Construction Defects

The standard insurance policy expected to respond to construction liability risks, including defective construction claims, is the commercial general liability (CGL) policy. Coverage for defective construction under CGL policies became an issue in the 1990s when insurers began to argue against coverage on the basis that a construction defect, by itself, was not an “occurrence” under the policy.

An occurrence is generally defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Construction defects have been defined as design or construction problems that result from a failure to construct or design the project or item in question in a reasonable and workmanlike manner. Construction Defect Claims fall into two categories: Patent Defects and Latent Defects. Patent defects are defects that are detectable through reasonable inspection, whereas latent defects are not detectable through reasonable inspection and are manifested over a period of time. Insurers have asserted that a CGL policy is intended to cover only damages from a contractor’s defective work -- not the contractor’s defective product or work -- and that coverage for the repair of defective materials or poor workmanship is properly excluded.

Background

CGL policies for contractors may be available in three different forms: 1) an “occurrence” form to cover occurrences that take place during the policy period, 2) a “manifestation occurrence” form intended to cover occurrences that first manifest during the policy period, 3) a “claims made” form for coverage of claims that are reported during the policy period.

Whether or not a construction defect is considered an “occurrence” under a particular CGL policy may depend on where the event took place and how that jurisdiction defines the term, which might be one of three ways: 1) that if the damage resulted from an intentional act of construction, it is not an occurrence, 2) that if damage is an unintended result of faulty workmanship, it qualifies as an occurrence, or 3) whether or not an occurrence took place depends upon the nature of the property damaged. A state may legislate a change in its interpretation of the term “occurrence” at any time, making coverage unpredictable for an insured. Even where the main definitions provide some clarity, however, an analysis of coverage is further complicated by the application of additional definitions.

A policyholder who has established that the construction defect complained of qualified as a coverage-triggering occurrence is still not guaranteed coverage, as the insurer may seek to apply a policy exclusion. The insurer may rely on an exclusion for a specific part of a property on which the contractor or subcontractor was performing operations, or for the contractor’s product, or for the contractor’s own work.

Injuries and Damages

Certain causes of action are common in construction defect lawsuits, including:

• breach of contract, in which the purchaser of the property discovers a defect and sues the builder; or,
• breach of warranty, which arises where the builder provides a time-limited warranty and a defect is discovered within that time period; or,
• negligence, where a claim arises out of an alleged breach of the duty of care in the building process that results in damages; or,
• strict liability (which some states limit to certain types of builders) which might provide an avenue of recovery to a homeowner whether the builder was negligent or not; or,
• misrepresentation and fraud claims, which are allowed in construction defect litigation and may include nondisclosure about defects; or,
• indemnity, where builders and contractors sued by homeowners may cross-claim against subcontractors.

Legislation and Regulation

In the 1990s and 2000s many states enacted construction-defect laws in response to increasing complaints from new-home buyers about faulty construction. It was hoped that the laws would standardize the complaint process and eventually reduce claims, but that was not consistently the case. Complaints persisted, especially in the South and the West where building rates were particularly high. In response to the escalating complaint levels, Nevada passed a law in 2015 that was intended to restrain the construction-defect laws enacted in 1995. Home builders and contractors applauded the 2015 change, claiming that lawsuits under the 1995 law raised the cost of doing business, while many disputes could be resolved through mediation instead of in a court of law. Some homeowner groups, however, complained that the reforms to the construction-defect rules made pursuing defect claims much harder and more expensive.

The 1995 Nevada law had been intended to level the playing field between homeowners and builders. The law required, among other things, that the prevailing side’s legal costs be paid by the losing side. Some critics alleged that this structure caused plaintiffs’ attorneys to file excessive claims and increased legal fees because they knew that the fees would be paid from settlements made by builders and insurers. So many suits were filed under the 1995 law that three state judges were appointed to hear only construction-defect claims in a court that became known as the “dirt court.”

The Nevada law enacted in 2015 required that homeowners provide full descriptions of alleged defects and go through a process to allow builders to fix the defects. Significantly, the new law removed the provision for the losing side to pay attorneys’ fees. Some builders claim that Nevada’s 2015 defect law will ultimately benefit consumers by lowering the cost of insurance premiums and lowering the cost of new homes. Following Nevada’s example, other states, particularly Arizona, Colorado, Florida and Washington, have proposed legislation to curtail their construction-defect laws and address the issues of attorneys’ fees, mandated inspection of defects by a professional before settlement, arbitration instead of litigation and other areas of frequent dispute.

