The Earth Movement Exclusion: How Does it Affect Construction Defect Cases?

Adam B. Edgecombe, Esq. | Jimerson & Cobb P.A. | September 26, 2016

One of the biggest considerations for parties on both sides of any lawsuit is whether insurance coverage will apply to the plaintiff’s claims. This is especially true in construction defect cases, where the cost of repairing the alleged damage can be significant, and quite often beyond the financial means of the construction professional being sued. However, many litigants in construction defect cases, on both sides of the litigation, do not understand the intricacies of the insurance policy at issue, including the Earth Movement Exclusion present in many policies.

The general liability policies of construction professionals whose work involves construction or modification of the foundation of a structure, or any type of compaction, grading, or moving of land or dirt on a construction site, will typically include the Earth Movement Exclusion (the “Exclusion”). The Exclusion is a clause in the general liability policy that removes coverage under the policy for injury or damage that is wholly or partially caused by virtually all types of earth or land movement, whether occurring naturally or as the result of human action. A common version of the Exclusion in Florida reads:

This insurance does not apply to any “bodily injury” or any “property damage” that is directly or indirectly caused by, involves, or is in any way connected or related to any movement of earth, whether naturally occurring or due to man-made or any other artificial causes.

Movement includes, but is not limited to, settlement, cracking, contraction, compaction, compression, consolidation, subsidence, shrinking, expansion, heaving, swelling, cave-in, erosion, vibration, shock, earthquake, landslide, mudflow, wind-driven, freezing, thawing or any other movement of earth, regardless of the cause.

Earth includes but is not limited to any dirt, soil, terrain, mud, silt, sediment, clay, rock, sand, fill material or any other substances or materials contained therein.

Based on the plain reading of this exclusion, one can see how it can easily cover a wide range of defect cases and/or claims. Accordingly, the Exclusion has significant implications for plaintiffs and their attorneys when bringing a construction defect claim that may be the result of some sort of earth movement believed to be caused by a construction defect.

The duty of an insurer to defend an insured is triggered when the complaint alleges facts that fairly and potentially bring the suit within policy coverage. State Farm and Casualty Co. v. Higgins, 788 So. 2d 992 (Fla. 4th DCA 2001); Smith v. General Acc. Ins. Co. of America, 641 So. 2d 123 (Fla. 4th DCA 1994). Similarly, there will be no duty to defend or indemnify an insured where the lawsuit’s claims are clearly covered by an exception to the policy. Keen v. Fla. Sheriffs’ Self Insurance, 962 So. 2d 1021 (Fla. 4th DCA); Reliance Ins. Co. v. Royal Motorcar Corp., 534 So.2d 922 (Fla. 4th DCA 1988). Therefore, plaintiffs whose complaints allege some form of damage due to settling or shifting of the foundation as a result of a construction defect may find that they have pled themselves out of having the defendant’s insurer provide coverage and/or a defense related to the claim.

For instance, suppose a plaintiff contracts with a general contractor for the construction of a new home. A few years after the home is completed and the plaintiff has moved in, she notices that her outside pavers have become uneven and cracked; she then inspects the rest of her home and finds several small cracks at the base of some of her walls. The plaintiff hires a construction professional to assess the damage to her home, and is told that it will cost at least $75,000 to repair the damage. The professional further informs the plaintiff that the damage is likely due to poor construction by the contractor who built the home, so the plaintiff hires an attorney to sue the contractor for her damages. The attorney subsequently drafts and files a complaint, alleging that, because of poor construction by the contractor, there has been soil shifting or subsidence, which has resulted in the damage to plaintiff’s home.

Upon receiving the complaint, the contractor submits the claim to his insurer, who promptly denies coverage for the plaintiff’s claim based upon the Earth Movement Exclusion contained in the contractor’s policy. While the plaintiff has a legitimate claim, and the contractor is in fact culpable for the damage, the contractor does not have assets to cover the $75,000 cost of repair (let alone additional funds to cover the plaintiff’s claim for attorney’s fees when she wins the case). As a result, plaintiff is left with the option of giving up on her suit or pursuing a claim where, when she prevails, the contractor will not be able to satisfy her judgment.

