2009 CONSTRUCTION LAW UPDATE

Transcription

1 2009 CONSTRUCTION LAW UPDATE Chapter 6: THE PRODUCTS-COMPLETED OPERATIONS HAZARD: WHEN COVERAGE EXISTS, JUST WHAT IS COVERED? Construction Law Library ASPEN Publishers REPRINTED WITH PERMISSION BY ASPEN PUBLISHERS, INC.

2 CHAPTER 6 THE PRODUCTS-COMPLETED OPERATIONS HAZARD: WHEN COVERAGE EXISTS, JUST WHAT IS COVERED? Edmund M. Kneisel Betsy Cooke 6.01 Introduction 6.02 Finding The PCOH Coverage: Unraveling The CGL Form 6.03 POZZI Window: PCOH Coverage for Damage to The Subcontractor s Defective Workmanship 6.04 Review of Recent PCOH Coverage Rulings [A] Unintended Damage to Other Property Caused by a Subcontractor Triggers PCOH Coverage [B] The Scope of the PCOH Coverage When There Is Damage to Other Work 6.05 When Installation of A Defective Product Should Trigger The PCOH Coverage [A] Whose Product Is It, Anyway? [B] The Accidental Occurrence Concepts Should Apply Equally to the Installation of Defective Components That Cause Post-Completion Property Damage [C] Physical Damage That Causes Loss of Use of Other Property Is Covered by the PCOH Provisions 6.06 Allocation of PCOH Coverage to Covered Losses in Jurisdictions that Restrict Coverage for Installation of A Defective Product 6.07 Conclusion

3 INSURANCE INTRODUCTION Putting aside the long-running controversy regarding coverage for pollution liability under older forms of commercial general liability (CGL) policies, 1 perhaps no area of insurance law has created more controversy during the last twenty-five years than the question of coverage for defective construction. Numerous commentators and even more courts have issued varying opinions on the subject, ranging the gamut from those who believe that damage or injuries caused by construction flaws are covered by the typical CGL form to those who conclude that such losses should be considered business risks that are not insurable. 2 When a sudden and accidental construction-related disaster occurs, causing loss of life or serious injury or destruction of third-party property, there is little disagreement that the typical CGL form should cover the loss. Controversy arises, however, when the dispute relates to liability for physical damage to the project itself or loss of use (delayed occupancy or diminished performance) caused by the same type of construction flaw. The question of coverage for such losses also becomes confused when considering the nature of the liability at issue and how it arises often in an arbitration or other contract dispute among the project owner, the general contractor, and the subcontractors. The typical construction contract may contain complex warranty and damages provisions, including liquidated damages clauses that complicate the resolution of disputes regarding defective construction. Relying on the CGL exclusion for contractual liability, some courts have ruled that no coverage exists for contract-related claims such as warranty claims arising in the typical construction arbitration or litigation addressing flawed construction. 3 The business risk concept is the handmaiden of the no coverage for contractual liability cases. This concept, derived from the so-called works/ products exclusions in 1 For many years, the focus of the controversy regarding coverage for environmental claims addressed the so-called sudden and accidental exception to the exclusion for liability caused by pollution the release of gases, solids, or other contaminants that polluted real property and in some cases caused bodily injury. Courts differed widely on the interpretation of the sudden and accidental language. Some courts focusing on sudden ruled that the policy language required the pollution to be abrupt or instantaneous, such as pollution resulting from an explosion or fire. Others, focusing on accidental, ruled that gradual but unintended and unexpected pollution was covered. In response, the insurance industry changed the standard CGL form to incorporate an absolute pollution exclusion designed to bar all coverage for pollution events and in turn began to offer specialized pollution liability and other forms of policies designed specifically to cover pollution risks or the costs of remedying previous pollution. See, e.g., Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1,10 (Tex. 2007) (citing detailed discussion in 9 Lee R. Russ & Thomas F. Segalla, Couch on Insurance 129:10-129:34 (3rd ed. 1997)). 2 The evolution of the CGL form, including the so-called broad form property damage coverages added to CGL forms in the mid-1970s, the impaired property exclusion (with its sudden and accidental exception), and development of business risks concepts, is summarized generally in E. Kneisel and J. Hannah, Insurance for Financial Loss Caused by Defective Construction: Loss of Use and Diminution of Value as Covered Property Damage, 2001 Construction Law Update (N. Sweeney, ed. 2001). 3 The more recent trend of authority has rejected the proposition that the theory of liability propounded by the claimant (contract as opposed to tort) determines the availability of CGL coverage, ruling instead that coverage is determined by the nature of the underlying act, if tortious or negligent, rather than by the liability theory asserted in the underlying claim. See, e.g., Lamar Homes, 242 S.W.3d at 8; United States Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871, 884 (Fla. 2007); ACUITY v. Burd & Smith Constr., Inc., 721 N.W.2d 33, 39 (N.D. 2006).

