CONSTRUCTION BUSINESS HANDBOOK Chapter 3: PIRATES, ROVERS, AND BUILDERS RISKS: SEABORNE COVERAGE LESSONS FOR SHORE-BASED CONSTRUCTION PROJECTS

Construction Law Library

ASPEN Publishers REPRINTED WITH PERMISSION BY ASPEN PUBLISHERS, INC.

CHAPTER 3

PIRATES, ROVERS, AND BUILDERS RISKS: SEABORNE COVERAGE LESSONS FOR SHORE-BASED CONSTRUCTION PROJECTS Edmund M. Kneisel Brian K. Epps Brandon T. Grinsted § 3.01

Introduction

§ 3.02

Review of Key Policy Clauses

§ 3.03

Lesson No. 1: Proof of Consequential, Resulting Damage

§ 3.04

Lesson No. 2: Availability of Diminution in Value/Loss of Use Coverage

§ 3.05

Lesson No. 3: Extended Coverage for Post-Construction Damage [A] Maintenance Period Coverage [B] Delay in Start-Up Coverage

§ 3.06

Lesson No. 4: Coverage for Prevention/Mitigation of Loss (“Sue and Labor”) [A] Does Sue and Labor Coverage Apply to an Insured’s Efforts to Prevent an Insured Loss? [B] When Does the Threat of an Insured Peril Trigger Sue and Labor Coverage? [C] The Respective Interests of Insured and Insurer Are Considered in Allocating Sue and Labor Costs

§ 3.07

Conclusion

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§ 3.01

§ 3.01

INTRODUCTION

Insurance in the United States (and elsewhere) had its genesis in the work of the Lloyd’s underwriters in a coffee house in London, which eventually expanded into one of the largest (and best known) worldwide insurance markets. The original Lloyd’s underwriters were specialists in marine-based risks, insuring against losses faced by owners of vessels during ocean voyages, i.e., the “perils of the seas.” As the market grew, underwriters progressed beyond their original practice of issuing “slips” of coverage for ocean voyages, and began issuing a broad range of “cover notes” accompanied by policy forms offering coverage for a variety of non-marine based risks. While the London market has expanded dramatically, the underwriters’ core business of marine insurance has essentially remained unchanged. The marine-based roots of the London market are reflected by some of the policy forms that are still in use, which are interesting from an historical perspective, but contain rather arcane language of questionable relevance to twenty-first century risks. For instance, the 1979 American Institute “Hull Clauses” form defines the perils insured against as follows: Touching on the Adventures and Perils which the Underwriters are contented to bear and take upon themselves, they are of the Seas, Men-of-War, Fire, Lightning, Earthquake Enemies, Pirates, Rovers Assailing Thieves, Jettisons, Letters of Mart and Counter-Mart, Surprises, Takings at Sea, Arrests, Restraints, and Detainments of all Kings, Princes and Peoples. . . .

While some construction contractors may have experienced losses caused by fire, lighting, earthquake, and even “arrests” or “restraints” of government officials, a contractor engaged in shore-based construction might wonder what in the world does this arcane language have to do with me and the coverage I need for construction-related risks? Aside from cases addressing what is commonly known as the “Inchmaree Clause” in the American Institute Form, the answer probably is “not much.”1 However, the issue of coverage for consequential damage caused by latent construction defects or faulty workmanship (the subject of the Inchmaree Clause) is one of the most hotly debated and often disputed areas of shore-based construction insurance law. As a result, much can be learned by studying the

1

The clause, entitled “additional perils,” is named after one of the leading coverage cases in British marine insurance law, Thames and Mersey Marine Ins. Co. v. Hamilton Fraser and Co., [1887] 12 A.C. 484 (HL), in which underwriters had denied coverage for damages to a vessel (the Inchmaree) caused by a bursting boiler because the perils insured against did not include damage caused by defective parts. The “Inchmaree Clause” was added to the standard marine form expressly to provide coverage for “loss or damage to the Vessel directly caused by . . . [b]reakdown of motor generators or other electrical machinery and electrical connections thereto, bursting of boilers, breakage of shafts or any latent defect in the machinery or hull, (excluding the cost and expense of replacing or repairing the defective part). . . .” American Institute Form 65-C.

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application of consequential damages principles to claims under marine-based policies, especially coverage provided by marine builders risk policy forms. It did not take the Lloyd’s market long to expand beyond providing basic coverage for “perils of the seas” to also issue coverage for the risks of constructing vessels that become subject to those perils. Coverage for marine construction risks typically did not need to protect against loss by “pirates and rovers,” but the historical language used in marine builders risk forms is still rather awkward. For instance, the February 8, 1979 American Institute Builder’s Risk Clauses (hereinafter “American Institute Form”) provides as follows: The Subject Matter of this insurance (herein referred to as the Vessel) is the hull, launches, lifeboats, rafts, furniture bunkers, stores, tackle, fitting, equipment, apparatus, machinery, boilers, refrigeration machine insulation, motor generators and other electrical machinery . . . and appurtenances, including materials, plans, patterns and moulds, staging, scaffolding and similar temporary construction (to the extent) only that the cost of any of the foregoing is included in the Agreed Values incorporated in or allocated to [the vessel]. . . .