However, if the plaintiff’s attorney had alleged that there was damage to the home as the result of a construction defect, but left out the allegations of the soil shifting or subsidence, then it is likely that, when the contractor submits the claim to his insurer, the insurer will at least have to defend the contractor by providing him with an attorney. As a result, the contractor will not be paying legal fees out of his own pocket and there is a chance the claim will be covered by the contractor’s policy, both of which facts can greatly influence whether or not a timely and successful resolution can be achieved for the plaintiff. The whole status of the case has been changed and the chance for plaintiff to settle her claim favorably has been greatly enhanced. Thus, one can see that, from the plaintiff’s perspective, an understanding of the Exception can have a significant and real impact on the success of a construction defect claim.

Similarly, an understanding of the Exclusion is also important for construction professionals as well. First, the professional needs to understand his general liability policy and determine if there is an Earth Movement Exclusion and then assess whether, and how, that Exclusion might be implicated in, or otherwise affect, his current and future projects. If the professional’s liability policy includes the Exclusion, perhaps the right decision for him is to purchase a policy wherein the Exclusion is not included. Alternatively, perhaps the right decision for him is to include an earth movement waiver in his own contracts, absolving him of liability for claims arising from earth movement. Regardless of how he chooses to address the situation, it is important for any construction professional whose work involves movement, compaction, or grading of soil to understand and consider the implications of the Exclusion to his business, and how to address such implications, prior to facing a defect suit involving earth movement.

Additionally, if a construction professional finds himself being sued for a claim involving possible earth movement, it is of equal importance that he consults an attorney who understands the implications of the Exclusion to review his policy and the lawsuit. At that time, the attorney can advise the professional whether he should persist in demanding coverage for the lawsuit’s claims (up to and including a declaratory action for coverage) or, if the attorney determines that the Exclusion applies, assist the professional in educating the plaintiff and her attorneys as to the implications of the Exclusion, how it affects the plaintiff’s claims, and negotiating a favorable resolution.

In summation, the Earth Movement Exclusion is an important and little-understood provision in construction professionals’ liability policies. Failure to understand and consider its implications can carry quite serious repercussions for the prosecution or defense of a defect case.

Clarification on Architect’s/Engineer’s Liability for Safety During Construction

Stan Martin | Commonsense Construction Law LLC | September 20, 2016

With underlying facts showing less-than-stellar actions on the part of more than one player, the Mississippi Supreme Court has clarified and confirmed the applicable standard for when a design professional should be liable for safety on a construction project. The case is McKean v. Yates Engineering Corp., (Sept. 15, 2016).

Yates Construction was the general contractor for a multi-story medical building in Meridian, MS. The building included reinforced concrete slabs. As the first story slab was being poured, Yates Construction asked a representative of Yates Engineering (whether the two companies are related is not discussed in the opinion) to provide engineering services for scaffolding for the second-story formwork. The engineer provided a design that was not feasible, including for example calling for 24’ long 4×4 posts (they are not available in that length). The engineer’s design was not followed in other ways, as well, noted but not explained in the decision. Workers who were injured when the scaffolding collapsed during the second-story concrete pour ultimately sued, among others, Yates Engineering.

The Mississippi Supreme Court addressed to what extent a designer may be liable for inspection and supervision, or otherwise to ensure safety during construction, in the absence of any contract requiring the same. Citing an earlier Mississippi appellate court decision that cited, in turn a Kansas Supreme Court decision, the MS high court enunciated a seven-factor test. Supervisory powers may go beyond the parameters of a contract, and invoke liability, based on the following:

(1) actual supervision and control of the work; (2) retention of the right to supervise and control; (3) constant participation in ongoing activities at the construction site; (4) supervision and coordination of subcontractors; (5) assumption of the responsibilities for safety practices; (6) authority to issue change orders; and (7) the right to stop the work.

Yates Engineering did not have any of these rights nor did it exercise any of these actions, and thus the engineer had no liability to the injured workers.

