Ohio Supreme Court Narrows Coverage for Construction Defect Claims

Arnanda M. Leffler and Anastasia J. Wade | Brouse McDowell | February 10, 2019

On October 9, 2018, the Ohio Supreme Court issued its long-awaited decision in Ohio Northern Univ. v. Charles Constr. Servs., 2018-Ohio-4057, holding that a general contractor was not entitled to insurance coverage for its subcontractor’s faulty work. Since then, some commentators have described the Court’s holding as eliminating all insurance coverage for claims involving defective construction. Such a broad reading is not warranted. Still, Ohio’s insureds would be wise to consider purchasing an endorsement that is readily available in today’s insurance market.

Coverage for Construction Defect Claims Nationally

For years, courts around the country have grappled with coverage for claims involving defective or faulty construction. These cases generally turn on whether the court determines that defective construction is an “occurrence.” An “occurrence” is defined as an accident, including continued or repeated exposure to harmful conditions. In practice, faulty work is almost always an accident as that word is commonly understood—contractor-insureds rarely, if ever, intend or expect to cause injury to persons or property, including their own work. Thus, the industry has long understood that insurance policies will generally provide at least some coverage for damage arising from defective work, subject to policy exclusions that bar coverage for the actual repair or replacement of an insured’s faulty work. Insurers, however, argue that defective work is a non-accidental “business risk” that is not an “occurrence” covered by the policy. Since 2012, almost all courts that have considered the issue have held that defective construction is an “occurrence” and, thus, it is covered by the policy, at least to the extent that work other than the insured’s work is damaged. See Black & Veatch Corp. v. Aspen Ins. (Uk) Ltd, 882 F.3d 952, 966 (10th Cir.2018) (citation omitted).

Ohio’s Position: Westfield Ins. Co. v. Custom Agri Sys., Inc.

In 2012, the Ohio Supreme Court decided Westfield Ins. Co. v. Custom Agri Sys., Inc., 2012-Ohio-4712, holding that claims for the cost to repair an insured’s defective work are not covered because they “are not claims for ‘property damage’ caused by an ‘occurrence’ under a commercial general liability [CGL] policy.” In its decision, however, the Court cited and 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 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.

Notably, however, 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. The Court addressed this issue in Ohio Northern.

Coverage for Subcontractor Work: Ohio Northern

In 2008, Ohio Northern contracted with Charles Construction Services (CCS) to construct a hotel and conference center. After CCS and its subcontractors completed the work, Ohio Northern discovered significant issues with the work and brought suit against CCS. CCS tendered the claim to its insurer, Cincinnati Insurance Company, which argued that it had no coverage obligations under Custom Agri. In response, CCS argued that Custom Agri was inapplicable because subcontractors performed almost all of the work at issue, not CCS.

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 certain policy exclusions that expressly preserved coverage for damaged work or damages arising from faulty work if: (1) a subcontractor performed the work; and, (2) the damage occurred after project completion. Cincinnati then appealed to the Ohio Supreme Court, which accepted the following proposition of law for review:

[Custom Agri] remains applicable to claims of defective construction or workmanship by a subcontractor included within the “products-completed operations hazard” of [a] commercial general liability policy.

Thus, the question before the Court was whether Custom Agri applies to claims involving a subcontractor’s faulty work. In its decision, the Court concluded that Custom Agri does apply to such claims.

The Court acknowledged that its decision went against the weight of authority from its sister-courts nationally, but nonetheless applied Custom Agri to hold that “property damage caused by a subcontractor’s faulty work is not fortuitous and does not meet the definition of ‘occurrence’ under a CGL policy.” The Court failed to address several arguments, including: (1) that this interpretation rendered meaningless the carve-back for subcontractor work in the Your Work exclusion; (2) that the drafting history of the exclusions confirmed that the insurers themselves intended to provide coverage for subcontractor defective work; and, (3) that the meaning of “occurrence” used in Custom Agri contradicted the long-standing meaning given to the word in every other context. Instead, the Court suggested that the Ohio General Assembly could address the issue by requiring that all policies issued in Ohio define “occurrence” to include defective workmanship. Of course, this suggestion brings little comfort to the contractor-insureds that paid substantial sums for “completed operations” endorsements that were intended to provide coverage for these claims in the first place.

