Editor's note: Although it is Professional Roofing's policy to provide location information for companies mentioned in articles, some locations are missing from this article because information about the companies in question could not be found.
Imagine a roofing contractor is finishing a long, difficult project. There are perhaps two days of flashings and punch-list work remaining. Suddenly, lightning strikes the building and a fire breaks out, destroying much of the newly installed roof system and other parts of the building.
Who is liable to pay for clearing debris, installing a new roof system and rebuilding the building's damaged portions?
Contractors generally have borne the financial risk of and responsibility for damages to their work—the risk of loss—before acceptance of the work. Contracts written by owners and subcontracts written by general contractors often include a provision explicitly stating the contractor signing the contract bears the full risk of loss until the owner's final acceptance of the work. If your contract includes such a provision, you should seek to eliminate or modify the provision so you are contractually liable only for losses and damages within your control and caused by you.
Most important, regardless of how the risk of loss is allocated, you should be sure there is insurance to cover a potential loss. You always should ensure a builder's risk or installation floater insurance policy is in place before beginning a project.
Builder's risk insurance is intended to cover risks of direct physical loss caused by a fortuitous event, which, so far as the parties involved with the contract are aware, depends on chance. Unlike a commercial general liability (CGL) policy, which excludes repairing or replacing an insured contractor's work, builder's risk and installation floater insurance policies specifically are intended to pay for repairing or replacing a contractor's work when it has been damaged or destroyed during construction by an external factor.
Be certain the project is covered by a builder's risk insurance policy when the construction contract is consummated. Just as there commonly will be insurance provisions requiring you to maintain a CGL policy, automobile liability and workers' compensation insurance, there should be a contract provision pertaining to builder's risk insurance and stating which party is responsible for purchasing and maintaining the builder's risk policy.
Builder's risk insurance
Builder's risk and installation floater insurance policies apply to direct physical losses or damages to covered property from a covered cause. For instance, if a fire or tornado damages a building during construction, the builder's risk policy covers the cost of replacing the damaged work.
Builder's risk insurance applies to a structure being built at a location described on the policy's declarations page. Builder's risk policies generally are site-specific and written for an amount equal to the construction contract's amount. The covered property is the building being constructed. The insurer is obligated to pay to replace covered property and, depending on the coverage purchased, other costs directly resulting from a covered peril. A builder's risk policy does not insure payment of the contract price.
The policy may include coverage for foundations, underground pipes and drains, and temporary structures such as scaffolding while they are at the insured location, as well as materials and equipment that will become part of the permanent structure. Builder's risk policies primarily are intended for new construction but are equally important for renovation and expansion projects, including reroofing contracts on existing buildings.
Although most builder's risk insurance policies are similar, they are not nearly as uniform as CGL insurance policies. Insurance policies are contracts between the insurance carrier and the party purchasing the policy. The terms in the policy itself determine what is covered. Although most carriers use standard policy forms developed by the Insurance Services Office for CGL insurance, insurers tend to use their own builder's risk coverage forms. A builder's risk policy may be purchased as a separate, stand-alone policy or as an endorsement to another policy, such as an owner's property insurance policy.
There are two general types of builder's risk policies: "all-peril" policies and "named peril" policies. All-peril policies commonly are used because they provide broader coverage than named peril policies. However, despite its name, an all-peril policy does not cover all perils; it covers all perils except perils that are expressly excluded. In contrast, a named peril policy covers only perils specifically enumerated in the policy. Although an all-peril policy has advantages, the difference in coverage between the two policy types is not as distinct as their names imply because of the numerous exclusions in all-peril policies. An all-peril policy typically will include language similar to the following:
Regardless of whether an all-peril or named peril policy is purchased, losses caused by fire, smoke, lightning, wind, hail, theft, vandalism, falling objects, explosions, and weight of ice, snow and sleet typically are covered; losses caused by defective workmanship or faulty design or specifications routinely are excluded.
Although damage caused by defects, errors and omissions in design, specifications and workmanship are excluded under builder's risk policies, if defective design or workmanship results in a covered peril, a builder's risk policy may cover the ensuing loss or damage caused by the covered peril.
For example, if defective workmanship causes a fire, the resulting damage will be covered by the builder's risk insurance even though defective workmanship is excluded. Coverage for floods and earthquakes may be able to be added through endorsements and by paying an additional premium.
