CGL, Builders Risk Coverage and Exclusions When Construction Defects Cause Property Damage

Jeffrey Cavignac | Construction Executive

Direct damage to property under construction caused by faulty or defective work or defective materials has been a coverage issue for decades. Two specific policies, the Commercial General Liability for the contractors building the structure and the Builders Risk Policy on the project both are sources of potential coverage. 

A CGL policy protects the named insured (the contractor in this case) from third party liability arising out of the insured’s operations that results in either bodily injury or property damage. Damage to property caused by poor workmanship or defective materials would qualify as property damage. To understand how the CGL policy might respond to claims such as these, it is necessary to evaluate several exclusions in the CGL policy. 

CGL policies cover “property damage,” defined as physical injury to tangible property, including loss of use of such property, and loss of use of tangible property that has not been physically injured. 

Exclusion M provides that there is no coverage for loss of use of property that has not been physically injured due to a defect in the work. This is significant, because it means that there is no CGL coverage for defective work without physical injury to the work. 

For example, prior to completion on a construction project, inspection revealed that windows were not properly installed, making them prone to leaks. But no leaking had occurred. Removing and reinstalling the windows delayed the project by two weeks. The owner made a claim against the GC for lost revenue for the two weeks. There is no CGL coverage because the loss of use was purely due to defective work, with no physical injury (the CGL only covers liability that results in bodily injury or tangible property damage). 

There are two additional exclusions applicable to property damage in the course of construction, exclusions J.5 and J.6:

  • Exclusion J.5 excludes property damage to that particular part of property on which the insured or its contractors are working if the property damage arises out of their work. This exclusion typically applies where a mistake in performance causes damage. Resultant property damage caused by the mistake would be covered, but damage to “that particular part” that caused the loss would not be covered. For example, an electrical contractor caused a fire while working in the mechanical room that triggered the fire suppression system building-wide, causing widespread water damage. The exclusion applies only to the electrical components in the mechanical room damaged by fire. 
  • Exclusion J.6 excludes property damage to that particular part of property that must be repaired or replaced because the insured’s work was defectively performed on it. For example, a concrete subcontractor improperly mixed a concrete batch, resulting in a section of foundation that cracked, causing a shift in the structure. Structural components supported by the faulty area were damaged. The section needed to be demolished and re-poured with major repairs needed to the rest of the structure. The re-pour is excluded but the damage to the rest of the structure was not.
    Сonfidence in the future

In both cases, the CGL affords coverage for physical damage to the work caused by defects or defective work–basically the ensuing damage. In neither case would the General Liability policy cover that particular part that was either worked on or needed to be repaired or replaced due to defective work. 

Project-Specific CGL Coverage (OCIPs and CCIPs) needs to be considered in a different light. Nearly every OCIP or CCIP will include an exclusion for property damage to the insured project during the course of construction (note, that a small minority of insurers may remove this exclusion if the contractor can provide evidence of a LEG 2 or 3 endorsement). These are often referred to as “Course of Construction” or “Builder’s Risk Exclusions.” These exclusions are added with the expectation that the builder’s risk insurance should provide coverage for damage to the structure during the course of construction. 

Providing coverage under a first party property form is preferred to a third- party liability form because it should eliminate any litigation. The key is negotiating broad and favorable terms under the Builders Risk policy. A well-written Builders Risk policy will include:

  • all stakeholders as insureds;
  • comply with the contractual terms of the contract;
  • possibly include earthquake and flood;
  • include water related damage other than flood; and
  • ideally include not only resultant damage caused by defective work or materials but if available damage to that “particular part” that caused the problem. 

The U.S. builder’s risk market is dominated by manuscript forms. There are some consistencies, but each form must be carefully reviewed. With respect to coverage for property damage during the course of construction caused by defective work, domestic forms generally fall into two categories. 

The first type, which is less common, excludes all damage caused by, or arising out of faulty workmanship. This removes coverage for repairing defective work as well as for any damage to the project resulting from the defective work. These forms offer less coverage than the ISO CGL policy and should be avoided. 

