South Carolina Coverage and Bad Faith Opinion

South Carolina Answers Certified Question For Attorney Client Privilege In Bad Faith Refusal to Defend

The South Carolina Supreme Court, on certified question from the Fourth Circuit, has decided whether an insurer waives the attorney-client privilege when it denies liability in a “bad faith” case. 

The issue arose out of a construction defect lawsuit when the insurer failed to defend its insured, a contractor.  After settling out of the case personally, the policyholder contractor sued the carrier for bad faith refusal to defend.  In discovery, the policyholder sought the carrier claim file including correspondence between the carrier and its coverage attorneys.  The Insurer claimed privilege over those communications, but the Insured argued that the Insurer’s denial of liability for bad faith and its affirmative defense of “good faith” resulted in waiver of the attorney-client privilege.  The discovery dispute ultimately found its way to the SC Supreme Court.

Holding:

A client does not waive the attorney-client privilege simply by bringing or defending a lawsuit; rather, waiver requires the additional interjection of the issue of advice of counsel (either expressly or implicitly) by the client.  In other words, whether or not “advice of counsel” is raised as an affirmative defense, if the client defends based on the affirmative theory that the client’s mental state at the time at issue (such as when the Insurer denied the Insured’s claim) was based on an evaluation of the law and the facts then existing, such would equate to putting the legal evaluation “at issue” and thus result in a waiver of the privilege.

“a client does not waive the privilege simply by bringing or defending a lawsuit. “

In reaching its conclusion, the Court relied heavily on an approach adopted by Arizona in the case State Farm Mutual Automobile Insurance Co. v. Lee.

Proposed South Carolina Legislation Might Limit Residential Specialty Contractors

The South Carolina legislature is considering legislation that will affect residential builders and specialty contractors.

The text with proposed changes below

SECTION    2.    Section 40-59-20(7) of the 1976 Code is amended to read:

“(7)    ‘Residential specialty contractor’ means an independent contractor who is not a licensed residential builder, who contracts with a licensed residential builder, general contractor, or individual property owner to do construction work, repairs, improvement, or reimprovement which requires special skills and involves the use of specialized construction trades or craft, when the undertakings exceed two hundred dollars and are not regulated by the provisions of Chapter 11. A residential specialty contractor is not authorized to construct additions to residential buildings or structures without supervision by a residential builder or other appropriately licensed person or entity. Residential specialty contracting includes the following areas of contracting and other areas as the commission may recognize by regulation:

(a)    plumbers;

(b)    electricians;

(c)    heating and air conditioning installers and repairers;

(d)    vinyl and aluminum siding installers;

(e)    insulation installers;

(f)    roofers;

(g)    floor covering installers;

(h)    masons;

(i)        dry wall installers;

(j)        carpenters;

(k)    stucco installers;

(l)    painters/and wall paperers.

Plumbers, electricians, and heating and air conditioning installers and repairers must be issued licenses after passing the required examination. Vinyl and aluminum siding installers, insulation installers, roofers, floor covering installers, masons, dry wall installers, carpenters, stucco installers, and painters and wall paperers must be issued registrations.

A residential specialty contractor is prohibited from undertaking work outside the scope of his license or registration, including employing, hiring, and contracting or subcontracting with others to perform such work on his behalf.

The provisions of this chapter do not preclude a licensed residential builder from also obtaining licensure or registration as a residential specialty contractor in an area of contracting identified in statute or recognized by the commission. In addition, a residential builder, who is licensed by examination in this State, is authorized to perform work in any of the areas of residential specialty contracting without separately obtaining a residential specialty contractor license or registration.

Trump Order on Blacklisting 

In March, President Trump signed a joint resolution eliminating the rule, which had required bidders on federal projects with a value in excess of $500K to report state and federal labor and safety violations within the past three years. The Blacklisting rule, also known as the Fair Pay and Safe Workplaces Executive Order 13673, only went into effect in October 2016.

The building industry would certainly favor a vacation from regulatory reporting. It remains to be seen if the Order will have an effect on insurance premiums.