Stripped to its essentials, the London marine builders risk form, like the typical shore-based builders risk policy, covers the entire project, i.e., the construction of the vessel. Moreover, the American Institute Form provides “all risk” coverage, but is subject to a significant caveat, modeled in effect on the Inchmaree Clause, that excludes coverage for the cost of repairing a defective part: This Policy insures against all risks of physical loss of or damage to the Vessel occurring during the currency of this Policy, except as hereinafter provided. In the event that faulty design of any part or parts should cause physical loss of or damage to the Vessel, this insurance shall not cover the cost or expense of repairing, replacing or renewing such parts or parts, nor any expenditure incurred by reasons of betterment or alteration in design.

This language may seem somewhat familiar to contractors engaged in shore-based projects who purchase “all risks builders risk” (ARBR) coverage, sometimes referred to as “construction all risk” (CAR) coverage. Such policies are needed to provide protections against construction-related loss during the course of the work, because the contractor’s liability for property damage to the work that occurs before the project is complete usually will not be covered by the contractor’s commercial general liability (CGL) policy.2 Accordingly, review of

2

As noted below and as discussed at length by numerous commentators, CGL policies can be extended to include coverage for a variety of construction-related claims and occurrences if in fact negligent workmanship causes damage to other property of third parties or results in bodily injury. See infra § 3.03.

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§ 3.01

the authorities construing marine builders risk coverage for consequential damage to the “vessel” caused by the installation of defective parts may provide helpful lessons for the shore-based contractor faced with similar claims under an ARBR or CAR policy. Typically, however, neither an ARBR nor a marine policy will cover the cost of remedying negligence in design if the only damage is to the defective part itself and if there is no other “resulting,” consequential damage caused by that part. Similarly, like an ARBR policy, a marine form only insures against damage that occurs “at the yard of the builder” (at the construction site) and during the “currency of the policy” (during the policy term). The issue of the duration of coverage can create controversy under marine builders risk and ARBR policies, as both types of policies usually limit coverage to damage that occurs within the stated policy period. In addition, marine construction and ARBR policies often contain an alternative cut-off date for coverage measured by “completion” of the work or acceptance or sometimes even preliminary acceptance of the project. At that point, coverage under the project owner’s property and operational policies will commence and insure, subject to applicable exclusions, the risks of post-completion damage to the property. If that damage is caused by pre-existing “construction defects,” there also may be overlapping coverage under the owner’s property policy, the ARBR policy, and even the products-completed operations hazard (PCOH) coverage of the general contractor’s CGL policy. Questions regarding which of the policies apply and who is at fault (i.e., causation) can lead to protracted litigation or arbitration and significant and prolonged coverage disputes. As noted last year by one of the authors of this article, “perhaps no area of insurance law has created more controversy during the last twenty-five years than the question of coverage for ‘defective construction.’”3 As stated a few years ago by another commentator, there is a perception among insurance industry professionals that “the impact of construction defect

3 Edmund M. Kneisel and Betsy Cooke, The Products-Completed Operations Hazard: When Coverage Exists, Just What is Covered, 2009 Construction Law Update 161, 163 (Neal J. Sweeney ed., 2009) (hereinafter “What is Covered”). See also Edmund Kneisel and Elliot A. Fus, Liability Coverage for Defective Construction: The “No Occurrence Myth,” 2007 Construction Law Update 115, 125-27 (Neal J. Sweeney ed., 2007) (hereinafter “No Occurrence Myth”). The insurance industry commentary about such coverage typically uses language referring to “construction defects” or “defective construction.” This language is employed to support arguments against coverage, such as the “no occurrence” argument that is now commonly rejected by the courts, and the argument, perhaps derived from the Inchmaree Clause of the marine form, that absent consequential, resulting damage to “other property,” there can be no coverage for the repair or replacement of the “defective part” itself or to the “defective work” that caused the damage. But see Pozzi Window Co. v. Auto Owners’ Ins. Co., 984 S.E.2d. 1241 (Fla. 2008) (PCOH coverage applies to damage to the negligent construction work of an installation subcontractor, even if the damage is confined to that work).

