Contractor General Liability Insurance And Workers´ Compensation Insurance Savings Up To 38%!

Court cases nationwide are split on the issue of whether or not construction defects are considered as occurrences.

A ruling by the Georgia Supreme Court that negligent construction resulting in damage to surrounding property constitutes an occurrence under a commercial general liability policy is the latest in a string of such decisions with courts divided on the issue.

In another recent case in Hawaii, Group Builders Inc. and Tradewind Insurance Co. Ltd. vs. Admiral Insurance Co., the Hawaii Supreme Court ruled that damage from construction defects was not considered an occurrence. Because of this and other cases, some insurers and re-insurers have began to change policy language to say that poor workmanship does not constitute an occurrence. However, property damage stemming from the poor workmanship itself would be considered as an occurrence.

SOURCE: Michael Bradford, Business Insurance

We came across a fantastic article that outlines the various theories of recovery against residential builders in South Carolina under implied warranty and tort liability. South Carolina has strong pro homeowner case law and builders need to be aware of the theories of recovery in order to avoid liability. We often see these theories of recovery listed on lawsuits filed against our builder clients that purchase contractor General Liability policies.  

The article also distinguishes between the liability of professional builders versus homeowners who build homes for their own private use. In some cases, homeowner builders can escape liability under the implied warranties.

Here are the highlights of the article:

Implied Warranty Of Workmanship / Workmanlike Service

* Warrants that the home will be built with the quality one   would reasonable expect for a careful, diligent workman.

* Arises from he contract for construction for a new home.

* Applicable only to a builder who “is in the business of constructing homes”.

Implied Warranty Of Habitability / Fitness For A Particular Purpose / Merchantability

* Warrants the home will be fit for habitation

* Arises from the initial sale of a new home, not a used home

* Applicable to the home’s first seller only (not necessarily the builder) and not to any subsequent sellers.

 Tort – Negligent Construction

* Builder is liability for negligence in construction of a house

* Violation of building codes and industry standards

* Homeowner may recover for mere economic loss

* Existence of duty depends on foreseeability of future purchasers

 Lack Of Privity Of Contract Not A Defense For Builder

The concept of privity of contract is important in determining if a duty is owed by a builder under implied warranties. Both parties (builder and initial purchaser) are in privity of contract. However, subsequent purchasers are not in privity of contract with the builder. Builders have attempted to use lack of privity as a defense but the courts in SC have struck down that argument. Instead, if it’s reasonably foreseeable that a home will be used by subsequent purchasers, the builder owes a duty to them under implied warranty law. In most situations, it is foreseeable that the home built by a professional builder will be used by multiple subsequent purchasers.

 A House Is Not A Product Under Strict Liability / Product Liability

The SC courts have ruled that strict liability and product liability theories of recovery are applicable because the building of a house is the performance of a service and not the sale of a product.

The Uniform Commercial Code (UCC) And Implied Warranties

Article 2 of the UCC governs the performance of goods and the associated warranties of fitness for a particular purpose and merchantability closely track the home construction implied warranties of habitability and workmanship. SC courts have looked at rationale found under Article 2 of the UCC when deciding construction implied warranty cases; however, they have dismissed the argument that the UCC should govern the sale of a house.

Warranty Disclaimers

Builders often attempt to disclaim implied warranties but SC courts require stringent conditions such as a requirement for the disclaimer to be conspicuous, known to buyer, and specifically bargained for (i.e. price discount or other desired benefit to buyer).

Statutes Of Repose And Statutes Of Limitation

In 2005, the SC legislature adopted an 8 year statute of repose, which applies to actions based on defective or unsafe condition of improvements to real property such as breach of contract, breach of warranty, and tort claims. The 8 year time period starts upon substantial completion of improvement to real property, within which, normal statutes of limitations continue to run. The applicable statute of limitations to bring an action for implied warranty and negligence actions for a home is three years in SC.

Source: Caveat Venditor, South Carolina Lawyer, March 2011, Joshua D. Spencer

On March 9, 2011, The SC Supreme Court granted a petition for rehearing on the controversial Crossmann v. Harleysville decision, which was the subject matter of two prior blogs.

Hopefully, the SC Supreme Ct. will reverse its prior, unfortunate decision that not only perverted the intent of the drafters of the General Liability policy, but also insulted builders by stating that property damage which results from faulty construction is always expected and intended.

Oral arguments will be held on May 23, 2011. Expect the insurance industry to be opposed by various contractor trade associations.

Stay tuned.

