Constitutional Law
Apr. 6, 2002
Building Shelter
The settlement of construction defect cases, and therefore the protection of developer defendants, depends almost entirely upon the nature and extent of insurance coverage. For lawyers who advise clients about construction projects and for lawyers who deal with the consequences of claims of defective construction after the job is done, attention to both detail and nuances is critical to ensure that a carrier will be there to defend and indemnify.
Robert S. Mann
Neutral, ADR Services, Inc.
Email: rmann@adrservices.com
Robert mediates and arbitrates business, real estate and construction disputes.
The settlement of construction defect cases, and therefore the protection of developer defendants, depends almost entirely upon the nature and extent of insurance coverage. For lawyers who advise clients about construction projects and for lawyers who deal with the consequences of claims of defective construction after the job is done, attention to both detail and nuances is critical to ensure that a carrier will be there to defend and indemnify.
Coverage starts with the correct policy. For the developer of a construction project, a commercial general liability policy is the starting point. But it's just a starting point. Other issues need to be considered:
nIf the policy is a comprehensive general liability policy issued as the 1973 Insurance Services Office form, does the policy have broad form coverage endorsement so that the defective work of others, done "on behalf" of the insured, is covered? See, e.g., Maryland Casualty Company v. Reeder, 221 Cal.App.3d 961 (1990). The 1973 general liability form, as drafted by the Insurance Services Office, did not contain broad form coverage in the basic policy, and that coverage was available only by a separate endorsement to the policy.
The 1986 Insurance Services Office form, renamed "Commercial General Liability," contains broad form coverage. Counsel should ensure that the broad form coverage language is included in the policy.
nAre the correct development entities identified in the policy as the named insureds? Often, title to the property is taken in the name of one entity, but another entity, or successor entity, actually proceeds with the development process. The entity or individual who undertakes the development must be named as the insured under the policy. Other related entities should be identified as additional insureds under the policy;
nIs the policy a claims-made policy or an occurrence policy? A claims-made policy will be of virtually no use in a construction defect action because construction defects are generally not identified until well after completion of the project and after the policy period.
nDoes completed operations coverage exist? Under the 1973 policy, completed operations coverage was available only by use of the separate broad form endorsement. The 1986 policy form incorporates completed operations language in the policy. Because the completed operations policy provisions include coverage for damage to the insured work by others (i.e., subcontractors), the developer can often obtain coverage under the completed operations provisions of the policy which would otherwise be excluded under the work product exclusion language in the policy.
A more interesting question is whether coverage under the completed operations provisions will continue after the policy has lapsed. At least one commentator takes the position that unless the policy is maintained until the time that the claim is made, even with an occurrence policy, no coverage exists. See Owner's Guide to Construction Risk Management and Insurance, Greg Bundschuh, 1997, J&H Marsh & McLennan, Section 4.1.
nAre the policy limits adequate? Many developers gauge the amount of the coverage by the cost of the job. Unfortunately, it is not uncommon for the cost of repair to exceed the original cost of construction, in which case the developer's insurance will not be adequate to protect the builder.
Developers also rely on subcontractors to provide additional protection in the event of construction defect claims. To obtain that protection, careful developers and their counsel require two things: Additional insured endorsements and contractual indemnity provisions. But sometimes these don't provide the protection that a developer expects or needs.
Additional insured endorsements simply name the developer as an additional insured under the subcontractor's policy of insurance. Additional insured endorsements have become increasingly important following the appellate court's decisions in Maryland Casualty v. Nationwide Ins. Co., 65 Cal.App.4th 21 (1998) (subcontractor's insurer owes developer a defense when developer is an additional insured) and Presley Homes Inc. v. American States Insurance Co., 90 Cal.App.4th 571 (2001) (insurer must provide 100 percent of the cost of defense for the additional insured).
Commonly, developers only require that the subcontractor provide the one-page additional insured endorsement as "proof" that the subcontractor has actually gone to its insurance carrier and named the developer as an additional insured. Sometimes developers also request the declarations page from the subcontractor's policy. Requiring only these two documents is not a careful practice, because the potential for problems arises from the nature of the subcontractor's policy, and without a copy of the entire policy, the developer cannot know whether the additional insured endorsement has any practical meaning.
A few examples illustrate this process:
Often, subcontractors purchase insurance policies with strict limitations on coverage. An example is a "classification endorsement" in a subcontractor's policy, sometimes referred to elsewhere in the policy as a "hazard schedule." A classification endorsement limits the coverage to a particular type of work. So, for example, if a stucco subcontractor has a classification endorsement that limits coverage to the application of lath and exterior plaster, but that subcontractor installs flashing around windows or doors that later turns out to be defective, the policy will not cover the claims for that work. In some cases where the tail has wagged the dog egregiously, i.e., where the subcontractor did more excluded work than included work, a carrier might try to rescind the entire policy on the grounds of misrepresentation.
Another example is a policy that provides coverage only for work performed pursuant to a "written contract." If a particular subcontractor's scope of work is enlarged beyond the original written agreement to include work that is defined only by invoices or purchase orders, that additional work might not be covered under the policy.
A third example is a subcontractor policy which does not contain completed operations coverage. When defects are discovered well after completion of the project, a policy without completed operations coverage is virtually useless.
A fourth example is the issue of the self-insured retention, or deductible. Suppose that a certificate of insurance is provided by a particular subcontractor showing coverage of $1 million. However, and unknown to the developer, the subcontractor's self-insured retention is $200,000. A very substantial self-insured retention can, for all practical purposes, either render the policy useless or seriously diminish its value to the developer.
A better approach to protecting the developer requires each subcontractor to supply not only the additional insured endorsement but also a copy of the underlying insurance policy so that the policy can be reviewed and limitations discovered before the work begins. There is a second, and perhaps equally important, reason to obtain the entire policy. Subcontractors, even large entities, routinely go out of business, change ownership or fail to keep adequate records. Years later, when the construction defect claims arise, and the subcontractor cannot be found, or there is no insurance file at that subcontractor's office, having a copy of the policy can prove to be invaluable to the developer.
Robert S. Mann, principal of Century City's The Mann Law Firm, represents plaintiffs and defendants in construction matters and mediates construction and business disputes.
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