I've been working on reviewing a general contracting agreement for a rebuild following Sandy, and the attendant insurance requirements. I just came across a very useful 50-state survey on the enforceability and construction of indemnification agreements, which you can access by clicking here. If you're involved with this area of the law, I think you'll find it helpful.
Those of us who represent contractors in coverage disputes have had to wrestle a lot over the past few years with so-called “business risk” exclusions, such as the “your work” and “your product” exclusions. Cynicism may be unhealthy, but the cynic in me says that insurance companies are twisting these exclusions far beyond their intended application, and that some judges (mostly the ones who used to work for defense firms or for insurance companies themselves) are letting them get away with it.
The supposed purpose of a business risk exclusion is to remove from coverage any claims based upon faulty workmanship that relate to repair of the faulty workmanship itself – not unforeseen and unexpected damage to other property. Example: I install a boiler in your house. The boiler blows up and takes out your family room. My liability carrier won’t pay for damage to the boiler (my work) – but it should pay for the consequential loss (repairing the family room).
That’s pretty much what the New Jersey Supreme Court held in Weedo v. Stone-E-Brick, 81 N.J. 233, 240 (1979), writing: “When a craftsman applies stucco to an exterior wall of a home in a faulty manner and discoloration, peeling and chipping result, the poorly-performed work will perforce have to be replaced or repaired by the tradesman or by a surety. On the other hand, should the stucco peel and fall from the wall, and thereby cause injury to the homeowner or his neighbor standing below or to a passing automobile, an occurrence of harm arises which is the proper subject of risk-sharing as provided by the type of policy before us in this case.”
As another example, let’s take a look at the First Circuit’s very recent decision in Oxford Aviation, Inc. v. Global Aerospace, Inc., Docket No. 11-2208 (1st Cir. May 18, 2012). I should point out that the decision is notable not only for what it says, but because retired U.S. Supreme Court Justice David Souter sat on the panel.
Facts: Oxford repairs airplanes. Airlarr owned an airplane and hired Oxford to fix it. During the flight home from Oxford’s facility in Maine to Airlarr’s home base in Pennsylvania, one of the plane’s windows cracked. Airlarr also contends that, following Oxford’s repairs, Airlarr was left with uncomfortable seats, leaking fuel injectors, a cracked turbocharger, and an improperly installed carpet.
Oxford’s general liability carrier (Global Aerospace) disclaimed coverage for the resulting lawsuit, including any duty to defend, based upon the business risk exclusions.
But the First Circuit ruled in favor of the policyholder. As for the “your work” exclusion, the Court wrote: “[T]he your-work exclusion by its terms does not apply to ‘property damage occurring away from premises you own or rent and arising out of your product or your work,’ and Airlarr explicitly alleged that the crack [in the window] occurred in-flight.”
As for the “your product” exclusion, the Court wrote: “Neither the complaint nor the incorporated estimate sheet say that the side window was a product installed by Oxford; and Global has not suggested otherwise, beyond a half-hearted argument that ‘your product’ should be read broadly in the context of the whole agreement.”
The Court similarly dispatched the carrier’s arguments based upon the “products completed” exclusion and the “impaired property” exclusion.
Here’s what the First Circuit had to say about so-called “faulty workmanship” claims generally: “For obvious reasons (e.g., to cover consequential damages claimed by third parties), the CGL policy does not have an exclusion broadly written to exclude all claims arising from faulty workmanship. Rather, [the carrier] has crafted complex exclusions occupying several pages of text; and they have created an opportunity in some cases for a complaint to circumvent all of them. Here, at least one scenario relating to the cracked window, occurring in flight and away from Oxford’s facilities, does fall within coverage and could plausibly avoid all cited exclusions.” (Emphasis added.)
Therefore, opined the Court, although coverage was a “close call,” the duty to defend existed.
