2016 Construction Law Seminar

Transcription

1 2016 Construction Law Seminar Current Issues and Developments in Commercial General Liability (CGL) Insurance Policies 1:35 p.m.- 2:05 p.m. Presented by Roger Stone Simmons, Perrine, Moyer, Bergman, P.L.C rd St. SE Suite 1200 Cedar Rapids, IA Phone: Thursday, February 25, 2016

2 Current Issues and Developments in Commercial General Liability (CGL) Insurance Policies

3 Today s Presenter: Roger W. Stone rstone@simmonsperrine.com

4 Refresher The Occurrence Issue Occurrence means an accident, including continuous or repeated exposure to substantially the same general harmful conditions.

5 Whether Defective Workmanship can be an Occurrence Under a CGL Policy Pursell Construction, Inc. v. Hawkeye-Security Insurance Co., 596 N.W. 2d 67 (Iowa 1999) The Court adopted the majority rule and held that defective workmanship standing alone, that is, resulting in damages only to the work product itself, is not an occurrence under a CGL policy.

6 Whether Defective Workmanship can be an Occurrence Under a CGL Policy Yegge v. Integrity Mut. Ins. Co., 534 N.W. 2d 100 (Iowa 1995) Breach of contract, breach of express warranty, breach of implied warranty and fraud do not constitute an occurrence under CGL policy).

7 Whether Defective Workmanship can be an Occurrence Under a CGL Policy The Iowa Court of Appeal properly rejected the insurer s broad interpretation of Pursell in the recent National Surety Corporation v. Westlake Investments, LLC, 2015 Westlaw (October 28, 2015) decision.

8 Whether Defective Workmanship can be an Occurrence Under a CGL Policy The Court of Appeals concluded the Purcell decision was not the controlling law and ruled defective construction is accidental, so it is an occurrence, and defective construction causing property damage may be covered under a contractor s commercial general liability policy.

9 The Big Picture: Intended Framework of the CGL Policy The insuring agreement specifically anticipates the occurrence of property damage caused by defective work. The construction-specific exclusions are intended to frame the fortuitous losses that are covered, as opposed to business risks. The exclusions narrow and define the scope of coverage for property damage caused by CD claims.

10 Damage to Other Property If the damage to property arises during construction of the project, there is no coverage for the damage under the CGL policy because of exclusion j(5). Exclusion j(5) of the policy states: This insurance does not apply to:... Property damage to [t]hat 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.

11 Damage to Other Property Exclusion j(5) is usually restricted to losses that arise during operations or construction of the project and does not exclude coverage for losses that occur after completion of the project. Mid-Continent Casualty Co. v. JHP Development, Inc., 557 F. 3d. 207 (5 th Cir. 2009).

12 Damage to Other Property In Fortney & Weygandt, Inc. v. American Manufacturers Mutual Insurance Co., 595 F.3d 308, 311 (6th Cir.2010) (applying Ohio law), the court interpreted the phrase that particular part included in a k.(6)-type exclusion: The opening words of the exclusion namely, [t]hat particular part are trebly restrictive, straining to the point of awkwardness to make clear that the exclusion applies only to building parts on which defective work was performed, and not to the building generally.

13 Damage to Other Property Alabama Sup. Ct. Owners Ins. Co. v. Jim Carr Homebuilder, LLC, 157 So. 3d 148 (Ala. 2014) Court held there can be no occurrence unless there is damage to property outside of the insured s scope of work. Homebuilder s scope of work was the entire home Therefore, the court held there was no coverage because the alleged defects and property damage were all related to the home.

14 Damage to Other Property Alabama Sup. Ct. 157 So. 3d 148 (Ala. 2014). It is not appropriate to use the kind of property damage at issue to determine whether there is an occurrence Performing defective work inadvertently is an accidental occurrence but the cost to repair or replace defective work itself is not property damage caused by an occurrence Damage beyond the defective work itself CAN be property damage caused by an occurrence even if it is to another part of the policyholder s OWN scope of work (here the home)

15 Owners Ins. Co. v. Jim Carr Homebuilder, LLC, 157 So. 3d 148 The decision holds that the your work exclusion does not apply (at all) to property damage claims that arise after operations are complete if the policy includes completed operations coverage

16 Subparagraph (6) of Exclusion j The Westlake case did not involve this exclusion. Subparagraph (6) of exclusion j, sometimes referred to as the incorrect work exclusion, is a companion to exclusion j(5), and it states that coverage does not extend 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.

