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Bi-Weekly Newsletter of the State Bar of Wisconsin
August
2009
Volume
1
Number
14

August 19, 2009
Property damage caused by an occurrence in the construction defect context can be confusing
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This article is published courtesy of the July 2009 State Bar Business Law Section Business Law Section newsletter.

Jeffrey Aiken

Tamara O'Brien

By Jeffrey P. Aiken and Tamara O’Brien, Whyte Hirschboeck Dudek S.C.

The insuring agreement of a standard commercial general liability (CGL) policy (the “Policy”) provides coverage for sums the insured becomes legally obligated to pay as damages because of property damage caused by an occurrence.¹ The policy requirement that property damage be caused by an occurrence has generated a surprising amount of confusion in the construction defect context. Courts have been fairly uniform in recognizing that faulty workmanship alone, in the absence of property damage (physical injury to or loss of use of tangible property), does not give rise to coverage. Uniformity is completely lacking, however, when it comes to defining what does constitute property damage caused by an occurrence.

Much of the confusion is attributable to attempts to read business risk principles (the notion that the insured is responsible for repairing its own defective work) into the policy’s insuring agreement. In fact, the policy language limits coverage in a manner consistent with the business risk concept through policy exclusions. Pre-1986 the policy form exclusions eliminated coverage for damage to the insured’s own work, which was defined to include all work performed by or on behalf of the insured. The policy form was amended in 1986 to preserve coverage for property damage involving work performed by a subcontractor. Failing to give effect to the policy structure, some court decisions have improperly determined that there is no “property damage” caused by an “occurrence” under the insuring agreement if the damage is to the insured’s own work – even work of subcontractors. However, the current Policy is designed to afford coverage under the insuring agreement for all accidental property damage; therefore if the damage is to the insured contractor’s own work, coverage may be excluded, but only by operation of specific policy exclusions.

Assume, for example, that a subcontractor performs roofing work for an insured general contractor constructing a new home. The subcontractor's work is deficient, and eventually allows water to infiltrate the home, damaging wallboard supplied and installed by another subcontractor, as well as several of the owner’s rare works of art. The owner sues the general contractor for damages consisting of the cost to correct the defective roof work, the cost to repair the damaged wallboard, and the value of the damaged artwork. While this type of claim should trigger the insuring agreement of the general contractor’s Policy – it alleges physical injury to tangible property caused by an occurrence of water infiltration – very different conclusions may be reached in different jurisdictions, and even for different reasons.

A. The “Property Damage” Requirement.

The Policy form defines property damage as physical injury to tangible property or loss of use of tangible property that is not physically injured. This definition is not ambiguous or complicated.² It has been recognized that “to the average, ordinary person, tangible property suffers a ‘physical’ injury when the property is altered in appearance, shape, color or in the other material dimension.”³ The water damage to wallboard and artwork in our factual scenario should satisfy the Policy definition of property damage. While this appears straight forward, courts have disagreed regarding whether property damage exists if the only damage is to the insured’s work or product itself. In one recent decision, for example, the court stated: “For a claim of faulty workmanship to give rise to ‘property damage,’ a claimant must demonstrate that there is damage to property separate from the defective property itself.”⁴ The rationale usually expressed is that CGL policies are intended to afford coverage for physical damage caused to other property, not for the “business risk” or “economic loss” of repairing or replacing faulty or damaged work.⁵

Courts applying Indiana law have held that property damage to a home or project caused by the defective work of a subcontractor of an insured general contractor does not qualify as property damage for CGL purposes because the Policy is intended to cover only the risk that the insured’s work will cause damage to property other than to the work itself. See Sheehan Construction, supra, and the cases cited therein. Such courts reason that a general contractor’s product is the entire house or project; accordingly, any damage to the home or project is damage to the insured’s product even if the work is performed by a subcontractor and does not satisfy the property damage requirement. In Sheehan Construction, the court determined the property damage requirement was not met where residential homes suffered a variety of types of water damage (water stains on walls and ceilings, damaged carpeting, warped floor boards, etc.) as a result of numerous faults in the workmanship of several different subcontractors (lack of flashing and caulking around windows, improperly installed roof shingles, bricks installed without weep holes, etc.). Applying this rationale to our factual scenario, the cost to repair the defective roof and the damaged wallboard would not be covered, because such damage to the house itself would not qualify as property damage. The value of the artwork, on the other hand, would satisfy the property damage requirement of the insuring agreement.

