I. Scenario
Suppose that you are a general contractor. You have a standard form Commercial General Liability (“CGL”) insurance policy.[1] You are hired to construct a home, or a commercial building. You hire subcontractors for some of the work, such as excavation of the building site and stabilization of cut slopes above the site.
Three months after construction is finished and a certificate of occupancy is issued, a retaining wall built by the subcontractor collapses, causing damage to the building and its contents. Do you have coverage under your CGL policy? When you are sued by the building owner, does your insurance carrier have to pay for your defense? Does it have to pay the damages claimed by the plaintiff? The answers depend on whether (1) there was an “occurrence” (2) that resulted in “property damage” (3) that is not excluded by the policy.
II. North Carolina Law
A. Duty to Defend. Once you have been sued, your first question is who will pay for your defense. In North Carolina, an insurer’s duty to defend its insured is based upon the coverage for which it has contracted for in the insurance policy, and the insured bears the burden of showing coverage for the claims.
To determine whether the claims that are made in a lawsuit are covered by the insurance policy, North Carolina uses the “comparison test.” The pleadings (complaint, answer) are read side-by-side with the insurance policy to determine whether the events as alleged in the pleadings are covered or not. The duty to defend exists if the events alleged in the pleadings are covered under the terms of the policy, regardless of whether the insured is ultimately found liable, and any doubt as to coverage is to be resolved in favor of the insured
Moreover, in evaluating whether an insurance company has a duty to defend, the Court is not restricted to the pleadings in the case. There is a duty to defend where the insurance company knows, or could reasonably ascertain facts that, if proven, would be covered by the policy. The insurer has a duty to investigate and evaluate facts expressed or implied in the complaint, as well as facts learned from the insured and from other sources. See, e.g., Waste Management of the Carolinas, Inc. v. Peerless Insurance Company, 340 S.E.2d 374, 378 (1986); Erie Insurance Exchange v. Builders Mutual Insurance Company, 752 S.E.2d 803, 810 (2013), disc. rev. denied, 747 S.E.2d 545 (2013).
Finally, if the claim is within the coverage of the policy, an insurance company’s refusal to defend is unjustified, even if it is based upon an honest but mistaken belief that the claim is not covered. In that case, the insurance company will be obligated to pay the amount and costs of a reasonable settlement, as well as the costs of the defense of the case. Erie Insurance, 742 S.E.2d at 810, 813-14.
B. Duty to Pay (Indemnity). Even if an insurance company is obligated to defend a lawsuit, that does not necessarily mean that it is obligated to pay the damages claimed and proven by a plaintiff. Whether the insurance company is obligated to pay damages depends on the facts as they actually turn out, rather than the facts that are alleged in the pleadings.
For coverage under a standard CGL policy, the main questions will be: (1) whether the faulty workmanship or construction defect is an “occurrence;” (2) whether “property damage” resulted from the faulty workmanship; and (3) whether the property damage is excluded by one of the “business risk” exclusions in the insurance policy.
1. Occurrence. A standard-form CGL policy contains some 22 specifically defined terms in Section V. “Occurrence” is usually defined as “an accident, including continuous or repeated exposure to substantially the same general, harmful conditions.” “Accident” is not a defined term in a standard CGL policy. However, North Carolina courts have held that “an accident is generally considered to be an unplanned and unforeseen happening or event, usually with unfortunate consequences.” Gaston County Dyeing Machine Co. v. Northfield Insurance Co., 351 N.C. 293, 302, 524 S.E.2d 558, 564 (2000). Whether events are “accidental” and constitute an “occurrence” depends on whether they were “unexpected and unintended” from the viewpoint of the insured. Waste Management, 340 S.E.2d at 379. The fact that the accident may have arisen from the insured’s negligence does not prohibit coverage. Builders Mutual Insurance Co. v. Mitchell, 709 S.E.2d 528, 533 (2011). An “occurrence” as defined by a CGL policy can be an accident caused by or resulting from faulty workmanship, including damage to any property other than the work product of the insured. Erie Insurance, 742 S.E.2d at 810.
2. Property Damage. “Property Damage” is defined in a standard CGL policy as (a) physical injury to tangible property, including all resulting use of that property, as well as (b) loss of use of tangible property that is not physically injured. As with the definition of “occurrence,” if the property that is damaged is the work product of the insured, there will not be coverage in North Carolina under a standard CGL policy. However, damage caused by the insured’s defective work to property other than insured’s work may constitute property damage.
For example, in the Erie Insurance v. Builders Mutual case, the defective work was an altered slope and retaining wall built by a subcontractor. There would have been no coverage for the cost to repair or replace the retaining wall itself. However, when it collapsed, it caused damage to other property - - the building, as well as the contents of the building. Damage to that other property was covered by the general contractor’s CGL policy.
