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.

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”).

Rather Than Limit Decision to “That Particular Part” of Developer’s Policy Necessary to Bar Coverage, 10th Circuit Renders Questionable Decision on Exclusion j(6)

William S. Bennett | SDV Insights

The 10th Circuit Court of Appeals, applying Colorado law, recently extended Colorado’s broad application of the phrase “arising out of” in insurance interpretation, barring an insured real estate developer from receiving a defense to a suit alleging liability for construction of a defective retaining wall and associated resulting damage.1  The decision also included a questionable analysis of the commercial general liability (“CGL”) policy’s exclusion j(6), contradicting both the plain meaning of the exclusion as well as existing 10th Circuit case law.

The underlying dispute concerned a land developer, HT Services, LLC, who was sued by the homeowner’s association (“HOA”) of one of its developments. The HOA alleged that HT Services negligently designed and constructed a retaining wall in the community. HT Services had CGL policies from Western Heritage Insurance Company in place from 2010 to 2013 that insured it for liability associated with four acres of land that the community was built upon.

HT Services tendered the HOA’s lawsuit to Western Heritage, which declined to defend and indemnify HT Services. After that matter settled, HT Services sued Western Heritage, alleging breach of contract and bad faith. Western Heritage moved for summary judgment, asserting two exclusions, and the District Court granted the motion in Western Heritage’s favor. In upholding the District Court’s decision, the 10th Circuit discussed two exclusions that the District Court determined precluded coverage.

The first was a “habitational new construction” exclusion present in the policies, comparable to many residential construction exclusions common across the industry. In pertinent part, the exclusion applied to bar coverage “arising out of, relating to or in any way connected with … the development, construction, conversion and/or demolition of [residential structures].”

Seeking to avoid this exclusion, HT Services argued that the retaining wall in question must be within a certain proximity of a residence to qualify as a “residential structure.” The court disagreed, and explained that the phrase “arising out of, relating to or in any way connected with” clearly encompassed the damages associated with the allegedly defective retaining wall, which “was constructed as a part of the development of the Willow Creek residential community.” This result was unsurprising.

However, the court next turned to and discussed exclusion j(6), which the court found “squarely applied” to the allegations of the HOA’s complaint, “including that it suffered damages resulting from HT Services’ defectively … constructed retaining walls.” Quoting another 10th Circuit case from 2006, Advantage Homebuilding LLC v. Maryland Cas. Co., the court stated that, in Colorado, this exclusion “was intended to exclude ‘property damage’ that directly or consequentially occurs from the faulty workmanship of the insured and its contractors/subcontractors … while the work is ongoing.”2

The court’s assertion that j(6) precludes coverage for HT Services contradicts the plain language of the j(6) exclusion and fails to cite the Advantage Homebuilding decision in full context.

Exclusion j(6) bars coverage for damage to “that particular part of any property that must be restored, repaired, or replaced because ‘your work’ was incorrectly performed on it.” The plain language of the exclusion contradicts the statement from Advantage Homebuilding that the court selectively quotes. The exclusion only applies to that particular part of any property that must be restored, repaired, or replaced due to faulty work. Consequential damage caused by the failure of that particular part faultily constructed is not barred from coverage by j(6). Accordingly, the Advantage Homebuilding court explained that “the express exception to exclusion j(6), though, allows an insured to recover consequential damages that arise out of his or her faulty workmanship after the completion of the work.”

The court here indicated that the HOA “suffered damages resulting from HT Services’ defectively constructed retaining walls.”3  Because j(6) does not apply to consequential damage to other parts of the broader project which are not defective, it is unclear why the court extended its application here, when it did not need to address the exclusion in the first instance.

Another issue with the j(6) analysis is its failure to discuss the “products-completed operations hazard.” A standard CGL provides that the j(6) exclusion does not apply to property damage included in the “products-completed operations hazard.” Given that the retaining wall was completed in February 2012, and the HOA sued HT Services in 2016, it is hard to reconcile the court’s failure to address this exception, especially in a duty to defend case with allegations stating that there was consequential, resulting damage when a court need only find a single allegation that could potentially be covered in order to extend the insured a defense.

The policies held by HT Services also contained a CG 21 04 exclusion, which bars coverage for all property damage included within the products completed operations hazard.4 The presence of this exclusion makes the court’s reliance on j(6) all the more surprising, as this exclusion would have been a far more appropriate basis for the court’s decision than j(6).

The impact of this case is uncertain, as it is not entirely clear that the court understood its statements about j(6) seemed to undermine j(6)’s exception for completed operations liability. However, policyholders should be prepared for this case to be cited by insurers in Colorado construction defect situations. Fortunately, the case casts Advantage Homebuilding, which seems to properly outline the framework for application of j(6) and coverage for damage resulting from faulty work, in a positive light. In any construction defect claim in Colorado, the policyholder’s focus should continue to be identifying and focusing on the components of the claim that constitute damage resulting from faulty work and the “rip and tear” amounts necessarily incurred to access and fix such work. 