4 INSURANCE 6.01 the typical CGL form, 4 gained primacy when the New Jersey Supreme Court applied it in Weedo v. Stone-E-Brick, Inc. 5 to bar all coverage for construction-related property damage to the work of the insured contractor. Weedo is one of the most commonly cited cases addressing claims arising out of damage for construction-related flaws; however, the case was decided almost thirty years ago and construed the provisions of a CGL policy form that should not control the outcome of such a case today, assuming the CGL policy at issue includes products-completed operations hazard (PCOH) coverage. This coverage, including the subcontractor exception language added to the standard CGL form in 1986, was developed post-weedo to eliminate the business risks exclusions when an insured general contractor is faced with post-completion property damage claims arising out of the work of a subcontractor. As discussed below, finding the PCOH coverage is like finding the solution to a puzzle, as the policy form itself does not include a separate heading labeled PCOH coverage and does not contain a specific grant of coverage that would parallel the coverage grants for property damage, bodily injury, personal injury, and advertising injury liability common in most CGL forms. If a CGL policy contains PCOH coverage, it should cover all liability of the insured general contractor for property damage to the work of the general contractor caused by the faulty workmanship of a subcontractor. However, relying on the business risks concepts and the Weedo line of cases, the highest courts in several states continue to reject coverage for damage caused by a subcontractor s flawed construction. These cases ignore the evolution of the PCOH coverage, including the subcontractor exception to the your work exclusion added to the standard policy form in 1986, preferring instead to rely on outmoded contractual liability and business risks concepts and the insurance industry s mischaracterization of PCOH coverage for defective construction work as tantamount to a construction bond: [T]he definition of accident required to establish an occurrence under the policies cannot be satisfied by claims based upon faulty workmanship. Such claims simply do not present the degree of fortuity contemplated by the ordinary definition of accident or its common judicial construction in this context. To hold otherwise would be to convert a policy for insurance into a performance bond. We are unwilling to do so, especially since such protections are already readily available for the protection of contractors. 6 4 As discussed below, CGL forms generally exclude coverage for property damage to your product or your work or that is caused by your work. See generally E. Kneisel and E. Fus, Liability Coverage for Defective Construction: The No Occurrence Myth, 2007 Construction Law Update 115, (N. Sweeney, ed. 2001) (hereinafter No Occurrence Myth ) A.2d 788 (N.J. 1979). 6 Kvaemer Metals Div. of Kvaemer U.S., Inc. v. Commercial Union Ins. Co., 908 A.2d 888, 899 (Pa. 2006) (internal citation omitted). The Kvaerner court relied heavily on the no occurrence ruling of the South Carolina Supreme Court in L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005). However, as discussed below, the South Carolina Supreme Court has limited its no occurrence concept significantly: If the defective work of a subcontractor damages other work, coverage is allowed,

5 6.01[A] 2009 CONSTRUCTION LAW UPDATE In jurisdictions that narrowly construe the meaning of accidental occurrence and suggest that defective construction is understood by the construction community to be an uninsurable business risk, there is very little that can be done to protect against the sometimes catastrophic liability incurred as a result of post-completion property damage caused by flawed construction. Unfortunately, coverage under all risk builders risk policies, even if part of an owner- or contractor-controlled insurance program (OCIP or CCIP), typically ends when the project ends; therefore, such policies will not insure against liability for property damage that occurs afterwards. Large contractors may be able to negotiate extended maintenance coverage or other forms of liability coverage, such as professional liability insurance, that may cover the insured s liability for certain types of post-completion damage to the completed work. However, such coverage may not be available to the typical small- to medium-sized general contractor/ home builder, who also will not have adequate CGL protection in jurisdictions (such as Pennsylvania) that deny coverage for damage to the completed work. Fortunately, the trend of authority is departing from the no occurrence myth, as illustrated by recent decisions of the highest courts of Florida, Kansas, Texas, Tennessee, and South Carolina. 7 These courts have recognized that negligent workmanship causing unexpected and unintended damage is just as fortuitous or accidental as any other form of negligent act covered by a standard CGL policy form. It would be a rare contractor indeed who actually intended the work it performed to cause property damage; however, the insurance industry has actually argued (during oral argument of the J.S. U.B. case in the Florida Supreme Court) that damage caused by negligent workmanship should not be deemed a covered, accidental occurrence because such damage ordinarily should be deemed to be a foreseeable event in any construction project. As suggested previously in the No Occurrence Myth article, such a construction of the PCOH coverage would effectively nullify CGL coverage for most constructionrelated claims under the typical form of policy purchased by a general contractor. 8 In jurisdictions that more liberally apply the unexpected and unintended component of the concepts of accident and fortuity, courts have rejected the no occurrence myth, allowing coverage under the PCOH provisions of the general contractor s CGL policy when the damage at issue is caused by a negligent subcontractor. This article focuses on cases decided in the jurisdictions, such as Florida, Texas, Tennessee, Wisconsin, and South Carolina, that have rejected the no occurrence myth by recognizing that the PCOH provisions do insure a general contractor against liability for post-completion property damage liability resulting from the negligent work of a subcontractor. Most such cases have arisen in the context of summary judgment, rather than after a trial on the merits; therefore, there is little discussion in the cases of the scope both for the repair of the damaged, other work and the repair of the work of the subcontractor that caused the damage. 7 U.S. Fire Ins. Co. v. J.S.U.B. Inc., 979 So. 2d 871 (Fla. 2007); Travelers Indem. Co. of Am. v. Moore & Assocs., Inc., 216 S.W.3d 302 (Tenn. 2007); Lamar Homes, 242 S.W.3d 1; [Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co.,] 137 P.3d 486 (Kan. 2006). See also Auto-Owners Ins. Co. v. Newman, No , 2008 WL , at *1 (S.C. Mar. 10, 2008); American Family Mut. Ins. Co. v. American Girl, Inc., 673 N.W.2d 65 (Wis. 2004). American Girl is discussed at length in No Occurrence Myth, supra note 4, at pp No Occurrence Myth, supra note 4, at 123.

