SURVEY OF THE CONSTRUCTION DEFECT LANDSCAPE

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1 WORKSHOP W3 Wednesday, November 11 8:30 a.m. 9:30 a.m. 10:00 a.m. 11:00 a.m. SURVEY OF THE CONSTRUCTION DEFECT LANDSCAPE Presented by Lee H. Shidlofsky Founding Member Shidlofsky Law Firm PLLC Coverage for construction defect claims has been one of the most widely litigated insurance issues over the past 2 decades. In early years, courts were trending away from coverage for these claims, but over the past 10 years, the pendulum has swung back in contractors favor. Find out where courts stand on the most commonly disputed issues, such as whether faulty workmanship constitutes an occurrence, as well as emerging legal arguments, including the application of the contractual liability exclusion in construction defect claims. Legislative developments, such as changes in statutes of repose, will also be examined. To print on both sides of the page, set your printer for duplex printing. Workshop W3 Copyright 2015 International Risk Management Institute, Inc. 1

2 WE HAVE THE TOOLS TO BUILD YOUR FOUNDATION At Allied World our range of coverage for the construction industry includes: Architects & Engineers Liability Builders Risk & Equipment Environmental Liability alliedworldinsurance.com Primary Construction Liability Surety Excess Casualty For more information contact MARK KLEABIR This information is provided as a general overview for agents and brokers. Coverage will be underwritten by an insurance subsidiary of Allied World Assurance Company Holdings, AG ( Allied World ). Such subsidiaries currently carry an A.M. Best rating of A (Excellent). Coverage is only offered through licensed agents and surplus lines brokers. Actual coverage may vary and is subject to policy language as issued. Risk Management services are provided or arranged through AWAC Services Company, a member company of Allied World. Allied World Assurance Company Holdings, AG. All rights reserved. August 2015.

3 Lee H. Shidlofsky Founding Member Shidlofsky Law Firm PLLC At Shidlofsky Law Firm PLLC, where he is a founding member, Mr. Shidlofsky heads up the Insurance Law Practice Group, which represents corporate policyholders in disputes with their insurance companies, advises plaintiffs on how to maximize an insurance recovery, and provides riskmanagement consultation on contractual risk transfer issues. His experience covers a variety of first-party and third-party insurance claims, including construction defect, commercial property, business interruption, pollution, errors and omissions, directors and officers, and commercial auto. Mr. Shidlofsky also mediates multiparty construction defect cases. Mr. Shidlofsky is a past chair of the Insurance Law Section and formerly held a council position with the Construction Law Section of the State Bar of Texas. He now serves as the insurance liaison to the Construction Law Section. Mr. Shidlofsky is the author of numerous articles and papers and is a frequent speaker at legal seminars across the country. He was recently elected as a Fellow to the American College of Construction Lawyers. Workshop W3 3

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5 Survey of Construction Defect Landscape Presented By: Lee H. Shidlofsky Shidlofsky Law Firm PLLC Best Insurance Quote This isn t California. We don t interpret contracts by getting naked and getting in a hot tub or talking about aspirations. - Judge Lynn Hughes Workshop W3 2 5

6 CGL Flow Chart INSURING AGREEMENT "Property Damage" "Occurrence" "Trigger" BUSINESS RISK EXCLUSIONS Course of Construction Completed Operations Exclusion "J5" Faulty Workmanship I Exclusion "J6" Faulty Workmanship II Exclusion "L" Your Work *** subcontractor exception*** 3 Exclusion "K" Your Product Exclusion "M" Impaired Property Exclusion "N" Sistership / Recall 4 Que Paso? A CGL s insuring agreement distinguishes between liability grounded in tort versus contract. Property damage flowing from a breach of contract is inherently foreseeable and, thus, not an occurrence. The economic loss rule determines coverage under a CGL policy. Damages flowing from defective work in breach of a construction contract are uninsured economic losses. Defective workmanship is an uninsurable business risk LHS 6

7 Miller s Law of Insurance Insurance Covers Everything Except What Happens Premiums 5 Workshop W3 7

8 7 State of the Union The occurrence debate has, for the most part, been resolved. Most courts now recognize and apply the subcontractor exception to exclusion L and recognize its intended effect. More jurisdictions are applying J(5) and J(6) in a manner that gives effect to the that particular part language Note: Choice of law remains a critical inquiry So Why Am I Here? Property Damage requirement Contract / Tort Distinction Business Risk Rationale Contractual Liability Exclusion Legally Obligated to Pay as Damages Breach of Contract Exclusions Legislation Impacting Insurance Coverage 8 8

9 What is Property Damage? 9 9 Key Issues Under Prong I Defect vs. Physical Damage Incorporation Theory Life / Safety Issues Damage to the Insured s Own Work vs. Third-Party Property Emerging Middle Ground Pure Economic Loss vs. Consequential Damages Damages Because Of... Property Damage Rip and Tear Coverage Workshop W3 11 9

10 A difference exists between a claim for the costs of repairing or removing defective work and a claim for the costs of repairing damage caused by the defective work The Crux of the Debate 12 The Perceived Problem When the damaged property is the insured s work, and the nature of the problem is characterized as faulty or defective workmanship, some courts get caught up on the buzz words instead of the substance Business Risk Rationale CGL policies were not intended to cover faulty workmanship. Right? Performance Bond Analogy 13 10

11 Defect vs. Physical Damage The physical damage prong distinguishes between physical injury to tangible property and a mere defect. Physical Injury Plain meaning connotes an alteration in appearance, shape, color, or in other material dimension (e.g., cracking, breaking, blistering, deflecting, corroding, rusting, rotting, peeling, dissolving, and so on). Odor? / Noise? / Aesthetic disappointment? Defect vs. Physical Damage A mere defect is not property damage (e.g., painting a room the wrong color) Tangible Property Can you touch or see it? Property interests (e.g., easements) What about costs incurred to prevent property damage? Most jurisdictions say no... but some split for environmental and life-safety issues Workshop W3 11

12 Defect vs. Physical Damage Incorporation Theory Many courts have adopted the position that the presence of a defective product within a larger whole, without some attendant physical injury to the larger structure, does not constitute property damage Some courts have focused on the amount of destruction that will occur to the larger whole in order to repair the defective component 19 What has to be Damaged? 20 Insured s Own Work vs. Third-Party Property Traditional approach by insurers was that damage must occur to third-party property (i.e., something other than the project) Definition of property damage does not support a distinction between damage to work itself vs. third-party property (i.e., look to exclusions) Claimant need not have an ownership interest in the property Emerging Middle Ground Defective work itself, even if physically damaged, is not property damage Damage to otherwise non-defective parts of the project? even to the insured s own work? can constitute property damage No real support in the property damage definition but viewed as a compromise between the policy language and the business risk rationale. 12

13 Emerging Middle Ground 21 Florida Amerisure Mutual Ins. Co. v. Auchter Co., 673 F.3d 1294 (11 th Cir. 2012) Colorado Greystone Construction, Inc. v. National Fire & Marine Ins. Co., 661 F.3d 1272 (10 th Cir. 2011) Georgia Taylor Morrison Servs., Inc. v. HDI-Gerling Am. Ins. Co., 746 S.E.2d 587 (Ga. 2013) Pure Economic Loss vs. Consequential Damage 22 Economic vs. Consequential Damages because of property damage Transformation of otherwise economic loss into covered damages Diminution in Value Profit / Overhead Increased Costs of Construction / Extended General Conditions Loss of Use / Business Interruption Attorneys Fees Workshop W3 13

14 Pure Economic Loss vs. Consequential Damage Economic vs. Consequential Lennar v. Great Am. Ins. Co., 200 S.W.3d 651 (Tex. App. Houston [14 th Dist.] 2006, no pet.) (i) the costs to repair water damage to the homes; (ii) the costs to remove and replace EIFS as a preventative measure; (III) the costs to remove and replace EIFS as a means to access and repair water damage; and (iv) overhead costs, inspection costs, personnel costs, and attorneys fees incurred by Lennar 23 Rip & Tear Rip & Tear Most jurisdictions hold that the repair cannot create the property damage But rip and tear expenses are covered if the requisite property damage exists in the first place (e.g., access costs) The Lennar example 24 14

15 25 The Moral of the Story Snap, Crackle & Pop plead specifically (beware of eight corners rule) When referencing subcontractors, the focus is on whether the subcontractor s work damaged another contractor s work When referencing general contractors, the focus is on resulting damage to otherwise non-defective work The economic losses have to be tied to the property damage (e.g., delay claims) The Contract / Tort Debate Workshop W

16 Variations on the Theme Phase I The Occurrence Requirement Business risk rationale Phase II Contractual Liability Exclusion Meaning of assume liability Phase III Legally Obligated to Pay as Damages Does this mean only tort liability? Phase IV Breach of Contract Exclusions Coming to a policy near you? 27 Contractual Liability Exclusion 28 16

17 The Exclusion 29 Gilbert Texas Construction Gilbert Tex. Construction, L.P. v. Underwriters at Lloyd s London, 327 S.W.3d 118 (Tex. 2010) (opinion on reh g). Gilbert contracted with DART for the construction of a commuter rail system. The parties entered into a contract, which included a provision that Gilbert would protect and repair adjacent property. On May 5, 1995, Dallas experienced unusually heavy rains. Rainwater flowed from the construction site and damaged an adjacent property owned by RTR. RTR sued Gilbert under several theories of recovery. Workshop W

18 Gilbert Texas Construction Ultimately, Gilbert moved for summary judgment on governmental immunity grounds based on its contract with DART. The trial court granted the motion leaving only an intended third party beneficiary breach of contract claim against Gilbert. After the ruling, the umbrella carrier for the first time reserved rights and then denied coverage based on the contractual liability exclusion. Trial Court ruled in favor of coverage. Appellate Court reversed. The unexpected battle ensues Gilbert Texas Construction Supreme Court of Texas granted petition for review. Argument 1: the appellate court erred in applying the contractually liability exclusion to negate coverage because it ONLY applies when the insured assumes the liability of another. Argument 2: the appellate court overlooked the fact that liability would have existed in the absence of the contract because the only reason Gilbert had governmental immunity in the first place was because of its contract with DART. 18

19 Gilbert Texas Construction Supreme Court, in a 9-0 opinion, AFFIRMED. The Court recognized that it was adopting the minority view. We disagree, by and large, with courts and treatises conclusions that the language of the contractual liability exclusion before us applies only to indemnity or holdharmless agreements.... Holding: Underwriters had no duty to indemnify and exception to exclusion did not apply because Gilbert could not have been liable in the absence of the contract. Court read liability that would exist to mean liability that did exist. 33 Gilbert Texas Construction 34 What does it mean to assume liability? In its contract with DART, however, Gilbert undertook a legal obligation to protect improvements and utilities on property adjacent to the construction site, and to repair or pay for damage to any such property resulting from a failure to comply with the requirements of this contract or failure to exercise reasonable care in performing the work. The latter obligation to exercise reasonable care in performing work mirrors Gilbert s duty to RTR under general principles. Exclusion Not Applicable The obligation to repair or pay for damage to RTR s property... extends beyond Gilbert s obligations under general law and incorporates contractual standards to which Gilbert obligated itself. Exclusion Applicable Workshop W3 19

20 Gilbert Texas Construction It was not at all clear exactly what the Supreme Court of Texas was saying in the opinion: Is the contractual liability exclusion a breach of contract exclusion? What does it really mean to assume liability? Is the case limited to its unusual facts? Does anyone see the irony? 35 Ewing v. Amerisure Basic garden-variety commercial construction defect claim involving cracking and flaking of tennis courts. Contractor (Ewing) entered into contract with school district for construction of tennis courts. State court lawsuit against GC and design team with claims of negligence, breach of contract, and breach of warranty. Amerisure denied a duty to defend based on the contractual liability exclusion. Relied on Gilbert Texas Construction for the proposition that the contractual liability exclusion was a breach of contract exclusion

21 Ewing The District Court The Contractual Liability Exclusion negates coverage because by entering into the contract with [the owner], Ewing is liable if the work it agreed to perform under that contract is defective On Appeal to The Fifth Circuit Originally Affirmed in a 2-1 decision. Ewing s contract with the School District was the source of its potential liability because Ewing s duty to construct usable tennis courts arose out of a contract. The physical damage alleged is to the subject matter of the contract. No coverage, but a great dissent! Merely entering into a contract is not an assumption of liability Majority approach renders the your work exclusion and its subcontractor exception meaningless Contravenes the intent and evolution of CGL policy Workshop W3 21

22 Can You Say Surplusage? 39 Interpretive Dance Take

23 The Fifth Circuit The Aftermath Vacate and Certify Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good and workmanlike manner, without more specific provisions enlarging this obligation, assume liability for damages arising out of the contractor s defective work? 41 Ewing v. Amerisure Supreme Court of Texas Victory (9-0) 420 S.W.3d 30 (Tex. 2014) Workshop W

24 Supreme Court of Texas Supreme Court first recognized that the allegations that Ewing failed to perform in a good and workmanlike manner are substantively the same as its claims that Ewing negligently performed under the contract because they contain the same factual allegations of misconduct. Supreme Court affirmatively recognized that Ewing had a common law (read: implied) duty to perform its contract with skill and care. 43 Supreme Court of Texas 44 The mere fact that the damages at issue are only to the subject matter of the contract does not mean that the contractual liability exclusion applies. Although the Court did not abandon the economic loss rule, or recognize any new causes of action, the coverage analysis does not depend on whether the ultimate liability is actionable in tort, contract or warranty. The central issue is whether the insured assumes liability for something other than what is already implied in every contract the duty to perform the contract in a good and workmanlike manner. 24

25 Supreme Court of Texas Accordingly, we conclude that a general contractor who agrees to perform its construction work in a good and workmanlike manner, without more, does not enlarge its duty to exercise ordinary care in fulfilling its contract, thus it does not assume liability for damages arising out of its defective work so as to trigger the Contractual Liability Exclusion. 45 Crownover v. Mid-Continent Cas. 757 F.3d 300 (5 th Cir. 2014) (Original Holding) 46 Breach of an express warranty of repair Had to do with HVAC and other issues in residential construction District court followed Gilbert and held that breach of express warranty is a contractual assumption of liability. District court construed Gilbert very broadly and held that contractual liability exclusion was a breach of contract exclusion. Originally argued the day after Ewing, but Fifth Circuit abated pending certified questions in Ewing Workshop W3 25

26 Crownover v. Mid-Continent Cas. 757 F.3d 300 (5 th Cir. 2014) (Original Holding) After Ewing was issued by the Supreme Court of Texas, the court still concluded that the district court did not err in applying the contractual liability exclusion to bar coverage. Notably, the court held that the fact that the contract had an express warranty of repair made the case closer to Gilbert than Ewing. Court rejected argument that an express warranty of repair merely codifies the remedy already available under the common law (i.e., the repair costs) Crownover Conundrum Whereas contractually agreeing to repair damage resultingfromafailuretoexercisereasonablecarein performing the work or agreeing to perform the work in a good and workmanlike manner would mirror a contractor s duty under general law [i.e., covered], contractually agreeing to repair damage resulting from a failure to comply with the requirements of the contract would not. [i.e., not covered] 48 26

