General Contractors May Have Coverage For Costs Arising Out Of Subcontractors' Defective Work
No matter how careful general contractors are during construction, problems with the construction work performed on projects may arise. If a subcontractor, hired by the general contractor, performs inadequate or defective work, a general contractor may face claims by the owner or others, seeking to hold the general contractor liable for costs associated with the subcontractor’s allegedly deficient work. Facing such claims, the general contractor’s first question may be, “Does my insurance cover this?” Under the Indiana Supreme Court’s recent decision in Sheehan Construction Co. v. Continental Casualty Co., 935 N.E.2d 160 (Ind. 2010), the answer to this question may be “yes,” if defective work was performed by one of the subcontractors hired by the general contractor, depending upon the facts of the case.
In Sheehan, homeowners in a subdivision brought claims against the general contractor (“Sheehan”) after the owners experienced water leaks in their homes. An engineering investigation revealed leaking windows, fungus growth on the siding, decayed OSB sheathing, deteriorating and decaying floor joists, and water stained carpeting. The damages resulted from the faulty workmanship of Sheehan’s subcontractors, including a lack of adequate flashing and quality caulking around the windows, lack of a weather resistant barrier behind the brick veneer, improperly installed roof shingles, improperly flashed or sealed openings for the chimneys and vents and inadequate ventilation in the crawl space.
Sheehan had a commercial general liability (“CGL”) policy with Continental Casualty Company (“Continental”) and was also an additional insured on a CGL policy belonging to one of its subcontractors. Both policies provided coverage for “sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ .... caused by an ‘occurrence.’” In turn, an “occurrence” was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” As is frequently the case though, both policies notably excluded from coverage “‘property damage’ to ‘your work’ arising out of it or any part of it….’” However, the “your work” exclusion did “not apply if the damaged work or the work out of which the damages arises was performed on [Sheehan’s] behalf by a subcontractor.”
After the homeowners sued Sheehan, Sheehan contacted Continental. Continental provided a defense for Sheehan in the litigation initiated by the homeowners under a reservation of rights. At the same time, Continental pursued a separate lawsuit against Sheehan seeking a determination that it was not obligated to indemnify Sheehan for the homeowners' claims that arose from the faulty construction work performed by Sheehan’s subcontractors. The Indiana Supreme Court held that the CGL policy issued by Continental could provide coverage for Sheehan concerning its subcontractors’ faulty work.
The specific issue addressed by the Court in Sheehan is not new. In fact, it is frequently litigated across the United States. For example, a recent decision by the Kentucky Supreme Court, addressing the issue but reaching a different result, is discussed in this issue of OnCite.
Jurisdictions that have held that a general contractor is not entitled to coverage against claims related to its subcontractor’s faulty workmanship frequently have done so based on the reasoning that faulty workmanship or improper construction does not constitute an “accident.” These courts frequently reason that because the cost to repair or replace damages caused by faulty workmanship is simply considered a business risk, it should be assumed by the contractor. However, the Indiana Supreme Court, in a departure from Indiana precedent, has aligned itself instead with those jurisdictions adopting the view that improper workmanship by a subcontractor can constitute “an accident so long as the resulting damage is an event that occurs without expectation or foresight.” According to the Sheehan court, whether such faulty work is an accident “depends on the facts of the case.” The court concluded that the CGL policy could cover the loss if the faulty workmanship was the result of unintentional conduct.
Under the Sheehan court’s reasoning, a court must determine whether a subcontractor’s defective work was performed intentionally. If so, there would be no “accident” or “occurrence” and, therefore, no coverage. On the other hand, if the faulty work is found to have been performed “without intention or design”, then there would be an “occurrence” and the general contractor would have coverage under the policy.
Note that the court in Sheehan also found support for its conclusion that an "accident" can, depending upon the facts of the case, include faulty workmanship in the presence of the “your work” exclusion in the policy. The CGL policy language included an exclusion for damage to "your work," and then narrowed this exclusion, by indicating that it 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]f the insuring provisions do not confer an initial grant of coverage, then there would be no reason for a 'your work' exclusion."
The Sheehan case will likely be viewed as a promising result by Indiana general contractors, many of whom likely have become accustomed to insurers telling them flatly, in reliance upon prior case law, that claims regarding the faulty workmanship of subcontractors were not afforded coverage under CGL policies. While the decision will in some cases open the door to allow coverage for general contractors concerning faulty workmanship of subcontractors, general contractors should exercise caution. The court points out that for the faulty workmanship to be covered, it must be unintentional – and whether it was unintentional depends on the facts of the case. Also, as the court pointed out, insurers may determine that this is the type of risk they do not want to cover and they are free to amend their CGL policies. Contractors should continue to carefully review existing CGL policies and watch for amendments that may affect coverage for work performed by subcontractors.