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.

Does a CGL Policy’s “Business Description” or “Class Code” Limit Coverage?

Farrell Miller | Cozen O’Connor

One way a CGL insurer can narrow otherwise broad bodily injury and property damage coverage is by activity. Activities that face similar risk can be grouped using an activity classification code, which can be incorporated into the policy through a class limitation endorsement.

For instance, a policy issued to an individual (for any business of which he is a sole owner) could include an “accounting” class code and a class limitation endorsement, effectively narrowing coverage to accounting activities. Courts routinely enforce such endorsements.[1]

Suppose that, instead of a class limitation endorsement for accounting, the policy’s declarations page merely said “business description: accounting” and “Class Code: 7619—Accounting.” Now suppose the individual also owns a non-accounting business and is sued for liability in connection with that business. Would that be covered? In other words, what effect should a court give to a class code or business description that isn’t incorporated into the policy by endorsement? This question underpins two divergent Circuit Court decisions.

In Smith v. Burlington Ins. Co., Smith owned and operated a courier service and a security service.[2] One of Smith’s armed security guards shot an unarmed teen while on duty at an Oklahoma apartment complex. The teen later died. His mother brought a wrongful-death action against Smith d/b/a Smith and Son Security. On Smith’s CGL policy with Burlington, the declarations designate “Form of Business” as “Individual,” and “Business Description” as “Courier Service.” The Policy section defining “who is an insured” says “If you are designated . . . as [a]n individual, you and your spouse are insureds, but only with respect to the conduct of a business of which you are the sole owner.” Within the policy was a “Schedule of Classification and Rates” listing “94099—Express Companies” (i.e. a Class Code).

Burlington denied coverage, saying that the policy was intended to cover Smith only for his courier service business. The district court sided with Burlington and the Tenth Circuit affirmed.[3] The district court held that two standard policy provisions effectively incorporated the business description into the policy itself. The first provision, a merger clause, says “declarations together with the common policy conditions and coverage form(s) and any endorsement(s), complete the above numbered policy.”[4] The second provision, in the “Representations” section, says “By accepting this policy, you agree: (a) The statements in the Declarations are accurate and complete; (b) Those statements are based upon representations you made to us; and (c) We have issued this policy in reliance upon your representations.”[5] The district court also held that using the Class Code “94099—Express Company” “rather than a code that could conceivably cover any armed security guard business confirms that there was no intent to cover Smith’s security business.”[6] The court concluded by stating that it refused to adopt a “strained interpretation that the ‘courier service’ policy covers any business Smith might choose to pursue.”[7]

In Mount Vernon Fire Ins. Co. v. Belize NY, Inc., a general contractor (GC) hired Belize NY, Inc. to perform demolition work at a church in Harlem. A few months later, the GC again hired Belize solely to supervise a subcontractors’ work at the church.[8] Months later, a person entered the church, shot and killed several people, and started a fire before taking his own life. A wrongful death suit was commenced against Belize, alleging that the GC unlawfully shut off the church’s sprinkler system and “bricked over” or eliminated several church exits.[9] On Belize’s CGL policy with Mount Vernon, the declarations designated Belize’s “Form of Business” as “Corporation,” and “Business Description” as “Carpentry.”[10] Two classifications were listed under “Premium Computation” on the Declarations Page: “Carpentry-Interior-001” and “Carpentry-001.”[11]

Mount Vernon denied coverage for the wrongful-death action, arguing that Belize was acting in a supervisory capacity rather than performing carpentry work at the time of the shooting.[12] The district court sided with Belize and the Second Circuit affirmed. The Second Circuit held that under New York law, exclusions “must be set forth clearly and unmistakably.”[13] But the policy didn’t do that, since there was no “specific language indicating that the classifications [or the business description] determine the scope of the coverage.”[14] “Were we to accept [Mount Vernon’s] argument, insurers would be permitted to argue for limitations of all kinds by invoking the stand-alone words of classification not otherwise referred to in a policy. If Mount Vernon wished to limit coverage based on classifications, it should have done so specifically.”[15]

The Smith and Mount Vernon courts appear to disagree about whether a standalone business description or class code can narrow coverage. Can Smith and Mount Vernon be harmonized? Here’s some guidance. If an insured has a CGL policy with a business description and/or class code suggesting a small risk, and seeks coverage for an activity that involves a completely different, larger, and perhaps more exotic risk (e.g. armed security service), then a court is likely to find that the insurer did not intend to cover the larger risk. To decide otherwise would unfairly blindside the insurer. On the other hand, if the insured has a policy with a business description and/or class code that suggest a risk that is similar to the actual claim (e.g. carpentry vs. construction supervision) then a court is likely to say “close enough” and find coverage. To decide otherwise would be unfair to the insured, since the policy wouldn’t clearly and unmistakably limit coverage. In the end, the safest course is to ensure that the policy accurately reflects both parties’ understanding of the risk.


