The Problem – Coverage for Faulty Workmanship.
A frequent question that we face is whether a property owner or contractor’s insurance policy provides coverage for the cost of repairing faulty work done by a subcontractor. The specific terms of the policy are critical here. If the policy contains a defective workmanship exclusion, it may not provide coverage.
A Recent Decision – Exclusions Have Exceptions.
The U.S. Court of Appeals for the Tenth Circuit addressed this question recently in the case of Rocky Mountain Prestress, LLC. v. Liberty Mutual Fire Insurance Company, No. 19-1169 (10th Cir. June 2, 2020). In that case, the property owner hired a general contractor to construct an office building. The owner had a Builder’s Risk insurance policy from Liberty Mutual that provided protection against “direct physical loss or damage caused by a covered peril to buildings or structures while in the course of construction, erection or fabrication.”
“Covered perils” in turn were defined as “risks of direct physical loss or damage, unless the loss is limited or caused by a peril that is excluded.” This type of insurance policy is frequently referred to as an “All Risk” policy, because these policies cover any fortuitous loss (i.e., a loss that occurred by chance, rather than intentionally) not resulting from an excluded risk or from fraud by the insured.
One of the exclusions in this particular policy was for “loss of damage consisting of, caused by, or resulting from an act, defect, error or omission (negligent or not) relating to . . . design, specifications, construction, materials or workmanship.” This type of exclusion is a “defective workmanship exclusion,” and if you are a property owner or a contractor, you should try to get a policy that does not have this exclusion.
In the Rocky Mountain Prestress case, the general contractor hired a subcontractor to perform a variety of work that included installing precast concrete components, including grouting the joints between the precast concrete column and pilaster elements. It was later discovered that the joints had been insufficiently grouted. They had to be shimmed and re-grouted, at substantial cost. The general contractor filed a claim under the property owner’s Builder’s Risk policy, and Liberty Mutual denied the claim because of the policy’s defective workmanship exclusion.
On appeal, the plaintiff did not dispute that the claimed loss resulted from a defect in the workmanship or materials used grouting the joints of the precast concrete elements that were installed. However, it argued that coverage was restored by the “resulting loss” exception to the defective work exclusion. The resulting loss exception in the policy provided that “if an act, defect, error or omission as described above results in a covered peril, [Liberty] do[es] cover the loss or damage caused by the covered peril.” “Covered peril” was defined as a risk or loss of damage that is not caused or limited by an “excluded” peril, and for that reason, the plaintiff argued that the policy’s language was circular, inconsistent and ambiguous, which would require the Court to interpret the policy in favor of overage for all of the costs of fixing the faulty workmanship.
The Tenth Circuit disagreed. Relying on published decisions from other courts across the country, the Tenth Circuit ruled that the plaintiff’s interpretation of the resulting loss exception would entirely swallow the defective work exclusion. In other words, the resulting loss exception could not be read to restore coverage for the expressly excluded cause of faulty workmanship. The Tenth Circuit therefore ruled in favor of the insurance company and affirmed the District Court’s ruling.
There are two takeaways here for property owners and contractors. First, be very careful about the insurance coverage that you purchase. In particular, try to avoid policies that contain a defective workmanship exclusion, as this may very well eliminate coverage for a wide variety of problems that are most likely to be encountered on construction projects. The “defective workmanship” exclusion is becoming more common, so it may not be possible to secure a policy without that exclusion, but it’s worth trying. Second, policies of this sort are complex, with not only exclusions from coverage, but then exceptions to those exclusions. Coverage counsel can be very helpful in obtaining the correct insurance and understanding your insurance coverage.