The second, more common, domestic form excludes loss or damage caused by faulty work, unless the damage is caused by a covered cause of loss. These are commonly referred to as “ensuing loss exceptions.” Taking the example of the concrete subcontractor who improperly mixed the concrete that resulted in structural damage, in this case the re-pour is excluded but the damage to the rest of the structure is not because collapse is a covered peril. 

Most domestic builder’s risk policies with ensuring loss exceptions provide roughly the same scope of coverage for property damage during the course of construction as an ISO CGL policy. Neither policy provides coverage for the cost of replacing defective work, but both policies cover direct damage to the rest of the project caused by the defective work. In the case of a Builders Risk policy this ensuing loss must be caused by a covered peril. 

An underwriting syndicate in London came up with proposed endorsements that specifically address the faulty workmanship issue. Authored by the London Engineering Group, these have come to be known as LEG1, LEG2 and LEG3: 

  • LEG1 is the most restrictive. It excludes coverage for all loss or damage “due to defects of material workmanship, design plan or specification,” whether damage to other property has occurred or not. LEG1 is the basic equivalent of the first category of US market forms that exclude all damage caused by defective work, without the “ensuing loss exception.” 
  • LEG2 excludes coverage for all loss or damage “due to defects of material workmanship, design plan or specification,” but maintains coverage for insured property damaged by the defect, except for the cost that would have been incurred if the replacement or rectification had been done before the damage. LEG2 is roughly equivalent to the U.S. market form with the “ensuing loss exception.” It covers resulting property damage to the project, but not damage to the part causing the problem. This makes LEG2 also roughly equivalent to an ISO CGL policy in terms of the scope of coverage for property damage during the course of construction. 
  • LEG3 provides the broadest coverage. This endorsement extends coverage to not only the ensuing damage, but damage to that “particular part” that caused the damage. Coverage does not extend to costs “incurred to improve the original material workmanship, design plan or specification.” As long as there is resulting property damage, the LEG3 form covers all repair costs, including the cost of repairing or replacing the defective work. 

LEG2 and LEG3 each contain an additional provision stating that “it is understood and agreed” that insured property shall not be considered damaged “notes solely by virtue of the existence of any defect of material workmanship, etc…”. In other words, there must be a covered cause of loss to trigger coverage. In simple terms, LEG3 coverage excludes the cost to repair a defect where there is no resulting damage, and the cost of improvements over and above the original work.

Here, in the example of the concrete subcontractor who improperly mixed the concrete that resulted in structural damage, the re-pour is covered along with damage to the rest of the structure. If, as an added safety precaution, the foundation was reinforced with metal rods, the cost of adding the metal rods would not be covered. The LEG3 form provides broader coverage for damage caused by defective work than the ISO CGL policy. The ISO CGL policy does not cover the cost of repairing or replacing defective work whereas LEG3 does. It should also be pointed out that LEG3 Endorsements are usually not available on smaller projects or frame construction.

Insuring construction projects are complex. There are numerous stakeholders as well as significant exposures, General Liability, property under construction, pollution, workers compensation, professional liability, etc. 

 Here are a few things to keep in mind: 

  • It is always better to have a loss covered by a property policy than a liability policy to avoid the litigation costs, ill will and time litigation can take. 
  • Negotiate the most favorable Builders Risk terms available. All Builders Risk policies are different and all are negotiable. 
  • Understand how construction defects caused by faulty workmanship or defective products will be treated. Whenever possible a LEG3 type endorsement should be sought. 
  • Communicate the coverage provided, or lack thereof to the named insureds. Just because the broker knows it, doesn’t mean the insured knows it. 

There is no substitute for taking the time to understand the risks of a project and negotiating favorable terms for all stakeholders. A well written and coordinated insurance program is a critical piece to a successful project.

Know and Meet Your Notice Requirements or Lose Your Payment Bond Claims

Chris Broughton | ConsensusDocs


Time is of the essence in the construction industry, and failing to provide timely notice of your payment bond claim can end your chance of recovery. Payment bonds guarantee payment for the subcontractors and suppliers who provide labor or materials on covered construction projects. Federal and state statutes governing payment bonds on public projects and the specific terms of non-statutory, private payment bonds have strict notice and timing requirements. Claimants who fail to provide timely notice can forfeit their chance of recovery.  This article provides a brief overview of the notice requirements for payment bond claims – who has to give notice, what notice is required, and when you have to give notice.

