Exclusions In Construction Insurance Policies

Jeff G. Coyner | The Green Law Group

Construction general liability policies are expensive in today’s market.  In response to this, insurance underwriters have attempted to make policies less expensive.  Insurance companies do this by adding exclusions to policies which limit the instances where a carrier may have to pay.

How exclusions make insurance less expensive

So for example, projects for new residential construction result in far more claims than residential remodel projects.  Therefore, if a contractor only performs residential remodels, adding a new residential construction exclusion to the policy will likely make the policy much less expensive and make sense for that contractor.  In a perfect world, this is picked up when the contractor fills out an application with the broker during the re-insurance process.

As the construction insurance market has become more competitive, I have seen more and more of these specific exclusions in the marketplace.  Some of these include but are not limited to:

  • Residential framing exclusions
  • Earth movement exclusions
  • Residential construction exclusions
  • New construction exclusions
  • Medical facility exclusions

Another common exclusion limits coverage to the type of work listed by a contractor on the re-insurance application.  For example, if a contractor states on an application that he works as a framing contractor, it may not be covered if he subsequently performs concrete repairs.

Miscommunications between brokers and contractors

All too often, I have a contractor come to my office seeking help because they are being sued and the insurance carrier has denied coverage.  When I look at the policy, I soon find that the policy contains an exclusion which makes no sense given the type of work performed by the contractor.

For example, I have had foundation drilling contractors with earth movement exclusions, general contractors with framing exclusions and contractors who build new homes with new residential constructions exclusions.  Most of the time, these contractors had no idea that these exclusions were in their policies.

When I investigate this issue, almost always the problem relates back to miscommunications between the brokers who sold the policies and the contractors.  Often the brokers did not take the time to completely understand what it is the contractors do, failed to tell the contractor what new exclusions were added to the policies to get a cheaper price and/or the contractors did not understand what information the brokers were actually seeking on the reinsurance applications.

The result can be catastrophic to a contractor’s business and may lead to malpractice claims against the brokers

Unfortunately, these miscommunications lead to terrible legal conflicts.  If a contractor ends up being uncovered, they may go out of business as a result of the tens or hundreds of thousands of dollars of attorney’s fees in defending an uncovered lawsuit.  The broker may also face professional negligence claims.

To address this issue, both brokers and the contractors must spend more time communicating exactly what work the contractors perform.  The insurance professionals who sell constructions polices need to become more familiar with the basic aspects of construction.  Finally, the contractors need to speak with an insurance attorney whenever they have any questions regarding the reinsurance process.

Nevada Supreme Court Rules Insured Must Prove Coverage Owed in Construction Defect Litigation

Jim Sams | Claims Journal

At least 14 construction defect lawsuits have been filed against developers and subcontractors that built thousands of Nevada homes.

Two insurers issued commercial liability policies to cover such claims, but they didn’t agree on whether a prior-damage clause in one of the policies excluded coverage. Two U.S. District Court judges in Las Vegas created a legal conundrum by issuing conflicting opinions as to whether the insurer or the insured bore the burden of proving that coverage was owed under an exception to that exclusion.

The Nevada Supreme Court helped settle that question on Thursday by ruling that an insured must prove that an exception in the policy language does not exclude coverage. The high court also decided that the insured can use extrinsic evidence — meaning testimony or documents not in the pleadings — to decide whether the exception applies.

The Supreme Court said in a unanimous decision that Nevada law is silent on the question, but under contract law, the burden always falls on one party or the other to produce evidence to persuade a judge.

“In Nevada, the burdens of production and persuasion rests with the insured, who has the initial burden of proving that the claim falls within the policy coverage,” the court said in a unanimous opinion, citing a previous ruling. “The assignment of the burden of proof to the insured to prove that the claim potentially falls within the exception to the exclusion, which in effect re-establishes coverage, is in alignment with these principles as well.”

The question came to the Supreme Court via a certified question asked by the federal 9th Circuit Court of Appeals, which is seeking to resolve the conflicting rulings by the U.S. District Court judges. Federal courts rely on state courts to resolve unsettled questions in state law.

Nevada homeowners brought 14 construction defect lawsuits against developers in Nevada state court from 2010 to 2013. The developers sued their subcontractors as third-party defendants. The subcontractors turned to Zurich American Insurance Co. to defend them because Zurich units had insured them while construction was underway.

Zurich obliged and reached settlements with the subcontractors, but also filed suit against Ironshore Specialty Insurance Co. for indemnification and defense.