The Discovery Rule and Tolling Statute of Limitations

In a 2014 unpublished opinion, the SC Court of Appeals discussed the threshold for “notice” as it pertains to statute(s) of limitations in construction defect cases. At the root of this action was a 2003 forensic report obtained by the HOA which was not acted upon until 2009.

As most of you are aware, construction defect litigation is often rooted in negligence, contract, warranty and other causes of action which are subject to three year statutes of limitations. Because defects are often latent, however, it is not uncommon for questions to arise as to when a Plaintiff knew, or should have known that a cause of action existed.

BACKGROUND

3 Chisolm Street Homeowners Association, Inc. (the “HOA”) brought suit in 2009 against several defendants that completed construction work on three condominium buildings in 2002. Genoa Construction Services, Inc., the general contractor, Masterpiece Millwork, Inc., the manufacturer of the windows used in the buildings, and Brock Green Architects and Planners, LLC, were each alleged contributors to defective conditions.

In determining when the statute of limitations began to run, the circuit court applied the “discovery rule,” which provides that the time to file a claim “begins to run when a cause of action reasonably ought to have been discovered.” Dean v. Ruscon Corp., 321 S.C. 360, 363, 468 S.E.2d 645, 647 (1996). The HOA argued that they were not on notice of the defective conditions and, alternatively, if found to be on notice such notice was limited to certain areas of the property but not all.

The HOA asserted that there were material issues of fact as to when the HOA discovered, or should have discovered, that a cause of action existed for original construction defects in all three condominium buildings—the main building, the gym building, and the cottage building.

HOLDING

The lower court ruled that a 2003 forensic report put the Plaintiff HOA on notice of defects in the main building. The appellate ruling upheld that finding and reasoned that the 2003 report also evidence that if the HOA had exercised reasonable diligence and investigated the other buildings in 2003, it would have discovered the defects before the statute of limitations ran. Barr, 330 S.C. at 645-46, 500 S.E.2d at 160 (holding had the plaintiffs “exercised reasonable diligence and investigated the problems noted in the . . . inspection reports, they could have realized the magnitude of the problem and brought suit before the statute of limitations ran”). An inspection report issued in 2007 that concerned the gym and cottage buildings alerted the HOA to defects that existed in 2003 and would have been discoverable. Moreover, according to an architect who inspected the buildings, the deterioration of the wooden windows in the gym building resulted, in part, from condensation buildup on the windows, which would “have been occurring prior to [his] observations” in 2007 because it was caused by installation of single-pane windows. Thus, the defect causing the condensation—the single-pane windows— existed at the time construction was completed in 2002. began to run, the circuit court applied the “discovery rule,” which provides that the time to file a claim “begins to run when a cause of action reasonably ought to have been discovered.” Dean v. Ruscon Corp., 321 S.C. 360, 363, 468 S.E.2d 645, 647 (1996). The HOA argues there are material issues of fact as to when the HOA discovered, or should have discovered, that a cause of action existed for original construction defects in all three condominium buildings—the main building, the gym building, and the cottage building.
As to the main building, we find the circuit court properly determined the statute of limitations began to run in 2003 because the Glick report, issued in April 2003, put the HOA on inquiry notice of defects that would have been discoverable through additional inspections and destructive testing, which both the report and the HOA president recommended. See Republic Contracting Corp. v. S.C. Dep’t of Highways & Pub. Transp., 332 S.C. 197, 207, 503 S.E.2d 761, 766 (Ct. App. 1998) (stating the statute of limitations begins to run “from the date the injury is discoverable by the exercise of reasonable diligence”); 332 S.C. at 208, 503 S.E.2d at 767 (holding the plaintiff “had sufficient information . . . to put it on inquiry notice, which, if developed, would have revealed the defects”). The Glick report also triggered the statute of limitations for claims against all three respondents because the report listed specific defects that put the HOA on inquiry notice to discover whether those defects were attributable to design, construction, or manufacturing errors. See Barr v. City of Rock Hill, 330 S.C. 640, 645, 500 S.E.2d 157, 160 (Ct. App. 1998) (stating a party has notice of claims when the facts and circumstances “would put a person of common knowledge and experience on notice that . . . some claim against another party might exist” (internal quotation marks and citation omitted) (emphasis in original)); Wiggins v. Edwards, 314 S.C. 126, 128, 442 S.E.2d 169, 170 (1994) (“The focus is upon the date of discovery of the injury, not the date of discovery of the wrongdoer.”); id. (“If, on the date of injury, a plaintiff knows or should know that she had some claim against someone else, the statute of limitations begins to run for all claims based on that injury.” (citation omitted)).

