COVER STORY, OCTOBER 2008

CGL INSURANCE COVERAGE
Your CGL policy may not cover you as much as you think.
Gary S. Kull, Esq., and Timothy B. Parlin, Esq.

Parlin

Caveat emptor!  This Latin phrase means “buyer beware” and applies to general contractors or builders who purchase commercial general liability coverage under the impression that such insurance will protect them against allegations of faulty work. Be advised that a comprehensive general liability insurance policy, commonly known as a CGL policy, does NOT afford coverage for faulty work alone.

By way of background, in order for there to be coverage under a CGL policy, there must be “property damage” caused by an “occurrence.” A typical CGL policy defines “property damage” as “physical injury to tangible property, including all resulting loss of use of that property” and “loss of use of tangible property that is not physically injured.”  An “occurrence” is typically defined as “an accident, including a continuous or repeated exposure to conditions, which results, during the policy period, in bodily injury or property damage neither expected nor intended from the standpoint of the insured.”

Kull

When a dispute arises over either defects in a house or a building constructed or sold by the general contractor or builder, i.e., the policyholder, or defects in a product manufactured or sold by the policyholder, the determination regarding whether the property damage and occurrence requirements have been satisfied requires the consideration of several factors. These factors include the policy’s definitions, the work and/or the product(s) the policyholder was contractually obligated to provide, the alleged faulty work, as well as the nature and cause of the alleged damage.

As an initial matter, you are cautioned to have your counsel and/or your insurance broker analyze the terms of your CGL policy, especially the policy’s definitions of “property damage” and “occurrence.” Then, counsel must determine how “property damage” and “occurrence” have been interpreted under your home state’s law. Many states have held that: 1) damage to someone else’s property, known as third-party property damage, is a prerequisite to potential coverage under your CGL policy; and 2) there is NO insurance coverage under your CGL policy for damages for the repair or replacement of your own work or product, so, as a general contractor, the repair or replacement of the subcontractor’s work is also not covered.

New Jersey courts have addressed what defects are, and are not, afforded insurance coverage under a general contractor’s or a builder’s CGL policy.  The New Jersey Supreme Court has drawn a sharp distinction between the repair and replacement of faulty materials, which it found not to be property damage that was covered under a CGL policy, versus damage to a third-party’s property caused by poor workmanship, which may be covered.  Other states have embraced New Jersey’s view that “business risks,” such as the repair or replacement of faulty materials, do not constitute third-party property damage under a CGL policy.

New Jersey, as well as many other jurisdictions, recognizes that faulty workmanship does not give rise to an occurrence where the alleged damage is confined to the general contractor’s or the builder’s own work, since repairing and replacing the alleged faulty workmanship is a contractual obligation that is the expected consequence of doing the work in the first place.

What if a policyholder seeks insurance coverage for the expenses he/she incurred when a house or building is alleged to have been defectively constructed, and is claimed to be partially or completely unusable or uninhabitable? Additionally, where an owner elects to sell the allegedly defective house or building, rather than correct the alleged defects, claims of diminution in value may be asserted. Courts around the country have considered whether such claims constitute “loss of use of property that is physically injured” and potentially fall within the second prong of the “property damage” definition contained in typical CGL policies.  Several courts have held that such “loss of use” and “diminution in value” claims do not constitute “property damage” caused by an “occurrence.” Once again, policyholders are advised to seek the advice of counsel as your state’s interpretation of this issue.

For example, in Illinois a general contractor’s CGL policy defined “property damage” as “physical injury to or destruction of tangible property, including all resulting loss of that property,” or “loss of use of tangible property that is not physically injured or destroyed, provided such loss of use is caused by physical injury to or destruction of tangible property.”  The court reasoned that, “[t]o the average, ordinary person, tangible property suffers a ‘physical’ injury when the property is altered in appearance, shape, color or in other material dimension. Conversely, to the average mind, tangible property does not experience ‘physical’ injury if that property suffers intangible damage, such as diminution in value.” The court succinctly stated, “comprehensive general liability policies . . . are intended to protect the [policyholder] from liability for injury or damage to the persons or property of others; they are not intended to pay the costs associated with repairing or replacing the [policyholder’s] defective work and products, which are purely economic losses. Finding [insurance] coverage for the cost of replacing or repairing defective work would transform the policy into something akin to a performance bond.”  Most other jurisdictions agree.

With regard to the questions as to whether business losses and other consequential damages are covered under a CGL policy, there is no clear answer.  Some courts have recognized that consequential damages, such as business loss and loss of profits, fall within the definition of property damage.  Other courts, however, have concluded that a CGL policy’s definition of property damage is limited to damage sustained by tangible property and does not include loss of profits.

General contractors and builders should always have an understanding, through consultation with their counsel and/or their insurance brokers, as to what will and will not be covered under their CGL policies.

Mr. Kull is a founding member of Carroll McNulty & Kull LLC in Basking Ridge, New Jersey.  Mr. Parlin is a senior associate at the firm. 

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.