Throughout 2009, there have been several important andinteresting cases that will likely impact various sectors of theinsurance industry. While this piece is not intended to be acomplete review of all 2009 insurance cases, it will provide aquick summary of some of the important cases decided by courtsaround the country in 2009.

Auto Owners Insurance Company v. Virginia T.Newman,
2009 WL 2851211 (S.C., September 8,2009)

In recent years, construction-defect coverage litigation hasquickly become a hot topic in insurance law. While some states'courts have yet to address this issue, the majority ofjurisdictions that have addressed it are split as to whether faultyworkmanship constitutes property damage caused by an occurrenceunder the coverage grant of a traditional commercial generalliability (CGL) policy.

A recent decision by the South Carolina Supreme Court mayrepresent a considerable shift with respect to the state's analysisregarding insurance coverage for claims based upon allegations offaulty workmanship. While Auto Owners Ins. Co. v. Newmanhas not yet been released for publication and, therefore, is stillsubject to revision or withdrawal, the court in AutoOwners distinguishes its holding from prior South CarolinaSupreme Court's holdings, particularly L-J v. Bituminous Fire& Marine Ins. Co., 621 S.E.2d 33 (S.C. 2005). It is alsoimportant to note, however, that the court did not overrule and/orcriticize its previous holding in L-J.

In Auto Owners, a homebuilder's general commercialliability insurer sought a declaratory judgment that its policy didnot provide coverage for a homeowner's claim for damages caused bythe negligence of a construction subcontractor relating to theinstallation of stucco siding. According to the complaint, “theapplication of the stucco did not conform to industry standards,”and permitted water to seep into the home and cause severe damageto the home's framing and exterior sheathing. The insurerdisclaimed coverage for the homeowner's claim. Specifically, theinsurer argued that the South Carolina Supreme Court's previousholding in L-J precluded coverage for property damagecaused faulty workmanship because such property damage was notcaused by an occurrence.

In L-J, a developer hired a general contractor toperform the site development and road construction for a project.The general contractor then hired subcontractors to perform themajority of the work. However, after construction was completed,the roads began to deteriorate allegedly as a result of negligentroad design, preparation, and construction. The developer thenfiled suit against the general contractor. The general contractor'sinsurer disclaimed coverage for the developer's claims. The generalcontractor then filed a declaratory judgment action against itsinsurer. Specifically, the general contractor claimed that itsinsurance carrier was obligated to cover the damages associatedwith the deteriorating road.

The South Carolina Supreme Court found that, although thedeterioration to the roadways may have constituted property damage,the various negligent acts of the subcontractors upon which thedeveloper based its claim did not constitute an occurrence forwhich the policy provided coverage. Specifically, the court inL-J concluded that because the negligent construction onlycaused damage to the defective work product itself, (i.e., theroad), such a claim was merely for faulty workmanship. Thus thecourt in L-J held that, because faulty workmanship is notsomething typically caused by an accident or by exposure to thesame general harmful conditions, the developer's claim did notallege an occurrence.

In Auto Owners, the South Carolina Supreme Courtdistinguished the facts presented in Auto Owners from thefacts presented in its prior holding in L-J. Specifically,the court in Auto Owners held that the fact that “thedefective stucco allowed for continuous moisture intrusionresulting in … damage to the home's exterior sheathing and woodenframing … establish that there was 'property damage' beyond that ofthe defective work product itself, and that therefore, thehomeowner's claim is not merely a claim for faulty workmanshiptypically excluded under a CGL policy.”

In support of the distinction discussed above, the court brieflyexamined the history of the CGL policy in the home constructionindustry. The court noted that, generally, “[a] CGL policy in thehome construction industry is designed to cover the risks faced byhomebuilders when a homeowner asserts a post-construction claimagainst the builder for damage to the home caused by allegedconstruction defects.” However, the court also noted that CGLpolicies typically include several construction-specific exclusionsdesigned to exclude from coverage certain types of property damage.In the context of construction-defect claims, a common exclusion atissue is the “your-work” exclusion, which bars coverage forproperty damage to the insured's work.

However, the court noted that in 1986, the insurance industryamended the “your-work” exclusion to provide an exception if thework was performed by a subcontractor on behalf of the insured.This exception has become commonly known as the subcontractorexception to the “your-work” exclusion. According to the court inAuto Owners, in adding the subcontractor exception, “theinsurance industry extended liability coverage for property damageto the contractor's completed work arising out of work performed bya subcontractor.”

Thus, the court held that by interpreting the term “occurrence”in accordance with whether there was property damage beyond thedefective work itself would give full effect to the subcontractorexception in the “your-work” exclusion. Consequently, applying theforegoing principles to the facts in Auto Owners, thecourt held that because the allegedly defective stucco, which wasinstalled by a subcontractor, permitted water intrusion thatallegedly caused severe damage to the home's framing and exteriorsheathing, which was non-defective, there was an occurrence underthe policy.

While the decision in Auto Owners distinguished itselffrom the South Carolina Supreme Court's previous holding inL-J, the dissent in Auto Owners believed thatL-J should have barred coverage for the homeowner'sclaims. Specifically, the dissent argued that the generalcontractor's work product was the entire home which included thestucco, framing, and exterior sheathing. The dissent inAuto-Owners agreed with the majority opinion thatL-J stated that “there may be coverage where faultyworkmanship causes third-party bodily injury or damage to propertyother than the contractor's work product.” However, because thedissent found that the entire home was the contractor's workproduct, it concluded that there was no occurrence under thepolicy.