For those of you who might want more reference material on the business risk exclusions, the Fall 2011 edition of the ABA Tort Trial & Insurance Practice Law Journal (Volume 47, Issue 1) contains a great article entitled “Recent Developments in Insurance Coverage Litigation,” which contains a section captioned “Coverage Related to Faulty Workmanship Claims.” The authors review a number of different recent decisions, and cite a South Carolina case, Crossman Communities of N.C., Inc. v. Harleysville Mut. Ins. Co., Op. No. 26909 (S.C. Jan. 7, 2011), withdrawn on rehearing and superseded by 717 S.E.2d 589 (S.C. 2011), in which the Court concluded that this area of the law is an “intellectual mess.”
Hmmm. If it’s really such an “intellectual mess,” and if the policyholder gets the benefit of the doubt on questions of policy construction…shouldn’t coverage be deemed to exist in any case not involving repair to the faulty workmanship itself?
(The Journal is available through TIPS here, although for some reason they don’t have a listing for Volume 47, Issue 1 on the ABA website yet.)
Here’s an interesting situation that recently came up. A general contractor (Aristone) got sued in a construction defect case involving continuous water damage to a building over several policy periods, involving several insurance companies. One of Aristone’s carriers – OneBeacon – stepped up to provide a defense. Another – Pennsylvania Manufacturers – took a “no pay” position, but agreed to go to binding arbitration with Aristone on the coverage dispute. Aristone won the arbitration against Pennsylvania as to coverage, and Pennsylvania then agreed to settle the insurance claim with Aristone for $150,000. In exchange for the payment, Aristone executed a general release in Pennsylvania’s favor, encompassing “[a]ll claims that have been brought against [Pennsylvania] or could have been brought against [Pennsylvania] in [the coverage] action brought by Aristone.” The release stated that it applied to Aristone and “[a]nyone who succeeds to [Aristone’s] rights and responsibilities.”
Later, OneBeacon filed suit against Pennsylvania, seeking reimbursement for Pennsylvania’s supposed allocated share of defense costs ($105,773.50, according to OneBeacon). Interestingly, the attorney who brought the coverage suit against Pennsylvania was the lawyer who had been previously appointed by OneBeacon to defend Aristone in the underlying suit (and who had negotiated the release with Pennsylvania on Aristone’s behalf). In response to OneBeacon’s suit, Pennsylvania naturally argued that OneBeacon’s claim was barred by Pennsylvania’s earlier settlement with Aristone.
The New Jersey Appellate Division, citing California authority, disagreed, writing: “Where two or more insurers independently provide primary insurance on the same risk for which they are both liable for any loss to the same insured, the insurance carrier who pays the loss or defends the lawsuit against the insured is entitled to equitable contribution from the other insurer or insurers…As a corollary to this principle, we hold that one insurer’s settlement with the insured is not a bar to a separate action against that other insurer or insurers for equitable contribution or indemnity.”
As to the effectiveness of the release, the Court wrote: “Because OneBeacon had an independent, rather than a derivative, right to contribution, Aristone’s release of its rights, like the settlement itself, did not, by itself, extinguish OneBeacon’s right to seek contribution.” (Emphasis added.) But the Court went on to hold that this specific release, by its terms, was ambiguous as to whether the parties actually intended to bar a future claim by OneBeacon against Pennsylvania for contribution. After criticizing the lawyers who drafted the release and who seem to have intentionally left it ambiguous, the Court ruled that the interpretation of the release would be an issue for trial.
The policyholder, Aristone, seems to have made out all right in this case – it got a full defense as well as a $150,000 payment against the claim. (It’s not clear whether the $150,000 was for a total policy buyback, which would raise its own set of separate issues, but that’s a subject for another post). But it seems that OneBeacon may have found itself in trouble here because of its failure to clarify the coverage picture up front as required by the New Jersey Supremes in Owens-Illinois v. United Ins. Co., 138 N.J. 437, 479 (1994). There, the Court specifically stated: “Insurers whose policies are triggered by an injury during a policy period must respond to any claims presented to them and, if they deny full coverage, must initiate proceedings to determine the portion allocable for defense and indemnity costs.”