Payment bond protection is a frequent feature in construction. Payment bonds are required on most federal construction projects of over $100,000 under the federal Miller Act. Similar state statutes, typically referred to as “Little Miller Acts,” also require payment bonds on most state and local construction projects. Owners on private projects may require their general contractor to provide a payment bond to protect the property from liens. Finally, general contractors may also require subcontractors to provide payment bonds on public or private projects.

There is a lot of potential payment bond protection out there, but as always, the devil is in the details. Each controlling statute (federal or state) and the specific terms of the payment bond, especially with a non-statutory bond, may have similar, but different, requirements for who has to give notice, who the notice goes to, the content of the notice and, of course, the deadline for giving notice.

Due to these important distinctions, you should always consult the law that governs your project and check the specific notice provisions in the payment bond on which you relied. On public projects, the Miller Act or applicable Little Miller Act takes precedent over the wording of the statutory bond. On private projects and subcontractor non-statutory, payment bonds on public projects, the terms of that private payment bond are likely to govern.

This article cannot address all the variations, subtleties, or court interpretations of these notice requirement. This article addresses the basics and mainly seeks to alert the reader to the key elements and the need to check the federal or state law and/or the specific terms of the payment bond early to make certain you do not learn of a deadline only after you missed it and lost your rights under the payment bond.

Miller Act

The federal Miller Act requires general contractors on federal government projects to furnish a payment bond to guarantee payment for subcontractors, suppliers, laborers and materialmen who provide work on construction contracts valued at $100,000 or more.[1] The bond’s value must equal the contract price, unless the contracting officer determines that it’s impractical to procure a bond in that amount. In those rare cases, the contracting officer will determine an alternate amount.

The purpose of the Miller Act is to provide an alternate route of recovery for unpaid subcontractors, laborers, suppliers, and materialmen to their traditional remedy on private projects. On private projects, those parties typically have statutory protection under state law to file a mechanic’s lien against the property to recover for unpaid work or materials. However, federal government property cannot be subject to a mechanic’s lien. Thus, the bond replaces the traditional mechanic’s lien that parties normally have on a private project.

While the Miller Act is intended to protect subcontractors, suppliers, materialmen, and laborers on government projects, there is a very important catch – there are strict notice and timing requirements to enforce claims against the Miller Act payment bond. Claimants who miss the notice deadline can forfeit otherwise valid claims. 

The applicable notice requirements differ depending on each party’s contractual relationship on the project. First-tier subcontractors and suppliers — those who directly contract with the general contractor — do not have to provide notice before filing suit against the payment bond. First-tier subcontractors and suppliers only have to wait until 90 days after labor was performed or materials were supplied. After the 90 day “grace period” is over, the first-tier subcontractor or supplier can file a claim directly against the payment bond. However, the claim must be filed within one year after the last labor was performed or last materials were supplied to the project.

Under the Miller Act, second-tier subcontractors — parties who subcontract with or provide materials to a first-tier subcontractor or supplier — are required to provide written notice to the general contractor of their claims within 90 days after they last performed work or supplied materials or equipment to the project. Second-tier contractors also have to file suit within one year after they last supplied labor or materials to the project.

Payment bond protection under the Miller Act only extends to second-tier subcontractors and suppliers. Those on the third tier, such as a supplier or subcontractor of a second-tier subcontractor, and those even further down the contractual chain do not have a claim against the bond. For suppliers, payment bond protection does not extend beyond a supplier to a first-tier subcontractor.  Suppliers to suppliers are not protected. In other words, for those parties not covered by the Miller Act, even if they provide proper notice, they will have no claim against the payment bond.