After Sixty Years, Subcontractors are Back in the Driver’s Seat in Bidding on California Construction Projects

William L Porter | Porter Law Group | September 2016

For almost the last sixty years, the standard for bidding on California construction projects has been governed by the landmark case of Drennan v. Star Paving (1958) 51 Cal.2d 409; which generally states that the contractor bidding to perform work for a project owner is entitled to rely on the bids of subcontractors in formulating its own bid to do the work. Under the equitable legal doctrine of “promissory estoppel”, which serves as the foundation of the Drennan case, even though there was no actual “contract” between the contractor and subcontractor at the time of bid, the contractor was entitled to enforce the subcontractor’s bid in reliance on this doctrine. For bidding purposes, promissory estoppel serves as an equitable substitute for an actual contract. The courts have, since that time, allowed promissory estoppel to act as a substitute for the contract in public bidding because, in equity, when a contractor “reasonably” relies on a subcontractor’s bid in formulating its own bid, it would be unjust to allow the subcontractor to withdraw a bid on which the contractor had relied in submitting its own successful bid.

While the above standard is in general quite reasonable, what has happened in the six decades since Drennan has led us far afield from the wisdom of that case. A look into the flurry of activity in a general contractor’s office on bid day illustrates: On a typical “bid day” a direct contractor might receive hundreds of bids from subcontractors, each presenting a price to perform its own specialized scope of work for the project. The contractor then typically selects the lowest responsive bid for each trade and includes sums for its own costs and profits and on that basis submits a single bid to the owner to perform the entire project, including all trades, often within minutes before the deadline. Usually, the contractor has no time or inclination to look any deeper into a subcontractor’s bid than the dollar figure presented by the subcontractor. A problem arises when subcontractor bids include terms other than price. Contractors have become quite accustomed to ignoring these other terms and focusing solely on the price. Contractors have done so with assurance that the strength of the Drennan case and the promissory estoppel doctrine will ultimately enforce the subcontractor’s bid price, often regardless of other terms presented in the bid.

The tendency of the Contractor to ignore non-price terms in subcontractor bids has been reinforced by post-Drennan legislative enactments and court decisions. Witness Public Contract Code 4107: Enacted in 1986, section 4107 authorizes a contractor to replace a listed subcontractor on a public works project when the subcontractor “fails or refuses to execute a written contract for the scope of work specified in the subcontractor’s bid and at the price specified in the subcontractor’s bid” [Public Contract Code section 4107(a)(1)]. Note that only “scope” and “price” are specified by the statute as the governing standard in determining when a contractor can be replaced. When a subcontractor refuses to sign the contract, the contractor then simply hires another subcontractor, almost certainly at a higher price, and relying on the doctrine of promissory estoppel and the Drennan case, successfully sues the subcontractor who would not sign the contract for the difference in price between the subcontractor’s bid and the replacement subcontractor’s bid.

Ignored in the equation that leads to a judgment against the subcontractor who would notsign the contract, has been the reason that the subcontractor would not sign. One common reason is that the subcontractor’s bid contained terms which are important to the subcontractor but which were ignored by the contractor who looked no further than the subcontractor bid price. These terms often include early deposits so subcontractors can purchase expensive equipment or materials to be installed, necessary worksite conditions, insurance and bonding limits, change order procedures, and other terms the subcontractor has included in its bid to protect its interests. From the perspective of the bidding subcontractor these are important terms of the subcontractor’s offer. The subcontractor reasonably believes that if the contractor accepts the offer, it is obliged to accept the subcontractor’s entire offer and not just the price alone. From the perspective of the contractor, it is the fact that the subcontractor would not sign the contract which contains customary and expected provisions that is paramount. The Drennan case and its progeny, supported by statutes like Public Contract Code 4017 and the promissory estoppeldoctrine, have always given the contractor the upper hand in the equation.