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claims on coverage availability and affordability has reached crisis status.”4 However, any “crisis” flowing from the courts’ interpretations of policies covering losses arising from construction-related damage, especially coverage provided by the PCOH language typically included in standard CGL forms, arguably has been brought on by the industry itself, as part of its continuing efforts to sell an ever-broadening array of coverages to the construction industry.5 In reaction to the perceived construction insurance “crisis” and in response to judicial rulings applying the policy language (as written), carriers have added various exclusions to their CGL forms that bar or limit coverage, such as exclusions for “EFIS” (synthetic stucco) claims, mold claims, and other similar claims that have generated significant liabilities arising in some cases from class action lawsuits against homebuilders and other contractors. To minimize exposure to such claims, the Insurance Services Office (ISO) has issued a form of endorsement that significantly limits coverage under the standard PCOH clause by deleting the “subcontractor exception” to the exclusion for damage to “your work.” This exception, added to the standard CGL policy form in 1986, has been construed to insure a general contractor against liability as a result of property damage caused by the “defective” work of a subcontractor. One version of the ISO “subcontractor exclusion” reads as follows: EXCLUSION—DAMAGE TO WORK PERFORMED BY SUBCONTRACTORS ON YOUR BEHALF This endorsement modifies insurance provided under the following: COMMERCIAL GENERAL LIABILITY COVERAGE PART Exclusion I. of Section I—Coverage A—Bodily Injury And Property Damage Liability is replaced by the following: 2. Exclusions This insurance does not apply to: 4

Ann R. Hickman, Commentary, Construction Defect Crisis Produces Coverage-restricting Endorsements, International Risk Management Institute (2003), http://www.irmi.com/expert/ articles/2003/hickman08.aspx. 5 As recently ruled by the Texas Court of Appeals in Houston in allowing PCOH coverage for construction flaws, “ ‘We realize that under our holding a general contractor who contracts out all the work to subcontractors . . . can ensure complete coverage for faulty workmanship. However, it is not our holding that creates this result: it is the addition of the new [subcontractor exception] language to the policy. We have not made the policy closer to a performance bond for general contractors, the insurance industry has.’” Lennar Corp. v. Great Am. Ins. Co., 200 S.W.3d 651, 674 (Tex. App. 2007) (quoting Kalchthaler v. Keller Constr. Co., 591 N.W.2d 169 (Wis. Ct. App. 1999)), review denied sub nom., Markel Am. Ins. Co. v. Lennar Corp., 2007 Tex. LEXIS 1102 (Dec. 14, 2007). See also Edmund M. Kneisel and Jeffrey A. Hannah, Insurance for Financial Loss Caused by Defective Construction: Loss of Use and Diminution of Value as Covered Property Damage, 2001 Construction Law Update 213-23 (Neal J. Sweeney ed., 2001) (hereinafter “Diminution in Value”) (discussing evolution of CGL form coverages for construction liability risks).

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§ 3.01

I. Damage To Your Work “Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

The elimination of the “subcontractor exception” language significantly narrows the scope of coverage available under the PCOH provisions of the standard CGL policy.6 While new policy exclusions or limitations may limit the scope of coverage provided by a contractor’s CGL policies, similar exclusions have not been incorporated in marine builders risk or ARBR forms. As a result, increasing numbers of contractors must request that their brokers/agents look beyond the CGL market and attempt to obtain coverage for construction risks under ARBR or other specialty forms. In appropriate circumstances, such policies can be modified to extend coverage beyond the normal project “completion” date or occupancy cut off, thereby potentially providing significant protection against losses from post-completion property damage that is caused by pre-existing construction flaws. Such extended coverage, often referred to as “maintenance coverage,” may provide a meaningful substitute for the more limited PCOH liability insurance because post-completion property damage during the specified “maintenance” period that is caused by construction “defects” can be covered.7 While an exhaustive review and comparison of marine builders risk and ARBR policies is beyond the scope of this article, there are, as noted above, significant “lessons” to be learned by a comparison of the coverages provided by such policies and the authorities construing them. In this article, we will focus on some of the more important of those coverage lessons, including the following: •

Coverage for consequential, “resulting” damage caused by defective parts (or work);

•

Durational limits on coverage and the possibility of obtaining “extended,” maintenance period coverage for construction-related property damage;

6 The exception language eliminated by this exclusion reads as follows: “This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” See What is Covered, supra note 3. 7 Owners obviously want protection from the financial loss resulting from negligent construction work. The most obvious source of such protection is either the financial resources of the contractor itself (the reason for indemnity/warranty clauses in construction contracts) and/or the resources of a third party, solvent insurer (the reason for including related insurance clauses in construction contracts). As illustrated by the growth of Owner Controlled Insurance Programs (OCIPs), the source of the protection provided, whether the financial resources of the contractor or of an insurer, usually is irrelevant. Thus, especially in the case of project-related builders risk coverage, the project owner/developer and even the company providing project financing usually are named as co-insureds or additional insureds on the ARBR policy. Issues concerning OCIP coverage and questions of co-insured or additional insured coverage for owners, developers and contractors are beyond the scope of this article.