6 INSURANCE 6.02 of the protections granted by the PCOH coverage. As a result, in jurisdictions that allow such coverage, questions regarding the scope of the PCOH protection still exist: Does such coverage insure against damage to the flawed work of the subcontractor if there is no damage to other work? Does such coverage require proof of actual negligence by the subcontractor or is any faulty construction that causes damage covered? Can PCOH coverage be triggered by the installation of a defective product as part of the building or project at issue? Does the coverage require proof of actual physical damage to the completed project (other than damage to the subcontractor s faulty work or the defective component installed as part of that work) to trigger the loss of use coverage available under the typical CGL form? Before suggesting answers to these questions, we begin by revisiting the puzzle that must be unraveled to find the source of PCOH coverage in the typical CGL form, followed by a discussion of the Florida Supreme Court s recent decision in Pozzi Window Co. v. Auto-Owners Insurance Co. 9 This case is one of the few recent decisions that address the scope of protections afforded by the PCOH coverage, finding such coverage is available even if the insured contractor s liability is limited to damage to the subcontractor s defective work FINDING THE PCOH COVERAGE: UNRAVELING THE CGL FORM Unlike the basic coverages provided by the CGL form (bodily injury, personal injury, advertising injury and property damage), there is no section of the policy that specifically explains the products-completed operations hazard. Thus, the typical policyholder (like numerous judges) may wonder: Just what is the coverage, where is it explained, and what does it insure? The CGL coverage is not a substitute for an all risk builders risk policy because a CGL policy will not cover damage to the project that occurs during the course of construction. Some form of exclusion for course of construction damage to a contractor s work has been included in CGL policies for at least the last thirty-five years. For instance, standard CGL exclusion j(5) bars any coverage for damage to [t]hat particular part of real property on which you or any contractors or subcontractors... are performing operations, if the property damage arises out of those operations. 10 Because this exclusion bars coverage for property damage that occurs during construction, it is clear that PCOH coverage only applies to completed operations. But where is the scope of that coverage explained? So. 2d 1241 (Ha. 2008). The first-listed author of this article served as lead counsel for Pozzi Window, assignee of the insured general contractor, during the trial and appeal of the Pozzi case. 10 As quoted in J.S.U.B., 979 So. 2d at The J.S.U.B. opinion, like many of the other recent decisions construing PCOH coverage, contains a good summary of the evolution of the provisions of the CGL form that may apply to construction-related claims.

7 6.02[A] 2009 CONSTRUCTION LAW UPDATE First, a contractor who buys PCOH coverage should find a reference to the PCOH coverage on the declarations page of the CGL form, often with a separate aggregate limit and sometimes with a separate deductible or retention. For example, the CGL policy at issue in the J.S. U.B. case had a general aggregate limit of $2 million but also had a separate aggregate limit of $2 million for the PCOH coverage. 11 Because postcompletion property damage will not be covered by a builder s risk policy, which usually ends on completion of the work, a general contractor who wants ongoing protection against liability for damage to the completed project should make sure that its CGL policy includes the PCOH coverage. After verifying that the declarations page references the PCOH coverage, the policyholder must then unravel the CGL puzzle to find just what the PCOH coverage includes. It is necessary to review at least four separate sections of the policy to locate the governing coverage provisions: The policy declarations; The policy exclusions for damage to your work ; The exceptions to the exclusions; and The policy definitions. After the declarations page, the first mention of the PCOH coverage is in an exception to exclusion j(6). This exclusion bars coverage for property damage to What particular part of any property that must be restored, repaired or replaced because `your work was incorrectly performed on it. 12 Like the broad course of construction exclusion j(5), exclusion j(6) eliminates coverage for the particular part of the property that your work damages, but neither exclusion expressly bars coverage for resulting damage to other property caused by your work. Indeed, as illustrated by the facts in J.S. U.B., carriers typically will concede that the CGL form covers damage to other property of third parties, such as damage to the homeowner s wallpaper when the sheetrock cracked as a result of the subsidence of the foundation of the homes that J.S.U.B. constructed. However, applying the broadly worded definition of your work to the CGL form exclusions for damage to your work and relying on business risk concepts, the insurance carrier refused to cover J.S.U.B. s liability for any of the costs of repairing the structural damage to the homes, such as the damage to the foundations and drywall. 13 The carrier s decision to deny coverage in J.S. U.B. is consistent with the approach of most carriers who deny coverage for defective construction claims. Carriers support such decisions by relying on the broadly worded definition of your work, which courts have ruled classifies the entire house (or project) as the work of the insured general contractor. 14 The definition includes all [w]ork or operations performed by you or on your behalf (i.e., the entire project); all materials, parts or equipment furnished (i.e., all of the installed components of the project); all [w]arranties or 11 Id. at 875 n Id. at Id. at See Travelers Indem. Co. of Am. v. Moore & Assoc., Inc., 216 S.W.3d 302, 310 (Tenn. 2007).