Ironshore had issued policies to the subcontractors after construction was complete. The carrier argued that no coverage was owed because of a provision in the policy that excluded coverage for any damage that occurred before the policy was issued.

Zurich countered that the exclusion for pre-existing damage had an exception that covered any sudden and accidental damage.

On Oct. 12, 2017, U.S District Court Gloria M. Navarro ruled in Zurich’s favor, finding that the prior-damage exclusion did not apply because the policies did not state when the damage occurred. She ordered Ironshore to share half the cost of the subcontractors’ lawsuits, which amounted to $488,233.

But five months later, U.S. District Court Judge Jennifer A. Dorsey granted summary judgment in a separate but nearly identical lawsuit in favor of Ironshore. She found that damage that occurred before the policy was issued was clearly excluded and the exception for sudden and accidental damage did not apply.

The Supreme Court said that Navarro’s ruling implicitly concluded that the insurer had the burden of proving that the exception to the exclusion applied, while Dorsey’s order implicitly concluded that the burden rested on the insured. Dorsey made the right call, the high court decided.

The opinion says that a majority of courts that have ruled on the question about who has the burden of proving whether an exception to a policy applies have denied that the burden lies on the insured. Nevada law requires that the insured establish coverage under a policy.

“We hold that the majority rule, which places the burden on the insured, to, in essence, reestablish coverage where it would not otherwise exist, accords with these principles,” the opinion says.

Mind the Gap: Coverage Gaps Created by Commercial General Liability Policies

Kelsey Dilday | Barnes & Thornburg

One of the most important things a business owner can do to protect their business is to purchase insurance. If you are new to the realm of insurance – or are simply relying on common sense – you may believe that the best policy to protect your business is a simple commercial general liability policy (CGL). After all, a typical CGL appears to provide broad coverage, usually for “all sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies.”

Yet while this language initially appears broad, the standard CGL policy is often rife with exclusions and definitions that may significantly undercut your coverage – limiting the types of injury and damage “to which this insurance applies.” These exclusions or definitions can create what are called coverage “gaps” when standing alone or interacting with other policies you may have.

The Professional Services Exclusion

Imagine this: You own an architecture and engineering firm that provides design specifications for large construction projects. Despite a design that, when implemented properly, would have been executed safely, your subcontractor’s employee is injured on the job when the bosses instruct them to perform a more dangerous maneuver than your designs specified. Your insurer issued you a CGL policy, which contained an exclusion for bodily injury “arising from or caused by the rendering or failure to render professional services.” You notify your CGL insurer, expecting CGL insurer coverage for the accident, because your designs were safe, and the accident was caused by deviation from your safe specifications.

To your surprise, your CGL insurer denies coverage on the basis that the bodily injury arises from your firm’s professional services, because you created the designs, and because many courts will interpret exclusionary language including phrases such as “arising from” or “arising out of” expansively. How do you navigate this coverage “gap?”

You may convince your CGL insurer that, because the cause of the accident was really deviation from your safety specifications, the bodily injury did not actually stem from your professional services, such that your CGL policy may still apply. However, that argument may be an uphill battle that largely depends on state interpretation of exclusionary provisions.

You may be able to argue that such a “gap” creates “illusory” coverage, where based on the services your firm regularly provides, your CGL policy fails to provide any coverage at all. Such an argument also depends on your jurisdiction, but where such an argument is accepted, courts will generally uphold the reasonable expectations of the insured and may require the insurer to cover such a gap, so long as your reasonable expectation was that such injuries would be covered upon procurement of the policy.

While there certainly may be arguments that you could make in favor of coverage, the easiest solution to the coverage gap is to ensure no gaps exist at all. One common way to do this is to ensure you have a policy that complements any “gap” created by your CGL policy. In this scenario, such a policy would be a professional liability policy specifically designed to provide coverage for bodily injury stemming from professional services that you offer.

When obtaining such a policy from a broker or insurer, it is important to read the language of each policy purchased to ensure that any coverage gaps are filled. For example, if a CGL policy excludes bodily injury arising from rendering or failure to render professional services, you should carefully review your professional liability policy to ensure that your professional liability policy does not exclude bodily injury generally, as such a combination may likewise provide only illusory coverage.

Other Common Coverage Gaps

Other common exclusions in a CGL policy that could create coverage gaps may be exclusions based on use of an automobile; cyberattacks or other data breaches; actions taken by directors and officers of a company that may cause harm your company; and/or pollution. Mitigating the harm that may derive from these coverage gaps can be similar to the strategies outlined above, with the most important being to ensure that, where any gaps may exist, a business owner has purchased a policy that may provide the coverage a CGL policy has excluded.

