A bewildering 12 months of state and federal court rulings have further complicated the insurance and liability landscape for homebuilders and contractors facing homeowners’ Chinese drywall damage claims, attorneys and brokers say.
Nine state and federal courts and one state legislature over the past year have addressed whether a construction defect—a defective product or faulty workmanship—is fortuitous and therefore an occurrence under the commercial general liability insurance policy.
Four jurisdictions determined it is; three said no; two ruled that a construction defect that causes consequential damage to property other than the work product is an occurrence; and one federal court contributed to conflicting case law that has developed in Oregon since its high court ruled in 2000 that a construction defect is not an occurrence (see “Scorecard” sidebar for an overview of all these decisions).
Attorneys even disagree over whether CGL policies governed by the three pro-insurer rulings should cover homebuilders and contractors for the cost of replacing defective drywall.
The lack of consensus over what the latest rulings mean for builders and contractors only intensifies long-standing coverage disputes. Attorneys and courts also take widely divergent views on where the majority of jurisdictions nationwide stand on the definition of occurrence in construction-defect cases.
“Doing this on a state-by-state basis has caused a lot of confusion among buyers and sellers,” said Jeffrey A. Segall, a Tampa-based senior vice president and the Florida Construction Practice leader at Willis of Florida, a unit of Willis Group Holdings.
In other construction defect legal developments over the past year:
• South Carolina lawmakers quickly introduced legislation (H.B. 3449 in the House and S.B. 43 in the Senate) to essentially strike down a Jan. 7 Supreme Court ruling in that state that a construction-defect that causes damage to a policyholder’s own work is not an occurrence in Crossmann Communities of North Carolina Inc. et al. vs. Harleysville Mutual Insurance Co. et al.
• The federal judge in the multidistrict Chinese drywall litigation in Louisiana (In Re Chinese Manufacturing drywall: Products liability litigation, MDL No. 2047, U.S. District Court Eastern District of Louisiana) ruled Feb. 8 that homebuilders and general contractors seeking coverage as additional named insureds on their subcontractors’ CGL policies do not have to pull the subcontractors into the upcoming trial over whether the insurers must cover the additional insureds’ drywall-related losses.
• In a test liability case, the MDL judge last April ruled that homebuilders and contractors must extensively refurbish seven homes to adequately remediate the damage the defective drywall caused. The total damage award exceeded $2.6 million.
• A Florida circuit court judge ruled in November that a group of homebuilders facing Chinese drywall-related claims are not strictly liable for the plaintiff homeowners’ damage. The judge dismissed the plaintiffs’ tort claims against the homebuilders but not against defendant drywall suppliers and installers in the case, Marlene Bennett vs. Centerline Homes Inc. et al., (Circuit Court for the 15th Judicial District, Palm Beach County, Fla., Case No. 50-2009 CA 014458; Nov. 5, 2010).
• A federal district court in Florida and a New Jersey appellate court ruled in separate cases late last year that the continuous trigger coverage theory does not obligate an insurer to defend and indemnify a policyholder facing construction defect losses that manifested before an insurer’s policy incepted.
The Florida case, Amerisure Insurance Co. et al. vs. Albanese Popkin et al. (U.S. District Court Southern District of Florida, Case No. 09-81213-CIV-MARRA; Nov. 30, 2010) involved Chinese drywall.
The only development favorable to both the construction industry and insurers is that the property damage and bodily injuries attributable to Chinese drywall might not be as extensive as originally feared.
In 2009, consultants from Towers Watson estimated that the resulting economic damages could total $15 billion to $25 billion, setting forth those initial estimates in an exclusive article written for NU. But now, total damages likely will not exceed $10 billion, according to Ron Kozlowski, Hong Kong-based senior actuary at Towers Watson and a co-author of the original article. Mr. Kozlowski explained that damage is being assessed at lower levels and that the problem has not been as widespread as anticipated.
The U.S. Consumer Product Safety Commission says homeowners in 43 states and the District of Columbia, American Samoa and Puerto Rico have blamed Chinese drywall for property damage or bodily injuries. But to date, only 3,805 homeowners—57 percent of whom reside in Florida—have filed reports to the agency.
Over the past half decade or so, CGL coverage terms and conditions for builders and contractors relating to construction defects have been relatively stable, according to brokers and attorneys. In general, CGL policies exclude coverage for construction defects tied to a policyholder’s own work. But an exception to that exclusion in many policies restores coverage to the policyholder if it had retained a subcontractor to perform the work.
In addition, depending on the relationship a buyer has with an underwriter, large accounts sometimes can negotiate even broader coverage terms, noted Mark E. Reagan, the Morristown, N.J.-based chairman of the Global Construction Practice at Marsh.