17 Subparagraph (6) of Exclusion j 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.

18 Refresher The Your Work Exclusion with the Subcontractor Exception Property Damage to your work arising out of it or any part of it and included in the productscompleted 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.

19 The subcontractor exception has been found to preserve coverage for liabilities arising from property damage involving a subcontractor in at least the following situations: [1] A subcontractor's defective work causes damage to the insured's work. [2] The insured contractor's defective work causes damage to the subcontractor's work. [3] The defective work of one or more subcontractors causes damage to a subcontractor's work.

20 The Your Work Exclusion The method recently approved by the United States Court of Appeals for the Eighth Circuit was CGL coverage did not exist for damage to the work product itself the silo and did exist for all property damage other than to the silo itself, including lost [material] and damage to the nearby equipment. Lexicon, Inc. v. Ace Am. Ins. Co., 634 F.3d 423, 427 (8th Cir. 2010).

21 What is Included In The Products Completed Operations Hazard? The PCO hazard in the GGL policy refers to BI and PD which occur away from premises owned or rented by the policyholder, and after the policyholder has completed work. It basically means (as a default provision) that the policyholder is assuming the risk (or hazard ) related to its completed operations UNLESS the policyholder purchases coverage for completed operations.

22 What is Included In The Products Completed Operations Hazard? Completed Operations. The your-work exclusion is not applicable to coverage under the products-completed operations hazard. For example, the owner of and general contractor for a silo sued the concrete contractor for negligent construction resulting in damage to the silo.

23 What is Included In The Products Completed Operations Hazard? Applying Minnesota law, the Kansas Court of Appeals examined the your-work exclusion which provides that Coverage A 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 concluding the exclusion suggests that property damage to work that is covered by products-completed operations hazard is not included within Coverage A and is strong evidence that products-completed operations coverage is not incorporated within the scope of Coverage A. Producers Co-op. Ass n of Girard v. Cromwell Constr., Inc., 253 P.3d 385, 2011 WL 103,824, at *11 (Kan. Ct. App. June 24, 2011).

24 Owners Ins. Co. v. Jim Carr Homebuilder, LLC, 157 So. 3d 148 If the policyholder purchases completed operations coverage, it removes the standard risk (or hazard ) for property damage arising out of completed operations. The damage at issue is therefore not included in the PCO hazard One prong of the your work exclusion is not satisfied. The your work exclusion does not apply.

25 Owners Ins. Co. v. Jim Carr Homebuilder, LLC, 157 So. 3d 148 The policyholder purchased $4 million of productscompleted operations coverage Illusory coverage if exclusion applied This part of the decision was outcome determinative the policy did not include the subcontractor exception Only decision to so hold? Will others follow? Potentially a significant development

26 But Don t Feel Too Good Pennsylvania National Mut. Cas. Ins. Co. v. St. Catherine of Siena Parish, 16 F. Supp. 3d 1370 (S.D. Ala. 2014) Alabama federal court applied Owners Ins. Holding to find existence of an occurrence But then held any/all coverage for breach of contract is barred by the contractual liability exclusion Potentially a significant and emerging problem for construction industry policyholders Win the battle; lose the war?

27 What is Property Damage?

28 Property Damage Property damage means: Physical injury to tangible property, including the loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that cause it: or 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.

29 Key Issues Under Prong 1 Defect vs. Physical Damage Incorporation theory Damage to the insured s own work vs. third-party property Emerging middle ground Pure economic loss vs. consequential damages Damages because of Rip and Tear coverage

30 The Crux of the Debate 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.

31 The Perceived Problem When the property damaged is the insured s work, and the nature of the problem is characterized as faulty or defective workmanship, some courts have a tendency to inquire whether property damage covers the repair or replacement of poor workmanship. Business Risk Rationale Performance Bond Analogy

32 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?

33 Contractual Liability Exclusion

34 Contractual Liability and Exclusion Contractual Liability: [B]odily 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: That the insured would have in the absence of the contract or agreement; or Assumed in a contract or agreement that is an insured contract

35 Contractual Liability and Exclusion In Westlake, the question arose whether the $1 million agreement to pay attorney fees in the consent judgment was assumption of a contractual liability and therefore not covered by the CGL policy. The Court of Appeals ruled that the jury could have found that the attorney fees obligation was arising from the provision in the contract for sale that required attorney fees to be paid for litigation relating to breach of the sales agreement. Under that provision, the attorney s fees were not a liability assumed by contract but rather damages resulting from a contact provision providing for payment of attorneys fees.