27 Interpretive Dance Take 2 49 Crownover Opinion on Rehearing 772 F.3d 197 (5 th Cir. 2014) 51 On rehearing, the court recognized that the key question is whether the source of the adjudicated liability the express duty to repair expanded the insured s liability. In rejecting application of the contractual liability exclusion, the court held that there is no doubt that the general law provides a duty to repair such that a contractual duty to repair clause does not expand the insured s liability. The fact that the arbitrator s award was based on an express contractual duty, rather than an implied general-law duty, is inconsequential. In sum, because the remedy for failure to fulfill the duty to repair is the same as for failure to perform work in a workmanlike manner (i.e., the cost to repair the defective work), the contractual duty to repair clause did not expand the insured s liability and implicate the contractual liability exclusion. Workshop W3 27

28 Travelers Property Cas. Co. of Am v. Peaker Services, Inc. 855 N.W.2d 523 (Mich. Ct. App. 2014) 52 Case involves services on the University of Michigan central power plant. University sued for breach of contract, including breach of express and implied warranties for a damaged generator. Carrier denied based on contractual liability exclusion. Case is similar to Crownover in that insurer specifically relied on a express warranty of repair provision that required the insured to be responsible for the costs to return [the property] to as was condition.... Insured argued that exclusion applied only to agreements wherein the insured assumed liability of a third party i.e., indemnity or hold harmless agreements. Gilbert vs. Ewing debate Travelers Property Cas. Co. of Am v. Peaker Services, Inc. 855 N.W.2d 523 (Mich. Ct. App. 2014) By warranting that its goods and services were free from defects in material and workmanship, and by agreeing to return the university s property to as was condition in the event that it damaged property during completion of the contract, defendant did not enlarge its duty to exercise ordinary care in fulfilling its contract. General principles of law required defendant to perform the contract with good and ordinary care and that defendant s goods were fit and merchantable fortheirintendedusesoasnottocausedamagestotheuniversity s property

29 Travelers Property Cas. Co. of Am v. Peaker Services, Inc. 855 N.W.2d 523 (Mich. Ct. App. 2014) Here, like the general contractor in Ewing, by agreeing to return the university s property to as was condition, defendant agreed to no more than what was imposed upon it under general law. As such, like in Ewing, defendant did not assume liability for damages arising out of its defective work so as to trigger the Contractual Liability Exclusion. 54 Pennsylvania Nat l Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish 16 F. Supp. 3d 1370 (S.D. Ala. 2014) Dispute stemming from a roofing construction contract and leaks that occurred after completion. The roofer was sued for negligence, breach of contract and breach of implied warranties. Jury awarded damaged based on a breach of contract theory. Carrier denied coverage based on the contractual liability exclusion. Court first determined that a breach of contract could in fact be an occurrence and there was no doubt about property damage. Court next determined that the subcontractor exception to the your work exclusion applied. But, court denied coverage based on contractual liability exclusion. Essentially, court found that the contractual liability exclusion was a breach of contract exclusion. Workshop W

30 Pennsylvania Nat. Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish 790 F.3d 1173 (11 th Cir. 2015) The District Court s interpretation of the contractual liability exclusion is inconsistent with the CGL policy s plain language. Although an implied warranty creates a duty for a contractor to use reasonable skill in performing its work under the contract, that duty does not constitute an assumption of liability. No meaningful distinction exists for coverage purposes between an express warranty and an implied warranty. The contractual liability exclusion was intended to exclude claims arising out of indemnity agreements only. 56 Employers Mut. Cas. Co. v Donnelly 300 P.3d 31 (Idaho 2013) The case arose out of a construction contract in which a contractor was sued for breach of contract and breach of warranties that caused physical damage and loss of use. At the trial of the underlying action, the jury awarded damages solely on a claim for breach of the implied warranty of workmanship. The key determination for whether an implied warranty of workmanship and therefore the insurance policy covers the damages is whether the duty is based upon a contractual promise or if the duty can be maintained without the contract. Based on the jury's verdict, the breach of implied warranty of workmanship occurred with regard to RCI's performance under the remodeling contract with the Donnellys. There is no duty beyond the contractual promise between RCI and the Donnellys. Since the insurance policy contains an express exclusion for contractual damages, we hold that the district court correctly found the awarded damages to be outside the scope of the insurance policy

31 Legally Obligated to Pay 58 Legally Obligated to Pay 59 We will pay those sums that the insured becomes legally obligated to pay as damages because of... property damage to which this insurance applies. Does the phrase legally obligated to pay as damages necessarily mean only tort damages are covered? Is a suit required to trigger a legal obligation to pay? Difference between the duty to defend and duty to indemnify? What about a settlement? Interplay between a legal obligation to pay as damages and a voluntary assumption of liability condition? Is there a prejudice requirement? Workshop W3 31

32 Big-D Constr. Corp. v. Take it for Granite Too 917 F. Supp. 2d 1096 (D. Nev. 2013) 60 Big-D was the general contractor for the remodeling of IGT s Las Vegas building. Big-D entered into a subcontract with Take it for Granite Too, who was responsible for installing various tiling and stonework on the interior and exterior of the IGT building. Three stone tiles fell from the exterior of IGT s building because of defective installation. IGT directed Big-D, because of life / safety concerns, to replace all of the stonework done by Take it for Granite Too. IGT and Big-D reached a settlement whereby all of the stonework was replaced. The GGL insurers denied coverage for the claim, in part, on the following grounds: (i) no occurrence ; (ii) no property damage other than to the three stone tiles; (iii) no legal obligation to pay ; (iv) voluntary assumption of liability; and (v) the contractual liability exclusion. Big-D Constr. Corp. v. Take it for Granite Too 917 F. Supp. 2d 1096 (D. Nev. 2013) Occurrence While the court held that faulty workmanship itself does not constitute an occurrence, the events of the three stone tiles falling from the building were unexpected, unforeseen, and unintended and thus came within the plain meaning of occurrence. 61 Property Damage The actual stone tiles that fell from the building and hit the ground were physically injured. Additionally, the court held that the safety measures taken to prevent future property damage or bodily injury are property damage. Finally, the court held that damage to the stucco substrate caused by the removal of the stone tiles constitutes property damage. The replacement of the stone tiles, however, is not property damage. 32

33 Big-D Constr. Corp. v. Take it for Granite Too 917 F. Supp. 2d 1096 (D. Nev. 2013) Legal Obligation to Pay The court recognized a split of authority as to whether a final judgment or a settlement as a result of a suit was required in order to trigger a legal obligation to pay. Because the phrase legally obligated to pay as damages is subject to two reasonable interpretations, the court concluded it was ambiguous. Because of the ambiguity, the court held that the duty to indemnify could be triggered absent a court order or judgment and could include amounts the insured was legally obligated to pay due to contractual obligations. 62 Voluntary Assumption of Liability Because the insurers improperly denied coverage, the insurers could not rely on the voluntary assumption of liability condition. Big-D Constr. Corp. v. Take it for Granite Too 917 F. Supp. 2d 1096 (D. Nev. 2013) Contractual Liability Exclusion The court noted that certain courts (e.g., Gilbert Texas Construction) construed the exclusion broadly to exclude coverage arising from any contractual assumption whereas other courts limited the exclusion to hold harmless and indemnity agreements. Because two interpretations exist, the court concluded that the exclusion was ambiguous. Accordingly, the court held that the exclusion only applies to the assumption by the insured of the liability of a third party and does not bar coverage for direct contractual liabilities. Workshop W

34 Breach of Contract Exclusions Coming to a Policy Near You? 64 34

35 Breach of Contract Exclusions Workshop W

36 Breach of Contract Exclusions 66 Breach of Contract Exclusions Courts have held that this exclusion, and ones like it, exclude any claim or suit directly or indirectly arising out of breaches of contract or warranty, and that the scope of the exclusion is not limited to contractual damages. See, e.g., Scottsdale Ins. Co. v. Mt. Hawley Ins. Co., 2011 WL (S.D. Tex. 2011), aff d, 488 F. App x 859 (5 th Cir. 2012). See also HC Waterford Props., LLC v. Mt. Hawley Ins. Co., 2009 WL (S.D. Fla. Aug. 21, 2009) (applying, in the alternative, an identical exclusion)

37 Legislating Insurance Coverage? 68 Legislation Impacting Insurance Coverage Occurrence Arkansas, Colorado, Hawaii and South Carolina No retroactive effect Anti-Indemnification Statutes Most states have statutes that specifically apply to construction contracts The modern trend is for the statute to apply both to indemnification and additional insured requirements Some states have exceptions for CIPs Notice New York Workshop W

38 Questions? 70 Lee H. Shidlofsky Shidlofsky Law Firm PLLC

39 Deconstructing CGL Insurance Coverage Issues in Construction Cases * Lee H. Shidlofsky** A. Introduction Modern construction remains a dangerous business even as construction means and methods have changed and improved over time. Claims arising from bodily injury and property damage on and o the jobsite are common, and even the most carefully planned and monitored projects can experience accidents. Commercial general liability ( CGL ) insurance is the dominant form of liability coverage applicable to such claims. CGL coverage, however, is not a construction-speci c product. Although some of the standard CGL exclusions are most often raised in the construction context, the basic CGL forms have been drafted broadly to apply to commercial endeavors of all types. Also, CGL coverage may overlap with coverages that are constructionspeci c products. For example, property damage to the project during the course of construction may be covered by builders risk insurance, which is rst-party insurance. Design professionals involved in a project (including architects, engineers, and designbuild contractors) likely maintain professional liability coverage. Disputes can arise as to whether a property damage claim arising from construction work implicates CGL coverage, builders risk coverage, professional liability coverage, a combination, or none of these. Disputes also arise as to whether a particular loss should be covered by insurance or by a performance bond. For these reasons, and others, construction-related claims frequently lead to coverage disputes under CGL policies, and such disputes can be complex and costly to resolve. This paper discusses how CGL insurance applies to third-party property damage claims that arise either during the course of construction or after construction operations have been completed. The most frequently disputed CGL coverage issue in the construction context is coverage for defective work and resultant damage. Because builders risk policies generally exclude coverage for * Portions of this article are excerpted from Chapter 3 of Construction Insurance: A Guide for Attorneys and Other Professionals (2011) (Chapter 3 was co-authored by Patrick J. Wielinski). ** Lee Shidlofsky is the founding member of Shidlofsky Law Firm PLLC, Austin TX, and is a Fellow in the American College of Construction Lawyers. Thomson Reuters E Journal of the ACCL E Vol. 9 No Workshop W3 This article is being reprinted from the Journal of the American College of Construction Lawyers, Vol. 9, No. 2 (Summer 2015). The Journal is available on Westlaw, where issues may be viewed and searched in the Westlaw database ACCLJ. 39

40 Journal of the ACCL defective work and design, owners, developers, and contractors may look to the CGL policy for coverage in connection with such claims. CGL insurers often take the position that such claims are business risks expressly excluded by CGL policies and/or that such claims arise from factors under the control of the insured and, therefore, fall outside the scope of CGL coverage. While the focus historically has been on the occurrence requirement, disputes also arise as to whether certain types of damage alleged in such claims fall within the scope of property damage, as de ned by CGL policies. Oftentimes, and despite the fact that the language is standard, the outcome of these issues may be dependent on which state's law applies to the interpretation of the CGL policy. The uncertainty from state to state is troubling for insureds and makes a choice-of-law analysis very important. B. Interpreting a CGL Policy Standard rules of contract interpretation apply to CGL policies whether written for construction operations or any other commercial venture. These rules include principles applied speci cally in the context of insurance coverage disputes e.g., that policies must be read as a whole, that all parts of a policy must be given e ect, that policy language is to be given its plain and ordinary meaning, and that extrinsic evidence is allowed only where policy language is ambiguous. 1 The standard CGL policy contains a broad insuring agreement that grants coverage for all sums the insured is legally obligated to pay as damages because of bodily injury or property damage caused by an occurrence. Bodily injury, property damage, and occurrence are de ned terms, and nearly all CGL policies employ identical or substantially similar de nitions of those terms. Although the insuring agreement is a very broad grant of coverage, the policy then shifts certain risks back to the insured through exclusions. Exclusions intended to clarify that CGL coverage does not apply to bodily injury covered by other speci c types of insurance (most notably auto liability and workers' compensation insurance) are often raised in the construction context. The CGL exclusions, however, that garner the most attention in the construction context are those that speci cally ad- 1 Although contract interpretation principles may vary from jurisdiction to jurisdiction, it is commonplace for a court to require the insured to carry the burden of proving a claim falls within the insuring agreement, whereas the insurer must carry the burden of proving the application of any exclusions. Moreover, because most jurisdictions recognize insurance policies are contracts of adhesion, many jurisdictions have adopted insurance policy interpretation principles that resolve any doubt or ambiguity in the insured's favor. See 1 Windt, Insurance Claims and Disputes: Representation of Insurance Companies and Insureds 4:2 (6th ed.) (updated March 2014). 54 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 40

41 CGL Insurance Coverage dress property damage claims and often are referred to as the business risk exclusions. The evolution of these exclusions and their exceptions is essential to the overall analysis of CGL coverage for construction-related claims. CGL coverage for construction-related property damage should turn on the applicability of these exclusions, rather than the broad insuring agreement and accompanying de nitions. That being said, much of the litigation over the past several years has been focused on the insuring agreement and, in particular, whether defective work can constitute property damage caused by an occurrence. This debate has morphed into a battle between tort versus contract damages and whether a CGL policy only exists to respond to tort-based damages. C. The CGL Insuring Agreement An analysis of coverage under any insurance policy, including a CGL policy, begins with the insuring agreement. The insuring agreement sets forth the scope of coverage to be provided without regard to exclusions and conditions. As noted above, the insuring agreement of CGL policies is broad. The Coverage A insuring agreement of a standard CGL policy 2 applies to bodily injury and property damage liability. It provides, in part, as follows: We will pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies. *** This insurance applies to bodily injury and property damage only if: (1) The property damage is caused by an occurrence that takes place in the coverage territory ; [and] (2) The bodily injury or property damage occurs during the policy period. Although the insuring agreement contains other provisions that apply to the scope and duration of the coverage, it is the rst sentence that frames the broad scope of coverage. It states the policy covers all sums the insured becomes legally obligated to pay as damages... to which the insurance applies that is, bodily injury or property damage that takes place during the policy period and is caused by an occurrence. The component parts of the CGL insuring agreement each have their own legal 2 References to the standard form CGL throughout this discussion will be to the 2007 form, CG , which remains the most widely used form. ISO Properties, Inc., The provisions of that form are substantially identical to those that have been included in the standard ISO form since That being said, there is a newer form that likely will someday become the standardbearer in the industry. See CG ( ISO Properties, Inc., 2012). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

