The State of Commercial General Liability Insurance Coverage for Defective Construction
Imagine this scenario: you contract with a company for the construction of your home. The company finishes it and you move in with your family. Soon after the move, you discover several construction defects that affect not only the value but also the structural integrity of the home. Does this defective workmanship constitute an "occurrence" so that it may be covered under the builder's commercial general liability insurance policy ("CGL")? Or, is the defective workmanship categorized as something else, so as to not fall under the policy's coverage?
Courts across the nation are reaching different conclusions when faced with this question. Kentucky addressed the issue in 2010 in the case Cincinnati Insurance Company v. Motorists Mutual Insurance Company, 306 S.W.3d 69 (Ky. 2010). InMotorists Mutual, a family contracted with Elite Builders for the construction of their residence. Elite was paid in full for their work, but the family sued Elite and its CGL carrier, Motorists Mutual years later for the poor workmanship. The homeowners' claims were settled by Motorists Mutual. After some legal maneuvering, Motorists Mutual ended up suing Cincinnati Insurance Company ("Cincinnati"), the successor to Motorists Mutual as Elite's CGL insurer. Motorists Mutual argued that Cincinnati had wrongfully breached its duty to defend and indemnify Elite in the homeowners' suit as required by the CGL policy terms issued by Cincinnati to Elite.
The subject CGL provided coverage for "property damage" caused by an "occurrence." Under the policy, an "occurrence" was defined as an "accident, including continuous or repeated exposure to substantially the same general harmful conditions." The term "accident" was not defined; the court afforded it its ordinary meaning.
The Kentucky Supreme Court held that claims of faulty workmanship, standing alone, are not "occurrences" under CGL policies. In its Opinion, the Kentucky Supreme Court discussed the doctrine of fortuity. The fortuity principle consists of two aspects: intent and control. According to the Court, these two aspects play an inherent role in all liability policies.
The Court in Motorists Mutual determined it was highly unlikely that Elite set out withintent to build a substandard house for the family. Further, Elite had control over the construction of the home, directly or indirectly, through the subcontractors it chose. Because of this control, it could not be said that the faulty work was an "accident," as required by the policy terms. As the Court stated, "[f]aulty workmanship is not an accident." Thus, Cincinnati did not have a duty to defend Elite under the CGL policy because a failure of workmanship does not involve the fortuity to constitute an accident.
By so holding, the Kentucky Supreme Court joined the majority viewpoint on the subject. Other state courts that side with Kentucky typically hold that construction defects are natural consequences of substandard work. The focus is on the intentional nature of construction, not the expectation or intent for damage resulting from the workmanship. This viewpoint supports the principle that liability should fall on the person who performed the negligent work, not an insurance carrier. Finding otherwise, proponents suggests, would make an insurance carrier guarantors of an insured's work in every instance. The Court in Motorists Mutual also expressed hope that their holding would result in the public policy goal of contractors choosing subcontractors more carefully.
Now that we know the majority viewpoint, how do other courts approach the issue? Some courts believe that defective workmanship is not the result of an "occurrence," but the resulting damage may be covered nonetheless by a policy if the damage is unintended and not within the purview of a contractor's control (thus meeting the fortuity principle). Under the Indiana Supreme Court's decision in Sheehan Construction Co. v. Continental Casualty Co., 935 N.E.2d 160 (Ind. 2010), Indiana courts must determine whether a subcontractor's defective work was performed intentionally. If so, there would be no "accident" or "occurrence" and, thus, no coverage. In contrast, if the faulty work is found to have been performed "without intention or design", then an "occurrence" exists and the builder is covered under the policy.
A third method is to consider all liabilities, including damage to the work itself, covered by the policy because defective construction is always accidental. Opponents of this methodology say it basically converts a liability policy into a performance bond and unfairly removes liability from the person responsible for the subpar work.
With the courts' varying interpretations of "occurrence", some states are defining "occurrence" statutorily. Four states so far have created laws which generally define construction defect claims as an occurrence for CGL purposes. The statutes' language differs significantly, but the purpose is the same: to bring consistency and predictability to CGL claims. By removing courts from the equation, the construction industry in these states is spared long and expensive court battles over competing definitions. While the construction entity may still have to defend against the construction defect claim, they no longer must litigate insurance coverage issues.
I expect more states to enact similar statutes in the coming years which address what constitutes an "occurrence" for CGL purposes. Doing so will benefit not only the construction industry, but will also free up overrun courts and possibly result in the overhaul of language found in CGL policies. When contractors and insurers share the same basic understanding of terms, it is a gain for everyone. The construction industry is making a slow recovery from the past years' economic recession. By freeing companies from court battles over policy coverage, they will be able to focus on what really matters: constructing quality work and reenergizing the industry.