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.