Some insurers, meanwhile, have invoked the pollution exclusion to deny Chinese drywall-related claims, said Rod Taylor, a Windermere, Fla.-based managing director in the Environmental Services Group at Aon Risk Solutions, a unit of Aon Corp. Therefore, because of their product liability coverage—which typically is exempt from the pollution exclusion—drywall manufacturers, distributors and suppliers are more likely to be covered for drywall-related claims than builders and contractors, Mr. Taylor observed.
Of course, recovering damages from a Chinese manufacturer or a small distributor or supplier that went out of business during the recession is difficult at best, brokers and attorneys note.
Plus, distributors and suppliers “are not typically highly insured,” Marsh’s Mr. Reagan said. “So the claims typically come back to the builder or subcontractor.”
An additional coverage complication with some distributors and suppliers is that only a small fraction of the amount of drywall they delivered to contractors was defective, making ascertaining their liability for damage at any home difficult, Mr. Reagan said
Aon’s Mr. Taylor noted that a few very large builders and contractors also purchase warranty insurance, which would cover construction-defect claims like those triggered by Chinese drywall. But the coverage is too expensive for small and midsize companies and even for most large risks, he said.
Coverage also might be available under professional-liability and environmental-impairment liability policies, said Michael R. Bradshaw, a vice president and Southeast regional construction claims director for Willis Group in Cary, N.C. “Our advice to clients is to place on notice all policies,” Mr. Bradshaw said.
Finding coverage of defective drywall-related claims all comes down to a policy’s language, its exclusions, exceptions and endorsements—and a court’s interpretation of what all of that means.
But court decisions, too, are also subject to conflicting interpretations.
For example, according to a new book co-authored by insurer attorney Randy J. Maniloff, a partner at White and Williams L.L.P. in Philadelphia, courts in the majority of states have determined that a construction defect is not an occurrence under the CGL policy. However, courts in an even greater two-thirds of states have ruled that consequential damage—property damage to other work or bodily injury—caused by a construction defect is an occurrence, says the book, “General Liability Insurance Coverage—Key Issues in Every State.”
In its 50-state analysis, however, policyholder law firm Saxe Doernberger & Vita P.C. of Hamden, Conn., paints a much different judicial landscape. Saxe Doernberger determined that by about a 3-1 margin, the majority rule is that all damage attributable to a construction defect is an occurrence. The firm found that only three states narrow the definition of occurrence to only consequential damage.
Even in jurisdictions where only consequential damage arises from an occurrence, insurers should cover policyholders’ cost of tearing out and replacing defective Chinese drywall, policyholder attorneys contend.
Insurers that would deny coverage for the cost of replacing the drywall would face “at least two significant problems,” explained policyholder attorney Robert M. Horkovich, a partner at Anderson Kill & Olick P.C. in New York.
“One: The developers are not the subcontractors installing the drywall, so the drywall is not the developers’ ‘work’ or ‘product.’
“Two: More obviously, in order to get to the wiring, plumbing and air conditioner coiling, you have to tear out the drywall anyway. So the costs of tearing out and replacing the drywall could be characterized as a consequential cost of repairing the property damage to the wiring, the plumbing or the AC coiling.”
David Pharr, a partner with Bradley Arant Boult Cummings L.L.P. in Jackson, Miss., who represents builders and contractors, listed numerous federal and state appellate and trial court decisions that support the consequential-cost argument and its application to drywall replacement. Several of the cases centered on the cost of removing asbestos from buildings after the fire-retardant material’s health hazard became known, he said.
Insurer attorneys disagree.
Charles J. Jesuit Jr., an associate with Cozen & O’Connor P.C. in Philadelphia, asserted that the cost of replacing drywall can be easily segregated from the cost of remediating consequential damage.
Mr. Jesuit also said courts made an exception for asbestos because of its extreme health hazard. While the science is still developing on the health problems that defective drywall causes, individuals do not appear to have ongoing health problems after they are no longer exposed to the drywall, he said.
Do builders and contractors have any hope of a standardized interpretation of what constitutes an occurrence in construction-defect cases?
Marsh’s Reagan says eliminating the exclusions, exceptions and endorsements in the CGL policy and modifying the definition of occurrence would help. He suggests that Section V, Definition 13 of the CGL policy define occurrence as property damage and bodily injury claims resulting from “faulty workmanship or construction defect” in work performed by the policyholder or a subcontractor.
As with the construction-defect coverage issue, the potential for such a modification is unclear. The Insurance Services Office says that it “is in the process of considering issues related to the topic.” But it notes that it has “no set timeframe for completing this process.”