[1] See, e.g.Evanston Ins. Co. v. Heeder, 490 Fed. Appx. 215 (11th Cir. 2012) (no coverage where classification limitation endorsement narrowed coverage to residential roofing, and claim arose from a commercial roofing project); Ruiz v. State Wide Insulation & Constr. Corp., 269 A.D.2d 518 (N.Y. App. Div. 2000) (no coverage where classification limitation endorsement narrowed coverage to painting and the insured party was hurt during a roof repair); Princeton Excess and Surplus Lines Ins. Co. v. US Global Security Incorporated, et al., Case 4:18-cv-02705 (S.D. Tex. Sept. 24, 2019) (no coverage where designated operations exclusion narrowed coverage to exclude injuries arising out of any work at or in bars, restaurants, taverns or other establishments selling or providing alcoholic beverages, and exception to exclusion did not apply as there were no allegations of an injury arising out of parking lot security operations).

[2] 2019 U.S. App. Lexis 19175, 2019 WL 2635725, at *1 (10th Cir. 2019) (interpreting Oklahoma law).

[3] Smith v. Burlington Ins. Co., 2018 U.S. Dist. Lexis 54403 (N.D. Okla. 2018), aff’d 2019 U.S. App. Lexis 19175, 2019 WL 2635725 (10th Cir. 2019).

[4] Id. at *11

[5] Id.

[6] Id. at *7.

[7] Id. at *15.

[8] 277 F.3d 232, 235 (2d Cir. 2002) (interpreting New York law).

[9] Id.

[10] Id. at 234.

[11] Id.

[12] Id. at 236.

[13] Id. at 237.

[14] Id.

[15] Id. at 239.

Liability Insurance Coverage: Basic Principles

Peter Selvin | Ervin Cohen & Jessup

There are certain core principles that must be applied in analyzing coverage under a liability insurance policy.

This two-part article sets out those principles. It also explores some counter-intuitive situations in which such coverage may come into play.


Insurance Liability

  • Hidden opportunities to obtain coverage in liability cases
  • Sometimes counter-intuitive
  • Often obscured by jargon and complexity
  • What strategies will assist in uncovering these opportunities?

The 8 Key Points

1. Law Tilted in Favor of Policyholders

Liability insurance provides protection (i.e., indemnity) in respect to a claim, but also funding for the insured’s defense to litigation. It also imposes a duty on the insurer to settle the case for its insured. The law heavily favors policyholders. In this regard, grants of coverage are construed broadly, whereas exclusions are construed narrowly. In addition, an insurer must give as much consideration to its insured as its own interests.

Where the policy provides a duty to defend, there are three important features: (1) the duty to defend is extremely broad; (2) where there is a duty to defend, the carrier is obligated to defend both covered and uncovered claims; and (3) a carrier that breaches the duty to defend may face huge penalties for doing so. California courts have repeatedly found that remote facts buried within causes of action that may potentially give rise to coverage are sufficient to invoke the defense duty. Thus, California law does not require that the insured’s conduct proximately cause the third-party claim in order to trigger the defense duty.

2. The specific causes of action in a complaint do not define or limit the scope of coverage.

The duty to defend is not limited by the causes of action that are pled by the plaintiff. “…That the precise causes of action pled by the third party complaint may fall outside policy coverage does not excuse the duty to defend where, under the facts alleged, reasonably inferable or otherwise known, the complaint could be fairly amended to state a covered liability.” Scottsdale Ins. Co. vs. MV Transportation, 36 Cal.App.4th 643, 654 (2005); Hartford Casualty vs. Swift Distribution, 59 Cal.4th 277 (2014).

3. The duty to defend has surprising breadth.

Under California Civil Code § 2778(4), the duty to defend is in all liability insurance contracts unless the policy clearly and unambiguously excludes such a duty. One of the most basic cornerstones of modern insurance law is that the duty to defend is broader than the duty to indemnifyAn insurer must provide a complete defense to its insured even where some causes of action may be outside coverage. Thus, if any claims in a third party complaint against a party insured under a CGL policy are even potentially covered by the policy, the insurer must provide its insured with a defense to all claims.

4. An insurer may be obligated to fund the prosecution of affirmative claims

Insurer responsibility for funding the prosecution of affirmative claims of an insured usually arises in the context of cross-complaints initiated in response to the underlying liability claim. Thus, in some instances, an insurer may be obligated to fund the prosecution of an insured’s counterclaim for affirmative relief where the request for that affirmative relief is inextricably intertwined with the defense of the covered action.

5. Opportunities for securing coverage are enhanced by the penalties flowing from an insurer’s wrongful failure to defend.

Consequences of an Insurer’s Wrongful Failure to Defend:

Waiver of Exclusions to Coverage. Where the carrier wrongfully fails to defend, it will be deemed to have waived any exclusions to coverage under the policy that it otherwise would have had with respect to its obligation to indemnify. If a carrier denies the insured a defense and it is ultimately determined that a defense was owed, the carrier can be subjected to a claim of bad faith and may ultimately be required to provide indemnity even where no duty to indemnify exists

Waiver of Right to Reimbursement for Defense of Uncovered Claims. An insurer that breaches its duty to defend is liable for the costs incurred in the insured’s defense and is precluded from pursuing a reimbursement claim or otherwise allocating between covered and non-covered fees and costs.