The dissent's reasoning is in accord with a recentconstruction-defect coverage decision by the Pennsylvania SuperiorCourt. (See Millers Capital Ins. Co. v. Gambone Bros. Dev.Co., 941 A.2d 706 [Pa. Super. 2007]). In Millers, thecourt addressed the issue of whether water damage to a home'sinterior due to faulty workmanship associated with stucco exteriorscould constitute an occurrence under a CGL policy. The insureddeveloper in Millers argued that the resulting waterdamage constituted an occurrence even though the damage due to thefaulty exteriors did not.

The court in Millers, however, rejected the insured'sarguments and held in favor of the insurance carrier. Specifically,the court held that the underlying complaints alleged claims basedupon faulty workmanship in that the homes were allegedlyconstructed with defective stucco exteriors. In Millers,when these alleged defects manifested themselves, “water damageresulted to the interior of the larger product — in this case, thehome interiors.” Thus, because the resulting damage was limited tothe insured's work/product — i.e., the entire home — there was nooccurrence or accident under the CGL policy.

The Pennsylvania Superior Court's holding in Millersdirectly comports with the dissent's reasoning in AutoOwners. Specifically, if the general contractor's work/productis the entire home, then there has been no occurrence under aninsurance policy if the only damage alleged is based upon claims offaulty workmanship that caused damage limited to the insured'swork/product.

Additionally, it is important to note that the court inMillers rejected the insured's subcontractor-exceptionargument in that if faulty workmanship that results in damagelimited to the insured's work/product is not an occurrence, thenthe subcontractor exception to the “your-work” exclusion would berendered mere surplus. However, the court in Millers heldthat the insured's argument completely ignored the policy'scoverage grant requirement of an occurrence. Thus, thesubcontractor exception was not mere surplus because the policy'scoverage grant only covered property damage caused by anoccurrence. Consequently, in order to satisfy the policy's coveragegrant, the court in Millers held that there must havefirst been a claim for property damage and/or bodily injury as aresult of an occurrence.

At this time, it is yet to be seen what effect the SouthCarolina Supreme Court's decision in Auto Owners may haveon construction-defect coverage litigation in South Carolina. Forthe time being, claim professionals should generally be aware ofthe subtle nuances and issues presented in construction-defectcoverage cases, as discussed above. As demonstrated by the holdingsin both Millers and Auto Owners, courts havetaken a different approach with respect to analyzing coverage forconstruction-defect claims. Therefore, it is important for claimprofessionals to be cognizant of how courts in their respectivejurisdiction have analyzed these issues.

Other Notable Decisions

Following is a list of some other notable and/or interestinginsurance law decisions from the past 12 months.

Essex Ins. Co. v. Bloomsouth Flooring Corp.,562 F.3d 399 (1st Cir. 2009)

The First Circuit Court of Appeals, applying Massachusetts law,held that unpleasant odors from carpeting installed by an insuredthat permeated a building constituted physical injury to propertyunder a CGL policy. Specifically, the First Circuit found thatodors can constitute physical injury to property under a CGL policyif the odor is “permeating or pervasive.” (See sidebar below.)

Revelation Industries, Inc. v. St. Paul Fire &Mar. Ins. Co., 206 P.3d 919 (Mont. 2009)

As a matter of first impression, the Supreme Court of Montanaheld that facts known to an insurer, albeit outside of thecomplaint, must be considered by the insurer in determining whetherit owes a duty to defend. Specifically, the court held that whilethere is no affirmative duty on an insurer to seek out informationbeyond the allegations contained in the complaint upon analyzingwhether a duty to defend exists, “insurers that look at factsbeyond the allegations in the complaint do so at their own risk, asthey will be required to defend and/or indemnify based oninformation discovered.” Thus, an insurer may not simply ignoreknown facts — whether obtained via its own investigation orsupplied to it by the insured — and look solely to the complaint indisclaiming coverage.

Liparoto Constr., Inc. v. General Shale Brick,Inc., 772 N.W.2d 801 (Mich. App.2009)

The Michigan Appellate Division held that the discoloration ofbricks on the exterior of a house after construction did notconstitute an occurrence under the contractor's CGL policy.

In Liparoto, the insured general contractor built thebrick exterior of a home. The bricks then became discolored becausethe lime-coating on the bricks reacted with an acid cleaner thatthe general contractor had used. The court held, however, thatthere was no occurrence under the policy because the allegeddiscoloration was confined to the insured general contractor'swork.

Piermount Iron Works, Inc. v. Evanston Ins.Co., 963 A.2d 818 (N.J. 2009)

The New Jersey Supreme Court held that the state'sadministrative regulations — with respect to an insurer's dutiesupon expiration of an insurance policy — were inapplicable tosurplus lines insurers. Specifically, the court held that theregulation's penalty provision that mandated continuation ofcoverage if an insurer failed to comply with the regulations didnot apply to surplus lines insurers.

N.Y. Ins. Law S 3420(c)(2) (McKinney2009)

On Jan. 17, 2009, the New York statute that required insurers todemonstrate material prejudice in order to disclaim coverage —based on an insured's failure to provide timely notice of a claimor suit — went into effect. “Material prejudice” is defined as thatwhich “materially impairs the ability of the insurer to investigateor defend the claim.” This legislative amendment is importantbecause, previously under New York law, insurers were not requiredto demonstrate prejudice upon disclaiming coverage based on latenotice.

However, the statute as amended essentially utilizes a two-yearthreshold for considering prejudice. Specifically, if notice isprovided within two years of the time required under the policy,then the insurer bears the burden of demonstrating prejudice. Ifnotice is provided after two years from when it was required underthe policy, then the burden is on the insured to demonstrate thatthe insurer was not prejudiced. Notwithstanding the foregoing, ifthe insured's liability has already been determined by a court orin binding arbitration, or if the insured has resolved theclaim/suit by settlement or other compromise prior to any notice tothe insurer, then there is an irrebuttable presumption ofprejudice.