As to the gym and cottage, the circuit court decision was upheld, reasoning that Glick’s report provided the HOA sufficient information to put it on inquiry notice of construction defects existing in these buildings. See Dean, 321 S.C. at 364, 468 S.E.2d

The appellate court took significant notice of the fact that:

(1) each of the three buildings was constructed at the same time, by the same general contractor, and in accordance with the same plans developed by the same architect;

(2) the minutes from the board of directors meeting in May 2003 provide that after receiving Glick’s report, the board discussed “steps that should be followed,” including “[i]nspection of the cottage and gym building[s]”;

(3) the minutes from the board of directors meeting in June 2003 demonstrate the HOA solicited proposals from companies for “additional investigation” into the defects highlighted in Glick’s report, although it ultimately decided not to pursue this course of action due to the cost;

(4) the HOA was urged to conduct further investigations by Glick, who warned of “significant and pervasive construction defect problems”; and

(5) an inspection report shows the HOA undertook remedial measures on the gym building some time before 2007 “in an effort to inhibit water intrusion at windows.”

There was also evidence that if the HOA had exercised reasonable diligence and investigated the other buildings in 2003, it would have discovered the defects before the statute of limitations ran. Barr, 330 S.C. at 645-46, 500 S.E.2d at 160 (holding had the plaintiffs “exercised reasonable diligence and investigated the problems noted in the . . . inspection reports, they could have realized the magnitude of the problem and brought suit before the statute of limitations ran”). An inspection report issued in 2007 that concerned the gym and cottage buildings alerted the HOA to defects that existed in 2003 and would have been discoverable. Moreover, according to an architect who inspected the buildings, the deterioration of the wooden windows in the gym building resulted, in part, from condensation buildup on the windows, which would “have been occurring prior to [his] observations” in 2007 because it was caused by installation of single-pane windows. Thus, the defect causing the condensation—the single-pane windows— existed at the time construction was completed in 2002.

COMMENT

It is well settled that an expert’s findings, when presented to a claimant, trigger the statute of limitations as to the specific defective conditions and locale where defects are present. This case is interesting in its treatment of the initial report as a trigger of all defects in not only the main building which was subject of the 2003 report, but additional structures.

The additional buildings create further intrigue due to their lack of similarity in use as the main building. A gym and cottage are certainly much different than a multi-story condominium tower. The court seems to rationalize the decision to include these buildings due to the fact similar contractors and materials were used which should have been significant to the HOA. Had these two structures been erected with different materials by distinguishable contracting entities it is a safe assumption that the court might very well have excluded these structures from the 2003 trigger.

Newman II Decision and SC Construction Defect Law

South Carolina Insurance Coverage in 2009

In the recent Supreme Court ruling on appeal of Auto Owners v. Virginia Newman, et al, (Newman II), the question was presented as to whether faulty construction that causes physical damage to tangible property (residential home) will trigger insurance coverage.  In the initial case (Newman I), assertions were made by a claimant that Trinity Construction built a defective home for Virginia Newman back in 1999.   The primary issue surrounded a subcontractor’s stucco application to the home’s exterior, and damages resulting from the application.  As an interesting side note, this was not an EIFS clad home, rather, traditional Portland cement/traditional stucco.

            The Plaintiff in the case, Ms. Newman, noticed water intrusion and subsequently retained an inspector to document the issues.  The expert (Engineer) observed that the stucco was improperly installed and the stucco, sheathing, and other components were damaged.  An arbitrator awarded Ms. Newman nearly $56,000 for her claims against Trinity.
            Auto Owners had issued a CGL policy to Trinity, and the claim was defended under a reservation of rights by the insurer.  Auto Owners filed a declaratory judgment action as South Carolina case precedent was murky, at best after the LJ-Bituminous decision in 2004.

