INSURANCE: BUILDER’S RISK & CONSTRUCTION COVERAGE

AN INTRODUCTION

Michael Sean Quinn[1]

Quinn & Quinn

1300 West Lynn #208

Austin, Texas 78703

(o) & (c) 512-656-0503

mquinn@msqlaw.com

(Resumes on Website:

www.michaelseanquinn.com,
or

simply as Michael Sean Quinn)

            Still, does anyone reading this paper react to this story thinking that the characters in the story may not have been received complete and total justice?  Even the insurance agent walked away without
any liability. Is this story simply about the miseries of the adult lives of
the somewhat rich and not so famous?  Is
it about the wretchedness of a type of insurance to be found everywhere in the
English-speaking world?  Is it about how
much people need to be told about how many different types of insurance they
really need to buy if they are going to spend a lot of money on a construction
project?  Is it about how people should
approach asking their insurance agents for advice and information?  Is it about how to make sure all the people
who provide you construction services get sued if a project goes to hell in a
handbasket?  Is it about how to make
sure you have the right lawyer?  We shall
return to some of these topics in due course. [3]

I.                  
Builder’s Risk
– What Is It? An Introduction

These days Builder’s Risk insurance is a special form of property
insurance coverage that generally provides coverage for projects under
construction, renovation, or repair and insures against accidental losses,
damages, or destruction of property.   Usually,
Builder’s Risk insurance is nothing but first-party insurance—nothing but property
insurance.  This has not always been
true, and it is still not always true, but it is almost always true, and it is
all we will talk about.[4]  Builder’s Risk policies are not always
separate policies.  Sometimes they come
as endorsements to other policies. 
Obviously, this can be very confusing.[5]

Some say that Builder’s Risk policies are different from other property
insurance policies in that they try to provide coverage for a “moving target.”  This point here is that sometimes Builder’s Risk
insurance may cover a construction company that builds house after house after
house.  (The same point might apply to a
company that repairs one house after another.) 
Or sometimes it may cover a company that is building a huge building
that goes up floor after floor after floor after floor. Any of these, of
course, is in some sense a moving target.  (Of course, come to think of it, auto
insurance—in so far as it is property insurance—insures a moving target, as
does vessel, airplane, and rocket insurance. 
Then again, the word “moving” here is a paradigm of ambiguity.  So much for clarity!)

Here is an excellent summary of some of what has been said in the last
couple of paragraphs, although some of it is a bit exaggerated.  “Builder’s Risk insurance is a unique[[6]]
form of property insurance that typically covers only projects under
construction, renovation, or repair and insures against accidental losses,
damages or destruction of property for which the insured has an insurable
interest. [Citation omitted.] An ‘insurable interest’ includes ‘any lawful and
substantial economic interest in the safety or preservation of the property of
loss, destruction, pecuniary damage,’ [Citation omitted.] A contractor
obligated to repair or replace any damage to the building has an insurance
interest in the project.[7]     Similarly, a building contractor is obligated
to ‘secure and insure’ the project has an insurable interest in the building
during the course of construction.  A Builder’[s]
Risk policy ‘should be read, if it can be without twisting words and rendering
plain meaning nugatory, so as to protect the builder [against covered loss]”.[8]

Business Risk insurance, at least on building construction, is certainly
different from some property insurance in that business Risk insurance
automatically insures at replacement value. 
It is obvious why this would be true. 
It is insuring new property at the time it is new.  We shall return to this matter later.

Almost every construction project has, or is supposed to have Builder’s Risk
insurance. Virtually all lending entities require it.  Virtually all genuinely solvent and honest construction
entities which are anything but tiny have it. 
All lawyers advising clients considering having buildings they own
remodeled or repaired to any substantial extent should advise their clients to
demand it or get it themselves.

Builder’s Risk insurance is sometimes purchased by the construction
company and sometimes by the owner of the building or by the owner-to-be of the
building.  Sometimes it is even purchased
by this or that sub-contractor. Who does all this depends on the
situation.  Sometimes “the situation” is
more or less determined by the construction contract.  If a construction company is building a large
number of houses in a subdivision, it is likely to be the purchaser of the
insurance.  If the construction company
is working on building an extension for an already existing complex building
owned by a large corporation, the chances are that the property owner will
arrange for and buy the insurance.  Of course,
the construction company (or, companies) may have input.  Usually, the property owner, the construction
company, various subcontractors, perhaps lenders, and sometimes others may be
insureds of various sorts.  They may be
named insureds on some policies; named insureds and additional named insureds
on others; and named insureds and additional insureds on others.   Obviously, this can produce problems, now and
then.

II. What’s Covered?

Actual Construction Project.  The property covered under a Builder’s Risk
policy usually includes the structures being built, the structures upon which
work is being done, sometimes structures quite close to the structures just
mentioned (sometimes not), foundations, materials that have not yet been incorporated
into the structure but are on-site, materials being moved on-site that will
ultimately be used in construction but are not yet on site, scaffolding, movable
warehouses, lawns, trees, plants, and yet other temporary structures may also
be covered by the policies, some of which may be subject to sub-limits.