__________________________________________________________________
1HT Services, LLC v. Western Heritage Ins. Co., 2021 WL 2206323 (10th Cir. 2021).
2Advantage Homebuilding LLC v. Md. Cas. Co., 470 F.3d 1003, 1012 (10th Cir. 2006).
3(Emphasis added).
4Letter from Nationwide/Western Heritage, Pl’s. Mot. For Partial Summ. J., Ex. 10 at 13, ECF No. 26-11

Delaware District Court Finds CGL Insurer Owes Condo Builder a Duty to Defend Faulty Workmanship Claims — Based on the Subcontractor Exception to the Your Work Exclusion

Anthony Miscioscia and Laura Rossi | White and Williams

On September 7, 2021, in one of the few decisions addressing the scope of coverage for faulty workmanship under Delaware law, the Delaware District Court denied an insurer’s motion seeking a declaration that it neither needed to defend nor indemnify an insured-builder under a commercial general liability policy.

In this declaratory judgment action, Pennsylvania National Mutual Casualty Insurance Company v. Zonko Builders, the insurer argued that the ongoing underlying action failed to properly plead an “occurrence” in a case alleging damages to a condominium caused by faulty workmanship involving subcontractors.* Zonko Builders (Zonko) served as the general contractor, supervising subcontractors. The Condominium Association sued Zonko for damages allegedly resulting from design and construction deficiencies. The motion was opposed by the Condominium Association, which cross-moved for partial judgment on the pleadings.

In AE-Newark Associates, L.P. v. CNA Insurance Companies2001 Del. Super. LEXIS 370 (Del. Super. Ct. Oct. 2, 2001), the Delaware Superior Court found that an insured was entitled to coverage for damages arising from a faulty roof system installed by a subcontractor on behalf of the insured general contractor.

Although the CGL policy at issue defined an “occurrence” as an accident, the policy also contained an endorsement providing that damages because of property damage to “your work” shall be deemed to be caused by an “occurrence” if the damage was performed on the insured’s behalf by a subcontractor. Nonetheless, the insurer argued that it owed no coverage because faulty workmanship is not an occurrence.

Relying on the 20-year old holding in AE-Newark Associates, as well as a number of out-of-state opinions, the Delaware District court in Zonko noted:“[w]hile we are mindful Delaware Courts have rejected a definition of ‘occurrence’ which includes faulty workmanship, we note no Delaware court analyzed the interplay of subcontractor exceptions and the term ‘occurrence.’” The court went on to explain that “if the Policy does not cover subcontractors’ faulty work, the Policy’s Your Work Exclusion need not specifically except subcontractors’ work. Such an interpretation contravenes Delaware law by rendering the Subcontractor Exception mere surplusage.” Thus, the court found that the Policy’s endorsement provided support to the fact that the definition of “occurrence” included subcontractors’ faulty work.

The court denied the motion as to the insurer’s duty to indemnify and dismissed the Condominium Association’s counterclaims, concluding that the Association lacked standing and the duty to indemnity issue was still unripe.

The Zonko opinion provides insurers with cautionary guidance that, in drafting an exclusion, an insurer may unwittingly provide an insured or court with ammunition to argue/find that the insuring agreement is otherwise broader than the insurer perhaps intended.

In Brief: Commercial General Liability Policies in USA

Bryce L. Friedman and Mary Beth Forshaw | Simpson Thacher & Bartlett

Standard commercial general liability policies

Bodily injury

What constitutes bodily injury under a standard CGL policy?

CGL policies generally provide coverage for bodily injury or property damage sustained by third parties (rather than the policyholder) as a result of an occurrence.

Insurance coverage litigation frequently centres on whether the underlying claims against the policyholder allege bodily injury or property damage within the meaning of the applicable insurance policy, and whether the events giving rise to the injury or damage were caused by an occurrence.

The phrase ‘bodily injury’ in insurance contracts generally connotes a physical problem. However, a number of courts have ruled that the term also encompasses non-physical or emotional distress, either standing alone or accompanied by physical manifestations.

The question of whether bodily injury exists may also arise where an underlying complaint alleges non-traditional or quasi-physical harm, such as biological or cellular level injury or medical monitoring claims. Courts addressing these and other analogous bodily injury questions have arrived at mixed decisions. Bodily injury determinations are often case-specific, turning on the particular factual record presented.

Property damage

What constitutes property damage under a standard CGL policy?

Property damage typically requires injury to or loss of use of tangible property. Therefore, the mere risk of future damage is generally insufficient to constitute property damage. Similarly, it is generally held that the inclusion of a defective component in a product, standing alone, does not constitute property damage. Numerous other allegations of harm or potential harm to property have generally been deemed to fall outside the scope of covered property damage, including the following:

  • injury to intangible property (such as computer data);
  • injury to goodwill or reputation;
  • pure economic loss; and
  • diminished property value.

