Is Defective Construction an “Occurrence”? The Answer Isn’t So Concrete
One of the largest issues litigated in today’s construction defect coverage actions is whether defective construction constitutes an “occurrence” (and therefore, may be covered) under liability insurance policies. Standard general liability insurance policies provide coverage for, among other things, “property damage” caused by an “occurrence.” See ISO Form CG 00 01 10 01, § I.1.b(1). “Occurrence” is generally defined to mean “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” See id. at § V.13.
Despite applying similar policy language to similar facts, and to the extent that faulty construction work meets the “property damage” requirement, courts in different jurisdictions have split on the question of whether defective construction falls within the “occurrence” definition. In this article, we highlight those splits, summarize recent legislation aimed at clarifying the “occurrence” issue, and identify the potential implications that legislation might have on the insurance and construction industries.
Case Law Deciding Whether Construction Defects are “Occurrences”
Generally, courts reach one of three conclusions when addressing the “occurrence” issue in construction defect coverage actions.
The first conclusion is that defective construction work and resulting damage are not covered under liability insurance policies because neither was the result of an “accident” (i.e., an “occurrence”). Courts reaching this conclusion typically hold that construction defects are the natural consequence of performing substandard work and focus on the intentional nature of the act of construction as opposed to whether the resulting “property damage” was expected or intended. The guiding principle underlying this view is that liability policies do not protect against foreseeable business risks the insured can mitigate, and that to hold construction defects are “occurrences” would impermissibly convert liability insurance policies into performance bonds (which generally have considerably higher premiums per dollar of coverage than liability policies) and liability insurers into guarantors of an insured’s work. A recent case exemplifying this line of reasoning (reported on Sedgwick’s Insurance Law Blog, which you can access and subscribe to here), is American Home Assurance Co. v. Trumbull Corp., No. GD-11-006886 (Ct. Com. Pl. Allegheny County Oct. 10, 2012).
There, Trumbull constructed a reinforced soil slope and foundation pad for a new J.C. Penney store that was part of a shopping complex in southwestern Pennsylvania. Shortly after the store opened, the walls of the J.C. Penney store and two other buildings in the complex cracked due to soil settlement. Because of the cracks, three commercial tenants moved out of the shopping center and sued Trumbull for faulty workmanship. Trumbull submitted the claim to its primary and excess general liability insurers, and its primary insurer agreed to defend it under a reservation of rights. The excess insurers, however, sued Trumbull and filed summary judgment motions seeking declarations that they were not obligated to provide coverage. Specifically, they argued that damage to buildings resulting from faulty workmanship does not constitute an “occurrence” under general liability policies. The court agreed, concluding that liability insurance policies never cover damage resulting from faulty workmanship because “faulty workmanship can never constitute an accident.”
The second conclusion some courts reach on this issue is that defective construction work itself is not covered because it is not the result of an “occurrence,” but that the resulting damage may be covered because it was fortuitous and unintended. See Westfield Ins. Co. v. Custom Agri Sys., Inc., 979 N.E.2d 269 (Ohio 2012). For example, in Pamperin Rentals II, LLC v. R.G. Hendricks & Sons Construction, Inc., 822 N.W.2d 736 (Wis. Ct. App. Sept. 5, 2012), the owner of seven gas stations sued the supplier of concrete used to construct the gas stations on the ground that the concrete was defective and damaged nearby asphalt. The supplier tendered the claim to its general liability insurers, which denied coverage because the gas station owner’s claims against the supplier did not allege “property damage” or an “occurrence.” The supplier sued, and the insurers filed motions for summary judgment raising the same arguments the insurers made when denying coverage. The lower court granted the insurers’ motions, but the appellate court reversed. After noting that the damage to the asphalt qualified as “property damage” within the meaning of policies at issue, the court held while the damage to the concrete itself was not covered, the damage to the asphalt was because it was neither expected nor intended and, therefore, an “occurrence.”