42 Journal of the ACCL signi cance. The remainder of this subsection addresses two terms in the rst sentence of the insuring agreement: legally obligated and because of. Separate subsections are devoted to the occurrence requirement and the scope of the term property damage. i. Legally Obligated As noted above, the insuring agreement applies to sums the insured becomes legally obligated to pay as damages. The satisfaction of the legally obligated requirement can be a source of disagreement between insureds and insurers. One issue is whether damages for breach of contract in the absence of a judgment give rise to the kind of legal obligation to pay contemplated by the insuring agreement. The issue is particularly signi cant in the construction context, where contractual relationships usually govern every facet of a project. One of the leading cases for the proposition that liability for breach of contract does not satisfy the legally obligated requirement in the CGL insuring agreement is Data Specialties, Inc. v. Transcontinental Insurance Co., 3 a case in which the insured electrical contractor sought coverage for damage to the electrical system that exploded while the insured was in the course of repairing it. The court held that, in the absence of a judgment against it, the insured was not legally obligated to pay the damages. The court relied primarily on California precedent, which was subsequently overruled and discredited by the California Supreme Court in Vandenberg v. Centennial Insurance Co. 4 In Vandenberg, the California Supreme Court expressly held that the phrase legally obligated to pay as damages in the CGL insuring agreement should be given its plain and ordinary meaning, and not one drawing an overly formal distinction between tort and contractual liability. 5 Nevertheless, other courts have adhered to the tort-versus-contract distinction. An example is 3 Data Specialties, Inc. v. Transcontinental Ins. Co., 125 F.3d 909 (5th Cir. 1997). Data Specialties was recently followed by the Fifth Circuit. See Federal Ins. Co. v. New Hampshire Ins. Co., 439 Fed. Appx. 287 (5th Cir. 2011) (applying Louisiana law) ( To this end, it is well settled that the use of the phrase legally obligated to pay in an insurance policy limits coverage to damages arising out of tortious acts and does not cover contractual obligations. ); see also Nationwide Mut. Ins. Co. v. CPB Intern., Inc., 562 F.3d 591, (3d Cir. 2009); VBF, Inc. v. Chubb Group of Ins. Companies, 263 F.3d 1226, 1231 (10th Cir. 2001). 4 Vandenberg v. Superior Court, 21 Cal. 4th 815, 88 Cal. Rptr. 2d 366, 982 P.2d 229 (1999). 5 The case law that the California Supreme Court overruled was based on a misreading of an early case, which interpreted a policy with an insuring agreement that expressly distinguished between liability imposed by law and li- 56 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 42

43 CGL Insurance Coverage McDonald Construction Company, Inc. v. Bituminous Casualty Corp., 6 in which the court held that the cost of replacing oor tiles pursuant to the insured's contractual obligation was not covered under its CGL policy because the cost arose from a preexisting contractual obligation and not a tort claim for damage to the tiles. Therefore, the contractor was not legally obligated to replace the tiles. Other cases reaching similar results include Detroit Water Team Joint Venture v. Agricultural Insurance Co. 7 and Ohio Casualty Insurance Co. v. Time Warner Entertainment Co., L.P., 8 both of which stand for the proposition that a legal obligation under the insuring agreement of the CGL agreement must be established by judgment or settlement. 9 Similarly, a federal district court in Virginia recently dismissed Chinese drywall cases on the basis that the insured voluntarily repaired the homes. 10 Other courts have held that liability arising out of breach of contract can give rise to damages for which the insured is legally obligated. In Wanzek Construction, Inc. v. Employers Insurance of Wausau, 11 the court determined that the cost of repairing defective coping stone on a swimming pool project was within the apparent contractual obligation of the insured contractor to repair or pay for property damage to the project. The court found that nothing in the CGL insuring agreement suggested a lawsuit was necessary to trigger coverage. Likewise, in Venture Encoding Serability by written contract. See Ritchie v. Anchor Cas. Co., 135 Cal. App. 2d 245, 286 P.2d 1000 (2d Dist. 1955). 6 McDonald Const. Co., Inc. v. Bituminous Cas. Corp., 279 Ga. App. 757, 632 S.E.2d 420 (2006). 7 Detroit Water Team Joint Venture v. Agricultural Ins. Co., 371 F.3d 336 (6th Cir. 2004). 8 Ohio Cas. Ins. Co. v. Time Warner Entertainment Co., L.P., 244 S.W.3d 885 (Tex. App. Dallas 2008). 9 See Couch on Insurance 3d 6:24 (updated November 2014) ( While the phrase legal liability includes liability assumed by contract, the phrases liability imposed by law, and legally obligated to pay as damages do not. (internal footnotes omitted)). 10 See Builders Mut. Ins. Co. v. Dragas Management Corp., 793 F. Supp. 2d 785, (E.D. Va. 2011), judgment vacated, 497 Fed. Appx. 313 (4th Cir. 2012) (vacating the judgment of the lower court and remanding with instructions to dismiss the case for lack of subject matter jurisdiction); see also Spirtas Co. v. Nautilus Ins. Co., 897 F. Supp. 2d 790 (E.D. Mo. 2012), a 'd, 715 F.3d 667 (8th Cir. 2013). 11 Wanzek Const., Inc. v. Employers Ins. of Wausau, 667 N.W.2d 473 (Minn. Ct. App. 2003), a 'd, 679 N.W.2d 322 (Minn. 2004). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

44 Journal of the ACCL vice, Inc. v. Atlantic Mutual Insurance Co., 12 the insured printer was obligated under the terms of its contract to remedy and correct any mistakes or errors in its printing services and was legally obligated to pay those expenses within the terms of its liability policy. For further examples, see Potomac Insurance of Illinois v. Huang 13 ( ling of a third-party lawsuit or a judgment against the insured was not necessary to establish the insured builder's legal obligation to repair leaking windows) and Desert Mountain Properties, Ltd. Partnership v. Liberty Mutual Fire Insurance Co. 14 (recognizing insured builder's legal obligation to pay the cost to repair even when no lawsuit is brought against the insured). The tort-versus-contract limitation placed on the legally obligated requirement in the CGL insuring agreement has been rejected by some courts on the basis that it lacks support in the language of the policy itself. Early commentary from the insurance industry itself as to the legally obligated requirement indicates that the coverage grant is broad enough to include the insured's legal obligation to pay damages for breach of contract, as well as for tort, subject to other limitations of the policy, including the de nitions of property damage and occurrence and the exclusions. 15 Recently, the Supreme Court of Texas held that an insurer was responsible for damages even though the insured had not been sued. 16 In discussing the insured's commitment to make repairs, the court noted that [t]he costs to perform that commitment are Lennar's legal liability Venture Encoding Service, Inc. v. Atlantic Mut. Ins. Co., 107 S.W.3d 729 (Tex. App. Fort Worth 2003). 13 Potomac Ins. of Illinois v. Huang, 2002 WL (D. Kan. 2002). 14 Desert Mountain Properties Ltd. Partnership v. Liberty Mut. Fire Ins. Co., 225 Ariz. 194, 236 P.3d 421, (Ct. App. Div ), opinion a 'd, 226 Ariz. 419, 250 P.3d 196 (2011); see also Big-D Const. Corp. v. Take it for Granite Too, 917 F. Supp. 2d 1096, 1117 (D. Nev. 2013) ( The Court concludes if the Nevada Supreme Court addressed this issue, it would nd that a legal obligation to pay a sum as damages would include sums due as a legal obligation under a contract. ). 15 Tinker, Comprehensive General Liability Insurance-Perspective and Overview, 25 Fed'n. Ins. Coun. Q. 217, 265 (Spring 1975). It should be noted that, despite limited success with the breach-of-contract-versus-tort dichotomy as to the legally obligated formulation in the insuring agreement, insurers more frequently have raised the same type of argument as to the de nition of occurrence. That issue is addressed below. 16 See Lennar Corp. v. Markel American Ins. Co., 413 S.W.3d 750, 757 (Tex. 2013). 17 Lennar Corp. v. Markel American Ins. Co., 413 S.W.3d 750 (Tex. 2013) (noting that Lennar's loss as shown by the settlements is the amount Marekl is obligated to pay under the policy). 58 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 44

45 CGL Insurance Coverage ii. Because Of Another key part of the CGL insuring agreement is the provision stating the insurer will pay damages the insured is legally obligated to pay because of bodily injury or property damage to which the insurance applies. The because of formulation has been found to be a basis for insureds to recover the costs to repair property damage (de ned, in part, as physical injury to tangible property ) to the project and other consequential damages. A case that extensively discusses this issue is Lennar Corp. v. Great American Insurance Co., 18 in which the insured homebuilder sought coverage for the cost to repair water damage to hundreds of homes due to a defectively installed exterior insulation and nish system (EIFS). The court determined that the damage to the homes arising out of the water in ltration through the defective EIFS caused property damage, and the costs of repairs were damages incurred because of that property damage within the insuring agreement of the insured's CGL policies. However, the court held that the costs to remove EIFS on otherwise undamaged homes as a preventive measure were not covered because they did not constitute damages paid by the insured because of property damage. These issues relating to the de nition of property damage are discussed more fully below. If damages because of property damage are broader than property damage itself, then there is a basis for recovery of consequential damages so long as those damages were caused by property damage. A leading case for this proposition is American Home Assurance Co. v. Libbey-Owens Ford Co., 19 which involved a claim against the manufacturer of window glass where the alleged damages included the windows themselves. The court held that consequential losses stemming from physical injury to the windows were covered, even though there may not have been coverage for the repair and replacement of the windows themselves. The court remanded the case to the trial court to determine which of the claimed consequential damages, including increased administrative and heating/cooling costs and lost rentals were due to the breakage of the insured's windows. For instances in which delay damages have also been awarded as damages because of property damage, see Riley Stoker Corp. v. 18 Lennar Corp. v. Great American Ins. Co., 200 S.W.3d 651 (Tex. App. Houston 14th Dist. 2006) (abrogated on other grounds by, Gilbert Texas Const., L.P. v. Underwriters at Lloyd's London, 327 S.W.3d 118 (Tex. 2010)). In a later opinion, the Supreme Court rea rmed the principle by holding that a CGL policy not only covers property damage, but also the costs incurred in locating the damage. See Lennar, 413 S.W.3d at American Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

46 Journal of the ACCL Fidelity & Guaranty Insurance Underwriters, Inc. 20 (upholding coverage for delay damages because of explosions and mechanical problems in connection with construction of two coal- red steam generators) and Insurance Company of North America v. Aberdeen Insurance Services, Inc. 21 (upholding coverage for liquidated damages assessed because of damage to pipeline caused by insured's subcontractor). Courts uphold coverage in these cases pursuant to the insuring agreement of the policy as damages because of property damage, within the de nition of that term in the policy. The because of language is key to recovering what would otherwise be denied as pure economic loss. 22 iii. During the Policy Period The concept of trigger that is, when property damage or bodily injury occurs so as to implicate coverage is one of the thorniest concepts in CGL coverage. 23 When bodily injury or property damage corresponds with a so-called boom event, it is relatively easy to determine which policy must respond to the loss. Construction losses, however, often involve latent damage or progressive, unobserved, damage that occurs over a period of time. When such damage occurs, it spawns complex disputes among insurers and between insureds and insurers as to when the damage occurred and which policy or policies must respond. The dispute centers around the fact that most CGL policies are written on an occurrence basis. In occurrence-based policies, the insuring agreement speci cally requires that the bodily injury or property damage take place during the policy period. This is in contrast with claims-made policies, under which it is the claim that must be made during the policy period, even if the particular act or omission that caused the damage happened prior to the policy period. 24 Because CGL policies provide coverage for property damage or bodily injury that occurs during the policy period, when the work 20 Riley Stoker Corp. v. Fidelity and Guar. Ins. Underwriters, Inc., 26 F.3d 581 (5th Cir. 1994) (applying Louisiana law). 21 Insurance Co. of North America v. Aberdeen Ins. Services, Inc., 253 F.3d 878 (5th Cir. 2001) (applying Texas law). 22 This topic will be further discussed in the property damage portion of the paper. 23 The term trigger is not the same as allocation. Trigger refers to the policy or policies that are potentially on the hook for a given loss whereas allocation is the method utilized for spreading the risk among the triggered policies. 24 Many professional liability policies issued to architects and engineers are written on a claims-made basis. The trigger analysis for claims-made policies is straightforward: The policy in place at the time a claim is rst made is the one (and typically the only one) that is triggered, provided that the claim is reported in a timely manner under the terms of the policy. 60 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 46

47 CGL Insurance Coverage was performed is not usually relevant. Thus, it is the timing of the resulting injury or damage (rather than the timing of the occurrence) that determines which policy or policies must respond to a particular loss. The trigger analysis for occurrence-based policies has spawned many di erent approaches: (1) the manifestation trigger, (2) the exposure trigger, (3) the actual injury or injury-in-fact trigger, and (4) the continuous trigger. 25 Trigger battles were commonplace in environmental coverage litigation and other types of long-tail claims (most notably, asbestosrelated claims), and the issue is also fertile ground for litigation in the construction defect arena. The trigger theory applied to a particular set of facts can have a signi cant impact on how much coverage is available to respond to a claim. Before summarizing the di erent trigger theories, it is important to note that di erent states follow di erent theories, and in some situations, the same state may apply a different theory depending on the type of injury (e.g., bodily injury versus property damage) or the nature of the policy (e.g., rstparty versus third-party coverage). Further, even when a state's high court has issued an opinion adopting a particular trigger theory, it must be remembered that the labels are somewhat malleable in nature. It is not uncommon for a court to apply a trigger theory so as to t a particular set of facts. 26 a. The Manifestation Trigger A manifestation trigger analysis considers damage to have occurred when it becomes apparent or readily identi able. Although the manifestation trigger may have some advantages when it comes to ease of application, it is not widely followed in connection with liability coverage. 27 Courts generally hold that it is not 25 It is dangerous to place labels on the di erent trigger theories because courts apply them in a di erent manner. What one court calls a manifestation trigger may be what another court calls an exposure trigger, and vice versa. See Don's Bldg. Supply, Inc. v. OneBeacon Ins. Co., 267 S.W.3d 20, (Tex. 2008). Moreover, it is important to note that the insurance industry has responded to the di erent triggering theories by modifying policy language. Most notably, after a decision that it viewed to be unfavorable, the insurance industry adopted what became known as the Montrose endorsement so as to control coverage in loss-in-progress and known-loss situations. 26 [G]eneralizations as to the relative support for each approach are somewhat shaky in view of the odd fusion of state and federal law that characterizes this question of policy interpretation. 2 Je rey W. Stempel, Stempel on Insurance Contracts 14.09[B] (3rd ed & Supp. 2009). 27 Bruner & O'Connor on Construction Law 11:182; see also 2 Je rey W. Stempel, Stempel on Insurance Contracts 14.09[B] (3rd ed & Supp. 2009) ( The manifestation theory is less widely embraced, at least for liability Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