Repair or Remodeling Projects.  Where the property being insured is
already erected and is only being repaired, renovated, or remodeled, the only
property that is insured under the Builder’s Risk policy is the new materials
being used and incorporated into the existing structure.  Building contents are not usually covered
without an endorsement. And why would there be an endorsement; who would need
one?  People usually have insurance on
that anyway. The same thing is true for original construction as well.

III. What Is Not
Covered?

In general, the equipment and tools of the contractor and the
subcontractors are usually not covered in standard forms, although they can be if there is an endorsement
or language to change this.  (In addition,
a crane used by the contractor to build the structure, but not intended to be
incorporated within the finished structure is not covered by Builder’s Risk.[9]   Presumably, it would be much more difficult
to get an endorsement for a crane than a hammer or a saw.)

If requested, other risks can be covered by variant policies or endorsements.  Often these are subject to additional prices
or fees, and there are sub-limits.  The
point here is that some of these things are—or at least classically were― not
actually to be found in exclusions.  They
were simply not found in coverage and were therefore not covered.  Here are some of them:

·        
Pollution cleanup

·        
Terrorism Risks

·        
Additional material transits (if there were
limits in the policy)

·        
Additional material storages (if there were
limits in the policy)

·        
Weather problems

·        
Earthquake coverage

·        
Flood coverage

·        
Blanket model home contents coverage

·        
Soft Cost Coverage (here is the additional cost
to pay attention to – and it is discussed in its own section below).

With respect to being found in exclusions or simply not being found in coverage the times
are changing.  Many insurers in many
policies these days are going out of their way to mention explicitly everything
(or at least more things) they want to make sure no one will think—or no one
will spend a lot of money trying to argue—is found in coverage.  The dangers are something like this.  First Argument:  You—insurer—have included something like X, namely Y.  One of the terms you used
to describe Y is ambiguous and may
be interpreted to include X.  (Anyone can see that from reading the
novels of George Eliot.) Second Argument: You—the insurer—sell another
insurance policy that includes X, so
even though you did not explicitly include it here, it is implicitly included.  Otherwise, you are either trying to cheat me
or you are trying to defraud me or you are committing bad faith—whichever.

            One kind of weather problem is rain,
and it has been listed as a cause that is not covered under some
circumstances, at least historically, although routine rain has not been a
significant matter from a coverage litigation point of view.  In other words, there have not been very many
reported cases.  Here is a typical “We
will not pay clause” or “This is not a covered cause” clause:

At least some of
the reported cases have involved temporary “roofs”—canvas tarps, and that sort
of thing.  In one case a state supreme
court found coverage when a sudden wind storm blew off a new addition to an
old building and a rainstorm that followed immediately did damage to some of
the contents of the older building.[10]

            In a more recent rain case, the
court sided with the insurer, and explicitly rejected the case just discussed
as authority.  The case of Aginsky v. Farmers Insurance Exchange.[11]  Owners of apartment buildings decided to
reroof them.  Property insurance was
purchased.  It is not clear that it was a
Builder’s Risk policy, but it was quite similar, in any case.  The roofs were removed, but the city “red-tagged” the buildings for some reasons pertaining to worries about structural
problems, and the projects came to a standstill. Naturally, tarps were put in
place.  Alas, high winds came and rainwater penetrated, so that water entered at least one of the buildings.

            The building owners sought
coverage.  The insurer denied it on the
basis of exclusion similar to the paradigm set forth above. And litigation
ensured.  This litigation contained a
twist.  It was such that the classic issue
of permanent roof versus temporary roof was never reached. The policy at issue in this case required that an actual roof of some sort be involved.  One of the issues in this case was whether a
temporary substitute, like a tarp, could be a roof at all, under Oregon law.  The court cited cases from California,[12] Mississippi, and Florida for the
proposition that tarp substitutes are not roofs.  The cases convinced the court.  The term, he said, is not even
ambiguous.  Tarps are simply not even
roofs.  A temporary roof is a “wooden
framing” of some sort and a “plastic tarp would not be considered a ‘roof’ by
any reasonable person.”[13]

            One of the most recent of these
cases resembles the case just discussed, except that it was a 20 story
condominium tower, and the construction contractor had settled, so that only
the property owner was left to adjudicate anything.[14]  In any case, the case involved virtually no
factual controversies; there were stipulations or agreements to virtually all
the facts. Rain came through preexisting openings in the building under
construction—whether where roofs or windows would be—which were covered by
tarps.  The court decided the case just
as the Oregon
court had, although the Nevada
court did not cite the Oregon
court.  Both agreed that there was no
roof, and hence no roof failure of any kind and both agreed that the California decision upon
which the Oregon
court had relied—the Diep case―was
the decisive case.

            The last bullet—Soft Costs—is the
topic most discussed by commentators these days, so we will return to it
briefly later, both in our discussion of exclusions and in a final discussion
of a particular case.