What’s Next for Ohio’s Construction Insureds?

Many commentators have written that the decision in Ohio Northern eliminates all coverage for construction defect claims. Taken to its logical conclusion, the absurdity of this argument is evident. Suppose an insured incorrectly affixes materials to the façade of a building, resulting in falling masonry that strikes and kills an innocent bystander. Or, suppose an insured incorrectly installs wiring during construction, resulting in a fire that destroys both the project and surrounding homes. Would any insurer even argue that there is no coverage for such claims?

The Court’s opinion in Ohio Northern cannot be read so broadly. The Court answered a narrow question: does Custom Agri apply to subcontractor work? The answer, according to the Court, is yes. But, Custom Agri held that, while there is no coverage for the repair or replacement of a policyholder’s defective work, there is coverage for consequential damages arising from that defective work. While at times the Court’s language in Ohio Northern is imprecise, the Court makes clear over and again that it is simply applying its precedent, Custom Agri. Notably, the Custom Agri Court relied upon multiple cases previously decided by Ohio courts holding that consequential damages arising from defective construction are covered occurrences. Had the Ohio Northern Court intended to overrule this prior precedent, cited in Custom Agri, it easily could have stated its intention to do so. The Court’s silence on these cases means they are still applicable to Ohio policyholders. Thus, consequential damages arising from defective construction should still be covered under CGL policies.

In fact, even Cincinnati recently confirmed that the Court’s opinion cannot be read so broadly as to eliminate coverage for consequential damages. In its response to a motion to reconsider filed by Ohio Northern, Cincinnati stated that the opinion “correctly recognizes that consequential damages, when they exist, may be covered.” For example, Cincinnati acknowledged that a subcontractor’s CGL coverage would apply at least “where a subcontractor damages part of a construction project that is not within its subcontract.” According to Cincinnati, the Court found no coverage for the consequential damages at issue in Ohio Northern because CCS was a general contractor and all of the damage to the project was CCS’s “work.”

An Ounce of Prevention…

While coverage firms like Brouse McDowell can and should continue to advocate for coverage for consequential damages, Ohio’s contractors should nonetheless consider purchasing additional coverage, particularly if they are acting as a general contractor. Numerous insurers now offer endorsements that reinstate the coverage that the Ohio Northern decision arguably eliminated. For example, some insurers amend their insuring agreement to specifically cover property damage to an insured’s work if it is performed by a subcontractor and falls within the products-completed operations hazard. Other insurers “deem” that property damage to the insured’s work is caused by an occurrence if it is unexpected and unintended. Yet other insurers amend the definition of “occurrence” to include “subcontracted property work damage.”

There may be material differences in how these various forms operate and the extent of coverage they provide, which is a subject that is beyond the scope of this article. Policyholders in Ohio should contact their brokers to discuss the options available to them and, if appropriate, should contact coverage counsel to discuss how the various, differing forms would operate. For their part, owners and developers should amend their construction contracts to compel contractors to purchase such endorsements.

Insureds and sophisticated brokers will understandably question why they and their clients must pay higher premiums to purchase endorsements to protect themselves from claims that the insurers intended would be covered by the existing CGL form. Nonetheless, here, an ounce of prevention is worth a pound of cure, and construction industry participants should contact their brokers and counsel today.

Massachusetts Federal Court Holds No Coverage for Mold and Water Damage Claim

Brian Margolies | TLSS Insurance Law Blog | January 15, 2019

In its recent decision in Clarendon National Ins. Co. v. Philadelphia Indemnity Ins. Co., 2019 WL 134614 (D. Mass. Jan. 8, 2019), the United States District Court for the District of Massachusetts had occasion to consider the application of a prior knowledge provision in the context of a claim for mold and water-related bodily injury and property damage.

Philadelphia insured a condominium property management company under a general liability insurance policy for the period September 1, 2007 through September 1, 2008.  In 2009, the insured was sued by a unit owner alleging bodily injury and property damage resulting from toxic mold conditions resulting from leaks that had been identified in her unit as early as 2004.  Notably, the complaint alleged that mold was identified in 2006 and that repair efforts were undertaken, but that these efforts all proved unsuccessful. Plaintiff alleged that she was forced to vacate her apartment in 2008 as a result of the conditions.

