No CGL Coverage for Building Contractor’s Shoddy Workmanship Causing Damage to the Work Itself

In a decision filed November 18, 2016, Arkansas U. S. district judge Susan Webber Wright, the same jurist who in 1998 handed a defeat to Paula Jones in her sexual harassment lawsuit against then President Bill Clinton, dealt this time with a more tame but still important question: Whether a CGL policy issued to a building general contractor covers its liability for defective workmanship causing property damage confined to the contractor’s own work product.

The new decision is titled Auto-Owner’s Insurance Company v. Hambuchen Construction, Inc., and is reported at 2016 U.S. Dist. LEXIS 160364. It answered the question posed in the negative and stands for the proposition that CGL policies insuring a contractor’s liability for property damage caused by an “occurrence”- defined in the policies as an accident – do not cover a contractor’s liability for property damage caused by defective workmanship alone, resulting in injury only to the work product itself. However, the court held, the insurer may still be obligated to indemnify the insured for collateral damage to other property.

Faced with a summary judgment motion challenging coverage by the insurer, Auto-Owner’s Insurance Company, which had issued a CGL policy to Hambuchen Construction, Inc., a contractor hired separately by the Pierce and Lessmann families to build a new residence for each of them, Hambuchen conceded that damage only to its own work product is not an “occurrence” and therefore not covered. Hambuchen argued, however, that the Pierces and the Lessmanns were making claims against Hambuchen for collateral damage to property other than Hambuchen’s work product itself.

The problem for Hambuchen was that the construction project for each of the two families was to build an entire home, so at least regarding the Pierce project, all of the improvements formed part of the work product of Hambuchen, a fact central to the court’s decision. The Pierces’ construction project included construction by Hambuchen of multiple decks on the exterior of the home, the portions of the structure that failed. Thus, in a lawsuit brought by the Pierces against Hambuchen, the Pierces alleged that two years after they moved into their new home, water began pooling on the back deck, water leaks began appearing at various places inside the home, and the basement flooded. Accordingly, the Pierces sought damages for defective workmanship only to Hambuchen ‘s work product, which did not qualify as property damage caused by an “occurrence.”

As for the Lessmanns, following completion of their new home by Hambuchen, they complained that the foundation was unstable and presented a list of other claimed damages resulting from the shifting foundation, including damage to sheet rock and sod. The court said that, although damage to sod “might qualify as collateral damage to other property,” damaged sheet rock resulting from a shifting foundation was “more likely properly classified as damage to the [insured’s] ‘work product’ itself.”

The court, in granting the summary judgment motion, conducted a three part analysis for evaluating coverage under the CGL policy issued to Hambuchen. First, it examined the facts of insured’s third party claims to determine whether the policy’s insuring agreement makes an initial grant of insurance covering them. Next, the court examined the policy’s exclusions to see whether any of them precluded coverage of the two homeowners’ claims against Hambuchen. Finally, the court looked to see whether any exception to an applicable exclusion reinstated coverage for the claims against Hambuchen.

Turning first to the policy’s insuring agreement, the court applied Arkansas law to determine whether the alleged losses resulted from an “occurrence,” defined by the policy as an “accident.” The Arkansas Supreme Court has held in this context that the term “accident” means “an event that takes place without one’s foresight or expectation – an event that proceeds from an unknown cause, or an unusual effect of a known cause and therefore not expected.”

Auto-Owners, the builder’s insurer, argued that its CGL policy provided no possible coverage for the homeowners’ lawsuits, because their claims were that the property damage at issue resulted from defective workmanship, not an unexpected event, and therefore not an “occurrence.” Instead of addressing the insurer’s argument directly, however, the court relied upon the decision Essex Ins. Co. v. Holder (2008) 370 Ark. 465, 540 in which the court held that when faulty workmanship results in damage to the insured’s work product, there is no coverage for that property damage, but the insurer may still be obligated to reimburse the insured for collateral damage to other property, not part of the work product itself. The Holder decision, therefore, did not address the defined meaning of the term “occurrence” set forth in the CGL policy. Instead, it evaluated the type of property damaged as the basis for deciding whether the damage was caused by an “accident.” It held that “defective workmanship standing alone – resulting in damages only to the work product itself – is not an occurrence. . .” (Holder, 370 Ark., p. 540.)

