The Evolution of CGL Coverage for Defective Construction in the Courts

Early Judicial Responses to Construction Defect Claims

Unfortunately, the CGL policy changes were largely ignored by insurers (and many insureds) and the courts. Rather, courts tended to depart from the terms of the policies themselves in favor of vague coverage platitudes such as a breach of contract is always intentional, not accidental, and, thus, could not be an occurrence, or that damage to an insured's work is always expected. ¹

The poster child for this view is Weedo v. Stone-E-Brick, Inc., 81 N.J. 233, 405 A.2d 788 (1979). The court recognized that construction defects do not constitute an occurrence and are covered only when the damage claimed is for the cost of correcting damage done to property other than the insured's own work, even though the Weedo  case based its business risk analysis on the 1973 policy exclusions without consideration of the effect of the BFPD exclusion on expanding coverage for the construction industry. The Weedo court bootstrapped its reasoning with a citation of Roger C. Henderson, "Insurance Protection for Products Liability and Completed Operations—What Every Lawyer Should Know," Nebraska Law Review, 1971. That article also failed to consider the existence of the BFPD exclusion, concluding that CGL coverage is for tort liability for physical damages to others and not for contractual liability of the insured for economic loss because the product or completed work is not what the damaged person bargained for.

The Weedo reasoning was eventually cited in nearly 200 other cases and continued to stand strong as virtually unstoppable and unsupported by more reasoned interpretations of the CGL policy according to its actual terms. Another frequently cited example of the application of Weedo (and the Henderson law review article) in support of a denial of coverage to a contractor is Wm. C. Vick Constr. Co. v. Pennsylvania Nat'l Mut. Cas. Ins. Co., 52 F. Supp. 2d 569 (E.D.N.C. 1999), in which the insured general contractor sought coverage from its CGL insurers for damages to a building caused by a leaky roof installed by a subcontractor. The policies before the court were on the 1973 form with a BFPD exclusion, but the court concluded that, because the damages were based solely on the costs of repairing the insured's allegedly faulty workmanship, there was no "occurrence" within the meaning of the policies.

A similar case is Knutson Constr. Co. v. St. Paul Fire & Marine Ins. Co., 396 N.W.2d 229 (Minn. 1986). The court applied a business risk rationale largely borrowed from Weedo/Henderson to deny coverage to a general contractor for property damage caused by its subcontractor's use of a defective mortar additive in brick masonry, observing that the replacement of the 1973 work performed exclusion by the BFPD endorsement work performed exclusion constituted only a slight difference in wording.

2000–2020: Clarifying the "Occurrence" Definition

In accord with the structure of the policy form, CGL insurance coverage for most defective construction claims historically turned on the applicability of exclusions relating to damage to the insured's own work. Due to the coverage enhancements introduced with the BFPD exclusion to the policy in the late 1960s and the subsequent incorporation of those enhancements into the policy itself in 1986, the insurance industry found itself paying claims that it may not have underwritten.

These claims ran the gamut of residential condominium defects, subdivision-wide construction and single-family homes, and commercial and industrial projects. Often, claims also involved alleged construction defects occurring years after completion but before the expiration of the applicable statute of repose, thus, triggering coverage under the completed operations hazard.

As a result, insurers pivoted toward interpreting defective construction insurance claims strictly according to the insuring agreement of the policy, contributing greatly to the explosion of construction defect coverage litigation. Many courts accepted a novel interpretation of the CGL insurance policy based on the definition of "occurrence" to deny claims involving defective work that had previously been covered under the more traditional policy approach of applying the property damage exclusions, ignoring the coverage preserved for defective work claims under those exclusions. By focusing on the definition of "occurrence" and, at the same time, diverting attention away from the coverage preserved under the property damage exclusions, these arguments and the cases that adopted them departed from the language of the CGL policy itself.

But eventually, the presence of the limited property damage exclusions in the policies weakened the "no occurrence/no property damage" argument. Applying the standard rules of contract interpretation, courts held that the insertion of exclusions such as exclusion l., the your work exclusion, exclusion j.(5) the operations exclusion, and exclusion j.(6), the incorrect work exclusion, indicated that the property damage claims exclusions were necessary because defective work claims, even many involving defective work by insureds, survived muster under the CGL insuring agreement. In other words, the existence of an occurrence and property damage was upheld. Other courts simply refused to accept that all property damage arising out of defective work flowed from an uninsured breach of contract, was expected or intended, and was not an occurrence. There was a sea change shift in the interpretation and handling of these claims.

As a result, automatic coverage denials in many states began to fall. Many states recognized that defective work can give rise to an occurrence, even where the property damage may be to the insured's own work. Many other states recognized that defective work could give rise to an occurrence but in slightly more limited circumstances, which is where the property damage is to other than the defective work itself, even if it's the insured's own work.

Illinois Shifts to Coverage for Unintended Construction Defects

The most recent jurisdiction to be added to the states that have recognized property damage arising out of defective work, even to the defective work of the named insured, is an occurrence. That shift was eagerly awaited for over 20 years, and on November 23, 2023, the Illinois Supreme Court reversed the course of Illinois law in Acuity v. M/I Homes of Chicago, LLC, 2023 IL 129087, 234 N.E.3d 97 (2023). The case involved CGL coverage for construction defects resulting in water damage to a townhome project.

In that context, the Illinois Supreme Court responded to the request of the intermediate appellate court to clarify the law as to the existence of property damage and occurrence in Illinois. The court acknowledged that M/I Homes, the insured, was supported by an amici curiae brief sponsored by AGC of America, National Association of Home Builders, American Subcontractors Association, and their local chapters in Illinois.