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•

Coverage for “diminution in value”/loss of use of the project; and

•

“Specialty” provisions, such as “sue and labor” clauses in marine forms or “delay in start-up” coverages in ARBR forms that may not expressly correspond with the same policy language in the other form, but that can provide a valuable coverage resource.

§ 3.02

REVIEW OF KEY POLICY CLAUSES

As discussed above, comparison of the American Institute Form8 and the typical, shore-based ARBR form may not reveal identical or perhaps even equivalent policy language. Nevertheless, there are enough similarities in the coverage provided that the authorities construing marine builders risk forms can provide useful guidance in seeking coverage under ARBR forms and vice versa. Both forms of policies protect against course of construction losses resulting from damage to the “vessel” or the “project” during the course of construction. Moreover, as reflected by the “defective parts” caveat to the “all risk” language of the traditional American Institute Form quoted above, a marine builders risk policy will not cover repair or replacement of the defective part itself or “betterment of design.” Similarly, an ARBR policy covering shore-based construction risks will also typically contain exclusions for claims limited to the cost of repairing defective parts. Such exclusions may be worded as follows: This Policy does not insure against: ... The cost of making good faulty or defective workmanship, material, construction, designs, plans and/or specifications, but this exclusion shall not apply to direct physical loss or direct physical damage resulting from such faulty or defective workmanship, material, construction, designs, plans and/or specifications.

Such exclusions will bar or at least limit coverage for damage caused by installing improperly designed or improperly manufactured parts; but the limitation on coverage for the cost of repairing the defects will not entirely bar coverage, if it can be shown, as discussed below, that failure of the defective part or parts caused consequential, “resulting” damage. Proof of such damage, including in some instances, significant financial exposure caused by loss of use of the vessel or plant, can trigger builders risk coverage in appropriate circumstances. 8 Recently, the London market has replaced or at least supplemented the traditional versions of the American Institute Form with an all-new WELCAR form. The evolution of the new form is attributable in large part to the need for coverage that expressly addresses the potentially huge financial and other unique risks regarding the billions of dollars being expended for offshore oil and gas exploration and extraction. See generally David Sharpe, Upstream and Offshore Energy Insurance 231-37 (2d ed. 2009).

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§ 3.02

The issue of whether or not a contractor (or project owner) is insured for consequential loss of use or diminution in value of the project also has generated considerable controversy and uncertainty regarding the scope of constructionrelated insurance coverage. Coverage for “loss of use” is a common, but often misunderstood and overlooked component of the definition of “property damage” in standard property or CGL policies. Such language can be a basis for obtaining coverage for the owner’s construction-related financial loss; or in the case of PCOH coverage, for the contractor’s risk of liability for such loss after the project is completed. However, the relevant language of the typical ARBR form differs and may be more restrictive. By contrast, the American Institute Form contains language that expressly covers diminution in value of the vessel caused by unrepaired or unrepairable damage attributable to flawed construction. The policy form is worded in the negative, but contains a positive grant of coverage for such losses: No claim for unrepaired damage shall be allowed, except to the extent that the aggregate damage insured against under the policy and left unrepaired at the expiration hereof shall be demonstrated by the Assured to have diminished the actual market value of the Vessel on that date if undamaged.

As discussed below, even if similar or equivalent language is not included in the ARBR form covering the shore-based project, the insured contractor should not overlook the possibility of triggering such coverage under the “loss of use” definition of property damage in its other policies.9 Also, assuming diminution of value/loss of use coverage is not available in the ARBR form, contractors should consider purchasing an alternative form of “economic loss”10 coverage for “delay in start-up.” Such coverage, which is similar to the “business interruption” coverage in an owner’s property policy, insures against the risk of financial loss resulting from a construction-related shut down or interruption that delays the start-up of the plant or occupancy of the facility, resulting in loss of income and profits from planned operations. Because delay in start-up coverage may overlap to some extent with the owner’s business interruption coverage, assuming the damage that causes the shutdown or partial shutdown/delay is construction-related, ARBR delay in start-up coverage can provide valuable, supplemental coverage that, in its effect, is somewhat similar to the “diminution in value” coverage included in the American Institute Form. Normally, however, the owner’s business interruption coverage will insure against 9

See Diminution in Value, supra note 5. Insurance carriers often contest extending coverage for financial risk, invoking the “economic loss” doctrine; however, that doctrine applies to “negligence” claims in tort cases, which in some jurisdictions cannot be based on economic (financial) loss alone absent some other, compensable damage. The doctrine should not apply to a contract-based claim for policy coverage, especially where the policy contains appropriate language and the loss arises out of a covered occurrence. See Diminution in Value, supra note 5 at 223-26. 10