Crossmann Is Bad Decision For SC Contractors

 The recent Crossmann decision by the SC Supreme Ct. is a bad decision that distorts the intent of the drafters of the General Liability policy and creates a fiction that all contractors intend or expect the property damage that arises from their faulty construction. Please see my prior blog for more details on the Crossmann decision.

The Crossmann case has set off a firestorm of protests in the contractor community and the resulting proposed legislation to overturn Crossmann which is modeled after a new Colorado law.

 Proposed Legislation Under Bill No: S. 431 Professional Contractor’s CGL Policy (February 8, 2011)

 After reviewing the proposed legislation, it’s my opinion that it’s favorable to the extent that it overturns Crossmann but it’s unfavorable to the extent that it forces other rules of interpretation for General Liability polices on the issue of coverage for construction defect.

The proposed legislation includes the following provisions that reinforce and add weight to existing common law principles of insurance policy interpretation for General Liability policies for construction professionals:

* favor interpretation of insurance coverage broadly for the insured

* favor broad interpretation of the duty to defend

* ambiguities in coverage settled in favor of insured

* consider reasonable expectations of coverage on behalf of insured 

The following additional provisions are included for dealing with construction defect claims under a General Liability policy for construction professionals which may go beyond existing common law principles of insurance policy interpretation:

 * in considering reasonable expectations of coverage for an insured, a court should look at

  – the reason why the insured purchased the insurance policy

  – whether the construction defect directly or indirectly resulted in bodily injury or property damage

  – any other sales or promotional materials from the carrier or ISO that describe the insurance policy that was sold and relied upon by the insured

* favor coverage if a provision that grants or restores coverage conflicts with a provision that excludes or limits coverage

* if carrier disclaims or limits coverage for a construction professional, the carrier bears burden of proving by a preponderance of evidence that a construction defect exclusion exists and there is no exception to the exclusion.

* duty to defend a construction professional is triggered by a potentially covered liability described in a claim notice or legal papers filed against construction professional concerning a construction defect.

* carrier shall defend a construction professional regardless of whether another carrier may also owe a duty to defend

The following provisions greatly alter the terms of a General Liability policy for professional contractors faced with construction defect claims:

* occurrence is redefined to do away with the “additional or accompanying requirement of an accident or fortuitous event” as referenced in Crossmann. This provision overturns the impact of Crossmann.

* “Prior Completed Operations Exclusions” and similar exclusions found on some contractor policies are prohibited to extent that they exclude bodily injury or property damage arising from construction defect that occurred prior to the policy effective date unless the insured had knowledge of such bodily injury or property damage.

Do Parties Really Understand The Big Picture?

I attended a SC Senate Banking And Insurance Committee meeting on February 9, 2011 as regards Bill No: S. 431 Professional Contractors CGL Policy. The purpose of the meeting was to provide the committee with feedback from affected parties regarding the proposed bill. The room was filled with both pro contractor and pro insurance industry factions. The committee heard concerns from three parties in favor of the legislation (representatives from a home owners association, general contractor, and subcontractor) and from two parties against the proposed legislation (insurance industry lobbyist and lawyer representing insurance industry trade group).

While the meeting progressed with statements from the parties and questions and comments from legislators, it struck me that both sides are proceeding under mistaken beliefs about their own positions.

Pro Contractor Mistaken Beliefs

Claim: The legislation will force General Liability carriers to provide construction defect coverage for contractors on a going forward basis.

Reality: While Crossmann is a terrible decision, the proposed legislation does not solve the problem of readily available construction defect coverage on a going forward basis for the following reasons:

* Carriers can still use Exclusion CG2294 or similar exclusions to deny construction defect claims.

* Carriers can refuse to insure contractors if they don’t like the new legislation.

* Carriers can agree to cover construction defect claims but may resort to a construction defect coverage sublimit such as $5,000.

* Carriers will likely use the new legislation as reason to justify rate increases.

While the anti Crossmann battle is worth fighting, contractors should not be told that this legislation will solve their problems.  However, the legislation to overturn Crossman is crtical for contractors with pending claims where carriers are now threatening to walk away from their obligations due to the Crossmann decision.

Pro Insurance Industry Mistaken Beliefs

Claim: Insurance carriers need Crossmann to protect their interests of being able to control the construction defect risk on a going forward basis.

Reality: The current solution of using Exclusion CG2294 has worked well for carriers wanting to deny construction defect claims. CG2294 has been readily used since 2004 and has been generally upheld by courts. However, for those construction defect cases that arose before the widespread use of CG2294 in 2004, the Crossmann “no occurrence claim denial strategy” is critical for escaping liability.