The third conclusion courts reach when analyzing the “occurrence” issue in construction defect cases is that all liabilities – including damage to the work itself – are covered because defective construction work itself is accidental and the insured rarely expects construction defects. See Travelers Indem. Co. of Am. v. Moore & Assocs., Inc., 216 S.W.3d 302, 308 (Tenn. 2007); Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007) (finding coverage for damage to a building’s foundation, sheetrock, and stone veneer allegedly caused by the builder’s defective construction of a house’s foundation); U.S. Fire Ins. Co. v. J.S.U.B., 979 So.2d 871 (Fla. 2007) (concluding that the costs of repairing a subcontractor’s use of poor soil, improper soil compaction, and testing were covered under a liability policy). These cases appear to be result-oriented in favor of finding coverage because they transform liability policies – for which insureds paid relatively little premium and which neither insureds nor insurers intended to cover defective construction work – into performance bonds. Stated another way, these decisions essentially provide insureds with huge, unintended and unfair windfalls – performance bonds for basically no premium.
Legislation Addressing the “Occurrence” Issue in the Construction Defect Context
Against this backdrop of courts’ varying interpretations of the “occurrence” issue, some state legislatures have decided to take measures into their own hands by passing laws attempting to clarify how the term “occurrence” should be interpreted in determining coverage for construction defect claims. Notably, these laws are fairly recent and may signify a trend in legislatures seeking to resolve (for better or worse, if at all) the “occurrence” issue.
The first state legislature to enter into the “occurrence” foray was Colorado's, which enacted Colorado Code § 13-20-808 effective May 21, 2010 (Section 808). Section 808 applies only to insurance policies issued after its effective date,¹ and provides that a court interpreting a liability insurance policy “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.” Colo. Code § 13-20-808(3) (emphasis added). Section 808 replaces more limited Colorado common law, which held that only “unforeseeable damage to non-defective property arising from faulty workmanship” qualified as an “occurrence” under liability insurance policies. See Greystone Constr., Inc. v. Nat’l Fire & Marine Ins. Co., 661 F.3d 1272 (10th Cir. 2011). However, the emphasized language notwithstanding, nothing in Section 808 requires coverage for damage to an insured’s own work unless otherwise provided in the insurance policy, or creates insurance coverage that is not included in the insurance policy. See Colo. Code § 13-20-808(3). So far, no courts have substantively analyzed Section 808.
Arkansas was the next state to legislate the “occurrence” issue with the enactment of Arkansas Code § 23-79-155 on March 23, 2011 (Section 155). Before Section 155’s enactment, Arkansas courts held that “faulty workmanship is not an accident,” although it was unclear whether coverage was available for the cost of repairing damage to property other than the defective work itself. See Essex Ins. Co. v. Holder, 261 S.W.3d 456 (Ark. 2007) (“[W]e hold that defective workmanship standing alone – resulting in damages only to the work product itself – is not an occurrence under a CGL policy”). Section 155 appears to clarify that it does, as it now requires that commercial general liability policies sold in Arkansas define “occurrence” to include “property damage or bodily injury resulting from faulty workmanship.”² Ark. Code § 23-79-155(a). Unfortunately, there isn’t any case law addressing Section 155’s scope and application, but Section 155 does not place restrictions on policy exclusions typically applied in construction defect coverage cases (such as the damage to property, damage to your product, and damage to your work exclusions). Id. at § 23-79-155(b). Accordingly, existing Arkansas case law interpreting those exclusions presumably is still good law.
In May 2011, the South Carolina Legislature joined the party and enacted South Carolina Code § 38-61-70 (Section 70). In addition to the traditional “occurrence” definition contained in the ISO Form, Section 70 provides that commercial general liability policies issued in South Carolina “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.” This clarified pre-Section 70 case law, which held that faulty workmanship was not an “occurrence” where the resulting damage was a natural and expected consequence of the faulty work rather than a fortuitous event. See Crossman Communities of N.C. v. Harleysville Mut. Ins. Co., 717 S.E.2d 589 (S.C. 2011). Section 70 purported to apply “to any pending or future dispute over coverage … as to all commercial general liability insurance policies issued in the past, currently in existence, or issued in the future,” but the South Carolina Supreme Court recently held that this provision violated the Contract Clauses of the U.S. and South Carolina Constitutions because it “fundamentally change[d] the definition of occurrence” in insurance policies and “substantially impair[ed] pre-existing contracts by materially changing their terms.” Harleysville Mut. Ins. Co. v. State, No. 27189, 2012 WL 5870799 (S.C. Nov. 21, 2012). Accordingly, Section 70 only applies to insurance policies issued on or after May 17, 2011.