            In its first published opinion on the matter, our court of appeals held that defective construction was an “Occurrence” as determined by rules of construction in the insuring agreement issued to Trinity.  Further, the court held that any exclusions (EIFS/Stucco etc) was construed in favor of the policyholder if the work excepted was performed by a subcontractor.  Of particular significance was that the interior damage to elements other than the cladding were covered as was the stucco removal due to the fact that the siding had to be removed in order to reach the damaged interior components.
            In September of 2009, the court withdrew and re-issued its opinion. In a bizarre twist, the opinion relies not on the subcontractor exclusion, or stucco exclusion, rather the rarely considered “Sistership” Exclusion.  In reaching this conclusion, Chief Justice Toal reversed her earlier holding that the cost to remove the stucco was covered.  The opinion seemed to further validate the concept that defective work performed by a subcontractor is an “occurrence” and, therefore, a damage which is covered.
             Newman clarified that coverage does not exist for the removal and demolition of exterior components excluded under the policy.  This is the most significant aspect of the opinion as logic would now presume that other defective construction claims will be interpreted and evaluated using the Newman case. 

            1.         Roofing Material Removal:      Not covered in situations where leaking causes a roof to be removed in order to access and correct water damaged areas beneath the roof membrane.

            2.         Windows and Doors:   Removal and replacement would, arguably, not be covered to make corrections to components such as pan flashing.  windows pulled to install flashing omitted during original construction. The biggest losers, though, may be homebuilders and commercial contractors who purchased CGL policies over the years, believing they were covered for all damages.

            3.         HVAC and Electrical: Removal and replacement of equipment would not be covered when such removal is necessary to correct issues involving floor deflection, indoor air quality, and caulking/fireproofing issues.

HISTORY AND BACKGROUND

            The September 2009 decision was actually the second opinion on the issue as well as a rehearing of Auto Owners Ins. Co. v. Newman, 2008 WL 64856 (S.C. Mar. 10, 2008) (Newman I). Newman I overturned the LJ case which is mentioned above.  The LJ opinion was doomed from its inception as it was based on a non-traditional factual pattern whereby damage to a road (Cracking) was determined to have been caused by a subcontractor’s work.  In sum, the court found no coverage due to the court’s opinion that the “Your Work” exception was applicable to the entirety of damages as the cracking was the only “damage” and that damage was the subcontractor’s work product.

            Because of the facts surrounding LJ, lawyers immediately looked for a case to overturn the opinion.  Since most construction defect cases involved houses and other commercial, horizontal structures, insurance policies were typically covering these risks, not highway construction.

            Newman I was the case that made the cut, as the SC Court of Appeals ruled in 2008 that defective stucco work performed by an insured subcontractor was covered under the general contractor’s policy.  The court found an “Occurrence” (Prong A) had caused physical damage to tangible property (Prong B) due to water intrusion causing damage to the component products and labor of other trades.  The court attempted to further clear up any confusion by listing the actual areas of the home that were damaged outside and apart from the actual stucco siding.

POLICY INTERPETATION UNDER NEWMAN I

            The court relied on the plain meaning examination of the insurance policy in question which both fail to define “accident” or “physical damage to tangible property” in the context of a trade contractor’s work damaging the work of another trade.  For example, it is not clearly defined whether a window installer’s defective placement of windows triggers coverage for damages to the interior wall and floor.   

            Significantly, the court in Newman I determined that costs associated with remedying the other property damage that resulted from an “occurrence”, the removal of such otherwise excluded work was also covered.  This issue prompted the rehearing.

AUTO OWNERS INSURANCE AND CLARIFICATIONS SOUGHT BY REHEARING

            AO argued that, based on L-J v. Bituminous, there was no “occurrence” within the terms of the CGL policy considered by the court in Newman. Once again, the court disagreed and upheld its prior holding that the negligent application of stucco by the subcontractor resulted in an “occurrence” of water intrusion, resulting in “property damage” that was tangible and adversely impacted the home owned by Ms. Newman.  Hence, the court ruled that this was covered.