48 Journal of the ACCL grounded in the policy language. 28 Even when a jurisdiction appears to have adopted a manifestation trigger, a marked di erence may exist as to how one court applies it versus another. 29 b. The Exposure Trigger Under an exposure trigger, coverage is triggered at the time of the exposure to the conditions that cause the damage. Although the exposure trigger has been applied with some frequency in bodily injury cases, especially in the asbestos context, it has not been widely followed in property damage cases. 30 As with the manifestation trigger, an exposure trigger su ers from textual problems when applied to the policy language because a CGL policy does not state the coverage applies if property is, during the policy period, exposed to a process, event, or substance that later results in bodily injury or physical injury to tangible property. 31 However, in practice, the nominal application of an exposure trigger often does not di er much from application of an actual injury or injury-in-fact trigger. 32 c. The Actual Injury or Injury-in-Fact Trigger The actual injury or injury-in-fact trigger, as the name implies, attempts to match the policy with the time period when the damage actually occurs. In contrast to a manifestation trigger, no insurance (although it is the norm for determining which rst-party property policy is triggered). ). 28 See Gelman Sciences, Inc. v. Fidelity and Cas. Co. of New York, 456 Mich. 305, 572 N.W.2d 617, 623 (1998) ( The manifestation trigger simply is not supported by the policy language. ), judgment amended on other grounds, 456 Mich. 1230, 576 N.W.2d 168 (1998) and (overruled by, Wilkie v. Auto-Owners Ins. Co., 469 Mich. 41, 664 N.W.2d 776 (2003)); Kief Farmers Co-op. Elevator Co. v. Farmland Mut. Ins. Co., 534 N.W.2d 28, (N.D. 1995) (noting that [t]he policy language does not even hint that property damage must be known to anyone in order to trigger coverage, and that [w]e will not rewrite this contract of insurance to exclude coverage on the basis of a manifestation theory ) Lee R. Russ & Thomas F. Segalla, Couch on Insurance 102:22 (3rd Ed & Supp. 2009) ( Among the courts which have considered delayed manifestation of injury cases, there is a marked di erence of opinion, sometimes within the same jurisdiction, as to when coverage is triggered. ). 30 See, e.g., Guaranty Nat. Ins. Co. v. Azrock Industries Inc., 211 F.3d 239, , 30 Envtl. L. Rep (5th Cir. 2000) ((discussing various trigger theories and concluding that di erent trigger theories would apply to property damage and bodily injury). One case that seemingly applies an exposure trigger is American Employer's Ins. Co. v. Pinkard Const. Co., 806 P.2d 954 (Colo. App. 1990). 31 See Don's Bldg. Supply, 267 S.W.3d at See, e.g., EnergyNorth Natural Gas, Inc. v. Underwriters at Lloyd's, 150 N.H. 828, 848 A.2d 715, 718 (2004) (recognizing little di erence between injuryin-fact and exposure theories when contamination begins almost immediately after release of hazardous materials). 62 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 48

49 CGL Insurance Coverage requirement exists that the damage become manifest or apparent during the policy period only that damage actually occurs during the policy period. This has led to some criticism over the sometimes di cult task of determining when property damage actually occurs. However, as one court noted, [p]inpointing the moment of injury retrospectively is sometimes di cult, but we cannot exalt ease of proof or administrative convenience over faithfulness to the policy language; our con ned task is to review the contract, not to revise it. 33 Perhaps because the actual injury or injury-in-fact trigger most closely tracks the policy language, it has gained traction as the proper trigger theory to be applied in determining CGL coverage for progressive property damage claims. 34 d. Continuous Trigger A so-called continuous trigger, although sometimes applied differently by di erent courts, generally provides that bodily injury and property damage that are continuous in nature are covered by all policies in e ect during the time the damage takes place. Neither the date of the negligent act nor the discovery of the damage or injury is particularly relevant in applying a continuous trigger theory. Perhaps the most widely cited case supporting a continuous trigger theory albeit not in the construction defect arena is Keene Corp. v. Insurance Company of North America. 35 The continuous trigger is often applied in construction defect cases. 36 The tendency of courts to apply the continuous or multiple trigger led to a revision of the CGL policy form in 2001 to require that bodily injury or property damage must not have been known to the insured prior to the inception of the policy period. That provision, located in the insuring agreement, states as follows: Prior to the policy period, no insured listed under Paragraph 1. of Section II Who is An Insured and no employee authorized by 33 Don's Bldg. Supply, 267 S.W.3d at Don's Bldg. Supply, Inc., 267 S.W.3d at 20; Transcontinental Ins. Co. v. W.G. Samuels Co., Inc., 370 F.3d 755, 758 (8th Cir. 2004) (applying Kansas law); Trizec Properties, Inc. v. Biltmore Const. Co., Inc., 767 F.2d 810, 813 (11th Cir. 1985) (applying Florida law); Hoang v. Assurance Co. of America, 149 P.3d 798, (Colo. 2007), as modi ed, (Mar. 5, 2007). 35 Keene Corp. v. Insurance Co. of North America, 667 F.2d 1034, 12 Envtl. L. Rep (D.C. Cir. 1981). 36 See Joe Harden Builders, Inc. v. Aetna Cas. and Sur. Co., 326 S.C. 231, 486 S.E.2d 89 (1997); Century Indem. Co. v. Golden Hills Builders, Inc., 348 S.C. 559, 561 S.E.2d 355 (2002) (overruled on other grounds by, Crossmann Communities of North Carolina, Inc. v. Harleysville Mut. Ins. Co., 395 S.C. 40, 717 S.E.2d 589 (2011)); Gruol Const. Co., Inc. v. Insurance Co. of North America, 11 Wash. App. 632, 524 P.2d 427 (Div ). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

50 Journal of the ACCL you to give or receive notice of an occurrence or claim, knew that the bodily injury or property damage had occurred, in whole or in part. If such a listed insured or authorized employee knew, prior to the policy period, that the bodily injury or property damage occurred, then any continuation, change or resumption of such bodily injury or property damage during or after the policy period will be deemed to have been known prior to the policy period. The provision goes on to set out criteria as to the means whereby bodily injury or property damage will be deemed to have been known by the insured to have occurred, including the earliest time when the insured reports the bodily injury or property damage, receives a written or verbal demand or claim for damages, or becomes aware by any other means that bodily injury or property damage has occurred. The provision is an attempt to isolate a loss in a single policy once it becomes known. D. The Occurrence Requirement One of the key requirements for coverage under a CGL policy is that the bodily injury or property damage be caused by an occurrence. Occurrence is de ned in the policy as an accident, including continuous or repeated exposure to substantially the same general harmful conditions. The de nition of occurrence is where the CGL directly incorporates the requirement of fortuity, which is part and parcel of the basic tenet of insurance that an insured should not be able to control the risk and obtain insurance coverage for intentional acts. i. Historical Development Exclusion (a) The CGL forms moved from a strict accident formulation to an occurrence basis in At that time, the term occurrence was de ned as an accident, including injurious exposure to conditions, which results, during the policy period, in bodily injury or property damage neither expected or intended from the of the standpoint of the insured. That de nition, without change, was maintained in the 1973 revisions to the CGL policy form. In 1986, the de nition of occurrence was added in its present iteration, and the neither expected or intended language was moved to an exclusion a. The exclusion states that the insurance does not apply to bodily injury or property damage expected or intended from the standpoint of the insured. The current de nition of occurrence, together with exclusion a, tracks the 1973 de nition in which the neither expected nor intended from the standpoint of the insured requirement was incorporated within the de nition of occurrence. In practical terms, issues relating to the fortuity of bodily injury or property damage arising out of construction risks are usually determined by reference to the occurrence requirement. Exclusion a, if addressed at all, is usually relegated to tag-along status. 64 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 50

51 CGL Insurance Coverage ii. Occurrence and Property Damage The issue of whether a contractor's defective work arises out of an occurrence has been hotly disputed throughout the United States. 37 Although opinions are diverse, the holdings generally break down into two opposing views: [O]ne line of cases has held that faulty or improper construction does not constitute an accident; rather, the damage is the natural and ordinary consequence of the insured's act. The other line of cases has held that improper or faulty construction does constitute an accident as long as the resulting damage is an event that occurs without the insured's expectation or foresight. 38 The trend in the case law favors coverage, based on the view that inadvertent construction defects resulting in property damage may constitute an occurrence. A seminal example, and one addressing the most common issues raised by CGL insurers, is the Supreme Court of Texas's opinion in Lamar Homes, Inc. v. Mid-Continent Casualty Co. 39 Lamar Homes involved a suit against an insured homebuilder arising out of a subcontractor's defective work. 40 The builder's CGL insurer denied coverage on the ground that faulty workmanship is not an occurrence, and that to nd otherwise would transform the CGL policy into a performance bond. 41 The case was certi ed by the Fifth Circuit to the Supreme Court of Texas, which recognized that not every case of faulty workmanship will result in coverage. 42 The court noted situations where faulty workmanship is intentional from the viewpoint of the insured, 37 The divergence in views of the occurrence requirement is one reason insureds need to carefully analyze which state's law will apply to a coverage dispute. Choice of law can be crucial in determining coverage and needs to be analyzed from the very outset of a claim. It oftentimes is assumed that the law of the state where the construction defect claim arises will apply to the coverage dispute. That, however, is not always the case especially when the insured is from a di erent state. Jurisdictions apply di erent tests to determine choice of law. Some states apply the most-signi cant-relationship test, some apply a lex loci contractus approach, and still others apply a variation from the Restatement (second) Con ict of Laws. Although the tests vary, an important and sometimes determinative factor is where the policy was issued to the insured. Typically, at least with respect to liability policies, where the policy was issued to the insured is more important than where the loss occurred. Additionally, some states have speci c insurance code provisions that address the choice-oflaw issue. Likewise, some policies also have speci c choice-of-law provisions. 38 Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 281 Kan. 844, 137 P.3d 486, 491 (2006). 39 Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007). 40 Lamar Homes, 242 S.W.3d at 5. Workshop W3 41 Lamar Homes, Inc., 242 S.W.3d at Lamar Homes, Inc., 242 S.W.3d at 7. Thomson Reuters E Journal of the ACCL E Vol. 9 No

52 Journal of the ACCL and where faulty workmanship merely diminishes the value of the damaged project without causing physical injury. 43 The court also observed that some faulty workmanship claims would be excluded under speci c business-risk exclusions. However, the court also reviewed the evolution of the CGL policy and reached the conclusion that the subcontractor exception to the your work exclusion was a purposeful addition to the CGL policy that has to be given e ect. 44 Likewise, the court rejected any contract versus tort distinction for determining whether the occurrence requirement is satis ed. 45 Similarly, the court rejected foreseeability as the boundary between accidental and intentional conduct. 46 Following Lamar Homes, the Florida Supreme Court addressed a case involving an insured general contractor's claim for damage to completed homes caused by its subcontractors' use of poor soil and improper soil compaction and testing. 47 The insurer argued that a subcontractor's faulty workmanship causing damage to the insured contractor's own work can never be an occurrence because it results in reasonably foreseeable damages. 48 The court, focusing on the evolution of CGL policy forms, rejected that analysis and instead found that the defective workmanship of a subcontractor can constitute an occurrence under a general contractor's CGL policy. 49 The court also rejected the insurer's contention that 43 Lamar Homes, Inc., 242 S.W.3d at Lamar Homes, Inc., 242 S.W.3d at The court properly rejected Mid-Continent's argument that the insured was using the subcontractor exception to create coverage. Lamar Homes, Inc., 242 S.W.3d at 14 ( [W]e have not said that the subcontractor exception creates coverage; rather, it reinstates coverage that would otherwise be excluded under the your-work exclusion. ). 45 Lamar Homes, Inc., at 13 ( Therefore, any preconceived notion that a CGL policy is only for tort liability must yield to the policy's actual language. ). See also Pryor, The Economic Loss Rule and Liability Insurance, 48 Ariz. L. Rev. 905, 917 (2006). 46 Lamar Homes, 242 S.W.3d at 8. If foreseeability means no coverage, then CGL coverage is illusory. Insurance premiums are based on actuarial risk. The reason why consumers buy insurance is because of foreseeable risks. If CGL insurance only protected against unforeseeable risks, then it would be of little use to contractors. See Travelers Indem. Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302, 308 (Tenn. 2007) ( If foreseeability is determined from the negligent completion of the project, then the negligent acts of the insured will almost never be accidents because, by de nition, negligence requires that damages be foreseeable. ). 47 J.S.U.B., 979 So.2d at 875, J.S.U.B., 979 So.2d at J.S.U.B., 979 So.2d at Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 52

53 CGL Insurance Coverage construing the term occurrence to include a subcontractor's defective work converts a CGL policy into a performance bond. 50 These cases are two illustrations of a trend of state courts nding that physical damage resulting from inadvertent construction defects constitutes an occurrence under a CGL policy. The supreme courts of Mississippi, 51 South Carolina, 52 Tennessee, 53 Kansas, 54 Wisconsin, 55 Indiana, 56 North Dakota 57 and West Virginia 58 also have issued opinions concluding that claims against an insured contractor satisfy the occurrence requirement. 50 J.S.U.B., 979 So.2d at Architex Ass'n, Inc. v. Scottsdale Ins. Co., 27 So. 3d 1148, 1162 (Miss. 2010) ( By failing to consider the policy as a whole, the circuit court erred in its occurrence analysis. Under Scottsdale's CGL policy, the term occurrence cannot be construed in such a manner as to preclude coverage for unexpected or unintended property damage resulting from work performed on [Architex's] behalf by a subcontractor. ). 52 Auto Owners Ins. Co., Inc. v. Newman, 385 S.C. 187, 684 S.E.2d 541, 544 (2009) ( Furthermore, although the subcontractor's negligent application of the stucco does not on its own constitute an occurrence, we nd that the continuous moisture intrusion resulting from the subcontractor's negligence is an occurrence as de ned by the CGL policy. ). The holding from the South Carolina court can be considered a middle-ground approach. The court held that damage to the work itself is not an occurrence, but damage beyond the defective work itself is an occurrence even if the damage is to the same project. The middleground approach is not grounded in the de nition of occurrence, as it still reads something into the de nition that simply is not there (i.e., a requirement of damage beyond the work itself). Even so, other courts have adopted it as an apparent compromise between the two diverging positions. See e.g., French v. Assurance Co. of America, 448 F.3d 693 (4th Cir. 2006). 53 TMoore & Assocs., Inc., 216 S.W.3d at 308 ( We decline to adopt a construction of accident which would so drastically limit the coverage under a CGL. ). 54 Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 281 Kan. 844, 137 P.3d 486, 495 (2006) ( The damage in the present case is an occurrence an even more expansive coverage term than accident because faulty materials and workmanship provided by Lee's subcontractors caused continuous exposure of the Steinberger home to moisture. ). 55 American Family Mut. Ins. Co. v. American Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65, 78 (2004) ( If, as American Family contends, losses actionable in contract are never CGL occurrences for purposes of the initial coverage grant, then the business risk exclusions are entirely unnecessary. ). 56 Sheehan Const. Co., Inc. v. Continental Cas. Co., 935 N.E.2d 160 (Ind. 2010), opinion adhered to as modi ed on reh'g on other grounds, 938 N.E.2d 685 (Ind. 2010). 57 K & L Homes, Inc. v. American Family Mut. Ins. Co., 2013 ND 57, 829 N.W.2d 724 (N.D. 2013). 58 Cherrington v. Erie Ins. Property and Cas. Co., 231 W. Va. 470, 745 S.E.2d 508 (2013). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

