Commentary and analysis on the
law of insurance coverage
Author: Carl A. Salisbury
Jimmy Carter was President of the United States, a new Toyota Corolla cost $3,698, and ear-worm-stimulating songs such as “Reunited” by Peaches & Herb and “My Sharona” by The Knack spent multiple weeks at the top of the Billboard charts. That’s how long it has been since the insurance world began living with Weedo v. Stone-E-Brick. More than three years ago, I wrote an article in Law 360 arguing that the Weedo decision was the tetracycline of insurance law. The anti-biotic tetracycline is toxic if ingested past its expiration date. And the reasoning of the Weedo decision passed its expiration date when the insurance industry overhauled the Commercial General Liability insurance policy a full thirty years ago. The New Jersey Supreme Court has now, finally, decided the coverage issue that Weedo left open — an issue for which courts across the country, nevertheless, have been erroneously citing Weedo since its publication in 1979. A little background is in order.
In 1973, the insurance industry made revisions to the standard CGL policy (then known as the “Comprehensive General Liability” policy). Among those changes was the addition of what became known as the “business risk” exclusions. (I have made the quixotic argument that we ought to stop calling them the “business risk” exclusions, but no one’s listening, thus far.) Taken together, these provisions barred coverage for the consequences of faulty construction. From 1973 until 1986, if you were a contractor who got sued for faulty workmanship on a construction project, your CGL policy was going to provide essentially no coverage for the damage resulting from it. That changed in several very important ways in 1986.
The 1973 version to the CGL policy contained the following exclusion, which became known as the “Your Work” exclusion:
“This insurance does not apply:
(o) to property damage to work performed by or on behalf of the named insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.”
The Weedo case involved the 1973 version of the CGL policy, which did not contain the subcontractor’s exception to the “Your Work” exclusion
The further revision to the policy in 1986 added an exception to exclusion “(o)” above for work performed by a subcontractor. The exception said, “This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” In other words, if you were a general contractor who had hired a subcontractor, say, to install windows, and the subcontractor did a shoddy job that resulted in a leaking building, the subcontractor exception to exclusion “(o)” would require the carrier to defend and indemnify you in a lawsuit by the building owner for the consequences of the subcontractor’s negligence.
The Weedo case involved the 1973 version of the CGL policy, which did not contain the subcontractor’s exception to the “Your Work” exclusion. In Weedo, a contractor had installed faulty stucco on the exterior of a home. When the stucco cracked, the homeowner paid to replace it and then sued the contractor. The issue in Weedo v. Stone-E-Brick was whether the contractor’s general liability carrier was liable to cover the defective construction. The case eventually reached the New Jersey Supreme Court, which held that the so-called business risk exclusions in the policy applied to bar coverage for the consequences of the contractor’s faulty workmanship. In reaching this conclusion, the court also made an unfortunate general observation about faulty construction that many other courts then used to deny coverage: “The consequence of not performing well is part of every business venture; the replacement or repair of faulty goods and works is a business expense, to be borne by the insured-contractor in order to satisfy customers.”
This ill-fated sentence led a great many courts for the next thirty-seven years to conclude that faulty workmanship is not a covered “occurrence.” Policyholder lawyers have been pushing back against this conclusion ever since because the Weedo court simply did not decide the “occurrence” issue. On the contrary, the insurer in Weedo conceded that the insuring agreement granted coverage and argued that the sole issue, instead, was whether the exclusions precluded coverage. Fast-forward to 2016.
The New Jersey Supreme Court has now decided an issue that most other States’ high courts have addressed in the past few years: “whether rain water damage caused by a subcontractor’s faulty workmanship constitutes ‘property damage’ and an ‘occurrence’ under a property developer’s commercial general liability (‘CGL’) insurance policy.” In Cypress Point Condominium Ass’n, Inc. v. Adria Towers, L.L.C., 226 N.J. 403 (2016)(get a copy here), the scenario was all-too familiar. A developer employed subcontractors to construct a condo building. After completion, the building leaked. The condo association sued the developer in state court for faulty construction and the developer’s liability carriers for coverage. The coverage case eventually reached the state Supreme Court.
