Construction projects often result in damages claims for construction defects. Securing insurance coverage for those claims will depend on many factors, including the specific facts and damages at issue, and which state’s law governs. The standard commercial general liability policy (“CGL”) provides coverage for “property damage” that is caused by an “occurrence.” Courts across the nation disagree on whether property damage caused by defective construction work is an “occurrence” as that term is defined in standard CGL policies.
Under South Carolina law, property damage resulting from faulty construction passes the first hurdle of constituting an “occurrence” under general liability insurance policies. The faulty construction itself, however, is not covered. For example, in a condominium project in Myrtle Beach, South Carolina, defective construction of exterior components resulted in water intrusion that caused damage to otherwise non-defective components of the condominium units. The property damage to non-defective components of the buildings was an “occurrence” that triggered coverage under general liability insurance coverage. See Crossman Communities of NC, Inc., et al. v. Harleysville Mut. Ins. Co., 395 S.C. 40 (2011). The cost of repairing the poorly constructed exterior components, however, was not covered by insurance.
Following Crossman, a South Carolina statute now specifies that the definition of “occurrence” in general liability policies includes property damage “resulting from faulty workmanship, exclusive of the faulty workmanship itself.” See S.C. Code § 38-61-70 (2011). The South Carolina Supreme Court has ruled that this statute may only be applied to general liability insurance contracts executed on or after the effective date of the statute – May 17, 2011. Any retroactive application is unconstitutional. See Harleysville Mut. Ins. Co. v. State, 401 S.C. 15 (2012). Given the strong line of case law on this issue, however, the retroactive application of the statute should not change the analysis – under South Carolina law, damage to otherwise non-defective property that results from construction defects constitutes an “occurrence” for insurance purposes.
The availability of coverage does not end with that analysis, however. Numerous exclusions in standard general liability policies may impact coverage for construction defect claims, including:
- The “expected or intended” exclusion, which precludes coverage for damage that is “expected or intended from the standpoint of the insured.”
- The “Your Work” exclusion, which precludes coverage for repair or replacement of the insured’s work if the damage occurred after completion of the project. This exclusion does not apply, however, if the work out of which the damage arises was performed by a subcontractor.
- Exclusion j(5), which precludes coverage for damage to “that particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations.”
- The “Loss of Use” exclusion, which precludes coverage for loss of use of property that has not been physically injured but cannot be used because it incorporates the insured’s defective work.
- The “Sistership” or “Recall” exclusion, which precludes coverage for damages claimed for “any loss, cost or expense … incurred for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of ‘Your Work’ (which is defined to include work done on the insured’s behalf) … if such work is withdrawn … from use … because of a known or suspected defect, deficiency, inadequacy, or dangerous condition in it.”
Examples of how courts have applied some of these exclusions in the context of construction defect claims include:
Bennett & Bennett Const., Inc. v. Auto Owners Ins. Co. 405 S.C. 1 (2013): A construction company was hired to replace stucco siding on a home and replace it with decorative brick. A subcontractor installed the brick, left the work site, and sent the contractor an invoice for its work. The general contractor inspected the work after the subcontractor had finished and discovered mortar and slurry had dried on the face of the brick. Pressure washing and an acid solution used to clean the brick resulted in discoloring and damage to the decorative sandy finish. Ultimately, the general contractor removed and replaced the brick and sought damages from the subcontractor that had installed the brick. The subcontractor’s insurer denied coverage. The South Carolina Supreme Court ruled that two exclusions precluded coverage for this damage.
First, exclusion j(5) excludes coverage for “property damage” to “that particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations.” The lower court had ruled that the language “are performingoperations” imposes a temporal element which rendered this exclusion inapplicable, because the damage occurred after the subcontractor had finished its work. The South Carolina Supreme Court disagreed. The court reasoned that the damages occurred during the course of the actions of the insured or its subcontractor, and therefore the exclusion barred coverage. See Bennett & Bennett Const., Inc. v. Auto Owners Ins. Co., 405 S.C. 1 (2013).
The Bennett court also addressed the exclusion for damages claimed for any loss, cost or expense incurred for the “loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of ‘Your Work’ … if such work is withdrawn … from use … because of a known or suspected defect, deficiency, inadequacy, or dangerous condition in it.” Some courts have limited the application of that exclusion to the costs of a product recall, which was its original intent. In the Bennett case, however, the court concluded that the brick face was “replaced” because of a “known defect or inadequacy in it.” Consequently, the court found that coverage was barred by this exclusion. Id.
Auto Owners Ins. Co. v. Newman, 385 S.C. 187, 684 S.E. 2d 541, 546 (2009): A subcontractor had negligently installed stucco on a home, which resulted in water intrusion and damage to the exterior sheathing and framing. The general contractor sought coverage under its general liability policy for the damages it had to pay to the homeowner for the damage to the exterior sheathing and framing. The court first concluded that the damage to the sheathing and framing – non-defective aspects of the construction – was an “accident” and an “occurrence” and therefore triggered coverage obligations under the policy. Addressing the “expected or intended” exclusion, the court concluded that faulty construction from a subcontractor was not “expected” by the contractor. The “expected or intended” exclusion, therefore, did not apply.
The Newman court also addressed the “Your Work” exclusion, which precludes coverage for repair or replacement of the insured’s work if the damage occurred after completion of the project. The exclusion in the insurance policy at issue in the Newman case, however, made an express exception for damage to subcontractor’s work or damage caused by subcontractors’ work. Because the defective work had been performed by a subcontractor, that exclusion did not bar coverage.
Finally, the Newman court evaluated the exclusion known as the “Sistership” or “Recall” exclusion. Originally intended to apply to product recalls, this exclusion precludes coverage for the “loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal, or disposal of the insured’s work (or work done on the insured’s behalf),” if the work is “withdrawn or recalled from the market” because of a known deficiency in the work. The court ruled that this exclusion barred coverage for the cost of removing and replacing defective stucco installed by the subcontractor, even though the consequential damage to other property was covered. Auto Owners Ins. Co. v. Newman, 385 S.C. 187, 684 S.E. 2d 541, 545-546 (2009). Like the Bennett court, the Newman court ignored the original intent of this exclusion, as well as the language “withdrawn or recalled from the market” in applying this exclusion. The ruling of no insurance coverage for the defective work itself, however, would have been the same regardless of this exclusion. The defective work itself is not considered an “occurrence” under general liability insurance policies, so the analysis could have stopped there with respect to the defective stucco that had to be removed and replaced.
Predicting how a court will rule in a given case can be difficult, but coverage for claims arising from construction defects may be available. Don’t leave insurance coverage on the table. A careful analysis of the facts and policy language is always the first step, and it may lead to recovering insurance.