8 INSURANCE 6.02 representations... with respect to the fitness, quality, durability, performance or use of `your work (i.e., all of the typical express or implied contractual warranties regarding the work); and the providing of or failure to provide warnings with respect to the work. 15 There are very few liability claims that could be made against a general contractor that would not be encompassed by this definition. As a result, exclusions j(5) and j(6) would bar coverage for most such claims, if the breadth of the your work exclusions were not narrowed by two exceptions that apply to CGL policies containing PCOH coverage. First, there is an exception to the j(6) exclusion for the cost of repairing property damage included in the products-completed operations hazard. 16 But this exception does not mean that there is coverage for post-completion damage to the particular part (or any other part) of your work as a general contractor. Such coverage is barred by a third key exclusion, standard form exclusion 1, which bars coverage for [p]roperty damage to your work arising out of it or any part of it and included in the productscompleted operations hazard. 17 One might ask, why is there an exclusion for risks encompassed by the PCOH coverage that the insured general contractor bought? The answer is provided by the exception to exclusion 1, which delineates the scope of protection provided by the PCOH coverage: 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. 18 This language eliminates the broadly worded your work exclusion and triggers PCOH coverage if (1) the property damage is caused by the faulty work of a subcontractor and (2) if such work occurs post-completion. PCOH coverage, however, does not eliminate the exclusion for damage caused by the work actually performed by the insured general contractor, rather than by a subcontractor. Carriers will argue that an exception to an exclusion cannot create coverage; however, this argument has been rejected by most of the courts considering it because there would be coverage for accidental, construction-related property damage under the standard CGL form if such coverage were not barred by the your work exclusions. 19 Thus, the exception does not create coverage; it merely restores coverage that otherwise would be available, as ruled by courts in jurisdictions such as Florida, Tennessee, Texas, and Wisconsin (and many others) that apply a broad, unexpected and unintended interpretation of the concept of accident J.S.U.B., 979 So. 2d at 876 n Id. at Id. 18 Id. 19 More recently, the insurance industry has shifted its defense argument from the exceptions can t create coverage position to the argument that defective construction is not an accidental occurrence. This argument became a principal focus of the J.S. U.B. appeal. Applying previous Florida authority, the Florida Supreme Court rejected the no occurrence argument, noting that the concept of accident includes injuries or damage neither expected nor intended from the standpoint of the insured. Id. at 883 (quoting State Farm Fire & Cas. Co. v. CTC Dev. Corp., 720 So. 2d 1072, 1076 (Fla. 1998)). See generally No Occurrence Myth, supra note The J.S.U.B. court noted that some courts had concluded that defective construction that damages the work product itself can never constitute an accident ; however, the court also noted that those cases arose in jurisdictions that construe accident narrowly. J.S.U.B., 979 So. 2d at The court also ruled that if the insuring provisions do not confer an initial grant of coverage for faulty workmanship,

9 6.02[A] 2009 CONSTRUCTION LAW UPDATE In J.S.U.B., the Florida Supreme Court rejected the insurance industry s no occurrence argument founded on the proposition that damage arising from defective construction is a foreseeable risk not covered by a CGL policy: [W]e fail to see how defective work that results in a claim against the contractor because of injury to a third party or damage to a third party s property is unforeseeable, while the same defective work that results in a claim against the contractor because of damage to the competed project is foreseeable. This distinction would make the definition of occurrence dependant on which property was damaged. 21 Finally, the J.S. U.B. court refused to apply previous cases barring coverage, noting that the outcome-determinative subcontractor exception was not added to the CGL form until 1986, after those cases had been decided. The J.S.U.B. court ruled that pre-1986 case authorities, including its own ruling in LaMarche v. Shelby Mutual Insurance Co. 22 and including Weedo, 23 had construed CGL policies that did not contain the subcontractor exception language and hence were no longer controlling: We conclude that the holding in LaMarche, which relied on Weedo and involved the issue of whether there was coverage for the contractor s own defective work, was dependent on the policy language of pre-1986 CGL policies, including the relevant insuring provisions and applicable exclusions. The Minnesota Supreme Court, the Tennessee Supreme Court, and the Wisconsin Supreme Court reached the same conclusion regarding prior state court decisions that relied on Weedo and interpreted pre-1986 CGL policies.... The role of precedent in insurance policy interpretation cases depends largely on whether the underlying facts and the policies at issue in the two decisions are similar.... [W]here the policies and underlying facts are different, then a previous decision should not be binding. 24 The final issue that should be considered is: When does the PCOH coverage apply? As noted above, coverage for course of performance damage to the work usually is provided by a builder s risk policy. The PCOH coverage for completed operations typically does not begin until after the builder s risk coverage ends. The timing and availability of the PCOH coverage is explained in the CGL policy s standard definition of the products-completed operations hazard, which includes: a. [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:... there would be no reason for [the policy] to exclude damage to your work. Id. at 886 (citing American Girl, 673 N.W.2d at 78, and Lamar Homes, 242 S.W.2d at 12) So. 2d at So. 2d 325 (Fla. 1980) A.2d 788 (N.J. 1979). 24 J.S.U.B., 979 So. 2d at

