Ohio Supreme Court Appears to Eliminate Coverage for Consequential Damages Caused by Defective Work
Two recent decisions of the Supreme Court of Ohio appear to have eliminated coverage under commercial general liability (CGL) policies for consequential damages caused by defective work on a construction project, even if inadvertent. For many years, it has been generally understood that a CGL policy does not provide coverage for the costs to correct defective work itself. That is, if a wall is built incorrectly, the contractor or subcontractor bears the cost to repair or replace it, not a CGL policy. However, it also had been generally understood that coverage often did exist for damages caused by the defective work to something or someone else, i.e. for “consequential damages” caused by the defective work. So, if the defective wall fell and damaged something else, the CGL policy would likely cover that cost. The Court’s recent decisions, however, lead to the conclusion that no coverage for consequential damages exists if they result from defective work.
In 2012, the Ohio Supreme Court considered whether claims for defective construction brought by an owner for property damage caused by a contractor’s faulty work are claims for “property damage” caused an “occurrence” under a CGL policy. In Westfield Insurance, Inc. v. Custom Agri, the owner sued its contractor for faulty construction of a steel grain bin. In turn, the contractor filed a third-party complaint against the subcontractor that built the grain bin. The subcontractor sought coverage under its CGL policy to defend and indemnify it in the litigation. The CGL policy covered any property damage that was caused by an occurrence, which was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”
The Court stated that the ordinary meaning of “accident” in the context of a CGL policy involves “fortuity,” and it determined that “claims for faulty workmanship, such as the one in the present case, are not fortuitous.” The Court, therefore, found that “[c]laims of defective construction or workmanship brought by a property owner are not claims for ‘property damage’ caused by an ‘occurrence’ under a [CGL] policy” and held the CGL policy did not provide coverage for the alleged defective construction of and workmanship on the steel grain bin.
This past year, in Ohio Northern University v. Charles Construction Services, Inc., the Court addressed the same issue in the context of whether a general contractor’s CGL policy covers claims for property damage caused by a subcontractor’s faulty work. In 2008, Ohio Northern University (ONU) engaged a contractor to build a luxury hotel and conference center on ONU’s campus. The estimated cost of the project was $8 million. The contractor obtained a CGL policy from Cincinnati Insurance Company (CIC) that included a products-completed operations-hazard (PCOH) clause, which covered damages “arising out of completed operations.” Like the CGL policy in Custom Agri, the policy defined occurrence as an “accident including continuous or repeated exposure to substantially the same general harmful conditions.” After the project was completed, ONU discovered extensive water damage from hidden leaks in the hotel that it believed were caused by the contractor and its subcontractors. While repairing the water damage, ONU found other structural defects on the property. It estimated the total repair costs at approximately $6 million.
In October 2012, ONU filed a complaint in common pleas court against the contractor for breach of contract related to the hotel’s damage. The contractor filed third-party complaints against several of its subcontractors and asked CIC to defend and indemnify it against any damages. CIC intervened in the lawsuit and asked the trial court to issue a judgment declaring that it had no duty to defend the contractor. The trial court held that CIC had no duty to defend the contractor based on the Custom Agri decision.
The Third District Court of Appeals reversed, however, and concluded that the CGL policy was ambiguous as to whether it covered claims for property damage caused by subcontractors’ defective work. It then construed the ambiguous language in favor of the contractor and remanded the matter to the trial court for further proceedings. CIC appealed.
The Ohio Supreme Court reinstated the trial court’s judgment, expanded Custom Agri and held that CIC had not been required to defend the contractor against ONU or indemnify it against any damages because “property damage caused by a subcontractor’s faulty work is not fortuitous and does not meet the definition of an ‘occurrence’ under a CGL policy.” The Court stated, “[b]y its terms, the CGL policy emphasizes that only ‘an occurrence’ can trigger coverage for property damage,” and that an occurrence is “defined as ‘an accident, including continuous or repeated exposure to substantially the same general harmful conditions.’”
Regarding the PCOH and subcontractor language contained in the CGL policy, the Court noted that
[i]f the subcontractors’ faulty work were fortuitous, the PCOH and subcontractor-specific terms would require coverage. But as we explained in Custom Agri, CGL policies are not intended to protect owners from ordinary ‘business risks’ that are normal, frequent or predictable consequences of doing business that the insured can manage . . . Here, we cannot say that the subcontractors’ faulty work was fortuitous.
Thus, the PCOH and subcontractor language in the contractor’s CGL policy “has no effect, despite the fact that [the contractor] had paid additional money for it.” The Court recognized its decision is contrary to those reached by multiple other state and federal courts addressing the same issue, but disregarded those holdings. The Court concluded by suggesting that Ohio’s legislature could change this result if it wished.
So, what do these two decisions mean for owners, contractors and subcontractors? Essentially, unless the Ohio legislature passes legislation requiring a different result, owners, contractors and subcontractors cannot rely on CGL policies to provide defense and indemnity for claims arising from defective work, including claims for consequential damages caused by the defective work. While Westfield and Ohio Northern do not address the consequential damages issue directly, the expected result flows logically from the decisions: If no occurrence exists under a CGL policy when defective work happens, then, by definition, no coverage exists under the policy regardless of whether the claim is for the cost to repair or replace the defective work itself or to cure other damages caused by the defective work. This leads to significant uninsured liabilities for owners, contractors, and subcontractors.
Faced with these developments, what should owners, contractors, and subcontractors do? First, consult with your insurance professional to discuss these developments and ensure you have a clear understanding of your coverage in such situations. Second, determine if additional coverages are available for consequential damages arising from defective work. Consider whether those should be contractually required of others or simply obtained by you as a prudent measure. Third, and most obviously, do everything you can to avoid or at least minimize defective work and the damages that can result from it. If something is wrong, deal with it as soon as you learn of it to avoid a land mine down the road. Fourth, if you are faced with a claim for consequential damages arising from defective work (either yours or another’s), consult with your legal counsel and insurance professional to determine how best to position yourself to maximize your coverage.
Disclaimer: The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.