Thomas F. Segalla, Matthew S. Lerner and Han K. Kim – October 1, 2012
Construction defect coverage and liability litigation continues to be jurisdictionally specific and dictated by the relevant terms, conditions, limitations, exclusions and endorsements contained in the policy of insurance at issue. An assessment of the cases reported in this update indicates that the practitioner and claims professional must understand the chronology of critical facts and how the policy provisions have been interpreted by the courts in a particular jurisdiction.
We should not assume that all courts interpret or apply the facts, policy provisions and law in the same fashion. Absent such an understanding, the participants in construction defect litigation can be blindsided and prevented from shifting the risk to the appropriate entity. Below we have reported those cases that we believe will have a significant impact on the analysis of the issues faced in current coverage and liability construction defect litigation. We hope that they will provide a road map for the development of construction contracts and the drafting of insurance policy provisions.
Coverage Cases
California
Insurance Brokers Do Not Have a Duty to Notify Insureds of Insurers’ Insolvency
Pacific Rim Mechanical Contractors, Inc. v. Aon Risk Ins. Services West, Inc., 203 Cal. App. 4th 1278 (Cal. App. 4th Dist. February 28, 2012)
In Pacific, the court dealt with an issue of first impression in California: Whether an insurance broker, after procuring a policy of insurance, an OCIP in particular, for a developer on a construction project, owes a duty to notify a subcontractor, who was later added as an insured, of the insurance company’s subsequent insolvency. The court answered in the negative. The court first noted that the duty insurance brokers owed to their clients was limited, only requiring them “to use reasonable care, diligence, and judgment in procuring the insurance.” The court held that such a duty could not be expanded to require the broker to monitor indefinitely the financial condition of the insurance company. Rather, the duty lay with the insurers under the Insurance Code § 677.2. The court further supported its holding by citing its case law that found no such duty in case of policy cancellation. The court refused to impose on insurance brokers a new duty to monitor and notify the financial conditions of insurance company as such a role belongs to the legislature.
Practice Note: The court notes that there are at least 10 states that impose a statutory duty to notify an insured of a subsequent insolvency as soon as the broker receives notice of the insolvency. See Sinder et al., Agent/Broker Liability for Insurer Insolvency (4th ed. 2006) pp. 3, 10 [as of Feb. 27, 2012].
California
Fictitious Business Name (“dba”) May Cause Ambiguity in an Insurance Policy
Zurich American Insurance Co. v. Claremont Liability Insurance Co., case number 3:10-cv-02232 (S.D. Cal. January 30, 2012)
San Diego Mirror & Window (SDM&W) entered into a subcontract with Davidson Builders, under which SDM&W agreed to provide and install windows and doors. SDM&W was the fictitious business name of J&B Manufacturing, which was incorporated in 1992. The underlying action included a cross-claim for indemnity by Davidson Builders against J&B Manufacturing dba SDM&W. Claremont, defendant in the instant action, issued a CGL policy to SDM&W; dba: Certified Installation. At the time of the policy issuance, however, Certified Installation had not yet been incorporated. Nor did Certified Installation obtain a contractor’s license until the expiration of the Claremont policy. Claremont’s underwriting files identified “SDM&W; dba: Certified Installation” as “New Business” and as the “Complete Business Name.”
J&B Manufacturing’s insurer Zurich, which defended SDM&W in the underlying action, argued that Claremont had a duty to defend and indemnify both J&B Manufacturing dba SDM&W and Certified Installation. The court held that the use of the “dba” designation indicated Claremont’s intent not to insure all the activities of SDM&W but rather just the activities undertaken under the fictitious name “Certified Installation.” The court, on the other hand, acknowledged that such interpretation was incompatible with some of the exclusions in the policy. As the policy was susceptible to two reasonable constructions, the court, in turn, considered extrinsic evidence such as Claremont’s underwriting file and the files of other companies which insured both J&B Manufacturing and Certified Installation. As such documents on numerous accounts identified Certified Installation as a new entity that was distinguishable from J&B Manufacturing, a long-standing business entity, the court held that there was no coverage for J&B Manufacturing under the Claremont policy and thus no duty to defend.
Practice Note: This case basically arose out of the way the covered entity was named in its insurance policy. The court, for example, did not accept plaintiff’s argument that “;” translated into “and.” The court also considered “dba” designation as limiting the scope of the business entity. These subtle differences must be considered when crafting policy language as they can result in ambiguity.