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all post-construction occurrences, whether construction-related or not, whereas the ARBR delay in start-up coverage is only triggered by actual, constructionrelated physical damage that typically must occur during the construction period and delay the completion of the project. The duration of the builders risk coverage is another issue that can generate controversy between the policyholder, its ARBR carrier, and between the ARBR carrier and other carriers who insure the owner against post-completion property damage. Obtaining some form of extended builders risk coverage may be critical to the contractor’s financial well being because its available CGL coverage, and even the owner’s property insurance policy, may not cover damage caused by “faulty workmanship.” As a result, the contractor should consider purchasing a “maintenance” period extension of the ARBR coverage, if available. One form of such coverage, which is incorporated in the WELCAR marine builders risk form, protects the contractor when property damage occurs during the specified “maintenance period,” which may (and should) correspond with the warranty period specified in the construction contract. While the coverage provided is worded as “maintenance period” coverage, such coverage can include protections against damage caused either by negligent repair work undertaken to correct warranted flaws or by pre-existing construction flaws. The only requirement is that the damage at issue must occur during the specified maintenance period and be construction-related. Another important question of coverage derives from a long-established principle of English law that has been extended, in some cases, to U.S. policies including some forms of builders risk policies. “Sue and labor” clauses are commonly used and effectively mandated by English law to be incorporated in all forms of marine risks coverages, including marine builders risk. Such clauses require the insured to take appropriate action, when possible, to avert or minimize loss and in turn, obligate the carrier to reimburse the reasonable costs of taking appropriate preventive action. In relevant part, the sue and labor clause of the American Institute Form reads as follows: And in the case of any Loss or Misfortune, it shall be lawful and necessary for the Assured . . . to sue, labor and travel for, in and about the defense, safeguard and recovery of the Vessel or any part thereof, without prejudice to this insurance, to the charges whereof the Underwriters will contribute their proportion. . . .

As is the case regarding the other subjects of coverage highlighted in this article, there are “lessons” to be learned from the history, language, and case authority applying marine “sue and labor” principles that may be borrowed and applied in seeking coverage for shore-based construction losses.

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§ 3.03

§ 3.03

LESSON NO. 1: PROOF OF CONSEQUENTIAL, RESULTING DAMAGE

As discussed in the introduction, ARBR policies and their marine counterparts typically exclude coverage for the cost of replacing or repairing defective parts or faulty workmanship. However, these “faulty workmanship” exclusions do not bar coverage for the costs to repair resulting damage to non-defective property, including loss of use or diminution in value of the project as a whole. Regardless of the type of policy at issue, it is essential to distinguish between the “faulty workmanship” or “defective product” and the resulting damage. Accordingly, examining the significant overlap in the case law construing marine builders risk and CGL policies can provide valuable guidance in addressing these issues under ARBR policies. For example, in Trinity Industries, Inc. v. Insurance Co. of North America,11 the insured builder sought coverage under its marine builders risk policy for sums it paid to the owner of a vessel as a result of an arbitration concerning a “twist” in the vessel caused by the insured’s misalignment of hull sections during construction. The trial court ruled that the arbitration award was within coverage; however, the Fifth Circuit reversed based on its interpretation of the phrase “physical loss or damage,” which it interpreted as requiring that an external event change the insured property from an initial, satisfactory state to an unsatisfactory state. While the court recognized the unique scope of coverage in “all risks” policies, it noted that such coverage did not extend to the costs incurred in correcting defective workmanship, at least in cases in which the defective workmanship did not cause an accident resulting in physical injury to other insured property.12 Because the twist in the hull sections did not, in turn, lead to an accident, the court of appeals concluded that the arbitration costs were not covered because the policy did not cover costs associated with defective, initial construction. The Texas Court of Appeals reached the same conclusion in North American Shipbuilding, Inc. v. Southern Marine & Aviation Underwriting, Inc.,13 in which the insured sought coverage under a similar all risks marine policy for costs incurred in repairing faulty welds caused by improperly mixed welding gas. The court of appeals, relying heavily on the Fifth Circuit’s interpretation of “physical loss or damage” in Trinity, affirmed the trial court’s grant of summary judgment in favor of the insurer because the defective welds did not result in an accident

11

916 F.2d 267 (5th Cir. 1990) (applying Louisiana law). The court distinguished cases in which the resulting loss was caused by a “discrete event,” such as the collapse of a concrete dome or brick wall. See, e.g., Dow Chem. Co. v. Royal Indem. Co., 635 F.2d 379 (5th Cir. 1981) (collapse of concrete dome caused, in part, by defective construction of styrofoam form); Essex House v. St. Paul Fire & Marine Ins. Co., 404 F. Supp. 978 (S.D. Ohio 1975) (faulty workmanship led to partial collapse of brick wall). 13 930 S.W.2d 829 (Tex. App. 1996). 12

