November 24, 2006

No Coverage for
Breach of Contract Claims
for Faulty Workmanship

Construction litigation over breach of contract claims for faulty workmanship, construction defects, and construction negligence resulting in property damage captured the Pennsylvania Supreme Court’s attention in Kvaerner v. Commercial Union, et al.  In a decision that will be critical to both insurance carriers and the construction industry, the Supreme Court held that construction defect breach of contract claims for faulty workmanship do not establish the requisite allegations of either an occurrence or an accident necessary to trigger insurance coverage under a typical commercial general insurance policy that is intended to insure for property damage caused by accidents.

The Kvaerner litigation began in 1997. Originally, Bethlehem Steel had contracted with Kvaerner to design and build coke ovens. Following construction, Bethlehem brought a civil action against Kvaerner, asserting claims for breach of contract and breach of warranty. Bethlehem alleged that Kvaerner had breached its contract as Kvaerner’s construction met neither the contract specifications and warranties, nor applicable construction industry standards. Bethlehem sought damages for the amount that it would cost to replace the coke ovens.

National Union concluded that the allegations in Bethlehem’s Complaint did not trigger coverage under its policy and refused to provide Kvaerner with either a defense or indemnification.

After being served with Bethlehem’s Complaint, Kvaerner placed its’ insurance carrier, National Union, on notice of the lawsuit, and further requested that National Union defend and indemnify Kvaerner under two commercial general liability insurance policies. One policy was a claims made policy, providing coverage against claims made during the life of the policy, and the other policy was an “occurrence” policy, providing coverage for any “act done” while the policy was in force. National Union concluded, in turn, that the allegations in Bethlehem’s Complaint did not trigger coverage under its policy, with National Union refusing to provide Kvaerner with either a defense or indemnification.

National Union argued that its policies only permitted coverage for allegations resulting from property damage caused by an “accident” under its insurance policies.

Kvaerner filed a Declaratory Judgment action against National Union in the local state court, alleging that National Union had a duty to defend and indemnify Kvaerner under the commercial insurance policies. Both parties sought summary judgment, with National Union arguing that its policies only permitted coverage for allegations resulting from property damage caused by an occurrence, which National Union contended was defined as an “accident” under its insurance policies.

National Union further contended that the underlying damages being sought by Bethlehem in its action against Kvaerner were not damages that were caused by an occurrence, but were damages that were caused by faulty workmanship. If true, National Union contended that those damages would be excluded under the “business risk/work product” exclusions under the insurance policies.

Kvaerner argued that National Union had to defend and indemnify it since the damages alleged were caused by an occurrence, deemed to be an unintended and unexpected event, in this case heavy rains.

Kvaerner argued, in support of summary judgment in opposition to National Union’s motion, that National Union had to defend and indemnify it since the damages alleged by Bethlehem were caused by an occurrence, deemed to be an unintended and unexpected event. This claim was supported by Kvaerner presenting two expert reports, in which the experts had opined that heavy rain, occurring during construction, had caused damage to the coke ovens. In addition, Kvaerner claimed that some of the damages alleged by Bethlehem resulted from improper work performed by a subcontractor, requiring National Union to provide coverage resulting from Kvaerner’s completed work product.

The trial court ruled that National Union was only required to provide coverage for property damage caused by an occurrence or accident., not for breach of contract.

Granting the summary judgment motion of National Union in denying Kvaerner’s cross-motion, the trial court ruled that National Union was only required to provide coverage for property damage caused by an occurrence or accident. It concluded that the policies were only intended to cover “accidental” damages, and that the insurance carrier was not required to defend or indemnify an insured for a breach of contract claim, presuming that damages resulting from a parties’ breach of contract cannot be classified as “accidental.”

Moreover, the trial court concluded that Bethlehem Steel only sought damages for a breach of contract, and was not seeking damages based on the occurrence of an accident, holding that the Complaint filed by Bethlehem did not trigger coverage under National Union’s commercial insurance policies.

Superior Court reversed and remanded the case, looking outside the four corners of Bethlehem’s Complaint for purposes of determining whether the expert report evidence presented by Kvaerner could have established that the claim for damages was triggered by an “occurrence” under the insurance policy.

On appeal, the Superior Court reversed the trial court’s order, and remanded the case back to the trial court for further proceedings. That order was entered in 2003. The Superior Court essentially ordered the remand by looking outside the four corners of Bethlehem’s Complaint for purposes of determining whether the expert report evidence presented by Kvaerner, in support of its cross-motion for summary judgment, could have established that the claim for damages was triggered by an “occurrence” under the insurance policy. Concluding that Kvaerner’s expert reports could have raised a genuine issue of material fact regarding the cause of Bethlehem’s damages, the Superior Court remanded the case back to the trial court for further findings of fact.

National Union appealed the Superior Court’s remand to the Supreme Court. The Supreme Court granted allocatur to determine whether Bethlehem’s Complaint would have required National Union to defend Kvaerner, whether Bethlehem’s damages could have been caused by an “occurrence,” and whether the “business risk/work product” exclusion in National Union’s insurance policies excluded coverage for the breach of contract claims being made against Kvaerner.

The Supreme Court found that “a carrier’s duty to defend and indemnify an insured in a suit brought by a third party depends upon a determination of whether the third-party’s Complaint triggers coverage.”

The Supreme Court found, in fact, that the Superior Court had erred when it looked beyond the allegations set forth in Bethlehem’s Complaint, further holding that “a carrier’s duty to defend and indemnify an insured in a suit brought by a third party depends upon a determination of whether the third-party’s Complaint triggers coverage.” This duty is based on long-standing law, citing to Wilson v. Maryland Insurance, 105 A.2nd 304 (Pa. 1956), wherein the Supreme Court had held that “the rule everywhere is that the obligation of a casualty insurance company to defend an action brought against the insured is to be determined solely by the allegations of the Complaint in the action.”