California
Court Found Ongoing Operations Language in the Additional Insured Endorsement Ambiguous
McMillin Constr. Servs., L.P. v. Arch Specialty Ins. Co., 2012 U.S. Dist. LEXIS 8339 (S.D. Cal. January 25, 2012)
The dispute arose out of an endorsement in a subcontractor’s insurance policy that provided coverage for McMillin as an additional insured, “but only with respect to liability arising out of [the subcontractor’s] ongoing operations performed for that insured.” McMillin alleged that the defendant insurers had a duty to defend and indemnify McMillin in an underlying construction defect action since the “arising out of” language provided broad coverage for damages regardless of timing and the “ongoing operations” language was ambiguous. Insurers focused on the “ongoing operations” language asserting that they had no duty to defend under the policy because the operations were no longer ongoing. The court found that there was an ambiguity in the Additional Insured Endorsement at issue in this case and held that defendant insurers were not entitled to summary judgment based on the Endorsement.
Practice Note: The court found the reasoning of the Ninth Circuit in a case involving an additional insured endorsement similar to the instant case persuasive. The Ninth Circuit found the language in the endorsement ambiguous since the language could be construed as imposing a temporal limitation on coverage, but it was equally reasonable to construe as addressing only the type of activity from which the liability must arise in order to be covered. Tri-Star Theme Builders, Inc. v. OneBeacon Ins. Co., 426 Fed. Appx. 507, 2011 WL 1361468 (9th Cir. 2011).
Colorado
§ 13-20-808 Does Not Apply Retroactively; “Occurrence” May Include Unanticipated Damage to Nondefective Property Resulting from Poor Workmanship
Greystone Constr. v. Nat’l Fire & Marine Ins. Co., 661 F.3d 1272 (10th Cir. Colo. November 1, 2011)
Greystone, a general contractor, built residential homes that were sold to individual buyers. Greystone hired subcontractors to perform all work on the houses. The houses, however, were built on soils containing expansive clays. The expansive clays later caused the houses’ foundation to shift, which resulted in extensive damage to the homes’ living areas. This damage was neither intended nor anticipated. Greystone had obtained a standard CGL policy from National. While the instant proceeding was taking place, the Colorado General Assembly enacted Colo. Rev. Stat. § 13-20-808, which expanded the
scope of “accident” previously established by case law.See United Fire above. The court here was presented with two primary issues: (1) Whether Colo. Rev. Stat. § 13-20-808 applies retroactively to this case and (2) whether property damage arising from poor workmanship is an occurrence. The court answered the first issue in the negative noting its presumption of prospective application absent legislative intent to the contrary. As to the second issue, the court held that the CGL policy may cover damage to nondefective property arising from poor workmanship. In support, the court noted “a strong trend in case law” interpreting the term “occurrence” to “encompass unanticipated damage to nondefective property resulting from poor workmanship.”
Practice Note: The court notes that “most federal circuit and state supreme court cases” are in line with its definition of “occurrence.” (citing cases from GA, IN, MS, SC, FL, TX, KS, UT, WI, and AK as well as 7th Cir. and 4th Cir.) The court also notes “other courts” that conclude that damage to a contractor’s work arising from defective construction can never constitute a covered occurrence. (citing cases from KY, AR, PA, NE, WV, OR, IA, and OH)
Colorado
CGL’s “Insured Contracts” Provision Only Applicable to the Name Insured
United Fire & Cas. Co. v. Boulder Plaza Residential, LLC, 633 F.3d 951 (10th Cir. Colo. Jan. 27, 2011)
A real estate developer and a construction company entered into a contract by which the construction company agreed to serve as the general contractor for the interior construction work of a condominium. The contract contained the general contractor’s agreement to indemnify the developer. The general contractor then entered into a subcontract with a flooring company by which the flooring company agreed to indemnify the general contractor. The subcontractor flooring company, in turn, obtained a CGL policy from United Fire & Casualty (“UFC”). The CGL policy provided coverage for “insured contracts,” which were defined as:
That part of any other contract or agreement pertaining to your business … under which you assume the tort liability of another party to pay for “bodily injury” or “property damage” to a third person or organization.
The developer argued that the general contractor’s assumption of contractual liability to the developer fell within the scope of the “insured contracts” covered by the CGL policy issued by UFC. It also argued that UFC accordingly had a duty to indemnify the general contractor for any liability to the developer. The court disagreed, reasoning that UFC’s CGL policy made a distinction between the named insured subcontractor and the additional insured general contractor, by using the terms such as “you and “your” to exclusively indicate the name insured. As the “insured contracts” provision only applied to the named insured’s contracts under such language, UFC did not have a duty to indemnify the general contractor for its contractual obligation.
Practice Note: Despite its inapplicability to the instant case, the court noted the enactment ofColo. Rev. Stat. § 13-20-808, which expanded the scope of “accident” previously established by Colorado’s case law. § 13-20-808 provides that “in interpreting a liability insurance policy issued to a construction professional, a court shall presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident.”
