New Challenges to Insurance Coverage for Defective Construction[dagger]

FDCC Quarterly, Winter 2006 by Wielinski, Patrick J, Young, Marc A

I.

INTRODUCTION

As any general contractor, subcontractor, and particularly any residential contractor will tell you, insurance coverage for defective construction has been constricting steadily over the past several years. Two sources of constriction of coverage are the subject of this article. The first limitation is the result of efforts by the insurance industry to amend the policy to eliminate or limit coverage for risks that are perceived to be difficult or impossible to underwrite. The second type of limitation is imposed through interpretation of the policy language by the courts.

Recent years have seen new and largely unforeseen developments in liabilities being faced by the construction industry. These liabilities are particularly centered in the residential construction sector, including subdivision-wide construction defect lawsuits in singlefamily units and condominium construction defect suits filed by homeowners associations in the commercial residential context. In addition, mold and Exterior Insulation and Finish Systems ("EIFS") claims increased, and terrorism emerged as a legitimate underwriting concern. This took place during the hard market portion of the normal insurance cycle, when prices are higher and coverage more difficult to obtain. Unfortunately, all of these factors have affected the availability of coverage under commercial general liability ("CGL") insurance policies for many other construction contractors, even those not typically involved in residential construction, much the same as the residential mold scare resulted in absolute exclusions being attached to commercial contractors' policies.

The result of the convergence of these factors is a reduction in the coverage available for construction exposures, a reduction that is accomplished through the amendment of the language of standard policies, usually through the attachments of endorsements to the policy. The last few years have seen the issuance of numerous such endorsements. Those that will be discussed in this article include elimination of the "subcontractor" exception as to coverage for defective work under the CGL policy; habitational exclusions for residential exposures; restrictive additional insured endorsements; silica exclusions; broad wrap up endorsements, as well as mold and Exterior Insulation and Finish Systems ("EIFS") endorsements.

Policy amendments to limit coverage are not the only issue facing the construction industry, particularly as to coverage for defective construction. That is the subject of a continuous effort by the insurance industry to limit coverage through insurance coverage litigation. As detailed below, the uninsured "business risks" for contractors under their CGL policies are carefully circumscribed under the policy-particularly in the property damage exclusions-which, when read and applied together with the insuring agreement and the definitions, often provide coverage for portions of this exposure. Unfortunately, certain insurers have experienced some success in diverting courts' attention from the entire policy and limiting the focus to artificial distinctions based upon breach of contract versus negligence and economic loss versus property damage, artificial distinctions without basis in the policy language or the better-reasoned case law.

As a result, courts continue to grapple with the issue of whether defective construction by an insured contractor constitutes an "occurrence" of "property damage" as defined in the CGL policy. Despite standardized policy language, courts around the United States have, at best, produced a confusing and mixed bag of results in applying those terms to defective construction. While mixed bags often defy categorization, a general trend is discernable in this case law. The courts that forsake the language of the policy for an amalgam of "breach of contract-economic loss" analysis tend to find no occurrence or property damage, and in turn, no coverage for the insured contractor. Those courts never reach the exclusion provisions of the policy that often extend coverage. In contrast, the courts that employ a more traditional analysis, that is, whether the physical injury to tangible property caused by the defect was either expected or intended from the standpoint of the insured, tend to find a covered occurrence. Part and parcel of this analysis is a determination of whether the claim involves damage to property other than the insured's own work.

These limitations only exacerbate one of the major problems facing the construction industry today, that is the disconnect between the tiers on a construction project as to the fair and practical allocation of risk. This disconnect is particularly apparent in the onerous and impossible insurance requirements imposed by many owners upon general contractors, or the even more onerous and impossible requirements imposed by a lender. Of course, general contractors are quick to rely on the "flow down," the argument that they are only passing on to their subcontractors the requirements they have assumed from the owner. Of course, this approach ignores the fact that insurers are usually more likely to provide broader coverage to larger general contractors than smaller risks such as specialty subcontractors. Thus, the risk is not effectively transferred when all is said and done.