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May 11.2009

“That Particular Part” Shouldn’t Be That Confusing

by David Smith

Construction defect coverage litigation has been declining over the years.  The building booms of the late 80s and 90s resulted in a boom of construction defect litigation too.  Coinciding nicely with the introduction of the 1986 ISO form policy with new wording, insurers found themselves paying for a lot of defective construction claims.  Since then, coverage for construction has gotten harder to get, and a lot narrower.  Insurers tightened down by introducing new – and more restrictive – versions of additional insured endorsements, by adding very restrictive versions of “Montrose” endorsements, and by ultimately by refusing to sell insurance to many contractors.

This decline in construction defect coverage litigation is probably due to both the end of the building boom, and also the fact that many of the issues have now been litigated all the way up to the top courts.  Therefore many of the once disputed issues are decided:  the scope of completed operations coverage; the meaning of “your work;” the alienated premises exclusions, and so on.  But it was somewhat surprising (to me at least) that some carriers are now disputing the meaning of “that particular part,” as that phrase is used in exclusions J(5) and J(6) of the current ISO CGL policy.  And interestingly, there are relatively few published court opinions across the nation that have interpreted these exclusions.
These exclusions are generally thought of as the “faulty workmanship” or “business risk exclusions,” and in the current version of the standard ISO CLG policy read:

Property damage to:

J(5)  That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations;

J(6)  That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.

The term “your work” is defined to include work or operations performed by you or on your behalf (thus, work done by subcontractors “becomes” the work of the general contractor) for the purposes of these exclusions.

The intention of these exclusions is to exclude coverage for defective work because of the moral hazard of doing so (coverage would encourage sloppy workmanship because the carriers would have to pay to put it right).  However, because these exclusions are restricted to the damage to “that particular part” of the property that needs correction because of the defective work, they do not apply to consequential damage to other parts of the same project which are not defective.

Text books published by the American Institute for Chartered Property Casualty Underwriters (the very books that CPCU’s1  all over the country learn from) make this abundantly clear.  In its discussion of exclusion J(5), one text notes:

The reference to “that particular part” is important.  No coverage applies to “that particular part” of real property damaged while work is being performed on it.  But, by inference, coverage does apply for damage to any other part of the property besides “that particular part,” as long as it is not otherwise excluded.”

Malecki, Horn, Wiening & Flitner, Commercial General Liability Insurance Vol. 1 (Third Edition, AICPCU 1995 ) at 95 (emphasis is original).  The text goes on to give an example of a contractor erecting a steel frame building, and by accident a beam falls from the hoisting crane, damaging other parts of the framework that had already been constructed.  The text instructs that the contractor’s CGL policy “would cover the damage to the property damaged by the beam that fell.  The property damaged by the beam was not ‘that particular part’ of real property being worked on at the time of the accident.”  Id.

A recent Texas case highlights the basic misunderstandings that the carriers are making with respect to these exclusions.  In Mid-Continent Casualty Co. v. JHP Development, Inc., 557 F.3d 207 (2009), a contractor (JHP) partially built a condominium project, finishing the foundations, walls, roofs, windows and doors.  The contract called for work to stop at that point, and only be finished as the individual condos were sold by the developer.  Still to be done was painting, flooring, plumbing and electrical fixtures, and activation of the HVAC system.  However, several months later, water intrusion problems became apparent, causing damage to interior drywall, stud framing, electrical wiring and wood flooring.  JHP’s insurer, Mid-Continent, denied the claim.

In the subsequent declaratory relief action and the appeal that followed, Mid-Continent argued (among other things) that exclusions J(5) and (6) applied.  The appellate court held that J(5) was inapplicable as it only applies to ongoing operations, and because all work had stopped at the project for a prolonged period of time, no operations were ongoing.  557 F.3d at 211-12.

The court also held that the “that particular part” language of exclusion J(6) meant that it too did not apply to the claim.  The court explained that “the plain meaning of the exclusion . . . is that property damage only to parts of the property that were themselves the subjects of the defective work is excluded.”  Id. at 214-15.  The court also noted that if insurers had wanted to exclude all damage to a project caused by any defective work in that project, they could easily have written the words to do so.

Distinguishing other cases interpreting exclusions “that bear some resemblance to exclusion J(6)” as a bar to coverage, the JHP court noted that in those cases the exclusionary language was different.  The court also criticized a decision by the South Carolina Supreme Court which had barred recovery for a similar claim because it said the CGL policy was not designed to insure business risks.  Citing the Texas Supreme Court, the JHP court noted that “‘such preconceived notion[s] . . . must yield to the policy’s actual language,’ and that ‘coverage for business risks depends, as it always has, on the policy’s language . . .’”  Id. at 216-17 (citation omitted).

Given the CPCU texts’ clarity, the thoughtful and intelligent analysis by some courts, and the clear view of such insurance coverage experts as IRMI (the International Risk Management Institute)2, that these exclusions do not bar coverage for non-defective work that is damaged because of defective work, it is surprising that some carriers are continuing to argue to the contrary.

1 The CPCU designation is the insurance industry’s highest accreditation – the equivalent of the CPA designation in the accounting world.

2 See, e.g., Wielinski, Insurance for Defective Construction (Second Edition, IRMI 2005) at 183, and 191-93; Wielinski and Gibson, Broad Form Property Damage Coverage (Third Edition, IRMI 1992) at 69.

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