In addition, supporting Crossmann hurts the insurance industry’s credibility since Crossmann distorts the intent of the drafters of the General Liability policy, Insurance Services Office (ISO), as explained in my earlier blog. The Independent Agents And Brokers Association (IIABA), the largest association of insurance agents, is on record in their Big I University publication as stating that the Crossmann line of “no occurrence claim denials” is a mistake. The faculty points out that the proper way to control the construction defect risk is through the use of Exclusions such as CG2294.

My Opinion

As has already been stated, Crossmann is a terrible decision and should be addressed. But how?

The proposed legislation goes way too far beyond solving the Crossmann problem. The additional rules about how General Liability policies apply to construction defect claims are an intrusion by the legislature on matters that should be left up to the courts.

If the courts fail to properly address a problem as in Crossmann and flip flop back and forth, matters of policy interpretation are better left up to state insurance departments working with Insurance Services Office (ISO). Bad rulings like Crossmann and proposed legislation will hopefully prompt state departments of insurance to get ISO to take action by issuing new clarification endorsements to settle matters of policy interpretation.

Even if the proposed legislation is limited (as I recommend) to overturning Crossmann, the positive effects for contractors will be minimal on a going forward basis for reasons outlined above under Pro Contractor Mistaken Beliefs.  However, overturning Crossmann is critical for contractors with pending construction defect claims.

Source: John Sadler

Decision Detrimental to Builders And Homeowners In South Carolina                                                                                                           

In the recent SC Supreme Court case of Crossmann v. Harleysville filed on January 7, 2011, the SC Supreme Court ruled that faulty workmanship which results in property damage to a builder’s work is no accident. Instead, such property damage is intended, foreseen, expected, and a natural and probable consequence of the builder’s faulty workmanship. Therefore, faulty workmanship does not rise to the level of an “occurrence” and as a result is not covered by a builder’s General Liability policy. 

The end result of Crossmann is that builders won’t be able to get construction defect coverage and homeowners will be left uncompensated when builders don’t have the assets to make repairs “out of pocket”. However, there is some hope that the insurance industry will develop a new endorsement to counter the Crossmann line of “no occurrence claim denials”. In addition, a bill is being drafted in the South Carolina legislature to do the same.

Summary Of “Occurrence” Requirement In Crossmann

In order for construction defect coverage to exist for a builder under a General Liability policy, the first hurdle to be cleared is that the claim must be the result of an “occurrence”. The policy defines “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions”. In other words, the term “occurrence” is generally synonymous with “accident”.

In a prior blog, it was explained how the SC Supreme Court finally got it right in its Auto Owners v. Newman decision where it held that the resulting property damage from faulty construction was an “occurrence” under the General Liability policy. In the Auto Owners case, the court held that the defective application of stucco in itself was not an “occurrence”; however, the resulting continuous moisture intrusion to the walls and exterior sheathing resulting from the subcontractor’s negligence was an “occurrence” since it was unexpected and not intended.

Unfortunately, in Crossmann, the SC Supreme Court flip flopped and decided that it erred in the Auto Owners v. Newman case to the extent that the prior finding of an “occurrence” did not take into account the fortuity (chance) component of an “accident” but instead relied upon the “continuous or repeated exposure to substantially the same general harmful conditions” part of the definition in isolation. Crossmann clarifies that an “occurrence” must be unintended, unforeseen, and fortuitous.

In addition, the court in Crossmann made the following statements:

* “… in analyzing whether a claim is covered under a CGL policy, we first focus on whether there has been an ‘occurrence’… we then look to whether there has been ‘property damage’ as defined by the policy.” 

* “In finding no ‘occurrence’, we need not determine whether there is “property damage” and we believe to address this issue creates unnecessary confusion.”

* “To provide coverage under these circumstances would transform the CGL policy into a performance bond.”

* In footnote (5), distinctions are drawn between tort actions (damages to property of a third party or injury to a person) and contractual actions (faulty workmanship that damages only the insured’s project). It is implied that contractual liability does not result in an occurrence, but tort liability does. The standard CGL policy “does not cover an accident of faulty workmanship, but rather faulty workmanship which causes an accident”.

Is Property Damage Resulting From Faulty Workmanship Always Intended And Expected? 

The ruling in this case is an insult to the many professional builders that I’ve advised and insured over the past 25 years. For those builder clients that have had construction defect claims filed against them, to say that they intended and expected the construction problem to arise is not true in the majority of cases. Many of the claims were frivolous lawsuits where the true cause of the problem was lack of routine maintenance on the part of the homeowner such as lack of caulking. Other claims resulted from the use of synthetic stucco (EIFS) and similar products where the builder had no reason to believe that such products would ultimately be found to be inherently defective. However, the majority of the claims were caused by unknowing mistakes in the construction process where the builder certainly didn’t expect a problem to arise. 