To control professional construction liability, some states have also implemented ‘right to cure’ statutes. Under this law, the project owner (i.e. homeowner) must first notify the construction professional of the alleged defects and allow them the opportunity to repair the defect, or pay the project owner for the program. The implementation of this law differs from state to state, as does the statute of limitations, including the time the project owner must wait after notifying the professional before they can proceed with a lawsuit.

Liability and Insurance

CGL coverage for the majority of defective construction claims often depends on whether or not policy exclusions relating to damage to the insured’s own work apply. When the broad form property damage endorsement was introduced in the late 1960s and largely incorporated into policies in the late 1980s, insurers contended that they became subject to claims they may not have underwritten or included in premium calculations. Residential condominiums and subdivisions of single-family homes frequently generated claims that occurred long after completion, but triggered coverage within the “products-completed operations” provisions of CGL policies.

With respect to completed operations coverage, work done by subcontractors was subject to an exception to the “your work” exclusion; this exception significantly enlarged the cope of coverage for contractors employing subcontractors. The application of other exclusions was also limited, making coverage available for property damage related to defective workmanship during operations. Insurers experiencing a rise in construction defect claims began to seek ways to avoid the coverage preserved by the limited property damage exclusions. A main insurer argument was that property damage resulting from defective construction is not an occurrence, but arguments were also made about breach of contract, property damage foreseeability, damage to third-party property versus damage to the insured’s work arising out of the performance of defective work.

Litigation

Important precedent illustrating some of the insurers’ arguments falls into several categories, including: 1) defective construction is an occurrence, 2) resulting damage to other work is an occurrence, 3) resulting damage to third-party property is an occurrence, and 4) defective work is not an occurrence.

Defective Work is an Occurrence
A 2013 North Dakota case, K & L Holmes, Inc. v. American Family Mut. Ins. Co., 829 N.W.2d 724 (N.D. 2013), upheld the principle that property damage arising out of defective construction could be an occurrence regardless of whether the property damage was to the insured’s work versus third-party property. The opinion held that faulty workmanship, in this case damage alleged to be the result of an excavation subcontractor’s defective work, could be an occurrence if the defective work was unintended and unexpected by the insured.

In 2013, in a similar case from West Virginia, Cherrington v. Erie Ins. Prop. & Cas. Co., 745 S.E.2d 508 (W. Va. 2013), the homeowner sued the builder over several alleged defects. The court found that defective work could constitute an occurrence if the damage was neither intended nor expected by the insured. The court observed that several states had applied the subcontractor exception in the policy’s “your work” exclusion and found that it would be rendered effectively meaningless if defective construction could not be an occurrence.

A recent case was filed by the Aria on the Bay condo association against the development affiliate Arquitectonica and six other firms working on the project. The suit alleges that the project was not built according to Florida building code standards, and as such, the association has had to spend large sums of money for repairs and maintenance that would have otherwise not occurred. The high profile condominium building has identified 114 deficiencies, such as lack of accessible building entrances, improperly installed mailboxes, cracked stucco and masonry walls, and defective elevators. The suit has yet to be resolved, but is an example of defective work. The decision will lend itself to the standard of occurrence claims.

Resulting Damage to Other Work is an Occurrence
Several cases slightly narrowed the scope of an “occurrence” by finding that property damage to the defective work itself was not an occurrence, but damage to other property, including the insured’s own work, could constitute an occurrence. In 2014, the Alabama Supreme Court reversed its earlier opinion that property damage arising out of defective workmanship constituted an occurrence only where it caused damage to personal property or other parts of the structure that were not part of the insured's own work. [Owners Ins. Co. v. Jim Carr Homebuilder LLC, 2014 Ala. LEXIS 44 (Ala. Mar. 28, 2014)] This decision was problematic because under the terms of most CGL policies, the entire construction project is regarded as the contractor’s work. In its ruling reversing itself, the court stated that it was outside the definition of “occurrence” in the policy to determine the existence of an occurrence based on such criteria as resulting damage to third-party property not a part of the project.

Similarly, a Georgia high court ruled in Taylor Morrison Servs., Inc. v. HDI-Gerling Am. Ins. Co., 746 S.E.2d 587 (Ga. 2013) that the term “occurrence” did not require damage to the property or work of others, but that the damage must be to other nondefective property to be covered. The Connecticut Supreme court held that a subcontractor’s alleged unintended defective construction could be an occurrence if it damaged the nondefective work or property of third persons.