Put another way, in a recent article in Claims Magazine, Ken Brownlee wrote: “When the auditor is reviewing a claim in litigation for declaratory relief, he or she should look for evidence that the adjuster sat down and reviewed the policy with the insured, seeking advance agreement that the coverage did not apply or applied to only part of the claim. If that is missing, the file was not well adjusted.”
I can easily imagine situations where, because of ambiguity as to who was covering what, Aristone would not have made out as well. What if, for example, OneBeacon had argued that it was entitled to attach the $150,000 settlement payment from Pennsylvania on equitable grounds, to contribute to the defense costs? (That may have been difficult to do here, because OneBeacon’s own appointed defense lawyer negotiated the release on Aristone’s behalf, but just suppose.) That’s why the idea of intentionally leaving settlement documents ambiguous makes me very nervous. I don’t know what specific provisions were in the release relating to contribution, but I’d have wanted some sort of protective language or indemnity agreement to deal with the possibility that someone would later want to attach the settlement funds paid to the policyholder.
One last item of interest: Insurance companies frequently disclaim coverage for construction defect claims based upon the so-called “business risk” exclusions (such as the “your work” exclusion). Here, it seems that OneBeacon did not do so.
The full citation for the Aristone case is Potomac Ins. Co. of Illinois v. Penn. Mfrs. Ins. Co., Docket No. A-3164-09T2 (N.J. App. Div. Apr. 13, 2012), and the full decision is here.
Here’s a fairly frequent scenario in the insurance world. The carrier takes a “no- pay” position on a liability claim. The policyholder settles the case and then seeks reimbursement from the carrier in a coverage suit. What exactly does the policyholder have to prove in order to get paid?
In Fireman’s Fund v. Security Ins. Co., 72 N.J. 63, 71 (1976), the New Jersey Supremes long ago set forth the general rule, writing: “Where an insurer wrongfully refuses coverage and a defense to its insured, so that the insured is obliged to defend himself in an action later held to be covered by the policy, the insurer is liable for the amount of the judgment obtained against the insured or of the settlement made by him…The only qualifications to this rule are that the amount paid in settlement be reasonable, and that the payment be made in good faith.”
A couple of weeks ago, this issue again came up, this time before the Appellate Division in GAF v. Allstate, 2012 N.J. Super. LEXIS 35. A class of homeowners filed a class action lawsuit against GAF, alleging that GAF’s roofing shingles were defective because they began to deteriorate “only a few years after installation.” National Union denied coverage for the suit, in part based on an “own product” exclusion, and GAF eventually settled the case on its own for $63 million.
In the subsequent coverage suit, GAF argued that the underlying claimants had alleged that there had been damage to items other than GAF’s shingles (GAF’s own product), such as other parts of the homeowners’ roofs. GAF contended that that was enough to trigger coverage for the settlement, without GAF having to prove that, in fact, items other than the GAF shingles had been damaged.
Following 12 years of expensive litigation and a 23-day jury trial, the jury came back with a no-cause against GAF, now affirmed by the Appellate Division.
The Appellate Division wrote: “It is incumbent upon the insured to articulate to a reasonable degree of certainty what portion of its overall damages constitute a covered loss. This can be accomplished either by direct evidence of payment for third-party damages or by competent testimony demonstrating that third-party losses were a reasonably likely consequence of damages to the insured's product.” It’s somewhat difficult to understand where this ruling leaves policyholders in complex coverage litigation involving multiple underlying claimants, such as in a class-action setting. Assume, for example, that GAF had put up an expert to say that “third-party losses were a reasonably likely consequence of disintegration of the shingles.” The carrier would likely have argued (A) that this testimony was impermissibly speculative and (B) that GAF had to prove third-party damage with respect to each individual class member. In other words, the carrier will almost certainly attempt to make the bar in such a coverage dispute unreachable, and we really don’t know how a trial court will respond.