36 CURRENT ISSUES AND DEVELOPMENTS IN COMMERCIAL GENERAL LIABILITY (CGL) INSURANCE POLICIES Roger W. Stone Simmons Perrine Moyer Bergman PLC Whether defective workmanship can be an Occurrence under a CGL Policy? Since 1999, the Iowa Supreme Court s decision in Pursell Construction, Inc. v. Hawkeye- Security Insurance Co., 596 N.W. 2d 67 (Iowa 1999), dominated Iowa law on insurance coverage for defective work. The Court adopted the majority rule and held that defective workmanship standing alone, that is, resulting in damages only to the work product itself, is not an occurrence under a CGL policy. Id. at 70. The Court explained that the damages [the developer] seeks are limited to the very property upon which Pursell performed work and were not the result of an occurrence as defined in the policy. Id. The parties had stipulated there was no physical damage to the project. Without any physical damage to the project, the Iowa Supreme Court concluded there was no insurance coverage available for the defects under the general contractor s commercial general liability policy. Insurers have attempted to expand the Pursell decision to preclude all insurance coverage for defective work, regardless of whether or not there was physical damage to the project. The Eighth Circuit Court of Appeals later discussed the distinction in Iowa law between an accident and faulty workmanship. Norwalk Ready Mixed Concrete, Inc. v. Travelers Ins. Cos., 246 F.3d 1132, 1137 (8th Cir.2001) (We therefore hold that defective workmanship, regardless of who is responsible for the defect, cannot be characterized as an accident under Iowa law); see also Liberty Mut. Ins. Co. v. Pella Corp., 650 F.3d 1161, 1176 (8th Cir.2011) (reaffirming that under Iowa law, defective workmanship cannot be considered an accident, and therefore an occurrence, and holding property damage due to defective windows was not an occurrence). Yegge v. Integrity Mut. Ins. Co., 534 N.W. 2d 100 (Iowa 1995) (breach of contract, breach of express warranty, breach of implied warranty and fraud do not constitute an occurrence under CGL policy). The Iowa Court of Appeal properly rejected the insurer s broad interpretation of Pursell in the recent National Surety Corporation v. Westlake Investments, LLC, 2015 Westlaw (October 28, 2015) decision. The Court of Appeals stated that In Pursell, the court found no occurrence, and consequently no coverage, because the only damage alleged from the defective workmanship (failure to construct basement floors at the proper elevation) was to the product itself. The Westlake case involved physical damage to the project; while in Pursell the parties stipulated there was no physical damage to the house. The Court of Appeals concluded the Purcell decision was not the controlling law and ruled defective construction is accidental, so it is an occurrence, and defective construction causing property damage may be covered under a contractor s commercial general liability policy. 1

37 Occurrence was defined in the policy as an accident, including continuous or repeated exposure to substantially the same general harmful conditions. The Court stated: Starting with the assumption that from the viewpoint of the insureds the work would be completed properly, then the damages were unforeseeable and constituted an accident and therefore an occurrence within the meaning of the CGL policy. Damage to property arising from defective construction was an occurrence. 2. Property Damage Exclusion The Iowa Court of Appeals stated in Westlake: We observe the question of whether faulty workmanship of a subcontractor fits within the definition of occurrence under a CGL policy has been litigated in a number of jurisdictions. The insuring language and exclusions in standard CGL policies have been modified over the years, and the recent evolution of the standard CGL policy explains the focus on this particular issue. The 1986 revision to the policy added several exclusions, including (j)(6) and (l ), which have an express exception for subcontractor work. Of jurisdictions that have analyzed the issue, the majority has decided inadvertent faulty workmanship of a subcontractor can be an occurrence covered by a CGL policy. See, e.g., Greystone Constr., Inc. v. Nat'l Fire & Marine Ins. Co., 661 F.3d 1272, 1282 (10th Cir.2011) (discussing cases); K & L Homes, Inc. v. Am. Family Mut. Ins. Co., 829 N.W.2d 724, (N.D.2013) (same). The Court of Appeals identified three circumstances where coverage for damage to a subcontractor s work existed under a CGL policy: The subcontractor exception has been found to preserve coverage for liabilities arising from property damage involving a subcontractor in at least the following situations: [1] A subcontractor's defective work causes damage to the insured's work. [2] The insured contractor's defective work causes damage to the subcontractor's work. [3] The defective work of one or more subcontractors causes damage to a subcontractor's work. K & L Homes, Inc., 829 N.W.2d at 739 (quoting Stephen N. Goldberg & James S. Carter Jr., Liability Insurance for Construction Defects in 3 New Appleman Law of Liability Insurance 28.04[10][a]-[b] (Matthew Bender 2d ed.2012)). 2