In this respect the decision parted company with other cases’ analyses, keying into the coverage element of “property damage” itself, rather than the nature of the occurrence. Under such analyses, “In general there is no coverage for the cost of removing and replacing defective work or material where the only property ‘damage’ is the defective work itself and no damage has occurred to other property. Such costs are considered economic loss, not ‘physical injury’ to the property.” (California Practice Guide, Insurance Litigation, §7:1426.)

Ironically, as set forth in a footnote in the subject decision, the Auto-Owners policy issued in 2008 preceded the effective date of an Arkansas statute providing that CGL policies sold in Arkansas must define the policy term “occurrence” to include property damage resulting from faulty workmanship.

Absent an exclusion, however, collateral damage to other property nearby was covered by the policy.

The court then proceeded to discuss the coverage exclusions of the policy, since Auto-Owners asserted that, even assuming that coverage was possible under the insuring agreement qualifying as “property damage” caused by “an occurrence”, there still was no coverage. The first exclusion considered was entitled “Damage to Your Work,” which excepted from coverage loss due to property damage to the contractor’s work arising out of it or any part of it and included in the products-completed operations hazard.”

In connection with this exclusion, Hambuchen made two arguments. First it contended that the insurer had failed to present evidence that all of the damages alleged in the owners’ lawsuits, especially the consequential or resultant damage beyond the alleged effective workmanship, fell under the policy’s definition of “your work.” The court examined the definition of “your work” as applied to the homeowners’ claims, and the court noted that the underlying lawsuits, with the possible exception of the cost of sod replacement claimed by the Lessmanns, the homeowner plaintiffs’ claims sought relief for damage to the completed homes, which certainly met the policy’s definition of “your work”, since they were building the homes from scratch. Furthermore, the court noted, “the damage to your work exclusion unambiguously encompassed property damage arising out of Hambuchen’s work, or a part of it. Accordingly the court found that the insurer had carried its burden to show that the property damage claim in the underlying lawsuits fell under the “Damages to your Work” exclusion.

The second Hambuchen argument regarding the “Damages to your Work” exclusion was that the “products-completed operations hazard” operated as an exception to the “your work” exclusion. Hambuchen contended that a products-completed operations hazard provision in a CGL policy is invariably an exception to the business risk exclusions such as “your work” exclusions. But the court rejected this view finding that risk insured by a products hazard and completed operations provision work, once completed and relinquished, will cause damage to property other than to the product or completed work itself. “Here,” said the court, ” the Pierces and Lessmanns seek relief for damage to the product or completed work [of Hambuchen] itself.” Accordingly, the court held that the “Damage to your Work” exclusion precluded coverage for all property damage claimed in the homeowners’ lawsuits, including property damage that comes under the policy’s “products- completed operations hazard” definition.

Because the court found no possibility that the damages alleged in the underlying cases fell within the policy’s coverage, Auto-Owners had no duty to defend or indemnify Hambuchen against the Pierces’ and Lessmanns’ lawsuits.

Finally, as if there were any life left in the contentions of Hambuchen, the Pierces and the Lessmanns (who were themselves allied with Hambuchen as defendants in the coverage litigation) the court examined the defense of late notice to the CGL insurer by Hambuchen of the Lessmanns lawsuit, a condition of coverage strictly enforced in Arkansas. Here the Lessmanns filed suit against Hambuchen in May, 2009, and Auto-Owners learned about the lawsuit six years later, in August, 20015. Since timely notice was as condition proceeding to coverage, the Lessmann lawsuit was outside of coverage for that reason, too.

Based on all the reasons given by the court, but not limiting itself to the individual defenses noted above, the court granted summary judgment in favor of Auto-Owners Insurance Company and against Hambuchen, the Pierces and the Lessmanns.