Can Faulty Workmanship Be An Accident?

Can property damage to a contractor’s work caused by faulty workmanship occur accidentally? Or is such property damage always the natural and probable (intended) consequence of faulty workmanship and thus not an accident? In Crossmann, the court ruled the latter. But, is this correct? I don’t think that it is. 

The Independent Insurance Agents And Brokers Association (IIABA) prepared a well thought out response to this issue in a 2006 publication entitled the “No Occurrence Claim Denial”. To follow is an overview of the findings of the IIABA faculty as regards the issue of the validity of the “no occurrence claim denial”.

When The “No Occurrence Claim Denial” Is Valid (Deliberate, Shoddy Work)

* Contractor’s deliberate use of substandard materials, violation of local building codes, breach of the construction contract, disregard for design specifications, or use of substandard construction practices so that faulty workmanship is or should have been foreseeable and expected.

* When “fly by night” contractors enter a disaster area such as after a hurricane and perform shoddy repairs by cutting corners to maximize profit and then make a quick exit. This is a deliberate act of faulty workmanship and such contractors know that their work will fail 

* When work is subbed to a contractor who is known to be incompetent or who has a poor track record of past problems. In such cases, it is a reasonable certainty that defective construction will be an “ordinary or natural consequence”.

When The “No Occurrence Claim Denial” Is Not Valid (Ordinary Negligence)

* Most contractors want to make a profit and understand that their reputation is important to this goal. With this in mind, no contractor would intentionally engage in faulty workmanship or expect that its work product would deteriorate. Unless there is evidence to the contrary, it should be assumed that faulty workmanship was negligently and accidentally caused. 

* In “Hot Topics Involving Liability Insurance Coverage”, Clifford J. Shapiro explains “Acts that cause construction defects normally are undertaken with the intent to perform the work properly, but unknowingly are performed improperly by mistake. The property damage that results from these mistakes is therefore neither intended nor expected by the contractor performing the work. Accordingly, property damage that arises out of construction defects should be considered ‘accidental’ and held to qualify as an ‘occurrence’ under the CGL insurance policy.” 

Crossmann Disregards Intent Of Drafters Of General Liability Policy Form 

The drafters of the General Liability policy form, Insurance Services Office (ISO), designed the policy form to provide a broad grant of coverage for “bodily injury” and “property damage” caused by an “occurrence” in the initial insuring agreement. Then, the design called for a list of policy exclusions to whittle away coverage for various uninsurable risks such as business risks. Furthermore, it was intended that various policy endorsements could be tacked onto the policy form to further alter coverage.

In order for coverage to be triggered for a construction defect claim, the incident must first be considered to be “property damage” caused by an “occurrence” before the impact of various property damage exclusions can be considered. The Crossmann case, in ruling that construction defect cases are not an “occurrence”, cuts off all subsequent discussion of the property damage exclusions and special property damage endorsements. This is a distortion because it was the intent of the drafters of the General Liability policy, Insurance Services Office (ISO), to control which types of property damage claims are or are not covered through the exclusions section of the policy. In addition, various insurance carriers draft special policy endorsements to clarify their intent on paying these claims.

Insurance Industry Already Provides Solution For Carriers To Avoid Construction Defect Claims 

In a free market, insurance carriers should be able to decide whether or not to write General Liability policies for builders as well as their approach to coverage for construction defect claims. Some may want to exclude all property damage arising from construction defect and others may want to provide total or partial coverage. The design of the General Liability policy allows this flexibility through the use of special policy endorsements to alter or clarify the coverages of the basic policy form.

Carriers that wish to insure contractors, but avoid paying construction defect claims, merely need to add the ISO policy endorsement entitled “Exclusion – Damage To Your Work Performed By Subcontractors On Your Behalf” (CG2294). This endorsement has been in widespread use since 2004 and has proven to be very effective in denying construction defect claims.

In my opinion, the reason why the carriers are not satisfied with CG2294 is because they can’t use it to address construction defect claims that arose before the widespread use of the endorsement in 2004. Instead, their only option to escape responsibility for these claims is to pursue the “no occurrence claim denial” strategy.

 At the present time, several carriers in South Carolina are using special property damage endorsements that they drafted to provide partial coverage to builders for construction defect claims. Most of these endorsements take the form of excluding coverage for property damage to the faulty work itself, but providing coverage for resulting property damage to non faulty work. Many within the building community think that this is an acceptable compromise. 

