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Faulty Workmanship on Newly- Constructed Alabama Home Constitutes an “Occurrence” Sufficient to Warrant Coverage for Insured’s Work under CGL Policy
by Kelly M. Kammer
Contractors face significant exposure for property damage resulting from allegedly faulty construction. While commercial general liability (CGL) policies help contractors manage these risks, rarely has CGL coverage been extended to damages to the policyholder’s work. Indeed, courts have historically been reluctant to find that CGL coverage exists when the damage is to the insured’s work although that reluctance has been abating in recent years. The recent Alabama Supreme Court case Owners Ins. Co. v. Jim Carr Homebuilder, LLC, –So.3d–, 2014 WL 1270629 (Ala. Mar. 28, 2014) is an example of a court finding that a CGL policy may be invoked to cover damage to the project resulting from conditions created by the policyholder’s allegedly faulty workmanship. Importantly, the decision finds that purportedly faulty work can constitute an “occurrence” triggering CGL coverage. Further, the Owners court found that where the policyholder purchases completed operations coverage, that coverage will essentially nullify the “your work” exclusion, thereby triggering coverage under the policy.
Background
In January 2006, Thomas Johnson and Pat Johnson contracted with JCH, a licensed homebuilder, for the construction of a new lake house. The Johnsons paid approximately $1.2 million for the design and construction of the house and took possession of the substantially finished house in early February 2007. Within a year, the Johnsons noted several problems with the house related to water leaking through the roof, walls, and floors, resulting in water damage to those and other areas of the house. The Johnsons notified JCH of the problems and JCH apparently made some efforts to remedy them; however, the Johnsons were not satisfied with those efforts, and ultimately sued JCH, alleging breach of contract, fraud, negligence and wantonness. The dispute proceeded to arbitration and the arbitrator ruled that JCH’s work was defective and awarded the Johnsons significant damages against JCH.
JCH sought coverage for the award under its CGL policy (“Policy”) that was issued by Owners Insurance Company (“Owners”). Owners refused coverage, however, and argued that the faulty workmanship did not constitute an “occurrence” as defined by the Policy. Owners sought a declaratory-judgment that it had no duty to defend and indemnify JCH with regard to the Johnsons’ claims. Owners’ attempt to refuse coverage ultimately failed, however, and the trial court held that the CGL Policy was triggered and Owners was required to fully indemnify JCH for the entire arbitration award. Owners subsequently filed its appeal.
The Alabama Supreme Court initially reversed the trial court’s decision, holding that there was no coverage because JCH’s faulty workmanship damaged the contractor’s own product. Upon reconsideration, the Alabama Supreme Court changed course, withdrew its prior decision and issued a new one that affirmed the lower court holding that Owners was obligated to provide coverage.
The Alabama Supreme Court Decision
In its appeal, Owners argued that the property damage upon which the award was based was not the result of an “occurrence,” i.e. “an accident, including continuous or repeated exposure to substantially the same general harmful conditions,” as defined by the Policy. Owners argued that faulty workmanship may only result in an “occurrence” to the extent that such workmanship results in damage to real or personal property that is not part of that construction or repair project. As there was no “occurrence” in Owners’ eyes, there could be no coverage under the Policy.
The Alabama Supreme Court found that in making that argument, Owners asked the term “occurrence” to do too much. The court reasoned that the Policy provision defining occurrence did not limit coverage based on the nature or location of the property damaged. Importantly, the court found that adopting Owners’ proposed reading of the term “occurrence” would result in illusory coverage. Indeed, under Owners’ interpretation, where an insured contractor is constructing a new building or complete renovation, there would be no portion of the project that would be covered under the policy if it was damaged as a result of faulty workmanship.
The court clarified that faulty workmanship itself is not “property damage” caused by or arising out of an “occurrence” and confirmed that the cost of repairing or replacing faulty workmanship is not the intended purpose of a CGL policy. Nonetheless, the court concluded that the definition of the term “occurrence” does not itself exclude from coverage the property damage alleged in Owners.
The court’s analysis did not end with its discussion of the term “occurrence” but also addressed the “your work” exclusion. The “your work” exclusion provides that a CGL policy is not intended to act as a warranty; as such, no coverage will exist under the CGL policy once the work has been completed. The “your work” exclusion is consistent with the purpose of a CGL policy, which, according to the Alabama Supreme Court, is to insure the builder from losses resulting from its negligence while engaged in the process of performing the construction work for which it was hired. Therefore, once construction was completed, it was not the intent of the Owners Policy to insure JCH against claims for damage to the Johnsons’ house arising from harmful conditions made possible by faulty workmanship previously performed by JCH. This risk is known as the “completed operations hazard” and, absent supplemental coverage purchased by the insured, is not covered by the standard CGL policy.
The Owners Policy — like most standard CGL policies – included an express “your work” exclusion that specifically addressed the completed-operations hazard. The pertinent provision of the Owners Policy provided that coverage did not apply to “‘[p]roperty damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’” However, in order to determine what property damage is ultimately included or excluded, including whether damage to the insured’s completed work is covered by the Policy, the court directed that one must look to the Policy declarations. If the declarations show coverage for products-completed operations, then the “your work” exclusion does not apply. In short, the “your work” exclusion applies if and only if the Policy’s declarations fail to show any coverage for products-completed operations.
A review of the Owners Policy declarations showed that JCH did indeed have coverage for both ‘Bodily Injury Products/Completed Operations’ and ‘Property Damage Products/Completed Operations.’ As such, JCH bargained and paid for coverage for its products-completed operations, which, according to the Alabama Supreme Court, thereby nullified and rendered inapplicable the ‘your work’ exclusion.
Owners argued that the Johnsons’ home and every component of the home was the work of JCH, and therefore the “your work” exclusion barred coverage under any set of circumstances. The court again rejected this argument and held that if it were to accept Owners’ interpretation, then Owners would have issued a policy providing only illusory coverage.
Thus, because there was no dispute that JCH’s “operations” on the Johnsons’ house were completed at the time of the alleged occurrences, the completed operations coverage applied to the Johnsons’ claims and the Alabama Supreme Court held that, pursuant to the terms of the Owners Policy, Owners was obligated to indemnify JCH.
Practical Implications
By including property damage resulting from exposure to conditions created by faulty workmanship within the definition of “occurrence,” the Alabama Supreme Court has broadened contractors’ potential for securing CGL coverage. Subject to any further clarification from the Alabama Supreme Court, it has further given contractors guidance in avoiding a denial of coverage by purchasing completed operations coverage. The Alabama Supreme Court’s ruling is consistent with a national trend of finding that faulty workmanship can constitute an “occurrence” under a CGL policy, thereby providing increased protection for contractors when property damage results from a condition created by faulty workmanship, even when such damage happens to be to the contractor’s work.