Waiver of Right to Insist on “Panel” Rates. An insurer that breaches the duty to defend is precluded from arguing that Civil Code § 2860 should limit its insured’s recoverable fees. “If [a] plaintiff is able to establish breach of the duty to defend, its damages are not limited by California Civil Code § 2860.” Atmel Corp. v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039, 1047 (N.D. Cal. 2005).

Unreasonable Delay By Carrier In Paying Defense Costs Can Constitute Breach Of The Duty To Defend As Subjecting Carrier To Claim For Bad Faith

In Travelers lndem. Co. of Connecticut v. Centex Homes, 2015 WL 58369 47, at *4 (N.D. Cal. 2015), the court held that “[a] failure to provide counsel or to guarantee the payment of legal fees immediately after an insurer’s duty to defend has been triggered constitutes a breach of the duty to defend, even if the insurer later reimburses the insured.” Id. at *5. In Okada the court found that the specific language in the policy required the insurer “must make contemporaneous payments for legal defense on claims covered by the policy.” Okada v. MGIC lndem. Corp., 283 (9th Cir. 1986).

Public Policy Reasons Supporting The Imposition Of Penalties on Insurers That Breach The Duty to Defend

These seemingly harsh results advance the policy of incentivizing insurers to vigorously search the underlying claim for the purpose of finding a duty to defend. “If the insured elects to proceed in tort, recovery is possible for not only all unpaid policy benefits and other contract damages, but also extra-contractual damages such as those for emotional distress, punitive damages and attorney fees”. Archdale v. American International Specialty Lines Ins. Co., 154 Cal. App. 4th 449, 467-68, n. 19 (2007).

Recent Developments in Bad Faith Liability

Recent case authority suggests that an insurer may be liable for bad faith even if it offers up its full policy limits to settle a third party liability claim. In that case the Court held that notwithstanding its offer of full policy limits, the insurer was unreasonable in refusing to agree to the inclusion of language in the settlement agreement which would have preserved the insured’s right, without offset, to court-ordered restitution from the tortfeasor. In those circumstances, the court allowed the insured’s bad faith case to proceed.

6. The “leverage” created by the duty to settle.

Once the duty to defend attaches, the insurer also has an obligation to settle the claim within policy limits. If the carrier rejects a reasonable settlement offer from the claimant that is within policy limits, it may be liable for any judgment that is in excess of the policy limits. Importantly, in rejecting such a settlement offer, the carrier may not take into account or consider any defenses it may have to coverage for the claim. In order to establish a claim for bad faith, the insured must demonstrate that the policy obligated the insurer to indemnify the insured for the underlying loss. Liability carrier has affirmative duty to negotiate toward a settlement on behalf of its insured, even in the absence of an offer or demand by the claimant.

7. Amounts ostensibly paid as restitution for “ill gotten gains” may in fact represent covered “damages”.

Whether amounts paid by policyholders to fund settlements are covered under an insurer’s duty to indemnify is often a contested issue. See, e.g., TIAA-CREF Individual & Institutional Services, LLC, et al. v. Illinois National Insurance Company, et al., Case No. N14C-05-178 JRJ (Delaware Superior Court, October 20, 2016) (finding that settlement amounts paid to settle class actions alleging unfair business practices did not represent uninsurable disgorgement). See also U.S. Bank v. Indian Harbor Insurance Company, 2014 WL 3012969 (D. Minn. 2014) (bank was entitled to coverage under its professional liability insurance for restitutionary amounts it paid in settlement of an overdraft fee overcharge class action).

8. Unexpected coverage opportunities in IP and commercial disputes

Utilizing coverage for “personal injury” or “advertising injury” in business disputes. In lawsuits involving claims of infringement, misappropriation or the violation of the right of privacy, the key portion of a CGL policy is the “personal injury” or “advertising injury” coverage found in Coverage B. That coverage section will typically contain language providing as follows:

1. We will pay those sums that the insured becomes legally obligated to pay as damages because of “personal and advertising injury” to which this insurance applies. We will have the right and duty to defend any “suit” seeking those damages…

2. This insurance applies to “personal and advertising injury” caused by an offense arising out of your business but only if the offense was committed in the “coverage territory” during the policy period.

“Accidental” conduct is not required for coverage for personal or advertising injury. Coverage for personal or advertising injury does not depend on the existence of an “occurrence,” which typically is defined in terms of “accidental” conduct. Thus, coverage for personal and advertising injury is not limited to negligence and may even cover intentional torts.

Commercial Property Insurance Coverage and Coronavirus

Shannon O’Malley | Zelle

No modern disease has dominated the news and affected the world-wide economy on such a scale as coronavirus (COVID-19). Coronavirus’s impact is widespread across almost all business sectors. Governments are shutting down whole regions and cities to quarantine and contain the outbreak. Workers are being urged to stay home for weeks, rather than days, to avoid contagion or spread of the disease.