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causing physical injury to insured property. In reaching its decision, the court noted that “[n]either the welds North American replaced nor the twisted hull in Trinity were ever in ‘an initial satisfactory state that was changed by some external event into an unsatisfactory state.’”14 These cases arguably ignore the fact that a marine builders risk policy is supposed to cover negligent, faulty construction—not only the external “perils of the seas” that might cause damage to the vessel. More recent Texas cases addressing construction-related PCOH claims recognize a distinction between the cost of repair or replacing initial, “defective construction” and the cost of repairing consequential damage caused by the defective construction. For instance, in Lennar Corp. v. Great American Insurance Co.,15 the Texas Court of Appeals considered claims for coverage under the PCOH provision of a homebuilder’s CGL policy for liability claims arising out of the installation of defective EIFS (exterior insulation and finish system) siding in more than 400 homes. The insured homebuilder sought coverage for the repair of consequential water intrusion damage (wood rot, mold, damage to wallpaper, paint, carpet, etc.) as well as the cost of removing the defective EIFS siding and replacing it with “traditional” stucco siding. The court held that the costs associated with repairing the damages resulting from water intrusion were covered because the water intrusion had caused consequential, “physical damage” to the completed homes, triggering the PCOH coverage. However, the court concluded there was no coverage for the cost of replacing the defective EIFS absent evidence of actual physical damage to the siding or the homes caused by the siding. The court made the following observation: The carriers cite North American Shipbuilding, Inc. v. Southern Marine & Aviation Underwriting, Inc., in which the court held that the insured shipbuilder’s replacement of initially defective welds did not constitute “physical loss . . . or damage” as required for coverage under a builder’s risk policy. . . . The court stated that the defective welds were never in “an initial satisfactory state that was changed by some external event into an unsatisfactory state,” but instead came into existence in a damaged state. . . . [W]e agree with its reasoning at least with respect to its interpretation of “property damage” because it is consistent with the definition of “property damage” in the CGL policies, which requires “physical injury” to tangible property. See Fid. & Deposit Co. of Md. v. Hartford Cas. Ins. Co., 215 F. Supp. 2d 1171, 1183 (D. Kan. 2002). . . . Here, the EIFS was not physically injured after application to the homes; the EIFS was not changed from a satisfactory state into an unsatisfactory state, or otherwise physically altered. Rather, the EIFS

14 15

Id. at 833-34. Cited supra note 5.

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§ 3.03

was already in an unsatisfactory state when applied to the homes because it is inherently defective. Therefore, the defective EIFS does not constitute “property damage.”16

The majority of cases addressing construction-related damage claims (whether construing marine or shore-based ARBR policies) have held that the costs of repairing or replacing a defective part or faulty workmanship are not covered; however, courts will typically find coverage if the defective part or faulty workmanship causes consequential physical damage to other parts of the insured project (or “vessel”). The key issue in these disputes, regardless of the type of policy at issue, is identifying the line of demarcation between the defective part or faulty workmanship and the resulting damages. The ruling in Promet Engineering (Singapore) Pte. Ltd. v. Sturge and Others, (The “Nukila”)17 contains one of the more interesting and thorough discussions of this issue under U.K. marine insurance law. The Promet court addressed the issue of the scope of coverage for resulting damages caused by an inherent defect in the tubular “legs” of a mobile offshore oil platform installed in the Java Sea. Four years after installation, during a routine inspection, significant cracks were discovered between the tubular legs and the “spud cans” that anchored the legs to the seabed. The cracks were caused by defective welds. Because the cracks created a risk of collapse of the platform, the legs were jacked up and the platform towed to port for repairs. The owner claimed coverage under its marine policy, invoking the “Inchmaree” Clause covering damage to the platform caused by “latent” defects and the “sue and labour [sic]” clause of the policy.18 The trial court rejected the claim for physical damage to the platform, ruling that “neither the columns nor the spud can had separate functions; they were physically joined together by the welds supported by internal diaphragms and bulkheads to form one structure which enabled the platform to stand on the seabed; what happened here was that there were flaws in the weld which developed into cracks . . . it was impossible to see that at this stage anything

16

Id. at 679 (emphasis added). The outcome may differ in cases involving the negligent workmanship of a subcontractor that damages the completed “work” of the insured general contractor, including the negligently installed component, as opposed to the non-negligent installation of a defective “part,” such as the defective EFIS siding. See supra note 3 (discussing the Pozzi ruling). 17 [1997] 2 Lloyd’s Rep. 146 (C.A.). 18 The Inchmaree Clause, common in marine policies for more than 100 years, covers consequential damage to the “vessel” caused by a latent defect. See supra note 1. The policy at issue in Promet also contained an “additional perils” clause that covered damage to the “defective part” itself, if that part caused consequential damage covered by the Inchmaree Clause. Id. at 149. The combination of the “defective parts” clause and the defective parts “buyback” clause in the more recent WELCAR form operate in a similar fashion. Like the Inchmaree Clause, the defective parts clause also refers to consequential damage caused by a “latent” defect.