The Sheehan Construction analysis is not true to the language of the Policy. First, it ignores the fact that the Policy defines the insured’s product as goods other than real property. Second, it merges the property damage requirement in the insuring agreement with the business risk exclusions which exclude coverage for property damage to the insured’s own work or product. The initial inquiry regarding whether property damage exists should have nothing to do with whose property or work is damaged – the policy definition requires only physical injury to tangible property. Physical damage to wallboard caused by water infiltration, for example, is property damage regardless of whether the wallboard is considered part of the general contractor’s product. Coverage may end up being precluded if the only damage is to the insured’s work or product, but that is by virtue of the policy exclusions, not because there is not property damage as defined in the policy. As recognized by the Wisconsin Supreme Court, there would be no need for the Policy to exclude coverage for property damage to the insured’s own work or product if damage to that work or product did not qualify as property damage in the first place.⁶

Nevertheless, in Sheehan Construction, the court rejected the insured’s argument that the court’s analysis was unsound because of the 1986 addition of the subcontractor exception to the Policy form. Although the Policy deleted the subcontractor exception by endorsement, the court also stated that because there was no property damage under the insuring agreement, the policy exclusions were never implicated. The court relied on R.N. Thompson & Associates, Inc. v. Monroe Guaranty Insurance Co., 686 N.E.2d 160, 163 n.5 (Ind. Ct. App. 1997).⁷ The Seventh Circuit did not address the district court’s holding that damage to the home did not constitute property damage. Instead, the court affirmed because the “your work” exclusion in Sheehan’s policy did not include the subcontractor exception.

B. Determining If Property Damage Is Caused By An "Occurrence."

To be covered, property damage must have been caused by an occurrence taking place within the coverage territory. “Occurrence” is defined as an “accident, including continuous or repeated exposure to substantially the same general harmful conditions.” An accident is an “event or change occurring without intent or volition through carelessness, unawareness, ignorance, or a combination of causes and producing an unfortunate result.” Webster's Third New International Dictionary 11 (1993). In other words, the Policy defines an occurrence as an accident consisting either of a single event or an accidental repeated exposure to substantially the same general harmful conditions.

1. Breach of Contract as an Occurrence

Insurers are quick to argue that a breach of contract or warranty, in and of itself, is not an accident, and some courts have agreed.⁸ As far as it goes, that may or may not be correct. But, neither the general principle of fortuity, which is a prerequisite for any liability coverage, nor the Policy language supports such an assertion across the board. If a breach of contract constitutes or gives rise to an accident, there may be coverage if property damage results.

Courts have recognized on various occasions that the term “‘[o]ccurrence’ is not defined by reference to the legal category of the claim.”⁹ Nor is there anything in the insuring agreement itself “to support any definitive tort/contract line of demarcation for purposes of determining whether a loss is covered by the CGL’s initial grant of coverage.”¹⁰ Rather, the core inquiry with respect to whether an occurrence exists is whether the facts underlying the theories of liability constitute an “accident [an event which takes place without one’s foresight or expectation], including continuous or repeated exposure to substantially the same general harmful conditions.”¹¹

The breach of contract itself does not preclude coverage under the policy language. As noted by the Wisconsin Supreme Court:

The business risk exclusions eliminate coverage for liability for property damage to the insured’s own work or product – liability that is typically actionable between the parties pursuant to the terms of their contract, not in tort. If the insuring agreement never confers coverage for this type of liability as an original definitional matter, then there is no need to specifically exclude it. Why would the insurance industry exclude damage to the insured’s own work or product if the damage could never be considered to have arisen from a covered ‘occurrence’ in the first place?¹²

