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Recent developments in construction defect insurance

State and federal courts are divided on whether standard CGL policies cover construction defect claims

In the last few years, courts have issued a flurry of opinions on the subject of construction defect insurance, with particular regard to the question of whether the average commercial general liability (CGL) policy provides coverage for construction defect claims against a contractor insured. The most extreme opinions have held that such claims never trigger coverage, a result that prompted several states to enact legislation to the contrary. The courts, in turn, responded to this new legislation with varying results, discussed below.

The issue turns on a few key policy provisions. The standard CGL policy provides coverage for damages arising out of “property damage” to which the policy applies. The property damage must be caused by an “occurrence,” which is, in turn, defined in part as “an accident.” In light of these provisions, courts often are asked to decide whether construction defects (and/or the damage caused by such defects) qualify as “property damage” caused by an “accident” for the purpose of these policies.

In several jurisdictions, including Arkansas, Hawaii, Iowa, Kentucky, Ohio, Oregon and Pennsylvania, courts have concluded that construction defect claims do not trigger CGL coverage, holding that defects are not “accidents” but foreseeable consequences of a contractor’s work on a project. Colorado, Hawaii and South Carolina recently followed suit, most notably in Hawaii, where the state Supreme Court held in 2010 in Group Builders, Inc. v. Admiral Insurance Company that any construction defect claim arising out of a breach of construction contract could not give rise to an “occurrence” for the purpose of CGL insurance.

The concern raised by this holding was that it effectively nullified coverage for “property damage” under any CGL policy. The holding also was in stark contrast to state and federal decisions interpreting Hawaii law, including Burlington v. Oceanic Design & Construction, Inc. and Hurtig v. Terminix Wood Treating & Contracting Co., all of which had acknowledged that defective work can give rise to an “occurrence” so long as other non-defective property is damaged.

In response to Group Builders, the Hawaii legislature enacted House Bill No. 924, which was expressly intended to overrule Group Builders and restore the status quo under Hawaii law prior to the decision. The legislature recognized that, prior to Group Builders, “construction professionals entered into and paid for insurance contracts under the reasonable, good-faith understanding that bodily injury and property damage resulting from construction defects would be covered under the insurance policy.”

It was perhaps not unexpected when, following the enactment of H.B. 924, some Hawaii courts recognized that it constituted a significant development in Hawaii law, while others held that Group Builders was not a deviation from prior Hawaii law, and continued denying coverage for construction defect claims. The District Court of Hawaii adopted the latter view most recently in Illinois National Insurance Company v. Nordic PCL Construction, Inc. The case arose out of alleged defects in two different projects for which Nordic was the general contractor. Nordic sought a defense from its insurers under a CGL and umbrella policy, as well as reimbursement for repairs that Nordic undertook at one of the projects.

Notwithstanding the passage of H.B. 924, the court granted summary judgment for the insurers, holding that the claims at issue were not covered. In doing so, the court relied on prior 9th Circuit and Hawaii state court decisions which, the court concluded, supported the proposition that claims arising from the alleged breach of a construction contract, including construction defect claims, do not involve accidents or “occurrences.”

The results in Colorado, South Carolina and Arkansas have been similarly mixed. Although no state court has addressed Colorado’s version of Hawaii H.B. 924, the 10th Circuit last year in Greystone Construction, Inc. v. National Fire & Marine Insurance Company, reversed the district court’s grant of summary judgment to an insurer who successfully argued that faulty construction cannot give rise to an “occurrence” for purposes of CGL coverage.

The 10th Circuit concluded that, given the opportunity to do so, the Colorado Supreme Court would interpret the term “occurrence” to “encompass unforeseeable damage to nondefective property arising from faulty workmanship.” In South Carolina, the legislature enactment on this issue is being challenged on constitutional grounds, the result of which challenge may impact the viability of an analogous provision under Arkansas law.

This is clearly an issue that is rapidly evolving and otherwise bears close attention. At stake are the substantial defense costs and potential damages in the average construction defect action, and the expectation of most construction insureds (and many carriers) that the CGL policies at issue were put in place, at least in part, for the express purposes of defending and indemnifying contractor insureds against such claims.

Contributing Author

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Edward Weiman

Edward E. Weiman is a partner in the Los Angeles office of Kelley Drye & Warren LLP. Mr. Weiman represents film and television companies and...

Additional Contributors: Audrey Jing

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