54 Journal of the ACCL Recent decisions from other states, including Arkansas, 59 Pennsylvania, 60 Hawaii, 61 New York 62 and Kentucky, 63 are examples of the opposing view. Even if the view that defective workmanship resulting in property damage can arise from an occurrence becomes universal, courts may continue to decide the issue di erently in given cases based on their facts. 64 And, some courts have adopted a middle ground approach whereby defective work is only an occurrence if it damages otherwise non-defective work. 65 This middle ground approach, which appears to be a compromise between the business risk rationale and contract interpretation principles, seems to be gaining in popularity. 59 Essex Ins. Co. v. Holder, 370 Ark. 465, 372 Ark. 535, 261 S.W.3d 456 (2007), superseded by statute, Ark. Code Ann (a)(2) (2011) (requiring CGL insurance policies to de ne occurrence to include [p]roperty damage or bodily injury resulting from faulty workmanship ). Even though Holder represents the view that faulty workmanship is not an occurrence, the facts of Holder do not reveal whether there was any actual property damage caused by defective work. The court's recitation of the facts indicates the court was dealing with the failure to complete work, delays in construction, and the failure to procure quali ed subcontractors. See Holder, 261 S.W.3d at Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 589 Pa. 317, 908 A.2d 888 (2006). 61 Group Builders, Inc. v. Admiral Ins. Co., 123 Haw. 142, 231 P.3d 67 (Ct. App. 2010); see also Nautilus Ins. Co. v. 3 Builders, Inc., 955 F. Supp. 2d 1121 (D. Haw. 2013). 62 National Union Fire Ins. Co. of Pittsburgh, PA v. Turner Const. Co., 119 A.D.3d 103, 986 N.Y.S.2d 74 (1st Dep't 2014); Rosewood Home Builders, LLC v. National Fire & Marine Ins. Co., 2013 WL (N.D. N.Y. 2013). 63 Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W.3d 69 (Ky. 2010), as corrected, (July 19, 2011); see also Liberty Mut. Fire Ins. Co. v. Kay & Kay Contracting, LLC, 545 Fed. Appx. 488 (6th Cir. 2013). 64 Compare L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 366 S.C. 117, 621 S.E.2d 33 (2005) ( nding no occurrence for damage arising from faulty workmanship), with Auto Owners Ins. Co., Inc. v. Newman, 385 S.C. 187, 684 S.E.2d 541 (2009) ( nding an occurrence when the faulty workmanship damaged other non-defective portions of the work). The issue in South Carolina got even more confusing, which ultimately culminated in yet another decision that sought to clarify both L-J and Newman. See Crossmann Communities of North Carolina, Inc. v. Harleysville Mut. Ins. Co., 395 S.C. 40, 717 S.E.2d 589 (2011). Simply put, the issue continues to be debated across the country. For a recent case discussing the occurrence issue and the split in authority, see Greystone Const., Inc. v. National Fire & Marine Ins. Co., 661 F.3d 1272 (10th Cir. 2011), as amended on reh'g in part, (Dec. 23, 2011). 65 See, e.g., Taylor Morrison Services, Inc. v. HDI-Gerling America Ins. Co., 293 Ga. 456, 746 S.E.2d 587 (2013); Capstone Bldg. Corp. v. American Motorists Ins. Co., 308 Conn. 760, 67 A.3d 961 (2013); Town & Country Property, L.L.C. v. Amerisure Ins. Co., 111 So. 3d 699 (Ala. 2011); Greystone Constr., 661 F.3d at (discussing the recent trend of nding an occurrence where the damage extends to nondefective property). 68 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 54

55 CGL Insurance Coverage Obviously, the cited cases are only a small sampling as this issue has been the subject of much litigation across the country. Also, in response to what has been perceived as bad case law, some states (e.g., Arkansas, Hawaii, South Carolina and Colorado) have passed legislation that speci cally addresses the occurrence issue. 66 While the statutes vary slightly, each attempts to legislatively de ne what constitutes an occurrence. It will be interesting to see if legislative interventions become a trend in the insurance coverage world. E. The Property Damage Requirement The concept of property damage is central to CGL insurance coverage for construction risks. As construction lawyers are aware, problems in a construction project do not only result in damage to the project or the property of third parties, but also economic losses that go beyond the value of damaged property itself. As discussed below, it is with respect to economic losses that disputes regarding the de nition of property damage most often occur. The standard CGL policy de nes property damage as: a) Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or b) Loss of use of tangible property that is not physically injured. All such loss of use shall be deemed to occur at the time of the occurrence that caused it. i. Physical Injury to Tangible Property and Loss of Use of Tangible Property In 1973, the insurance industry revised the de nition of property damage to require physical injury to or destruction of tangible property. It was thought that the addition of the word physical (together with other exclusions in the policy) would eliminate coverage for claims for damages such as diminution in value of property that was not itself physically injured. The physical injury requirement was a reaction to the landmark case of Hauenstein v. St. Paul-Mercury Indemnity Co. 67 In that case, the insured supplied defective plaster that was applied to the walls and ceilings of a building. The plaster shrank and cracked after application and had to be removed and replaced. The court held that the application of the defective plaster in e ect lowered the 66 Recently, New Jersey's state legislature introduced Bill No. A1077, which would require insurers in that state to de ne occurrence under a CGL policy to include faulty workmanship. 67 Hauenstein v. Saint Paul-Mercury Indem. Co., 242 Minn. 354, 65 N.W.2d 122 (1954). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

56 Journal of the ACCL market value of the building, constituting property damage under the terms of the policy's insuring agreement. The court held that the measure of the damage was the diminution in the market value of the building or the cost of removing the defective plaster and restoring the building to its former condition, plus any loss from deprivation of use, whichever was lesser. By adding the word physical to the de nition of property damage, the insurance industry hoped that this type of diminution-in-value claim would be found outside the scope of CGL coverage. The rst prong of the property damage de nition is the one most frequently at issue in the construction context, particularly with respect to construction defect claims. The key is distinguishing between a mere defect and physical injury to tangible property. Generally speaking, tangible property su ers a physical injury when the property is altered in appearance, shape, color, or in another material dimension. 68 Competing views exist as to whether the mere incorporation of a defective component into a larger product constitutes property damage. When a product manufactured or installed by an insured has been integrated into another party's property, damage to that property, as a whole, excluding the cost of repairing or replacing the defective part, constitutes property damage. 69 The second prong of the property damage de nition deals with inability to use property that is not physically injured. An example is where a property owner alleges his business sustained 68 See Acadia Ins. Co. v. Peerless Ins. Co., 679 F. Supp. 2d 229 (D. Mass. 2010); Webster v. Acadia Ins. Co., 156 N.H. 317, 934 A.2d 567 (2007); Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 10 (Tex. 2007) ( These allegations of cracking sheetrock and stone veneer are allegations of physical injury to tangible property. ); American Family Mut. Ins. Co. v. American Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65, 75 (2004) ( The sinking, buckling, and cracking of the warehouse was plainly physical injury to tangible property. ). 69 See Travelers Ins. Co. v. Eljer Mfg., Inc., 197 Ill. 2d 278, 258 Ill. Dec. 792, 757 N.E.2d 481 (2001); see also Esicorp, Inc. v. Liberty Mut. Ins. Co., 266 F.3d 859, 862, 32 Envtl. L. Rep (8th Cir. 2001) (holding that defective steel pipe sections welded into pipe system did not constitute physical injury to tangible property); National Union Fire Ins. Co. of Pittsburgh, P.A. v. Terra Industries, Inc., 216 F. Supp. 2d 899, 917 (N.D. Iowa 2002), a 'd, 346 F.3d 1160 (8th Cir. 2003) (holding that carbonated beverages su ered property damage as a result of introduction of carbon dioxide containing benzene); F& H Const. v. ITT Hartford Ins. Co. of Midwest, 118 Cal. App. 4th 364, 12 Cal. Rptr. 3d 896, 901 (3d Dist. 2004) ( [T]he prevailing view is that the incorporation of a defective component or product into a larger structure does not constitute property damage unless and until the defective component causes physical injury to tangible property in at least some other part of the system. ); see also Tweet/ Garot-August Winter, LLC v. Liberty Mut. Fire Ins. Co., 2007 WL (E.D. Wis. 2007) (collecting cases). 70 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 56

57 CGL Insurance Coverage economic loss during a construction delay. 70 Outside of this context, however, the second prong of the property damage de nition oftentimes is problematic because of the impaired property exclusion elsewhere in the policy (as discussed below). It has been argued that defective construction claims fail to allege property damage because damage to the work itself constitutes a mere economic loss or an uninsurable business risk. The de nition of property damage, however, does not require that the physical injury to tangible property be to the property of others or of third parties. In rejecting the view that the property damage de nition requires damage to third-party property, one federal court stated: The de nition of property damage in the policies does not limit the coverage to property that is not in the possession of or work product of the insured. [The insured] correctly points out that if the work product of the insured could never come within the de nition of property damage, then the exclusions set forth in the policy to limit such damages would be without meaning. 71 Despite the fact that the de nition of property damage does not require that damage be to the property of a third party, some courts have read the property damage requirement in conjunction with the business risk exclusions to hold that damage to the work itself does not constitute property damage. 72 A detailed analysis of the property damage issue from a slightly 70 See Geurin Contractors, Inc. v. Bituminous Cas. Corp., 5 Ark. App. 229, 636 S.W.2d 638, 641 (1982); Gibson & Associates, Inc. v. Home Ins. Co., 966 F. Supp. 468, 477 (N.D. Tex. 1997). Other examples exist when, for example, a component part causes a loss of use to the product into which it was incorporated. See, e.g., Anthem Electronics, Inc. v. Paci c Employers Ins. Co., 302 F.3d 1049, 1057 (9th Cir. 2002). Similarly, the second prong may be satis- ed if a piece of equipment fails and that causes a loss of use beyond the piece of equipment itself. See, e.g., Hartzell Industries, Inc. v. Federal Ins. Co., 168 F. Supp. 2d 789, 795 (S.D. Ohio 2001). For an excellent discussion of these cases, as well as a historical perspective of the property damage de nition, see James Du y O'Connor, Construction Defects: Property Damage and the Commercial General Liability Policy, The Construction Lawyer 11 (Spring 2004); and James Du y O'Connor, What Every Court Should Know About Insurance Coverage for Defective Construction, Vol. 5 Journal of the American College of Construction Lawyers, No. 11, Winter Fidelity & Deposit Co. of Maryland v. Hartford Cas. Ins. Co., 189 F. Supp. 2d 1212, 1220 (D. Kan. 2002). 72 See, e.g., R.N. Thompson & Associates, Inc. v. Monroe Guar. Ins. Co., 686 N.E.2d 160, (Ind. Ct. App. 1997) (abrogated by, Sheehan Const. Co., Inc. v. Continental Cas. Co., 935 N.E.2d 160 (Ind. 2010)) (holding that commercial general liability policies could provide coverage for subcontractors' faulty workmanship); Acadia Ins. Co. v. Peerless Ins. Co., 679 F. Supp. 2d 229, 240 (D. Mass. 2010) ( [F]or purposes of a CGL policy, covered property damage is alleged only when property other than the insured's work product has su ered harm. ); U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871, 889 (Fla. 2007) Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

58 Journal of the ACCL di erent perspective was undertaken by the Florida Supreme Court in Auto-Owners Insurance Co. v. Pozzi Window Co. 73 There, the court grappled with the distinction between replacement of a building component rendered defective by faulty installation as opposed to a component that was inherently defective and installed properly. The owner purchased windows, which were installed by a subcontractor. Subsequent to their installation, the windows leaked, causing damage to substantial portions of the owner's home as well as to windows, which had to be removed and replaced. The CGL insurer agreed that the damages to the home were covered, but denied coverage for the replacement of the windows. The court concluded that the record did not resolve whether the windows themselves were defective when installed, or whether they only eventually leaked because of defective installation. According to the court, if the windows themselves were defective, the cost of their replacement would not be the result of property damage but simply the cost of rectifying defective work itself. In contrast, if the claim were for the replacement of windows that were not defective at installation, but were damaged by defective installation, then that would constitute damages because of property damage and the replacement of the windows would be covered. The rule announced in Pozzi was recently analyzed and followed by the Eleventh Circuit. Indeed, like with the occurrence requirement, there appears to be an emerging middle ground approach that requires damage beyond the defective work itself to some otherwise non-defective portion of the project. 74 In other words, as in the Auchter decision, a defective roof is not property damage even if the roof itself is physically damaged, but resultant damage caused by the roof to otherwise non-defective portions of the project (e.g, wet sheetrock) are property damage. ii. Economic Loss and Consequential Damages Insurers sometimes argue that a loss is purely economic in nature and, thus, not property damage. Although it is almost uniformly recognized that purely economic losses (i.e., economic losses not tied to any property damage) are not covered, the same is not true for consequential economic losses that arise from or ( [O]ther courts have also recognized that there is a di erence between a claim for the costs of repairing or removing the defective work, which is not a claim for property damage, and a claim for the costs of repairing damage caused by the defective work, which is a claim for property damage. ). 73 Auto-Owners Ins. Co. v. Pozzi Window Co., 984 So. 2d 1241 (Fla. 2008). 74 One Texas federal court has explicitly recognized the issue, but did not ultimately hold whether Texas would follow the middle ground approach. See Building Specialties, Inc. v. Liberty Mut. Fire Ins. Co., 712 F. Supp. 2d 628, (S.D. Tex. 2010). 72 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 58