             For now, let us take a look at material in
transit as opposed to material in the contractor’s warehouse.  There is a neat Texas case precisely on this point, which
may have avoided stating its real motivation. 
 The case was United Stated Fidelity and Guaranty v. Hutson Construction Company, Inc.,[15]
which concerned a construction project in Paris,
Texas.  Paris is a smallish city in northeast Texas about
105 miles from Dallas and about 112 miles from Duncanville, a good sized suburb
that is south and very slightly west of (much of) Dallas.  Hutson was building a new building in Paris, and it had Builder’s
Risk insurance with limits of liability of over $338,000 if property was lost
while at the Paris
premises.  The policy covered losses of
property while in the “due course of transit,” although there was a limit of
$5000.

            Hutson purchased copper wiring for
use in the building.  It purchased it,
not all at once, but in smaller quantities. 
(We speculate that it did so in order to get better prices, or perhaps
better wiring.)  In any case, Hutson
stored the wiring in what it said was a designated location in a warehouse in Duncanville.  Alas! There was a theft, so Hutson made a
claim under the Builder’s Risk policy, surely ―in part― because it had not
purchased other insurance upon the wiring.  The carrier denied coverage, since the wiring
was not in transit, but the trial court agreed with Hutson.  The Dallas Court of Appeals, however, agreed
with the carrier, and the Texas Supreme Court agreed with the court of appeals.

            Here is the reasoning of the court
of appeals.  The meaning of the phrase
“in transit” when it comes to property was decided by the Texas Supreme Court
long ago in the case of Amory
Manufacturing Co. v. Gulf C. & S. F. Ry.,[16]  where that court drew a distinction
between “in transit” and “in transitu.”  The former phrase, held the court, meant,
“having been set in motion towards its destination” whereas the latter phrase
included being readied to be set in motion and would therefore include, for
example, sitting on a railroad platform. 
Lower Texas courts have followed this
precedent for many years.  Goods in
storage waiting to be shipped, for example, have been held not to be in
transit; they are not “in [the] course of passing from point to point.”[17]  (Of course, movement is not the only
issue.  In one case, a truck arrived at
the delivery point, but the building was closed, so the truck pulled up to the
loading dock and was locked.  Thereafter,
over the weekend, the theft occurred. 
The insurer denied coverage.  The
court held that the goods were still in transit and that the seemingly
precedential cases did not apply.[18]

IV. How long Is This Type of Policy In Force?

Builder’s Risk
coverage is not permanent coverage and provides coverage only during the
“course of construction.”  The coverage
period for a Builder’s Risk policy depends on the language of the policy
itself, as well as the contract between the property owner and the
contractor.  The language of the policy
is not always crystal clear.

      Some of these policies are blanket
policies, in the sense that they cover multiple projects, some are single
project policies.  Some of them last for
particular periods of time; some of them do not.  All of them which specify particular periods
of time usually specify a year or two. 
Virtually all that specify a year, at one point in time, had an
automatic and enforceable extension if a covered ongoing incomplete project or
projects come at the end of the year. Obviously this can be a problem.  This can be particularly true if the insured
contractor has run out of money, has been misbehaving in some relevant manner,
if the property owner is troublesome in a relevant way, and so forth.              Nowadays,
many of these policies have a number of termination dates built into them.  Insurers like to take the view that the first
one to be satisfied terminates the policy. It is an interesting question
whether this is really clearly set forth in the policy.  It is also an interesting question whether
this fact—if it is a fact—is made clear to policy purchasers, much least to
each policyholder, or even each significant policy holder, such as the owner,
the lender, and the general contractor. 
Let us take them one by one, and see what we end up with.

Beginning.   A policy might run for the length of time it
takes to build a building but not longer than X days after the beginning of the project. The start date for coverage may begin on the first day of
construction, or may even begin before the construction has actually or officially
started, providing coverage when the contractor is in the preparation phase,
e.g., when material has begun to arrive on the premises.[19] 

      End.  When
coverage ends can be a point of dispute between the insured and its carriers.  A Builder’s Risk policy may provide that
coverage ends on a date certain or upon the happening of a certain event such
as occupancy, owner’s acceptance, date on which the construction contract is
complete, or date certificate of occupancy is issued by a government agency – or
it may not provide any termination date. 
The determination of when a building is “occupied” or when construction
is “completed” has been addressed by many courts.  Courts have consistently held that a building
is “occupied: or “completed,” and the Builder’s Risk coverage terminates, only
when the building is ready for its “intended use.” Often this means that it
must really be completely ready.  If the
punch list work isn’t done, the construction or similar type work isn’t done.[20]    

      Here is a summary of some of
the main triggers which have ended Builder’s Risk policies.

·        
The interest of the insured  terminates,

·        
Occupancy begins,

·        
The project is abandoned,

·        
A number of days specified in the insurance
contract pass after required testing,

·        
The expiration date of the policy,

·        
The property is accepted as finished by the
purchaser, and/or

·        
X days
(usually 30, 60, 90 days) after construction is complete.[21]

            Regardless
of the actual event that triggers the termination of Builder’s Risk coverage,
it is imperative that the owner purchase property and fire insurance to provide
coverage once the Builder’s Risk insurance expires.  Overlap is probably safer that trying to get
it exactly right.