A typical named peril insurance policy covers new structures during construction; materials intended to be integral parts of such structures; construction forms; and the contractor's work on additions, alterations, repairs or renovations of existing structures. The policy will state:
"Losses Covered: We insure you against financial loss resulting from accidental, direct physical loss of or damage to covered property caused by any of the following perils:
The most important difference between all-peril and named peril policies concerns burden of proof. Because all-peril policies cover all causes of loss except those specifically excluded, the insurance carrier must prove the cause of a loss in a given situation was excluded. With an all-peril policy, the insured contractor does not have to prove the loss was covered by a particular peril or cause. The insured contractor only must prove a loss or damage occurred and was caused by a fortuitous event or circumstance; the burden of proof shifts to the insurance carrier to show the loss was caused by an exclusion stated in the policy. With a named peril policy, the insured contractor has the burden of proving one of the covered perils identified in the policy caused the loss.
Installation floaters
An installation floater policy is a type of builder's risk insurance. Typically, a builder's risk policy is purchased by the owner or general contractor for a new construction project and covers the entire project. An installation floater policy typically is purchased by an individual specialty contractor, such as a roofing contractor, and covers only the specialty contractor's work, including all property in the insured contractor's care, custody or control.
When performing reroofing work, it is particularly important to be sure a builder's risk or installation floater policy is in place. If there is a fire or other direct physical damage during a reroofing project that causes loss of roofing materials stored at the job site and a portion of the roof that already has been reroofed, an installation floater would be the likely insurance used to respond to the loss. You should consider purchasing "blanket" installation floaters so installation floater coverage is in place for all projects regardless of contractual insurance requirements or risk of loss provisions.
Depending on the policy, current builder's risk and installation floater policies may cover materials and equipment while in transit; stored at a job site or elsewhere before a construction project; during the rigging process; and during installation. For instance, HVAC units being lifted by helicopter onto a roof for installation may be covered by an installation floater policy held by the mechanical contractor.
When construction materials are stored off-site, ensure builder's risk or installation floater insurance covers the materials. Unlike a CGL policy, automobile liability or workers' compensation insurance, an installation floater policy is not a one-size-fits-all policy; rather it should match the specific operations and exposures of the specialty contractor purchasing the policy.
AIA contract provisions
The widely used standard construction contract documents promulgated by The American Institute of Architects (AIA) require owners to purchase and maintain builder's risk insurance for projects and be responsible for paying any deductible. The AIA General Conditions—AIA Document A201—state that if an owner does not intend to purchase builder's risk insurance, the owner should notify the contractor, and the cost of obtaining builder's risk insurance should be added to the contract's amount through a change order.
The AIA General Conditions also state that if an owner fails to procure builder's risk insurance or notify the contractor that the owner does not intend to purchase builder's risk coverage, the owner is responsible for the losses that would have been covered by the builder's risk policy.
Assuming a builder's risk policy is in place, the AIA contract documents stipulate that all parties look exclusively to recover from the builder's risk policy in the event of a loss and waive all claims against each other even if the damages might be covered by a contract's indemnification obligation. In other words, assuming there was a fire caused by negligence involving one of the parties (for example, a representative of the owner threw a cigarette into a trash pile or a roof mechanic torched improperly), the loss and costs to rebuild are covered by the builder's risk insurance policy and the parties are precluded from asserting claims against each other.
A 1986 decision by the Appellate Court of Illinois involving construction of the Rosemont Horizon Arena (now the Allstate Arena) in Rosemont, Ill., illustrates the AIA language's effects.
Using AIA construction contract documents, the Village of Rosemont contracted with Lentin Lumber Co. to have the company design, fabricate and install a roof system for the new arena. Weyerhaeuser Co., Federal Way, Wash., was contracted to manufacture and supply the roofing beams; Lentin Lumber hired CST Construction Co. as a subcontractor to install the roof structure; and Enterprise Engineering Corp., Peshtigo, Wis., was chosen to prepare laminated wood roof framing drawings. Performance bonds were issued by Lentin Lumber and its surety, Heritage Insurance Co. of America, Moline, Ill., as well as by CST Construction and its surety, Accident Insurance Co.
As required by the AIA contracts it signed with Lentin Lumber and Weyerhaeuser, Rosemont purchased a $6 million builder's risk insurance policy. During construction, the arena's roof collapsed. Rosemont collected $1.5 million under the builder's risk policy and sought to recover an additional $5 million from Lentin Lumber, Weyerhaeuser, CST Construction, Enterprise Engineering, Heritage Insurance and Accident Insurance. The AIA contracts required Rosemont to purchase and maintain property insurance that insures against fire and extended coverage and includes all-risk insurance for physical loss or damage.
