New Jersey Supreme Court Continues Trend: CGL Policy Covers Damages Resulting from Subcontractor’s Faulty Workmanship

The purpose of a commercial general liability (“CGL”) insurance policy is to “protect[ ] business owners against liability to third-parties.”[1] The most commonly purchased CGL insurance policy is the standard form, which is occasionally modified by the Insurance Services Office, Inc. (“ISO”).[2] As a result, most insurers prepare their CGL policies based on ISO’s standard forms.[3] The ISO has promulgated a number of standard form CGL policies, including one policy in 1973 and another in 1986. The 1973 and 1986 standard form CGL policies have critical differences and those differences drove the rationale in the New Jersey Supreme Court’s watershed ruling in Cypress Point Condominium Association, Inc. v. Adria Towers, LLC finding coverage for a developer for damage to other work caused by subcontractors’ defective construction. This decision continues what appears to be a trend among various state and federal courts finding coverage is available under a CGL policy for defective construction under certain circumstances.

Background — Condo Association Claims of Defective Construction

The Cypress case arose following the construction of Cypress Point, a luxury condominium complex, containing fifty-three residential units. Adria Towers, LLC, Metro Homes, LLC, and Commerce Construction Management, LLC (collectively, “the developer” or “co-defendants”) served as the project’s developer and general contractor and hired subcontractors to carry out the majority of the construction.

After construction was complete, the Cypress Point Condominium Association (“the Association” or “plaintiff”) experienced water-related problems, such as roof leaks, water infiltration at the interior window jambs and sills of the residential units, and water intrusion into the common areas and interior structures. The Association brought an immediate action against the developer and its insurers seeking coverage under the developer’s 1986 CGL policies for consequential damages caused by the subcontractors’ defective work.

The Association alleged faulty workmanship in construction, including, but not limited to, defectively built or installed roofs, gutters, brick facades, exterior insulation and finishing system siding, windows, doors, and sealants. The Association additionally claimed consequential damages, consisting of, among other things, damage to steel supports, exterior and interior sheathing and sheetrock, and insulation, to Cypress Point’s common areas, interior structures, and residential units.[4] The trial court found that there was no “property damage” or “occurrence,” as defined and required by the policies, to trigger coverage.

In July, 2015, the Appellate Division of the Superior Court of New Jersey reversed the trial court’s decision[5] and held that unintended and unexpected consequential damage to common areas and residential units caused by subcontractors’ defective work constituted “property damage” and an “occurrence” under the CGL insurance policy. The Appellate Division found under the plain language of the CGL policies that the damages alleged in the Association’s claim satisfied the policies’ definitions of “property damage” and “occurrence.” The Appellate Division distinguished two prior New Jersey cases relied upon by the trial court in finding for the insurers, “because they (1) involved only replacement costs flowing from a business risk, rather than consequential damages caused by defective work; and (2) interpreted different language than the policy language in this appeal,” which was based on the 1986 standard CGL form rather than the 1973 version.[6]

The New Jersey Supreme Court then granted certification to consider the question of whether the 1986 standard form CGL policy prepared by ISO provides coverage to a developer and/or general contractor when a subcontractor’s faulty work causes consequential damage to the project.

The New Jersey Supreme Court Addresses Coverage for Defective Construction under ISO’s 1986 CGL Policy

On August 4, 2016, the New Jersey Supreme Court unanimously affirmed the judgment of the Appellate Division, and held that the “consequential damages caused by the subcontractors’ faulty workmanship constitute[d] ‘property damage,’ and the incident resulting in that damage — water from rain flowing into the interior of the property due to the subcontractors’ faulty workmanship — [was] an ‘occurrence’ under the plain language of the developer’s [1986] CGL policy at issue here.”[7]

The Court began by examining the general principles governing the interpretation of insurance policies, which are analyzed under the rules “simple contract law.”[8] “In attempting to discern the meaning of a provision in an insurance contract, the plain language is ordinarily the most direct route” and when the “language of a contract is plain and capable of legal construction, the language alone must determine the agreement’s force and effect.”[9] As to insurance contracts, “the general rule of construction [is] that if the controlling language of a policy will support two meanings, one favorable to the insurer and the other to the insured, the interpretation favoring coverage should be applied.”[10] The Court may only look to extrinsic evidence as an aid to an ambiguous provision.[11] Thus, the Court sought to determine whether “property damage” and an “occurrence” existed at Cypress Point under plain language of the developer’s 1986 CGL policy.

