A Brief History
The building industry is constantly experimenting with new building products and techniques in an effort to reduce costs, become more efficient, and to add value. Sometimes these products don’t stand the test of time as unforeseen problems may arise that result in construction defects. Examples include EIFS or synthetic stucco, Masonite siding, Georgia Pacific siding, polybutylene plumbing, and more recently, Chinese drywall.
The full weight of the construction defect crisis began to be felt by the insurance industry about ten years ago. Regionally, in the Southeast, the first wave of large-scale lawsuits arose over EIFS. The insurance industry fully funded a plaintiff attorney’s “gravy train” in this area since most of the costs were covered by General Liability insurance policies of manufacturers, distributors, builders, and installers. The EIFS epidemic, with its readily available funding source (General Liability carriers), seemed to fuel the spread of construction defect claims of all different types.
As a result, two trends emerged. The first was that most insurance carriers left the market and refused to write General Liability insurance for builders since they reasoned they couldn’t make a profit at any premium level. The second was that those few that remained in the market decided that they did not want to be a funding source for the next wave of construction defect lawsuits. In response, the insurance industry adopted an array of exclusionary endorsement forms from which carriers could pick and choose to limit their risk.
To follow is a listing and brief commentary of commonly found exclusions that can severely impact coverage for builders. In addition, solutions are provided where applicable.
Synthetic Stucco (EIFS) Exclusion: If you’re a builder and you install or repair EIFS, you need to buy a special General Liability policy from the high-risk marketplace to cover this type of work.
Soil Movement Exclusion: Expansive soils have been a problem in some parts of the country and have been a major source of construction defect lawsuits. Its possible to pick up coverage for this exposure through the use of certain home owner’s warranty products such as HBW 2-10.
Fungus, Mold, And Mildew Exclusion: This exclusion was added almost immediately to most General Liability policies when toxic mold lawsuits began to first appear. This strategy proved to be effective in cutting off what many feared to be the next “gravy train” of construction defect litigation. Most versions of this exclusion only eliminate coverage for the “property damage” portion of the lawsuit but leave coverage in place for “bodily injury”. If you’re concerned about this exclusion, you can purchase a special Mold And Pollution Liability policy from the high risk insurance market. The minimum premiums start out in the $2,500 to $5,000 range and prices increase according to your sales.
Absolute Pollution Exclusion: This is a powerful exclusion that can have consequences beyond what you normally think of as pollution. This is exemplified in the recently emerging Chinese drywall crisis where its alleged that drywall from certain plants in China release noxious fumes that cause corrosion of metal in a home, a foul smelling odor, and health problems. The insurance carriers plan on denying these claims by using the Absolute Pollution Exclusion. Pollution is broadly defined under this exclusion as any solid, liquid, or gaseous contaminant or irritant. Once again, if you are concerned about this exposure, you can buy a special Pollution Liability policy through the high risk marketplace.
Prior Completed Operations Exclusion: The standard General Liability policy form normally picks up coverage for building operations completed prior to the start of the policy term as long as the covered “property damage” or “bodily injury” occurs during the policy term. However, with the addition of the Prior Completed Operations Exclusion, coverage for prior completed operations is eliminated. This presents a problem because the General Liability forms from the prior years don’t pick up this coverage to the extent that the “property damage” or “bodily injury” occurs after the expiration of the prior policy terms. Some versions of this endorsement limit its scope to “property damage” only. You may want to attempt to negotiate the elimination of this endorsement if it appears on your policy.
Products / Completed Operations Exclusion: This exclusion has perhaps the most devastating impact of any of the construction defect exclusions. Quite simply, this exclusion eliminates coverage for all “bodily injury” and “property damage” that occurs after the home has been sold. In my opinion, this exclusion is unacceptable for a builder under any circumstances resulting in the need to find a new insurance carrier.
Property Damage To Your Work Exclusion: This exclusion is not a stand alone exclusion like the rest that have been mentioned. Instead, it is part of the regular General Liability policy form and appears as exclusion L. This exclusion eliminates coverage for “property damage” to your “work” arising out of it…. However, there is an important exception where coverage is given back if the damaged work was performed on your behalf by a subcontractor. This exception is what historically gave builders (that were general contractors) broad coverage under their own General Liability policy for construction defect claims.
Exclusion: Damage To Your Work Performed By Subcontractors On Your Behalf (CG2294): Around 2004, most carriers began adding this exclusion to builder’s General Liability policies to eliminate the favorable coverage exception that was granted to builders (that were general contractors) under the Property Damage To Your Work Exclusion listed above. The presence of CG2294 eliminates coverage for construction defect claims. If CG2294 appears on your policy, there are two viable solutions. First, ask if your carrier has a “buyback” of the lost coverage for an additional premium charge. Second, search for a carrier that has a less severe version of this exclusion that only eliminates coverage for “property damage” to the faulty work itself but not to resulting “property damage” to the non-faulty work.
Unfavorable Case Law
In order to have a favorable claim outcome, builders not only have to avoid the above mentioned exclusions, but also must not fall victim to unfavorable case law. Nationally, a number of courts have ruled that a contractor’s General Liability policy does not cover “property damage” to either faulty work or resulting non-faulty work under the theory that such damages don’t constitute an “occurrence”. The South Carolina Supreme Court ruled similarly in the road contractor case of L-J vs Bituminous. However, the South Carolina Supreme Court recently clarified its ruling for builders in the Auto Owners vs Newman rehearing. In this case, the court ruled that “property damage” to non-faulty work is an “occurrence” and thus subject to coverage (unless otherwise excluded). This is a mostly favorable ruling for builders in South Carolina but is still an overall coverage reduction to the extent that coverage is precluded for property damage to the faulty work itself.
Builders must employ aggressive risk management techniques to protect against out of pocked losses due to policy exclusions and unfavorable case law. Examples of such techniques include contractual transfer of risks to subcontractors (ex: hold harmless / indemnification provision and insurance requirements), the use of home owner warranties, thorough documentation of construction files, and being proactive in dispute resolution.
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