            The court reiterated that the subcontractor’s negligent application of the stucco did not, in and of itself, constitute an “occurrence” absent tangible damage to the work or products integrated within the house by others. The Supreme Court appears to be in line with the definition of an occurrence as opined by the SC Ct. of Appeals as recently as Spring, 2009 in Auto Owners v. Rhodes.

            The South Carolina Supreme Court in Newman II also addressed the applicability of two exclusions in the CGL policy. Auto Owners argued that, even if an occurrence was present, indemnity was not appropriate if that damage was within the expected or intended damages exclusion that was discussed in a very important Texas opinion, Lamar Homes v. Mid-Continent Casualty.

            In this argument, Auto Owners contended that damages awarded to Ms. Newman which were relative to the framing and exterior sheathing of the home were not covered due to the assumption that a builder should expect moisture intrusion from defective stucco placement to result in water related damages.  The court ruled that it was not reasonable to assume a contractor intended or expected an inferior product, citing the Lamar Homes decision.  Therefore, the court rejected the argument based on the expected or intended injury exclusion, that argument being essentially a restatement of arguments rejected by the courts listed above as to the ability to foresee  property damage arising from defective workmanship.

            The “Sistership Exclusion” was effectively argued by Auto Owners in Newman II.  (Author’s Note:  Many of us that practice in the construction realm anxiously awaited the Newman II decision and had varying theories as to how the court would come to either one or two conclusions regarding the defective work of a subcontractor.  In my discussions, I never heard the sistership exclusion mentioned once.  I bashfully admit that I had not ever heard of it, much less considered it). 

            The Sistership argument is based on the following logic: 

            Even if the damage to the home constituted an occurrence of property damage to tangible property within the insuring agreement, the exclusion nullified coverage for replacement and repairing defective stucco itself as an incidental cost to repairing the damage to other property.

            The “sistership exclusion,” is an often ignored element of the standard CGL policy as it argues that there is no coverage for damages claimed for any loss, cost, or expense incurred as a result of the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal, or disposal of the insured’s product, work, or impaired property in the event such is withdrawn or recalled from the market or from use because of a known or suspected defect, deficiency, inadequacy, or dangerous condition in it.

            Everyone ignored this ancillary, “Plan C” argument.  Everyone but the court, that is, as it agreed with this argument.  In contractual matters, the insurance policy is to be read and applied independently of any other exclusion. Since the subcontractor exception preserved coverage for property damage that would otherwise be excluded as the named insured’s work, the court pointed to another exclusion that barred coverage for damage to the defective workmanship itself.

            There is wide speculation that the court’s reliance on this exclusion will serve to further muddy the waters.  This reasoning states that a “Product Recall” exclusion (“Sistership) should not be applicable in the analysis of property damage and coverage in residential or commercial construction.  The court’s reasoning is troublesome to both defense attorneys and those that represent owners of property in construction defect claims.   The court appears to have ignored the  primary issue on appeal, which was whether construction deficiencies causing physical damage to tangible property constitute “occurrences” and “property damage”. 

            The reliance on obscure exclusions or endorsements affecting coverage is damaging to both contractors and their insurers as both sides want some clarity.  If you build houses, you have the right to know whether or not your policy will cover your subcontractor’s work.  As an insurance company, billions of dollars rest on the same question.  Therefore, the construction industry and insurance industry should certainly agree that consistency is needed if they are going to engage in business practices which are based on some element of risk.  Had the court answered the primary issues left open by LJ and Auto Owners I, the construction industry would have a better idea as to what their policies covered and, just as importantly, the insurance industry would have a much better gauge on pricing these policies of insurance.  To be continued.

South Carolina Construction Defect Law

Clay Olson is an attorney in Charleston South Carolina at Olson & Good, PC. With multiple locations in Charleston County, Mr. Olson serves Olson & Good clients in construction matters including insurance defense, construction defect litigation, mechanics lien, commercial loan modification and foreclosure. Mr. Olson services several industries in collection issues, risk transfer and management of business risks, insurance coverage and policy language.