Illinois Appellate Court Clarifies What Is and Is Not an “Occurrence” in the Construction Defect Context

Marianne Bradley and Anthony Miscioscia | White and Williams LLP

On December 31, 2019, the First District Illinois Appellate Court issued its decision in Owners Insurance Company v. Precision Painting & Decorating Corporation, clarifying what does and does not constitute “property damage” caused by an “occurrence” in the construction defect context. 2019 IL App. (1st) 190926-U, 2019 Ill. App. Unpub. Lexis 2425.

The underlying case involved allegations of negligence, consumer fraud and breach of contract. In particular, the underlying homeowner claimants alleged that Precision Painting & Decorating Corporation (Precision), whom the homeowners had hired to perform certain exterior paintwork at their home, failed to conform to U.S. Environmental Protection Agency (EPA) regulations with respect to the presence of lead-based paint. In its contract, Precision had agreed to take special care with respect to containing lead dust while working on the homeowners’ property. Despite having agreed to do so, Precision (allegedly) took almost no precautions, resulting in significant contamination to the interior of the home.

Owners Insurance Company (Owners) had issued Precision a CGL policy, providing coverage for “property damage” caused by an “occurrence,” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”

Precision tendered its defense to Owners. Owners filed a DJ Action arguing that it owed no duty to defend as the homeowners had failed to allege any “property damage” caused by an “occurrence.” Specifically, Owners argued that, under Illinois law, damages resulting from an insured’s breach of contract are not recoverable under a CGL policy.

The trial court agreed, finding that no “accident” or “occurrence” was alleged. The trial court observed that the homeowners’ contract with Precision had specifically provided for various EPA-required precautions with respect to the use of lead-based paint. The trial court concluded that Precision’s failure to implement those precautions was not an “accident,” which in the trial court’s view, referred to something “unforeseen or untoward or disastrous.” Instead, the trial court characterized Precision’s conduct as nothing more than a foreseeable breach of contract.

Precision appealed, and the Appellate Court reversed and remanded. The Appellate Court found that the trial court’s focus on foreseeability was misplaced. It observed that: “[i]nstead of focusing on the foreseeability of the event itself (the release of lead-based particles), or even generally the damages (lead contamination),” Illinois case law instructs courts “to focus on what, specifically, was damaged, and whether the remediation of that damage fits within the general purpose of a CGL policy.” Id. at *12 (emphasis added). The Appellate Court emphasized that: “when the underlying lawsuit against the insured contractor alleges damages beyond repair and replacement, and beyond damage to other parts of the same project over which that contractor was responsible, those additional damages are deemed to be the result of an ‘accident.’” Id. at *14.

The Appellate Court was careful to contrast these so-called “beyond” damages with damages arising out of faulty workmanship, alone. It reiterated that it is well-settled under Illinois law that “there is no occurrence when a [contractor’s] defective workmanship necessitates removing and repairing work.” Id. at *14. This is true even when a contractor’s faulty workmanship results in consequential damages to any other part of the project for which the contractor has responsibility, as it remains part of the contractor’s work product. However, where damages extend beyond the scope of a contractor’s work product, the court concluded that those damages are more properly classified as unforeseeable accidents, and thus “occurrences.”

The Appellate Court found that Precision’s “work product” was limited to the exterior of plaintiffs’ house. Thus, any damage to the interior of the home, as well as to the surrounding land, was outside the scope of Precision’s project. Because plaintiffs had alleged damages “beyond repair and replacement, and beyond damage to other parts of the same project over which [Precision] was responsible,” plaintiffs had satisfactorily alleged “property damage” caused by an “occurrence.” The Appellate Court reversed and remanded in accordance with those findings.

Bad Faith Damages Against Surplus Line Insurers Might Not Be Capped in Illinois

Paul Walker-Bright | Neal, Gerber & Eisenberg | November 15, 2019

I recently had occasion to read through the Illinois Surplus Line Law in detail when I noticed something interesting:  surplus lines insurance companies may not be subject to the cap on bad faith damages usually applied to claims against insurers in Illinois. Allow me to explain.

In Illinois there is a statute, 215 ILCS 5/155 (“Section 155”), that governs bad faith claims against insurers. It states that:

In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts:

(a)  60% of the amount which the court or jury finds such party is entitled to recover against the company, exclusive of all costs;

(b)  $60,000;

(c)  the excess of the amount which the court or jury finds such party is entitled to recover, exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the claim prior to the action.

In 1996, the Illinois Supreme Court held that Section 155 pre-empts common law tort claims for breach of the implied duty of good faith and fair dealing against insurers and provides the sole basis for policyholders to recover from insurers for breach of said duty. See Cramer v. Ins. Exch. Agency, 174 Ill.2d 513, 675 N.E.2d 897 (1996). As one can see, Section 155 limits recovery against an insurer to reasonable attorneys’ fees, other costs, and the lesser of the amounts in (a), (b) and (c) above. The effect is to limit the policyholder’s recovery to reasonable attorneys’ fees, costs, and $60,000 or less. No punitive damages or other tort damages, regardless of how egregious the insurer’s conduct was. The Supreme Court in Cramer did state that Section 155 does not pre-empt a tort that has separate and independent elements and is based on something other than an insurer’s failure to pay a claim, but policyholders can find it difficult to meet this test.