3. Exclusions. A standard CGL policy contains 17 different exclusions, many of them lengthy. The “business risk” exclusions are the “damage to your property,” damage to your product,” and “damage to your work” exclusions. The one seen most often in the construction context is the “damage to your work” exclusion, which excludes coverage for property damage to the insured’s own completed work. The exclusion includes an exception - - the “subcontractor exception” - - that restores some coverage. The subcontractor exception provides that the “your work” 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 bottom line is that if the property damage was caused by a subcontractor’s work, the “your work” exclusion will not exclude coverage under the general contractor’s CGL policy, unless the insurer has added an endorsement that eliminates the subcontractor exception. That endorsement - - CG 22 94 - - has been around for some time, so contractors need to pay careful attention to the contents of their CGL policies and avoid that endorsement.
III. Other States.
This is one of the most contentious areas in construction insurance coverage, and different states have reached different results on the same questions. Accordingly, if you do work in states other than North Carolina, you should pay attention to the law in those states.
Some states, for example, flatly hold that faulty workmanship is not an occurrence, even where it is performed by a subcontractor. See, e.g., Ohio Northern University v. Charles Construction Services, Inc., 120 N.E.3d 762, 771 (Ohio 2018). The trend among state supreme courts that have considered the issue, however, including our neighboring states, is that construction defects can constitute occurrences, and contractors have coverage under CGL policies, particularly for unexpected damage caused by defective work of subcontractors.[2] The most recent State Supreme Court decision on this topic is Skanska USA Building, Inc. v. M. A. P. Mechanical Contractors, Inc., No. 159510-159511 (Michigan Supreme Court, June 29, 2020). In that case, the Plaintiff, Skanska USA Building, was the construction manager on a renovation project for a medical center. Skanska subcontracted the heating and cooling portion of the project to defendant M.A.P. Mechanical Contractors (MAP”). MAP. had a CGL policy from Amerisure Insurance Company. Skanska and the medical center were additional named insureds on the MAP CGL policy.
MAP installed a steam boiler and related piping for the medical center’s heating system, including several expansion joints. After the project was complete, Skanska discovered that MAP had installed some of the expansion joints backward, resulting in significant damage to concrete, steel and the heating system. The cost to repair and replace the defective work was $1.4 million.
Skanska submitted the claim to Amerisure, and Amerisure denied coverage. The case made it all the way to the Michigan Supreme Court, where the primary issue was whether an “accident” may include unintentionally faulty subcontractor work that damages an insured’s own work product. The Michigan Supreme Court answered this question in the affirmative, and the same results should apply in North Carolina.
Like North Carolina, the law in Michigan says that “accident” is “an undefined contingency, a casualty, happening by chance, something out of the usual course of things, unusual, fortuitous, not anticipated, and not naturally to be expected.” The Michigan Supreme Court held that faulty work by a subcontractor falls within the plain meaning of most of those terms, in that it happens by chance, is outside the usual course of things, and is neither anticipated nor naturally to be expected. The Court pointed out that many other courts, some of which are cited in footnote 2 below, have reached the same conclusion in the same context.
You should also note that legislation has been enacted to change court decisions in some states, and to require that CGL policies define an “occurrence” to include property damage or personal injury resulting from faulty workmanship. South Carolina is an example. After a contrary decision from the South Carolina Supreme Court, the legislature enacted a statute requiring CGL policies in that state to define “occurrence” to include property damage or bodily injury resulting from faulty workmanship.[3]
[1] The purpose of CGL policies used in the construction industry is to protect builders from risks associated with owners bringing post-construction claims for damage to buildings or other property caused by alleged construction defects. See Auto Owners Ins. Co. v. Newman, 684 S.E.2d 541, 545 (S.C. 2009). Construction-specific exclusions narrow the scope of coverage afforded by standard-form CGL policies and exclude from coverage property damage associated with certain categories of risks. Id. The standard-form CGL policy is published by the Insurance Services Office, Inc., a/k/a “ISO,” an industry organization that promulgates various standard insurance policies used by insurers throughout the country. See Hartford Fire Ins. Co. v. California, 509 U.S. 764, 772 (1993). The current CGL policy began in 1940, as the “comprehensive general liability” policy. It was renamed the “commercial general liability” policy in 1986. See U.S. Ins. Co. v. J.S.U.B., Inc., 97 So. 2d 871, 896, n.4, 5 (Florida 2007).