V.            
How Do
Policies Cover Loses?

Builder’s Risk
policies cover fortuitous losses resulting from damage to the construction,
unless excluded.  There are two types of
policies.  They can be either “all Risk” policies, like most standard property policies, that insure
all Risks not specifically excluded from the policy or “named-peril” policies, only providing coverage for specific perils
set forth in the policy.  One does not
see “named peril” Builder’s Risk insurance policies these days very often,
although there are no doubt some out there. 

      Here is some standard “all Risk”
policy language “Section I insures against all Risk of physical loss of and/or
physical damage to property covered hereunder, provided such loss or damage
arises from an Occurrence within the Policy Period. . . .” [22]  When the language is all risk, it thereby
includes any fortuitous cause of loss while construction is going on fire,
theft, vandalism, accident, etc.  Notice
that the word “fortuitous” is restricted to the insured.  Someone else—entirely outside the control,
and perhaps the knowledge of the insured—can do something deliberate, and that
would be considered fortuitous. 
Fortuitousness is to be judged from the point of view of the
insured.  If there is a string of
insureds, what is fortuitous from the point of view of one insured may not be
from the point of view of another, depending upon what they all know about what
is going on.

      Here is some standard “named
peril” insuring agreement language.  It
is to be found in a standard policy.  ‘We
will pay for direct physical loss of or damage to “Covered Property at the
premises described in the Declarations at the premises described caused by or
resulting from any Covered Cause of Loss at the premises described in the
Declarations caused by or resulting from any Covered Cause of Loss.’  The capitalization of letters in this policy,
as in many policies, usually indicates that the terms are defined terms; thus
the phrase ‘Covered Cause of Loss’ is a defined term, and there is a whole
several pages listing covered causes of losses. 
Of course, policies are not always consistent on this point.

      To determine whether a loss is
fortuitous, and therefore covered by the policy, courts must determine whether
the loss resulted from a “chance”-appearing event—chance-looking, that is from
the point of view of the person sustaining the injury or loss, rather than one
that was deliberate, intended, planned, or quite within the control of the
insureds.  As in a standard property or CGL policy, losses that result from the principal
insured’s intended misconduct will not be covered under the Builder’s Risk
policy. (Problems can arise here.  What
if an insured subcontractor hates the contractor and burns down the building
under construction in the midst of the construction project?  Can the owner recover?  Can the contractor?)

VI.         
What Is Most Commonly Excluded From Coverage?

            Think about the organization of the
paper this way.  Section IV,  “What is Not Covered,” was about the natural
events and natural forces which are not included among those things which are
not covered.  This section is about those
activities of insureds, or other facts and factors, which can defeat or stand
in the way of coverage. Oh unhappy day!

A. Range of Exclusions. 

There are several standard exclusions in Builder’s Risk policies.  Some of the most common and often litigated
exclusions are those relating to faulty workmanship, faulty materials and
defective design.  This insurance is for
bad and injurious stuff which happens during the process of constructing,
renovating, or repairing a building, not stuff that happens before that. It is
not for manufacturing errors committed by companies that make that which the
builder buys and uses. It is also not for professional errors in design, even
if the builder did the designing; of course, that is often not so and it was
done before construction began.  Besides,
it is not building, and that is what
is insured.

An interesting
and unpublished opinion involving Builder’s Risk exclusions is Indian Harbor Insurance Co.  v. Clarinet, LLC.[23]  Clarinet purchased a near century-old building
in St. Louis in
order to convert it into luxury apartments and retail/commercial space.  Clarinet applied for and purchased a Builder’s
Risk policy from Indian
Harbor.  A year or so into the project, a storm passed
through St. Louis
and the building partially collapsed.  A
claim was made with Indian
Harbor and they denied
coverage.  Although windstorm damage was
covered by the policy, Indian
Harbor took the position
that the collapse was caused, not by wind storm, but by the following:

·        
Inadequate, faulty or defective workmanship;

·        
Methods of construction;

·        
The building was not maintained in a reasonable
condition; and

·        
Failure to provide adequate bracing to the
structure.

The policy stated
that coverage will not be provided where the loss results from, “rust or other
corrosion, decay, deterioration, hidden or latent defect or any quality in the
property that causes it to damage or destroy itself.”[24]

      The Court’s opinion focuses a great deal
on whether the loss was, in fact, caused by a windstorm, and what if, any effect
does it have on coverage if other, specifically excluded, “causes of loss” were
involved.  The Court ultimately held that
when given its plain meaning and considering the policy in its entirety, a
windstorm, which is a Covered Cause of Loss, need not be the sole cause of the
collapse of the building for coverage to exist.[25]  Furthermore, according to the Court to the
extent the policy is ambiguous in regard to whether an exclusion applied, where
a Covered Cause of Loss (such as wind) is also a cause of loss, the ambiguity
must be resolved in favor of the insured; Clarinet, in this case.[26]  Thus, in order to be a covered windstorm, the
windstorm must have been a “substantial factor” in bringing about the collapse
of the building.[27]

Let us take a
look at these exclusions—the ones we just mentioned―in what we shall call ¨real
[that is, litigation] life.¨ Then we shall look at some others.