The insurers’ arguments supporting denial of coverage were also familiar. They claimed that CGL policies are supposed to cover the contractor for damage only to third-party property and not for damage to the construction project, itself. Predictably, they relied on Weedo for the proposition that a finding of coverage would “shift[ ] the risks inherent in constructing a building from the developer and general contractor, who are in the best position to control a subcontractor’s work, to their insurers.” They also argued that “a subcontractor’s faulty workmanship does not have the fortuity element required for the faulty workmanship to constitute an ‘accident,’ and is therefore not an ‘occurrence’ under the terms of the policies. In other words, damage to any portion of the project caused by defective construction is not accidental because it is one of the normal, frequent, and predictable consequences of the construction business.”
Acknowledging that it had “never addressed questions of coverage for consequential damages caused by faulty workmanship under the 1986 ISO standard form CGL policy,” the Supreme Court surveyed at least a part of the landscape of decisions in other states on that question. (“ISO” is the Insurance Services Office, the insurance industry trade association that, among other things, drafts standard insurance policy forms for use by carriers nationwide.) There can be no doubt that, in recent years, the majority of the high courts of States across the country have concluded that the consequential damages caused by a subcontractor’s faulty workmanship can constitute “property damage” caused by an “occurrence” under the standard-form, post-1986, CGL policy.
Prof. Christopher French of Penn. State wrote an influential law review article that provides a comprehensive survey of state and federal court decisions on the specific issue whether faulty workmanship is a covered “occurrence.” The Cypress Point opinion repeatedly cites Prof. French’s article for support. The article is Christopher C. French, “Construction Defects: Are They ‘Occurrences’?” 47 Gonz. L.Rev. 1 (2011–12), a full copy of which you can find here. It is the most thorough treatment of this coverage issue in print. (Full disclosure: Chris French and I are friends and, for the past four or five years, we have done an annual webinar together on this specific coverage issue.) The New Jersey Supreme Court found the survey of other court decisions “informative because they represent ‘a strong recent trend in the case law [of most federal circuit and state courts] interpet[ing] the term ‘occurrence’ to encompass unanticipated damage to nondefective property resulting from poor workmanship.’” It shouldn’t be surprising, then, that the New Jersey court ruled on Cypress Point’s coverage claims in a way that was consistent with the “informative” decisions of its sister courts. Happily for policyholders, then, Prof. French will be able to add New Jersey to the list of states in which construction defects are “occurrences” when he prepares (as he occasionally does) the next addendum to his Gonzaga law review article.
The CGL policy defines “property damage” to mean “physical injury to tangible property” and also “the loss of use of tangible property that is not physically injured.” The court in Cypress Point found that water infiltration from the faulty construction caused mold contamination in the building, which “resulted in loss of use of the affected areas by Cypress Point residents.” This loss of use was a consequential damage that constituted covered “property damage.” The court then considered “whether the subcontractors’ faulty workmanship, and the damages that flowed therefrom, constitute an ‘occurrence’ triggering an initial grant of coverage for the Association’s claims.”
The majority of the high courts across the country have concluded that consequential damages caused by a subcontractor’s faulty workmanship can constitute “property damage” caused by an “occurrence”
The court said that it had yet to define the term “accident” in a CGL policy. While technically true, this statement isn’t entirely sound. The word “accident” has been used in the CGL policy since 1966 and the New Jersey Supreme has decided hundreds of cases in which it had to determine whether an event was a covered “accident” under a CGL policy. And in those cases, the court has uniformly found that “the accidental nature of an occurrence is determined by analyzing whether the alleged wrongdoer intended or expected to cause an injury.” In other words, an intentional act (driving a car, say) can result in unintentional damage or injury (negligently running over a pedestrian) and this will qualify as a covered “accident.”
Nonetheless, the Cypress Point opinion provides a succinct statement of the meaning of “accident” in a way that doesn’t appear in the other New Jersey court decisions that have construed the word. It held: “[W]e find that the term ‘accident’ in the policies at issue encompasses unintended and unexpected harm caused by negligent conduct.” No one in Cypress Point had ever claimed that the subcontractors intentionally performed substandard work. This is an important point in cases such as this. It’s just common sense that a contractor doesn’t normally set out to intentionally do shoddy work. Absent proof that a contractor engaged in sabotage of the construction project, faulty workmanship is always going to be unintentional.