The Supreme Court faulted the Superior Court for looking beyond the four corners of Bethlehem’s Complaint.

Concluding that the Superior Court premised its coverage determination on expert reports submitted by Kvaerner in support of its cross-motion for summary judgment, the Supreme Court faulted the Superior Court for looking beyond the four corners of Bethlehem’s Complaint, and for departing from the “well-established precedent of this court”. Finding no reason to expand upon a “well-reasoned and long-standing rule that an insured’s duty to defend is triggered, if at all, by the factual averments contained in the Complaint,” the Kvaerner Supreme Court held that a determination as to the necessity of providing coverage can only be examined by analyzing the allegations set forth in the third-party Complaint.

Analyzing National Union’s insurance policies, the Supreme Court concluded that the insurance policies only provided protection for damages resulting from “property damage” when “caused by an occurrence.” “Occurrence” under the insurance policies was defined as “an accident, including continuous or repeated exposure to substantially the same or general harmful conditions.” Necessarily, the insurance policies required an analysis as to whether the damages, for which Bethlehem sought a recovery against Kvaerner, were caused by “an accident”, as opposed to having been caused by faulty workmanship.

The Supreme Court further held that faulty workmanship does not satisfy the definitional requirement of an “accident.”

In Kvaerner, the Supreme Court concluded that the damages being claimed were alleged to have been caused by faulty workmanship, and not by the occurrence of any accident. Holding that the insurance policies were intended only to insure against accidents, and were not guarantees or performance bonds for contractor workmanship, the Supreme Court further held that faulty workmanship does not satisfy the definitional requirement of an “accident” as required to trigger the insurance carrier’s duty to defend and indemnify for an “occurrence”, further concluding that National Union, on the facts of this case, was not required to defend and indemnify Kvaerner for faulty workmanship in the absence of any proof that an accident had occurred resulting in damages caused by Kvaerner’s negligence.

Practical Tips

As a practical matter, the Kvaerner ruling will empower insurance carriers to use declaratory judgment actions as a shield against construction defect claims being made under commercial general insurance policies in the absence of any claim, being made by the third-party, that the “insured” contractor was “negligent.”

Typically, a construction defect complaint brought by third parties against contractors, no matter their size or leverage, involve several theories of recovery, including breach of contract, breach of warranty, both express and implied, and a theory for liabilities and damages in general negligence. Consumer complaints often include claims for recovery for fraud, misrepresentation, both negligent and intentional, and unfair trade practices.

Insurance carriers will need to begin their coverage analysis with a determination as to the underlying “gravaman” of the damage claim.

Insurance carriers, placed on notice of third party complaints and claims for damages against insured contractors, will need to begin their coverage analysis with a determination as to the underlying “gravaman” of the damage claim, to determine whether coverage must be provided to the insured for purposes of defending and indemnifying.

Insurance carriers should carefully analyze the third-party complaint to determine whether the allegations allege breach of contract for faulty workmanship, as opposed to property damage.

When uncertain as to whether the third party complaint might trigger coverage for property damages under the insurance policy, it is suggested that insurance carriers carefully analyze the third-party complaint to determine whether the essence of the allegations in the complaint are alleging breach of contract for faulty workmanship, as opposed to alleging property damage as the result of an unexpected and unintended event, characterized as damages resulting from an “occurrence,” necessitating the precedent “accident.”

Interestingly enough, the Court noted that the majority of courts in other jurisdictions have consistently held that coverage under a commercial policy “is not triggered by poor workmanship that causes injury to the work product itself,” with a minority of jurisdictions holding that faulty or negligent workmanship constitutes an “accident” so long as the insured did not intend for the damage to occur. American Family Mutual Insurance Co. v. American Girl, 673 N.W. 2nd 65 (Wis. 2004); Fidelity and Deposit of Maryland v. Hartford Casualty, 189 F. Supp. 2nd 1212 (D. Kan. 2002); Joe Banks Drywall v. Transcontinental Insurance, 753 S.O. 2nd 980 (La. App. 2000); Erie Insurance v. Colony Development, 736 N.E. 2nd 941 (Ohio. App. 1999).

The Kvaerner Supreme Court indicated that it believed that CGL policies are not the “proper means” to protect against faulty workmanship risks.

However, the Kvaerner Supreme Court indicated that it believed that an analysis of damages based on faulty workmanship can be overly broad, further believing that CGL policies are not the “proper means” to protect against such risks, concurring with the majority of jurisdictions, and declining to apply coverage in such cases.

The Supreme Court added a footnote, citing to a seminal Law Review article by Roger C. Henderson, reviewing the application and limitations of CGL policies, wherein Henderson had indicated “the risk intended to be insured is the possibility that the goods, products, or work insured, once relinquished and completed, would cause bodily injury or damage to property other than to the completed work itself, and for which the insured be found liable. The insured, as a source of goods or services, may be liable as a matter of contract law to make good on products or work which is defective or otherwise unsuitable because it is lacking in some capacity. This may even extend to an obligation to completely replace or rebuild the deficient work or product. This liability, however, is not what the coverages in question are designed to protect against. The 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 that for which the damaged person bargained.” See Insurance Protection for Products Liability and Completed Operations; What Every Lawyer Should Know, 50 Neb. L. Re. 415 (1971).

Questions

Questions concerning this decision, or any questions involving casualty litigation practice and procedures, can be directed to our general litigation department attorneys.

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