An Occurrence Requires Damage to Third-Party Property
Cases from several jurisdictions, including New York, Michigan, Kentucky and New Jersey, severely limit the definition of occurrence for property damage arising out of defective work by holding that only property damage to third-party property is covered under the CGL policy. Some builders complain that whatever the basis that a court uses to apply the third-party property damage limitation on the definition of occurrence, that limitation potentially denies coverage for major portions of damages associated with many defective workmanship claims, and that the limitation is contrary to the structure, terms and intent of a CGL policy. [Rosewood Homebuilders LLC v. National Fire & Marine Ins. Co., 2013 U.S. Dist. LEXIS 45374 (N.D.N.Y. Mar. 29, 2013); Oak Creek Apartments LLC v. Garcia, 2013 Mich. App. LEXIS 550 (Mich. Ct. App. Mar. 21, 2013); Liberty Mut. Ins. Co. v. Kay & Kay Contracting LLC, 545 Fed. Appx. 488 (6th Cir. Ky. 2013); National Union Fire Ins. Co. of Pittsburgh, Pa. v. Turner Constr. Co., 119 A.D.3d 103 (N.Y. App. Div. 1st Dep't May 15, 2014)]

Defective Construction Is Not an Occurrence
The U.S. Court of Appeals for the Sixth Circuit issued a ruling in McBride v. Acuity, 510 Fed. Appx. 451 (6th Cir. Ky. 2013), a case involving cracks in walls and floors resulting from the concrete subcontractor’s defective work, holding that the faulty workmanship did not constitute an occurrence even though the insured’s subcontractor performed the work, meaning that no coverage existed under the builder’s CGL policy for damages.

In another 2013 case, Allied Roofing, Inc. v. Western Reserve Grp., 2013-Ohio-1637 (Ohio Ct. App. Franklin County Apr. 23, 2013), an Ohio state court denied coverage to a roofer for damages involving rooftop air conditioning units that occurred when the roofing contractor removed and reinstalled the units as part of the roofing job. The court relied on precedent from a previous Ohio case which held that the claims involved only damage to the insured’s own work for defective workmanship, and were not claims for property damage caused by an occurrence.

A recent dispute over defective roofing heard in federal court in Hawaii found that under the law that applied to the CGL policy when it was written, faulty workmanship was not an occurrence; rather, defective work is considered a breach of contract with the damages being reasonably foreseeable. [Nautilus Ins. Co. v. 3 Builders, Inc., 955 F. Supp. 2d 1121 (D. Haw. 2013)]

Future Outlook

The laws regarding CGL coverage for construction defect claims are constantly changing, along with judicial interpretations of existing laws that have resulted in different treatments in different states. There is no certainty in this area of insurance, making it likely that the “defective construction as an occurrence” issue will generate litigation for some time. As large builders continue to develop projects in multiple states, insurers need to keep themselves informed of recent rulings and be aware of the impact of choice of law on policy interpretation.

In the News

2020

• Britain's grasping housebuilders must be shaken to their foundations - Liam Halligan, The Telegraph (07/04/2020)
  An inquiry is long overdue into an industry that imposes “contrived scarcity” on homebuyers amid a distinct lack of competition.

2019

• Construction worker sues Marriott after watching coworkers die on site near Disney - Marco Santana, Orlando Sentinel (08/26/2019)
  A coworker of two men who fell to their deaths at a hotel construction site near Walt Disney World’s Epcot last year has sued Marriott and others in Orange Circuit Court, saying the companies acted with “gross negligence” by not providing sufficient safeguards for workers.

2018

• New York Insurance Law: Under Construction - Proskauer, JD Supra (04/03/2018)
  Imagine you hired a general contractor to renovate the master bathroom of your home. The general contractor hired a subcontractor to do the plumbing work, but the subcontractor botched the job, resulting in a massive leak causing extensive damage to other areas of your home and valuable personal property. You demand full compensation for the loss, but unfortunately the contractors you hired had no assets besides their comprehensive general liability insurance policies. . . . Will those insurance policies cover this loss? . . . . Until now, New York courts may well have answered this question in the negative, because they did not consider a subcontractor’s defective workmanship to qualify as an “occurrence” under CGL policies. But that view may be changing. . . . Recently, a number of cases in courts around the country have taken a fresh look at coverage in this scenario and reached the opposite conclusion. In 2016, the New Jersey Supreme Court changed its previous position and decided that under current CGL policies, damages caused by a subcontractor are a covered “occurrence” and therefore insurable.

