This article is the first of two articles discussing what is covered by standard commercial general liability insurance policies. The second article will appear in the January 2009 issue.
Commercial general liability (CGL) insurance policies provide insurance coverage for bodily injury and property damage claims. However, CGL policies do not provide coverage for replacement or repair of defective work. You need to understand the nature of CGL policies and the details of contractual liability exclusions.
If a claim or suit against your company seeks only to recover the cost of reroofing or repairing an allegedly defectively installed roof system or the economic loss sustained by the building owner because of defective work (meaning the building's value declined because the work did not meet contract requirements), standard CGL insurance policies will not provide coverage (though there are some special endorsements available through the NRCA/CNA insurance program that provide coverage applicable to roofing work in certain circumstances.)
A CGL insurance policy is not a performance bond. It does not guarantee contractual performance. Per the terms of CGL policies, there is only coverage for bodily injury and property damage claims caused by an "occurrence."
CGL policies define an occurrence as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." Because CGL policies do not define "accident," courts defer to common usage and standard dictionary definitions, which generally define an accident as a fortuitous, unexpected or unintended event, when considering whether a claim constitutes an occurrence.
In the coverage portion of CGL insurance policies, no distinction is made regarding the origin of property damage or personal injury. If there is an allegation of property damage or bodily injury resulting from an occurrence for which your company allegedly is liable, your insurance carrier has a duty to defend the suit and pay claims for property damage and bodily injury unless an exclusion applies.
CGL policies define "property damage" as "physical damage to tangible property, including all resulting loss of use of that property." Damage to the insured contractor's work is specifically excluded.
Contractual liability exclusion
In addition to exclusions applicable to a contractor's work and work product, CGL insurance policies contain a contractual liability exclusion, typically identified as "exclusion (b)" in the policies. Understanding this exclusion's scope, meaning and intent is critical because the exclusion's title, "contractual liability," suggests a much broader meaning than is intended.
The contractual liability exclusion states CGL insurance does not apply to "bodily injury" or "property damage" for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.
Does this mean there is no coverage for bodily injury or property damage claims that are based on a claim against a contractor for breach of contract?
If a breach of contract lawsuit is brought against your company and includes a claim for damage to property other than work your company performed, will your CGL insurance carrier be obligated to defend the suit and cover the property damage claim if your company is found liable?
Court cases
Given that the current text of the contractual liability exclusion has been included in CGL policies since 1986, you would think the answers to these questions would be well-known and uniformly applied by insurance carriers and courts. However, because the exclusion is broadly and imprecisely written and judges respond to the arguments that are presented to them by individual litigants and attorneys whose knowledge and expertise of insurance coverage issues varies, court decisions are not uniform.
The contractual liability exclusion does not exclude all claims that are based on an alleged breach of contract. The contractual liability exclusion's meaning was addressed in a comprehensive 2004 decision by the Supreme Court of Wisconsin in American Family Insurance Co. v. American Girl Inc.
The case concerned a large warehouse built in Middleton, Wis. The Renschler Co. Inc., Madison, Wis., was the general contractor, who served as the designer and builder of the warehouse, which was built in 1994. The Renschler Co. hired a soils engineer to analyze the soil conditions at the construction site. The soils engineer recommended a particular method for compressing the soil, and the soil preparation was performed in accordance with the soils engineer's recommendations.
Shortly after the warehouse was completed, it began to sink and, after being deemed structurally unsound, was razed.
Per its contract's terms, The Renschler Co. warranted to American Girl that the warehouse's design and structural components would be free from defects. The Renschler Co. tendered the claim to its liability insurance carrier, American Family Insurance, Madison. American Family Insurance filed a declaratory judgment action to determine whether its CGL policy applied to the claim, which was based exclusively on contractual obligations.
Although the trial court held the claim was covered, the court of appeals ruled the contractual liability exclusion precluded coverage because The Renschler Co.'s liability was derived entirely from its obligations under the construction contract. The Renschler Co. appealed to the Supreme Court of Wisconsin, which reversed the decision.
In explaining its decision, the Wisconsin Supreme Court said "[t]he key to understanding the exclusion … is the concept of liability assumed."
While recognizing a contractor assumes liability whenever he or she enters into a construction contract, the court said the contractual liability exclusion refers only to a contractor's assumption of a third party's liability.