59 CGL Insurance Coverage relate to property damage. 75 CGL policies have been interpreted to cover consequential economic damages based on the language of the insuring agreement stating that [w]e will pay those sums that the insured becomes legally obligated to pay as damages because of... property damage. The words because of indicate that the damages must have their origin in physical injury to or loss of use of tangible property. Accordingly, once property damage has been established, the policy then covers economic losses that ow because of the property damage. 76 For example, diminution in value in and of itself is a purely economic loss that would not constitute property damage. 77 However, diminution in value resulting from physical injury to tangible property constitutes damage because of property damage. 78 Other forms of economic loss that occur on construction projects (e.g., project delays, cost overruns, etc.) could be covered as well provided that the economic losses are tied to otherwise covered property damage. 79 iii. Rip and Tear Another issue that has been litigated with some frequency is whether the CGL policy provides coverage for the costs to rip out otherwise non-defective work in order to repair defects in the insured's work. While at rst glance the case law across the 75 See National Union Fire Ins. Co. of Pittsburgh, Pa. v. Puget Plastics Corp., 532 F.3d 398, 403 (5th Cir. 2008) (discussing damages because of property damage ); American Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986) ( nding coverage for consequential losses stemming from physical injury to windows even though there was no coverage for the repair or replacement of the windows themselves). Likewise, courts have rejected the economic loss rule as a test of whether the property damage requirement has been satis ed. See American Family Mut. Ins. Co. v. American Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65, 75 (2004) ( The economic loss doctrine is a remedies principle. It determines how a loss can be recovered in tort or in contract/ warranty law. It does not determine whether an insurance policy covers a claim, which depends instead upon the policy language. ); U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871, 889 n.11 (Fla. 2007); Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 12 (Tex. 2007). 76 See Donald S. Malecki & Arthur L. Flitner, Commercial General Liability 7 (7th ed. 2001) ( In light of [the because of ] wording, all damages owing as a consequence of bodily injury or property damage would be encompassed by the insurer's promise, subject to any applicable exclusion or condition. This includes purely economic damages, as long as they result from otherwise covered bodily injury or property damage. ). 77 See Lamar Homes, 242 S.W.3d at See Missouri Terrazzo Co. v. Iowa Nat. Mut. Ins. Co., 740 F.2d 647 (8th Cir. 1984); see also Mid-Continent Cas. Co. v. Academy Development, Inc., 476 Fed. Appx. 316 (5th Cir. 2012) ( nding diminution in value to be damages because of property damage ). 79 See, e.g., Mid-Continent Cas. Co. v. Bay Rock Operating Co., 614 F.3d 105, , 72 O.G.R. 123 (5th Cir. 2010). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

60 Journal of the ACCL country seems to be mixed, a careful look at the fact patterns discussed in the cases suggests a prevailing view. In particular, the majority view can be summed up as follows: the costs to rip out otherwise non-defective work in order to repair otherwise non-covered defective work is not property damage, but the costs to rip out non-defective work in order to repair covered property damage is considered damages because of property damage and is covered. 80 The rationale of many of these decisions is that the nature of the repairs cannot create coverage if none exists. 81 In some instances, once property damage occurs, courts will allow recovery of safety measures taken to prevent future property damage or bodily injury. 82 F. The Historical Development of the CGL Forms and Coverage for Defective Work In the majority of cases involving property damage to some part of the project itself (as opposed to, for example, damage to a neighboring structure), the insurer will assert or suggest that construction defects themselves are not covered because they are not property damage caused by an occurrence, and/or that only damage resulting from a construction defect is covered. As noted above, the majority of CGL coverage disputes in the construction context in some way spring from this scenario. At the outset of any such coverage dispute, consideration of the historical development of the standard CGL policy is important. The standard CGL policy form has been in a state of continuing development for decades, including major revisions in Courts hearing construction defect disputes have been particularly amenable to considering the historical development of CGL forms to determine the scope of coverage under present-day policies. The historical development of CGL forms re ects the efforts of the insurance industry to meet the perceived needs of the construction industry and to clarify and modify coverage as new risks have emerged. However, it also illustrates that when emerging, di cult-to-predict risks have resulted in unanticipated exposures for contractors and insurers, contractions of coverage 80 See Lennar Corp. v. Great American Ins. Co., 200 S.W.3d 651, (Tex. App. Houston 14th Dist. 2006) (abrogated on other grounds by, Gilbert Texas Const., L.P. v. Underwriters at Lloyd's London, 327 S.W.3d 118 (Tex. 2010)); Fidelity & Deposit Co. of Maryland v. Hartford Cas. Ins. Co., 215 F. Supp. 2d 1171, 1183 (D. Kan. 2002). See also Sandgrund, Greystone and Insurance Coverage for Get to and Rip and Tear Expenses, 41 Colo. Law. 69 (Mar. 2012); Steven Rawls, Do CGL Policies Cover Rip and Tear Expenses?, available at (March 2011). 81 See New Hampshire Ins. Co. v. Vieira, 930 F.2d 696, 701 (9th Cir. 1991). 82 See Big-D Const. Corp. v. Take it for Granite Too, 917 F. Supp. 2d 1096, (D. Nev. 2013). 74 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 60

61 CGL Insurance Coverage have resulted. Examples include new exclusions of exposures such as asbestos, fungus and mold, lead, and EIFS. i. Business Risk and Revisions of the Forms A tension has long existed between the underwriting of CGL coverage for damage to the work caused by an insured contractor and what underwriters traditionally have referred to as an uninsured business risk. The drafting of CGL forms over the past 60 years re ects an e ort by the insurance industry to provide a quantum of coverage for certain construction risks, including defective construction, where providing coverage squares with the fortuity which must underpin all insurance. However, in determining whether a certain type of loss is su ciently fortuitous to be insurable, there can be a ne line between certainty and foreseeability. Many disputes regarding coverage for defective work and resultant damage hinge on such ne distinctions. The drafters of the standard CGL form have attempted to address the concept of uninsured business risk primarily through exclusions and exceptions that have been modi ed over several years. The standard CGL policy form is promulgated by the Insurance Services O ce ( ISO ), an industry organization that drafts many standard forms used by insurers, including the main ISO CGL occurrence form (also known as form CG 00 01). Over the years, the ISO CGL form has undergone several major revisions, including revisions a ecting coverage for construction risks. One such revision was issued in 1966, when exclusion o (the work performed exclusion) was added to the policy in order to broadly exclude coverage for property damage arising out of work performed by or on behalf of the named insured. This excluded coverage for property damage arising out of the work of the insured and its subcontractors. However, in recognition of the nearly blanket nature of the exclusion vis-à-vis damage to the work, two companion endorsements were made available in One endorsement expanded coverage to include ongoing operations, and one expanded coverage to include both ongoing operations and completed operations. Exclusion o was retained in the 1973 revision of the form, and the two endorsements also were retained. For a time, the endorsements became collectively known as the broad form property damage endorsement. The endorsement providing only operations coverage became separately known as advisory endorsement 3006 (excluding completed operations). The endorsement providing both operations and Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

62 Journal of the ACCL completed operations coverage became separately known as advisory endorsement 3005 (including completed operations). 83 Endorsement 3005 proved to be an overwhelmingly more popular endorsement in the construction industry, and it eventually came to be referred to simply as the broad form property damage endorsement (BFPDE). Indeed, insurance provisions in construction contracts sometimes still refer to the BFPDE, even though its coverage was long ago incorporated into the main CGL policy form, as discussed further below. The BFPDE expanded the coverage under the 1973 version of the main CGL form by, among other modi cations, modifying the work performed exclusion to delete the reference to work performed on behalf of the named insured. As a result, coverage included property damage arising out of work performed by subcontractors. The CGL policy form underwent another major revision in The 1986 revisions were widely hailed throughout the insurance industry, both for their simpli cation and reduction of the number of forms, as well as their use of more plain language. 84 One of the simpli cations sought by ISO was to clarify the limitations on the business risk concept introduced in 1973 by the BFPDE. Because of the popularity of the extra coverage provided by the BFPDE, one major revision to the main CGL form was adding an exception for subcontractor work to Exclusion l (the your work exclusion). This key exception states that the your work exclusion does not apply to work performed on the named insured's behalf by a subcontractor. The revisions also rewrote and streamlined other exclusions, including exclusions j and m, which apply primarily to risks that arise during construction operations and loss-of-use damages (as discussed further below). 85 ii. CGL Coverage vs. Performance Bonds In addition to citing the business risk doctrine as a basis to deny coverage for certain damages arising from construction defects, insurers have argued that providing liability coverage for such damages would impermissibly convert CGL policies into performance bonds. Of course, it is true that a performance bond is not insurance, and vice versa. Insurance is a contract of indemnity, while a 83 For a more detailed discussion of the development of CGL forms as applied to the construction industry dating back to the 1950s, see Patrick J. Wielinski, Insurance for Defective Construction Chs. 1, 11 (2d ed. 2005) Eric Mills Holmes, Holmes' Appleman on Insurance 129.1[C] (2d ed. 2002). 85 Tinker, Comprehensive General Liability Insurance Perspective and Overview, 25 Fed'n. Ins. Couns. Q. 217, 226 (Spring 1975). 76 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 62

63 CGL Insurance Coverage surety bond is a guaranty of the performance of the principal's obligations. An insurance policy is issued based on an evaluation of risks that are actuarially linked to premiums. Expected losses (sometimes referred to as loss picks by underwriters) are determined in advance. In contrast, a surety bond is underwritten based on what amounts to a credit evaluation of the particular contractor and its capabilities to perform its contracts with the expectation that no losses will occur. As part of the underwriting of a bond, the surety analyzes the strengths and weaknesses of the contractor and its ability to perform its obligations. The process is very similar to the process used by a lender in making a loan. In addition, the performance bond is not for the protection of the contractor (the principal), but rather for the protection of the owner (the obligee). Cases such as United States Fire Insurance Co. v. J.S.U.B., Inc. 86 and Lamar Homes, Inc. v. Mid- Continent Casualty Co. 87 have addressed the distinctions between the two types of instruments. In Lamar Homes, the Supreme Court of Texas concluded that any similarities between CGL coverage and a performance bond under the circumstances of a subcontractor defect claim were irrelevant to the scope of coverage under a CGL policy, and that no rule of policy construction operates to eliminate coverage simply because similar protection may also be available through another product. 88 As noted above, a performance bond is a three-party instrument between the obligee, the surety, and the contractor, with the surety retaining a right of indemnity against the contractor as well as other indemnitors, typically the contractor's individual owners. Thus, the contractor will ultimately be required to pay the loss from its own funds by indemnifying the surety for amounts paid to or for the bene t of the obligee. This is a fundamental distinction between performance bonds and CGL coverage: an insurance company has no right of indemnity against its insured for covered losses. An insurer is instead limited to recover against third parties through subrogation (to the extent subrogation is not limited by the insurance policy and/or separate waivers of subrogation). One of the assumptions behind the argument that CGL coverage should be limited where it would subsume certain obligations of a performance bond is that the scope of a performance bond and a CGL policy must be mutually exclusive. While it is true that there are many types of risks and losses that fall within the ambit of a bond and not an insurance policy, and vice versa, there can be considerable overlap between the two. 86 U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871 (Fla. 2007). Workshop W3 87 Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007). 88 Lamar Homes, Inc., 242 S.W.3d at 11. Thomson Reuters E Journal of the ACCL E Vol. 9 No

64 Journal of the ACCL For example, assume that a residential condominium building is constructed with defective balconies which slope backward toward the building. The problem is compounded by defective waterproo ng and ashing that allow water to enter nished individual units. The plans and speci cations called for a proper slope and proper waterproo ng and ashing, but the general contractor used a subcontractor who failed to perform as required. If the general contractor does not x the defective balconies after a request from the developer (the surety bond obligee), this may trigger a performance bond default and the surety's obligation to remedy the work. In that case, the surety would usually cover the cost of removing and rebuilding the balcony (some of which may be treated as covered rip-and-tear work under a CGL policy). Resultant damage to unit owner build-outs that were not in the scope of the contractor's work would likely not be covered by the performance bond but would be covered under the contractor's CGL policy as resultant damage. Upon payment to the owner of a performance bond claim involving defective workmanship, the surety would have a right of indemni cation against the principal-contractor and would be subrogated to the contractor's rights under its CGL policy. A surety's right of subrogation against its principal's CGL insurer is well recognized. 89 Some courts continue to nd that CGL coverage for defective workmanship is generally barred because to hold otherwise would convert the policy into a performance bond. In that regard, see Essex Insurance Co. v. Holder., 90 relying upon Nabholz Construction Corp. v. St. Paul Fire & Marine Insurance Co. 91 Overall, however, the argument seems to be waning as an independent basis to deny CGL coverage for defective workmanship claims. 92 G. Exclusions Although the focus of this paper is on the insuring agreement and, in particular, the property damage requirement, courts oftentimes incorporate business risk notions into the interpretation of what constitutes property damage caused by an 89 See Essex Builders Group, Inc. v. Amerisure Ins. Co., 429 F. Supp. 2d 1274 (M.D. Fla. 2005); Fidelity & Deposit Co. of Maryland v. Hartford Cas. Ins. Co., 189 F. Supp. 2d 1212 (D. Kan. 2002); American Oil Co. v. L. A. Davidson, Inc., 95 Mich. App. 358, 290 N.W.2d 144, 28 U.C.C. Rep. Serv (1980). See also Joanne Brooks, et al., The Importance of Insurance Coverages for Sureties, ABA Forum on the Construction Industry/Tips Fidelity & Surety Law Committee Joint Program Mid-Winter Meeting (2005). 90 Essex Ins. Co. v. Holder, 370 Ark. 465, 372 Ark. 535, 261 S.W.3d 456 (2007). 91 Nabholz Const. Corp. v. St. Paul Fire and Marine Ins. Co., 354 F. Supp. 2d 917 (E.D. Ark. 2005). 92 See Lexicon, Inc. v. ACE American Ins. Co., 634 F.3d 423 (8th Cir. 2011). 78 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 64

65 CGL Insurance Coverage occurrence. For this reason, a brief discussion of the commonly invoked business risk exclusions is in order. i. Expected or Intended Injury As the discussion of the de nition of occurrence emphasized, the notion of fortuity that is, an accident is central to the principle of liability insurance, i.e., that an insured cannot control the risk or intentionally cause bodily injury or property damage. Exclusion a, the expected or intended injury exclusion, states that the insurance does not apply to bodily injury or property damage expected or intended from the standpoint of the insured. The expected or intended injury exclusion had its genesis in prior de nitions of occurrence, and is discussed above in connection with the de nition of occurrence. ii. Contractual Liability Exclusion (and Coverage) The contractual liability exclusion is of critical importance in the construction context because construction contracts usually contain some form of indemnity or hold harmless agreement whereby a downstream party (such as a contractor) agrees to indemnify the upstream party (such as an owner) for bodily injury and property damage arising out of the contractor's operations. An example of such an indemnity agreement is found in paragraph 3.18 of A201, the General Conditions for the Construction Contract promulgated by the American Institute of Architects. The enforceability of an indemnity clause in a construction contract is determined by reference to the applicable state law, and may be subject to regulations or an anti-indemnity statute. That indemnity obligation may be insured under a CGL policy, but under an equally complex exclusion that provides coverage by means of an exception. The standard CGL policy provides coverage for this indemnity exposure by means of the contractual liability coverage provided for in the policy. 93 The coverage is part of the standard form but is provided in a somewhat circuitous manner that is, by means of an exception to exclusion b, the contractual liability exclusion. The exclusion states that the insurance does not apply to: Bodily injury or property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages: 93 The term contractual liability coverage although frequently used is somewhat a misnomer. While the better reasoned view is that the insuring agreement of the CGL policy is broad enough to include coverage for contractually-assumed liabilities that otherwise satisfy the property damage and occurrence requirements, the so-called contractual liability coverage referred to by many is actually nothing more than an exception to an exclusion. Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