These prophylactic and reactive governmental actions, and individual actions taken by businesses, are having a huge impact on businesses’ bottom lines. The ripple effects of shutdown factories and an absent workforce are being felt across many different business sectors. The disruption of supply chains from Chinese factories, for example, is affecting businesses like Apple, Microsoft, Toyota, and Samsung. Pharmaceutical companies are also facing potential shortages due to disruptions in the drug supply chain. Hospitality and travel-based industries such as airlines, hotels, and car rentals, not to mention local economies driven by tourism, are also facing cancellations and ongoing losses as a result of this disease. Many companies have restricted business travel. Conferences, festivals, marathons, and other events have been cancelled. Even more significantly, workers and managers are concerned with the potential exposure to this virus. People are contacting their employers, looking for alternative work arrangements. Schools and daycares may close for extended periods of time, leaving working parents scrambling for alternative child care.

Based on these substantial economic challenges, companies will undoubtedly look for ways to recoup or at least minimize their business income losses. Many may look to their property insurance policies for assistance. But unless the policies contain specific provisions for non-physical damage coverage, these companies are unlikely to find relief within the four corners of their policies.

A.    Commercial Property Insurance Policies’ Business Interruption Coverage is Tied to Insured Physical Property Damage

The policy language is key. While articles that provide a general analysis are useful, ultimately, the specific policy language at issue, in concert with the facts, will determine whether coverage is triggered by coronavirus and its impacts.

Generally, most property policies that offer business interruption coverage require a causal connection between insured physical loss or damage and the loss of income.

For example, the ISO commercial property business income form generally states:

We will pay for the actual loss of Business Income you sustain due to the necessary “suspension” of your “operations” during the “period of restoration.” The “suspension” must be caused by direct physical loss of or damage to property at premises which are described in the Declarations and for which a Business Income Limit Of Insurance is shown in the Declarations…

The issue both insurers and insureds will face, therefore, is whether the insured’s lost business income was the direct result of physical loss or damage. This will be a key issue in considering coverage for coronavirus-related claims. Coronavirus-related losses that businesses are experiencing to date are typically due to causes other than physical property damage – e.g., people are staying home from work – they are not producing necessary good and services for other businesses, they are not traveling, and they are not purchasing goods and services to the same degree. None of these causes of economic loss are related to physical damage to insured property.

1.      What is insured physical damage?

Creative policyholders and their attorneys may try to link the virus and physical property damage. As always, the specific policy language at issue is key and should be thoroughly analyzed in the event an insured submits a claim under their property insurance policy arising out of any coronavirus event. Ultimately, the key factual issue is whether the insured property was actually physically altered and/or affected by the virus.

a.      Physical loss or damage generally requires an alteration of the property.

Importantly, there appears to be a split in jurisdictions as to what actually constitutes “physical loss or damage.” Some courts restrict their analysis to require tangible changes resulting in material damage to property.[1] Others more liberally find “physical loss” due to changes that cannot be seen or touched as long as there is a demonstrable alteration of the insured property.[2]

One court analyzed whether property exposed to high humidity, mold, and mildew from wet air constituted direct physical loss or damage.[3] The court determined there must be a distinct and demonstrable physical change to the property necessitating some remedial action to demonstrate physical loss or damage. “The recognition that physical damage or alteration of property may occur at the microscopic level does not obviate the requirement that physical damage need be distinct and demonstrable. In the methamphetamine odor damage cases, the physical damage is demonstrated by the persistent, pervasive odor. In the absence of such odor, no physical damage could be found. The mere adherence of molecules to porous surfaces, without more, does not equate to physical loss or damage.”[4]

Here, policyholders are likely to argue that the physical impact of a virus from an infected person’s coughing or sneezing physically damages property. But some courts appear to reject the notion that a simple sneeze or cough physically alters or changes property such to cause “physical loss or damage.” The fact that the virus may be cleaned without essentially altering the property is evidence that there is no initial damage. And the insured bears the burden to meet the threshold issue that there is physical loss or damage.[5] Nevertheless, it is not wholly clear whether all jurisdictions would follow this analysis and the facts in each case may be determinative.

b.      The property must actually be physically affected by coronavirus.

While policyholders will use cases discussing intangible losses to property such as odors and gases to support their claim that property potentially affected by the virus is physically damaged, it is important to be aware which jurisdiction’s law applies and the facts of the case. Regardless, courts appear to universally require the insured’s property to be, in some way, physically affected.

Therefore, there needs to be investigation to confirm that the virus did, indeed, touch the property. Courts actually require physical damage, rather than the supposition of damage. Courts have rejected insureds’ claims for loss when a federal authority prohibits import due to suspected contamination without a showing of actual physical damage.[6] Courts recognize that although property may be treated as if it were physically contaminated by disease and lost its function, insurance policies specifically require a physical loss. To characterize an insured’s inability to transport its product across the border and sell the product in the United States as direct physical loss to property, without showing actual damage, renders the word “physical” meaningless.[7]

Therefore, to the extent a company may seek damages because product may come from a region affected by coronavirus, or even from a location where an infected person worked, without a demonstration of physical damage (i.e. confirmation of coronavirus’s presence), it should not be covered.