2. Faulty Workmanship as an Occurrence.

Another fertile area for dispute surrounds whether or not faulty workmanship itself can qualify as an occurrence giving rise to property damage. Insurers often argue that if faulty workmanship is an occurrence, then the Policy is really a performance bond. This argument has most often been rejected for a number of reasons, including the fact that even if the insuring agreement requirements for property damage caused by an occurrence are satisfied, coverage may still be negated by application of policy exclusions, if the damage is truly a business risk.¹³

Some courts have held that property damage is the natural and ordinary consequence of faulty work and, therefore, faulty work cannot constitute an occurrence.¹⁴¹⁵ Stated slightly differently, the Nebraska Supreme Court held that “faulty workmanship, standing alone, is not covered under a standard Policy because it is not a fortuitous event.”¹⁶ In our example of defective roof work that permitted water infiltration and damage to wallboard and artwork, the courts that follow this approach may conclude that even if the wallboard and artwork suffered property damage, the damage was the foreseeable result of the roofing subcontractor’s negligent work rather than the result of an accidental event.

Although most (but not all) courts agree that faulty workmanship alone is not an occurrence, many courts will find the occurrence requirement is satisfied if the faulty workmanship causes damage that is unexpected or unintended.¹⁷ Courts adopting this rule frequently point out that contractors do not usually set out to perform negligently or to cause damage, and that if the defective work was inadvertent, by definition, resulting damage was unintended. In Lennar Corp. v. Auto-Owners Insurance Co., 151 P.3d 538, 546 (Ariz. Ct. App. 2007), the court recognized that even if a contractor (or a subcontractor) intends to perform construction work, it does not follow that the contractor intended to provide faulty work, or that the contractor should have anticipated damage as the natural consequence of its work.¹⁸

Many cases require damage to property of a third party, not just damage to the insured’s own work, before the damage will be deemed to have been “accidental.”¹⁹

Texas courts, among others, have found that even defective construction that damages only the insured’s work can be an occurrence.²⁰ These decisions reason that if the faulty work is negligent, and therefore inadvertent, the resulting damage is unexpected and unintended regardless of who performs the work or who owns the property that is damaged.²¹ Moreover, the definition of occurrence in the policy does not focus on who owns the property that is damaged. And, of course, if the occurrence requirement could never be met where the insured’s negligence results in damage to the insured’s own work, the exclusion for damage to the insured’s own work would be unnecessary.²²

Wisconsin cases have most often held that the failure of a contractor or a subcontractor to properly perform work can give rise to an occurrence that results in property damage for purposes of the general contractor's CGL coverage, but such failure does not itself qualify as an occurrence.²³ Thus, in our fact example, the roofing subcontractor’s faulty work itself would not qualify as an occurrence, but the water infiltration that resulted from the faulty work does qualify as an occurrence that, in turn, caused physical injury to tangible property.

Nevertheless, even within Wisconsin, decisions have gone both ways. In Doyle v. Engelke, 580 N.W.2d 245 (Wis. 1998), the Wisconsin Supreme Court held that a subcontractor's negligent workmanship is, in and of itself, an occurrence. Subsequently in Glendenning’s Limestone it was acknowledged that under the Doyle decision, “the ‘occurrence’ is the faulty or negligent workmanship itself.” 721 N.W. 2d at 716. Yet, the Glendenning court ultimately chose to follow the analysis used more recently in American Girl, rather than the analysis in Doyle Id. The fact remains: there is conflict or at least confusion among Wisconsin Supreme Court decisions on whether faulty workmanship itself may satisfy the occurrence requirement. The most recent pronouncement on the issue in Toldt, an appellate court decision, followed the majority of Wisconsin decisions, finding that the occurrence (mud rivers) arose from the faulty workmanship (negligent erosion control practices) and caused damage to adjacent property, but never mentioned the Doyle decision.

