Hot Issues in Construction Defects Insurance Coverage

Hot Issues in Construction Defects Insurance Coverage

A March 4, plenary session at the ICLC annual meeting was devoted to hot issues in construction defects insurance coverage. These include: (1) issues arising out of the Chinese drywall problem-some drywall manufactured in China emit sulfur fumes associated with respiratory and sinus problems in some residents and cause metals, such as air conditioning coils, to corrode; (2) additional insured claims; and (3) priority of coverage disputes, e.g., as between additional insured and named insured coverage, or between a wrap-up insurer and general liability insurer. The speakers were Marianne Boykin of Liberty Mutual Insurance/Helmsman Management Services; Maria Moreno; Ruth S. Kochenderfer of Steptoe & Johnson LLP; John B. Mumford, Jr. of Hancock, Daniel, Johnson & Nagle; and Jeffrey J. Vita of Saxe, Doernberger & Vita, P.C.

In the paper accompanying their presentation, Ruth S. Kochenderfer and John Mumford, Jr. identify the insurance issues arising from the Chinese drywall problem as including whether there is an occurrence, the number of occurrences, trigger of coverage, the pollution exclusion, and the "business risk" exclusions. Each of these issues is discussed. Ms. Kochenderfer noted in the conference that the issue as to the number of occurrences issues is a particularly "hot debate." A majority of jurisdictions, but not all, have found that faulty workmanship or construction defect claims, including defective Chinese drywall, neither constitute nor arise from an "accident" and thus there is no "occurrence" and therefore no coverage under standard CGL policies. While the Fifth Circuit so held, the Mississippi Supreme Court recently found otherwise. Another key issue is does each home built with Chinese drywall constitute a separate occurrence, or was a contractor's use of Chinese drywall and total exposure a single occurrence for purposes of determining any deductible or self-insured retention and the policy limits? The authors examine various tests and court decisions on the number of occurrences in these matters and find that there is no clear, universal answer. The outcome will depend upon such factors as how limits are applied in the policy at issue and what tests the court will apply to the question. If there is an "occurrence," an issue may arise as to when did the injury or damage resulting from the occurrence take place and which policy or policies may be triggered as a result. The authors discuss the most commonly used trigger theories and find that the outcome may well depend on which of the theories the court applies to the issue. At the conference, the speakers mentioned that it might be at the point of exposure, or when there was a manifestation of bodily damage or property damage or emotional damage, or when there was injury-in-fact or is the occurrence continuous.

Will the pollution exclusion preclude coverage for Chinese drywall defects? The authors examine various pollution exclusion provisions and survey court decisions on the issue and determine that in most, but not all instances, the exclusion will bar coverage for Chinese drywall claims. They also identify arguments to the contrary that policyholders' counsel can argue. Lastly, the authors discuss the possible application of "business risk" exclusions, such as: the "your product" exclusion, the "your work" exclusion, the "impaired property" exclusion, and the "sistership" exclusion. The authors conclude that coverage for Chinese drywall claims often will be precluded based on the facts of the claims and the policy language of the insurance contracts at issue.

Jeffrey Vita addressed the issue of determining priority in the instance of overlapping coverage. A paper accompanying his presentation notes that this is a frequent point of contention in construction defect claims, as several policies may be implicated: (1) Property owners may well have commercial property and/or builder's risk insurance; (2) General contractors and subcontractors typically have liability coverage; (3) Project owners may be named as additional insureds under the general contractor's and subcontractor's liability policies: and (4) The general contractors likewise require coverage as additional insureds under their subcontractors' policies.

Thus, for construction projects there are multiple policies insuring the same risk. A whole host of issues can come into play. Mr. Vita likens the scenario to a game of "hot potato" with each insured and insurer alike seeking to avoid being stuck with substantial liability. He finds that the determination of priority among these policies often depends upon the language of the insurance policies at issue, the construction contracts involved and the law of the jurisdiction which governs the loss.

The paper discusses some of the most frequent issues that arise in making this determination. A prime one is the use of the "Other Insurance" clause to minimize an insurer's payment obligation when there is other insurance for the same loss. Various types of such clauses, notably the pro rata, excess and escape clauses are discussed. The courts have applied diverse methods to "reconcile the dueling other insurance clauses." Another frequently arising issue concerns the additional insured requirements. When a loss occurs, owners and general contractors typically look to their additional insured's policies before turning to their own policies. This preserves their own policy limits and minimizes their loss history, which keeps premiums down. To accomplish this, owners and general contractors have construction agreements that require other parties for example, subcontractors, to purchase insurance that is primary should there be a loss at the project. Most contractor agreements have a contractual indemnity provision which requires the subcontractor to accept liability for claims brought against the owner or general contractor, when it is wholly or partially responsible for the alleged loss or damage.

Some courts have found that such indemnity provisions affect insurance coverage priority, but not all have found that the contractual indemnity agreement controlled the outcome of insurance priority. The existence of excess or umbrella insurance has led to further controversy as to whether the language in such policies takes precedence over contractual indemnity provisions. Issues of horizontal and vertical exhaustion come into play. Still other situations involve instances where coverage is purchased to specifically insure losses at a particular construction project while other coverage generally insures the same party for losses within a broad coverage territory. In some jurisdictions, the policy "closer to the risk" may be tapped before the blanket policy is reached. Lastly, courts have found that self-insured retentions are not insurance and so cannot be reached under "other insurance" clauses.

These and other construction defects insurance issues are examined in Chapter 37 of California Insurance Law and Practice (Lexis Nexis). Among the additional topics discussed in the chapter are insurance coverages relevant to construction projects, builder's risk insurance issues; CGL coverage issues such as pertinent exclusions; E&O exclusions, burning limits, project-specific policies, and design-build policies; completed operations coverage under wrap programs; continuing loss issues; and issues pursuing insurance coverage for a construction claim. The next release of New Appleman Insurance Law Practice Guide will also feature a chapter on the insurance issues surrounding construction defects.