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July 5, 2016

When is Defective Workmanship an Occurrence Under a Standard CGL Policy?

The Iowa Supreme Court recently answered that question by holding that defective workmanship by an insured’s subcontractor may constitute an occurrence under a standard-form CGL policy. In National Surety Corp. v. Westlake Investments LLC, No. 14-1274 (Iowa June 10, 2016), Westlake purchased an apartment complex while it was under construction, that later sustained damage from water intrusion. Westlake sued the developer and general contractor which were insureds under a primary standard form CGL policy and a follow-form excess policy issued by National Surety. The suit settled with the insureds assigning their rights under the excess policy to Westlake.

In the ensuing coverage litigation, a jury found National Surety liable for the costs of the settlement based on the defective workmanship of subcontractors that participated in construction of the apartment complex. On appeal, the insurer argued that the trial court erred by instructing the jury that defective construction work performed by subcontractors could constitute an “occurrence” under the excess policy.

The Iowa Supreme Court ultimately sided with the trial court’s formulation of Iowa law, holding that defective work performed by an insured’s subcontractor may constitute an accident, and therefore an “occurrence.” It first held that property damage resulting from an intentional act that the insured did not expect or intend “qualifies as an accident amounting to an occurrence…so long as the insured did not expect and intend both the act itself and the resulting property damage.” It explained that interpreting the term “accident” or “occurrence” to preclude coverage for all property damage arising from negligent work performed by an insured’s subcontractor “would be unreasonable in light of the exceptions and exclusions” contained in the policy.

More specifically, the court hinged its analysis on reading the policy as a whole in light of the “your work” exclusions in the standard ISO form CGL policy. It zeroed in on the exclusion applicable to “Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operation hazard” and emphasized the caveat following that exclusion, stating that the 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.”

The court reasoned that “[i]t would be illogical for an insurance policy to contain an exclusion negating coverage its insuring agreement did not actually provide or an exception to an exclusion restoring it.” Thus, it concluded that a reasonable ordinary person who read the exclusion “would believe it covered defective work performed by the insured’s subcontractor unless the resulting property damage was specifically precluded from coverage by an exclusion or endorsement.” It further cited the history of the standard ISO forms and “the industry’s own interpretative literature” to buttress its conclusion that the policy contemplated coverage for the defective construction of an insured’s subcontractor under the completed operations coverage.

The court added that its holding is in line with the “trend among courts and commentators interpreting such policies.” Whether that so-called “trend” continues to gather support among the states’ highest courts remains to be seen, but the decision underscores the need to review state specific law when determining whether or not faulty workmanship may constitute an “occurrence” when confronted with the ever-present but varied claims for property damage caused by faulty workmanship.