Construction Defect Claims: Don’t Let Your Money Fall Through the Cracks
Presenters: Paul Boatman
Matthew Schlesinger
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Paul Boatman, Director of Risk Management, Prometheus Real Estate Group, Inc.
Paul has nearly twenty years’ experience as risk manager for various companies, including serving as a risk management consultant in KPMG’s Insurance and Risk Management practice.
Matthew J. Schlesinger, Partner, Reed Smith LLP
Matt has recovered hundreds of millions of dollars in insurance coverage disputes nationwide for Fortune 500 and other policyholder corporations and counsels clients on renewals and insurance‐related issues. Matt is listed as a Washington, DC Super Lawyer. Recording of this session via any media type is strictly prohibited.
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What You Will Learn
• Types of potentially applicable coverage –
purchasing the best coverage.
• Tips on managing a construction defect loss.
• Hot‐button legal issues and emerging legal trends.
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Case Study
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Developer builds large multi‐home complex
Several years after completion, residents start to complain about mold
Several construction defects resulted in: water infiltration through roofs, windows and doors; condensation in HVAC systems and washer/dryer closets; gaps in subflooring, etc.
“Rip and tear” work required
Some of the defective work was performed by subcontractors
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Purchasing the Right/Best Coverage
• Builders Risk Insurance
o
First‐party/ coverage for buildings & property/business interruption during construction
― Replacement Cost Value (RCV) subject to Actual Cost Valuation (ACV) holdback
o
o
•
•
Insureds: owner/developer, general contractor, often sub‐
contractors
Key exclusions: faulty or defective workmanship, material, design; mold/pollution; coverage termination for partial use
First Party/BI
First Party Coverage ‐ after construction is completed
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Purchasing the Right/Best Coverage
• CGL (Commercial General Liability)
o
o
o
o
o
o
Third‐party coverage for bodily injury/property damage arising out of premises, products, completed‐ops, personal/advertising injury
Triggered by an “occurrence” (accident or continuous exposure to the same conditions)
Typical exclusion for liability covered under a project‐specific policy, like an OCIP
“Your Work” Exclusion (L): PD to your work but does not apply if the work was performed by a sub‐contractor
“Impaired Property” Exclusion (M): PD to other property that cannot be used because of “your work” or “your product”
Pollution Exclusion
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Purchasing the Right/Best Coverage
• CIP (Consolidated Insurance Program)
o
o
o
o
Builders risk, CGL and workers compensation
Purchased by the owner (OCIP) or contractor (CCIP) or a combination of participating parties
Covers most or all parties working on a common project
Possible benefits: greater control of the scope of coverage, lower insurance costs, and reduced litigation among participants; better control over safety and claims handling
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Purchasing the Right/Best Coverage
• Environmental Liability (Pollution Legal Liability or Contractors Pollution Liability)
o
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PLL covers previously unknown or newly discovered conditions. Can include “re‐opener” coverage for previously remediated site
CPL covers disturbance of pre‐existing pollution or creation of new pollution (mold, oil spill, etc.) by construction work
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Purchasing the Right/Best Coverage
• Key considerations:
o
o
o
o
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First party coverage/third party coverage
Operations and products‐completed operations coverage
Coverage for subcontractor’s work and products
“Primary, non‐contributory” other insurance language
Builder’s Risk Issues:
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–
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Clarify termination of coverage to accommodate partial completion/occupancy
Soft costs coverage
ACV gap (if project is a renovation, rather than new construction, coverage for existing structure will likely be RCV)