2017

• Lawsuit Claims Portland Hotel Doors Killed Woman - The Associated Press, US News (05/02/2017)
  
  The family of an 87-year-old woman who died after she was hit by the automatic front doors of a Portland hotel has filed a $2.7 million lawsuit against the hotel.
• Construction defects bill OK’d by state Senate committee - Luke Perkins, Durango Herald (02/27/2017)
  The second piece of legislation aimed at resolving concerns with construction defects in Colorado passed 5-2 Monday by the Senate Business, Labor and Technology committee. . . . Senate Bill 156 would require homeowners seeking restitution for faulty work by contractors to go through mandatory arbitration or mediation. It also would require homeowners’ associations to acquire written consent from a majority of owners to pursue litigation The measure is one of a package of bills to resolve the lack of affordable housing in the state. . . . The shortage has been attributed to ballooning insurance premiums placed on construction companies, which dissuades them from building condos.

2016

• Threat of Litigation Mutes Condo Development - MFE (08/10/2016)
  

  The Wall Street Journal's Chris Kirkham looks at why so many condo developers in Denver—one of the nation's hottest housing markets—are sitting on the sidelines. . . . The threat of a lawsuit stemming from construction defects looms large in Denver, making many projects fizzle before the planning stage. Since homeowner associations can file a suit on behalf of hundreds of households, many developers are wary, to say the least.

2014

• Alabama joins recent trend of states finding defective work may be covered under a commercial general liability policy - Heather Howell Wright, Bradley Arant Boult Cummings LLP (08/01/2014)
  Through this decision, the Alabama Supreme Court joined the recent (but not uniform) trend in other jurisdictions that recognize that defective work may be covered under a CGL.
• Report: Caltrans Overrode Worries about Bay Bridge - AP, AP (06/08/2014)
  The decision by California transportation officials to hire a Chinese company that had never built a bridge to make key components of the San Francisco-Oakland Bay Bridge's eastern section ended up being a costly choice in terms of both dollars and confidence in the span's structural integrity, a newspaper reported Sunday.
• Confusion over construction defect liability spawns legal battles - Mike Tsikoudakis, Business Insurance (05/21/2014)
  Four states recently have passed statutes defining construction defect claims as occurrences, but commercial general liability policyholders continue to be frustrated by coverage gaps for faulty work construction.
• Texas Supreme Court limits liability insurance exclusions - Chris Tomlinson , AP (01/17/2014)
  The Texas Supreme Court issued a key ruling Friday that should boost consumer confidence in the liability insurance coverage that builders and general contractors carry.

Additional Items

• Completed Operations Hazard Coverage In A Wrap-up Policy
  The Court of Appeal’s decision in Constructions Reliance Inc. (Constructions Reliance du Canada Ltée) v. Compagnie d’assurances Temple1 recently ruled on the interpretation of “completed operations hazard” in a wrap-up insurance policy.

   

• Seattle, contractors will be investigated in Pier 58 collapse by state and federal safety inspectors
  Federal and state workplace safety inspectors have opened investigations into the partial collapse of Seattle’s Pier 58 as demolition crews worked Sunday to remove the city-owned structure also known as Waterfront Park.

   

• Everett company faces $230,000 fine for safety violations
  State inspectors allege that Chilos Builders exposed workers to hazards at area construction sites.

   

• Company building Amazon center has been cited for safety violations at other sites
  The company contracted to build an Amazon robotics fulfillment center in Suffolk, where two workers died in an industrial accident Saturday, was cited by the Occupational Safety and Health Administration earlier this year for violations at a Georgia construction site.

   

• Lawsuit filed against makers of Montreal-area dike that burst, flooding town
  A Montreal-area town says its insurance company is suing the maker of a dike that burst last spring, flooding streets and forcing thousands of residents from their homes. Officials from Ste-Marthe-sur-le-Lac said Tuesday legal action has been filed against the firm Gendron Lefebvre, which was responsible for work carried out in 1979.

   

• New Orleans Sues Owners Over Deadly Hotel Project Collapse
  New Orleans officials say the city is suing the owners of a hotel that was under construction when it collapsed 10 months ago, killing three workers.