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

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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.

Colorado Statutory Bad Faith: Doubling Down On An Insurer’s Unreasonable Delay Or Denial

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Jonathan Bukowski | Property Insurance Coverage Law Blog | August 19, 2017

In August 2008, Colorado created a statutory bad faith claim of action for first-party policyholders not only separate and distinct from a claim for common law bad faith breach of an insurance contract, but establishes a much more reasonable threshold to prevail against an insurer under Colorado Revised Statute § 10-3-1115 and Colorado Revised Statute § 10-3-1116.

Most importantly, the statute provides significant recourse for a successful policyholder in the form of:

  • Two times the covered benefit,
  • attorneys’ fees, and
  • court costs

To bring a claim for statutory bad faith under § 10-3-1115 and § 10-3-1116, the party(s) asserting the claim must have entitlement to benefits owed directly to or on behalf of an insured under an insurance policy. However, this does not include any nonparticipating provider performing services or a person asserting a claim against an insured under a liability policy.

Finally, the party asserting the claim must establish:

  1. The insurer delayed or denied authorizing payment of a covered benefit, and
  2. the insurer had no reasonable basis for delaying or denying the covered benefit.

Colorado Revised Statute § 10-3-1116 does not require proof of actual damages. Rather, a policyholder’s recovery is determined by the amount of the “covered benefit” in dispute. Therefore, the right of action is sufficient by itself without the need for an accompanying breach of contract claim, allowing a policyholder to recover two times the “covered benefit” even when the benefit is ultimately paid and no actual damages are sustained.

In passing this bad faith statute, Colorado has provided protection to its policyholders and a strong remedy against the insurers that unreasonably delay and/or deny valid claims.

Iowa Appellate Court Upholds Appraisal Award For Insured

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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).

Cost-Plus Contract and the Disorganized Contractor

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I’Ashea Myles-Dihigo | The Dispute Resolver | September 6, 2017

Some contractors are better at record keeping than others.  I always seem to run into this issue when I working with a client and I’ve asked them to provide me with all of their records regarding the project.  The usual answer that I get is, “I don’t keep those kinds of records,” or “All I have are text messages.”  Depending on the type of contract dispute, the lack of accurate record keeping may not be such a big deal, however, when there is a dispute regarding a cost-plus contract, recording keeping can become a central issue.  This concept is explained by the Tennessee Court of Appeals in the case of Forrest Construction Company, LLC v. Laughlin.
Generally speaking in Tennessee, when a contractor seeks to recover unpaid fees relative to a cost-plus contract, and the owner denies owing fees, the contractor must show the court an itemization of each expenditure made on the project.  In Forrest Construction Company, LLC v. Laughlin, homeowner entered into a cost plus contract with Forrest Construction Company to build a home. Forrest Construction Company, LLC v. Laughlin, 337 S.W. 3d 211 (Tenn. Ct. App. 2009).  Prior to completion, of the house, Forrest Construction and the homeowner began to have disputes about payment.  Id. at 216.  Forrest Construction stopped work on the home, filed a lien, and thereafter filed a breach of contract action against the homeowner and an action to recover damages based on the doctrine of quantum meruit. Id. at 218.  Forrest Construction claimed that homeowner breached the contract by failing to timely pay pursuant to the terms of the parties’ agreement. Id. Defendant homeowners filed a counter-claim against Forrest Construction for negligent construction, gross negligence, negligence per se, breach of contract, and violations of the Tennessee Consumer Protection Act.  Id. at 218-219.
The contract at issue in Forrest Construction required that the contractor retained a detailed accounting and back-up documents for all expenditures and draw requests on the project.  When the homeowner asked Forrest Construction for the accounting records on the project, the contractor could only provide a “two foot thick pile” of unorganized receipts.  Id. at 224.  The Court found this type of record keeping to be unacceptable when it said,  “In any cost-plus contract there is an implicit understanding between the parties that the cost must be reasonable and proper.” Id. at 223-224; Kerner v. Gilt, 296 So. 2d 428, 431 (La. App. 4 Cir., 1974). “The contractor is under a duty of itemizing each and every expenditure made by him on the job and where the owner denies being indebted to the contractor the latter has the burden of proving each and every item of expense in connection with the job.” Id. (citing Wendel v. Maybury, 75 So.2d 379 (Orl. La. App. 1954); Lee v. National Cylinder Gas Co., 58 So. 2d 568 (Orl. La. App. 1952)); see also 17A Am Jur. 2d Contracts, Sec. 495 (2008). Forrest Construction never itemized the expenditures it sought to recover from the homeowner. Id. Instead, it submitted essentially unsubstantiated requests for draws. Id. Moreover, when called upon to provide proper documentation and itemization of the costs, it provided a wholly disorganized, un-itemized box of documents, many of which were unrelated to the actual project.  Id. As a result of this finding, the Court reversed the trial court’s decision in favor of the contractor and instead held that the contractor materially breached the contract first.
The take away from this case is when a contractor chooses to work under a cost-plus contract agreement, the contractor should be sure that they are able to maintain the heightened accounting requirement that goes along with that type of agreement. This means fully documenting each expenditure in an organized manner. If your client is like many of my clients, the fixed-fee agreement may work better because it does not require the heightened accounting in order to recover on a dispute of non-payment.