Generally, warranty or repair work will not extend the deadline to file notice.[2] However, where materials or equipment are supplied to the same project under multiple contracts or purchase orders, the notice period runs from the date of last the materials or equipment were last furnished to the project.[3] 

For parties subject to the Miller Act notice requirements, proper notice is a condition precedent to filing a civil action to recover against the bond.[4] The purpose of the notice is to inform the general contractor of claims against their subcontractors by those further down the stream.[5] Notice is not required for first-tier subcontractors because there is less risk of unknown claims. The general contractor, as the contracting party, should know whether its first-tier subcontractors have been paid for their work. Furthermore, notice to the surety is not required.[6]

The notice must be in writing and include the name of the subcontractor or supplier to whom the labor was performed, materials were supplied, and state with “substantial accuracy” the amount of the claim.[7] 

The claimant must serve the notice in the following manner:

(a) by any means that provides written, third-party verification of delivery to the contractor at any place the contractor maintains an office or conducts business or at the contractor’s residence; or

(b) in any manner in which the United States marshal of the district in which the public improvement is situated by law may serve summons. [8]

Oral notice alone is generally not sufficient, although in one case oral notice was sufficient when the general contractor acknowledged the notice in writing.[9]  Courts may be lenient as to manner of written notice as long as the contractor receives actual notice of the claim.[10] A federal district court held that an equipment supplier satisfied its notice requirements by email. The court concluded that the email provided actual notice to the general contractor, included sufficient information about the amount owed to the supplier, and the email included verification that the notice was actually received.[11]

State Little Miller Acts

The notice provisions under state Little Miller Acts appear similar to the federal Miller Act and may be virtually identical in some instances. Nevertheless, there can be important differences that can determine whether or not notice is proper and the claim is valid.  In addition to notice requirements, the coverage of state Little Miller Act payment bonds may be different than the federal Miller Act – exactly who and how far down the chain of privity coverage extends.

North Carolina’s Little Miller Act, like its federal counterpart, requires first-tier subcontractors to wait 90 days after labor was performed or materials were supplied before filing suit to recover against the payment bond.[12] However, second-tier subcontractors, suppliers, materialmen and the like do not have to send notice to the general contractor until 120 days after labor was performed or materials were supplied to the project.[13]

State requirements may vary depending the type of work or materials supplied to the project. Under Massachusetts’ Little Miller Act, second-tier subcontractors are required to provide notice to the general contractor within 65 days after labor was performed or materials were provided to the project. If any portion of the claim covers specially fabricated materials, the claimant must provide notice to the general contractor within 20 days after receiving written approval for use of the material.[14]

In some states, potential claimants have to provide preliminary notice to preserve their payment bond claims. Under Georgia law, the general contractor can trigger the preliminary notice requirement by filing a notice of commencement with the clerk of the superior court where the project is located within 15 days after starting work on the project. The general contractor must provide a copy of the notice of commencement within 10 days after receiving a request from any subcontractor, supplier, materialman or other party on the project.[15] If the general contractor timely files and sends the notice of commencement to requesting parties, then any second-tier subcontractor must provide written notice to the general contractor within 30 days after the notice of commencement is filed or 30 days after first labor was performed or materials were supplied, whichever is later.[16]

In California, second-tier subcontractors are required to provide preliminary notice to the public entity and general contractor within twenty days after first providing labor or materials on the project. If the claimant fails to send its preliminary notice, then the claimant can preserve its claim by sending notice to the surety and the principal on the bond within 15 days after the notice of completion is recorded. If the general contractor fails to record the notice of completion, then the claimant’s time period to provide notice to the surety and principal on the bond extends to 75 days after work is completed. [17]

There can also be differences in the deadline to enforce a claim against a contractor’s payment bond. Under Georgia’s Little Miller Act, claimants are required to file suit against the payment bond within one year of actual completion and acceptance of the work by the public authority.[18] The Supreme Court of Georgia has interpreted this to run from substantial completion with only punch-list items remaining.[19]  Recall that the limitations periods under the Miller Act, many other state Little Miller Acts, and private payment bonds are tied to when the claimant last supplied labor or materials and not the timing of project substantial completion. This distinction again underscores the need to be aware of the controlling statutory requirement on public projects and the terms of the payment bond at issue.

Private Payment Bonds

In addition to payment bonds required by law on public projects, private owners may require their general contractor to provide a payment bond to protect the property from liens. General contractors on public or private projects may also require their subcontractors to provide payment bonds.