"We conclude that the contractually assumed liability exclusion applies where the insured has contractually assumed the liability of a third party, as in an indemnification or hold-harmless agreement: It does not operate to exclude coverage for any and all liabilities to which the insured is exposed under the terms of the contracts it makes generally," the court said.
Citing court decisions in Michigan, Utah and West Virginia, the Wisconsin Supreme Court ruled the contractual liability exclusion "refers to a specific contractual assumption of liability by the insured as exemplified by an indemnity agreement" and a previous Wisconsin case, stating the exclusion excludes coverage for incidents involving purely contractual remedies, was overbroad.
Because American Girl's claims against The Renschler Co. were based on breach of contractual obligations and not assumption of third-party liability, the court ruled American Family Insurance had a duty to defend and indemnify The Renschler Co. against the claims.
In E & R Rubalcava Construction Inc. v. Burlington Insurance Group Inc., a 2000 Texas case, a federal district court judge ruled the contractual liability exclusion does not apply if an insured contractor is being sued for his alleged conduct. In this case, E & R Rubalcava Construction, Wylie, Texas, a subcontractor to Goff Homes, Dallas, installed allegedly faulty home foundations, leading to property damage.
After Goff Homes was sued by homeowners and entered into a settlement agreement with the homeowners, Goff Homes sued E & R Rubalcava Construction to recover the amounts paid based on breach of contract and a contractual indemnification obligation. Burlington Insurance Group, Burlington, N.C., contended it did not have a duty to defend or indemnify E & R Rubalcava Construction, relying on the contractual liability exclusion. The court disagreed.
"Where liability could be imposed either pursuant to the contractual indemnity or generally applicable legal principles, the contractual liability exclusion does not work to deny coverage," the court said.
Because E & R Rubalcava Construction was being sued by Goff Homes based on E & R Rubalcava Construction's negligence and not because E & R Rubalcava Construction had contractually agreed to indemnify Goff Homes from its negligence, Burlington Insurance Group was obligated to defend E & R Rubalcava Construction.
Similarly, in Nitterhouse Concrete Products v. Pennsylvania Manufacturers' Association (PMA) Insurance Co., a Pennsylvania trial court ruled the contractual liability exclusion does not apply to a claim based on the insured contractor's fault but rather when the contractor assumes another's liability. In this case, a claim was made against Nitterhouse Concrete Products Inc., Chambersburg, Pa., on numerous grounds, all of which arose from Nitterhouse Concrete Products' contractual obligations.
PMA Insurance, Blue Bell, Pa., contended the claim against Nitterhouse Concrete Products was based on breach of contract and intentional conduct and thus excluded under the CGL policy. Reasoning that the contractual liability exclusion "would be wholly superfluous if a breach of contract could never constitute an occurrence," the court recognized a breach of contract might constitute an occurrence and the contractual liability exclusion did not apply to the claims made against Nitterhouse Concrete Products based on its conduct.
Courts in Alaska, Louisiana, Michigan, Minnesota, North Dakota and South Dakota also have considered the contractual liability exclusion and ruled the exclusion applies only to the assumption of another party's liability and does not preclude insurance coverage generally for claims based on breach of contract.
Despite articles that have been written about the subject and numerous court decisions indicating the contractual liability exclusion applies only to an insured's contractual assumption of another party's liability, there are instances in which insurance carriers contend there is no insurance coverage for an alleged breach of contract claim when a contractor tenders a suit alleging breach of contract.
There is an Ohio appellate court case in which the contractor's attorney apparently did not seek to demonstrate to the court the proper scope of the contractual liability exclusion, indicating the contractual liability exclusion precludes insurance coverage for claims based on breach of contract.
In Victoria's Secret Stores Inc. v. Epstein Contracting Inc., the contractor contracted to perform construction and remodeling at a Victoria's Secret store at 565 Broadway, New York, N.Y.
The contract required the contractor to remove a suspended ceiling and install a new ceiling that was to be connected to the building's main structural support beams. Instead, the contractor installed the new ceiling to a second existing suspended ceiling. Four months later, the ceiling dropped 12 inches and began to crack. The store was closed for five months while repairs were made. There was no property damage other than to the ceiling itself.
Following an arbitration proceeding during which Victoria's Secret asserted claims against the contractor for breach of contract and indemnification, negligence and fraud, Victoria's Secret obtained an award in excess of $1 million because of the contractor's failure to comply with the contract.