California Court of Appeal: Inserting The Phrase “Ongoing Operations” In An Additional Endorsement Is Not Enough to Preclude Coverage for Completed Operations

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Gary Barrera | California Construction Law Blog | September 11, 2017

In a victory for additional insureds, a California appeals court held, in Pulte Home Corp. v. American Safety Indemnity Co., Cal.Ct.App. (4th Dist.), Docket No. D070478 (filed 8/30/17), that an insurer’s denial of coverage for completed operations based on the inclusion of the phrase “ongoing operations” in an additional insured endorsement, was improper. Additionally, an insurer wishing to limit coverage under an additional insured endorsement to ongoing operations must do so via clear and explicit language.

Pulte Home Corp. v. American Safety Indemnity Co.

In the Pulte case, Pulte Home Corp. was the general contractor and developer for two residential housing projects beginning in 2003 and sold in 2005 and 2006.  During construction, Pulte entered into subcontracts that obligated the subcontractors to name Pulte as an additional insured on their policies for completed operations.  One of the insurers, American Safety, issued three types of additional insured endorsements with substantially similar language.  The first endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’ which is ongoing and which is performed by the [named insured subcontractor] for [Pulte]” on or after the endorsement’s effective date.  The second endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’ and only as respects ongoing operations performed by the [named insured subcontractor] for [Pulte]” on or after the endorsement’s effective date.  The third endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’” performed at the project designated in the endorsement and only for “ongoing operations performed by the [named insured subcontractor]” on or after the endorsement’s effective date.

In 2011 and 2013, two construction defect lawsuits were filed against Pulte by homeowners on each project. Pulte tendered its defense of the lawsuits to American Safety.  American Safety denied Pulte’s tenders, in part, on the grounds that coverage under the additional insured endorsements was limited to ongoing operations, and that the lawsuits alleged liability arising out of completed operations.  Pulte sued American Safety for bad faith.  The trial court ruled that American Safety’s denial of Pulte’s tenders was improper and that the additional insured endorsements were ambiguous because they did not effectively exclude coverage for completed operations.

The Appeal

On appeal, American Safety argued that the additional insured endorsements excluded coverage for completed operations because the inclusion of the phrase “ongoing operations” after the phrase “your work” was a limitation on “your work” and eliminated completed operations coverage. American Safety also argued that the endorsements limited coverage to the time frame of the subcontractors’ ongoing operations, and since the homes were sold as completed units, ongoing operations had already concluded.

The Court of Appeal rejected American Safety’s arguments. First, the court held that American Safety’s contention that there were no allegations of ongoing operations incorrectly focused on when the homeowners sustained financial damage through their purchase of the defective homes, and not when the homes became physically damaged.  The court opined that the property damage could have occurred while the subcontractor’s operations were ongoing but after the homes had been sold, and since the property damage became evident after the work was completed, American Safety was placed on sufficient notice that some of the subcontractors’ work could have been ongoing and/or completed during its policy periods, since the homes were built in phases.

Next, the Court of Appeal reaffirmed the trial court’s ruling that the additional insured endorsements were ambiguous because they combined coverage for ongoing and completed operations in a single clause, and failed to expressly limit coverage to the time of the subcontractors’ ongoing operations. The court held that the endorsements’ language allowing coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’” could reasonably be read as a grant of coverage for liability arising out of the named insured’s completed operations.  The court ruled that the mere linking of the phrase “ongoing operations” to the “liability arising out of ‘your work’” clause did not explicitly restrict coverage to ongoing operations.  The court explained that if the “ongoing operations” language was intended by American Safety to preclude coverage for completed operations, the endorsements had to expressly state that coverage was limited to claims arising out of work performed during the policy period.

The Court of Appeal also noted the subcontracts’ requirement that Pulte be named as an additional insured for completed operations. The court observed that at the time American Safety issued the additional insured endorsements and at the time of Pulte’s tenders, it was aware that the subcontracts obligated the subcontractors to name Pulte as an additional insured for completed operations.  The court ruled that based on American Safety’s knowledge of this information, it should have taken into account Pulte’s reasonable expectations of coverage in interpreting its policy, but it did not do so, thereby failing to give equal consideration to its interests and its insureds’ interests.

Conclusion

The Pulte decision should provide developers and general contractors with powerful ammunition against insurers’ attempts to deny completed operations coverage merely because the endorsements contain the phrase “ongoing operations,” without taking into account whether the wording of the endorsement is ambiguous. Pulte makes it clear that insurers intending to limit coverage to ongoing operations must ensure that their endorsements contain clear and unambiguous language to that effect. Pulte is also noteworthy from the perspective of a developer and general contractor because if a subcontractor’s insurer has knowledge of the subcontractor’s contractual obligation to add the developer or general contractor to its policies of insurance as an additional insured for completed operations, it obligates the insurer to consider the developer or general contractor’s reasonable expectations of coverage when evaluating an additional insured tender.

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