What Does Your Insurance Really Cover?

March 19, 2012

When it comes to insurance, general liability standards vary widely – know where you stand.

As extreme weather continues to pummel the southeastern coastline, damaged buisnesses and buildings abound – as well as canceled events.

Schools, universities and other major buildings used as event venues can suddenly become emergency response hubs or shelters. Consider looking into event cancellation insurance and whether or not you’re eligible. If forces beyond your control, like the weather, are at fault, it could save you a significant amount of money on things like deposits to vendors.

In addition to considering event cancelation insurance, a wide variety of policies can cover other damage that befalls your building. In the worst of times, insurance can even be a building owner’s best friend.

But if the policy doesn’t cover what you think it covers, you’ll quickly be facing an expensive nightmare.

In addition to property insurance, which covers damage to your property by someone else, nearly all buildings carry comprehensive general liability (CGL) policies that protect the building owner against others’ claims of injury or damage. But what you may not realize is that the standard terms in these policies are defined quite differently by many states.

What you don’t know could cost you.

The introduction above was edited on September 28, 2018 by BUILDINGS staff writer Sarah Kloepple.

What Can Happen?

Imagine a hypothetical scenario in which Smith Construction installs stucco on the curbside wall of the Jones Office Building.

Six months later, during a severe rain storm with high winds, stucco falls off the wall and lands on a pedestrian. Rainwater then seeps into the Jones building, causing not only structural damage, but also a six-week shutdown of several floors of the building and the consequent loss of rent from the office building’s tenants.

Before this incident, Smith Construction bought CGL coverage from XYZ Assurance. The policy has some standard requirements, including the identification of an occurrence that caused damage, with the inclusion of a customary completed operations exclusion. This exempts the insurance company from having to replace whatever the customer was contractually required to install.

The situation grows more complex when the pedestrian sues both the office building and the construction company for bodily injury caused by the falling chunk of stucco.

In return, Jones Office Building sues Smith Construction for breach of warranty, defective workmanship, and negligence, seeking indemnification (adequate compensation for financial losses), contribution, and the costs of structural repairs and lost rental.

Related: 5 Ways to Fail Your Building’s Disaster Response

Smith turns to its insurer, XYZ, demanding coverage against these claims. But the insurance company refuses to provide indemnity or legal defense, asserting that an occurrence did not cause the damage.

The result: a declaratory judgment suit between XYZ and Smith to interpret the terms of the insurance policy.

But who is in the right?

How Your Location Impacts Coverage

The answer – and the outcome of the suit – depend on which state’s law applies. Were the damages to the pedestrian and the Jones Office Building caused by an “occurrence” as Smith’s insurer understands it? Can mere poor workmanship constitute an “occurrence”? The states are split.

Pennsylvania, for example, says no. In 2006, the Pennsylvania Supreme Court noted that standard policy language defines an occurrence as an accident – i.e. an unexpected event caused by a degree of fortuity.

Poor workmanship, even if it’s presented as a negligence claim, is not an unexpected accident. To claim otherwise would transform a CGL policy into a performance bond.

In 2007, the Pennsylvania courts held that rainfall also doesn’t constitute an “occurrence” because it’s not unexpected, even if the rain damages the interior of a building due to a stucco contractor’s faulty workmanship.

Ohio, Kentucky, Massachusetts, Mississippi, and Arkansas have all adopted a similarly restrictive view since 2008, so the outcome of Smith v. XYZ Assurance in these states would end in the insurance company’s favor.

On Guard for Legal Complications

My client, Smith Asphalt Co. (whose name has been changed to protect their privacy), experienced a problem much like the Smith vs. XYZ Assurance case. Old English Homes in southern New Jersey hired Smith to install a base course of asphalt (one of three or more layers of work in a typical roadway) for a road in a new residential development.

The original plans called for a 3-inch asphalt layer, but Smith warned Old English that the layer should be increased to 4 inches or construction vehicles should be barred from using the new roadway. Old English thanked Smith kindly for its advice and ignored it.

Surprise! The asphalt base and its gravel underlay were too shallow, just as Smith predicted.

Cracks and pits soon developed after heavy construction equipment drove on the new road. Old English then thanked Smith for its warning by suing them for poor workmanship and agreeing to install the defectively designed roadway. This lawsuit was ultimately dismissed with prejudice. No settlement was paid or offered.

Smith’s CGL carriers both refused to indemnify Smith or provide a defense, so Smith was stuck with legal bills of about $9,500.