38 The Court of Appeals identified that loss of use or rent was compensable property damage: Westlake presented substantial evidence with regard to repair costs and damage to Westlake's reputation which led to loss of use, lost profits, and lost rental income. The jury determined the consent judgment, in its entirety, was reasonable and prudent. 11 We affirm the jury's finding that Westlake's claim for physical injury and loss of use constitutes property damage caused by an occurrence within the meaning of the policy. 3. Exclusion j(5) excludes property damage arising out of your operations The primary means of insuring loss during construction is builders risk insurance, which is first party insurance purchased by the owner or contractor. CGL policies usually exclude losses due to operations that cause defective workmanship or repairs due to faulty workmanship, but provide coverage for ensuing loss when faulty workmanship results in another cause of loss to the work. If the damage to property arises during construction of the project, there is no coverage for the damage under the CGL policy because of exclusion j(5). Exclusion j(5) of the policy states: This insurance does not apply to:... Property damage to [t]hat 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. Exclusion j(5) is usually restricted to losses that arise during operations or construction of the project and does not exclude coverage for losses that occur after completion of the project. Mid-Continent Casualty Co. v. JHP Development, Inc., 557 F. #3d. 207 (5 th Cir. 2009). Assuming that damage occurs during operations, the that particular part language further limits the scope of the exclusion. Only that particular part of the work on which the operations are actually being performed and which is damaged is excluded. See, ISO Circular General Liability GL79-12 (January 29, 1979). In Fortney & Weygandt, Inc. v. American Manufacturers Mutual Insurance Co., 595 F.3d 308, 311 (6th Cir.2010) (applying Ohio law), the court interpreted the phrase that particular part included in a k.(6)-type exclusion: The opening words of the exclusion namely, [t]hat particular part are trebly restrictive, straining to the point of awkwardness to make clear that the exclusion applies only to building parts on which defective work was performed, and not to the building generally. And we also agree that part, as used in this exclusion, means the distinct component parts of a building things like the interior drywall, stud framing, electrical wiring, or, as here, the foundation. 3

39 One commentator has pointed out that [t]he use of the word particular suggests that the exclusion only applies to the smallest unit or division of the work in question. SCOTT C. TURNER, INSURANCE COVERAGE OF CONSTRUCTION DISPUTES 32:5 (2011). In the commentator s words, [t]his coverage approach is often called the component parts approach, and part as used in this exclusion, means the distinct component parts of a building. Id. In Westlake, the Court of Appeals determined that substantial evidence supported the jury finding that the property damage occurred after construction was completed. 4. Subparagraph (6) of Exclusion j The Westlake case did not involve this exclusion. Subparagraph (6) of exclusion j, sometimes referred to as the incorrect work exclusion, is a companion to exclusion j(5), and it states that coverage does not extend 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. This exclusion does not apply to a completed operations loss, that is namely one that occurs after the work is put to its intended use or the work is completed. Exclusion l, the your-work exclusion applies in such situations. Completed Operations. The your-work exclusion is not applicable to coverage under the products-completed operations hazard. For example, the owner of and general contractor for a silo sued the concrete contractor for negligent construction resulting in damage to the silo. The district court entered judgments against the concrete contractor and in favor of the owner and general contractor. The owner and general contractor initiated garnishment proceedings against the concrete contractor s CGL insurer. Applying Minnesota law, the Kansas Court of Appeals examined the your-work exclusion which provides that Coverage A 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 concluding the exclusion suggests that property damage to work that is covered by products-completed operations hazard is not included within Coverage A and is strong evidence that products-completed operations coverage is not incorporated within the scope of Coverage A. Producers Co-op. Ass n of Girard v. Cromwell Constr., Inc., 253 P.3d 385, 2011 WL 103,824, at *11 (Kan. Ct. App. June 24, 2011). Similarly, the Alabama Supreme Court recently examined the relationship between the your-work exclusion and the declaration page, concluding the your-work exclusion only 4

