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Four states recently have passed statutes defining construction defect claims as occurrences, but commercial general liability policyholders continue to be frustrated by coverage gaps for faulty work construction.
Although incongruous court decisions over whether construction defect claims are covered under CGL policies continue to drive uncertainty in coverage and increase litigation costs, a unique trend among states may take the battle out of the courts, experts say.
Contractors, subcontractors, land owners or developers can be named in a construction defect suit, and the issue of coverage arises when one of those entities turns to their CGL policy for coverage against those claims, said Julian Ehrlich, senior vp of claims for Aon Risk Solutions' construction services group in New York.
“One of the interesting and compelling aspects of the issue of coverage for defective construction is that jurisdictions differ, so policyholders don't know what they're going to get,” Mr. Ehrlich said.
At the root of the issue is whether construction defects, defined as damages resulting from shoddy or faulty work, constitute an occurrence triggering the policy, experts say.
“In context of construction defect, the term "occurrence' is ambiguous,” Mr. Ehrlich said. “The definition of terms frames the debate, and here we have undefined terms.”
The policy language within the CGL form has been interpreted differently by courts deciding construction defect claims, causing disparities in coverage for policyholders, experts say.
The CGL form was designed to apply to various risks across many different industries, said Frank Armstrong, Tampa, Fla.-based senior vp and national director of construction claims for Willis North America.
“Certain pieces of it don't fit well, at least according to some courts in the country, with coverage for construction defect risks,” he said.
Typically, once a loss occurs, the CGL insuring agreement must be satisfied, which generally means there must be property damage arising from an occurrence as defined by the policy, Mr. Armstrong said. Once the insuring agreement is satisfied, different policy provisions will be applied to determine the scope of coverage.
“The insuring agreement and other policy provisions have been interpreted by courts around the country in different ways,” he said.
The word “occurrence” is “where the problem starts,” he said, noting that two courts in different states interpret the exact same word and definition differently with respect to construction defect.
Further exacerbating the matter is the cost of litigation for policyholders, experts say.
F. Warren Jacoby, Philadelphia-based vice chairman at Cozen O'Connor and head of the law firm's construction law and litigation practice, said “the biggest challenge right now is the cost of litigation.”
“People are just tiring of the judicial process,” he said. “In the court systems, you get bogged down with e-discovery and all sorts of issues, so the litigation process has become very expensive for most people.”
Construction defect litigation is expensive and lengthy, as the construction industry often is forced to litigate insurance coverage issues while at the same time defending against the construction defect claim in the underlying case, said Jeffrey J. Vita, a partner at law firm Saxe Doernberger & Vita P.C. in Hamden, Conn.
Insurance solutions for construction defect claims are expensive and somewhat limited, experts say.
“There's a least one major carrier out there that is offering an endorsement that, for example, will provide coverage for construction defect under the law of the most favorable state that the policyholder does business in,” Mr. Ehrlich said.
Construction defect endorsements are common, with only a few major construction markets not offering the coverage, said Paul Primavera, senior vp and practice leader of Lockton Cos. L.L.C.'s national claim advisory group in Washington.
The endorsement provides the certainty and consistency of coverage for construction defects so it doesn't change depending upon the jurisdiction, Mr. Primavera said.
“The one aspect of it that is somewhat inconsistent is the pricing, or lack thereof,” he said. “The cost associated with that will depend on the appetite of the individual insurer with that particular policyholder, and also depends on the size of the policyholder if they take a retention.”
While courts are trending to side with policyholders that a construction defect claim constitutes an occurrence under their CGL policies, four states have passed legislative statutes to address the issue, experts say.
Arkansas, Colorado, Hawaii and South Carolina have laws that legislate that construction defect claims constitute occurrences.
The disparity in court decisions has led the construction industry to seek relief through legislative efforts, said Willis' Mr. Armstrong, who noted that the legislation initiated and ultimately passed was “unique,” in that it essentially creates statutory law on how certain CGL terms are to be applied for construction defect losses.
“State legislatures...have recognized this battleground, and they have taken it out of the courts' hands, and they've passed legislation that in various forms says faulty work does constitute an accident under a CGL policy,” said Mr. Vita.
“They have done it specifically for these construction claims,” he said.
Colorado was the first state to pass a law, H.B. 10-1394, in May 2010. The Legislature addressed the conflicting expectations of insureds because of the complex and lengthy endorsements and exclusions facing construction professionals, according to the bill.
“In interpreting a liability insurance policy issued to a construction professional, a court shall presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident unless the property damage is intended and expected by the insured,” the statute reads.
“The legislatures have stepped in to try to get some relief for the construction industry, which is so vital to so many of the states' economies,” Mr. Vita said.
“You have to read the specific language of each of those four statutes because they vary significantly in what they say. But the general intent is to take this issue out of the courts' hands,” he said.
Mr. Ehrlich of Aon said the effects of the legislation may create more uncertainty as states and courts continue to define CGL policy language with respect to construction defect claims.
“It remains to be seen whether that trend will spread, whether more legislatures will address that issue and attempt to resolve it by statute,” he said.
“These four states have stepped up. I expect that you're going to see more states pass similar legislation in the coming year or two,” Mr. Vita said.