However, although economic loss is not equated with property damage, courts may use a policyholder’s economic loss as a measure of damages for property damage where physical damage is found to exist.

Occurrences

What constitutes an occurrence under a standard CGL policy?

Virtually all modern-day general liability insurance policies provide coverage for an occurrence that takes place during the policy period. The insurance term ‘occurrence’ is typically equated with or defined as an accident or an event that results in damage or injury that was unexpected and unintended by the policyholder.

Insurance litigation frequently involves several issues relating to the occurrence requirement:

  • whether intentional conduct that results in unexpected or unintended harm constitutes an occurrence;
  • whether negligent conduct that results in expected or intended harm constitutes an occurrence;
  • whether an event or series of events constitutes a single occurrence or multiple occurrences;
  • whether the occurrence falls within a given policy period (ie, what is the operative event that triggers a policy?); and
  • how insurance obligations should be divided among multiple insurers (or the policyholder) when an occurrence spans multiple policy periods (ie, allocation).

Although it is a widely accepted principle that insurance policies provide coverage only for fortuitous events, and cannot insure against intentional or wilful conduct, it is less clear whether (and under what circumstances) intentional conduct that results in unexpected and unforeseen damage can constitute a covered occurrence. This question has arisen in a multitude of factual contexts, including claims arising out of faulty workmanship, pollution and fax blasting in violation of federal statutes. In evaluating the occurrence issue, some courts focus on the initial conduct of the policyholder, while other courts look to whether the resulting harm was unexpected or unintended.

How is the number of covered occurrences determined?

The determination of whether damage or injury is caused by a single occurrence or by multiple occurrences has significant implications for available coverage. The number of occurrences may impact both the policyholder’s responsibility for deductible payments and the per occurrence policy limits that are available. Thus, it is a hotly contested issue in insurance litigation. Most courts utilise a cause-based analysis to determine the number of occurrences. Under the cause-oriented approach, if there is one proximate cause of the injury, there is one occurrence, regardless of the number of claims or incidents of harm.

In contrast, under an effects-oriented analysis, the focus is on the number of discrete injury-causing events.

A number of occurrences disputes arise in virtually all substantive areas of insurance litigation, including claims arising out of asbestos, environmental harm, natural disasters, and the manufacture or distribution of harmful products.

Coverage

What event or events trigger insurance coverage?

Litigation that centres on whether a given policy period has been implicated by an occurrence is generally referred to as a ‘trigger of coverage’ dispute. ‘Trigger’ describes what must happen within the policy period for an insurer’s coverage obligations to be implicated. In cases involving ongoing or continuous property damage or personal injury, the question of what triggers policy coverage may be complex. From a legal perspective, courts employ several different methods to resolve trigger disputes. For bodily injury claims, the operative trigger event has been held to be:

  • at the time of exposure to a harmful substance;
  • at the time the injury manifests itself;
  • at the time of actual ‘injury in fact’; or
  • a combination or inclusion of all of the above.

Property damage claims have also given rise to multiple trigger approaches, some of which focus on the initial event that set the property damage into motion, while others look to the time that physical damage became evident. From a factual perspective, parties are often required to submit voluminous evidence in support of their position as to when property damage or bodily injury actually occurred. Expert witnesses are often retained to address trigger issues.

How is insurance coverage allocated across multiple insurance policies?

When an occurrence triggers multiple policy periods, disputes frequently arise as to how indemnity costs should be allocated among various insurers. The emerging trend in courts in the United States is a pro rata approach, which apportions loss among triggered policies based on insurers’ proportionate responsibilities. In applying pro rata allocation, courts have considered:

  • the time that each insurer is on the risk;
  • the policy limits of each triggered policy;
  • the proportion of injuries during each policy; or
  • a combination of these and other factors.

Pro rata allocation also typically contemplates policyholder responsibility for periods of no coverage or insufficient coverage. The pro rata allocation approach stems from policy language that limits insurers’ obligations to damage ‘during the policy period’. Some jurisdictions that utilise a pro rata approach recognise an ‘unavailabilty’ exception. The unavailability exception provides that apportionment to the insured for uninsured periods is not warranted if insurance was unavailable in the marketplace during the relevant time frame. If this unavailability is established, losses during the uninsured periods are allocated among the insurers.

A minority of courts endorse a joint and several liability approach, under which a policyholder is entitled to select a single policy from multiple triggered policies from which to seek indemnification. This approach stems from common policy language requiring an insurer to pay ‘all sums’ that the policyholder becomes legally obligated to pay. Notably, even courts that endorse all sums allocation typically allow a targeted insurer to pursue contributions from other triggered insurers.

Law stated date

Correct on

Give the date on which the information above is accurate.

18 November 2020