66 Journal of the ACCL (1) That the insured would have in the absence of the contract or agreement; or (2) Assumed in a contract or agreement that is an insured contract, provided the bodily injury or property damage occurs subsequent to the execution of the contract or agreement... In turn, the de ned term insured contract lists the types of indemni cation clauses to which the exclusion does not apply (and for which there is coverage), including a lease of premises, a sidetrack agreement, an easement or license agreement, an obligation to indemnify a municipality except in connection with work for a municipality, and an elevator or maintenance agreement. Most signi cantly, subparagraph f of the de nition of insured contract includes: That part of any other contract or agreement pertaining to your business (including an indemni cation of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for bodily injury or property damage to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement. As noted above, the general purpose of contractual liability coverage is to insure the indemnitor's obligation to indemnify the indemnitee for bodily injury or property damage to third parties arising out of performance of the contract. While exclusion b excludes coverage for all liability assumed by contract, the exception for insured contracts for the most part swallows the exclusion for many claims in the construction context. It must be emphasized that the vast majority of jurisdictions have concluded that the exclusion does not apply to property damage for which the insured is directly liable based on breach of contract. 94 By its terms, it applies only to liability by reason of the assumption of liability that is, pursuant to a hold harmless agreement that is not within the companion de nition of insured contract. Case law, for the most part, upholds this underwriting 94 See Pennsylvania Nat l Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish, No , 2015 WL (11th Cir. June 10, 2015) ( The Supreme Court of Alabama s logic in Townsend Ford that a provision excluding from coverage damages by reason of the assumption of liability in a contract was intended to exclude claims arising out of indemnity agreements only applies regardless of whether the injured party brings a breach of contract claim based on the breach of an express or implied warranty. ); Indiana Ins. Co. v. Kopetsky, 11 N.E.3d 508, 524 (Ind. Ct. App. 2014), opinion corrected on reh'g on other grounds, 14 N.E.3d 850 (Ind. Ct. App. 2014) ( Today we join those jurisdictions who have held that contractual liability exclusions in CGL policies bar coverage not for liability incurred by a contract breach but, rather, for liability assumed from a third party, which seems to be the majority position by a wide margin. ). 80 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 66

67 CGL Insurance Coverage intent. In American Family Mutual Insurance Co. v. American Girl, Inc., 95 the court held that the exclusion applies where the insured has contractually assumed the liability of a third party, as in an indemni cation or hold harmless agreement, and that it does not operate to exclude coverage for any and all liabilities to which the insured is exposed under the terms of the contracts it makes generally. 96 Recently, the Texas Supreme Court rejected a long line of case law and commentary to hold that the contractual liability exclusion was not limited to hold harmess and indemnity agreements. 97 Even so, as made clear by a subsequent opinion, the contractual liability exclusion is not a breach of contract exclusion. 98 iii. Exclusions for Ongoing Operations and Incorrect Work As noted above, the primary means of insuring a project during construction is builders risk insurance, which is rst-party coverage usually obtained by the owner or the general contractor. However, in certain circumstances, the CGL policy also provides coverage for operations in progress, and the operations exclusions have been frequently litigated in the construction defect context. The operations exclusions mirror builders risk coverage in that they usually exclude the cost of making good faulty workmanship, but provide coverage for ensuing loss where defective workmanship results in another cause of loss to the work. Under subparagraphs (5) and (6) of exclusion j, the concept of ensuing loss is embodied in the limitation of the exclusions to that particular part upon which the insured is performing operations, or 95 American Family Mut. Ins. Co. v. American Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65, (2004). 96 See also Federated Mut. Ins. Co. v. Grapevine Excavation Inc., 197 F.3d 720, 726 (5th Cir. 1999) (exclusion denies coverage when the insured assumes responsibility for the conduct of a third party and not its own conduct); Olympic, Inc. v. Providence Wash. Ins. Co. of Alaska, 648 P.2d 1008, 1011 (Alaska 1982) (liability assumed by insured in a contract refers to liability incurred when one promises to indemnify or hold harmless another, and it does not refer to liability that results from breach of contract). 97 See Gilbert Texas Const., L.P. v. Underwriters at Lloyd's London, 327 S.W.3d 118 (Tex. 2010) (exclusion applies even if the insured does not assume the liability of another and is sued only for its own breach of contract). The Gilbert court is not alone in this regard. See Employers Mut. Cas. Co. v. Donnelly, 154 Idaho 499, 300 P.3d 31 (2013). 98 See Ewing Const. Co., Inc. v. Amerisure Ins. Co., 420 S.W.3d 30 (Tex. 2014); see also Crownover v. Mid-Continent Cas. Co., 772 F.3d 197 (5th Cir. 2014); Travelers Property Cas. Co. of America v. Peaker Services, Inc., 306 Mich. App. 178, 855 N.W.2d 523 (2014), appeal denied, 861 N.W.2d 899 (Mich. 2015). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

68 Journal of the ACCL property that must be replaced because of defective work performed upon it. Subparagraph (5) of exclusion j, commonly referred to as the ongoing operations exclusion, states that the insurance does not apply to property damage to: That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the property damage arises out of those operations. As discussed in CU Lloyd's of Texas v. Main Street Homes, Inc., 99 because of the use of the present tense, courts have found that the ongoing operations exclusion does not apply to property damage that occurs after construction is complete, but only to property damage that occurs while operations are in progress. In addition, courts have found the exclusion applies only to damage caused during active physical construction activities, as explained in Mid-Continent Casualty Co. v. JHP Development, Inc. 100 Assuming the property damage occurs while operations are in progress, the that particular part language further limits the scope of the exclusion. Only that particular part of the work on which operations are actually being performed and which is damaged is excluded. In an explanatory circular, ISO sets out an example where a steel erector is erecting steel beams furnished by the general contractor. Having erected four of the beams, the subcontractor is in the process of erecting a fth steel beam when the beam falls, resulting in damage to all ve beams. Only the damage to the fth beam is excluded as that particular part upon which it was performing operations. 101 Subparagraph (6) of exclusion j, sometimes referred to as the incorrect work exclusion, is a companion to exclusion j(5). It states that the insurance does not apply to property damage to: That particular part of any property that must be restored, repaired, or replaced because your work was incorrectly performed on it. Exclusion j(6) is subject to the following exception: Paragraph (6) of this exclusion does not apply to property damage included in the products-completed operations hazard. The express provision that exclusion j(6) does not apply to the 99 CU Lloyd's of Texas v. Main Street Homes, Inc., 79 S.W.3d 687 (Tex. App. Austin 2002). 100 Mid-Continent Cas. Co. v. JHP Development, Inc., 557 F.3d 207 (5th Cir. 2009) (indicating that exclusion j(5) did not apply to damage caused during a prolonged suspension of active construction work during which the insured was not actively performing a task at the jobsite). 101 ISO Circular General Liability GL79-12 (January 29, 1979). 82 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 68

69 CGL Insurance Coverage products-completed operations hazard is routinely upheld by the courts and clari es that the exclusion does not apply to a completed operations loss (that is, a loss that occurs after the work is put to its intended use or all work under the insured's contract is completed). 102 Rather, it is exclusion l, the your-work exclusion (discussed below), that applies in such situations. As is the case with the ongoing operations exclusion, the that particular part language in the exclusion often limits its applicability. In many construction claims, particularly construction defect claims, the amount of available coverage turns on the interpretation of the that particular part language. Insurers may argue that coverage for all of the insured's work is excluded under the exclusion. Thus, the insured must be able to segregate out the defective from the non-defective portions of the work in determining that particular part, in order to limit the scope of the exclusion. Transportation Insurance Co. v. Piedmont Construction Group, LLC 103 provides an example of the competing arguments employed by insureds and insurers as to the scope of the term that particular part. In that case, during the course of a dormitory renovation, a plumbing subcontractor negligently ignited wood scrap, damaging the rest of the dormitory. The insurer argued that, because the contractor's renovation contract involved the entire dormitory, coverage for the entire loss was excluded. The court rejected this argument, determining that particular part of the real property upon which the contractor's subcontractor was working applied only to the room in which the plumber was working at the time the re was started, rather than the entire building that was being renovated at the time of the re. Mid-Continent Casualty Co. v. JHP Development, Inc. 104 involved a more typical construction defect scenario, where property damage caused by defective work on a condominium project allowed water to in ltrate the structure and damage otherwise non-defective portions of the work. In upholding coverage for the non-defective portions of the condominium project under the contractor's policy, the court applied the that particular part limitation in exclusion j(6). The court held that the exclusion barred coverage only for property damage to parts of the property that constituted defective work by the insured, and that the exclu- 102 The importance of the distinction between ongoing operations and the products-completed operations hazard is discussed below in connection with Exclusion l, the your-work exclusion. 103 Transportation Ins. Co. v. Piedmont Const. Group, LLC., 301 Ga. App. 17, 686 S.E.2d 824 (2009). 104 Mid-Continent Cas. Co. v. JHP Development, Inc., 557 F.3d 207 (5th Cir. 2009). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

70 Journal of the ACCL sion did not bar coverage for damage to parts of the property that were not defective work by the insured but were damaged as a result of defective work by the insured on other parts of the property. 105 Another case involving the that particular part limitation is Gore Design Completion, Ltd. v. Hartford Fire Insurance Co. 106 There, the insured miswired a component of an in- ight entertainment system in a commercial aircraft, resulting in physical damage to the aircraft's entire electrical system. The court observed that if exclusion j(6) were applied to the entire aircraft, rather than only the in- ight entertainment system, the that particular part limitation would be read out of the policy. 107 Some courts, however, do no read the that particular part language narrowly and instead apply it broadly. 108 iv. The Your-Work Exclusion and the Subcontractor Exception The concept of business risk that is, that the construction participant should be responsible for the quality of its own work is particularly re ected in exclusion l, the your work exclusion. This exclusion is commonly at issue in construction defect cases. Although the exclusion applies to the de ned term your work, it is subject to an exception for property damage arising out of work performed by a subcontractor. This subcontractor exception may provide a considerable amount of coverage for insureds that perform construction services through subcontractors. 109 The exception was a concession by the insurance industry that the general contractor is unable to monitor and control all the work of subcontractors, and that property damage arising out of such work is more fortuitous than work that a general contractor performs directly. The signi cance of 105 Mid-Continent Cas. Co., 557 F.3d at Gore Design Completions, Ltd. v. Hartford Fire Ins. Co., 538 F.3d 365 (5th Cir. 2008). 107 See also Fortney & Weygandt, Inc. v. American Mfrs. Mut. Ins. Co., 595 F.3d 308, 311 (6th Cir. 2010); Roaring Lion, LLC v. Nautilus Ins. Co., 2011 WL (D. Mont. 2011), report and recommendation adopted, 2011 WL (D. Mont. 2011). 108 See, e.g., Lafayette Ins. Co. v. Peerboom, 813 F. Supp. 2d 823, 834 (S.D. Miss. 2011); Jet Line Services, Inc. v. American Employers Ins. Co., 404 Mass. 706, 537 N.E.2d 107, 111 (1989). 109 The term subcontractor is not de ned in the CGL policy and has been applied broadly to include material suppliers. See Mosser Const., Inc. v. The Travelers Indem. Co., 430 Fed. Appx. 417, (6th Cir. 2011); Limbach Co. LLC v. Zurich American Ins. Co., 396 F.3d 358, (4th Cir. 2005); Building Specialties, Inc. v. Liberty Mut. Fire Ins. Co., 712 F. Supp. 2d 628, (S.D. Tex. 2010); Wanzek Const., Inc. v. Employers Ins. of Wausau, 679 N.W.2d 322, 329 (Minn. 2004). 84 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 70

71 CGL Insurance Coverage the exception follows from the fact that self-performed work by a general contractor now appears to be the exception, rather than the rule, on complex construction projects. The your-work exclusion states that the insurance does not apply to: Property damage to your work arising out of it or any part of it and included in the products-completed operations hazard. This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor. The exclusion by its terms applies to property damage to your work, de ned in the policy as follows: Your Work means: (1) Work or operations performed by you or on your behalf; and (2) Materials, parts or equipment furnished in connection with such work or operations. Includes: (1) Warranties or representations made at any time with respect to the tness, quality, durability, performance or use of your work, and (2) The providing of or failure to provide warnings or instructions. In turn, the terms you and your refer to the named insured on the policy. Finally, the exclusion only applies to property damage within the products-completed operations hazard, de ned to include: [A]ll bodily injury and property damage occurring away from premises you own or rent and arising out of your product or your work except: (1) Products that are still in your physical possession; or (2) Work that has not yet been completed or abandoned. However, your work will be deemed completed at the earliest of the following times: (a) When all of the work called for in your contract has been completed. (b) When all of the work to be done at the job site has been completed if your contract calls for work at more than one (c) job site. When that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project. Work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed. The e ect of the your work exclusion is to exclude coverage for all property damage to the named insured's work arising out of it Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

72 Journal of the ACCL or any part of it. Because the term your work is de ned in the policy to include work performed by the named insured or on its behalf, the exclusion, but for the explicit exception for property damage arising out of work performed by subcontractors, would also apply to subcontractor work. And, because of the widespread use of subcontractors in the construction industry, the exception often preserves coverage for insureds, and, by virtue of the subcontractor exception, the named insured has coverage notwithstanding the exclusion for exposures such as: E Property damage to work performed by the insured when the damage results from the work of the insured's subcontractor; E Property damage to work performed by the insured's subcontractor when the damage results from that subcontractor's work; E Property damage to work performed by the insured's subcontractor when the damage results from work performed by the insured; and E Property damage to work performed by the insured's subcontractor when the damage results from the work of another contractor or subcontractor. 110 It appears that the insurance industry determined that the construction industry would view the CGL policy as a more attractive product and that the CGL policy could be better sold if it contained coverage for property damage arising out of subcontractor work. 111 In addition, the extension of coverage to subcontractors' defective work was in accord with the notion that the insured should have coverage for liability to or because of work other than its own. 112 The discernible trend in the case law is to provide coverage for property damage arising out of the work of a subcontractor under an insured contractor's CGL policy. Illustrative cases include United States Fire Insurance Co. v. J.S.U.B., Inc. 113 (the subcontractor exception to the your work exclusion provides coverage for 110 Maureen McLendon, et al., Commercial Liability Insurance (IRMI 2003); see also K & L Homes, Inc. v. American Family Mut. Ins. Co., 2013 ND 57, 829 N.W.2d 724, 739 (N.D. 2013) (quoting Stephen N. Goldberg & James S. Carter Jr., Liability Insurance for Construction Defects, 3 New Appleman Law of Liability Insurance 28.04[10][a]-[b] (2d ed. 2012)). 111 Je rey W. Stempel, Stempel On Insurance Contracts 14.13(D) at (3rd ed & Supp. 2009). 112 Aiken and O'Brien, Contractor Coverage for Construction Claims Under CGL Policies: The Basics and Beyond, 44 Tort Trial & Ins. Prac. L.J. 993, 1010 (Spring/Summer 2009). 113 U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871 (Fla. 2007). 86 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 72