Hawaii
Intentional Nondisclosure and Fraud Do Not Constitute an Accident or Occurrence
State Farm Fire & Cas. Co. v. Vogelgesang, 2011 U.S. Dist. LEXIS 72618 (D. Haw. July 6, 2011)
Homeowners sued their contractor, alleging that the contractor had defectively constructed and failed to complete their homes. The underlying complaint alleged that various aspects of the residence were not completed properly, that the contractor deceived the homeowners about the status of the contractor’s workers, and that the contractor failed to provide certain disclosures. State Farm agreed to defend the insured contractor under a reservation of rights and pursued the instant declaratory judgment action seeking a determination as to whether State Farm had a duty to defend or indemnify the insured under a CGL and umbrella policies. The court held that intentional nondisclosure and fraud alleged in the complaint did not constitute an accident and thus were not an occurrence or loss under Hawaii insurance law. The court found that the remaining claims asserted in the underlying litigation arose from the contractor’s alleged breach of construction contract and held that breach of contract claims were not accidents and, thus, did not trigger State Farm’s duty to defend under the policies. The court also found that the homeowners’ negligence claim that the contractor failed to finish the residence in a timely and workmanlike manner was not truly an independent cause of action, but instead a restatement of the breach of contract claim.
Practice Note: The court also considered the impact of H.B. No. 924, the recently enacted legislation affecting insurance coverage under CGL policies for construction defects. It provides that, for liability insurance policies that cover occurrences during the policy period and insure a construction professional for liability arising from construction-related work, the meaning of the term “occurrence” shall be construed in accordance with the law as it existed at the time that the insurance policy was issued.
Illinois
Damage to the Structure Itself, Regardless of Whether the Insured Worked on that Particular Part of the Structure, Is Not an Accident
Nautilus Ins. Co. v. 1735 W. Diversey, LLC, 2011 U.S. Dist. LEXIS 82246 (N.D. Ill. July 21, 2011)
1735 W. Diversey, LLC (Diversey), the insured, converted a vacant building into condominiums by installing new mechanical, electrical and plumbing in the interior, installing new roof coverings and windows on the exterior and tuckpointing the exterior surfaces of the building, among other things. Diversey obtained commercial lines policies from Nautilus, which covered bodily injuries and property damage caused by an “occurrence.” The policies also contained a “Products-Completed Operation Hazard” exclusion. Soon after the units were sold to individual buyers, one of the new owners started complaining about water leakage. The board of directors of the condominium, which was organized to manage the common areas of the units, hired an inspection company to investigate the cause–nearly five years after the work on the condominiums was completed. The inspection company concluded that a primary cause of water infiltration was the deteriorated exterior brick masonry walls. Diversey argued that its faulty workmanship was covered by the policies as its workmanship damaged parts of the building that they did not work upon and was not damage to the project itself. The court held that, under Illinois law, damage to the structure itself, regardless of whether the insured worked on that particular part of the structure, could not be an accident, and, thus, was not an occurrence. As to the underlying complaint regarding damages to personal property, the court held that the “Products-Completed Operations Hazard” exclusion applied as they occurred both after the work was completed and after the insured had transferred ownership to the individual unit owners.
Practice Note: The court notes that treating faulty workmanship as an “accident” is equivalent to transforming an insurance policy into performance bond, illustrating its unwillingness to adopt such expansive definition.
Mississippi
Coverage Barred by Business Risk Exclusions
Lafayette Ins. Co. v. Peerboom, 813 F. Supp. 2d 823 (S.D. Miss. June 2, 2011)
Certain homeowners claimed they sustained damage when a contractor failed to use proper equipment to raise their home 24 inches, which allowed the house to fall. Lafayette Insurance sought a declaratory judgment its policy provided no coverage for the damage. Lafayette moved for summary judgment asserting that the incident was not an occurrence, and the business risk exclusions would bar coverage even if it were an occurrence. The court found that even though the homeowners did not identify what caused the house to fall, the complaint left open the possibility that the property damage at issue was proximately caused by an accident and thus was the result of an occurrence. Accordingly, the court ruled that summary judgment could not be granted on this basis. The court noted that some cases found the business risk exclusions inapplicable if the insured was working only on the foundation and the entire structure was damaged. The court found that, in this case, it was manifest that the insured was hired to perform work on the entire house. Therefore, the risk that the house would fall and sustain damage was not merely a fortuitous event, but a business risk which fell squarely within the policy exclusions.
Practice Note: Under Mississippi law, the determination of whether a liability insurance carrier has a duty to defend depends on the policy language and the allegations of the complaint. Under the so-called “eight-corners” test, the allegations in the complaint are analyzed against the language in the policy to determine coverage and the duty to defend.