The Court found that both “property damage” and an “occurrence” existed at Cypress Point. The Court first examined the issue regarding property damage. The plain language of the 1986 CGL policy included the standard form policy language and provided coverage for “those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ … caused by an ‘occurrence’ that takes place in the ‘coverage territory’ … [and] … occurs during the policy period.”[12] The 1986 CGL policy defines “property damage” as a “[p]hysical injury to tangible property including all resulting loss of use of that property.”[13] The Court found “property damage” existed because the consequential water damage qualified as “[p]hysical injury to tangible property including all resulting loss of use of that property.”[14] The Court specifically referenced the Association’s mold growth, damage to the completed and non-defective common areas and units, and the loss of use of the affected areas.[15]

The Court subsequently examined whether an “occurrence” had occurred. The 1986 CGL policy defines an “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”[16] The insurers argued the damage at issue was a “normal, predictable risk of doing business,” relying on Weedo v. Stone-E-Brick, Inc.[17] and Firemen’s Insurance Co. of Newark v. National Union Fire Insurance Co.[18] The Court disagreed and rejected the insurers’ argument that faulty workmanship can never be an accident because it results in reasonably foreseeable damages. The Court found that consequential property damage was not foreseeable, and no one even claimed the subcontractors intentionally caused the property damage. Thus, the Court held that Weedo and Firemen’s were inapplicable for two reasons — first, because both cases involved an earlier ISO form of the CGL policy from 1973, and not the 1986 policy that was at issue, and second, because the developer in Cypress was seeking insurance coverage for consequential damages resulting from faulty workmanship, rather than seeking coverage for the cost of replacing the faulty workmanship, as was the case in Weedo and Firemen’s.[19]

The Association’s allegations sufficiently stated that an “occurrence” existed because the consequential water damage to the completed and non-defective portions of Cypress Point was an “accident.” The Court found that an “accident” as used in the 1986 CGL policy “encompasses unintended and unexpected harm caused by negligent conduct” and because the result of the subcontractors’ faulty workmanship here — consequential water damage to the completed and non-defective portions of Cypress Point — was an ‘accident,’ it [constituted as] an ‘occurrence’ under the policies and is covered so long as the other parameters set by the [1986 CGL] policies are met.”[20]

The Court lastly examined the “your work” exclusion clause in the 1986 CGL policy. The 1986 CGL policy does not provide insurance coverage for “property damage” to “your work” arising out of it or any part of it.[21] However, unlike the 1973 CGL policy, the 1986 CGL policy includes a subcontractor exception to the “your work” exclusion.[22] The subcontractor exception explicitly provides that the “your work” exclusion “does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”[23]

The Court observed that, when viewed in isolation, the “your work” exclusion would seem to eliminate coverage for the Association’s claims — after all, as to the developer or general contractor, the entire condominium is “your work.”[24] However, the Court found that the 1986 subcontractor exception “unquestionably applies,” because the water damage to the completed and non-defective portions of Cypress Point resulted from the faulty workmanship performed by subcontractors, and thus was a covered loss.[25]

Strong Trend for Policyholders

The Cypress decision is another win for policyholders. The Court’s ruling strengthens the trend that under the 1986 ISO standard form CGL policy, a developer’s or general contractor’s insurance must respond with coverage when a subcontractor’s faulty work causes consequential damage to other, non-defective portions of a project. The decision is another example for insurers of the potential exposures for claims due to a subcontractor’s faulty or defective work under the 1986 CGL policy.

** Jessica Manning is former associate at Laurie & Brennan LLP. We thank her for her work on this article.

[1] Cypress Point Condo. Ass’n v. Adria Towers, L.L.C., 226 N.J. 403, 143 A.3d 273, 281 (2016)(the CGL policy originated in the 1940s as a result of a voluntary effort in the insurance industry to address the misunderstanding, coverage disputes, and litigation that resulted from the unique language used by each liability insurer. In 1966, ISO revised and expanded the CGL policy to cover “occurrences,” which provided coverage for “accidents” and “continuous exposure to conditions.”) (quoting 3 Jeffrey E. Thomas, New Appleman on Insurance, Law Library Edition  §16.02[3][a][i](Appleman)).

[2] Id. (quoting Appleman, supra at  §16.02[3][a][iii]).

[3] Id. (quoting Appleman, supra at  §16.02[3][a][iv]).

[4] Id. at 277.

[5] Cypress Point Condo. Ass’n, Inc. v. Adria Towers, L.L.C., 441 N.J. Super 369 (App. Div. 2015).

[6] Id. at 375-77.

[7] Cypress Point Condo. Ass’n, 143 A.3d at 276.

[8] Id. at 280.

[9] Id.

[10] Id.

[11] Id.

[12] Id. at 277.

[13] Id.

[14] Id. at 286.

[15] Id.

[16] Id. at 277.

[17] Id. at 278. Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979).

[18] Id. Firemen’s Ins. Co. of Newark v. Nat’l Union Fire Ins. Co., 387 N.J. Super. 434 (App. Div. 2006).

[19] Id. at 282-84, 287-88.

[20] Id. at 288.

[21]Id. at 289.

[22] Id.

[23] Id.

[24] Id.

[25] Id.