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Key Steps After Learning of Loss
• Secure the site; assess the damage; mitigate if necessary; photograph/video and document
• Obtain insurance policies
• Notify insurers ASAP
• Review the construction contracts for indemnity obligations and risk transfer provisions
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Key Steps After Learning of Loss
• Assess potential for liability
o
o
o
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Faulty workmanship (subcontractors & GC)
Faulty site management (GC)
Design Flaw (A&E)
Manufacturer’s Defect (Manufacturer/Supplier)
• Request that all insurers be put on notice
• Do not settle any claims without insurer consent
• Contact insurer’s subrogation team ASAP
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Key Steps After Learning of Loss
• Invite the insurers to inspect, but maintain control
o
Do not speculate as to cause
• Try to get all parties working together to: determine cause; formulate remediation plan; share information; resolve disputes
• Obtain insurer consent before spending/paying money potentially covered
• KEEP INSURERS INVOLVED THROUGHOUT THE ENTIRE PROCESS
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Legal Issues – Occurrence under CGL
GenRe Research, Insurance Issues (Sept. 2013)
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Legal Issues – Occurrence under CGL
• “No”: Defective construction work and resulting damage is •
•
not an “accident,” but rather, a foreseeable business risk. CGL policies are not performance bonds (e.g., AZ, KY, NJ, NY, OH, PA)
“Yes”: Faulty or defective workmanship, or at least the resulting damage, is fortuitous and unintended (e.g., AL, CT, FL, ND, TX, WI, WV)
State legislatures have sought to clarify that construction defects are “occurrences” (e.g., AR, CO, HI, SC)
o
But, some courts have precluded in spite of statutes. See, e.g., Bennett & Bennett Constr. v. Auto Owners Ins. Co. (S.C. 2013)
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Legal Issues – Occurrence under CGL
• Owners Ins. Co. v. Jim Carr Homebuilder (Ala. 2014)
o
o
Defective installations (flashing, brick/mortar, windows, caulking, roof) caused $1.2M in water damage to home
Insurer argued any damage was to the contractor’s own product – the house – and not covered
― Court agreed in prior ruling
o
Ct.: While CGL policies do not cover the cost to repair/replace the faulty workmanship itself, the surrounding damage – i.e., to the rest of the house – is covered
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Legal Issues – Occurrence under CGL
• Taylor Morrison Services v. HDI‐
Gerling (Ga. 2013)
o
o
o
o
Defective foundation led to water intrusion, cracked floors and driveways, warped and buckling flooring
For there to be an occurrence, no need for property damage beyond the insured’s work itself
A claim for breach of warranty may constitute an occurrence
Still, cost of replacing defective work – i.e., a window – may not be covered
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Legal Issues – Occurrence under CGL
• Avoiding “occurrence” uncertainty
o
May be able to negotiate language to avoid this issue. For example, endorsement providing that coverage for construction defects will be provided under the law of the most favorable state where policyholder conducts business
–
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Provides certainty and consistency of coverage; result does not change depending on jurisdiction
Beware a “choice of law” provision
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Legal Issues – Rip and Tear?
• Are “rip and tear” (a.k.a., “get to”) damages covered? Frequent point of contention ‐ whether damages caused by the need to remove or replace non‐defective work to “get to” and repair defective work or products is covered
o
o
“Yes” (e.g., AK, CO, KS, MO, OH, TX, WA) “No” (e.g, AZ, GA, SC)
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Legal Issues – Rip and Tear?
• Colorado Pool v. Scottsdale (Co. Ct. App. 2012)
o
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Subcontractor forced by General to re‐do a pool and the deck, sidewalk, retaining wall and electrical conduits were damaged in the process
Ct: demolishing and replacing the pool uncovered, but “rip and tear” damage to the non‐defective other work was covered
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Legal Issues – Rip and Tear?