A similar split exists in Illinois (and several other states) as well.²⁴ The issue has not been resolved by the Illinois Supreme Court as of the date this article was written. A recent American Bar Association presentation offered the following tally on whether faulty workmanship can constitute an occurrence: 23 States favor the policyholder (Alabama, Alaska, Arizona, California, Colorado, Florida, Kansas, Louisiana, Maine, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Mexico, North Dakota, Ohio, Oregon, South Carolina, Tennessee, Texas, Washington and Wisconsin); 14 States favor the insurer (Arkansas, Connecticut, Delaware, Hawaii, Indiana, Iowa, Maryland, Massachusetts, Mississippi, North Carolina, Pennsylvania, Virginia, West Virginia, Wyoming); 11 States have mixed results (District of Columbia, Georgia, Illinois, Kentucky, Michigan, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, Utah; and 2 States have not addressed the issue (Idaho and Vermont).²⁵

Cases in jurisdictions other than Wisconsin also hold, for varying reasons, that the defective work itself is not an accident (i.e. the occurrence) but may give rise to an occurrence.²⁶ For example, in a recent decision of the South Carolina Supreme Court, the court held that the subcontractor’s negligent installation of stucco which “allowed for continuous moisture intrusion resulting in substantial water damage to the home's exterior sheathing and wooden framing. . .led to an ‘occurrence’ invoking coverage under the Policy for the resulting 'property damage' to other property not the work product.”²⁷ In other words, the defective work was not the occurrence but rather gave rise to the later occurrence – namely the continuous water intrusion.

The point is that cases must be carefully scrutinized to assess the validity of, and basis for, their holdings before extending any particular case to a superficially similar fact circumstance where the relationship between faulty workmanship and an occurrence is at issue. For example, two Wisconsin cases frequently cited for the proposition that CGL policies cover faulty workmanship which causes an accident (as opposed to the “accident” of faulty workmanship and suggesting the rulings are a function of the occurrence requirement), were in fact based on application of the policy exclusions.²⁸ In American Girl, the Wisconsin Supreme Court pointed out that Bulen and Weedo were decided on the basis of the business risk exclusions, not on the basis of the occurrence requirement of the insuring agreement. 673 N.W.2d at 77.²⁹

In short, there clearly are disparate approaches to whether or not faulty workmanship can constitute or can give rise to an occurrence. The analysis in most cases is closely tied to whether there is damage to property, i.e. something other than simply defective work. Those decisions that apply the policy language as written tend to find coverage under the insuring agreement (before addressing policy exclusions) where the effect of faulty workmanship is unintended damage to property.

Endnotes

¹This article references the 2006 Commercial General Liability Coverage Form (CG 00 01 12 07) promulgated by ISO Properties, Inc.

²Wisconsin Label Corp. v. Northbrook Prop. & Cas. Ins. Co., 607 N.W.2d 276, 284 (Wis. 2000).

³Tweet/Garot-August Winter, LLC. v. Liberty Mut. Fire Ins. Co., No. 06-C-800, 2007 WL 445988, at *5 (E.D. Wis. Feb 7, 2007) quoting Travelers Ins. Co. v. Eljer Mfg. Inc., 757 N.E.2d 481, 496 (Ill. 2001).

⁴MW Builders, Inc. v. Safeco Ins. Co. of Am., 267 Fed. Appx.552, 554 (9^th Cir. Feb 15, 2008)(unpublished) (applying Oregon law); Adair Group, Inc. v. St. Paul Fire & Marine Ins. Co., 477 F.3d 1186, 1188 (10^th Cir. 2007).

⁵Westfield Ins. Co. v. Sheehan Constr. Co., No. 1:05-CV-0617-RLY-TAB, 2008 WL 4099007 (S.D. Ind. Aug. 29, 2008), aff’d 564 F.3d 817 (7^th Cir. 2009); Knutson Constr. Co. v. St. Paul Fire & Marine Ins Co., 396 N.W.2d 229, 235-37 (Minn. 1986); Auto-Owners Ins. Co. v. Pozzi Window Co., 984 So. 2d 1241, 1248 (Fla. 2008) quoting United States Fire Ins. Co. v. J.S.U.B, Inc, 979 So. 2d 871,889 (Fla. 2007).

⁶American Girl, 673 N.W. 2d at 78.

⁷See also, Adair Group, Inc. supra, 477 F.3d at 1188.

⁸See e.g. Transportation Ins. Co. v. AARK Constr. Group Ltd., 526 F. Supp. 2d 350, 356-57 (E.D.N.Y. 2007); Great Divide Ins. Co. v. Bitterroot Timberframes of Wyo., LLC., No. 06-CV-020-WCB, 2006 WL 3933078, at *(D. Wyo. Oct. 20, 2006); Kvaerner Metals v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006).

⁹American Girl, 673 N.W.2d at 77; Glendenning’s Limestone & Ready-Mix Co., v. Reimer, 721 N.W.2d 704, 712 (Wis. Ct. App. 2006).

¹⁰American Girl, 673 N.W.2d at 77; Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 13 (Tex. 2007).

¹¹American Girl, 673 N.W.2d at 75-76; Lamar Homes, Inc., 242 S.W.3d at 16.

¹²American Girl, 673 N.W.2d, at 78; See also, Auto Owners Ins. Co. v. Newman, No. 26450, 208 WL 648546, (S.C. March 10, 2008)(a narrow interpretation of “occurrence” would render the business risk exclusions meaningless); Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 137 P.3d 486, 494 (Kan. 2006).

¹³Travelers Indem. Co. of Am. v. Moore & Assocs., Inc. 216 S.W.3d 302, 309 (Tenn. 2007); Lennar Corp. v. Great Am. Ins. Co., 200 S.W.3d 651, 673-674 (Tex. Ct. App. 2006).

¹⁴Westfield Ins. Co., 2008 WL 4099007, at *11, citing R.N. Thompson, 686 N.E.2d at 165. See also, Stoneridge Dev. Co. Essex Ins. Co., 888 N.E.2d 633 (Ill. Ct. App. 2008); Monticello Ins. Co. v. Wil-Freds Constr., Inc. 661 N.E.2d 451, 456 (Ill. Ct. App. 1996); French v. Assurance Co. of America, 448 F.3d 693, 703 (4^th Cir. 2006)(applying Maryland law)(the cost to repair defectively installed stucco is expected and intended under the terms of the parties’ contract).

¹⁵Note, however, that the court in French also found that the moisture intrusion into the home was unexpected, as was the subcontractor’s negligent performance of its work, so that the moisture intrusion was an occurrence, and the cost of correcting the damage to the insured contractor’s otherwise nondefective work caused by the subcontractor’s negligence was covered. 448 F.3d at 704-06.

¹⁶General Security Indemnity Company of Arizona, 2009 WL 400053 (Colo. App.); Auto-Owners Ins. Co. v. Home Pride Cos., 684 N.W.2d 571, 577 (Neb. 2004). See also Selective Ins. Co. v. Cagnoni Dev., LLC., No. 106-CV-0760-DFH-TAB, 2008 WL 126950, at *11 n.4 (S.D. Ind. Jan 10, 2008), where the court characterized the rule that faulty work cannot be an occurrence because it is not accidental as the “majority” rule, citing cases from Indiana, Illinois, Michigan, Ohio, Iowa, and New Hampshire.

¹⁷Stanley Martin v. Ohio Casualty, 2009 WL 367589 (4^th Cir., slip copy); Auto-Owners Ins. Co. v. Pozzi Window, 984 So. 2d 1241 (Fla. 2008); Country Mut. Ins. Co. v. Carr, 867 N.E.2d 1157 (Ill. Ct. App. 2007); J.S.U.B., Inc., 979 So. 2d at 888; Webster v. Acadia Ins. Co., 934 A.2d 567 (N.H. 2007); Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 137 P.3d at 495; Auto-Owners, 684 N.W.2d at 578.

