The insurer’s denial places the builder-developer in the difficult position of having to wage war simultaneously on two fronts –defending the defect litigation and then also suing its insurer (and perhaps its subcontractor’s insurers under an additional insured theory) to obtain the protection that was bargained for when the substantial premiums for the policies were paid.

As a practical matter, however, many builder-developers do not pursue coverage from the responsible insurers because the typical denial form letter sent by the insurer at first blush seems very convincing.

Insurers typically deny coverage because the complaint alleges breach of contract, including breach of warranty, and therefore from the insurer’s perspective, the claim cannot fairly be characterized as an occurrence that is covered by insurance. The insurer may also take the position that its policy contains business risk exclusions that do not allow coverage for claims involving faulty workmanship or a defective product.

If all else fails, the insurer will contend that there must be other insurance available to cover most, if not all, of the loss because its policy was intended to pay only in a last resort, excess capacity.

What many builder-developers do not know is that the insurers’ positions, while initially appealing, do not hold up in many construction defect claim settings. For example, while it is true that most general liability insurance policies contain an exclusion for claims that allege breach of contract, that exclusion also typically contains an exception that, if the builder-developer would be held liable for the alleged damage independently of the contract claim, then coverage must be made available.

A breach of warranty claim is a good example where the exception should apply. With increased frequency, builder-developers and suppliers of construction products are being sued under various state product liability act statutes and common law product liability principles where the plaintiffs contend liability may be imposed regardless of any contract requirements pertaining to warranties.

The breach of contract roadblock is also a red herring because most builder-developers obtain contract liability coverage through their general liability policies. Thus, to the extent that a contract requires the builder-developer to assume certain tort liability associated with the project, the general liability policy is supposed to provide insurance protection for that liability.

The insurers’ no occurrence argument is equally unavailing in many instances. As a general matter, insurers are quick to point out that general liability policies do not provide coverage for faulty workmanship or defective products, on the grounds that damage from such workmanship is not accidental. That is a true statement. However, most lawsuits filed against builder-developers or suppliers of goods today do not merely allege damage to the work or products supplied by the builder-deveoper or its subcontractors.

More important, the plaintiff’s exorbitant damage claim usually is not limited to the repair or replacement of the goods or services provided. Instead, plaintiffs routinely claim that because the builder-developer’s workmanship was flawed, the plaintiffs experienced damage to other property, incurred substantial loss of use expense, and incurred a host of other innovative damages.

Under these circumstances, the insurer usually is required to provide a defense to the claim, and probably will be obligated to provide indemnity for some or all of the damages or settlement costs ultimately incurred. As a matter of practice, however, many insurers will try a broad-brush denial, citing the absence of third party property damage. This type of denial can, and should, be challenged.

To illustrate the point consider the following example: A builder-developer builds a new home development. Its subcontractor installs windows that are defective and result in water infiltrating the homes, causing damage to sheetrock, furniture, and rugs. Because the builder-developer’s alleged faulty work and product resulted in damage to property in addition to property supplied or worked on by the builder-developer, the general liability insurer would be held accountable in most courts for the costs associated with compensating the homeowners for repairing or replacing the sheetrock, furniture and rugs. Depending on the specific facts, the insurer’s obligation to pay may also extend to compensating the homeowners for their loss of use of this property. These damages likely will be far greater than the cost merely of replacing the defective windows.

Likewise, the business risk exclusions, which are standard in most general liability policies, seek to establish that the insurer is not agreeing to function as the performance bond surety. Thus, the “your work,” “your product,” and “impaired property” exclusions bar coverage for claims that arise out of the work or products supplied by the builder-developer (or, in many cases, its subcontractors).

The business risk exclusion analysis is not substantively different from the no occurrence argument. If there is damage to property other than the builder-developer’s work itself, it is likely that there was an insured occurrence and the business risk exclusions should not apply.

The bottom line is that coverage must be made available whenever the builder-developer is sued for damages that extend beyond the work or products that it supplied for the project. Therefore, it is critically important to understand the nature of the plaintiff’s claim and its alleged damages.

In some cases, the builder-developer’s work or product may be incorporated into a larger aspect of a project, which causes damage to other component parts of the overall project. Again, in these circumstances, the insurer should be required to provide coverage because third party property damage has taken place.

However, in the vast majority of cases, insurers will not delve deeply into understanding the precise facts of the asserted claim unless and until the builder-developer — or its coverage counsel — demand it.

In this regard, it is also important to know that insurers have a continuing obligation to evaluate their coverage obligation for claims. Sometimes, the plaintiff’s complaint does not make clear that the claim involves more than a defective product or faulty work supplied by the builder. Rather, that information may be developed when: (a) interrogatories are served in the litigation; (b) depositions take place; or (c) expert reports are exchanged. Under these circumstances, the builder-developer or its coverage counsel needs to supply that information to the insurer so that the claim may be reviewed. A coverage denial is always subject to reversal upon the presentation of new facts.

Another insurer-favorite hurdle to obtaining coverage for construction defect claims is the other insurance argument. When the claim is initially presented, the insurer will seek to gather information about insurance that may be available from other parties connected to the project — the owner, the builder-developer’s subcontractors, the architect, etc.

The purpose of this information gathering effort is to put the insurer in the position to argue that coverage should be made available under any policy except the one that it issued to the builder.

Nearly all general liability policies contain another insurance clause which seeks to address priority of payment when overlapping coverage is available. The trouble is that all of the other potentially applicable insurance policies in the mix on a particular claim contain a substantially similar other insurance provision, which seeks to establish primary coverage elsewhere. Under these circumstances, builder-developers should feel hamstrung.

In a litigation setting, when courts are presented with this scenario, the majority rule is to require all insurers to contribute to payment of the loss – either on a pro rata or proportional basis. Again, skilled coverage counsel can work with the insurers to break through the other insurance logjam.

There little doubt that construction defect claims present a myriad of complex and difficult coverage questions. However, the obstacles to coverage often are not insurmountable. Insurance coverage is attainable for construction defect litigation but a complete and comprehensive understanding of the facts is critical. SLDT