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State high court ruling favors CGL insurers in construction suit

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HARRISBURG, Pa.—In a setback for policyholders, Pennsylvania's highest court has ruled that faulty workmanship cannot be considered an accident in order to establish coverage under a commercial general liability policy.

The opinion, issued last week by the Pennsylvania Supreme Court, overturned a 2003 Pennsylvania Superior Court ruling that had awarded coverage to a contractor, the Kvaerner Metals Division of Kvaerner U.S. Inc. of Bridgewater, N.J.

Kvaerner was sued in 1997 for breach of contract and breach of warranty by Bethlehem Steel Corp., a customer to which Kvaerner had sold equipment that underwent a faulty installation.

In its decision, the lower court determined that defense cost coverage should be granted to Kvaerner because the cause of the defect was in dispute, and one of the possible causes could have been torrential rains that occurred during installation of the coke oven battery, which would have been a covered peril under the CGL policy.

However, because Bethlehem Steel's lawsuit alleged only breach of contract and breach of warranty and not improper installation or damage due to weather, there was no coverage under the CGL policy, the Pennsylvania Supreme Court ruled in an appeal brought by National Union Fire Insurance Co. of Pittsburgh, Pa., a unit of American International Group Inc.

The decision could have wide implications in other construction-defect coverage cases in Pennsylvania because the issue of what constitutes an occurrence triggering coverage under CGL policies has been widely disputed in the state, according to Deborah M. Minkoff, an attorney at Cozen O'Connor in Philadelphia, who represented the insurer in the case.

"Whether faulty workmanship can constitute an occurrence is a very hot topic right now," she said. "Policyholders were successful in arguing that it was an accident because it was unexpected and unintended. Courts then were wanting to stretch coverage."

Now however, "with this decision, Pennsylvania holds that claims of faulty workmanship are not covered by commercial general liability policies. Many construction-defect claims and other insurance coverage disputes will be affected by this opinion," Ms. Minkoff said.

The case is also likely to be cited in jurisdictions outside of Pennsylvania because contractors nationwide have been challenging the definition of occurrence under CGL policies, according to Charles T. Young, a policyholder attorney at McNees Wallace & Nurick L.L.C. in Harrisburg, Pa., who was not connected to the Kvaerner case.

"This case will be cited in other jurisdictions, but it's obviously not controlling. So it will have some splash outside the state of Pennsylvania, but not huge," he said. "But it's the last word in Pennsylvania."

In ruling against the policyholder, the Pennsylvania Supreme Court took a narrow approach to interpreting two common insurance coverage principles: the extent of the insurer duty to defend and whether CGL policies cover contractual liability in addition to tort liability, said Ed Joyce, a policyholder attorney with Heller Ehrman L.L.C. in New York, who also was not involved in the Kvaerner case.

In ruling in favor of the policyholder, the lower court took into consideration other potential coverage triggers that were not identified in the underlying complaint--namely the rainstorm--to grant defense coverage to the policyholder, but the Supreme Court did not, he pointed out.

"To the extent that there can be a narrow interpretation of the duty to defend--which in and of itself is a broad duty--Pennsylvania is coming in on the side of the classic old school, 'Don't go outside the four corners of the complaint,' " Mr. Joyce said.

Secondly, "more courts don't make the contract-tort distinction," he added, referring to the narrow definition of occurrence applied in this case.

"The policy doesn't say, 'we only cover tortuous liability.' If all contractual liability were not covered, per se, then why would you have limited exclusions about certain types of contract activity. It wouldn't make any sense. You wouldn't need to do it," Mr. Joyce said.

Attorneys at Kirkpatrick & Lockhart Nicholson Graham L.L.P. in Pittsburgh, who represented policyholder Kvaerner in the case, were not available to comment.

Kvaerner Metals Division of Kvaerner U.S. Inc. et al. vs. Commercial Union Insurance Co. et al. Case No. J-161-2004. Supreme Court of Pennsylvania Middle District. Oct. 25, 2006.