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The vast majority of construction projects are insured through commercial general liability (CGL) policies obtained and maintained by general contractors and their subcontractors.

As a means of exercising control over the coverage, many developers include provisions in their prime contracts requiring contractors to maintain the same level of coverage for a period of 10 years after completion—coinciding with California’s statute of limitations for latent construction defects.

The purpose of this provision is to ensure a continuous pool of insurance coverage exists if defects are discovered in the statutory period. However, because of the volume of defect litigation during the last two decades, and significant changes to common CGL policy endorsements, many developers and contractors are finding that the pool of coverage they have contracted for is nearly empty, if it ever existed to begin with.

The problem is twofold:

  • most CGL policies insure every project a contractor works on with the same pool of money; and
  • insurance carriers have created more onerous endorsements limiting coverage (particularly for construction defects) and these endorsements have become increasingly widespread.
CGL Coverage Basics
Contrary to the understanding of many developers and contractors (even sophisticated ones), CGL policies do not insure against defective workmanship. Rather, they insure against personal injuries and property damage caused by the insured contractor’s work. Thus, to the surprise of many clients, construction defects are not always covered by a contractor’s CGL policies.

This analysis gets more nuanced. Only personal injuries and property damage that “occur” during a policy period are covered under most CGL policies. This is relatively easy to determine when a contractor spills a bucket of paint on a new car; the property damage is readily apparent the moment the paint hits the hood. It gets more complicated with damage arising from construction defects, which can remain hidden for years.

As an example, assume a contractor improperly installs a waterproofing membrane on a wood-framed deck. The membrane is then covered with a concrete topping material. The defective membrane installation causes no damage until the first rain, at the earliest. Even then, it could take months (or even years) for enough water to bypass the improperly installed membrane and get to wood. After a few years of exposure, the wood substrate begins to rot, creating avenues for water to get to the framing members. After a few more years, the framing members have developed dry rot so severe that the deck’s entire support structure is compromised. When this happens, particles from the wood (and often corroded sheet metal flashings) leach out of small openings in the face of the deck, and an owner learns, for the first time, that there is a problem.

The potential multi-million-dollar question is: When did the damage occur? In 1995, the California Supreme Court answered that question in the context of standard CGL policy language. Specifically, in Montrose Chemical Corp. v. Admiral Insurance, the court held that, where damage progresses over multiple policy years (commonly referred to as a “progressive or continuing loss”), standard CGL policies provide coverage under each policy period the damage could be said to have progressed (e.g., if the waterproofing contractor has 10 years of continuous CGL coverage post-completion, the owner could potentially hit as many as 10 policy limits to repair the resulting damage).

Montrose-Based Exclusions
Not long after the Montrose decision, insurance carriers began crafting policy exclusions to circumvent it. Although they take many forms, the most common are “anti-stacking” endorsements and “prior works” exclusions.

Anti-stacking endorsements typically provide that if any occurrence (including a progressive loss) is covered by more than one policy issued by the carrier, the most the carrier will pay for the occurrence is one policy limit—thus preventing a claimant from stacking multiple policy limits from that carrier. These clauses are often effective to limit coverage for carriers that issue multiple policies to the same contractor.

Prior works exclusions work differently. These exclusions preclude coverage for work completed before the policy’s inception date. While this exclusion is extremely effective at limiting policy stacking, it comes with unexpected consequences for developers and contractors. Specifically, by creating an earlier triggering event for the exclusion (completion of work) than for the coverage (occurrence of damage), it has the potential to substantially reduce coverage for damage arising from construction defects, and in some cases renders it completely illusory.

As an example, assume the waterproofer’s policy runs from July 1, 2005 to June 30, 2006. A project is completed on June 1, 2006, and the first rain event following completion does not occur until Sept. 1, 2006. When damage is discovered several years later in 2010, the owner notifies the contractor, and the contractor notifies its carriers. If all of the waterproofer’s policies have prior works exclusions, the only policy with potential coverage is the 2005-2006 policy.

More alarmingly, the carrier that issued the 2005-2006 policy could (and almost certainly would) contest liability on the grounds that most, if not all, of the property damage occurred after its policy expired. Specifically, the carrier would argue that, without any rain between the date of completion (June 1, 2006) and the expiration of the policy (June 30, 2006), the odds that any damage occurred during its policy period are slim. Second, the carrier would argue that, at most, it is only liable for the cost of repairing the roof sheathing, as the framing damage and ceiling leak damage undeniably occurred years after the policy expired.

In essence, an earlier triggering event for the exclusion (completion of work) than for the coverage (occurrence of damage) creates a loophole that allows all of the carriers to “walk between the raindrops” on liability for progressive loss claim —rendering the vast majority of the damage uncovered.

Insuring a construction project is a complicated undertaking. It is imperative that developers and contractors understand the reach and long-term impact of the endorsements contained in their insurance policies so they can evaluate the risks they are assuming and the benefits and drawbacks of negotiating specialty endorsements; removal of Montrose-based exclusions; or alternative methods of insuring their projects altogether.

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