For decades, courts in Illinois had interpreted the definitions of "property damage" and "occurrence" in the standard CGL policy to deny coverage for property damage arising out of defective construction as to the entire construction project itself. Those courts found coverage only in the unlikely event of damage to other real property and, perhaps, to the personal property of project owners. In reality, this amounted to little, if any, coverage for Illinois insureds; Illinois had lagged behind numerous other jurisdictions in upholding coverage for unexpected and unintended property damage arising out of faulty workmanship by the insured. The Illinois Supreme Court noted that such a narrow view of coverage is unsupported by the policy language, and it joined the majority of jurisdictions in holding that unexpected and unintended physical injury to tangible property arising out of defective work amounts to an occurrence of property damage under a CGL policy.

The court further opined that once an occurrence of property damage is found, resort must be had to the property damage exclusions within the policy to determine ultimate coverage, including exclusion l., the your work exclusion, including the subcontractor exception; exclusion j.(5), the operations exclusion; and exclusion j.(6), the incorrect work exclusion, including their particular part limitations, as well as exclusion m., the impaired property or property that has not been physically injured exclusion. In doing so, the court rejected the notion that property damage arising out of defective workmanship amounts to an uninsurable "business risk," the cost of which is to be borne by the insured contractor itself.

Aligning itself with the majority of jurisdictions, the court concluded that uninsured business risks are to be sorted out through the application of the property damage exclusions. In that regard, it remanded the case to the trial court to determine issues relating to the applicability of those exclusions to the facts before it. ²

While Acuity Homes v. M/I Homes was pending before the Illinois Supreme Court, the Northern District of Illinois entered judgment on the pleadings in favor of Acuity, the insurer, in a declaratory judgment action brought against it by Cornice & Rose (C&R), the insured architectural firm, seeking a defense as to property damage alleged against C&R by an owner. Cornice & Rose Int'l v. Acuity, 631 F. Supp. 3d 551 (N.D. Ill. 2022). The district court upheld Acuity's denial of coverage based on the Illinois law in effect at that time, finding the pleadings alleged that no third-party property was damaged beyond the work of the insured and that Acuity was entitled to judgment on the pleadings that it owed no duty to defend C&R.

C&R appealed, relying on the change in Illinois wrought by Acuity v. M/I Homes. Cornice & Rose Int'l, LLC v. Acuity, No. 23-1152, 2024 WL 4880102, 2024 U.S. App. LEXIS 29925 (7th Cir. Nov. 25, 2024). In response to C&R's appeal, Acuity sought to cut some of its losses from Acuity v. M/I Homes by requesting the court determine that Acuity v. M/I Homes was, in fact, an outlier case that fell outside the presumption of a retrospective application of a supreme court opinion because it changed the law. The Seventh Circuit flatly rejected that argument, stating that "rather than changing the law, [M/I] Homes reiterated the longstanding principle that contracts are to be interpreted as written and that at most, it clarified Illinois law and abrogated decisions that interpreted insurance policies based on their generic purpose instead of their text." Therefore, the court panel found that M/I Homes did not change the law but rather reaffirmed the principle that contracts must be enforced as written, abrogating prior decisions that prioritized policy intent over text. ³

Other Jurisdictions Bucking the Trend

Despite the ongoing trend, several jurisdictions continue to apply narrow interpretations of CGL coverage for property damage arising out of defective work, including the following.

• Massachusetts remains aligned with the lingering minority view that faulty workmanship is a business risk outside CGL coverage. It remains one of a relatively small number of jurisdictions that, contrary to the definition of "property damage" in the CGL policy, limit coverage to only third-party property and deny coverage for damage to the work of the insured, often leading to anomalous results and confusion.

• New York courts have historically followed the overly restrictive view that faulty construction claims are not covered under a CGL policy unless they cause damage to property that is outside the scope of the insured's construction project. Considering the changes that Insurance Services Office, Inc., has made to the standard CGL policy form since 1986, namely adding the subcontractor exception to the your work exclusion and by the fact that the overwhelming trend among state supreme courts has been to recognize these types of damages as occurrences, the New York Court of Appeals, the highest court in that state, may be poised to forsake the now outmoded limitations on the occurrence/property damage issues under prior New York law. ⁴

• Pennsylvania leads the way in its narrow interpretation of occurrence. The long line of cases in which the courts of Pennsylvania have declined to uphold unexpected and unintended property damage arising out of the insured's work to be an occurrence has continued to ignore the national trend. So far, there does not appear to be any serious indication of when this will change; nevertheless, it would seem to be inevitable.

• Delaware courts have held that defective workmanship is not an "occurrence" under CGL policies, reasoning that an occurrence requires an accidental or unexpected event outside the control of human agency. However, in a case where the subcontractor exception provision was added as a manuscripted endorsement, the court's discussion indicates some movement away from Delaware state court opinions that refuse to recognize that faulty workmanship can give rise to an occurrence under the proper circumstances.

Conclusion

The move away from overly restrictive approaches such as the third-party property damage requirement and toward the application of the actual terms of the CGL policy itself to preserve coverage remains the natural progression in most states. Settled principles of policy interpretation will likely carry the day as they have in states such as New Jersey, Florida, Texas, and most recently Illinois, where restrictions on occurrence/property damage as to coverage for defective workmanship had previously held sway. This anomaly is hopefully and sensibly fading, so that standard definitions, terms, and conditions in effect throughout the entire construction industry should be interpreted and applied in a similar manner among the 50 states and to construction claims that bear the same elements of damage.