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consequential had happened which could be characterized as damage to the vessel. . . .”19 The insured appealed, and the court of appeals reached a different conclusion. Lord Justice Hobhouse provided the principal ruling of the court of appeals. Because defective welds had caused the fatigue cracks at issue, Justice Hobhouse had little difficulty in concluding that the defective welds were “latent,” i.e., unknown to the owner, and hence fortuitous: “The presence or absence of a latent defect in the hull or machinery of a vessel is, by definition, unknown to the assured and whether or not . . . such a defect . . . will during a given period of time . . . cause any damage is fortuitous from the point of view of the assured.”20 He then concluded that the progression of the fatigue cracks, caused by the defective welds, constituted consequential damage to the “vessel” that triggered coverage: At the commencement of the period of cover there was a latent defect in the welds joining the underside of the top plate of each spud can to the external surface of the leg tube. By that time that latent defect had also given rise to minute fatigue cracks in the surface of the tube in the way of the weld which could also properly be described as latent defects. Those features during the period of cover caused extensive fractures in the full thickness of the tube extending in places both above and below the defective weld, extensive fractures in the metal of the top plating and bulkheads of the spud cans and other fractures at other locations. This was on any ordinary use of language damage to the subject-matter insured, the hull etc. of Nukila.21

The court of appeals acknowledged that the insured must show a “physical change in the condition of the vessel” caused by the latent defect, however, the court rejected the proposition that the leg assembly as a whole was a “defective part,” concluding instead that the leg assembly was part of the hull that had been damaged by the latently defective welds. In the United States, the issue of coverage for resulting damages caused by construction flaws often arises in policies that exclude coverage for the “cost of makinggoodfaultyordefectiveworkmanship,materials,constructionordesign. . . .” Such exclusions usually contain an exception allowing coverage for “damage resulting from such faulty or defective workmanship, material, construction or design.” The intent of these provisions is to reaffirm the distinction between the 19

Id. at 147. Id. at 151. 21 Id. at 152. Justice Hobhouse questioned whether or not it was necessary, for coverage purposes, to identify a discrete, latently defective “part” that damaged another non-defective part. He concluded that if such a finding were necessary, the weld itself qualified as a “part”: “The weld is a part just as much as is a bracket or bulkhead or plate or the totality of the leg structure.” Id. at 156. Concurring Lord Justice Ward agreed that it was not necessary or required by the policy to determine whether or not a discrete, identifiable “part” had caused the damage, so long as the damage at issue had been caused by a latent defect. Id. at 160. 20

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§ 3.03

cost to repair or replace defective parts that were never in a “satisfactory state,” which is not typically covered, from the costs incurred in repairing resulting or “ensuing loss” damage to non-defective property caused by the defective part, which is covered.22 For instance, in Laquila Construction, Inc. v. Traveler’s Indemnity Co.,23 the insured contracted to provide concrete of a certain minimum strength for construction of a new building. Construction on the project was halted after it was discovered that the concrete was below the required minimum strength. Some of the work that was previously completed had to be removed and later reinstalled in order to remove and replace the defective concrete slab on the fifth floor. The insured made a claim under its ARBR policy for the costs of repairing the slab as well as the costs of shoring the height of the building while the corrective work took place. The insurer denied coverage based on the following exclusion: 1. PERILS EXCLUDED ... (b) Cost of making good faulty or defective workmanship or material, but this exclusion shall not apply to physical damage resulting from such faulty or defective workmanship or material.24

The insured argued that the “resulting loss” provision covered the costs associated with the removal and reinstallation of the additional building materials because, according to the insured, the defective concrete “physically damaged the insured property (the structural slab and/or the building as a whole) because it was physically incorporated into the larger entity and could only be removed at a cost.”25 The court disagreed, finding that the mere removal of the defective concrete slab did not constitute physical loss or damage to covered property. Importantly, the court noted that, had the defective concrete collapsed and damaged other, non-defective property, those losses would qualify as covered ensuing losses under the policy. As discussed in the concluding sections of this article, the outcome might have differed if the policy had contained a “sue and labor” clause covering loss prevention costs. A similar result was reached in Allianz Insurance Co. v. Impero,26 in which the insured sought coverage under its ARBR policy for the cost of repairing voids in a concrete wall which were caused by a subcontractor’s failure to perform 22

All-risk policies that refer to “resulting” loss or damage are functionally equivalent to policies referring to “ensuing” loss or damages. See, e.g., Continental Cas. Co. v. Landmark Hotels, LLC, 184 F. App’x 649, 650 (9th Cir. 2006) (noting that resulting loss provision operated precisely like ensuing loss provision); Wright v. Safeco Ins. Co. of Am., 109 P.3d 1, 7 (Wash. Ct. App. 2004) (holding that “ensuing loss provisions are exceptions to policy exclusions . . .”). 23 66 F. Supp. 2d 543 (S.D.N.Y. 1999), aff’d, 216 F.3d 1072 (2d Cir. 2000). 24 Id. at 544 (emphasis added). 25 Id. at 545. 26 654 F. Supp. 16 (E.D. Wash. 1986).