The ConsensusDocs 261 is one of the more frequently used payment bond forms. Under the ConsensusDocs 261, “Claimant” is defined as any party that either has a direct contract with the Contractor or has a contract with a subcontractor that has a direct contract with the Contractor. Any Claimant who has not been paid in full after ninety days (90) since labor or work was performed or materials were provided has a claim against the payment bond.

Claimants who are in direct privity with the contractor are not required to provide preliminary notice before filing suit to enforce their claim. Contrarily, Claimants who are not in direct privity with the contractor are required to provide written notice of non-payment to the Contractor, Owner, and Surety within 90 days after labor was performed or materials were supplied to the project. The notice must state with “substantial accuracy” the amount claimed and include the name of the party to whom the materials were furnished or for whom the work or labor was performed.

The Claimant must provide its written notice through any means that provides third party verification, or serve it in a manner in which process may be served in the state where the project is located. Additionally, either type of Claimant must file suit to enforce their payment bond claim within one year from the date on which the Claimant last performed labor or furnished materials or equipment to the project.


Payment bonds are for the protection of subcontractors or suppliers, but that security can easily be lost. Subcontractors and suppliers should take the basic precautions of learning the notice requirements that apply to the payment bond before payment trouble so that the claimant has the opportunity to comply with those requirements. 

[1] 40 U.S.C. § 3131 (b) (general cite – et. seq.)

[2] United States ex rel. Olson v. W.H. Cates Constr. Co., 972 F.2d 987 (8th Cir. 1992); S. Steel. Co. v. United Pac. Ins. Co., 935 F.2d 1201 (11th Cir. 1991); United States ex rel Magna Masonry, Inc. v. R.T. Woodfield, Inc., 709 F.2d 249, 251 (4th Cir. 1983); United States ex rel. State Electric Supply Co. v. Hesselden Constr. Co., 404 F.2d 774 (10th Cir. 1969).

[3] Ramona Equip. Rental, Inc. v. Carolina Cas. Ins. Co., 755 F.3d 1063 (9th Cir. 2014); United States ex rel. Water Works Supply Crop. v.. George Hyman Constr. Co., 131 F.3d 28 (1st Cir. 1997); United States ex rel. A&M Pretroleum, Inc. v. Santa Fe Engineers, Inc., 822 F.2d 547 (5th Cir. 1987); Noland Co. v. Allied Contractors, Inc., 273 F.2d 917 (4th Cir. 1959).

[4] United States ex rel. John D. Aher Co. v. J.F. White Contracting Co., 648 F.2d 29, 31 (1st Cir. 1981).

[5] Id [6] Continental Casualty Co v. United States, 305 F.2d 794, 797 (8th Cir. 1962).

[7] 40 U.S.C. § 3131 (b)(2). [8] 40 U.S.C.§ 3133(b)(2)(A)-(B).

[9] Houston Fire & Casualty Ins. Co. v. United States, 217 F.2d 727, 729 (5th Cir. 1954).

[10] Maccaferri Gabions, Inc. v. Dynateria Inc., 91 F.3d 1431, 1437 (11th Cir. 1996) (stating that courts have become “somewhat lenient” about the method of notice given).

[11]  United States ex rel. v. Fid. & Deposit Co. of Md., 2013 U.S. Dist. LEXIS 127869, at *12 – 13 (D. Md. Sept. 9, 2013).

[12] N.C. Gen. Stat. § 44A-27(a). [13]  N.C. Gen. Stat.§ 44A-27 (b).

[14] Mass. Gen. Laws. Ch. 149, § 29. [15] O.C.G.A. § 13-10-62(a).

[16] O.C.G.A. § 13-10-63 (a)(2). [17] Cal. Civ. Code § 9560 (b). [18] O.C.G.A. § 36-91-95.

[19] United States Fid. & Guar. Co. v. Rome Concrete Pipe Co., 353 S.E.2d 15, 16, n.1. (1987).

Avoid Creating Coverage By Estoppel, Waiver & Forfeiture: California

Alicia Gurries | Cozen O’Connor

Waiver, estoppel and forfeiture are doctrines on which insureds often rely to try to create coverage outside the terms of the insurance policy. Insureds will often assert that they are entitled to such extra-contractual coverage based entirely on how the insurer handled the claim.  But under California law, these doctrines often do not apply, and an insurer can avoid a potential waiver, estoppel or forfeiture by communicating with the insured.