10 INSURANCE 6.02 (2) Work that has not yet been completed or abandoned. b. Your work will be deemed completed at the earliest of the following times: (1) When all of the work called for in your contract has been completed.... (3) 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. 25 As the boldface language states, the PCOH coverage is not a substitute for a builder S risk policy that covers course of construction damage or for a first party property damage policy that covers the insured contractor for post-completion damage to the contractor s own property (at the contractor s premises). Thus, an owner-developer who acts as its own contractor may not be able to obtain any CGL coverage for damages to the owner-developer-contractor s work, even if caused by a subcontractor. The definition also makes clear that damage to unfinished work in progress is not covered; therefore, exclusion j(5) is unaffected by the PCOH coverage. However, subpart (b) of the PCOH definition provides that the coverage applies not only to damage after all the work on the project has been completed (and the builder s risk coverage, if any, ends) but also when there is partial completion of a portion of the work, even if the entire project has not been tested, inspected, and fully and finally completed. According to subpart (b)(3) of the definition, the PCOH coverage can apply to damage that occurs before final completion of the project, as long as the particular subcontractor s work that causes the damage is completed and put to its intended use. 26 In sum, several different sections of the standard CGL policy must be reviewed to understand the scope and availability of the PCOH coverage: (1) the declarations specifying that such coverage has been purchased; (2) the exclusions that bar coverage for damage to your work and the exception to the exclusion for post-completion damage to your work if the damage was the fault of a subcontractor; (3) the broadly worded definition of your work that, as used in exclusions j(5), j(6), and 1, would bar coverage for all damage to the insured s work, if the subcontractor exception did not apply; and (4) the definition of the products-completed operations hazard. While confusing at least, and ambiguous at best, when applied to claims for defective construction, the CGL policy form has been unraveled by many courts which 25 See, e.g., Supreme Serv. & Specialty Co. v. Sonny Greer, Inc., 958 So. 2d 634, 640 (La. 2007) (emphasis added). 26 Issues regarding the scope of the put to use language are beyond the scope of this chapter. For more information on this issue, see Stewart Interior Contractors, L.L.C. v. Metalpro Indus., L.L.C., 969 So. 2d 653, 664 (La. Ct. App. 2007) (citing Gaylord Chem. Corp. v. Propump, Inc., 753 So. 2d 349, 355 (La. Ct. App. 2000); Superior Steel, Inc. v. Bituminous Cas. Corp., 415 So. 2d 354 (La. Ct. App. 1982); and Lee R. Russ, et al., 9A Couch on Insurance (3d ed. 2006)).

11 6.03[A] 2009 CONSTRUCTION LAW UPDATE have found varying degrees of coverage for post-completion property damage to the insured general contractor s work. The following nationwide map, derived in part from the briefing in J.S. U.B., illustrates the rulings (if any) in the various states that have addressed coverage for defective construction: Because the law continues to change rapidly in this area, careful review of each state s law is necessary to determine the scope of the PCOH coverage available to an insured general contractor POZZI WINDOW: PCOH COVERAGE FOR DAMAGE TO THE SUBCONTRACTOR S DEFECTIVE WORKMANSHIP In J.S. U.B., after rejecting the carrier s no occurrence defense, the Florida Supreme Court considered whether or not the facts of the case established an occurrence of property damage covered by the CGL form. In a companion case, Pozzi Window Co. v. Auto-Owners Insurance Co., 27 the Florida court attempted to clarify its ruling by explaining what types of property damage claims would be covered by the PCOH provisions. The J.S. U.B. case presented a classic instance of soil subsidence and settlement caused by the negligent soil testing and compaction work of a subcontractor. The subsidence damaged the foundations and walls of the completed homes. The court had little difficulty concluding that the soil subcontractor s faulty workmanship, which had caused damage to other parts of the completed homes, qualified as property damage covered by the general contractor s CGL policy: So. 2d 1241 (Fla. 2008).