B. Faulty Design. 

Insofar as these exclusions appear in policies covering builders keep the
following in mind.  To be sure, exactly
these words appear in the exclusionary sections of Builder’s Risk
policies.  The reasons for this exclusion
are two.  First, contractors do
not—indeed, almost never—design the buildings they build.  Second, if they do build them, they do it
before they build them.  One wonders what
would happen if a contractor did actually design a building, and then had to
change the design in the middle of construction.  Would this not be part of the building
process?  What if the contractor’s
design accomplished during construction was disastrous and caused
problems, should that not be covered? 
Clearly, it is not![28] 

Now let’s start over again. 
Builder’s Risk insurance policies often insure property owners while
construction projects are proceeding or while renovation, expansion, or repair
projects are proceeding.  Such
undertakings may all involve design.  And
of course, the faulty design exclusion will deny the property owner coverage no
less than it would deny the builder coverage. 
An interesting example of this is a commercial-industrial Texas case from the
1980s involving a huge addition to an oil refinery in Corpus Christi.[29]  This case involved an all-risk Builder’s Risk
insurance policy with a faulty design exclusion, where the exclusion did not
“exclude physical loss or damage arising as a consequence of [for example] that
faulty. . . design.”  Interestingly, that
appears to have been exactly what happened in this case.  Part X was
faulty design; its installation caused rust and corrosion on part Y, which would normally have been
excluded, and that lead to other losses. 
Rust and corrosion would normally have been excluded.  But, at least at that time, under Texas law,
at that time, if an excluded peril was caused by a peril which was not
excluded, but covered the excluded peril was not excluded, so at least part of
the loss was not excluded.  And that part
of the loss was absolutely enormous.[30]

C. Faulty Workmanship.

First-party property insurance policies, in general, do not provide
coverage for property damage directly caused by contractors of virtually any
sort working on insured properties.  In
other words, faulty workmanship is quite often a standard exclusion in
virtually all kinds of property policies.[31]  We have difficulty understanding why a
property owner cannot obtain coverage against an accidental loss caused by
someone, say, repairing the roof of his house who fouls the whole thing up
injuriously so that the job has to be done again.  That is surely physical injury to tangible
property.

            In any case, Builder’s Risk
insurance policies are, quite often, no different from other property
insurance in this regard:  faulty
workmanship in such cases is not covered. 
This is true whether or not the general contractor or any sub-contractor
is or is not covered.  The property owner
may alone be covered.  There is no
coverage for direct physical injury caused by faulty workmanship, although
there may be coverage for physical property damage caused by the faulty
workmanship itself.  Thus, if the roof is
poorly done, and it rains, and it floor is injured, the floor may be
injured.  And so forth.  Then again, if there is no explicit exception
to the exclusion of the sort just laid out, there will be no coverage
whatsoever.  Here is an example of such
policy language: there is an exclusion for “[t]he cost of making good any
faulty or defective workmanship or material. . . .”[32]

            There are other types of cases, of
course.  In one significant case, the
Builder’s Risk policy covered only the general contractor.  Only the faulty workmanship—or any
activities—of its employees were subject to the policy terms, including the
exclusions, such as the faulty workmanship exclusion.[33]  (This case involved welding at a gigantic
public facility in El Paso.)

            The court in the Kroll Construction case found a way to
be helpful to the general contractor. 
The exclusion did not exclude coverage for “physical damage directly
resulting from such faulty or defective workmanship or material[,]” and it turns out
a gigantic portion of the contractor’s expenses were taken up with that,[34]
so he got some judicial help.

            Sometimes, the phrase “faulty
workmanship” is found to be ambiguous. 
Sometimes it is found to refer (i) the quality of a finished product,
and sometimes it is taken to refer to a (ii) flawed process.[35]  Obviously, if it referred only to a finished
process, then a failure of a roofer to put a temporary cover over a partially
completed job for a night could not be faulty workmanship.  In our view, this particular argument over
ambiguity is nonsense.  What the phrase
means depends on the context in which the problem of injury arises.  The Ninth Circuit did not agree and reversed
the District Court.  It held that there
had to be a flawed product in order for there to be flawed workmanship, and
that means that alternative (i) by itself is correct.  Of course, that is the alternative       favorable to the insured, and the
insurer had to pay the property owner to the extend consistent with the policy.