Understandably, not everyone is satisfied with this outcome. Don’t get me wrong:  Section 155 was enacted to benefit policyholders, and the fee-shifting aspect does help make lawsuits against insurers more economically feasible. Nevertheless, the feeling remains that the legislature could have gone further.

Enter the Illinois Surplus Line Law, 215 ILCS 5/445. This law governs when and how “surplus line insurance” may be procured for Illinois policyholders. “Surplus line insurance” means:

insurance on a risk:

(A)  of the kinds specified in Classes 2 and 3 of Section 4 of this Code; and

(B)  that is procured from an unauthorized insurer after the insurance producer representing the insured or the surplus line producer is unable, after diligent effort, to procure the insurance from authorized insurers; and

(C)  where Illinois is the home state of the insured, for policies effective, renewed or extended on July 21, 2011 or later and for multiyear policies upon the policy anniversary that falls on or after July 21, 2011; and

(D)  that is located in Illinois, for policies effective prior to July 21, 2011.

215 ILCS 5/445(1) (definition of “surplus line insurance”). Section 4 of the Insurance Code states that Class 2 insurance is “Casualty, Fidelity and Surety” and Class 3 insurance is “Fire and Marine, etc.” 215 ILCS 5/4. These are very broad categories that include accident and health, liability, vehicle, and property insurance. Id. The purpose of the Surplus Line Law “is to make it possible to secure protection against a risk when authorized companies will not provide that protection.” Corday’s Dept. Store, Inc. v. NY Fire & Marine Underwriters, Inc., 442 F.2d 100, 103-04 (7th Cir. 1971). Consequently, surplus lines insurance is fairly common, particularly for unusual or hard to insure risks. For example, flood insurance is often procured through surplus line insurers. https://www.investopedia.com/terms/s/surplus-lines-insurance.asp.

Now for the interesting part. The Surplus Line Law states that:

Surplus line insurance procured under this Section, including insurance procured from a domestic surplus line insurer, is not subject to the provisions of the Illinois Insurance Code other than Sections 123, 123.1, 401, 401.1, 402, 403, 403A, 408, and all of the provisions of Article XXXI to the extent that the provisions of Article XXXI are not inconsistent with the terms of this Act.

215 ILCS 5/445(12). Notice what is missing from the list:  Section 155, which is part of the Insurance Code. If surplus line insurance is “not subject to” Section 155, that statute should not pre-empt common law tort claims for bad faith against surplus line insurers. These insurers have the benefit of not being subject to other parts of the Insurance Code, such as having to issue policies on forms approved by the Department of Insurance. See Cordray’s Dept. Store, 442 F.2d at 104. Therefore, it makes sense that they should not have the benefit of Section 155. This means that policyholders that obtain surplus line insurance may be able to recover more than the limited amounts in Section 155 if they sue their insurers for bad faith, including punitive and other tort damages. See Cramer, 174 Ill.2d at 522-23, 675 N.E.2d at 901-02 (noting that some Illinois courts had held policyholders could recover tort damages, including punitive damages, from insurers that acted in bad faith). In an appropriate case, this could prove to be an unpleasant surprise for an unsuspecting surplus line insurer.

Illinois Appellate Court Requires School Board to Pay for Services Rendered Under an Invalid Construction Contract

Brianne Dunn, Respicio Vazquez and Jackie Wernz | Franczek | November 5, 2019

A recent Illinois Appellate Court case appears to have closed a loophole through which some school districts and other public entities have avoided liability for work performed by construction companies under invalid contracts. Although the Illinois Supreme Court has agreed to review the decision, school districts and other public entities should be aware of the potential effects of this case if the decision is upheld.

Restore Construction Company v. Board of Education of Proviso Township High Schools District 209 involved a dispute between a high school district and a construction company for work resulting in approximately $7 million in emergency repairs the company made for the high school after a fire. The repairs were never authorized by the Board of Education or and the contract was not submitted to a competitive bidding process. Rather, the Superintendent first signed a contract with the company. Later, the Board President amended an earlier, Board-approved contract with the company to address the new work; the amendment, however, was not approved by the Board.  Accordingly, neither contract or amendment was competitively bid out or Board approved. 

After paying approximately $5 million to the company for the fire cleanup, the Board refused to pay the remainder due. Relying on earlier court decisions in Illinois holding that a contract cannot be implied “in fact” where the contract was entered into in violation of law, the Board argued that the contracts were void ab initio, or at the start, because they were not entered into in compliance with law, and that no contract could be implied “in fact” without compliance with contractual requirements of the law. 