12 INSURANCE 6.03 [T]his case does not involve a claim for the cost of repairing the subcontractor s defective work, but rather a claim for repairing the structural damage to the completed homes caused by the subcontractor s defective work. Specifically, it was the subsequent soil settlement due to the subcontractor s faulty workmanship that caused the structural damage to the homes.... [T]he structural damage to the homes is property damage within the meaning of the policies. 28 Should the outcome differ if the only damage at issue was to the negligent subcontractor s defective work? This is the question the Florida Supreme Court had to address in answering the certified question in Pozzi. In Pozzi, water intrusion had damaged a multi-million-dollar home located in the Coconut Grove area of Miami, Florida. The homeowner alleged that custom windows installed in the home had leaked, causing damage to the windows themselves and to the interior of the house. The homeowner sued the general contractor, the window installer, and the window manufacturer, Pozzi Window Company, which settled with the homeowner by agreeing to repair and/or replace the windows. Pozzi then pursued crossclaims seeking equitable contribution from the general contractor and its owner, individually, who had acted as qualifier on the home construction project. Pozzi alleged that the water intrusion damage had been caused by the negligent workmanship of the subcontractor who installed the windows, alleging further that the general contractor had negligently failed to supervise the window installation work. Pozzi eventually settled with the general contractor, obtaining an assignment of rights to pursue a claim for insurance coverage against the general contractor s insurer, Auto-Owners Insurance Company. The U.S. District Court Judge granted Pozzi s motion for partial summary judgment, finding that under the plain language of the PCOH coverage provisions, Auto-Owners had breached the policy by denying coverage and by failing to defend the claims alleged against the individual owner of the insured general contractor. Thereafter, the trial jury returned a verdict finding that the settlement between Pozzi and the insured general contractor was not collusive and awarding compensatory and punitive damages against Auto-Owners. The district court entered post-judgment rulings upholding the jury s verdict for compensatory damages, but rejecting the punitive damages award. On appeal, the U.S. Court of Appeals for the Eleventh Circuit certified the PCOH coverage issue to the Florida Supreme Court, asking the Florida court to answer the following question: DOES A STANDARD FORM [COMMERCIAL] GENERAL LIABILITY POLICY WITH PRODUCT[S] COMPLETED OPERATIONS HAZARD COVERAGE... ISSUED TO A GENERAL CONTRACTOR, COVER THE GENERAL CONTRACTOR S LIABILITY TO A THIRD PARTY FOR THE COSTS OF REPAIR OR 28 J.S.U.B., 979 So. 2d at 890.

13 6.03[A] 2009 CONSTRUCTION LAW UPDATE REPLACEMENT OF DEFECTIVE WORK BY ITS SUB CONTRACTOR? 29 The same day, December 20, 2007, that the Florida court issued its ruling in J.S. U.B., the court also issued a ruling in Pozzi answering the Eleventh Circuit s certified question. Applying the accidental occurrence ruling in J.S. U.B., the Florida court noted that Auto-Owners does not contend, and there is no indication in the record, that the Builder expected the windows to be defectively installed. Thus, like the faulty soil preparation in J.S. U.B., the defective installation of the windows in Pozzi, which the general contractor did not intend or expect, was an occurrence potentially covered by the CGL policies. 30 At that point, in addressing the question of property damage, the court departed from the J.S.U.B. ruling: Unlike J.S. U.B., which involved a claim for the costs to repair structural damage to homes caused by the subcontractor s defective work, this case involves a claim for the cost to repair or replace the defectively installed windows.... Because the subcontractor s defective installation of the windows is not itself physical injury to tangible property, there is no property damage under the terms of the CGL policies. 31 As a result, in its initial Pozzi ruling, the Florida Supreme Court answered the Eleventh Circuit s certified question in the negative, concluding that the cost of repairing or replacing the defective work of the window installer was not repair or replacement of property damage covered by the general contractor s CGL policy. In J.S. U.B., the property damage at issue (to the foundations and sheet rock) arose out of the negligent soil contractor s work. There is no indication that the insured made any claim for repair or replacement of the subcontractor s work itself. In Pozzi, the underlying property damage claim, which had been made by the window manufacturer, Pozzi, against the insured general contractor, was confined to subcontractor s window installation work. Because the same water intrusion that had damaged the interior of the home also had damaged the subcontractor s window installation work, Pozzi sought rehearing of the December 20, 2007 ruling. In its motion for rehearing, Pozzi emphasized the plain language of the subcontractor exception, which as quoted above, covers damage to all of the work of the insured general contractor, if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor (emphasis added). On June 12, 2008, the Florida Supreme Court granted 29 As quoted by the Florida Supreme Court in Pozzi, 984 So. 2d at See also Pozzi Window Co. v. Auto-Owners Ins. Co., 446 F.3d 1178, 1188 (11th Cir. 2006). The Eleventh Circuit affirmed the trial court s ruling rejecting the jury s punitive damages award, an issue that was not certified for review or considered by the Florida Supreme Court. Pozzi, 984 So. 2d at 1246 n Pozzi Window Co. v. Auto-Owners Ins. Co., No , 2007 WL (Fla. Dec. 20, 2007), reh g granted and new opinion substituted, 984 So. 2d 1241, 1248 (Fla. 2008); see also Mealey s Litigation Report: Construction Defects Insurance Report, High Court Distinguishes Defective Installation, Defective Windows, 5-6 Mealey s Const. Def. Ins. Rep. 10 (2008). 31 In reaching this result, the court cited the Tennessee Supreme Court s ruling in Moore for the proposition that the mere inclusion of a defective component as part of a subcontractor s work is not property damage covered by a CGL form.