            One of the most interesting of these
types of cases is Otis Elevator Company
v. Factory Mutual Insurance Company,[36]  wherein
Otis had been retained to build and finish a tram system in a large
airport, and had naturally had utilized a prominent subcontractor to help it,
which had, in turn, hired an individual sub-subcontractor to help them both.  The latter and foul-up, doing considerable
damage to the tram-cars which were being tested and to other parts of the tram
line.[37]

            The court refused to rely on the
faulty workmanship exclusion, since the faulty workmanship of the suburb did
not directly cause any physical damage directly to the tram cars or anything
else.  Of course, the negligent
workmanship of the “sub-sub” was such that the tram car should never have been
accelerated to “full-speed-ahead,” since it had no effective brakes at that speed
(or any other), but the faulty workmanship of the sub-sub, did not directly
cause physical injury to the car itself.[38]

            For the lawyer representing an
insured, it is worth keeping in mind that workmanship exclusions are written
quite differently and various Builder’s Risk policies.  This means that different policies present
different litigation possibilities.  We
ran across a policy recently in which the workmanship exclusion worked this
way:  “the insurer excludes liability for
faulty design, specifications, workmanship, surveying, engineering, material
selected and delivery,” etc. Arguably this restricts the excluded workmanship
to that which occurs before actual physical building begins.  This is rare, of course, but it is a genuine
possibility.

      We have also noticed that
controversies over workmanship exclusions occur most frequently, when we are
dealing with all-risk property policies, including Builder’s Risk policies.  We are not clear about why this would be
true.  Maybe it is because there was
more of them at least at one time. 

VII.       What Is the “Soft Cost” Problem?

Builder’s Risk
coverage is intended to reimburse for additional expenses, incurred after the
project would have been completed if no loss had occurred, and resulting from a
delay in the completion of the project, caused by direct physical loss or
damage from a covered peril.  It is often
said that “hard costs” are associated with the “sticks and bricks” of a
project, the “soft costs” coverage is extended to a very specific list of
construction overhead costs and expense categories and can often be selected by
the insured a the time of application. 
Categories of soft costs can include:

·        
Interest on construction financing

·        
Real estate taxes

·        
Marketing and leasing expenses

·        
Architect, consultant, engineering and developer
fees

·        
Construction general conditions

·        
Bond and permit fees

·        
Testing and inspection fees

·        
Bank and letter of credit fees

·        
Administrative costs, licensing, and permits

·        
Legal and accounting

·        
Commissions for re-negotiations of leases

·        
Insurance premiums for Builder’s Risk, Workers
Compensation and General Liability.

As you can see, soft costs are not
necessarily incurred in connection with the actual process of repairing,
rebuilding or replacing damaged property and may also include business
interruption and other time element losses. 
Soft costs seem to have become an increasingly important component of Builder’s
Risk claims.  This is especially true in
the case of long-term projects involving complex financing arrangements where
an insured’s cumulative claim for additional costs resulting from project
delays, extra expenses and lost rental income may equal or even exceed the hard
costs of labor, materials, and equipment incurred in rebuilding damaged
property. 

            The
case that brought the issue of soft costs into the forefront (and presumably
sent shock waves through the insurance industry) is Zurich American Ins. Co. v. Keating Building Corp.[39]  Prior to this case, it appears that
courts had little occasion to provide guidance on which delay and soft costs
are covered under standard Builder’s Risk policy forms and endorsements or,
when coverage was determined, how the specific costs are to be measured.[40]  The court in Keating applied basic principles of general contracting and policy
interpretation and held that a standard Builder’s Risk policy provided coverage
for three standard categories of soft costs – 1) extended general conditions;
2) delay costs and 3) price increases.  
This was decided despite limiting language in the policy’s coverage
agreement and an exclusion for consequential losses. 

            Prior
to Keating, courts had provided
little, if any, guidance on which delay and soft costs are covered under
standard Builder’s Risk policy forms and endorsements.  Also missing was any discussion or direction
on how specific costs should be measured. 
The District Court of New Jersey applied basic principles of general
contract and policy interpretation and held that the standard Builder’s Risk
policy provided coverage for three categories of soft costs:

Perhaps the most impactful of this
ruling was that coverage was found to exist for these damages despite limiting
policy language and a broad consequential loss exclusion in this particular
policy.  The policy involved in Keating was an “all Risk” policy as
opposed to one written on a “Named Peril” basis.[41] 

            This
suit involved an expansion and renovation project by the owners of the
Tropicana hotel and casino in Atlantic
City, New Jersey.  Keating was hired as the general contractor
on the project which was scheduled to be completed some time in the first
quarter of 2004.[42]  The work included a three-floor dining,
retail and entertainment space topped by a seven-level parking garage and
seventeen additional floors of hotel rooms. 
   