The unreachable and ever-moving bar seems to be contrary to the New Jersey Supreme Court’s public-policy based ruling in Owens-Illinois v. United Ins. Co., 138 N.J. 437 (1994). There, the Court stated that in complex coverage litigation, a “rough measure” was all that was needed to establish coverage, writing: “Because the defendants refused to involve themselves in the defense of the claims as presented, they should be bound by the facts set forth in the plaintiff's own records with respect to the dates of exposure and with respect to the amounts of settlements and defense costs. Those losses for indemnity and defense costs should be allocated promptly among the companies in accordance with [a] mathematical model developed, subject to policy limits and exclusions. We stress that there can be no relitigation of those settled claims…Available data should enable the master to grasp the generality of the underlying claims and the exposures involved.” (Emphasis added.)
We almost certainly have not heard the end of this issue. The one seemingly certain thing is that policyholders can’t enforce coverage for underlying settlements simply because the underlying claimants alleged covered damage. At the very least, in the class action product-liability property damage context, the Court will likely require an expert to review a statistically significant portion of the underlying claims and opine that, in the words of the GAF court, “third-party losses were a reasonably likely consequence of damages to the insured's product.” (Isn’t insurance law fun?)
The late, great comedian Alan King used to tell a story that went like this: “The other day, my house caught fire. My lawyer said, ‘Shouldn’t be a problem. What kind of coverage do you have?’ I said, ‘Fire and theft.’ The lawyer frowned. ‘Uh oh. Wrong kind. Should be fire OR theft.’”
Recently, a lot of builders and manufacturers have been experiencing similar unhappiness with their coverage for so-called “faulty workmanship” claims. Carriers have been arguing that faulty workmanship can never constitute a covered “occurrence” that triggers insurance, and also that, even if an “occurrence” happened, liability coverage is precluded by the “your work” exclusion (one of the so-called “business risk” exclusions).
The typical “your work” exclusion in a commercial general liability policy precludes coverage for the following:
“’Property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’ This 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.”
Later versions of the language eliminate the subcontractor exception.
So, what’s the purpose of the exclusion? Some time ago, a pretty good article in Claims Magazine gave the following example: A policyholder builds a retaining wall for a customer. The wall falls down. Under the exclusion, there’s no coverage for damage to the wall itself. If the falling wall crushes a claimant’s patio furniture, though, coverage exists. In other words, there’s no coverage for fixing defective work, but there IS coverage for consequential losses caused by the defective work.
A few courts don’t quite seem to grasp this concept. And now, let me distribute some sour grapes: I lost the issue at the trial court level not long ago in Bob Meyer Communities Inc. v. James R. Slim Plastering Inc. The case involved the allegedly faulty installation of window flashing by a subcontractor, and resultant water damage to luxury homes. The judge decided that the entire homes were the general contractor’s “work,” and that the general contractor therefore could not recover from liability insurance for allegations of faulty workmanship limited to the window flashing made by the homeowners. The court wrote:
“If the completed residence is viewed as [the policyholder’s] work product, under its CGL policies, [the policyholder] bears the risk of faulty workmanship causing damage to any part of the residence.”
The problem with this analysis is that the whole residence was not defective – only the window flashing installed by the subcontractor. The consequential damages resulting from the defect (as opposed to replacement of the flashing itself) should therefore be covered, under the logic in the Claims article.
But, there is hope. In Port Imperial Condominium Association v. K. Hovnanian, my good friend Lynda Bennett of Lowenstein Sandler (an excellent coverage lawyer) recently successfully navigated her client around the exclusion. The case involved water damage to condominiums in a waterfront development due to allegedly improper framing, installation and flashing of balcony doors.
In response to the carriers’ “no pay” argument, and as a result of Lynda’s great work, Judge Sarkisian (Hudson County) wrote: “It is clear…that general liability coverage is available for consequential property damage that flows from an insured’s faulty workmanship, and that other courts have recognized that faulty workmanship can result in accidental, unexpected, and unintended damage to third party property which satisfies the definition of ‘occurrence’ of the standard general liability policy.”