14 INSURANCE 6.03 Pozzi s motion for rehearing and issued a new opinion, holding that damage to the subcontractor s work itself (the window installation) qualified as insured property damage covered by the general contractor s CGL policy: [I]f the claim is for the repair or replacement of windows that were not initially defective but were damaged by the defective installation, then there is physical injury to tangible property. In other words, because the windows were purchased separately by the Homeowner, were not themselves defective, and were damaged as a result of the faulty installation, then there is physical injury to tangible property, i.e., windows damaged by defective installation. Indeed, damage to the windows themselves caused by the defective installation is similar to damage to any other personal item of the Homeowner, such as wallpaper or furniture. Thus, coverage would exist for the cost of repair or replacement of the windows because the Subcontractor s defective installation caused property damage. 32 However, the court noted that the Eleventh Circuit had interchangeably characterized the case in two distinct manners, referring both to defective windows and defective installation of the windows. The Pozzi court distinguished between claims for negligent installation of nondefective windows and installation of defective windows, noting that if the windows were defective both prior to installation and as installed, then that is merely a claim to replace a defective component in the project that is not covered property damage. 33 Because the court concluded that the record suggested a factual issue regarding whether the damage had been caused by defects in the windows themselves or by faulty installation, the court did not expressly answer the Eleventh Circuit s certified question but returned the case to the federal court for resolution. The Eleventh Circuit had little difficulty deciding that the case did involve faulty workmanship lack of proper window shims, bucks, and other negligent work by the window installer that caused the water intrusion damage at issue. The federal court also noted that its certification order had referred to faulty workmanship or defective work more than twenty times, and to defective windows only twice. In addition, the court noted that the arguments on appeal had focused exclusively on the question of whether or not the Auto-Owners policy covered claims for faulty installation/negligent workmanship by the window installer. As a result, the court ruled that by not raising the point, Auto- 32 Pozzi, 984 So.2d at As discussed below, carriers may argue that coverage for the repair or replacement of the defective work should be limited to situations in which the owner, acting as a third party, purchases the nondefective, damaged component, such as the windows at issue in Pozzi. Such an argument would not be consistent with the plain language of the subcontractor exception, which covers damage to the subcontractor s work, as well as damage arising from the work. 33 Id. at The court cited a Florida Court of Appeals decision denying coverage for the cost of removal and replacement of the wrong grade of cedar siding, noting that the mere inclusion of a defective component... does not constitute property damage unless the defective component results in physical injury to some other tangible property. Id. (citing West Orange Lumber Co. v. Indiana Lumbermens Mut. Ins. Co., 898 So. 2d 1147, 1148 (Fla. Ct. App. 2005)). This language suggests that if the defective component breaks and only damages itself, there is no coverage.

15 6.03[A] 2009 CONSTRUCTION LAW UPDATE Owners had waived any argument on appeal that the case involved installation of defective windows. Accordingly, the Eleventh Circuit affirmed the trial court s judgment awarding compensatory damages and remanded the case to the trial court for a determination of Pozzi s claim for attorneys fees Pozzi Window Co. v. Auto-Owners Ins., No , 2008 U.S. App. LEXIS (11th Cir. Sept. 26, 2008). Under Florida law, a policyholder who successfully litigates an insurance claim is entitled as a matter of right to recover the reasonable attorneys fees incurred in establishing coverage. See Fla. Stat. Ann

16 6.04[A] 2009 CONSTRUCTION LAW UPDATE The rulings in J.S. U.B. and Pozzi clarify Florida law by holding that negligent construction work that causes property damage that is neither expected nor intended by the insured is covered by the PCOH provisions of a standard form CGL policy. Each case presents a classic circumstance (settling and soil subsidence causing cracked walls and foundations and water intrusion that damages the completed project) that has led to varied results in similar cases elsewhere. Pozzi goes one step beyond J.S. U.B. in recognizing that cognizable, post-completion property damage caused by a negligent subcontractor is covered, even if that damage is confined to the negligent work of the subcontractor. However, language of the Pozzi opinion also suggests that if the damage at issue is caused by installation of a defective component, then there is no CGL coverage for the insured general contractor s liability for such damage: Because the Subcontractor s defective installation of the defective windows is not itself `physical injury to tangible property, there would be no property damage under the terms of the CGL policies. 35 If no identifiable property damage has occurred, it is hard to quarrel with such an outcome. The correction of substandard, nonconforming work, such as use of the wrong grade of siding or other materials, is a classic example of a business risk that is not within the scope of a CGL policy. However, if there has been physical damage to the insured general contractor s work, should it make any difference whether the damage is caused in whole or in part by the installation (whether negligently done or not) of a defective component or exclusively by the negligent installation work of the subcontractor? Before attempting to answer this question, it is appropriate to discuss some of the key recent rulings in other jurisdictions that uphold claims seeking PCOH coverage for damage caused by defective construction REVIEW OF RECENT PCOH COVERAGE RULINGS [A] Unintended Damage to Other Property Caused by a Subcontractor Triggers PCOH Coverage Shortly before the Pozzi decision, the Tennessee Supreme Court provided what, in hindsight, was a good start but not necessarily a complete analysis of when coverage should exist for defective window installation work. In Travelers Indemnity Co. of America v. Moore & Associates, 36 the court s three-part holding focused on what damages may trigger coverage under a CGL policy. In Moore, an insured contractor, hired to design and construct a hotel, employed a subcontractor to install the hotel windows. One year after construction was completed, the owner sued the contractor for damages caused by water and moisture penetration as a result of allegedly negligent design and installation of the windows. The water penetration caused deterioration both to the wall structure and to some finishes and fixtures in the hotel rooms. The insurer immediately sought a declaratory judgment that it had no duty to defend the contractor for the alleged damages. In the first part of its holding, the court found that the negligent installation of windows led to water damage of other property, including the room finishes and 35 Pozzi, 984 So. 2d at S.W.3d 302 (Tenn. 2007).