            Before
construction began, Zurich
issued a Builder’s Risk policy covering both the project owner and the general
contractor for losses arising out of an accident.  This policy contained a Policy Valuation
Clause providing that Zurich
would only cover costs to “repair or replace property lost or damaged
at the time and place of loss with materials of like kind and quality.”[43]  The policy also expressly excluded damages
“caused directly or indirectly and/or contributed to, in whole or in part” by
“consequential loss, damage or expense of any kind or description including but
not limited . .. penalties for non-completion, delay in completion, or non-compliance with contract conditions . . . .”[44]  Finally, Zurich’s policy included a “Delay in
Completion” endorsement insuring the owner, but not the contractor or any of
the subcontractors, against the loss of gross earnings, rental income and “soft
costs/additional expenses” associated with a delay in the schedule.[45]

            In
October 2003, a portion of six floors of the garage collapsed on top of the
three-level retail, dining and entertainment complex.  The collapse caused significant damage and
numerous injuries, including four deaths, to construction workers.[46]  Keating, the contractor, submitted a claim
under the Zurich
policy for costs that it claimed resulted directly from the accident, such as
debris removal, repair of the garage, and increased construction costs due to
delay.    The owner submitted its own
claim under the “Delay in Completion” endorsement for losses it allegedly
sustained as a result of delay in finishing the project, mostly lost rental income,
other lost hotel revenue and was subjected additional financing costs.[47]  The claim totaled $80 million for the eight-month delay and the cost increase.

            Zurich paid half of the
claim but refused to pay the remainder. 
According to Zurich,
the delay claims were not covered because the insuring provision language was
limited to the costs to repair or replace the damage portion of the project and
did not extend to increased costs needed to complete construction of the
undamaged property.[48]

            The
Court rejected Zurich’s
argument and held that the policy covered all of the disputed categories of
soft costs.  There were several reasons
for the Court’s conclusion.  First, the
Court began with the proposition that the policy was an “all Risk” policy,
insuring against all risks of direct physical loss or damage so absent a
specific exclusion the policy covered all
fortuitous losses proximately caused by a covered peril.  Second, according to the Court, the policy
did not distinguish between losses resulting from damage and undamaged portions
of the property and insured damage at the entire insured project, not just the
area of the project where the accident occurred.[49]  Finally, the Court stated that Zurich could have limited
the coverage under its policy by including restrictive language to the effect
that only repair costs were covered, but it failed to do so. 

            Regarding
the policy’s consequential loss exclusion, the Court adopted the so-called
“efficient proximate cause” doctrine, which provides that coverage is available
if the covered peril was the efficient proximate cause of the loss and an
excluded peril merely occurred in the chain of events that followed.  The Court also stated that the types of
losses excluded in the policy – “liquidated damages,” “performance penalties,”
“loss of market or delay,” and “penalties of non-completion, delay in
completion, or non-compliance with contract conditions” – were purely economic
losses separate from regular construction costs.[50]  The Court held that to extend the exclusion
of consequential losses to include regular construction costs incurred to
complete the project was impermissible and unwarranted under the New Jersey rule
requiring narrow interpretation of exclusionary language.[51]  The Court held that Zurich must pay the extra costs that the
owner paid to complete the project, without regard to whether the costs involve
work at the project away from the immediate are of the collapse.[52]

            The
impact of Keating (decided in 2007)
may not be fully known at this time.  The
case has been cited four or five times (for the “efficient proximate cause”
doctrine and basic construction of ambiguous/unambiguous policy language
discussions), but the decision has not been fully scrutinized as to its all-encompassing
soft costs ruling. After Keating, it
could be that soft costs, whether incurred on or off –site will be recoverable
even though they would appear to fall squarely into the category of excluded
consequential losses.  Also, the court
held that those costs were recoverable under the property damage coverage even
though they are more in the nature of time element costs that grow with
time.  Traditionally, time element
coverages are subject to a very different set of limits and deductibles to
control costs and prevent any incentive for insurers to claim coverage for
project delays resulting from other causes or even non-covered perils.

            It
has been noted that some insurers have altered policy language in an attempt to
better control soft cost exposure.  These
policies provide coverage for all soft costs under a general “Delay in Completion
Coverage Part.”[53]  Obviously, insurer’s are trying to create
policy language that will provide them with better control over their exposure
and define exactly what “soft costs” are covered and to what extent.
   

VIII.            
The Question
of Appraisals?

2.                 
Appraisal

If we and you disagree on the value of the property or the amount of
loss, either may make written demand for an appraisal of the loss.  In this event, each party will select a
competent and impartial appraiser.  The
two appraisers will select an umpire.  If
they cannot agree, either may request that selection be made by a judge of a
court having jurisdiction.  The
appraisers will state separately the value of the property and amount of
loss.  If they fail to agree, they will
submit their differences to the umpire. 
A decision agreed to by any two will be binding.  Each party will:

a.     
Pay its
chosen appraiser; and 

  

b.     
Bear the
other expenses of the appraisal and umpire equally.

If there is an appraisal, we will still retain our right to deny the
claim.

            No
court in the State of Texas
has examined the appraisal clause in a Builder’s Risk policy.  However, the Texas Supreme Court recently
upheld an appraisal clause in a homeowner’s policy in State Farm v. Johnson.[54]  The Johnson
case involved a claim of hail damage to the roof of the insured’s house.  State Farm’s inspector and the insured’s
contractor disagreed on whether the roof needed to be repaired or
replaced.  The insured, Johnson, demanded
appraisal of the “amount of loss” under the standard appraisal clause, similar
to that quoted above.  State Farm refused
to participate in the appraisal process asserting that the parties’ dispute
concerned causation and not the amount of the loss.[55]

Johnson filed suit seeking to
compel the appraisal. 