A comprehensive insurance package will generally contain protections for all facets of an operation. Such a package may include a policy or multiple policies providing coverage for commercial general liability, commercial property, professional liability, automobiles, directors and officers’ liability, and/or cyber liability.

A business owner should always mind the gaps in coverage that a CGL policy can create. Pay particular attention when purchasing new policies or a package of policies to ensure that those policies work together, rather than against one another in a way that might leave you with uncovered liability. There is no reason to battle an insurer over concepts such as interpretation or illusory coverage stemming from a coverage gap when those gaps could have been successfully avoided in the first place.

Construction Defect Damages May Exceed Cost To Repair

Peter Selvin | Ervin Cohen & Jessup

Construction defect cases often involve damage claims beyond simply the cost to repair the allegedly defective unit or component. These consequential damages may include damages for loss of use, expenses for mitigation and even attorney fees. For this reason, builders, suppliers, contractors and subcontractors who are faced with such claims should carefully review their insurance coverages, especially their CGL policies.

At the threshold, a defendant seeking coverage under its CGL policy in connection with a construction defect claim must satisfy the policy’s “occurrence” requirement. Although there is a split of authority on this point nationally, California law is settled that inadvertent property damage caused by intended construction activity constitutes an “occurrence.” See, e.g., Geddes & Smith v. St. Paul Mercury Indemnity Co., 51 Cal. 2d 558, 563 (1959); Anthem Electronics v. Pacific  Employers Insurance, 302 F.3d 1049 (9th Cir. 2002). See also Scott C. Turner, “Insurance Coverage of Construction Disputes,” Sections 6:56, 6:62 (2nd Ed.).

The next step is to establish that there has been “property damage.” This is because the basic coverage grant typically provides that the CGL insurer is responsible for paying “those sums that the insured becomes legally obligated to pay because of … property damage to which this insurance applies.” In turn, “property damage” is typically defined as either “physical injury to or destruction of tangible property … including the loss of use … resulting therefrom” or “loss of use of tangible property which has not been physically injured or destroyed [that has been] caused by an occurrence.”

It has been generally held that incorporation of defective components or faulty workmanship into a project constitutes “physical injury to tangible property,” thereby allowing coverage for damages from the loss, including damages measured by resulting decrease in the property’s value. See, e.g., United States Fid. & Guar. Co. v. Wilken Insulation Co., 550 N.E. 2d 1032 (Ill.App. 1989). The theory behind this rationale is that typical a coverage grant requires the CGL carrier to pay “those sums that insured becomes legally obligated to pay because of … property damage” (emphasis added). In other words, carrier responsibility includes not only damages that arise directly from the “property damage,” but also all sums arising because of the property damage. See, e.g., AIU Ins. Co. v. Superior Court, 51 Cal. 3d. 807 (1990) (reimbursement of response costs and the costs of injunctive relief under CERCLA and related statutes are insured “because of” property damage). While not exhaustive, the following examples illustrate some of the categories of consequential damages for which a CGL carrier may have responsibility.

Damage to the Larger Structure Caused by the Construction Defect

It is well established that damage to a physical structure, including the structure’s non-defective units or components, arising from the incorporation of the defective work should be covered under a CGL policy. See e.g., Economy Lumber v. Insurance Company of North America, 157 Cal. App. 3d 641 (1984). In some cases, damages are expressed as the diminution in value of the larger structure caused by the construction defect. See Franco Belli Plumbing & Heating v. Liberty Mut. Ins. Co., 2012 WL 2830247, *8 (E.D.N.Y. 2012) (“when one product is integrated into a larger entity, and the component product proves defective, the harm is considered harm to the entity to the extent that the market value of the entity is reduced in excess of the value of the defective component”); see also Anthem Electronics 302 F.3d at 1056-57 (“we decline to hold that coverage was precluded simply because the extent of such damage is expressed as an economic loss”).

So-Called “Rip and Tear” Damages

Where an owner must undertake repair work to existing conditions in order to access and remediate the defective work, the damages resulting therefrom may be covered. Thus, costs and expenses relating to this activity are considered part of consequential damages for which there should be coverage. Turner, supra, Section 6.29 (coverage for the damage to other, non-defective work necessarily caused in the course of removing or repairing the defective work).

Coverage for Costs Arising from Mitigation Efforts

In some cases, an owner may be obliged to take actions and incur expenses in order to protect the project from further damage caused by the alleged defect. Although the courts are split on this issue, the majority say these expenses are also considered as part of consequential damages for which there should be coverage. Turner, supra, Section 6.14, 6.22 (“costs incurred for mitigation or prevention of further property damage” are recoverable against CGL carrier).