17 6.04[A] 2009 CONSTRUCTION LAW UPDATE fixtures. Thus, the negligent installation of the windows constituted an occurrence and triggered initial coverage under the policy. 37 The court further intimated that the contractor had shown the requisite property damage because the damages cited went beyond simply replacing a defective component or correcting faulty workmanship. 38 Finally, the court held that damages to the contractor s overall work product are covered if those damages are caused by the faulty workmanship of a subcontractor. 39 Accordingly, if the insured can show that an occurrence (a subcontractor s defective work) caused property damage to other property that is part of the work of the insured general contractor, the subcontractor exception extends PCOH coverage to protect the general contractor against liability for such damage. As a threshold matter, the Moore court s analysis of whether there was an accident potentially triggering coverage was based on whether damages would have been foreseeable if the insured had completed the work properly. 40 The Moore court rejected the proposition that negligence by a subcontractor is always foreseeable (so any damages resulting from such negligence could not be deemed an accident ), concluding that such a determination would be nonsensical. In particular, citing Travelers defective roofing analogy, the court rejected the carrier s limited view of what could be considered to be an accidental occurrence: Travelers concedes `that if a contractor improperly installs a shingle that later falls and hits a passerby, this event is unforeseeable and is an occurrence or accident. However, Travelers simultaneously insists that if a contractor improperly installs windows that leak and cause flood damage to the hotel, this event is foreseeable because it is a natural consequence of improperly installed windows. We are unpersuaded by this distinction. A shingle falling and injuring a person is a natural consequence of an improperly installed shingle just as water damage is a natural consequence of an improperly installed window. If we assume that either the shingle or the window installation will be completed negligently, it is foreseeable that damages will result. If, however, we assume that the installation of both the shingle and the window will be completed properly, then neither the falling shingle nor the water penetration is foreseeable and both events are accidents. Assuming that the windows would be installed properly, Moore could not have foreseen the water penetration. 41 In finding coverage for the liability of the general contractor resulting from the defective work of a subcontractor, the Tennessee court rejected the insurance industry s argument that such work could never constitute an insured occurrence Id. at Id. 39 Id. 40 Id. at Id. See also discussion of J.S.U.B. in Moore, 216 S.W.3d at

18 INSURANCE 6.04[A] Moore and J.S. U.B. reached similar conclusions by rejecting the no occurrence myth and finding that the defective work of a subcontractor can be an accidental occurrence if such work causes property damage to other parts of the insured general contractor s work. However, both cases suggest that the costs to repair or replace the defective work itself would not be covered, especially if such costs were deemed to be preventative work to correct the mere inclusion of a defective component as part of the completed project. 43 Both cases leave open the question (later answered in Pozzi) of whether there is coverage for property damage liability if that liability is confined to the cost of repairing the subcontractor s defective work. Other recent decisions illustrate a strong trend (as ruled in Florida and Tennessee) that PCOH coverage protects a general contractor against liability for the ensuing or resulting damage to other parts of the insured contractor s work, if that damage is caused by the negligent work of a subcontractor. In American Family Mutual Insurance Co. v. American Girl, Inc., 44 a subcontractor gave faulty advice regarding the proper method for compressing the soil beneath a warehouse being constructed by the insured general contractor. The resulting subsidence damaged the warehouse, leading to the general contractor s insurance claim. The Wisconsin Supreme Court concluded that even when the property damage is limited to the overall work product of the insured general contractor, the damages should be covered: The policy defines property damage as physical injury to tangible property, including all resulting loss of use of that property. The sinking, buckling, and crackling of the [warehouse] as a result of the soil settlement qualifies as physical injury to tangible property. 45 In reaching this result, the court relied on the existence of the your work exclusions as a basis for rejecting the carrier s no occurrence defense, reasoning as follows: If the insuring agreement never confers coverage for this type of liability as an original definitional matter, then there is no need to specifically exclude it. Why would the insurance industry exclude damage to the insured s own work or product if the damage could never be considered to have arisen from a covered occurrence in the first place? 46 The third case in what might be considered the pre- J.S. U.B. PCOH trilogy is the Texas Supreme Court s ruling in Lamar Homes, Inc. v. Mid-Continent Casualty Co. 47 In Lamar Homes, much like American Girl, negligent foundation work by a subcontractor 43 J.S.U.B., 979 So. 2d at N.W.2d 65 (Wis. 2004). 45 Id. at Id. at 78. The court noted that the subcontractor exception does not create coverage that is otherwise non-existent; instead, where initial coverage would be excluded, the exception operates to restore the otherwise excluded coverage. Id. Accord, Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 137 P.3d 486, 488, (Kan. 2006)( water intrusion caused by improper installation and/or defective windows is a covered occurrence) S.W.3d 1 (Tex. 2007).