Although the terms are often used interchangeably, the doctrines are different. Estoppel refers to conduct by the insurer that reasonably causes an insured to rely to his detriment. Waiver is an express or implicit intentional relinquishment of a known right demonstrated. And forfeiture is the assessment of a penalty against the insurer for either misconduct or failure to perform an obligation under the contract.”[1]

The general rule under California law is that estoppel and waiver cannot be used to create coverage under an insurance policy where such coverage did not originally exist.[2] In other words, these doctrines cannot be used to create coverage for risks that are outside the scope of the insuring agreement or that fall within a policy exclusion.[3] 

A common assertion by insureds to expand coverage is that an insurer that failed to raise a coverage defense in a coverage position letter has either waived or is estopped from asserting that defense. But several reasons may explain why the insurer initially did not raise the coverage defense. For example, it could be that facts supporting a defense were not disclosed to the claims professional until after the claims professional sent the initial coverage position letter.

Waiver in California is not automatic. It rests on the insurer’s intent: “Case law is clear that ‘waiver’ is the intentional relinquishment of a known right after knowledge of the facts.”[4] A waiver may be either express, based on the insurer’s words, or implied, based on insurer’s conduct indicating an intent to relinquish the right.[5] Although waiver generally is a question of fact,[6] proving a waiver is extremely difficult. Where an insurer did not initially include a coverage defense in its reservation, it should do so as soon as it determines the defense may apply, no matter how much time has passed since it issued its initial reservation. Several decisions have ruled that such later-made reservations are effective.[7] One situation where a waiver may apply is when an insurer elects to forgo a coverage defense when so doing could give the insured a right to independent counsel.[8]

Estoppel differs from waiver in that the focus is on the insured’s detrimental reliance. The elements to establish estoppel are that (1) the insurer must be aware of the facts, (2) the insured could reasonably believe that the insurer intended that the insured rely on the insurer’s conduct, (3) the insured must be ignorant of the true facts, and (4) the insured must rely upon the insurer’s conduct to the insured’s detriment.[9] An insurer may be estopped from asserting a policy right or defense even though it did not intend to mislead, as long as the insured reasonably relied to its detriment upon the insurer’s action. [10] Generally, the doctrine of estoppel cannot bring within coverage risks that the policy does not cover or that the policy excludes.[11] But in limited situations, e.g., when a liability insurer, with knowledge of a potential coverage defense, agrees to defend its insured without reservation of rights, the insurer may be estopped from relying on its coverage defenses (assuming the elements of estoppel are all met).[12] 

Where an insurer declines coverage based on one coverage defense, but does not deny on another applicable coverage defense, the insurer should not be estopped from subsequently asserting the second coverage defense, even if the first ground is unsupportable. Because the insurer denied coverage, the insured cannot establish that it relied to its detriment to believe that it would have such coverage.[13]

Forfeiture is a penalty against the insurer for misconduct or the nonperformance of some obligation or condition.[14]  To establish a forfeiture, the insured must establish by clear and convincing evidence conduct designed to mislead them; the courts will not impose forfeiture if the insurer did not engage in behavior designed to mislead the insured. Forfeiture does not require that the insured is, in fact, misled.  [15]

The claims professional should be aware that under California law, the doctrines of waiver, estoppel, and forfeiture do not apply automatically. The claims professional should understand the rules regarding the application of these doctrines and be able to apply them to the claims he or she is handling. In this way, the claims professional may most effectively be able to determine how best to address any assertions that the insurer has waived, is estopped from relying upon, or has forfeited any coverage defense, especially because those defenses may remain available to the insurer.

[1] Chase v. Blue Cross of Calif. (1996) 42 Cal.App.4th 1142, 1151 (Chase).

[2] Aetna Cas. & Sur. Co. v. Richmond (1977) 76 Cal.App.3d 645, 652-653.

[3] Advanced Network v. Peerless Ins. Co. (2010) 190 Cal.App.4th 1054.

[4] Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 32-33. 

[5] Id. at 32. 

