Articles

(Insurance Coverage of Construction Claims)

When a claim arises during or after completion of a construction project, will your insurance cover the cost of your defense and any liability you incur? The answer certainly will depend on the type of coverage you purchased. The answer also will depend on your attention to detail in contract administration. Attention to insurance details is essential to preserve available coverage.

This article will examine coverage under standard commercial general liability insurance policies, discuss administration of the insurance requirement during the course of a construction project, and recommend procedures to follow to help ensure your coverage under a commercial general liability policy.

Construction contracts, including AIA Document A201, General Conditions of the Contract for Construction, usually require the contractor to obtain and maintain various types of insurance, including general liability coverage. Comprehensive general liability and commercial general liability ("CGL") policies are the most common liability policies and cover personal injury and property damage claims.

Most CGL policies incorporate standard provisions published by the Insurance Services Office ("ISO") on standardized forms. Under CGL policies, the insurer agrees to pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which the insurance applies. The insurer also agrees to defend any suit seeking those damages. The term bodily injury is self-explanatory, but...

1. What Is "Property Damage" Under CGL Policies In Construction Cases?

Under standard CGL policies, property damage means "physical injury to tangible property." When the claim is for a construction defect, coverage will depend on whether a physical injury to property has occurred. Intangible damage (economic losses) such as damages for inadequate value, cost of repair or replacement or diminution in value resulting from inferior quality are not physical damage and therefore are not covered property damage.

For example, in a prominent series of construction cases nationwide, the claims arose out of the use of polybutylene plumbing systems in residential housing. Courts held that the cost of repairing or replacing the defective plumbing was a purely economic loss, ("intangible damage") not covered by insurance. There was no "property damage" to the construction project or the plumbing system which caused it to fail. It simply was a defective system.

Repairing or replacing the defective plumbing, however, necessarily required the destruction and later repair of floors, walls or ceilings. Courts held that although the cost of replacing the plumbing was not covered by insurance, the cost of the repairs to the floors, walls or ceilings was covered property damage. The rationale for the distinction between the cost of replacing the defective plumbing system and repairing property damaged during the replacement process is that insurance will not cover the cost of repair or replacement of the work required under the construction contract. But damage to property other than the work itself caused by the work or the repair or replacement of the work is covered property damage. Other courts, such as Illinois courts, held that damage caused by replacing the plumbing system, which had not leaked, was not physical injury to tangible property arising out of an "occurrence" under the insurance policy.

In short, although the cost of repairing or replacing defective work might not be covered property damage, if defective work or its repair causes damage to other property, that damage may be covered by insurance, depending on the law of your state.

Even if the claim involves "property damage," CGL policies contain another condition to coverage. For insurance to apply, property damage must be caused by an "occurrence" that takes place during the policy period.

Interpreting the term "occurrence" has spawned a great deal of litigation. Under standard CGL policies, an occurrence is defined as "an accident, including the continuous or repeated exposure to substantially the same general harmful conditions." Courts have held that the natural and ordinary consequences of an act do not constitute an occurrence. In construction cases, many courts have held that because construction defects are the natural and ordinary consequences of improper construction materials or techniques, claims for defective construction do not constitute a covered "occurrence."

Likewise, most insurance policies exclude coverage of bodily injury or property damage claims "expected or intended from the standpoint of the insured." This exclusion also is cited as a basis of denying coverage for claims of faulty workmanship. Repair or replacement costs can be expected to be required to remedy improper work. Therefore, those repair costs are not accidental, caused by an "occurrence."

In addition to denying coverage of construction defect claims based on the definitions of "property damage" and "occurrence," ISO form policies also contain standard business risks exclusions that may exclude coverage of construction claims.

Business risks exclusions are premised on the theory that liability insurance policies are not intended to provide protection against the insured's own faulty workmanship or product. That is a normal risk associated with the construction business. The rationale for business risks exclusions is that liability insurance should not be used to satisfy a contractual warranty or to substitute for a performance bond.

The most common business risks exclusions exclude coverage of:

This exclusion is based on the principle that damage to real property caused by ongoing construction is not an insured loss. Damage to real property may be anticipated on many construction projects. Plans and specifications usually contain provisions for the restoration of real estate or landscaping. Courts consider such work to be a contractual, not an insured, obligation.

Another common business risks exclusion excludes coverage of:

This exclusion precludes coverage of property (other than the work itself) damaged during the construction process where the work was performed incorrectly. An exception is provided for damage occurring after construction is complete. This exclusion gives new meaning to the saying "timing is everything." Repairs to or replacement of work during construction may cause damage to property other than the work itself. The cost of such repair work is a cost of performing the work under the construction contract and usually is not covered by insurance. If, however, the damage and repairs occur after the completion of the work, "products-completed operations" coverage may cover the cost of the repairs. This is analogous to the concept that even if defective work is not "property damage," damage to property caused by the repair or replacement of defective work is "property damage." In this case, however, the "products-completed operations" coverage applies to claims caused by the work if the claim occurs after completion of the project. If the property damage occurs after the work is completed, this exclusion may not apply and insurance may cover the loss.

A third common business risks exclusion excludes coverage of:

CGL policies exclude coverage of damage to ongoing construction work or damage caused by the work. Damage to ongoing work is deemed to be a contractual risk inherent in any project. Such damage ordinarily must be repaired before the work is accepted under the terms of the construction contract. This exclusion often is given as a basis of disallowing coverage of claims for the repair of faulty or non-conforming work.