The AIA contracts also stated that the owner and contractor waived all rights against each other and subcontractors for damages caused by fire or other perils to the extent covered by the builder's risk insurance the owner was required to obtain or other property insurance applicable to the work. Referring to these AIA contract provisions, the trial court said it was clear the parties mutually agreed that insurance alone would provide recovery for any property loss or damage to the work and dismissed Rosemont's claims against the contractors and their sureties.
Rosemont appealed the trial court's dismissal, contending the court failed to construe the contract as a whole and ignored contract provisions requiring the contractor to provide liability insurance and indemnify the owner.
The Appellate Court of Illinois disagreed, pointing out the contractor liability insurance and indemnification provisions in the AIA contract applied to claims other than to the work itself and were intended to protect the owner from claims by third parties. Therefore, the court found no inconsistency between the liability insurance and indemnification provisions and the explicit waiver of claims covered by the builder's risk insurance the owner was required to purchase and maintain. In addition, the court stated the waiver also applied to damages to bleachers and exterior masonry when the roof collapsed because Rosemont was required to maintain insurance covering all the work.
Courts in some states, such as Minnesota and Texas, have gone further and ruled that the waiver provision in the AIA construction contracts extends to an existing building's damage that is covered by property insurance policies—not necessarily builder's risk policies—the owner maintains. (For more information, see "Precedents and contract provisions," February 2004 issue, page 16.)
Coverage
Insurance coverage should be in place before beginning any construction activity, including shipping materials for a project. You should examine policy language to ascertain whether materials are covered while in transit. Many builder's risk policies do not begin until construction materials are delivered. Typically, coverage ends when construction is completed, the insured no longer has an insurable interest in the property, or the policy expires or is cancelled (whichever occurs first). Some policies state coverage ceases when the structure is occupied or being used as intended.
Disputes often arise when a loss occurs at the end of a project or after construction is complete, a punch-list item remains or the owner has not yet formally accepted the work.
In the case of Hartford Fire Insurance Co. v. Riefolo Construction Co. Inc., the New Jersey Supreme Court was faced with such a dispute. In this case, the Board of Education of Vocational Schools in Essex County, N.J., contracted with five prime contractors to build a new Essex County Technical Careers Center in Newark, N.J. Each construction contract required the contractor to procure and maintain builder's risk insurance during the life of the contract, as well as procure a performance bond in an amount equal to the contract amount. Each contractor was contractually obligated to repair all damage to the building occurring before its acceptance unless the damage was caused by the school district. Per the contract, acceptance occurred when all work—including punch-list items—was complete.
In April 1972, the contractors received written notice to begin the project; Oct. 2, 1973, was the scheduled completion date. As of April 1, 1974, construction still was not complete. However, the school district determined it needed to assign employees to the careers center to prepare for the 1974-75 school year. On May 17, 1974, the architect formally advised the school district that its staff could use the building's executive staff area but no classes could be conducted until the building was 100 percent complete, as well as inspected and approved by the Division of Building Services of the State Department of Education.
Starting in June 1974, school district personnel were assigned to the building. As of Aug. 8, 1974, 16 school district employees, including six teachers, occupied the first floor and the library on the second floor. Portions of the third floor were used to store furniture. School district staff members were interviewing prospective students in the building, but no classes were held.
Construction continued as the school district began to use the building during the summer of 1974. On Aug. 7, 1974, 16 workers still were on the job. By Aug. 8, 1974, the building was between 90 and 95 percent complete. On that day, the school district purchased a casualty insurance policy from Hartford Fire Insurance Co., Hartford, Conn. Hartford Fire Insurance issued a binder evidencing coverage for $6.5 million commencing that day.
On Aug. 9, 1974, a fire started among cartons stored by the school district on the building's third floor, causing $250,000 in damage. The Newark Fire Department stated the fire's cause was "undetermined" and may have been a discarded cigarette thrown by a worker. The school district notified the five construction contractors to begin repair work and stated that payments for repairs would be provided through the school district's insurer and the builder's risk insurance carriers.
In fact, Hartford Fire Insurance paid the contractors but later filed a lawsuit seeking reimbursement from the contractors. The builder's risk policies for three of the contractors had been allowed to lapse in July 1973, July 1974 and April 1974 without previous notice to the school district, contrary to the contract requirements.
