Insurance Coverage for Construction Liability

11.20.2002

Every major construction project involves a complex web of interrelationships among a host of parties, including the developer, the general contractor and its sub-contractors, manufacturers and material suppliers, and engineers, architects, and other design professionals. For a project to be successful, it is up to the developer or its construction manager to manage the parties to ensure coordination of their work, especially on critical matters like scope, pricing and scheduling.

No less critical is coordinating insurance for the project, especially liability insurance for completed operations. For the last 20 years, the risk of litigation particularly construction defect claims brought by unhappy owners has been a fact of life for residential and commercial developers. The parties to a major construction project each bring with them their different insurance needs and their different insurance policies. For a project to successfully address its potential liability issues, the developer or its project manager must harmonize the parties' insurance assets.

Who Provides The Insurance?
Traditionally, there have been two broad methods for ensuring that the parties to a construction project maintain adequate insurance (1) having each party maintain its own insurance, in accordance with specified requirements, to cover its own area of risk; or (2) sweeping all the project participants into a single wrap-up policy obtained by the developer or general contractor.

Under the first approach, which I refer to BYOI (bring your own insurance), each participant in the project obtains its own insurance. The terms of insurance such as limits, deductibles, and coverages to be obtained are spelled out by contract. Participants demonstrate that they have met these requirements by providing certificates of insurance to the developer.

This approach requires careful monitoring. All too often, the developer fails to track compliance to ensure that the project participants have obtained the required insurance particularly if the project lasts longer than initially contemplated and coverages must be renewed or extended. When the system works, however, the project should enjoy ample coverage, with the added protection offered by redundant and overlapping insurance.

Of course, redundant and overlapping insurance has a cost. To reduce premium costs, developers sometimes employ a wrap-up program that seeks to provide all the insurance needs of the project through one set of policies. All project participants are named as insureds on the wrap-up policies. These policies (including excess layers) may have high limits, waiver of subrogation claims among the project's participants, and sometimes provisions for the participants to be defended jointly by counsel in the event of litigation. The developer allocates premium costs among the various participants.

When wrap-up programs work well, they result in lower overall premium costs, fewer cross-claims among project participants, and better overall insurance coverage, particularly for some of the smaller players who may have difficulty purchasing their own insurance in the current market.

What May Be Covered?
Even with the best of insurance programs, it is important to understand what type of losses are covered by traditional liability policies and what type of losses are not. CGL policies provide coverage for damage claims resulting from property damage or, under some circumstances, loss of use. Property damage is a strictly defined term, which generally means "physical injury to tangible property." If construction problems result, for example, in roofs or windows that leak, concrete that cracks, or siding that warps, traditional CGL policies should provide defense and indemnity coverage. And the policies should provide coverage regardless of whether claims are asserted under theories of breach of contract or warranty, or under tort theories such as negligence or strict liability.

Often, insurance companies deny claims that result from construction problems alleging a lack of "property damage." CGL insurance policies, however, usually define "property damage" to include coverage for loss of use of the property absent actual physical injury to the property. Likewise, insurance companies often deny claims that result from attempts to cure latent defects in construction, such as curing defective window flashings prior to a strong rain causing leaks or upgrading an inadequate seismic safety system prior to an earthquake. Insurance companies usually allege that such claims have not yet resulted in "property damage." It is widely recognized, and insurance companies have argued, however, that CGL insurance policies cover loss mitigation costs incurred to prevent future "property damage," absent an express exclusion in the insurance policy to the contrary.

It should be noted that traditional CGL insurance policies will not cover lawsuits arising out of contractor cost overruns or delays. Moreover, such policies contain several exclusions that bar coverage for certain aspects of a construction project. Policies typically exclude property damage resulting from "your work" and "your product." Under these exclusions, a subcontractor may not have insurance coverage for claims for damage to its own work arising out of its own poor workmanship, and a component manufacturer may not have coverage for claims for damage to its own product arising out of product defects. Under older ISO forms that were standard before 1985, these exclusions could also affect coverage for the developer unless the developer purchased what was known as the "broad form property damage endorsement." Newer ISO forms in effect since 1985, however, have made clear that the "your work" and "your product" exclusions do not apply to the developer.

Many other exclusions do apply uniformly to developers, GCs, subcontractors, and other project participants. The subsidence exclusion, for example, bars claims for property damage arising out of earth movement or soils settlement. The interpretation of the subsidence exclusion varies from state to state and depends upon what other factors also contribute to the earth movement (like faulty design or workmanship).

