Defective Construction, Resulting Property Damage, and Potential CGL Coverage: What’s the law, and How do we deal with it?

By and | May 30, 2019

The majority of state supreme courts considering the issue over the last 20 years have determined that negligent or unintentional defective construction that causes property damage is an “occurrence”, potentially giving rise to coverage under a Commercial General Liability insurance (“CGL”) policy. See Black & Veatch Corp. v. Aspen Ins. (UK) Ltd., 882 F.3d 952, 966 (10th Cir. 2018); Cherrington v. Erie Ins. Property & Cas. Co., 745 S.E.2d 508, 518 & n.19-22 (W. Va. 2013) (surveying relevant caselaw and statutory provisions nationwide). While an “occurrence” is a necessary condition to CGL coverage, by no means is it sufficient. The “business risk” exclusions in paragraphs j(5) and j(6) of the CGL policy form, the paragraph k. “your product” exclusion, and the paragraph l. “your work” exclusion, further limit the circumstances under which CGL coverage is available in this context.

An example of property damage caused by defective construction that might give rise to CGL coverage involves post-construction damage to interior insulation or drywall, caused by water infiltration through a roof that was defectively constructed. Assuming that the defective construction was accidental and performed by a subcontractor, then damage to the insulation or drywall should be covered, although repair of the defective roof may not be covered. Moreover, in some states, if “getting to” the insulation or drywall to repair the damage entailed “rip and tear” property damage, then such damage might also be covered.

Importantly, in a lawsuit against the general contractor that both involved claims for damages associated with the defective roof (not covered) and with the consequential damage to the insulation or drywall (covered), the overall benefit of CGL coverage in this context might still be significant. CGL coverage typically is provided on a “duty to defend” basis. The “duty to defend” obligates the insurer to defend the entire lawsuit if there is potentially coverage for any part of the damages sought in a lawsuit. So, in the example, even if the insulation/drywall damage were negligible in comparison to the defective roof, the CGL coverage usually would obligate the insurer to defend the entire lawsuit.

While the legal trend is favorable, in some states, the highest court has ruled counter to the trend. See, e.g., Ohio Northern University v. Charles Construction Services, Inc., 120 N.E.3d 762 (Ohio 2018) (“property damage caused by a subcontractor’s faulty work is not fortuitous and does not meet the definition of an “occurrence” under a CGL policy”). And in some states, the highest court has not ruled on the issue, leaving the question unanswered.

There are numerous ways to criticize Ohio Northern University and other counter-trend decisions. But here we’ll offer more practical takeaways. A construction industry policyholder should determine, in advance, whether the law is favorable in the states in which it operates. If state law is unfavorable or unsettled, then forewarned is forearmed, and the policyholder should consider preventive steps:

  • It is always important to employ appropriate quality control, risk shifting, and asset protection strategies. But if defective construction is not covered by the CGL policy as a matter of state law, non-insurance based strategies and tactics become critical. For example, in addition to insisting that subcontractors are experienced, capable, and reputable, construction industry policyholders may need to take hard line positions on their subcontractors’ and other counter-parties’ defense and indemnity obligations during contract negotiation and require proof and/or financial security that they have assets sufficient to back up those obligations.
  • Construction industry policyholders with substantial market power (and especially owners/contractors offering OCIPs/CCIPs, respectively) might ask their brokers to explore insurance policy solutions, e.g., an endorsement indicating that accidental defective construction that causes property damage qualifies as an “occurrence” or an endorsement dictating that the laws of a favorable jurisdiction govern the interpretation and application of the terms of the insurance policy.

If preventive steps are not feasible, then at the very least a construction industry policyholder should take into account unfavorable or uncertain law in pricing projects and setting reserves.

Scott HechtChristina Arnone

Contact Scott Hecht or Christina Arnone for more information.