• Builders Mut. Ins. Co. v. Lacey Constr. Co., Inc. (D.S.C. 2012)
o Negligently constructed retaining walls failed to retain soil; caused cracks in foundation
o Ct: insurer was not obligated to indemnify for costs to repair and replace walls, nor was insurer obligated to indemnify “any incidental demolition or reconstruction necessitated by the repair”
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Legal Issues – Contractual Liability
• Ewing Construction v. Amerisure (Tex. Jan. 17, 2014)
o
o
o
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Tennis courts started cracking
Insurer refused to defend – contended contractual liability exclusion precluded coverage b/c (i) contractors assume duty to perform work in good and workmanlike manner; and (ii) liability assumed in a contract is excluded
Ct: exclusion does not apply unless contractual liability beyond normal common‐law performance duty
NOTE: CGL coverage would be gutted for contractors who work under contract (virtually all do)
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Legal Issues – Contractual Liability
• Colony Nat’l Ins. Co. v. Manitex (5th Cir. 2012)
o
o
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Policyholder purchased cranes, and assumed associated liabilities from seller
Insurer denied coverage – contended that policyholder assumed only contract liabilities, so “insured contract” exception to contractual liability exclusion (for assumption of tort liability) did not apply
Ct: coverage was excluded; policyholder’s liability arose strictly from contract, i.e., the purchase agreement. Liability would not have been “imposed by law in the absence of any contract or agreement”
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Legal Issues – Additional Insured
• Carl E. Woodward v. Acceptance, (5th Cir. Feb. 14, 2014)
o
o
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Claim that concrete subcontractor did not properly build foundation piers
Policy provided additional insured coverage to Woodward (a large construction firm) arising out of the subcontractor’s ongoing operations, but not completed operations
Ct: “Liability for [the construction] damages arises out of completed operations, for which Woodward was not an additional insured . . . .”
―
Though the damage, as opposed to the liability, likely occurred during the sub’s ongoing operations
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Legal Issues – Additional Insured
Insurance industry has made efforts to narrow scope of additional insured coverage. See Carl E. Woodward LLC v. Acceptance Indem. Ins. Co. (5th Cir. 2014)
Effective April 1, 2013, ISO introduced revised suite of AIEs. Four principle changes:
1)
2)
3)
4)
“To the extent permitted by law”
“Not broader than . . . required by the Contract”
Lesser of that “required by contract” or the Policy
No direct contractual relationship needed
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Legal Issues – Additional Insured
• Avoid possible gaps in coverage
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“To the extent permitted by law” –
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“Not broader than . . . .required by contract”
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Compare AIE with relevant state laws: will you have the requisite “upstream” and/or “downstream” coverage for your project? Review indemnification obligations under construction contracts, and contractual insurance requirements in particular. May affect scope of coverage
Lesser of “that required by contract” or the Policy
– Compare policies’ limits of liability to construction contract indemnification requirements
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Legal Issues – “Your Work” Exclusion
• Cherrington v. Erie Ins. Prop. & Cas. (W. Va. 2013)
o
o
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Uneven concrete flooring, water infiltration through roof and chimney joints, sagging support beam, cracks in drywall
Policy excepted subcontractors’ work from “your work” exclusion, but another exclusion excluded “your work” and
work performed by “others on your behalf” Ct. – two exclusions conflict; cannot allow policy to give coverage in one exclusion and take it away in the next. Subcontractor’s defective work is covered –
Ct. also held that defective construction can be an “occurrence” and faulty work itself my constitute “property damage
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Case Study – A Cautionary Tale
• Key coverage issues:
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o
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Additional named insureds: coverage for claims made against subcontractor, management company, and other non‐insured defendants? Insurer demanded allocation covered and non‐covered entities.
No first party mold coverage: enhanced mold coverage, but only for third party claims. Client proactively addressed complaints, and insurer denied because no “written demand or written notice.” Also ran afoul of “no voluntary payment” provision.
Excluded maintenance costs: Residents requested mold inspection and remediations by clicking on website “maintenance request” link. Insurer denied – excluded as “maintenance, upgrades, improvements, or installations.”
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Questions, Comments and Contact Information
Paul Boatman
Prometheus Real Estate Group, Inc.
pboatman@prometheusreg.com
Phone: (650) 931‐3459 Matthew J. Schlesinger
Reed Smith LLP
mschlesinger@reedsmith.com
Phone: (202) 414‐9423
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