40 applies if the declaration page omits coverage for products completed operations hazard. Owners Insurance Company v. Jim Carr Homebuilders, LLC, 157 So. 3d 148, (Ala. 2014). Because the builder bought completed operations, the your work exclusion did not apply after completion of the work. The your-work exclusion has no applicability to productscompleted operations hazard coverage. 5. Exclusion l your work exclusion The concept of business risk i.e., that contractors should be responsible for the quality of its own work is manifests in exclusion l the your work exclusion. The exclusion applies to the defined term your work, but is subject to an exception for property damage arising out of work performed by a subcontractor. This exception for subcontractor work may provide a great deal of coverage for contractors who do large amounts of work through subcontractors. 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 method recently approved by the United States Court of Appeals for the Eighth Circuit was CGL coverage did not exist for damage to the work product itself the silo and did exist for all property damage other than to the silo itself, including lost [material] and damage to the nearby equipment. Lexicon, Inc. v. Ace Am. Ins. Co., 634 F.3d 423, 427 (8th Cir. 2010). CGL policies generally provide coverage for property damage to work performed by the insured s subcontractor when the damage results from either work performed by the insured or the work of another contractor or subcontractor. Maureen McClendon, Jack Gibson & Jeffrey Woodward, Commercial Liability Insurance (IRMI 2003), cited in James Duffy O Connor, What Every Court Should Know About Insurance Coverage for Defective Construction, 5 Journal of the American College of Construction Lawyers, p. 1 (Winter 2011). 6. Endorsement 6 excludes damage for Earth Movement or subsidence The Court of Appeals determined that the jury could have determined that the earth movement exclusion did not apply to the damages: On the policy's endorsement 6, the Earth Movement or Subsidence exclusion, the jury was instructed: 5

41 The Arch policy excludes coverage for damages arising out of the subsidence, settling, sinking, slipping, falling away, caving in, shifting, eroding, consolidating, compacting, falling, rising, tilting, or any other similar movement of earth or mud, regardless of whether such movement is a naturally occurring phenomena or manmade. Jury Instruction No. 27. The jury received evidence regarding freeze/thaw cycles, but evidence specifying any frost heave at the apartment complex was equivocal at best. Furthermore, NSC failed to establish that any part of the consent judgment was attributable to earth movement damage. Assuming, without deciding, the earth movement exclusion is applicable under the circumstances, given the evidence presented at trial, the jury could have reasonably determined this exclusion did not apply. 7. Contractual Liability and Exclusion Contractual liability is important in construction because of the frequency of indemnity agreements in construction contracts. The enforceability of indemnity agreements depends upon both statutory and common law restrictions on indemnity obligations, including antiindemnity statutes. Insurance coverage for indemnity agreements is usually provided for by an exception to the exclusion of coverage for liability assumed by contract. In Westlake, the question arose whether the $1 million agreement to pay attorney fees in the consent judgment was assumption of a contractual liability and therefore not covered by the CGL policy. The Court of Appeals ruled that the jury could have found that the attorney fees obligation was arising from the provision in the contract for sale that required attorney fees to be paid for litigation relating to breach of the sales agreement. Under that provision, the attorney s fees were not a liability assumed by contract but rather damages resulting from a contact provision providing for payment of attorneys fees. The exclusion for contractual liability does not apply to liability for damages (1) that the insured would have in the absence of the contract or agreement. [T]he contractual-liability exclusion is limited to contracts wherein the insured assumes the liability of another. Travelers Prop. Cas. Co. of Am. v. Peaker Servs., Inc., 855 N.W.2d 523, 530 (Mich. Ct. App. 2014). In Westlake, the insured would have had liability for the attorney s fees independent of the consent judgment, because it had another contract under which it had promised to pay attorneys fees in connection with litigation of a breach. 8. Conclusions: Contractors in Iowa, at a minimum, should expect insurance coverage in the following circumstances: The subcontractor exception has been found to preserve coverage for liabilities arising from property damage involving a subcontractor in at least the following situations: 6

42 [1] A subcontractor s defective work causes damage to the insured s work. [2] The insured contractor s defective work causes damage to the subcontractor s work. [3] The defective work of one or more subcontractors causes damage to a subcontractor s work. The Westlake decision by the Iowa Court of Appeals moved Iowa law towards the law in a majority of other states to have considered the issue. General contractors may have insurance coverage available for property damage resulting from defective construction, especially in the context of (1) property damage resulting from a subcontractor s defective work and (2) property damage to a subcontractor s work. Subcontractors will likely have coverage under their CGL policies for the work of their subcontractors. General contractors may have insurance proceeds to contribute towards dispute resolution involving the work of subcontractors. 7