73 CGL Insurance Coverage property damage to homes arising out of defective site preparation); Lamar Homes, Inc. v. Mid-Continent Casualty Co. 114 (the subcontractor exception preserves coverage when a general contractor becomes liable for damage to work performed by a subcontractor or for damage to the general contractor's own work arising out of a subcontractor's work); Travelers Indemnity Company of America v. Moore & Associates 115 (damages resulting from the subcontractor's faulty installation of windows are not excluded from coverage, even if those damages a ected the general contractor's own work); Architex Association, Inc. v. Scottsdale Insurance Co. 116 (the subcontractor exception applies to property damage to a foundation resulting from defective installation of rebar by the named insured's subcontractor); American Family Mutual Insurance Co. v. American Girl, Inc. 117 (damage to a warehouse arising out of defective site preparation is within the exception, determining that con icting authorities interpreting CGL policies that did not include the subcontractor exception are no longer controlling because the damage to an insured contractor's work caused by a subcontractor is within the subcontractor exception in the 1986 form); and Auto Owners Insurance Co. v. Newman 118 (the subcontractor exception preserved coverage for damage arising out of defective installation of EIFS by a subcontractor, which would otherwise be excluded under the your work exclusion). Nevertheless, other courts have refused to apply the subcontractor exception to property damage arising out of a subcontractor's work. For example, see Kvaerner Metals v. Commercial Union Insurance Co. 119 (the subcontractor exception did not obviate the fact that faulty work on a coke battery resulting in damage to the battery itself was not an accident under the contractor's CGL policy); William C. Vick Construction Co. v. Pennsylvania National Mutual Casualty Insurance Co. 120 (seminal case decided under the 1973 broad form property damage endorsement that 114 Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007). 115 Travelers Indem. Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302 (Tenn. 2007). 116 Architex Ass'n, Inc. v. Scottsdale Ins. Co., 27 So. 3d 1148 (Miss. 2010). 117 American Family Mut. Ins. Co. v. American Girl, Inc., 2004 WI 2, 268 Wis. 2d 16, 673 N.W.2d 65 (2004). 118 Auto Owners Ins. Co., Inc. v. Newman, 385 S.C. 187, 684 S.E.2d 541 (2009). 119 Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 589 Pa. 317, 908 A.2d 888 (2006). 120 Wm. C. Vick Const. Co. v. Pennsylvania Nat. Mut. Cas. Ins. Co., 52 F. Supp. 2d 569 (E.D. N.C. 1999), a 'd, 213 F.3d 634 (4th Cir. 2000). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

74 Journal of the ACCL coverage for the defective workmanship of the insured's subcontractor was nevertheless excluded based upon a business risk rationale); and Lexicon, Inc. v. ACE American Insurance Co. 121 ( nding that a silo collapse arising out of defective welding by a subcontractor was not an occurrence under Arkansas law). The breadth of the subcontractor exception to the your work exclusion led to the promulgation of a standard endorsement by ISO, CG , that modi es the your work exclusion by eliminating the subcontractor exception to the exclusion. By issuing the endorsement, ISO has, in e ect, facilitated a signi cant reduction in coverage for many construction insureds. 122 Construction insureds need to pay careful attention at the time of insurance procurement to whether quoted CGL policies are subject to this new endorsement, as a true determination of the relative cost and scope of coverage must take into account the potentially signi cant e ect of the presence or absence of the subcontractor exception. v. Impaired Property Exclusion The complexity of modern construction raises new risks associated with construction-related property damage, one of which is damage to neighboring or existing property. For example, assume that a contractor is hired to construct a major addition to a computer chip plant. In the course of doing so, it cuts o power to the plant, shutting it down and contaminating all the clean rooms, resulting in a total loss of product for several days. While the property damage to the electrical equipment may be relatively minimal, the damage to the clean rooms and the chips may be substantial. It is this risk of damage to other property that the impaired property exclusion is intended to apply. Exclusion m, added to the 1986 CGL form, states that the insurance does not apply to: Property damage to impaired property or property that has not been physically injured, arising out of: (1) a defect, de ciency, inadequacy or dangerous condition of your product or your work ; or (2) a delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms. This exclusion does not apply to the loss of use of other property 121 Lexicon, Inc. v. ACE American Ins. Co., 634 F.3d 423 (8th Cir. 2011). 122 The Supreme Court of Texas, in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 12 (Tex. 2007), recognized the existence of this endorsement and its e ects on coverage. See also VRV Development L.P. v. Mid-Continent Cas. Co., 630 F.3d 451, 455 n.5 (5th Cir. 2011); J.B.D. Const., Inc. v. Mid-Continent Cas. Co., 571 Fed. Appx. 918, 925 (11th Cir. 2014); Builders Mut. Ins. Co. v. Kalman, 2009 WL (D.S.C. 2009). 88 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 74

75 CGL Insurance Coverage arising out of sudden and accidental physical injury to your product or your work after it has been put to its intended use. The 1986 revision also added the following de nition of impaired property to the policy: Impaired property means tangible property, other than your product or your work, that cannot be used or is less useful because: (a) it incorporates your product or your work that is known or thought to be defective, de cient, inadequate or dangerous; or (b) you have failed to ful ll the terms of a contract or agreement; If such property can be restored to use by: (a) the repair, replacement, adjustment or removal of your product or your work or (b) your ful lling the terms of the contract or agreement. A key to understanding the exclusion is that it applies to two di erent types of property damage: impaired property and property that has not been physically injured. The term impaired property is primarily directed to exclusion of damages for loss of use, as it is de ned to include tangible property, other than the insured's product or work, that cannot be used or is less useful. The exclusion's reference to property that has not been physically injured appears directed to diminution-in-value claims where no property has been physically injured or destroyed. 123 An example of an impaired property exclusion case is Admiral Insurance Co. v. Little Big Inch Pipeline Co., 124 in which the court held that exclusion m applied to bar coverage for diminution-invalue claims arising out of the insured subcontractor's defective work in turning o natural gas service to a mobile home park because no property had been physically injured and the loss arose out of the insured's inadequate performance. Another key factor in determining whether property is impaired for purposes of the exclusion is the status of the named insured. If the named insured is a general contractor that is in charge of the entire project, no portion of that project can constitute impaired property because property is, by de nition, 123 The insurance industry continuously has grappled with the diminution in value concept as a measure of damages for property that has not been physically injured under the CGL policy, particularly under the de nition of property damage. In 1973 ISO added the requirement that the property be physically injured under the de nition of property damage in the policy. In addition, it has attempted to address the issue through predecessor exclusions to the impaired property exclusion. 124 Admiral Ins. Co. v. Little Big Inch Pipeline Co., Inc., 523 F. Supp. 2d 524 (W.D. Tex. 2007). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

76 Journal of the ACCL impaired only if it is property other than the named insured's work. A case illustrating this concept is Corn Plus Cooperative v. Continental Casualty Co., 125 in which the court held that exclusion m barred coverage for the cost associated with the repair of the insured's defective welding at an ethanol processing plant. The exclusion also applied to consequential damages, including loss of use of the plant and decreased ethanol production, because the plant itself was not the insured's work only the welding was and the insured's work rendered the ethanol plant impaired. In other words, the impaired property exclusion targets situations where a defective product, after being incorporated into the property of another, must be replaced or removed at great expense thereby causing a loss of use of the property. 126 Moreover, the exclusion bars coverage for loss-of-use claims where the loss was caused solely by the insured's failure to provide work of the quality or performance capabilities called for by the contract and where there has been no physical injury to property other than the insured's work itself. The exclusion does not apply if there is damage to property other than the insured's work or if the insured's work cannot be repaired or replaced without causing physical injury to other property. 127 The de nition of impaired property is not satis ed where property cannot be restored to use by the repair of the insured's work. This was the situation in Federated Mutual Insurance Co. v. Grapevine Excavation, Inc., 128 where it was alleged that the insured excavation contractor's work damaged a parking lot, and the proposed repair was to overlay the parking lot with additional asphalt, rather than remove or repair the select ll installed by the subcontractor. The court held that the parking lot did not constitute impaired property because there was no suggestion that the damage to the surface of the parking lot could be restored by the repair, replacement, adjustment, or removal of the select ll installed by the excavation subcontractor. The entire exclusion is also subject to an exception for sudden and accidental physical injury to the insured's work after it has been put to its intended use. For example, in Mississippi 125 Corn Plus Co-op. v. Continental Cas. Co., 516 F.3d 674 (8th Cir. 2008). 126 Standard Fire Ins. Co. v. Chester O'Donley & Associates, Inc., 972 S.W.2d 1, 9 (Tenn. Ct. App. 1998); see also Regional Steel Corporation v. Liberty Surplus Insurance Corporation, 226 Cal. App. 4th 1377, 173 Cal. Rptr. 3d 91, 104 (2d Dist. 2014). 127 Chester-O'Donley & Assoc., 972 S.W.3d at Federated Mut. Ins. Co. v. Grapevine Excavation Inc., 197 F.3d 720 (5th Cir. 1999). 90 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 76

77 CGL Insurance Coverage Phosphates Corp. v. Furnace and Tube Service, Inc., 129 the court held that the impaired property exclusion did not exclude coverage for loss of use of a sulfuric acid plant arising out of the sudden and accidental injury to the plant after the water boiler worked on by the insured was put to its intended use. Though the impaired property exclusion was inserted into the CGL policy form in 1986, a body of case law interpreting this exclusion has been slow to develop, perhaps because of the complexities within the exclusion's language. vi. Product Recall (Sistership) Exclusion Another exclusion sometimes cited in the construction defect context is exclusion n, the product recall exclusion, which states that the insurance does not apply to: Damages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of: (1) Your product ; (2) Your work ; or (3) Impaired property. If such work, or property is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, de ciency, inadequacy or dangerous condition in it. Exclusion n historically is known as the sistership exclusion because of the underwriting intent at the time it was rst drafted: to deny coverage for claims based upon the cost of withdrawing a product from the market, replacing a product, or the loss of use of a product that is temporarily or permanently withdrawn from market because of occurrences involving the same or a similar product. That intent was explained in Gulf Insurance Co. v. Parker Products, Inc. 130 The name derives from an occurrence in the aircraft industry where all airplanes of a certain make and type were grounded by an order of the Civil Aeronautics Administration because one crashed and others were suspected of having a common structural defect. The damages arising out of the loss of use of all of the sister planes were enormous. The recall of equipment or parts discovered to have a common fault involve expenses incurred to prevent accidents that have not occurred. While the insurance covers damages for bodily injuries and property damage caused by the product that failed, it never was intended that the insurer would be saddled with the 129 Mississippi Phosphates Corp. v. Furnace and Tube Service, Inc., 2009 WL (S.D. Miss. 2009). 130 Gulf Ins. Co. v. Parker Products, Inc., 498 S.W.2d 676 (Tex. 1973). Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

78 Journal of the ACCL cost of preventing other failures, any more than it was intended that the insurer would pay the cost of preventing the rst failure if the product had been discovered to be in a dangerous condition before the occurrence. 131 Nevertheless, the product recall exclusion applies only to damages claimed for any loss, cost, or expense incurred if a product is withdrawn or recalled from the market because of a known or suspected defect. 132 In Auto Owners Insurance Co. v. Newman, 133 however, after holding that coverage for property damage arising out of the installation of defective stucco by the insured homebuilder's subcontractor caused water in ltration damage to a home, the court went on to apply the product recall exclusion, even though the property damage was to a single home and did not involve the withdrawal of any other homes from the market or use. Moreover, it was not clear from the opinion whether the home that was damaged ever was withdrawn from use. The court held that the exclusion applied to the cost of removal and replacement of the defective stucco, determining that those costs fell within the exclusion as the cost of repair and replacement of the insured's work that was withdrawn from use because of a defect. Again, the application of the exclusion under these circumstances is open to question, especially where the subcontractor exception expressly preserves coverage for the cost of repairing and replacing property damage caused by the defective work of subcontractors, including the work of the subcontractor itself. H. Conclusion Despite the fact that CGL policies oftentimes employ standard language, courts across the country have taken di erent approaches to coverage for defective workmanship. Although most cases should be won or lost by analyzing the speci c business risk exclusions, a large majority of the cases have, at least historically, focused on the insuring agreement and, in particular, the occurrence and property damage requirements. Much like an electoral map, it is possible to identify those states that conclude that faulty workmanship can constitute property damage caused by an occurrence and those states that reject such a 131 Gulf Ins. Co., 498 S.W.2d at Chester-O'Donley, 972 S.W.2d at ( nding that the recall exclusion does not apply to claims involving losses resulting from failure of insured's defective duct work when they are not based upon withdrawal or recall of the insured's own product or work). 133 Auto Owners Ins. Co., Inc. v. Newman, 385 S.C. 187, 684 S.E.2d 541 (2009). For another questionable application, see Bright Wood Corp. v. Bankers Standard Ins. Co., 665 N.W.2d 544, 549 (Minn. Ct. App. 2003) (applying the exclusion deteriorating window components). 92 Thomson Reuters E Journal of the ACCL E Vol. 9 No. 2 78

79 CGL Insurance Coverage view. Unlike an electoral map, an emerging middle ground exists that is neither blue nor red. The middle ground approach, which can best be described as a judicial compromise between the actual policy language and the business risk rationale, holds that defective workmanship causing damage to the insured's work can be property damage caused by an occurrence so long as the damage is to something other than the defective work itself. Workshop W3 Thomson Reuters E Journal of the ACCL E Vol. 9 No

80 Notes 80

81 To enter the drawing for $500, affix your personal bar code label here or complete this evaluation online. W3. Survey of the Construction Defect Landscape Rating scale for all questions: 4 = Excellent 3 = Very Good 2 = Average 1 = Somewhat Disappointing 0 = Very Disappointing Overall rating for this workshop? Lee H. Shidlofsky Preparation and quality of information Energy and enthusiasm of delivery Educational focus (not a sales pitch) Comments: