Standard CGL Policies Provide Coverage for Sub's Construction Defects, Florida Supreme Court Holds

February 11, 2008

This article originally appeared as a post on the blog ConstructionWebLinks.com.

Co-authored with Laura Thomson

In a much-anticipated decision, the Florida Supreme Court has confirmed that a subcontractor's faulty workmanship can constitute an accident and thus be an "occurrence" under a post-1986 commercial general liability (CGL) policy. United States Fire Insurance Co. v. J.S.U.B., Inc., 2007 WL 4440232, 2007 Fla. LEXIS 2394 (Fla. 2007).

The Florida decision is consistent with the law in the majority of states to consider the issue, including Wisconsin, Kansas, Texas, Minnesota and Tennessee. This is good news for contractors (and other insureds) that expect their coverage to be governed by the actual language in their CGL policies and not by broad principles held over from pre-1986 CGL policies and employed by a minority of courts in other jurisdictions.

The Florida case involved a subcontractor's use of poor soil and improper soil compaction and testing, which damaged foundations, drywall and other interior portions of several completed homes built by J.S.U.B, Inc.

J.S.U.B. sought coverage for the damage under CGL policies issued by United State Fire Insurance Co. U.S. Fire agreed that J.S.U.B.'s policies covered damage to the homeowner's personal property, such as its wallpaper, but denied coverage for the costs of repairing the structural damage to the homes.

After repairing to the homes, J.S.U.B. filed a declaratory judgment action to determine whether coverage existed for the cost of repairing the structural damage. The trial court entered judgment for U.S. Fire, relying on a 1980 Florida Supreme Court case holding that faulty workmanship was not covered. LaMarche v. Shelby Mutual Insurance Co., 390 So. 2d 325 (Fla. 1980),

A Florida appellate court reversed. The Florida Supreme Court took up the issue and affirmed the appellate court, noting that LaMarche rested on pre-1986 CGL policy language, which was inapplicable.

The U.S. Fire CGL policies provided coverage for the "sums that the insured becomes legally obligated to pay as damages” because of "bodily injury" or "property damage" caused by an "occurrence" within the "coverage territory" during the policy period.

"Occurrence" is defined in the policy as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." The policies also contained "products-completed operations hazard coverage." Among its exclusions were (j) Damage to Property (with a "products-completed operations hazard" exception) and (l) Damage to Your Work (with a subcontractor exception).

U.S. Fire did not argue that the policy exclusions barred coverage but rather that the insuring agreement itself barred coverage for the claim. U.S. Fire argued that only third-party property damage was covered under the agreement.

Finding no such distinction in the definition of "occurrence," the Florida Supreme Court rejected this argument and held that the appropriate consideration is not whose property is damaged but whether the damage was expected or intended from the standpoint of the insured.

The court rejected the argument that faulty workmanship is expected and therefore outside the scope of the policies. "There is simply nothing in the definition of the term 'occurrence' that limits coverage in the manner advanced by U.S. Fire, and we decline to read the broad 'business risk' exclusions at issue in 1980 decision in LaMarche into the definition of 'occurrence' used in the coverage provisions of the post-1986 standard CGL policies at issue."

The court further rejected the argument that construing the definition of "occurrence" to include a subcontractor's defective work converts the liability policy into a performance bond.

Discussing salient differences between the policies and performance bonds, the court explained that finding the damages may result from an occurrence "is only the first step in determining whether the damages are covered." As the court explained, coverage still may be precluded because the occurrence did not cause "property damage" within the meaning of the policy or because of an exclusion to the insuring agreement.

As to the exclusions applicable here, the court found that U.S. Fire's position would render the "products-completed operations hazard" exception to Exclusion (j)(6) and the subcontractor exception to Exclusion (l) meaningless.

While cautioning that exclusionary clauses cannot be relied upon to create coverage, the court explained that pertinent provisions should be read together. And, the court "simply [could] not ignore the exception that has now been incorporated into exclusion (l), an exception that clearly applies to damages to the insured's own work arising out of the work of a subcontractor."

As the court reasoned, if the insuring provision does not confer the initial grant of coverage for faulty workmanship, there would be no need for the "your work" exclusion or for the subcontractor exception to this exclusion.

The court devoted a portion of its decision to the "origin and evolution of CGL policies." In discussing the addition of the subcontractor exception to the 1986 revision of the standard form CGL, the court quoted 2 Stempel on Insurance Contracts §14.13 [D] for the rationale behind the addition:

[T]he insurance and policyholder communities agreed that the CGL policy should provide coverage for defective construction claims so long as the allegedly defective work had been performed by a subcontractor rather than the policyholder itself. This 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.

The court also quoted a July 15, 1986, Insurance Services Office circular which "confirm[s] that the 1986 revisions to the standard CGL policy not only incorporated the 'Broad Form' property endorsement but also specifically cover[ed] damage caused by faulty workmanship to other parts of work in progress; and damage, to, or caused by, a subcontractor's work after the insured's operations are completed."

Chief Judge Lewis, in his concurrence, noted the "substantial evidence" that the insurance industry itself altered the intent of CGL policies "by extending coverage – albeit in a convoluted fashion – to insureds for fortuitous damage caused to their completed projects by faulty subcontractor work."

Of particular note, he wrote that court opinions which "hold otherwise regarding standard-form post-1986 CGL policies do not address the evidence in this and other more recent CGL cases," which he emphasized "indicates that this extension of coverage, while inartfully executed, is exactly what the parties have accomplished – and intended to accomplish – by altering the your-work exclusions to no longer exclude the type of coverage disputed in these cases.”

The court further rejected a public policy argument. It found that contractors would not face a "moral hazard" regarding coverage for their own work – being reimbursed under its insurance contracts for the cost of repairing damage caused by defective work is not a windfall to a contractor. Moreover, the court noted, "if the insurer decides that this is a risk it does not want to insure, it can clearly amend the policy to exclude coverage, as can be done simply by either eliminating the subcontractor exception or adding the breach of contract exclusion."

The court concluded that the subcontractor's faulty workmanship caused structural settlement to the homes, which was "property damage" covered under the policy.