Enter the 2016 case of Flintco Pacific, Inc. v. TEC Management Consultants, Inc. (2016-Cal. App. 4th-, 2016 WL 3541694, Court of Appeal, Second Appellate District) certified for partial publication, July 19, 2016. This case presents a significant clarification, if not an erosion, of the Drennan doctrine. In Flintco, subcontractor TEC submitted a bid to perform glazing (window) work on a community college for the sum of $1,272,090.00. Within the bid there was a requirement that Flintco pay a 35% deposit ($445,231.50) as security so that TEC could lock in the prices with suppliers of the materials to be installed. Also included were terms that the bid could be withdrawn if not accepted within 15 days and that if not accepted or withdrawn that the price was subject to a minimum 3% escalation per quarter if the bid was held open after the 15 days. Flintco accepted the bid and informed TEC by letter that it was the lowest bidder and would be awarded the contract and also informed TEC that “the contract award is contingent upon the following terms and conditions,” including (1) that TEC accept liquidated damages and retention provisions, (2) agree on a complete scope of work, and (3) provide a bond. Flintco then sent TEC a contract including these terms and additional terms. The contract did not include the provision from the TEC bid that a 35% deposit would be paid. Negotiations ensued but no agreement was reached on key issues, including the provision that TEC would provide a bond or that Flintco would pay the 35% deposit. TEC then exercised its stated option after 15 days to withdraw its bid. Flintco then hired another subcontractor to perform the work at a higher price and sued TEC on the doctrine of promissory estoppel, citing the Drennan case, for the $327,050.00 difference between the bid of TEC and the higher bid of the replacement subcontractor.

One of the requirements to establish promissory estoppel is that Flintco “reasonably rely” on the bid in formulating its own bid. The Court of Appeal however noted that, Flintco management readily acknowledged that it considered only TEC’s bid price in deciding to list TEC as its glazing subcontractor. This, the court concluded, was unreasonable. It was also not reasonable for Flintco to ignore the 35% deposit requirement and other materials terms of the bid. Flintco was therefore disqualified from availing itself of the doctrine ofpromissory estoppel. By sending TEC its contract which contained terms differing from the bid terms, Flintco was issuing a “counteroffer” which TEC was free to reject. TEC rejected that counteroffer when it responded by rescinding its offer. Flintco’s lawsuit against TEC for the $327,050 difference in price between the TEC bid and the replacement subcontractor bid was therefore unsuccessful at trial and in the Court of Appeal.

The Flintco v. TEC case presents an erosion of the Drennan case and the Promissory Estoppel doctrine for California construction bidding. Subcontractors have new hope that important conditions within their bid documents cannot be ignored at the whim of contractors. Contractors have a new responsibility to closely examine subcontractor bids for terms on which they cannot agree, and when they do not agree, to reject those bids. As a result of the Flitco v. TEC Management case, there can be no doubt that bid days will be more hectic than ever before.

Oregon Supreme Court Forecloses Insurers from Taking a Second Bite at the Apple

Nick Thede | The Policyholder Report | September 22, 2016

Today, the Oregon Supreme Court unanimously rejected a liability insurer’s attempt to avoid paying on a judgment entered against its insured in Fountain Court Homeowners’ Ass’n v. FountainCourt Dev., LLC. The Court held that an insurer cannot re-litigate an underlying lawsuit as part of an insurance-coverage lawsuit, and that a claimant must show only that some property damage occurred during the insurer’s policy period. In so holding, the Court eliminated a series of arguments frequently raised by Oregon liability insurers.

The case arose from an insurance-coverage action in which a homeowners association was seeking to collect on a judgment it obtained against a siding company following a construction-defect lawsuit. The jury in the construction-defect lawsuit found that the siding company’s negligent construction resulted in continuous and progressive water damage that caused property damage to the association’s buildings. When the association attempted to collect on the judgment, the sider’s insurer argued that it was entitled to re-litigate the merits of the construction-defect lawsuit and that the association was not entitled to coverage because it could not establish the specific amount of damages that occurred during its coverage period.

The Court rejected both positions.

