Direct damage to property under construction caused by faulty or defective work or defective materials has been a coverage issue for decades. Two specific policies, the Commercial General Liability for the contractors building the structure and the Builders Risk Policy on the project both are sources of potential coverage.
A CGL policy protects the named insured (the contractor in this case) from third party liability arising out of the insured’s operations that results in either bodily injury or property damage. Damage to property caused by poor workmanship or defective materials would qualify as property damage. To understand how the CGL policy might respond to claims such as these, it is necessary to evaluate several exclusions in the CGL policy.
CGL policies cover “property damage,” defined as physical injury to tangible property, including loss of use of such property, and loss of use of tangible property that has not been physically injured.
Exclusion M provides that there is no coverage for loss of use of property that has not been physically injured due to a defect in the work. This is significant, because it means that there is no CGL coverage for defective work without physical injury to the work.
For example, prior to completion on a construction project, inspection revealed that windows were not properly installed, making them prone to leaks. But no leaking had occurred. Removing and reinstalling the windows delayed the project by two weeks. The owner made a claim against the GC for lost revenue for the two weeks. There is no CGL coverage because the loss of use was purely due to defective work, with no physical injury (the CGL only covers liability that results in bodily injury or tangible property damage).
There are two additional exclusions applicable to property damage in the course of construction, exclusions J.5 and J.6:
In both cases, the CGL affords coverage for physical damage to the work caused by defects or defective work--basically the ensuing damage. In neither case would the General Liability policy cover that particular part that was either worked on or needed to be repaired or replaced due to defective work.
Project-Specific CGL Coverage (OCIPs and CCIPs) needs to be considered in a different light. Nearly every OCIP or CCIP will include an exclusion for property damage to the insured project during the course of construction (note, that a small minority of insurers may remove this exclusion if the contractor can provide evidence of a LEG 2 or 3 endorsement). These are often referred to as “Course of Construction” or “Builder’s Risk Exclusions.” These exclusions are added with the expectation that the builder’s risk insurance should provide coverage for damage to the structure during the course of construction.
Providing coverage under a first party property form is preferred to a third- party liability form because it should eliminate any litigation. The key is negotiating broad and favorable terms under the Builders Risk policy. A well-written Builders Risk policy will include:
The U.S. builder’s risk market is dominated by manuscript forms. There are some consistencies, but each form must be carefully reviewed. With respect to coverage for property damage during the course of construction caused by defective work, domestic forms generally fall into two categories.
The first type, which is less common, excludes all damage caused by, or arising out of faulty workmanship. This removes coverage for repairing defective work as well as for any damage to the project resulting from the defective work. These forms offer less coverage than the ISO CGL policy and should be avoided.
The second, more common, domestic form excludes loss or damage caused by faulty work, unless the damage is caused by a covered cause of loss. These are commonly referred to as “ensuing loss exceptions.” Taking the example of the concrete subcontractor who improperly mixed the concrete that resulted in structural damage, in this case the re-pour is excluded but the damage to the rest of the structure is not because collapse is a covered peril.
Most domestic builder’s risk policies with ensuring loss exceptions provide roughly the same scope of coverage for property damage during the course of construction as an ISO CGL policy. Neither policy provides coverage for the cost of replacing defective work, but both policies cover direct damage to the rest of the project caused by the defective work. In the case of a Builders Risk policy this ensuing loss must be caused by a covered peril.
An underwriting syndicate in London came up with proposed endorsements that specifically address the faulty workmanship issue. Authored by the London Engineering Group, these have come to be known as LEG1, LEG2 and LEG3:
LEG2 and LEG3 each contain an additional provision stating that “it is understood and agreed” that insured property shall not be considered damaged “notes solely by virtue of the existence of any defect of material workmanship, etc...”. In other words, there must be a covered cause of loss to trigger coverage. In simple terms, LEG3 coverage excludes the cost to repair a defect where there is no resulting damage, and the cost of improvements over and above the original work.
Here, in the example of the concrete subcontractor who improperly mixed the concrete that resulted in structural damage, the re-pour is covered along with damage to the rest of the structure. If, as an added safety precaution, the foundation was reinforced with metal rods, the cost of adding the metal rods would not be covered. The LEG3 form provides broader coverage for damage caused by defective work than the ISO CGL policy. The ISO CGL policy does not cover the cost of repairing or replacing defective work whereas LEG3 does. It should also be pointed out that LEG3 Endorsements are usually not available on smaller projects or frame construction.
Insuring construction projects are complex. There are numerous stakeholders as well as significant exposures, General Liability, property under construction, pollution, workers compensation, professional liability, etc.
Here are a few things to keep in mind:
There is no substitute for taking the time to understand the risks of a project and negotiating favorable terms for all stakeholders. A well written and coordinated insurance program is a critical piece to a successful project.
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