In an analogous context, the Fifth Circuit recently tried a Solomonic approach, guaranteed to make everyone unhappy. American Home Assurance v. Cat Tech LLC involved damage to a “hydrotreating reactor,” allegedly caused by a repair contractor. There were three categories of property damage involved:
(1) Damage to the specific parts of the reactor upon which Cat Tech (the policyholder) performed defective work.
(2) Damage to the parts of the reactor upon which Cat Tech performed non-defective work, but which were damaged because of later mechanical problems in the reactor.
(3) Damage to property upon which Cat Tech did not work, but which was nevertheless harmed, apparently because of the later mechanical problems.
The Court held that items (1) and (2) should be excluded, but not (3), writing:
“The ‘your work’ exclusion precludes coverage for damage to that part of [the reactor owner’s] property upon which Cat Tech performed repair services, defective or otherwise. It does not preclude coverage for any damage to [the reactor owner’s] property that Cat Tech did not repair or service.”
Question: If policy language can be this elaborate and confusing, shouldn’t the policyholder get the benefit of the doubt?
It’s amazing how, when the economy tanked, construction defects began to multiply exponentially. I’m not (necessarily) trying to ascribe purely financial motives to the plaintiffs in these cases, but there’s no doubt that, at my firm at least, we’ve seen a marked increase in the amount of coverage litigation over construction defects.
So, what’s the coverage fight all about? A lot of it involves the so-called “your work” exclusion contained in general liability policies. (In the ongoing game of words, insurance companies like to refer to this as the “business risk” exclusion, even though the words “business risk” don’t actually appear in the policy forms.) Boiled down to its essence, this type of exclusion says that if you get sued for damage to your “own work,” there’s no coverage. So if you’re a builder, and you install stucco on a building, and the stucco falls apart, and you get sued as a result, there’s no coverage under your general liability policy for repairing the stucco.
This begs the question: What if the crummy stucco falls on somebody else’s truck (or head) and totals it? If you’re the general contractor and you get sued, you’re not covered for the repair of the stucco – but how about the replacement cost of the truck (or head)?
Lots of cases say that faulty workmanship that causes damage to other property is a covered “occurrence” under a general liability policy. See Weedo v. Stone-e-Brick, Inc., 81 N.J. 233 (1978) (a contractor's general liability policy typically does not cover an accident of faulty workmanship but rather faulty workmanship which causes an accident); Firemen=s Insurance Company of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (App. Div. 2006) (drawing a distinction between economic loss to faulty workmanship and faulty workmanship that causes damage to other property); Hartford Insurance Group v. Marson, 186 N.J. Super. 253 (App. Div. 1982) (noting that claim against policyholder for damage done by its defective workmanship to metal panels installed by another contractor is not excluded).
A few years ago, in United States Fire Insurance Company v. J.S.U.B., 979 So.2d 871 (Fla. 2007), the Florida Supreme Court provided a detailed history of the evolution of the “your work” exclusion, which is useful to anyone dealing with one of these claims. The Court noted that the 1986 version of the standard form commercial general liability policy contained language specifically stating that that the exclusion for faulty workmanship did not apply to work within the products-completed operation hazard. The 1986 policy also added a new “your work” exclusion - with an express exception for work done by subcontractors. The exception was later removed from certain standard forms.
The takeaways here:
- If you’re in a business (or if you’re representing a business) where products/completed operations coverage may be an issue, carefully examine the exclusions for “your work” and “your product” and make sure you have adequate protection before problems happen.
- Broad disclaimers of coverage based upon so-called “business risk” exclusions generally aren’t appropriate. Remember, for example, that the “your work” exclusion is designed to preclude coverage for damage to “your work” – and only “your work.” If defective work causes damage to other property, coverage exists.
- If a property damage claim is brought against a policyholder and the complaint lists “breach of contract” as the source of the claim, the insurance company should examine the facts of the incident carefully and not simply assume that breach-of-contract claim is never covered by a general liability policy.