Notably, the virus is thought to be spread from person-to-person through droplets (i.e. sneezes and coughing). While there may be spread from contact with infected surfaces or objects, this is not considered the primary way the virus is spread. Therefore, whether a company that shuts down to clean surfaces potentially impacted by the virus actually sustained physical loss or damage, rather than just suspected damage, is an important consideration.

c.       Other policy hurdles.

Even if coronavirus contamination could be considered physical damage to property, other policy terms and conditions may limit or preclude coverage.

First, an insurer is typically only liable for the lesser of the cost to repair or replace the lost or damaged property. The question is, then, what is the cost to remediate coronavirus from the property? Is it simply washing down surfaces with soapy water and testing? While the information concerning remediating the virus from surfaces is still new and likely developing, most experts agree that cleaning surfaces with soap and water, bleach, or vinegar will kill the virus. Moreover, there is evidence that the virus only lasts on surfaces between 2 hours and nine days. In fact, in at least one case, an office in Kuala Lumpur was closed for thorough cleaning following the confirmation of infection of an employee. That closure, however, was expected to last only one day.

Other coverage questions are also implicated. For example, most policies tie deductibles to the number of occurrences. How many occurrences of the virus may be triggered? Is it an occurrence each time an infected person sneezes or distributes particles of the virus on property? Similarly, if the property is cleaned, and someone re-infects the location, is that a separate occurrence triggering a new deductible?

Another factor is that business interruption coverage is tied to a policy’s period of restoration (aka period of indemnity or period of liability). In some ISO forms, the period of restoration has a waiting period, such as 72 hours, before coverage begins. And the period lasts only as long as it should take to repair the physical loss or damage using due diligence and dispatch. If the “physical damage” is the particles of virus on surfaces of a building, how long should it reasonably take to use soap and water, or bleach, to clean those surfaces?

In conjunction with the insured’s obligation to show actual physical damage, these other examples demonstrate that an insured will face numerous hurdles to recovery under a typical property policy.

2.      Exclusions may apply to preclude coverage.

If the insured can demonstrate that product or property was damaged by coronavirus, policies may also contain exclusions that preclude coverage.

Typically, policies exclude coverage for contamination and pollution. Many such policies include the words “bacteria” and “virus” in those provisions. If the policy explicitly excludes viruses, “damage” arising from coronavirus is not covered.

The contamination exclusion may also apply to preclude coverage. The language of the policy and the specific exclusion will be important. Also important is whether the virus is actually present to cause damage. For example, if an insurer seeks to rely on the contamination exclusion to preclude coverage for “damage” caused by the coronavirus, courts may require the insurer to demonstrate the property was actually contaminated by the virus.[8]

Some courts are loathe to expansively apply the contamination exclusion. They apply the term “contamination” contextually, and find it is a question of material fact for the jury to determine its ultimate meaning.[9] Many courts have expressed concern on the seemingly “limitless” application the term “contamination” may encompass. Therefore, the context of the contamination exclusion as a whole must be considered when applying it to coronavirus.

Accordingly, certain exclusions may apply to preclude claims for alleged property damage from coronavirus, but those exclusions must be analyzed closely in the context of the policy and the facts.

B.    Some Special Coverages and Policy Provisions May Have Non-Physical Damage Coverage Extensions

Typical property insurance coverage forms require the property to actually sustain physical loss or damage. Notably, however, some policies have expanded coverage to include non-physical types of loss. And certain insurance programs write coverage for cancellations specifically relating to epidemics.

A prudent insurer should look for endorsements or provisions within a policy that carve out and cover non-physical damage. This may include crisis management coverage, coverage for interruption by communicable disease, or cancellation of bookings coverage.

These provisions must be reviewed carefully to determine their breadth, including whether they may be extended to cover upstream or downstream losses due to closure of supplier or customer locations due to fear of infectious diseases. Many of these provisions make clear that they apply when there is actual, not suspected, presence of communicable diseases at the insured’s location.

These provisions also often have limitations such as sublimits and waiting periods that may affect the insured’s claim. Nevertheless, the provisions should be considered in the context of the policy as whole to determine whether coverage exists and how the policy responds.

C.    Specific Business Interruption Provisions Require the Income Loss to Directly Result from Insured Physical Loss or Damage

Property policies often provide business interruption coverage arising out of damage to the insured’s property. If there is no direct damage to the insured’s property due to the virus, however, the insured may look to extensions of coverage for indirect losses arising from the virus. This policy language must also be closely reviewed, however, because these provisions typically also require physical loss or damage to property to trigger coverage.