[6] Aetna Cas. & Sur. Co. v. Richmond (1977) 76 Cal.App.3d 645, 653. 

[7] Ringler Associates Inc. v. Maryland Casualty Co. (2000) 80 Cal.App.4th 1165; American Motorists Ins. Co. v. Allied-Sysco Food Services, Inc. (1993) 19 Cal.App.4th 1342, 1350; National Union Fire Ins. Co. v. Siliconix, Inc. (N.D.Cal.1989) 726 F.Supp. 264, 270; Stonewall Ins. Co. v. City of Palos Verdes Estates (1996) 46 Cal.App.4th 1810, 1839.

[8] See Cal. Ins. Code § 2860.

[9] Colony Ins. Co. v. Crusader Ins. Co. (2010) 188 Cal.App.4th 743, 751.

[10] Chasesupra, 42 Cal.App.4th at 1157 (The court stated that “an insurer is estopped from asserting a right, even though it did not intend to mislead, as long as the insured reasonably relied to its detriment upon the insurer’s action.”); Waller, supra, 11 Cal.4th at 34. 

[11] Advanced Network, Inc. v. Peerles Ins. Co. (2010) 109 Cal.App.4th 1054, 1066.

[12] Miller v. Elite Ins. Co. (1980) 100 Cal. App. 3d 739, 754-56;

[13] Wallersupra, 11 Cal.4th at 35; see also Stonewall Ins. Co. v. City of Palos Verdes Estates (1996) 46 Cal.App.4th 1810, 1839 (The court found that the insurer was estopped from denying  coverage after a delay of 2 1/2 years, which was only three weeks before the trial. The court identified detriment to the policyholder because it had a right to independent counsel, who had no time to prepare for trial.); Granco Steel, Inc. v. Workmen’s Compensation Appeals Board (1968) 68 Cal.2d 191, 200 (The insurer was estopped from denying coverage based on its agent’s representation that coverage would be provided upon insured’s request (which was done).);Fanucci v. Allstate Ins. Co. (ND CA 2009) 638 F.Supp.2d 1125, 1144 (applying Calif. law) (Coverage by estoppel may exist when the insurer makes incorrect representations about the type of coverage that will be provided by a policy.)

[14] Chase, supra, 42 Cal.App.4th at 1149.  

[15] Id. at 1157 (Citations, ellipses and quotation marks omitted.);  Wallersupra, 11 Cal4th at 31

The Ultimate Sanction: Dismissal as a Spoliation Remedy

Richard Maleski | Cozen O’Connor

It will come as no surprise to subrogation professionals that retaining evidence for future inspection is essential to successfully prosecuting a subrogation claim. A new opinion out of the U.S. District Court for the Western District of Virginia demonstrates just how essential evidence retention is. In Nautilus Insurance Co. v. Appalachian Power Co., Case No. 7:19-cv-00380 (W.D. Va.), Nautilus brought an action against the defendant utility for damages to a workshop insured by Nautilus. Nautilus retained a fire investigator, who inspected the scene and advised Nautilus of the importance of preserving the fire scene so Appalachian Power could participate. Nautilus’s adjuster acknowledged this, but later told the fire investigator to close his file and advised the insured that demolition could begin. Nearly three months later, Nautilus placed Appalachian Power on notice of a potential claim. Appalachian Power sent an expert to the scene, by which time it had been demolished.

During the subsequent litigation, the court excluded Nautilus’s fire investigator’s testimony and struck his expert report. In a subsequent motion for summary judgment, however, the court went a step further and dismissed the lawsuit due to Nautilus’s spoliation of evidence. In administering the ultimate sanction, the court noted that it is undisputed that Nautilus advised its insured the fire scene could be demolished (as opposed to the insured taking this action without Nautilus’s permission, which may have warranted a less severe sanction). The court also dismissed Nautilus’s contention that Appalachian Power was clearly on notice of the loss due to its status as utility provider. In dismissing this argument, the court drew a distinction between a subrogation target being aware of a loss and being specifically informed that a potential claim may be made against it.