In response to Hartford Fire Insurance's lawsuit, the contractors argued that because either the building's substantial completion or its occupancy by the school district at the time of the fire would have voided builder's risk coverage under the policy's terms, contractors' failure to maintain builder's risk insurance coverage in August 1974 did not injure the school district. The contractors argued that proper interpretation of the contract shifted the risk of loss to the school district once the school district occupied the building. The contractors also argued that because the fire started among the cartons stored by the school district, the school district was responsible for the damage.
The trial court found that the school district was occupying the building and construction was substantially complete at the time of the fire. The judge ruled that the builder's risk policy would not have provided coverage following owner occupancy of the building or substantial completion of construction. Therefore, the trial court concluded the risk of loss transferred to the school district and the contractors were excused from their obligation to maintain insurance and did not bear the risk of loss at the time of the fire.
The trial court ruled that the contractors' failure to notify the school district of the lapse of builder's risk insurance policies was a breach of contract without a loss because, by obtaining insurance Aug. 8, 1974, without the required notice, the school district did precisely what it would have done with notice from the contractors.
The court ruled in favor of the contractors, saying the provisions requiring the contractors to assume the risk of loss should be read together with the obligation to maintain builder's risk insurance. The trial court was heavily influenced by the fact that the building was occupied and builder's risk insurance applies to buildings during construction. Reading the risk of loss and builder's risk insurance provisions together, the judge reasoned that the risk of loss would remain on the contractors only while they were able to maintain the builder's risk insurance coverage.
Because the building was occupied, the trial court considered it to be no longer "in the course of construction" as defined by the insurance contract and that builder's risk insurance no longer was maintainable. The trial court used a "substantial completion" standard to measure the term of coverage.
Hartford Fire Insurance objected on the grounds that the substantial completion standard applies only to contractors' right to obtain payment and does not apply to builder's risk insurance. On appeal, the New Jersey Supreme Court agreed with Hartford Fire Insurance and reversed the trial court's decision because the construction contract stated the risk of loss remained with the contractors unless the school district's conduct caused the loss or until the project was accepted by the school district; the construction contract stated acceptance occurs only when "all work is complete, including all punch list items originated prior to the acceptance date."
Although the fire's cause was unknown, the contractors did not prove the school district caused the fire and construction was neither 100 percent complete nor accepted at the time of the fire; occupation of the building did not constitute acceptance. Therefore, the contractors were liable for all fire damage despite the advanced stage of construction and partial occupancy by the school district. In addition, the contractors' performance bond sureties were liable for the contractors' breach of contract.
Contrary to the trial court's reasoning, the New Jersey Supreme Court pointed out there was no contract provision limiting or conditioning the contractors' assumption of risk to the availability of builder's risk insurance. The court also pointed out builder's risk insurance is not necessarily limited to unoccupied buildings; builder's risk insurance could be maintained by obtaining the insured contractor's consent and making a rate adjustment. Here, the contract required builder's risk insurance be maintained "during the life of this contract."
Citing court decisions in Michigan, Missouri and North Carolina, the New Jersey Supreme Court ruled that the proper standard to determine the duration of the contractors' obligation to maintain builder's risk insurance was not substantial completion but whether the building was "ready for the use or occupancy for which it was intended." Because some construction work remained and the building had not yet been inspected and approved by the Division of Building Services—a prerequisite for student attendance—the building still was "in the course of construction." Therefore, the contractors had a contractual obligation to maintain the builder's risk insurance policy at the time of the fire, which they breached.
This ruling underscores the need for contractors to be certain their insurance meets their contracts' insurance requirements by having construction-savvy insurance advisers review and compare contractual insurance requirements with the contractor's insurance coverage and then modifying the contract's insurance requirements or obtaining additional insurance.
In addition to the costs of repairing or replacing physical damage to property covered under a builder's risk policy, supplemental builder's risk insurance coverage may be available to cover so-called "soft costs," which include economic losses caused by a delay in completion resulting from a covered peril, such as the cost to extend a construction loan. Supplemental coverage—subject to a dollar limitation set forth in the policy—may be available to cover the cost of liquidated damages assessed against the contractor for failure to complete the project by a certain date because of the covered peril.
The essentials
Builder's risk and installation floater insurance policies are essential to cover potential losses during construction projects. All parties involved in construction projects can benefit by ensuring builder's risk or appropriate installation floater policies are in place before beginning any construction activity, including ordering materials. To proceed otherwise creates a potentially economically devastating situation.
Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.
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