            The
Court granted State Farm’s petition to decide whether the dispute fell within
the scope of the policy’s appraisal clause. 
Historically, courts held that the scope of an appraisal clause is
limited to damages, not liability – although the line between the two is not
always clear.[56]  According to the Court in Johnson, even when
the parties’ dispute involves causation, there is not necessarily a question of
liability vs. damages because causation can relate to both, relying primarily
on Lundstrom v. United Services
Automobile Ass’n.[57]   The Johnson Court wrote:

If State Farm is correct that
appraisers can never allocate damages between covered and excluded perils, then
appraisals can never assess hail damage unless a roof is brand new.  That would render appraisal clauses largely
inoperative, a construction we must avoid.

IX.               
Subrogation & Waiver

    Here is part of a typical waiver clause, although, of course, not the only one: “Notwithstanding any other provisions contained in this Contract, the Owner and the Contractor each waives all rights against each other and any of their agents and/or employees, each of the other, from damages caused by fire or other perils to the extent to the extent covered by property insurance obtained pursuant to this Contract or other property insurance applicable to the Work. . . .” Why the clause proceeds in terms of “fire or other perils” is a mystery to me; “all perils covered by” would work just fine.
In recent years, one of the principal issues in this sort of insurance litigation is whether the waiver covered only property damages (physical injury to tangible property) directly connected to the “Work,” i.e., that which was established by the terms of the contract as that which the contractor was to do.  Naturally, the builder’s risk insurer wants the waiver to be as narrow and restricted as possible. 
The courts are going the other way.  Although they are reasoning not explicitly as follows, here is the basic idea.  The policies are perfectly clear that the waiver extends to all property insurance policies any part of which is applicable to the “Work” however that meaning of that term is sketched in the policy.  If a policy is applicable to any extent and it covers the loss in dispute, the waiver applies. American Zurich Insurance Company v. Barker Roofing, L.P., 387 S.W.3d 54 (Tex. App–Amarillo 2012, no pet.). (The abbreviation “no pet.” means that the party that lost in the Court of Appeals did not appeal to the Texas Supreme Court.) See Security National Insurance Company, v. Briohn Building Corporation, 2012 WL 5439017 ()(Judge Stadtmueller being more sympathetic to the insurer’s point of view, but regards himself as being controlled by clear Wisconsin law.) 
    The Barker Roofing illustrates the reach of the courts’ positions.  It explicitly says that business interruption is within the waiver.  The reason is that BI claims are inherently connected to property damage.  For that court, this connection was enough, and the court was right.
    The position reflected in these two cases will be the controlling law until the standard construction contracts change their waiver clauses, and this is not likely to happen any time soon. The result in these two cases is–and has been for a long time–so obvious, it is hard to see why insurers are contesting it. 
Same Insurer. At least under many circumstances, all of the parties participating in
the covered project are insured by the came carrier. 
Therefore, there would be no reason for subrogation.  However, with different circumstances, where
fault could be placed upon a party not involved in the project, there is no
reason to believe that a Builder’s Risk insurer would not have the right to
subrogation, barring some statutory or common law exclusion of such subrogation
cases.[58]
On final point on the matter of waiver should be mentioned.  Usually, these subrogation case not an insurance company against an ordinary person.  Usually it is a property insurer against another carrier–a liability carrier for the named defendant.  

X.       Valued Policy Statutes

Many states,
including Texas,
have what’s called “Valued Policy” statutes.[59]  These statutes typically apply to fire
policies and provide that when a total loss is decided, the insurer is required
to pay its policy limits to the insured. 
There are very few opinions addressing similar statutes and Builder’s
Risk insurance.  However, on at least two
occasions, courts have held that Builder’s Risk policies are exempt from these
statutes.[60]

XI.        Conclusion

            This paper began with a story.  The story was designed to make it appear as
though the event happened in or around Jefferson County in Texas.  They well could have since Builder’s Risk
insurance policies are roughly the same all over the country.  It was also designed to express our puzzlement
over property owners not being able to obtain first-party property insurance
for their property when general contractors injure their property.  They can, of course, sue the contractor for negligence,
but it cannot obtain liability insurance for its own negligence, although it
can sue a subcontractor, and may have liability insurance for its negligence in
not having sufficiently looked out for or carefully supervised the
subcontractor, assuming he, she, or it was guilty of negligence.

            Our attitude here is not just
puzzlement.  It is disagreement.  We think there should be coverage available
for this sort of thing.  There is no
reason it should not be available, and there are good reasons it should be
available. The case which provides the basis of the story is a California
case.  It is Roberts v. Assurance Company of America, a paradoxical name for
this particular insurance company, as a trip through the last several years of
WestLaw cases will show you, and the case may be found at 78 Cal.Rptr.3d 361 (Cal.App. 2008).

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