Finally, business risks exclusions exclude coverage of:

The exception in this exclusion is of particular importance to general and prime contractors. General and prime contractors should ensure that their policies contain coverage of property damage to subcontracted work. A common claim that arises in construction cases is that the work of the insured was defective and property must be restored, repaired or replaced because the insured's work was incorrectly performed on it. Like the ongoing work exclusion, if a contractor's own work is damaged after its work is completed, insurance usually will not cover the loss. The subcontracted work exception, however, reflects the distinction between a general contractor and its subcontractors. Although insurance may not cover damage to a contractor's own work, a general contractor stands in a position different from its subcontractors.

If the nonconforming work was not performed by the general contractor itself, but instead by a subcontractor, the claim for repair or replacement of the nonconforming work may be covered. This result is logical because the general contractor did not perform the work and did not intend its subcontractor to perform nonconforming work. Therefore, the damage was not expected or intended by the general contractor and is caused by an occurrence.

Even if a construction claim for "property damage" caused by an "occurrence" is made, and no exclusions apply, another trap for the inattentive may prevent coverage.

All insurance policies require insureds to provide the insurance company notice of claims. The purpose of the notice requirement is to permit the insurance company to initiate a timely investigation of the claim. Standard CGL policies provide that notice "as soon as practicable" is a condition to coverage of a claim. As a result, if timely notice is not provided, the insurance company may deny coverage. As a general rule, courts require notice to be given as of the date a reasonably prudent person would have foreseen a lawsuit and would have contacted either his lawyer or liability insurer. Needless to say, a conservative approach is best. If facts develop indicating that a claim may be asserted in a lawsuit or a demand for arbitration, even if there is no basis for the claim, notice should be given. To whom should notice be given?

CGL policies indicate where to provide notice and what information should be included. Although providing notice to your insurance agent or broker may be convenient, notice directly to the insurance company is prudent. In the event the insurance agent or broker does not forward the notice to the appropriate insurance company, coverage may be lost. Which insurance company should be notified?

Once again, a conservative approach is prudent. All of your own general liability insurers should be notified. If you have an umbrella policy, that carrier should be notified as well. In addition, a contractor may be named as additional insured on policies of subcontractors or other parties on a project. If a claim arises that may be covered under a policy on which the contractor may be named as additional insured, notice should be given to the provider (typically a subcontractor) of the additional insurance as well as the additional insurance company (typically listed on the Certificate of Insurance). Special issues relating to additional insureds are discussed below, but notice should be provided to any insurance company that may potentially cover a claim on behalf of your firm as additional insured.

Most construction contracts require certificates of insurance confirming the types and amounts of coverage provided to the owner or contractor as additional insured. A certificate of insurance itself, however, generally does not confer any rights upon the additional insured. Standard form certificates include the provision:

This means that a certificate of insurance does not provide insurance coverage. It merely describes the primary insured's insurance coverage and policy limits, and identifies the agent or broker which produced the certificate, the insurance companies and the holder of the certificate.

Because the certificate of insurance provides no rights itself, when a contract requires the general or prime contractor or a subcontractor to be named as additional insured, they must verify either that the insurance company has issued a separate endorsement to the primary insured identifying the additional insured or that the policy itself includes a "blanket additional insured endorsement." A blanket additional insured endorsement provides that the definition of "insured" in the policy is amended to include any person or organization that the named insured is obligated by contract (such as AIA 201) to add as additional insured under the policy.

If a blanket additional insured endorsement appears in the policy, the additional insured is added to the policy automatically when the construction contract becomes effective. Without one, additional insured status must be confirmed with the insurance company.

This recommendation to verify additional insured status with the insurance company requires due diligence after entering into the construction contract, but is essential to ensuring that your rights to insurance coverage are protected. In addition, copies of insurance policies usually are not provided at the time of entering into the construction contract. Follow-up is necessary to confirm that the obligated contracting party (or that party's insurance broker) actually arranged for the insurance company to issue the separate "additional insured endorsement," or that the insurance policy includes a "blanket additional insured endorsement." Do not rely on a Certificate of Insurance for insurance protection. A Certificate provides no more than information as to possible overage in place.

Finally, coverage as additional insured may not be as broad as coverage as primary insured under the firm's own liability policy. Most CGL policies and additional insured endorsements provide coverage only as to claims arising out of the activities of the primary insured. Some policies further limit coverage to claims arising out of the ongoing operations of the primary insured, precluding coverage of any claim occurring after the primary insured's work is completed. It is important, therefore, that you examine the policy naming your firm as additional insured to be certain that you are provided the coverage your contract requires.

At the contracting stage of any Project, all contractors should ensure that appropriate insurance coverage is provided for any claim that can arise during or after the Project. Special care should be taken by general contractors to ensure that their subcontractors provide the insurance coverage required under their subcontract. When a claim arises, place all possible insurance companies on notice of the claim to preserve your rights under the insurance policies.

With attention to detail from the inception to the completion of the Project, you can enhance the likelihood that you will be protected in the event a claim arises out of the Project.

© Michael D. McCormick
Momkus McCluskey, LLC
3051 Oak Grove Drive
Suite 220
Downers Grove, Illinois 60515