Standard form CGL policies are triggered by property damage occurring during the policy period. Thus, physical injury to property must occur during the policy period. This is a different legal question from determining when an owner's claim arises. Under the law of most states, a claim for property damage resulting from construction defects will arise, and the statute of limitations will begin to run, when the owner learns that his property has been damaged or contains latent defects. In situations where damage is ongoing but the owner does not notice damage until several years later for example, micro-cracking in concrete that only results in major cracks after several years insurance policies in place years before the owner makes a claim may provide coverage. In contrast, in situations where latent defects are discovered that may lead to future property damage, the owner may file a lawsuit long before property damage takes place.

Where property damage takes place continually or progressively over several years, courts have wrestled with the question of which insurance policies provide coverage. Insurance companies have argued that damage occurring over several years should be covered by only one of the policies in place during that span of time for example, the policy in place when the damage commenced or the policy in place when the damage manifested itself. Under the better view, adopted by California and many other states, courts apply a "continuous trigger" that imposes coverage on each policy in place during the time span when property damage is occurring.

Many types of construction defects do not result in physical injury to tangible property until long after the project is complete. A common mistake made by developers is to obtain first-rate insurance coverage during the period of construction and then not require project participants to maintain insurance for future years when claims are likely to arise. When a disgruntled owner files claims for construction defects years after the project is complete, developers often find that some of the project participants have gone out of business or let their insurance lapse, leading to coverage gaps.

To avoid such problems, a developer should require in the contract documents that the participants maintain insurance for several years after completion of the projects and demonstrate compliance through certificates of insurance sent annually to the developer. Alternatively, developers can obtain what is known is "tail coverage" that applies to claims of property damage occurring for a period of years after the project is complete. Tail coverage is often intended to coincide with the applicable statute of limitations or statute of repose (e.g., ten years in California). Several insurance companies now offer tail coverage through endorsements, and it is likely that this product will become more widespread in the future.

Current Developments

Quincy Mutual Fire Insurance Company v. Borough of Bellmawr
The New Jersey Supreme Court recently held that a policyholder's initial deposit of waste into a landfill constituted the first trigger of coverage under New Jersey's Owens-Illinois continuous trigger theory. Additionally, the court clarified the Owens-Illinois allocation analysis by holding that any calculation should be performed on the basis of days on the risk, not years on the risk. In Quincy, Bellmawr shipped municipal waste to a New Jersey landfill for a period of thirteen years beginning in May 1978. In 1981, the landfill was closed by the EPA and placed on the Superfund List as a result of the discovery of hazardous chemicals in the soil, surface waters, and ground waters at the site. During this period of time, Bellmawr purchased CGL insurance policies from two companies: Century Indemnity (June 18, 1977 until June 18, 1978) and Quincy Mutual (June 18, 1978 until June 18, 1981). Bellmawr sought insurance coverage from both Century Indemnity and Quincy Mutual for its defense and settlement costs incurred with respect to the EPA lawsuit to recover remedial and response costs associated with the landfill. Quincy Mutual and Century Indemnity entered into an agreement that they would pay Bellmawr's defense costs and later determine any allocation of indemnification between them.

In 1996, Quincy Mutual brought a declaratory judgment action to determine each insurance company's respective liability for Bellmawr's claim. At trial, Century Indemnity presented uncontroverted expert testimony that dispersal of any contaminants at the landfill would not have occurred until at least 185 days after any waste had been deposited at the landfill. Relying heavily upon this testimony, and applying Owens-Illinois continuous trigger of coverage analysis, the trial court determined the Quincy Mutual policies were the only policies triggered for this claim.

The appellate court affirmed. Quincy Mutual appealed to the Supreme Court, where the principal question presented was whether, under the continuous trigger theory, the injury process commenced with either (i) the deposit of contaminants in the landfill or (ii) the dispersal of the contaminants into the surrounding groundwater. If the Supreme Court adopted the former position, then Century Indemnity's policies would be triggered to provide coverage. Otherwise, and as the lower courts had held, if the Supreme Court adopted the theory that the injury process began with the contamination of the groundwater, Century Indemnity's would not be required to respond because such injury, according to the uncontroverted expert, could not have occurred during the time period of Century Indemnity's policy. Examining the cumulative and progressive nature of toxic waste injury, and comparing such injuries to asbestos-related injuries, the New Jersey Supreme Court held that the deposit of contaminants in a landfill commences the trigger of coverage analysis under Owens-Illinois. Accordingly, Century Indemnity was required to participate in the defense and indemnity of Bellmawr.

Finally, seizing the opportunity to further clarify the Owens-Illinois analysis, the Court held that, since both Quincy Mutual's and Century Indemnity's insurance policies were implicated, their respective liability would be allocated based on the number of days, not the number of years, each policy provided coverage during the continuous trigger period.