Here, however, the company sought payment for what it was owed based on equitable principles, not the existence of a valid contract. The Appellate Court held that even though there was no valid contract in place, it would be unjust to allow the school district to retain the company’s services without paying the reasonable value for them. Thus, a contract implied in law could be enforced against the school district.

Prior to this decision through this unusual loophole, public entities could, in some instances, avoid payment for services already provided by third parties. For instance, one case the Appellate Court distinguished in Restore Construction Co. stemmed from work a company performed in excess to the terms of an express contract. In both cases, the company did work that the school district benefitted from, but only in Restore was the school district required to pay for those services. The only distinction appears to be the legal basis under which the company sought relief; in Restore the relief was sought in equity, whereas in the earlier case the company argued that the contract was actually valid.

The Supreme Court has agreed to review the case, so it remains to be seen if the decision will stand. If it does, however, school districts and other public entities should expect this “loophole” to be closed as companies seeking payment for previously completed work should be expected to proceed under theories of equity instead of contract so that they can rely on the precedent in this case.

Illinois Expands Protections Under The Contractor Prompt Payment Act By Imposing New Restrictions On Retainage

Mark Johnson | Seyfarth Shaw | September 2, 2019

The Illinois Contractor Prompt Payment Act, 815 ILCS 603/1, et seq. (the “Act”) was first enacted in 2007 and designed to safeguard contractors and subcontractors on private projects by providing a mechanism to expedite payments for work performed. The Act applies to all private construction projects in Illinois, except those involving single family residences or multiple family residences with twelve or fewer units in a single building. With the Act, Illinois joined a growing number of states that had enacted similar legislation.

On August 20, 2019, Illinois amended the Act and again joined a growing number of states that are expanding their protections for contractors, this time by restricting the amount of retainage that may be withheld on a construction project. The amendment, codified at 815 ILCS 603/20, imposes a ten percent (10%) cap on the amount of retainage that may be withheld and reduces that cap to five percent (5%) once the project is fifty percent (50%) complete. Specifically, the Act provides:

No construction contract may permit the withholding of retainage from any payment in excess of the amounts permitted in this Section. A construction contract may provide for the withholding of retainage of up to 10% of any payment made prior to the completion of 50% of the contract. When a contract is 50% complete, retainage withheld shall be reduced so that no more than 5% is held. After the contract is 50% complete, no more than 5% of the amount of any subsequent payments made under the contract may be held as retainage.

815 ILCS 603/20

A “construction contract” under the Act “means a contract or subcontract” for the “design, construction, alteration, improvement or repair” of property. Therefore, this cap applies equally to owner-contractor agreements and to contractor-subcontractor agreements, as well as to owner-architect and design agreements. Also, because the terms “contractor” and “subcontractor” have the same broad meanings ascribed to them by the Illinois Mechanics Lien Act, this cap equally applies to construction managers, design-builders, sub-subcontractors, and material suppliers. 

While the amendment is effective immediately, it does not impact contracts entered into prior to August 20, 2019. It will, however, impact any ongoing contract negotiations involving the withholding of retainage. 

The amendment represents a significant victory for contractors, who have long argued that withholding 10% of payments earned until the end of a project negatively impacts their cash flow. The requirement to reduce retainage to 5% once the project reaches its midpoint and thereafter to withhold no more than 5% from subsequent payments will result in an infusion of funds to the contractor and a reduction of an owner’s security from what has been traditionally withheld on construction projects in Illinois. Whether there will be a resulting increase in the prevalence of payment and performance bonds or other forms of security on construction projects remains to be seen. 

The cap presumably is tied to the contract price for determining when the contract has been 50% completed, as opposed to the overall percentage of work actually performed. But for projects where those benchmarks may not be commensurate with each other, this issue could be the subject of contract negotiations between owner and contractor. 

Owners will need to bear the cap in mind when they negotiate construction financing with lenders. For, while the amount of retainage that owners may withhold is now capped, the Act does not apply to construction loans or limit the amount of retainage that lenders may insist on withholding from construction draws. Owners will need to make sure that their cash flow requirements for a project are sufficient, in view of what their lenders ultimately insist on withholding.

New Illinois Law Impacts Retainage For Contractors

Matthew Horn | SmithAmundsen | September 13, 2019

The Illinois legislature recently passed a law modifying the Contractor Prompt Payment Act, impacting retainage on all private projects (except residential projects involving twelve units or less). The law sets the ceiling for retainage at 10%, and requires that retainage be reduced to no more than 5% once the project is 50% complete.

The new law is generally favorable for contractors and subcontractors from a cash flow perspective. However, it raises concern among developers and owners, who have been able to defeat the bill in earlier sessions.  In light of the new law, all applicable construction contracts need to be reviewed and modified to ensure compliance.

Failing to comply with the new law can be costly—if a party fails to adhere to the new retainage requirements, the other party is entitled to suspend performance on the contract and collect 10% interest per annum on all outstanding amounts.