1.      There must be a causal connection between the property damage and the business interruption loss.

If an insured seeks business interruption coverage due to “damage” at its property arising from coronavirus, the insured’s loss of business must still be causally connected to the physical loss or damage. For example, an insured’s business may sustain losses due to causes other than insured physical loss or damage to property, such as a lack of workers, a decline in tourism, or a reduction in aggregate demand for goods and services as people stay home and businesses close. Property policies provide coverage for business interruption losses directly resulting from insured property damage. Courts interpreting the language “directly resulting from” as requiring the insured to demonstrate that there is a causal link between insured property damage and the claimed time element loss.[10]

Therefore, to the extent there are other non-covered causes of an insured’s loss, those must be assessed and considered in the evaluation of any claim. Losses that are not causally connected to physical loss or damage to the insured’s property may not be covered.

2.      The Period of Restoration may limit coverage.

Moreover, property policies do not provide business interruption coverage for an unlimited period of time following damage. Rather, business interruption coverage is limited to the Period of Restoration (also called Period of Indemnity and Period of Liability). Policies typically define a Period of Restoration as:

the period of time that:

  1. begins with the date of accidental direct physical loss caused by an insured loss at the described premises; and
  2. ends on the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality.

Courts interpret this language to mean “the time by which an insured acting ‘as quickly as possible’ would have completed repairs to its property. This is a theoretical calculation reflecting ‘the length of time required with the exercise of due diligence and dispatch to rebuild, repair or replace the damaged premises. Where the actual restoration period exceeds the theoretical period or where the premises are not restored, the theoretical period becomes the computation period.’”[11]

Therefore, if the business interruption coverage is tied to the theoretical period of time it should take an insured, acting with due diligence and dispatch, to clean the property to remove traces of coronavirus, the Period of Restoration is likely to be relatively short. Companies may experience prolonged periods of delays, potential shutdowns, and loss of productivity due to employee illness or other issues unrelated to physical damage to their property that do not fall within coverage or the Period of Restoration.

3.      Civil authority coverage generally should not apply.

Because many companies are not likely to have a direct claim for damage to their property, they may look to other coverages in their business interruption policies. The most obvious type of business interruption coverage that policyholders may look to in making a claim arising out of coronavirus is their business interruption civil authority coverage.

Civil authority coverage generally does not require physical damage to the insured’s property. Rather, the coverage is based on the interruption of the insured’s business, when an order of civil or military authority impairs access to the insured’s property as a result of insured physical damage. Therefore, coverage is generally contingent on actual physical property damage, rather than fear of contagion.

Many civil authority provisions are reactive and do not provide coverage for prophylactic measures. Courts addressed this issue following 9/11 and rejected claims arising from the FAA’s closure of airspace.[12] One court determined the government’s order to shut down all air traffic was not the direct result of property damage, but rather was “based on the fear of future attacks.”[13] “The Airport was reopened when it was able to comply with more rigorous safety standards; the timetable had nothing to do with repairing, mitigating, or responding to the damage caused by the attack on the Pentagon.”[14] Based on this, the court determined the insured’s loss was not the “direct result” of damage to adjacent premises.

In locations subject to damaging weather events, such as hurricanes, courts have applied policies as written, and rejected insureds’ attempts to seek coverage when orders are issued before property damage occurs.[15] One court noted:

The Policy’s plain language requires that the civil authority prohibit access as a “direct result of direct physical loss or damage to property” within one mile of the [insured’s] premises. The Policy does not insure against impairment of operations that occurs simply because a civil authority prohibits access unless the civil authority order meets the requirements of the policy—one of those requirements is a nexus between the order and certain physical damage. Reading the Civil Authority section as a whole, it is clear that it was not written with the expectation that a civil authority order prohibiting access would issue before the property damage that forms the basis of the order actually occurs. The direct nexus between the damage sustained and the order that the policy requires suggests that the Policy was designed to address the situation where damage occurs and the civil authority subsequently prohibits access.

Accordingly, unless the insured can prove that an order of civil authority was directly due to property damage at or near the insured’s location, the Policy’s civil authority provision should not apply.

4.      Contingent BI coverage generally should not apply.

Another potential avenue for coverage that an insured may look to is an insurance policy’s contingent business interruption provision (“CBI”). CBI insures against a company’s lost business in the event the insured’s customer or supplier sustains insured physical loss or damage at their property. A typical provision provides:

This policy…is extended to cover the actual loss sustained by the Insured resulting from the necessary interruption of the business conducted by the Insured, whether partial or total, caused by loss, damage or destruction covered herein…to:

Property that directly or indirectly prevents a supplier of goods, services or information to the Insured from rendering their goods, services or information or property that directly or indirectly prevents a receiver of goods, services or information from the Insured from accepting or receiving the Insured’s goods, services or information.

Therefore, if a business sustains a loss because its supplier is a factory in China, which is shut down due to coronavirus, then that business may attempt to seek coverage under the CBI provision. But like the civil authority coverage, the supplier’s shut down generally must be caused by insured physical loss or damage.