The Court first concluded that an insurer is not entitled to a wholesale re-litigation of the construction-defect lawsuit in the insurance coverage action. The insurer argued that it was entitled to a new trial on the merits of the case against the sider because it was “not bound by the facts of the underlying lawsuit” and “not bound by the factual findings assumed within the judgment.” The Court rejected that argument, acknowledging that the question in the insurance-coverage lawsuit is whether the facts adduced in the underlying construction-defect case fall within the coverage provided by the policy. In other words, “the insurer is not, as [it] contends, entitled to second-guess or retry ‘thenature of [the sider]’s liability.’” The Court did, however, acknowledge that the insurer is entitled to litigate issues in the coverage action “such as whether an exclusion applies or whether the damages awarded are otherwise covered by the policy.” Importantly, this portion of the opinion eliminates the potential for inconsistent or contradictory decisions regarding the insured’s liability or damages.

Next, the Court rejected the insurer’s “injury-in-fact” argument, which relied on the position that the association could not establish that the property damage was caused by an “occurrence” because it could not establish the specific amount of damage during any one policy period. The Court concluded that a claimant must show only that some property damage occurred during the relevant policy period to trigger coverage, not the precise amount of damage that occurred during any one policy period. The Court refused to adopt the insurer’s strict trigger-of-coverage argument, citing the nature of continuous and progressive property damage that cannot be broken into discrete parts.

Finally, the Court addressed the issue of allocation of damages, but ultimately determined the issue was not properly preserved. In a telling portion of the opinion, however, the Court tacitly approved the trial court’s imposition of the “all sums” rule, citing prior decisions. The Court seemingly reserved application of the “pro rata” rule, which simply allocates damages based on an insurer’s time on risk, for contribution actions between insurers. While the Court did not go so far as to expressly adopt the “all sums” approach, it undoubtedly held that Oregon courts may utilize it under the appropriate circumstances.

Oregon Federal Court Endorses Broad Definition of “Property Damage”

David Delmar | The Policyholder Report | July 28, 2016

In a recent case, Oregon Shakespeare Festival Ass’n v. Great American Ins. Co., the 6162007610_b92e89e087_zfederal District Court for the District of Oregon adopted a liberal interpretation of “property damage.” The Oregon Shakespeare Festival Association (OSF) suffered a loss during its season: nearby wildfires caused smoke to infiltrate a partially outdoor theater where performances were being held, necessitating cancellations.

OSF’s insurance policy covered “direct physical loss or damage” to its property and the “actual loss of Business Income” caused by such loss or damage. To get coverage for the business losses it sustained by cancelling performances, OSF had to show that the smoke infiltration, the undisputed reason for the cancellations, was “direct physical loss or damage” to property.

OSF argued that “physical loss or damage” means “any injury or harm to a natural or material thing.” Great American, OSF’s insurer, argued that air is not “property” and that covered damage must be “physical”— not just smoky air. The court agreed with OSF, finding that Great American’s definition was too restrictive. There was nothing in the policy, the court said, to suggest that contaminated indoor air is not covered, nor could Great American explain why air is not “physical”:

[W]ildfire smoke infiltrated the interior of the theater, making it uninhabitable and unusable for holding performances … Even though the loss or damage was not structural or permanent, the property experienced a loss of “essential functionality” … Based on the case law, as discussed above, the Elizabethan Theatre sustained “physical loss or damage to property” when the wildfire smoke infiltrated the theater and rendered it unusable for its intended purpose.

The court’s analysis suggests that a condition indirectly affecting property — that is, a condition preventing the intended use of property even if it does not necessarily damage the property itself — is “physical loss or damage.”

This broad interpretation has implications for both first-party and liability insurance claims, and could trigger coverage in a wider array of contexts. For example, under this interpretation wetting of gypsum board sufficient to affect its supportive function would be covered property damage. Even active leaks could qualify as property damage, since water intrusion in wall assemblies or interior living spaces is analogous to wildfire smoke in a partially enclosed outdoor theater.

Ball Janik will continue to track the development of the state of the law on this issue. We suggest that those who may have suffered losses along these lines consult with counsel to explore available insurance coverage options.