Insurance Coverage – Duty to Defend – Construction Defects

by Low, Ball & Lynch
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Regional Steel Corporation v. Liberty Surplus Insurance Corporation

Court of Appeal, Second Appellate District (June 13, 2014)

There has been a split of decisions in California as to whether incorporation of a defective product into a construction project may itself constitute “property damage” under a CGL policy, or whether more is required to show “property damage” to some other portion of the project.  This case addressed that split where the allegations of a cross-complaint were critical of the insured’s “product” incorporated into a construction project, without alleging any resultant damage elsewhere in the project.

JSM Florentine, LLC (“JSM”) was the owner of an apartment building being constructed in North Hollywood in 2004.  Regional Steel Corporation (“Regional”) was a subcontractor engaged to provide reinforcing steel or “rebar” to the project’s columns, walls and floors.  Regional prepared and submitted shop drawings calling for use of both 90 degree and 135 degree seismic rebar tie hooks in the shear walls.  This specification was approved by both JSM and the project architect, Babayan Associates (“Babayan”).  Regional thereafter began installing the rebar on the first several floors of the project, which was subsequently covered up by concrete poured by Webcor Construction, LP (“Webcor”).  Shortly thereafter, the city building inspector issued a correction notice requiring that only the 135 degree tie hooks be used and forbidding use of 90 degree tie hooks.  The city subsequently notified JSM that several levels of the garage had defective (i.e., 90 degree) tie hooks, and that they had to be removed and repaired.  JSM withheld some $545,000 in invoices from Regional, pending agreement over responsibility for the repairs.

Regional filed an action against JSM for payment of the $545,000.  JSM cross-complained against Regional and others, including Babayan and Webcor, for defective construction relative to the use of 90 degree tie hooks by Regional, Webcor’s pouring of concrete over the tie hooks, and Babayan’s approval of the same.  JSM sought damages including cost of removal and replacement of the alleged defective tie hooks and loss of use and rental income due to delays on the project.  Webcor filed a cross-complaint seeking indemnity against JSM, Regional and Babayan, alleging (in a conclusory fashion) that its own fault was passive and secondary.

JSM and Regional were both named insureds under a commercial liability policy from Liberty Surplus Insurance Corporation (“Liberty”), which was converted to a “wrap” policy specific to the project.  The policy applied to “property damage” caused by an “occurrence” and excluded coverage for “property damage” to “impaired property” arising out of a “defect” in “your work” or “your product.”

Regional tendered defense of JSM’s cross-complaint to Liberty, which denied that it had any duty to defend the claim.  Liberty asserted that the purely economic losses caused by the need to repair did not constitute property damage.  After Webcor’s cross-complaint was filed, Regional tendered again to Liberty, based on allegations in Webcor’s cross-complaint that the claims raised by JSM against Webcor were Regional’s responsibility, specifically as to out-of-level concrete floors and resulting cracks in the same.  Liberty denied this second tender, noting that there was no evidence JSM itself was asserting claims for out-of-level floors, or that it alleged this had anything to do with Regional’s work.

Regional, JSM, Webcor and Babayan settled the claims amongst them. The settlement agreement (to which Liberty was not a party) set forth that Regional “caused or was responsible for damage to, and loss of use of, tangible property…including …out-of-level, cracked…floors.”  Regional thereafter filed suit against Liberty, alleging claims for breach of contract and bad faith for failure to defend and settle the claims against it.  Liberty filed for summary judgment, and the trial court found that Liberty had no duty to defend Regional.

The Court of Appeal affirmed, holding that the defective steel work did not constitute “property damage,” and that the destructive work required to repair it did not transform it into property damage caused by an occurrence.  In reaching the conclusion that the defective tie hooks did not constitute “property damage,” the court noted that there was a conflict in law as to whether construction defects that are incorporated into a whole property constitute property damage for purposes of a Commercial General Liability (“CGL”) policy.

The first line of cases followed the rule that coverage for the cost of removing and replacing the defective work or material of the insured is not covered, and that such cost is an economic loss, not physical injury to the property.  The Court noted that these cases are “consistent with the basic purpose of liability policies,” which are not designed to provide contractors and developers with coverage against claims that their work is inferior or defective.  According to the Court, the risk of replacing and repairing defective materials or poor workmanship has generally been considered a commercial risk which is not passed on to the liability insurer.

The second line of cases has held that incorporation of a defective part into a whole construction project may constitute property damage within the meaning of a CGL policy.  In this regard, the Court looked at Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1, where the California Supreme Court held that there was property damage under a CGL policy based on the incorporation of asbestos tiles and insulation into a building because the potentially hazardous material was physically linked to the building.  The Court here noted thatArmstrong, as well as other cases following its ruling, all generally involved contamination by hazardous defective materials or products that were incorporated into a whole.  This contamination resulted in property damage to the property as a whole, not just to the defective product itself.

The Court noted that even in Armstrong, the Supreme Court acknowledged the general rule that there was no “property damage” and thus no coverage for replacement of a defective part installed by the insured, but that because of the hazards allegedly caused by the defective asbestos tiles and insulation, that rule was not applicable.  The Court of Appeal held that the Armstrong line of cases was not applicable here, since the allegedly defective rebar ties did not contaminate any other portion of the project or the project itself.  Consequently, there was no property damage.

Summary judgment for the insurer was affirmed.

COMMENT

This may be an issue ripe for review by the Supreme Court, since the Appellate Court has effectively attempted to limit the Supreme Court’s ruling in Armstrong.  Unless challenged, this case holds that there is no coverage where the only claimed “property damage” is the removal of the insured’s product itself.

For a copy of the complete decision, see:

http://www.courts.ca.gov/opinions/documents/B245961.PDF

 

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