Finally, the court examined the exclusion that might apply to bar coverage; specifically, the “Your Work” exclusion. The court observed that, while the exclusionary language would otherwise bar coverage for the damage to Cypress Point, the provision “contains an important exception that ‘narrows the exclusion by expressly declaring that it does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.’” According to the court, the exception “unquestionably applies to this case.”
The court made policyholder lawyers particularly happy by referring to a “Circular” that was issued by ISO at the time of the 1896 revision to the CGL. ISO frequently issues public comments on the intent and meaning of the policy language it drafts. Insurance carriers often use these comments and Circulars when they seek approval from State Insurance Commissioners to incorporate new ISO language into their policies. Consequently, policyholder lawyers often point to these comments and Circulars when litigating the meaning of policy language, but their success in using ISO’s pronouncements in this way has been uneven. The Cypress Point court observed that “the ISO itself addressed the addition of the subcontractor exception in a July 1986 circular, which ‘confirm[ed] that the 1986 revisions to the standard CGL policy … specifically ‘cover[ed] damage caused by faulty workmanship to other parts of work in progress; and damage to, or caused by, a subcontractor’s work after the insured’s operations are completed.’” (You can get a copy of the ISO July 1986 Circular here.)
Some final words about what this opinion does and does not instruct about analyzing construction-defect coverage cases.
First, the court expressly set out a three-step process for deciding coverage questions. Step one is to decide whether the general coverage grant in the policy provides coverage under the circumstances. This typically involves deciding whether the events that gave rise to the alleged damage was an “accident” that constituted a covered “occurrence.” The court provided guidance about the meaning of the word “accident.” If an event constitutes a covered occurrence, step two is to determine if there are any exclusions that might take the coverage away. Step three is to examine the policy for any exceptions to an applicable exclusion in coverage. In my experience, courts do not always analyze policies with this kind of discipline and, when they fail to do so, it can cause mischief. The Cypress Point decision will help in that respect.
Weedo v. Stone-E-Brick can no longer work its pernicious influence on courts when they decide whether the CGL policy covers faulty workmanship
Second, the decision appears to hold that Cypress Point would be entitled to coverage not for the damage to the defective components, themselves, but only for damage to the building elements that suffered water damage. In an early part of the decision, the court defines what it means by “the consequential damages” as “damage to steel supports, exterior and interior sheathing and sheetrock, and insulation, to Cypress Point’s common areas, interior structures, and residential units.” Contrast that with the list of “faulty workmanship” that Cypress Point alleged: “defectively built or installed roofs, gutters, brick facades, exterior insulation and finishing system siding, windows, doors, and sealants.” The faulty work quite plainly references the defects, themselves. The actual holding of the decision says that coverage applies to the “consequential water damage.” (“[T]he Association’s claims of consequential water damage resulting from defective workmanship performed by subcontractors constitutes both an ‘occurrence’ and ‘property damage’ under the terms of the policies.”) The question is whether the court got this part of the decision right. Let’s take another look at the “Your Work” exclusion.
The policy says that it will not apply to “‘property damage’ to ‘your work’ arising out of it or any part of it.” That’s clear enough. It excludes coverage for both the defects, themselves, as well as any property damage arising out of the defects. The exception, however, gives coverage back for the defects, themselves. It says, the exclusion does not apply “if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” The entire exclusion drops completely out of the policy (including the part of the exclusion that applies to the defects, themselves) if “the damaged work” was performed by a subcontractor. There is no other provision anywhere in the standard CGL policy that precludes the policyholder from getting coverage for the costs to fix the defects, themselves. The “Your Work” exclusion is the only one.
This is an important point that frequently gets lost, overlooked, or just decided erroneously (as it apparently did in Cypress Point) when courts analyze the “Your Work” exclusion. Here’s hoping that the New Jersey Supreme Court will have an opportunity to take another look at that particular issue before another thirty-seven years go by.
In the meantime, it’s good for policyholders in New Jersey and elsewhere that Weedo v. Stone-E-Brick can no longer work its pernicious influence on courts when they decide whether the CGL policy covers faulty workmanship.