¹⁸See also Travelers Indem. Co. of Am., 216 S.W.3d at 308; Lennar Corp., 200 S.W.3d at 669 n.18.

¹⁹See e.g. General Security, 2009 WL 400053, ¶ 6; Lennar Corp. v. Auto-Owners Ins. Co., 151 P.3d at 545; Lennar Corp. v. Great Am. Ins. Co., 200 S.W.3d at 669 n.18 (listing cases that have so ruled); Auto-Owners Ins. Co. v. Home Pride Companies, Inc., 684 N.W.2d at 535.

²⁰Lennar Corp. v. Great Am., 200 S.W.2d at 664. The Texas Supreme Court later reached the same conclusion in Lamar Homes, Inc., 242 S.W.3d at 16, quoting Federated Mut. Ins. Co. v. Grapevine Excavation, Inc., 197 F.3d 720, 725 (5^th Cir. 1999).

²¹Lennar Corp. v. Great Am., 200 S.W.3d at 669 n.18; Lamar Homes, Inc., 242 S.W.3d at 9.

²²Lennar Corp., 200 S.W.3d at 671.

²³American Girl, 673 N.W.2d at 70 (soil engineer’s negligent advice (faulty workmanship) gave rise to soil settlement (the occurrence) which caused property damage to a building (cracking and buckling); Toldt Woods Condos. Owner’s Ass’n. v. Madeline Square, LLC, No. 2007AP1763, 2008 WL 3387532, ¶ 21 (Wis. Ct. App. Aug. 13, 2008)(mud rivers that caused damage to adjacent property were occurrences that arose from faulty workmanship in the nature of negligent erosion control practices); Kalchthaler, 591 N.W.2d at 173 (the occurrence, leaking windows, was caused by a subcontractor’s faulty workmanship); Glendenning's Limestone, 721 N.W.2d at 714 (construing the ruling in American Girl, stated: “We understand this to mean that faulty workmanship may cause, or be a cause of, an ‘occurrence,’ such as . . . the settling of soil under a building; we do not read it to say that faulty workmanship itself is an ‘occurrence’.”) The catch phrase is that “a CGL policy does not cover faulty workmanship, only faulty workmanship that causes damage to other property.” Toldt Woods Condos. Owner’s Ass’n, 2008 WL 3387532, ¶ 16; R.N. Thompson, 686 N.E.2d at 165.

²⁴See Stoneridge Deve. Co. v. Essex Ins. Co., 888 N.E.2d 633 (Ill. Ct. App. 2008); Country Mut. Ins. Co. v. Carr, 867 N.E. 2d 1157 (Ill. Ct. App. 2007); Viking Constr. Management, Inc. v. Liberty Mut. Fire Ins. Co., 831 N.E. 2d 1 (Ill. Ct. App. 2005).

²⁵Are Your Construction Defects Covered? Navigating the CGL Policy Maze, slide 40, The American Bar Association Forum on the Construction Industry National Teleconference (October 23, 2008).

²⁶Travelers Indem. Co. of Am., 216 S.W.3d at 309.

²⁷Auto Owners Insurance Co. v. Newman, 2008 WL 648546, at *3 relying upon High Country Associates v. New Hampshire Insurance Co., 648 A.2d 474, 477 (N.H. 1994), where the court found that continuous exposure of a condominium building to moisture resulting from a subcontractor’s defective installation of siding constituted an “occurrence.”

²⁸ Bulen v. West Bend Mut. Ins. Co., 371 N.W.2d 392 (Wis. Ct. App. 1985) and Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 (N.J. 1979).

²⁹ See also, Travelers Indem. Co. of Am., 216 S.2d 3d at 307.

This article is published courtesy of the July 2009 State Bar Business Law Section Business Law Section newsletter. The State Bar offers its members the opportunity to network with other lawyers who share a common interest through its 26 sections. Section membership includes access to newsletters, email lists to facilitate information sharing, and other resources.
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