Philadelphia denied coverage to its insured for the underlying suit on several grounds, including a mold exclusion in its policy.  An argument was raised, however, as to coverage for property damage resulting solely from water intrusion, which was not subject to the exclusion.  Philadelphia argued that any such water-related damage was precluded from coverage on the basis of a provision in its policy’s insuring agreement stating that no coverage would be available for any property damage known to exist by the insured prior to the policy’s inception date and that “any continuation, change, or resulting of such … ‘property damage’ … will be deemed to have been known to have occurred at the earliest time when an insured … becomes aware” of such occurrence.

Looking to the allegations in the complaint – that water damage had been identified as early as 2004 – the court agreed that the damage was known by the insured prior to the inception of the Philadelphia policy.  In so concluding, the court rejected the counterargument that the complaint suggested the possibility of new property damage during the policy period given that the insured had undertaken repair efforts after the initial damage was originally identified.  As the court explained, “attempts to remediate the damage, even temporarily successful ones, do not transform the later continuation or recurrence of that very damage into new instances of property damage that would potentially be covered.” 

A Fire Destroying More Than Half of the Project is not a Cardinal Change Where the Parties Entered Into a Separate Agreement to Cover the Fire Remediation Work

Kristopher Berr | Constructlaw | November 29, 2018

IES Commercial, Inc. v. Manhattan Torcon, A Joint Venture, 2018 U.S. Dist. LEXIS 164973 (D. Md. Sept. 26, 2018)

In 2009, the Army Corps of Engineers hired Manhattan Torcon Joint Venture (“MT”) as general contractor to build a biological research facility at Fort Detrick, Maryland.  MT subcontracted with IES Commercial, Inc. (“IES”) to perform the electrical system work.

In August 2013, after IES had completed over 90% of its work, a fire destroyed or damaged more than half of the facility, including significant portions of IES’s work. MT ordered IES to perform significant fire remediation work in addition to the remainder of its base contract work. In November 2013, IES and MT entered into a subcontract amendment referred to as the “Fire Rider,” which included an agreed rate schedule for the fire remediation work, along with a procedure by which IES would perform work at MT’s direction, submit daily work tickets and monthly invoices, and be paid within ten days after MT received payment from its insurer.

The parties performed under the Fire Rider for over four years.  During this time, IES complained that MT was mismanaging the work by, among other things, failing to develop a schedule accounting for fire remediation work in addition to base contract work, and by requiring IES to work out of sequence. In September 2017, MT informed IES it would not be paid for the remainder of its work because MT’s insurer had ceased payments. In December 2017, IES sued MT in federal court in Maryland, asserting breach of contract and cardinal change claims. It also sued MT’s sureties under the Miller Act. MT and its sureties moved to dismiss all counts. The Court denied the motion with respect to the breach of contract and Miller Act claims but granted the motion on the cardinal change claim.

In granting the motion, the Court first reasoned that IES had misconstrued the nature of a cardinal change claim. Under the cardinal change theory, a contractor is entitled to recover damages when work ordered by the government is materially different from the work initially bargained for. In its complaint, however, IES did not allege that MT ordered work materially different from IES’s original scope. Instead, it alleged that the fire itself constituted a cardinal change. Thus, IES failed to allege a valid cardinal change claim.

Second, even assuming that the changed work ordered by MT – rather than the fire itself – was a cardinal change, the Court held that claim still failed because IES failed to allege damages resulting from that work. Instead, IES alleged damages consisting primarily of labor inefficiency costs, allegedly caused by MT’s mismanagement of the project. However, IES did not allege that MT’s mismanagement after the fire was, itself, a cardinal change. Thus, IES failed to allege increased costs resulting from a cardinal change.

Finally, the Court held that the cardinal change claim was barred by the existence of the Fire Rider. According to the Court, a cardinal change occurs when the government demands a contractual alteration that requires the contractor to perform duties materially different from those originally bargained for. Here, however, the parties bargained for and entered into the Fire Rider to account specifically for fire remediation work. Thus, the Court held that the cardinal change claim failed as a matter of law because IES was not ordered to complete fire remediation work materially different from its contractual scope of work. Instead, it agreed to perform the work pursuant to a new agreement.