Finally, Hawaii became the latest state to legislatively address the “occurrence” issue in construction defect cases with the enactment of Section 431:1-217 on June 3, 2011 (Section 217). The preamble of the bill which resulted in Section 217’s enactment notes that it was an express response to Group Builders, Inc. v. Admiral Insurance Co., 231 P.3d 67 (Haw. Ct. App. 2010), in which the court denied coverage for both defects in the insured’s own work and resulting “property damage” caused by faulty workmanship on the ground that faulty workmanship claims arise out of contract breaches as opposed to “occurrences.”
The Hawaii Legislature noted that “construction professionals entered into and paid for insurance contracts under the reasonable, good-faith understanding that bodily injury and property damage resulting from construction defects would be covered under the insurance policy” prior to Group Builders, and that Group Builders “create[d] uncertainty in the construction industry, and invalidate[d] insurance coverage that was understood to exist and that was already paid for by construction professionals.” However, rather than seek to reinstate the coverage that the Hawaii Legislature alleged was eliminated by Group Builders and define “occurrence” in the construction defect coverage context, Section 217 simply provides that “the meaning of the term ‘occurrence’ shall be construed in accordance with the law as it existed at the time that the insurance policy was issued.” Haw. Rev. Stat. § 431:1-217(a). Accordingly, it appears that even under Section 217, insurance policies issued after Group Builders are subject to its holding that construction defect claims are not covered under liability policies because they do not arise out of “occurrences.”
Impact of Recent Law Regarding Defective Construction as an “Occurrence”
The Colorado, Arkansas, South Carolina, and Hawaii Legislatures all attempted to clarify whether claims arising out of defective construction work allege “occurrences” – and, therefore, at least potentially trigger coverage – under general liability insurance policies. Interestingly, they came at the issue differently: Section 808 in Colorado states that damage to the insured’s work itself qualifies as an "occurrence" unless the subject policy expressly provides otherwise, Section 155 in Arkansas does not seem to specifically address whether damage to the insured’s work itself is covered (although it is doubtful), and Section 70 in South Carolina expressly provides that damage to the insured’s work itself is not an "occurrence." And in Hawaii, where Section 217 simply refers parties back to the case law, coverage simply depends on when a policy was issued. Because courts in these states generally have not yet issued opinions addressing these recent statutes, it is unclear what their ultimate effect on the "occurrence" issue will be. Whatever that effect is, it does not appear that these statutes will put an end to litigation over this issue.
Based on the language of these statutes, Colorado’s Section 808 appears to represent the biggest shift in state law regarding the “occurrence” issue. Specifically, whereas pre-Section 808 case law held that only third-party property damaged by allegedly defective construction work could be said to have been caused by an “occurrence” within the meaning of a liability policy, Section 808 now expressly provides that even damage to the faulty construction work itself is presumed to be the result of an “occurrence.” To the extent that other state legislatures enact statutes addressing the "occurrence" issue and follow Colorado's lead in bringing their states into line with case law holding that both defective construction work and resulting “property damage” are the result of “occurrences,” liability insurers might respond in one of at least three ways.
First, the most likely response by liability insurers would be to simply include more specific policy exclusions precluding coverage for “property damage” to an insured’s own work.
Second, liability insurers could charge higher premiums for policies issued to the construction industry in these states, and/or issue policies only in excess of significant self-insured retentions (SIR) because they would now be forced to provide coverage for risks that they never intended to take on, and that liability policies traditionally do not cover. Higher premiums or SIRs, however, may result in increased construction costs: the premiums would likely be passed along to construction project owners and developers, and significant SIRs could limit the pool of insureds capable of performing construction work to only those that could absorb them, thus decreasing competition.
Third, liability insurers could cease issuing policies to parties that perform construction work entirely, which likely would cause the construction industry to come to a screeching halt.
Overall, until cases start substantively analyzing, interpreting and applying these statutes, it is unclear how these and future similar statutes will affect the construction and liability insurance industries.