[2] Black & Veatch Corp. v. Aspen Ins. (UK) Ltd., 882 F..3d 952, 966 (10th Cir. 2018; New York law) (Damages to other property resulting from subcontractor’s work were occurrences and satisfied accident requirement; “State supreme courts that have considered the issue since 2012 have reached near unanimity that construction defects can constitute occurrences and contractors have coverage under CGL policies, at least for the unexpected damage caused by defective workmanship done by subcontractors”); National Surety Corp. v. Westlake Investments, LLC, 880 N.W.2d 724, 742 (Iowa 2016) (“Our conclusion that defective work performed by an insured’s subcontractor may constitute an occurrence triggering coverage under the modern standard-form CGL policy reflects the overwhelming trend among courts and commentators interpreting such policies.”); Carithers v. Mid-Continent Casualty Co., 782 F.3d 1240, 1249-1251 (11th Circuit 2015; Florida law) (“sub-contractors defective work [that] did not cause damage to other property” did not constitute “property damage;” however, when a contractor’s defective work causes damage to other property, and that defective work must be remedied to repair the other property, then the repairs to the contractor’s defective work itself are covered by the policy.); Nautilus Ins. Co. v. Strongwell Corp., 967 F. Supp. 2d 807, 815 (W.D.Va. 2013; Virginia law) (when an insured defectively performs a contract and the defective performance damaged only the insured’s work or product, there is no coverage; on the other hand, if a subcontractor’s faulty workmanship results in damage to property other than the subcontractor’s work product, there may be an occurrence triggering coverage under the policy.); Cherrington v. Erie Ins. Property and Cas. Co., 745 S.E.2d 508, 519-20 (West Virginia 2013) (“does defective workmanship constitute an ‘occurrence’ under a policy of CGL insurance? We find that, consistent with decisions rendered by a majority of our sister jurisdictions, it does.”); Auto Owners Ins. Co. v. Newman, 645 S.E.2d 541, 545 (S.C. 2009) (“we hold that the subcontractor’s negligence resulted in an ‘occurrence’ falling within the CGL policy’s initial grant of coverage for the resulting ‘property damage’ to the home’s framing and exterior sheathing.”); Taylor Morrison Services, Inc. v. HDI-Gerling America Ins. Co., 746 S.E.2d 587, 591 (Georgia 2013) (“We hold, therefore, that an ‘occurrence’ as the term is used in a standard CGL policy, does not require damage to the property or work of someone other than the insured.”); Capstone Building Corp. v. American Motorists Ins. Co., 67A.3d 961, 973-74 (Conn. 2013) (answering certified question; “We conclude that defective construction or faulty workmanship that causes damage to non-defective property may constitute property damage resulting from an occurrence, thus triggering coverage under the [CGL] policy. We also conclude, however, that if the property damage is the result of an insured’s defective work, it is excluded from coverage by such a policy. Finally, property damage caused by a subcontractor’s defective work may be covered under the exception to the ‘your work’ exclusion.”); K & L Homes, Inc. v. American Family Mut. Ins. Co., 829 N.W.2d 724, 736-37 (N.D. 2013) (“We conclude faulty workmanship may constitute an ‘occurrence’ if the faulty work was ‘unexpected’ and not intended by the insured, and the property damage was not anticipated or intentional, so that neither the cause nor the harm was anticipated, intended or expected.”); American Empire Surplus Lines Ins. Co. v. Hathaway Dev. Co., 707 S.E.2d 369 (Georgia 2011) (faulty workmanship causing damage to third party property may be an occurrence.); U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So. 2d 871, 891 (Florida 2007) (“We conclude that faulty workmanship that is neither intended nor expected from the standpoint of the contractor can constitute an ‘accident’ and thus an ‘occurrence’ under a post-1986 standard form CGL policy. We further conclude that physical injury to the completed project that occurs as a result of the defective work can constitute ‘property damage’ as defined in a CGL policy. Accordingly, we hold that a post-1986 standard form [CGL] policy . . ., issued to a general contractor, provides coverage for a claim made against the contractor for damage to the completed project caused by a subcontractor’s defective work provided there is no specific exclusion that otherwise excludes coverage.”); Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W. 3d 1, 20 (Texas 2007) (“In summary, we conclude that allegations of unintended construction defects may constitute an ‘accident’ or ‘occurrence’ under a CGL policy and that allegations of damage to, or loss of use of, the home itself may also constitute ‘property damage’ sufficient to trigger the duty to defend under a CGL policy.”); Travelers Indemnity Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302, 310-11 (Tennessee 2007) (general contractor’s CGL policy covered defective installation of hotel windows by subcontractor); American Family Mut. Ins. Co. v. American Girl, Inc., 673 NW 2d 65, 70 (Wisconsin 2004) (damage to warehouse caused by a soil settlement beneath the building and occurring because of subcontractor’s faulty advice was ‘property damage’ resulting from an ‘occurrence’”); Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 137 P. 2d 486, 495 (Kansas 2006) (Subcontractor’s faulty workmanship and materials constituted an occurrence).
[3] See S.C. Code Ann. § 38-61-70(B)(2) (2011) (“Commercial general liability insurance policies shall contain or be deemed to contain a definition of ‘occurrence’ that includes: . . . property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself.”), retroactive application held unconstitutional by Harleysville Mut. Ins. Co. v. South Carolina, 401 S.C. 15, 736 S.E.2d 651 (2012). See also Ark. Code Ann. § 23-79-155(a)(2) (2011) (“A commercial general liability insurance policy offered for sale in this state shall contain a definition of ‘occurrence’ that includes: . . . Property damage or bodily injury resulting from faulty workmanship.”); Colo. Rev. Stat. § 13-20-808(3) (2010) (“In interpreting a liability insurance policy issued to a construction professional, a court shall presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident unless the property damage is intended and expected by the insured.”)
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