Victoria's Secret then sought to recover damages from the contractor's insurance carrier. The Ohio Court of Appeals, without properly analyzing the contractual liability exclusion's scope, ruled the contractual liability exclusion precluded insurance coverage because the claim arose from the contractor's assumption of liability in a contract and would not have arisen absent the contract.
The Victoria's Secret case underscores the need for you to understand the contractual liability exclusion and be prepared to show its limited scope.
Exceptions
The contractual liability exclusion in standard CGL policies has two exceptions that significantly limit the exclusion's scope and provide coverage for some indemnification agreements. The contractual liability exclusion does not apply to the following:
CGL policies define an insured contract as: "… that part of any other contract or agreement pertaining to your business … under which you assume the tort liability of another party to pay for 'bodily injury' or 'property damage' to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement."
Although the contractual liability exclusion initially takes away coverage for liability of another that you assume in a contract, the "insured contract" exception will provide coverage for many indemnification agreements found in construction contracts.
In a 2001 Nebraska case, Day v. Toman, the U.S. Eighth Circuit Court of Appeals held that a master service contract in which a contractor agreed to indemnify a building owner "against any and all losses, claims, demands, liabilities … incident to the work performed under the contract" was an insured contract.
As a result, the contractor was to indemnify the building owner even if damages were caused in whole or part by the owner's negligence, strict liability or other legal fault. The court held the indemnity clause fell within the insured contract's definition because the contractor assumed the owner's tort liability.
In Gibson & Associates Inc. v. Home Insurance Co., a Texas court ruled in 1997 that a CGL insurer wrongfully denied a utility and site contractor's claim for property damage by misapplying the contractual liability exclusion.
In this case, the contractor was to make improvements along Main Street in Dallas. As a result of the contractor's untimely performance, the city was sued by store owners affected by the delayed work. The city, in turn, sued the contractor, seeking recovery for the damages sought by the store owners for breach of contract and under an indemnification provision in the contract.
The court ruled there was no insurance coverage for the city's breach of contract claim against the contractor but contractual liability coverage applied to the city's claim for indemnity because the contract's indemnification provision made the contract an insured contract.
In addition to courts in Nebraska and Texas, courts in Alabama, Arkansas, New Hampshire, South Carolina, Virginia and West Virginia have issued similar decisions.
The exception for "liability in the absence of a contract" means the contractual liability exclusion does not exclude coverage for a claim or loss if the insured party would be liable for the property damage or bodily injury in the absence of an indemnity agreement.
In USF Insurance Co. v. Mr. Dollar Inc., a Pennsylvania U.S. District Court Judge found the "liability in the absence of a contract" exception applicable.
As a result of the careless disposal of a cigarette by Philadelphia-based Mr. Dollar's president, there was a fire at a retail store leased to Mr. Dollar and several other stores. A settlement and stipulation of judgment in the amount of $366,877.90 was reached between Mr. Dollar and the insurance carrier for the landlord. Mr. Dollar's insurance carrier, USF Insurance, Farmington Hills, Mich., argued it was not obligated to pay the judgment because of the contractual liability exclusion.
Because Mr. Dollar would have been liable in the absence of the settlement agreement, the court ruled USF Insurance was required to pay the claim.
What it means
The contractual liability exclusion does not broadly exclude all claims brought against a contractor for breach of contract but rather potentially applies in situations when a contractor agrees to accept others' liability.
Despite some court decisions that fail to carefully evaluate the contractual liability exclusion and incorrectly conclude there is no coverage for a claim based on an alleged breach of contract, the contractual liability exclusion applies to contractual assumption of another's liability; it is not an exclusion for breach of contract claims against the insured where there is property damage or bodily injury.
Even when there is an assumption of another party's liability in an indemnification agreement, the insured contract or "liability in the absence of the contract" exceptions to the contractual liability exclusion may come into play and provide coverage.
You and your attorney need to be knowledgeable about the contractual liability exclusion and its exceptions and prepared to show the exclusion does not necessarily exclude CGL insurance coverage when you face a claim based on an alleged breach of contract. Whether a plaintiff brings a claim against you as a breach of contract or a claim for negligence or a negligence claim is dismissed and only a contract claim remains in a lawsuit should not affect CGL insurance coverage.
Instead, it is the nature of the damage—specifically, whether there is property damage other than the work itself or bodily injury—and whether there has been an occurrence that determine whether CGL coverage applies.
In our next article, we will focus on whether defective workmanship is considered an occurrence and triggers CGL insurance when there is resulting property damage.
Jared W. Heald is an attorney and Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.
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