Timely Paying Appraisal Award Exempted Insurer from Breach of Contract and Bad Faith Claim

Marle Laur | Property Insurance Coverage Law Blog | November 3, 2018

In the case Biasatti v. GuideOne National Ins. Co., No. 07-17-00044-CV (Tex. Ct.App. Aug. 16, 2018), Steven Biasatti and Paul Gross, d/b/a TopDog Properties, brought suit against its insurance company, GuideOne National Insurance Company for breach of contract.

TopDog Properties (“TopDog”) was insured through a commercial insurance policy issued by GuideOne National Insurance Company (“GuideOne”). The property suffered a loss as a result of wind and hail damage, and TopDog put GuideOne on notice of the loss. The insurer inspected the property and determined that the damage totaled $1,896.88. GuideOne did not issue payment to the insured since the damage was less than the $5,000.00 deductible. When GuideOne did not change its coverage determination after a second inspection, TopDog requested appraisal of the claim. GuideOne responded that under the policy, only the insurer could invoke appraisal, and it declined to do so. The insured filed suit.

Months after TopDog filed suit, GuideOne invoked appraisal. The insured resisted, and the trial court refused to compel the appraisal. On appeal, the trial court was directed to grant GuideOne’s motion to compel appraisal.

The appraisers and umpire set the amount of loss at $168,808.00. GuideOne sent TopDog a check for $146,927.30, which reflected the amount awarded less the deductible and depreciation.

TopDog then filed a motion for partial summary judgment against the insurer for breach of contract and failure to timely pay the insured’s claim. The insurer argued, in its own motion for summary judgment, that since it had promptly paid the appraisal award, the insured’s claims against GuideOne could no longer stand. The trial court ruled in favor of GuideOne’s motion. TopDog appealed.

The appellate court affirmed the trial court’s ruling, holding that since GuideOne invoked the appraisal clause following the benefits dispute, as permitted by the policy, then timely tendered the appraisal award, TopDog received the benefits it was entitled to under the policy and did not demonstrate that any policy benefits were withheld.

Better Early Than Late

J. Ryan Fowler | Property Insurance Coverage Law Blog | October 3, 2018

I often get asked: “Can I still file a lawsuit against my insurance company for my claim from. . . .” Like all good lawyers my answer is maybe. The reality is that the deadlines to file a lawsuit against an insurance company are controlled by the state law that applies to your claim and the facts of your individual case.

In Texas claims for breach of the duty of good faith and fair dealing and violations of the Texas Insurance Code must be brought within two years after the cause of action accrues. The normal period of bringing a breach of contract claim, four years, is commonly reduced to within two years and a day of the date of accrual by most insurance policies. Simply stated most lawsuits against an insurance company must be filed within two years of when the causes of action accrues. Sounds easy but “when does the causes of action accrue”, you ask?

Recently the United States District Court, Southern District of Texas, Laredo Division revisited this question in Rodriquez v. State Farm Lloyds.1 The insured had a pipe burst of January 6, 2015, and filed the lawsuit against State Farm Lloyds on July 13, 2017. We can all see that more than two years passed between the date of the loss and the filing of the lawsuit, but when did the causes of action accrue?

The court discussed the general rule that a cause of action accrues when facts come into existence that authorize a party to seek a judicial remedy. The court then discussed that in an insurance case both for breach of contract and insurance code violations, a cause of action accrues when the insurer denies the claim.

Next, the court examined the record for when the insurer denied the claim. The competing two possible dates are below:

  1. January 21, 2015 – State Farm sent a letter to insured informing that evaluation over and damage less than deductible.
  2. October 2015 – State Farm administratively closed the claim for the first time.

The insured argued that after the denial letter in January the insurer continued to communicate with the insured and was still investing the claim until the insurer issued a “final denial” in 2016. The court determined that nothing indicated that the insurer ever changed or withdrew its initial claim determination and that reinvestigation itself is insufficient to show a prior decision’s withdrawal or change. Therefore, the court held that the limitations period was never reset, and the lawsuit was time-barred and must be dismissed.

It is always important to consult a lawyer to review the facts of your case to determine when the applicable statutes of limitations has started to run and ultimately when a lawsuit must be filed to preserve your rights.
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1 Rodriguez v. State Farm Lloyds, 2018 WL 3966270, No. 5:17-CV-161 (S.D. Tex. Aug. 17, 2018).