The insured bears the burden to show that “the claimed business loss was caused by damage to property that ‘directly or indirectly prevent[ed]’ a client from accepting or receiving [the insured’s] services.”[16] If the insured cannot identify any interruption of its business due to property damage to a customer or supplier, there likely is no coverage.

Notably, it may be difficult to determine the reason behind the shutdown of suppliers’ or customers’ locations. Whether those shutdowns are due to actual physical damage, or (as is more probable) to quarantine and contain the spread of the virus from person-to-person, the insured bears the burden to produce evidence triggering coverage.

Even if the insured may be able to demonstrate there was damage at a supplier’s or customer’s location, other policy provisions may also affect coverage. Many policies have sublimits for CBI coverage, waiting periods, and high deductibles. These factors also must be considered when analyzing any CBI claim.

5.      Ingress/Egress.

Some policies have extensions of coverage for Ingress/Egress, which covers the insured’s loss due to the necessary interruption of the insured’s business due to prevention of ingress to or egress from the insured’s property, whether or not the insured’s property was damaged. Again, insureds seeking coverage under their policies’ ingress/egress provisions must show that their property cannot be accessed due to actual insured physical loss or damage.[17] With respect to coronavirus claims, it may prove challenging to demonstrate that any ingress is prevented due to physical damage, rather than fear of bodily injury due to person-to-person contagion.

6.      Other BI coverages.

Other typical BI coverages in policies may also be examined for coverage. For example, some policies provide coverage for Logistics Extra Costs or Attractive Property Coverages. Like civil authority, CBI, and Ingress/Egress provisions, however, these provisions generally tie the loss of income to insured physical loss or damage. Therefore, the insured typically still must prove that its lost income is due to actual physical damage. As discussed, the insured will likely have difficulty meeting this burden.

D.    Conclusion

Businesses are unquestionably being affected by coronavirus. Companies are suspending travel for their employees. Some employees are being urged to work from home. Even the CDC is recommending extended at-home stays when individuals suspect infection with the disease. The entire country of Italy is effectuating quarantine and curfew measures.

All of these actions will impact productivity and companies’ bottom lines. But the majority of these measures relate to labor force protections rather than physical property damage. And without the trigger of physical loss or damage that causally causes the loss of income, property insurance policies are unlikely to respond to these losses.

If history is any guide, policyholders and their attorneys will attempt to advance creative arguments for coverage in response to coronavirus. The key to responding properly is a careful analysis of the specific policy terms and conditions at issue, informed by experience and relevant legal authority.

[1]     Universal Image Productions, Inc. v. Chubb Corp., 703 F.Supp.2d 705, 710 (E.D. Mich. 2010) (holding that even though mold and bacteria permeated a floor, because the entire premises did not need to be vacated, and the insured could not meet its burden to show it suffered any structural or any other tangible damage to the property, there was no direct physical loss to property); Mastellone v. Lightning Rod Mut. Ins. Co., 175 Ohio App.3d 23, 41 (Oh. Ct. App. 2008) (holding that mold staining on exterior wood siding did not rise to the level of “physical injury” because it was only temporary and could be cleaned by using a solution of bleach and trisodium phosphate. The court concluded, “the presence of mold did not alter or otherwise affect the structural integrity of the siding. The experts all agreed that the mold was present only on the surface of the siding and could be removed without causing any harm to the wood. Absent any specific alteration of the siding, the [insureds] failed to show that their house suffered any direct physical injury as required by the homeowners’ policy.”).

[2]     In Mellin v. Northern Security Ins. Co., 167 N.E. 544 (N.H. 2015), the New Hampshire Supreme Court found that cat urine odor emanating from a neighboring condominium constituted “physical loss.” The court determined that an insured may suffer physical loss “from a contaminant or condition that causes changes to the property that cannot be seen or touched.” Id. at 549. Importantly, however, even the Mellin court recognized that “physical loss” should not be interpreted overly broadly. It concluded that the term “‘physical loss’ requires a distinct and demonstrable alteration of the insured property.” Id. at 550. For the Mellin court, this included changes perceived by the sense of smell.

[3]     Columbiaknit, Inc. v. Affiliated FM Ins. Co., No. CIV. 98-434-HU, 1999 WL 619100, at *7 (D. Or. Aug. 4, 1999).

[4]     Id. (emphasis added).

[5]     Id. (recognizing it is the insured’s burden to show that a covered loss has occurred and the property was physically damaged).

[6]     Source Food Technology, Inc. v. U.S. Fidelity and Guar. Co., 465 F.3d 834 (8th Cir. 2006).

[7]     Id. at 838.

[8]     Duensing v. Traveler’s Companies, 257 Mon. 376, 849 P.2d 203 (Mont. 1993).

[9]     Parks Real Estate Purchasing Grp. v. St. Paul Fire & Marine Ins. Co., 472 F.3d 33, 45 (2d Cir. 2006).