Indiana Insurance Company v. Alloyd Insulation CompanyAn Ohio appellate court recently held that a claim for damages which occurred as a result of faulty workmanship was covered under a contractor's CGL insurance policy. In this case, Indiana Insurance refused to defend Alloyd with respect to a claim brought by the Delaware County Library District Board of Trustees ("Library Board") alleging that defective workmanship by Alloyd resulted in corrosion and other damage to the Library Board's property. In finding that Indiana Insurance was required to defend Alloyd with respect to such claims, the appellate court distinguished between coverage for the faulty workmanship itself from damages which result from faulty workmanship. Indeed, the appellate court cautioned that claims against policyholders to rectify faulty workmanship as well as claims against policyholders for breach of contract would not be covered under a CGL insurance policy.

Atlantic Mutual Insurance Company v. J. Lamb, Inc.
The California Court of Appeals, Second District recently held that a policyholder's acts of contacting a competitor's customers and falsely accusing the competitor of infringing on its patent constituted "personal injury" under an Atlantic Mutual CGL insurance policy which defined personal injury to include publication of materials that disparage a person's or organization's goods, products or services. Moreover, the appellate court amplified California's strict requirement that once the duty to defend has been triggered by the mere possibility of coverage for a claim, an insurance company must defend the claim unless it can conclusively demonstrate that an exclusion applies. Because Atlantic Mutual could not meet this strict standard, the appellate court denied Atlantic Mutual's motion for summary judgment regarding its duty to indemnify.

Lamb was sued by one of its competitors based upon allegations that a Lamb the employee had contacted the competitor's customers and falsely accused the competitor of violating Lamb's patents. Lamb tendered claim for defense to both Granite State and Atlantic Mutual who had issued successive insurance policies which provided CGL coverage to Lamb. Both insurance companies denied coverage and refused to defend Lamb arguing that there was no claim for either personal injury or advertising injury. Atlantic Mutual further contended that the alleged acts were subject to the first publication exclusion in the insurance policy because the alleged acts did not occur during the policy period. Lamb reached a settlement with Granite State after it had settled the underlying action, however, Atlantic Mutual refused to change its position.

Atlantic Mutual filed a declaratory judgment action seeking a determination of its duties to defend and to indemnify Lamb. Atlantic Mutual argued that it had no duty to defend or indemnify Lamb because the allegations in the underlying complaint did not constitute "personal injury" under the policy and, moreover, that the acts committed by Lamb, whether they constituted personal injury or not, were not made "during the policy period" and/or the first publication exclusion applied to preclude coverage. The trial court entered summary judgment in favor of Atlantic Mutual finding that the acts alleged as taken by Lamb did not constitute "personal injury" under the Atlantic Mutual policy.

The Court of Appeals reversed and remanded. Specifically, the appellate court rejected Atlantic Mutual's argument that the claims asserted by Lamb's competitor did not constitute "personal injury" under the Atlantic Mutual insurance policy. The court took particular notice of the expansive definition of "personal injury" which includes any publication of material which "disparages a person's or organization's goods, products or services." Distinguishing previous California case law cited by Atlantic Mutual in which the insurance policies at issue did not include such an expansive definition of "personal injury," the appellate court found that were the added language to have any meaning, allegations of the type asserted against Lamb must fall within the ambit of the Atlantic Mutual insurance policy. Accordingly, the appellate court held that Atlantic Mutual's duty to defend was triggered by the allegations in the underlying complaint.

The appellate court further rejected Atlantic Mutual's argument that it could eliminate conclusively the potential for liability under the first publication exclusion. The appellate court found that Atlantic Mutual's equivocal and self-serving production of a claims adjuster's declaration did not rise to the level of the conclusive evidence necessary to defeat coverage. The Court of Appeals, therefore, reversed the trial court with respect to Atlantic Mutual's duty to defend and remanded the case back to the trial court to determine the application of the first publication exclusion.

Dart Industries, Inc. v. Commercial Union Insurance Company
In a case of first impression, the California Supreme Court in Dart Industries recently set forth the burdens of proof with respect to cases involving a lost insurance policy. Following the same California law guidelines as when an insurance policy has not been lost, the Supreme Court held that a policyholder has the burden of proving (1) that the lost policy insured the policyholder during the period in question and (2) the substance of each policy provision essential for the policyholder's claim for relief. Likewise, similar to California law when an insurance policy has not been lost, an insurance company has the burden of demonstrating any policy provision, which would defeat the claim for coverage. In applying these rules to the case before it, the California Supreme Court went on to explicate the second prong of a policyholder's burden of proof: the substance of the essential terms of the missing policy. The California Supreme Court clarified that a policyholder need not establish the exact terms of the policy, but rather the relative substance of the document. For example, in this action, Dart offered oral testimony as to the existence of "occurrence-based" coverage during the time period and that such coverage included claims for injuries caused by DES exposure during the policy term but not manifesting until after the term ended. The Supreme Court of California found this uncorroborated evidence was sufficient to support a finding of coverage on behalf of Dart.