The company sued both carriers for indemnification for legal fees incurred in this case and in the first-party lawsuit for coverage. Smith claimed that any language of a complaint against it that falls within the policy’s scope requires the carriers to provide defense even if the underlying claim is meritless.

The carriers objected, saying that because the basis of the claim was that Smith failed to fulfill its construction contract, finding in favor of coverage would convert the CGL policy into a performance bond. There was no sudden “accident” or “occurrence,” nor could they link Smith alleged negligence and poor workmanship to the roadway damages.

Both Smith and its carriers moved for summary judgment, arguing that there were no material facts in dispute. The trial judge declined to grant summary judgment to either side and scheduled a trial, assuming accurately that this would produce a settlement.

The two carriers divided the cost of the settlement and Smith ended up with a dismissal of the lawsuit and a reimbursement of over 50% of their out-of-pocket expenses.

Not the stuff of heroic courtroom legend, but a business-like approach to risk management.

However, other states would declare the opposite.

In 1959, the California Supreme Court held that the faulty installation of defective doors constituted an “accident” and that water damage to the building (not including replacement of the faulty doors themselves, which are excluded by the completed operations exclusion) and the consequent loss of use were covered by the policy after all.

They defined an accident as an “unexpected, unforeseen, or undesigned” event. Certainly a construction failure must be unintended to qualify for coverage. Other than blatantly obvious accidents waiting to happen, damages to third parties from faulty workmanship appear to fall within the scope of California’s CGL coverage. Indiana, Georgia, Texas, and Florida reaffirmed this position.

New Jersey, on the other hand, expanded CGL coverage even further.

Read also: De-Risk Building Management with the Cloud

Since at least 1979, the state has held that defective workmanship that results in bodily injury to a person or damage to someone else’s property is a covered occurrence in a CGL policy even if the defect develops gradually instead of suddenly.

In 2011, South Carolina held for coverage in a similar progressive property damage case where the damage was caused by the policyholder’s subcontractor (“the subcontractor exception”), using a “time on risk” analysis to apportion damages. Maryland, Kansas, and Wisconsin adopted the same subcontractor exception.

What If My Company Operates in Multiple States?

Which state’s law applies to Smith v. XYZ Assurance? The answer depends on several factors.

The law of the state where the accident occurred is generally not applicable unless the policy specifically identifies a site-specific risk. The resulting declaratory judgment suit doesn’t seek damages from the accident itself, but instead asks the court to interpret the provisions of an insurance contract.

The conflict of laws principles (rules that determine whose legal system applies to the dispute) are then applied. In contract cases, most states follow the governmental interest test to determine which state’s CGL precedent applies. This test includes:

  • If the parties mutually understood that a specific site was the location of an insured risk, the law of that state will apply unless it is shown that some other state has a superior interest in the outcome.

  • Does the policy identify a site-specific risk? If operations are covered in only one jurisdiction, a site-specific risk is inferred. However, if the policy covers operations in multiple states, then the mere fact that a particular state is listed doesn’t justify an inference of site-specific coverage in that state. In that case, the site of the insured risk must be expressly designated. Operations in multiple states can make multiple designations of site-specific risk for different locations.

  • If the policy doesn’t include any site-specific provisions, the courts will look to a handful of factors to determine which state has the most interest in the case. These include where the insurance contract was formed, where the contract was negotiated, where it will be performed, and where the accident occurred. The domicile of the insured and the insurer are considered as well.

The policyholder’s place of performance is the state where it maintains its business office or where it mailed or electronically transferred its payments for insurance premiums.

The insurance company performs in the forum state (the state whose courts will hear and decide the dispute) where it may be required to proffer a defense, which may or may not be the state where the accident occurred. Courts weigh these factors qualitatively, and as can be expected, the nuances of this process vary widely between states.

How can you protect yourself?

The most important lesson is to know where you stand – be aware of the law governing the occurrence clause in your home state, plus any states where you’re about to start construction.

Make sure you include site-specific designations in your policy endorsements, even multiple designations for different projects. Cover your bases before the outset of any project as a proactive defense against future claims.

Bill Tobolsky, the founder of Tobolsky Law, focuses his practice on large and small businesses, nonprofits, and charitable foundations in civil litigation, including business, commercial, and construction disputes, insurance coverage litigation, real estate litigation, foreclosure defense, surety and guarantee matters, construction liens and bonding issues.

This article was originally posted on March 20, 2012.

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