Subrogation professionals are used to spoliation defenses resulting in adverse inferences or jury instructions at trial, but rarely do courts use their inherent authority to outright dismiss cases as a remedy for spoliation. This decision highlights the importance of retaining all potential evidence and giving all potential targets detailed notice of a potential claim and an opportunity to perform their own forensic investigation. Failure to do so may have an even larger impact on a subrogation claim than originally thought.

Construction Costs Must Be Reasonable

David Adelstein | Florida Construction Legal Updates

When it comes to proving a construction cost, particularly a cost in dispute, the cost must be REASONABLE.   Costs subject to claims must be reasonably incurred and the party incurring the costs must show the costs are reasonable.

An example of the burden falling on the contractor to prove the reasonableness of costs is found in government contracting.

“[T]here is no presumption that a [government] contractor is entitled to reimbursement ‘simply because it incurred…costs.’”  Kellogg Brown & Root Services, Inc. v. Secretary of Army, 973 F.3d 1366, 1371 (Fed. Cir. 2020) (citation omitted).  Stated differently, a federal contractor is not entitled to a presumption of reasonableness just because it incurs costs.  Id.

In government contracting, the Federal Acquisition Regulations (known as “FAR”) puts the burden of reasonableness on the contractor that incurred the costs.  Id.

FAR s. 31-201-2(a) [Determining allowability] provides, “A cost is allowable only when the cost complies with all of the following requirements: (1) Reasonableness….”

FAR 31-201-3 [Determining reasonableness] maintains:

(a) A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.

 (b) What is reasonable depends upon a variety of considerations and circumstances, including-

            (1) Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;

            (2) Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations;

            (3) The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and

            (4) Any significant deviations from the contractor’s established practices.

In Kellogg Brown & Root Services, a government contractor on an international project received a task order from the government to provide accommodations and life support services which equated to trailers for temporary housing for army personnel.  The government was to provide protection / security for the contractor.  The contractor subcontracted the procurement of the trailers.  The contractor claimed due to delays from the Army’s failure to meet its protection obligations, there were delivery delays resulting in storage costs and additional double handling costs (e.g., loading and unloading of trailers more than once) incurred by its subcontractor.  The contractor submitted a claim of “$48,754,547.25 in equitable adjustments for idle truck costs due to the backup of trailers at the border and double handling costs” due to the government’s failure to provide protection, along with associated markup.  Kellogg Brown & Roof Services, supra, at 1369.   The contracting officer’s final decision denied all of the claim but $3,783,005 which pertained to land that had to be leased to store the trailers due to the delay.

The contractor appealed the final decision to the Armed Services Board of Contract Appeals.  The Board concluded that the contractor had NOT demonstrated its costs were reasonable.  In particular, the Board found: (a) the contractor did not demonstrate a prudent person conducting a competitive business would have resolved its subcontractor’s delay claim upon the same model submitted by the subcontractor; and (b) the contractor did not demonstrate the double handling costs were reasonable.  The contractor submitted estimates from its subcontractor and did not submit any actual costs; thus, the Board found the damages models (estimates) were unreasonable and flawed.  For this reason, the Board denied all recovery prompting the contractor to appeal to the United States Court of Appeals for the Federal Circuit.

The United States Court of Appeals agreed with the Board that the contractor failed to show the costs it incurred were reasonable.  Even if the contractor established the government’s liability for the costs, the claim failed due to the failure to show the reasonableness of the incurred cots.

In addressing this issue, the Court noted that the contractor was not required to show the actual costs incurred by the subcontractor, but it was required to show the payments to its subcontractor—costs incurred—were reasonable.  The problem for the contractor was that it failed to show in any of its cost calculations that the methodology used to calculate the delay costs was reasonable.  Instead, the Court picked apart, based on what the Board concluded from the evidence, the model employed by the contractor for being inconsistent and unreasonable based on a number of different grounds as the contractor’s damages model did not depict actual events that occurred.  The Court explained, “[the contractor] supplied no meaningful evidence to the Board showing the reasonableness of its costs, nor has it explained the inconsistencies between its proposed cost model and the factual record.”  Kellogg Brown & Root Services, supra, at 1374.

Regardless of the type of project, it is important to remember that a party (e.g., contractor) still must demonstrate that the cost it is claiming as damages is a cost that it is reasonably incurred!