Faulty Workmanship Can Be An Accident

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After a spate of bad decisions for policyholders on whether general liability policies can ever provide coverage for construction liabilities, three courts, in the past few weeks, have done an about-face, holding that there is coverage in certain circumstances for such liabilities.

Relying on the subcontractor exception to the "your work" exclusion, the Second Circuit has ruled that a general liability policy provides coverage for liability sustained by a swimming pool installer on account of cracks that developed in the pools following installation. The appellate court reversed the district court, which had relied on an earlier Second Circuit decision in finding that defects in the insured’s workmanship could not be considered "accidents."

On appeal, the policyholder argued that the language of the exception to the "own work" exclusion for work "performed on [the insured’s] behalf by a sub-contractor" demonstrated that in some circumstances the insured’s own work is covered. The Second Circuit agreed, "As coverage is limited by the policy to ‘occurrences’ and defects in the insured’s own work in some circumstances are covered, these policies . . . unmistakably include defects in the insured’s own work within the category of an ‘occurrence’." Scottsdale Ins. v. R. I. Pools, 11-3529-cv (2d Cir. March 21, 2013). The Second Circuit remanded the case for a determination of whether the "sub-contractor" exception applied.

Following on the heels of the Scottsdale decision, the North Dakota Supreme Court overruled an earlier decision and held that property damage caused by faulty workmanship "may constitute an ‘occurrence’ if the faulty work was ‘unexpected’ and not intended by the insured, and the property damage was not anticipated or intentional, so that neither the cause nor the harm was anticipated, intended or expected. This is consistent with our definition of ‘accident’ for purposes of a CGL policy." K&L Homes v. American Family Mutual Ins. Co., 2013 ND 57 (April 5, 2013).

In reaching this decision, the North Dakota high court reviewed the drafting history of the CGL policy, including the adoption of the "subcontractor exception" to the exclusion from coverage of damages to an insured’s own "work." Quoting from a 2007 Florida Supreme Court decision on the issue, the K&L Homes court noted that CGL policies were broadened to provide coverage for defective construction claims where the defective work was performed by the insured’s subcontractor. This broadening resulted "both because of the demands of the policyholder community (which wanted this sort of coverage) and the view of insurers that the CGL was a more attractive product that could be better sold if it contained this coverage."

Lastly, the First Department of New York’s Appellate Division added further momentum to this pro-policyholder trend April 16, 2013, when it affirmed a lower court decision that "faulty workmanship" can be an "occurrence" where it damages property other than to the policyholder’s own work. I.J. White Corp. v. Columbia Cas. Co. The policyholder had sought defense and indemnification for a breach of contract action arising from an allegedly defective spiral freezer system that led to ruining the buyer’s cakes upon cutting. The insurer argued that faulty workmanship – the defective freezer system – was not an "occurrence" and that, in any event, there was no "property damage."

Both the trial court and the Appellate Division disagreed. Noting that the underlying complaint alleged damage to the plaintiff’s cakes, the court concluded that the CGL policy was properly triggered. While recognizing that an earlier decision of the same court had held that CGL policies "do not insure against faulty workmanship in the work product itself," the I.J. White court held that such policies "do insure against property damage caused by faulty workmanship to something other than the work product." Moreover, although not explicitly stated in the majority’s opinion, the majority rejected an argument made by Columbia Casualty that there is no coverage for breach of contract actions, another argument often made by insurers.

These decisions reverse a recent trend by some courts to find coverage under CGL policies where the underlying damage is allegedly caused by faulty workmanship. The K&L Homes court surveyed recent decisions in the Supreme Courts of Alabama (2011), Arkansas (2008), Kentucky (2010), Oregon (2000) and Pennsylvania (2006), all holding that property damage caused by faulty workmanship was not an "occurrence," or that it was not an "occurrence" when the only damage was to the "work" itself. Those courts reasoned that such underlying claims are not on account of an "accident" because defects in work are "foreseeable," or are not "fortuitous." The Scottsdale and K&L Homes cases correctly recognized that contractors and manufacturers often rely on subcontractors to perform some or all of their "work," and that insurance plays a key role in protecting a policyholder from damages caused by a subcontractor’s negligence, which – from the standpoint of the insured – is "accidental." Similarly, the I.J. White court correctly reasoned that "faulty workmanship" can result in a covered "occurrence" where it is alleged that such negligence results in third-party property damage.

Policyholders buying insurance to protect against losses stemming from the "faulty workmanship" of subcontractors should be sure their policies include the "subcontractor" exception to the "your work" exclusion, and should consider seeking an endorsement that clarifies the "occurrence" definition by providing that the term "occurrence" includes faulty or negligent workmanship by subcontractors. Similarly, just because a claim is couched as a breach of contract does not automatically mean that general liability coverage is unavailable.