[10]   See, e.g., Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd’s, 199 Cal.App.4th 1038, 1056, 131 Cal.Rptr.3d 129 (Cal. App. 2011) (rejecting an insured’s claim for business loss due to the FDA’s Advisory to consumers regarding potential E. coli in spinach and the subsequent reduction in the insured’s earnings because there was no causal link or nexus between the business loss and an event covered by the policy); Commonwealth Enterprises v. Liberty Mut. Ins. Co., 101 F.3d 705, 1996 WL 660869 (9th Cir. 1996) (rejecting the insured’s claim for lost business income under California law, even though a fire initially caused the insured’s interruption, because that interruption was primarily caused by the discovery of asbestos contamination, not fire damage); Syufy Enterprises v. Home Ins. Co. of Indiana, No, 94-0756, 1995 WL 129229, * 2 (N.D. Cal. 1995) (excluding coverage for business interruption loss due to curfews following the Rodney King trial because the loss was not a direct result of damage to or destruction of property and, therefore, the insured could not demonstrate the requisite causal link necessary for involving coverage); Pacific Coast Eng. Co. v. St. Paul Fire & Marine Ins. Co., 9 Cal.App.3d 270, 274, 88 Cal.Rptr. 122 (Cal. App. 1970) (finding that a property policy only provides business interruption coverage for losses directly resulting from interruption of the operations at the insured’s property, not merely from the interruption of the work being done at the insured’s location at the time of the loss).

[11]     G&S Metal Consultants, Inc. v. Cont’l Cas. Co., 200 F. Supp. 3d 760, 769 (N.D. Ind. 2016). See also Steel Products Co. v. Millers Nat. Ins. Co., 209 N.W.2d 32, 38 (Iowa 1973); Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 411 F.3d 384, 398 (2d Cir.2005); SR Int’l Bus. Ins. Co. v. World Trade Ctr. Properties, LLC, No. 01 CIV. 9291, 2005 WL 827074, at *3–4 (S.D.N.Y. Feb. 15, 2005) (collecting cases).

[12]     United Air Lines, Inc. v. Insurance Co. of the State of Pennsylvania, 439 F.3d 128 (2d Cir. 2006).

[13]     Id. at 134.

[14]     Id. at 135.

[15]     Jones, Walker, Waechter, Poitevent, Carrere & Denegre, LLP v. Chubb Corp., No. CIV.A. 09-6057, 2010 WL 4026375, at *3 (E.D. La. Oct. 12, 2010).

[16]     Arthur Andersen LLP v. Fed. Insurance Co., 416 N.J. Super. 334, 349, 3 A.3d 1279, 1288 (App. Div. 2010).

[17]     See e.g. City of Chicago v. Factory Mut. Ins. Co., No. 02 C 7023, 2004 WL 549447, at *4 (N.D. Ill. Mar. 18, 2004) (holding “upon careful interpretation of each clause of the Ingress/Egress policy within the context of the contract as a whole, it becomes clear that the provision insures against business interruptions due to the prevention of ingress to or egress from the City’s airports, provided that the prevention is the result of direct physical damage to property that is at or within 1,000 feet of the airport premises.”).

Alabama Supreme Court Reverses Determination of Coverage for Faulty Workmanship

Tred R. Eyerly | Insurance Law Hawaii | July 1, 2019

    Although the lower court held that the insured contractor was entitled to coverage and indemnification under a CGL policy despite claims based upon faulty workmanship, the Alabama Supreme Court reversed. Nationwide Mut. Fire Ins. Co. v. David Group, Inc., 2019 Ala. LEXIS 52 (Ala. May 24, 2019).

    The David Group (TDG) specialized in custom-built homes. The Shahs purchased a newly built home from TDG in October 2006. After moving in, the Shahs experienced problems with their new home that TDG was unable to correct. In February 2008, the Shahs sued TDG. The complaint alleged that serious defects existed, resulting in health and safety issues, building code violations, poor workmanship, misuse of construction materials, and disregard of property installation methods. The case went to arbitration and an award of $12,725 was issued to the Shahs.

    Nationwide was TDG’s CGL carrier and initially defended TDG. After Nationwide withdrew its defense, TDG sued seeking a judgment declaring that Nationwide was obligated to defend and indemnify. The trial court denied Nationwide’s motion for summary judgment and issued a partial summary judgment in favor of TDG on the issue of coverage. Nationwide appealed. 

    Nationwide argued that the “defects” alleged by the Shahs and identified by the arbitrator were the result of faulty work performed by TDG. The defects were not “occurrences” under the policy. The court had repeatedly held that faulty workmanship itself was not an occurrence under a CGL policy. Faulty work could lead to an occurrence and trigger coverage under a CGL policy if the work subjected personal property or other parts of the damaged structure to continuous or repeated exposure to some other general harmful condition, and, as a result, personal property or other parts of the structure were damaged. The complaint alleged faulty workmanship, but did not allege additional or resulting damage to their house or to their personal property as a result of the faulty workmanship. 

    Under these circumstances, there was nothing demonstrating that there was property damage or personal injury resulting from an occurrence that triggered coverage under a CGL policy. The trial court’s judgment was reversed.