Loss of Use

Damage resulting from the loss of use of the premises is a key item within the larger category of consequential damages. Am. Home Assurance v. Libbey-Owens-Ford, 786 F. 2d 22,  25 (1st Cir. 1986); Federated Mutual Insurance Co. v. Concrete Units, 363 N. W. 2d 751 (Minn. 1985); Gibraltar Casualty Co. v. Sargent & Lundy, 214 Ill. App. 3d 768 (1990); Lucker Manufacturing Co. v. The Home Insurance Co., 23 F. 3d 808 (3rd Cir. 1994); M. Mooney Corp. v. United States Fidelity & Guaranty Co., 618 A.2d 793, 796 (N. H. 1992); Thee Sombrero v. Scottsdale Ins. Co., 28 Cal. App. 5th 729 (2018); Turner, supra, Section 6:33.

Attorney Fees Awards

Some courts have held that attorney fees awards against the negligent contractor, subcontractor or supplier qualify as an element of consequential damages recoverable under a CGL policy. For example, in APL Co. v. Valley Forge Ins. Co., 754 F.2d 1084 (N.D. Cal. 2010), reversed on other grounds, 541 Fed. Appx. 770 (2013), the court concluded that the attorney fees award against the insured was covered under the insurance policy at issue. The court cited the policy provision there that coverage was provided for “those sums that the insured becomes legally obligated to pay as damages because of …’property damage.’” The court noted that inasmuch as the insured became obligated to pay attorneys’ fees to the claimant arising out of the underlying property damage claim, the award was properly recoverable against the insurer. 754 F.2d at 1094.

Other cases have reached the same result. See, e.g., American Family Mutual Ins. Co. v. Spectre West Building Corp., 2011 WL 488891 (D. Az. Feb. 4, 2011) (in the context of a construction defect case, the Court found that attorneys’ fees that were assessed against the insured were covered under the insurance policy, noting that “the issue before the court is not whether attorneys’ fees and costs can be characterized as ‘property damage’, but whether they can be characterized as damages that [the defendant construction company] became legally obligated to pay because of property damage”).

“Tail Coverage” – Understanding The Extended Reporting Period

Pamela G. Michiels | Phelps Dunbar

Professional liability policies, almost always written on a claims-made basis, typically contain a number of options for the insured to obtain an Extended Reporting Period (ERP). What does that mean? And why might it be necessary, or at least a good idea? While many variations on the ERP exist, the basic purpose, function and operation of the ERP are fairly standard. Here’s what you should know.  

The ERP, also known as “tail coverage,” provides for an additional period of time during which the insured can report a claim after its claims-made policy has expired. That’s important, because the policy itself typically provides that the claim must be first made against the insured, and reported to the insurer, during the policy period. Tail coverage typically isn’t necessary if the insured is renewing its coverage, but it can be invaluable where that’s not the case. 

  • Some policies provide a limited “automatic” ERP to allow the insured a grace period, usually 30 to 60 days, to report a claim that was made during the policy period.This typically costs the insured nothing. 
  • If an insured’s policy is cancelled or non-renewed by the insurer, or the insured elects to cease carrying professional liability coverage, an “optional” ERP is available at an additional cost to the insured. The cost is usually based on a multiple of the premium on the cancelled or expiring policy. Such tail coverage is typically purchased in one-year increments, up to five years, and sometimes longer – but as the tail grows, the cost goes up, since the insurer is taking on additional risk.
  • Typically, the only instance in which an ERP will not be offered is where the policy has been cancelled for cause – nonpayment of premium, fraud or material misrepresentation.
  • Some ERPs extend the time during which a claim that was first made during the policy period can be reported.Other ERPs allow for the extension of coverage where the claim was both first made against the insured and reported to the insurer during the ERP, as long as the wrongful act giving rise to the claim took place after the retroactive date and prior to the end of the original policy period. 
  • The ERP does not extend the policy period, and does not change the scope of coverage or increase the policy’s available limits.
  • A common reason to obtain tail coverage is where an insured is winding up its business – due to retirement, sale or unprofitability, for example. While there’s no need to maintain professional liability coverage on a shuttered business, the insured will want to maintain some protection against wrongful acts it may have committed prior to the policy’s expiration, but a claim has not arisen and thus cannot be reported until after the policy has expired.
  • An ERP is always optional, and an insured is never required to purchase one. However, the ERP provides a great deal of additional protection and should be seriously considered, especially if the insured foresees a major change to its business or its insurance program.