Summary

The Crossmann decision creates a fiction that builders always intend or expect the property damage that results from even unknowing faulty construction. It also subverts the General Liability policy form drafter’s intent of basic policy construction, as well as the ability of insurance carriers to alter or clarify the coverage of the basic policy form through the use of special property damage endorsements.

The line of “no occurrence claim denial” cases should be remedied by the drafting of a new “occurrence” clarification endorsement by Insurance Services Office (ISO) or by individual carriers. Such an endorsement should clarify that continuous or repeated exposure to substantially the same general harmful condition(s) shall constitute an “occurrence”, and that there is no additional or accompanying requirement of an accident or fortuitous event to constitute an “occurrence”. If ISO or individual carriers don’t voluntarily address this problem, state legislatures will attempt to pass contractor friendly legislation that will go way beyond remedying the “no occurrence claim denial” strategy.

 John M. Sadler

Sadler & Company, Inc.

Sources: IIABA, “No Occurrence Claim Denial”, 2006; House Bill 10-1394, 67th Colorado General Assembly

We are routinely asked by our builder clients if we believe it’s ok to have the homeowner purchase and carry the Builders Risk coverage.  The following are some points to ponder:

• Are your materials covered while in transit and temporary storage?  If so, how much?
• How are you going to insure your business profit and overhead on the job?
• Where you going to obtain coverages for your scaffolding and construction forms?
• Can you be certain the coverage is actually in force? 
• Will the policy cover collapse or theft of building materials before they are permanently attached? 

The answers to the above questions are probably going to be unfavorable.  This is why we recommend that our builder clients carry the Builders Risk policy instead of allowing the homeowner to set it up.

 Source:  Jon Fritinger/Great American Insurance and Sadler & Company, Inc.

A federal judge has ruled that a homeowner’s insurance policy does not have to pay for damages caused by faulty Chinese drywall.  With Chinese drywall continuing to be a concern for homeowners, the judge’s ruling could affect how thousands of lawsuits by homeowners will be settled.

The judge based his decision on the exclusion within the homeowner’s policy which excludes damage caused by latent defect, faulty materials, corrosion, and pollution.  With this exclusion, the policy would not cover removing or replacing the faulty drywall or any subsequent damages.

Needless to say this decision sets an unfavorable precedent for homeowners.

Source:  Insurance Journal

“The property loss from Chinese drywall could exceed every U.S. hurricane except Katrina and Andrew”. 

The complaints received by the Consumer Products Safety Commission show that the impact of Chinese drywall will be widespread.  Between 2004-2006, an estimated 500 million pounds of tainted drywall came into the United States.  It is quite possible that the tainted drywall is now in more than 100,000 homes.  The tainted drywall supplies have affected all but 12 states, with the greatest problems occurring in Florida, Louisiana, Mississippi, Alabama, and Virginia. 

“Based on $80 per square foot (the lowest cost from the verdicts made public) in 100,000 homes with an average of 2,200 square feet per house, the loss would be $18 billion in property damage”. 

The damaging health effects of having to live with the drywall have not been discussed, but the potential for property damage/claims alone are catastrophic. 

Source:  http://www.iiaba.net/IAMag/NewsViews/052010.html

Our builder clients always ask us about the difference between an employee and a subcontractor (AKA independent contractor) for purposes of Workers Compensation and tax withholding. There are a number of rules of thumb on this issue that have been circulating from IRS and Workers Compensation authorities. However, we just found a fantastic article on this topic that we wanted to share that provides more thorough advice on the topic. Read the article by clicking on the source link below.

 Source:  Independent Contractor or Employee, SC Lawyer Magazine  January 2010

One of our builder insurance clients recently posed the following question – Could a builder who is excluded under his own policy be stuck with a Workers Compensation claim for the owner of a subcontracting company who is not covered under his own Workers Compensation policy?

I spoke to a manager at the South Carolina Workers Compensation Commission who advised that it would be rare for an injured owner of a subcontracting company to be successful in tapping into coverage under a general contractor’s Workers Compensation policy.  The injured owner would have to prove that he is an employee of the general contractor.  This may be difficult short of a situation where the general contractor is just calling the subcontractor an independent contractor to evade paying payroll taxes.

My advice to our builder clients is this:

It is best if the owner of the subcontracting company is covered under his own Workers Compensation policy.  It is very common for them to not be covered.  It is an acceptable risk in my opinion for the builder to accept a certificate of insurance showing that the owner is not covered.  It may be helpful for the builder to have a provision in his contract with the subcontractor to the effect that the subcontractor understands that he is not entitled to benefits under the builder’s Workers Compensation policy and that no premium has been deducted. 

Source:  John Sadler