Insurance Gap For Residential Homebuilders: No CGL Coverage For Contractors Sued Under An Implied Warranty of Habitability Claim

June 2, 2017 Firm News

When residential homeowners assert claims of defective construction, homebuilders often tender those defective construction claims to their commercial general liability insurer. Recently, the Seventh Circuit revealed an insurance gap for residential homebuilders from such claims in Allied Property & Casualty Ins. Co. v. Metro North Condominium Association, Case No. 15-cv-03925 (7th Cir. March 8, 2017). The Seventh Circuit held that an insurer was not liable for damages its insured caused – even to other property – when the only legal theory asserted was a breach of the implied warranty of habitability. While the facts of the underlying case are unique in that the plaintiff had no other pending claims against the insured, the holding that an insurer’s policy did not cover the insured for an otherwise covered claim solely because the cause of action was for implied warranty of habitability is of significant importance to contractors and subcontractors that may face such claims.

The underlying case involved a condominium association and its owners suffering extensive water damage due to defectively installed windows. During rain storms in 2006, water infiltrated common areas as well as numerous private condominium units leading to damage alleged to exceed $5 million. To recover the losses, the condominium association (the “Condo Board”) initiated litigation in state court against the building’s developer in 2009.

In 2012, the Condo Board filed another state court action and directly sued the subcontractors that installed the defective windows, CSC Glass and CSC Construction (collectively, “CSC”). The Condo Board sued CSC asserting an implied warranty of habitability claim. Under Illinois law, owners typically cannot sue subcontractors directly for implied warranty of habitability claims. However, if the developer is insolvent – which was the case here – Illinois provides an exception to the rule. This is known as the Minton exception. Minton protects homeowners’ rights to recover for a subcontractor performing defective work where the owner otherwise has no recourse against its developer due to the developer’s insolvency. Minton v. Richards Group of Chicago, 116 Ill. App. 3d 852 (1st Dist. 1983).

In the state court litigation, CSC settled the Condo Board’s lawsuit for $700,000. The settlement agreement expressly stated that the settlement amount was only for those damages that CSC caused to parts of the building on which CSC did not perform work. As such, the Condo Board and CSC agreed that the settlement compensated the Condo Board for damage CSC caused to “other property”. Damage to other property is generally covered by CGL insurance and CSC assigned the Condo Board its right to the insurance proceeds covering the damage. CSC’s CGL insurer was Allied Property & Casualty Insurance Company (“Allied”).

Allied then filed its lawsuit in federal court seeking a declaration that it did not have to pay the $700,000. Allied and the Condo Board, as assignee of CSC, filed dueling motions for summary judgment as to whether the policy required Allied to cover the claim. The trial court granted summary judgment in Allied’s favor and the Condo Board appealed. The Seventh Circuit affirmed the trial court’s ruling and held that because the claim against the insured was for the implied warranty of habitability, the insurer did not have to cover the claim.

What is the Role of CGL Insurance in the Construction Industry?

Nearly every contractor and subcontractor performing construction work carries and is required to carry commercial general liability (“CGL”) insurance. Owners and contractors rely on CGL insurance to protect and cover the risks of damage to other property and bodily injury when performing work. For example, if a roofer is performing work and the roofer’s work accidentally causes the roof to collapse, CGL insurance will cover the cost of the damage to property other than the roof that occurred, which costs could be significant and exceed the roofer’s subcontract. Damage to other property while performing work is not a risk that the roofer prices into its subcontract because it has CGL insurance. If the roofer did price in the potential cost of paying for damage to other property or bodily injury resulting from its work, and if insurance did not cover those risks, then the roofer (and all contractors) would have to charge far more for their work. Significantly, CGL insurance also provides contractors a defense against any claims brought alleging that the contractor caused bodily injury or damage to other property.

What is the Implied Warranty of Habitability?

The implied warranty of habitability is a cause of action created by Illinois courts to protect homeowners from latent defects in their newly-built homes. The rationale put forth by courts to support the doctrine’s creation is that homeowners do not have the ability to determine whether the home they purchased has a latent defect, that homeowners are not in the business of construction, unlike homebuilders, and homeowners rely on the honesty and competency of homebuilders and that repair costs of latent defects should be borne by the responsible homebuilder. 324 W. Pratt Condominium Ass’n v. Platt Const. Group, Inc., 2013 IL App (1st) 130744. As such, it has been longstanding Illinois law that homeowners, unlike commercial buyers, have recourse after purchasing the home from a developer if latent defects are discovered. Importantly for the Allied case holding, in creating the implied warranty of habitability action Illinois courts have stated that the measure of damages for a breach of the implied warranty of habitability is the cost of repairing the defective condition.

Why Did The Allied Court Rule That CGL Insurance Does Not Cover Damage To Other Property?

In reviewing the summary judgment ruling, the Seventh Circuit accepted as true that the damages sought by CSC against Allied were solely for damage to other property. The court acknowledged that damage to other property is covered by Allied’s CGL insurance policy to CSC. But the court’s analysis did not stop there. The court noted that insurers are only required to pay covered claims if the insured is legally responsible for those damages. The court questioned whether the damages to other property, albeit covered by the CGL policy, were legally recoverable by the Condo Board against CSC under an implied warranty of habitability claim. If not, then the insured was not “legally responsible” for the damages, and the insurer would not have to cover the claim.

The court reasoned that had CSC not entered into the settlement agreement and instead litigated the Condo Board’s claim, then CSC’s liability would have been the cost of repairing the defective condition, which would be repairing or replacing the defective windows. However, the actual repair costs were not sought by CSC from Allied as they were not part of the settlement agreement. As such, the court held that CSC was not legally responsible for damage to other property, the only damage that CSC sought coverage for from Allied.

Consequences of Allied to Homebuilders

Allied has created an insurance gap for homebuilders faced with a lawsuit alleging only an implied warranty of habitability claim. Under Allied, if a homebuilder tenders its CGL carrier an implied warranty of habitability claim, the insurer will now likely reject defending and covering the claim under Allied. If that denial occurs, the contractor may be facing a claim where the delineation between repair work and damage to other property is not clear and the claim amount can be significant. Contractors expect insurance to, at a minimum, provide a complete defense for such a claim. Instead, under Allied, a contractor may face large exposure in a lawsuit without the insurance it has come to expect to protect against such claims.
Most construction defect lawsuits include theories of recovery beyond just an implied warranty of habitability claim. Allied will not alter the insurance coverage analysis for those claims. But Allied confirms that homebuilder contractors should be aware that their CGL insurance likely will not offer defense or indemnity coverage if faced only with an implied warranty of habitability lawsuit even if it is apparent that the lawsuit includes damage to other property.