skanska USA Building Inc. v. M.A.P. Mechanical Contractors, Inc., Amerisure Insurance Company, And Amerisure Mutual Insurance Company, No. 340871, No. 341589, State of Michigan Court of Appeals (March 19, 2019) the Michigan Court of Appeals was asked to resolve a dispute over whether there was an “occurrence” as defined by the policy that required defense and indemnity.

The dispute arose from the faulty installation of parts in the steam heat system of a hospital construction project resulted in an insurance coverage dispute. The resulting damage required extensive repairs, in excess of $1 million. The insurance carrier, Amerisure Insurance Company (“Amerisure”), appealed an order denying its motion for summary disposition.

BASIC FACTS

Starting in 2008, plaintiff was the construction manager on a renovation project for Mid-Michigan Medical Center in Midland (“Medical Center” or “MMMC”). Plaintiff subcontracted the heating and cooling portion of the project to defendant M.A.P. Mechanical Contractors (“MAP”). MAP obtained a commercial general liability insurance policy (“CGL policy”) from Amerisure. Plaintiff and the Medical Center are named as additional insureds on the CGL policy.

In 2009, MAP installed a steam boiler and related piping for the Medical Center’s heating system. MAP’s installation included several expansion joints, which are designed to accommodate the expansion of the piping caused by the flowing steam. Plaintiff determined that MAP had installed some of the expansion joints backward. Significant damage to concrete, steel, and the heating system had occurred.

According to plaintiff, the cost of the repair and replacement work was approximately $1.4 million. Plaintiff submitted a claim to Amerisure seeking coverage as an insured. Plaintiff’s claim was denied.

Amerisure asserted several grounds for summary disposition, including: (1) MAP’s defective construction was not a covered occurrence within the CGL policy; (2) plaintiff failed to provide proper notice of a claim; (3) plaintiff entered into a settlement without Amerisure’s consent; and (4) several exclusions barred coverage.

The trial court denied Amerisure’s motion.

The policy defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” However, the policy did not define the word “accident.”

Defective workmanship, standing alone, is not an occurrence within the meaning of a general liability insurance contract, an occurrence exists where the insured’s faulty work product damages the property of another.

There is no indication MAP purposefully installed the expansion joints backwards. The parties affected by MAP’s negligence did not anticipate, foresee, or expect backward expansion joints or property damage to the entire length of the underground steam and condensate lines.

ANALYSIS

The dispositive issue in this case is whether there was an “occurrence” triggering coverage. There was no genuine issue of material fact that plaintiff sought coverage for replacement of its own work product.

At issue was whether there was an “occurrence” triggering coverage. Because the policy did not define “accident,” the Court looked to a common definition of “accident,”  that anything that begins to be, that happens, or that is a result which is not anticipated and is unforeseen and unexpected by the person injured or affected thereby—that is, takes place without the insured’s foresight or expectation and without design or intentional causation on his part. In other words, an accident is an undesigned contingency, a casualty, a happening by chance, something out of the usual course of things, unusual, fortuitous, not anticipated, and not naturally to be expected.

The fortuity required is not what is commonly meant by a failure of workmanship. The court was unable to find in the policy language a reasonable basis to expect coverage for defective workmanship.

In sum, the court concluded that defective workmanship of the insured, standing alone, was not the result of an occurrence within the meaning of the insurance contract. Summary disposition was properly granted on this issue.

A fundamental tenet of Michigan jurisprudence, like that of every state, is that unambiguous contracts are not open to judicial construction and must be enforced as written. Courts enforce contracts according to their unambiguous terms because doing so respects the freedom of individuals freely to arrange their affairs via contract. The general rule of contracts is that competent persons shall have the utmost liberty of contracting and that their agreements voluntarily and fairly made shall be held valid and enforced in the courts.

The Michigan Court of Appeal noted that it is an established principle of law that an “occurrence” cannot include damages for the insured’s own faulty workmanship. Amerisure was, therefore, entitled to judgment as a matter of law because coverage was not triggered due to lack of an “occurrence” and there is no genuine issue of material fact that the only damage was to plaintiff’s own work product (rather, that of its subcontractor).

Because there is no coverage, there was no need to address whether any of the exclusions apply or whether conditions precedent were met.

ZALMA OPINION

CGL policies provide extensive coverage to its policyholders. It does not, however, cover every potentiality. It will never provide coverage for a loss that is not fortuitous, contingent or an unknown event. It will not protect the policyholder from damage caused by the policyholder’s own negligence to its own product. For that reason judgment was entered in favor of the insurer.

No Coverage for Defects in Subcontrator’s Own Work

Tred R. Eyerly | Insurance Law Hawaii | February 11, 2019

    Damage to the concrete floor installed by the insured subcontractor was not property damage and thus not covered under the insured’s CGL policy. Kalman Floor Co. v. Old Republic Gen. Ins. Corp., 2019 U.S. Dist. LEXIS 3319 (D. Colo Jan. 8, 2019). 

    In 2007, Kalman Floor Co. was subcontracted to construct over 158,000 square feet of concrete flooring for a cold storage facility. The concrete floor was completed in late 2008. In late 2009, the contractor notified Kalman that pockmarks, or “pop-outs,” were visible on the concrete flooring. The only damage to tangible property in the facility caused by the pop-outs was the concrete flooring itself.

    On January 31, 2009, Old Republic issued a general liability policy to Kalman for one year. The policy excluded for damage to “your work,” defined as “work or operations performed by you or on your behalf.” Old Republic denied coverage for damage to the concrete floor. Kalman sued, seeking a declaration that the exclusions did not bar coverage. 

    Under Tenth Circuit law, as established in Greystone Const, Inc. v. Nat’l Fire & Marine Ins. Co., 661 F.3d 1272 (10th Cir. 2011), the term “occurrence” in a CGL policy encompassed unforeseeable damage to non-defective property arising from faulty workmanship. The policy was intended to protect the insured business from claims by third parties concerning personal injury or property damage resulting from accidents. In discovery, Kalman admitted the pop-outs in the concrete floor “did not physically injure or damage any tangible property other than the floor system it installed.” Thus, under the terms of the policy, property damage did not occur. 

    Consequently, Old Republic’s motion for summary judgment was granted and the case dismissed with prejudice.