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appropriate “slump” tests on the concrete mixture. The faulty workmanship exclusion at issue eliminated coverage for the “[c]ost of making good faulty or defective workmanship, material, construction or design, but this exclusion shall not apply to the damage resulting from such faulty or defective workmanship, material, construction or design. . . .”27 Because the defective concrete in the walls did not cause any damage to any other portion of the structure or property, the court held that the loss was not covered. The court explained that, “when a contractor assumes the obligation of completing a structure in accordance with plans and specifications and fails to perform properly, he cannot recover under the all-risk policy for the cost of making good his faulty work.”28 As in Laquila, the court noted that a different result may have been reached if the wall had collapsed and caused damage to other portions of the project or equipment.29 Likewise, in Vermont Electric Power Co. v. Hartford Steam Boiler Inspection & Insurance Co.,30 the insured sought coverage under its all risks policy for damages to transformers caused by a design defect. The policy at issue contained the following exclusion: This policy does not insure against loss caused by any of the following. However, any ensuing loss not excluded or excepted in this policy is covered. C. Faulty, inadequate, or defective: ... (2) design, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction . . . of part or all of any property, on or off the described premises.31

The insured argued that coverage should be allowed because the design defect had caused “ensuing loss” damages to the transformers.32 The court rejected this argument: This case presents precisely the type of situation in which the loss is directly related to the original excluded risk. Characterizing the damage to the transformers as an ensuing loss would supersede Continental’s exception for losses caused by design defect. As Continental’s policy unambiguously excludes coverage for such losses, Continental’s motion for summary judgment is granted.33 27

Id. at 17. Id. at 18. 29 Id. See also GTE Corp. v. Allendale Mut. Ins. Co., 372 F.3d 598, 605 (3d Cir. 2004) (court ruled that “cost of making good” exclusion in an all-risks policy applied to costs incurred in redesigning computer equipment to avoid Y2K issue because there was no allegation that design flaw caused damage to other property). 30 72 F. Supp. 2d 441 (D. Vt. 1999). 31 Id. at 445. 32 Id. 33 Id. 28

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Laquila, Impero, and Hartford Steam hold that an insured will not be able to recover the costs incurred in repairing defective parts or workmanship absent evidence of actual property damage that can be characterized as a resulting or “ensuing” loss. Careful review of policy language and case authority is important, however, as some courts have recognized that damage to a non-defective part or product caused by the negligent installation of that product can be covered.34 Moreover, if the defective part or faulty workmanship causes consequential damage to other property, most courts hold that the insured may recover all the costs associated with the resulting damage, including, in some cases, the costs of remedying the cause of the loss. For example, in National Fire Insurance Co. v. Valero Energy Corp.,35 the Texas Court of Appeals held that an exception in the ARBR policy for damages “arising as a consequence” of faulty workmanship covered a loss resulting from the use of inadequately designed machine components. During the testing phase of an oil refinery expansion project, a citrate scrubber sustained substantial damage because of a faulty design. As a consequence, the insured had to shut down the refinery to make repairs and alterations. The ARBR policy at issue excluded the cost of making good faulty workmanship, materials, construction or design, but excepted from the exclusion “physical loss or damage arising as a consequence of faulty workmanship, material, construction or design.”36 The court reasoned that the loss at issue could be characterized in one of two ways: (1) the use of inadequate components required the insured to replace them to “make good” the faulty design; or (2) as a consequence of the faulty design and the inadequacy of the components, there was physical damage to the components necessitating their replacement. Adopting a reasonable construction of the exclusionary clause favoring the insured, the court concluded that the loss had occurred “as a consequence of” the faulty design, thereby bringing the loss within the scope of coverage. Similarly, in Rosenberg v. First State Insurance Co.,37 the insured obtained an ARBR policy for a commercial building under construction. The policy covered lost rents due to “untenantability, caused by damage to or destruction of the building . . . by the peril(s) insured against during the term of this policy.”38 In addition, the policy contained the standard form of exclusion for “making good faulty or defective workmanship” with the exception for “damage resulting from such faulty or defective workmanship. . . .”39 The insureds did not complete the building on schedule due to damage resulting from the premature removal of

34

See supra note 3 (discussing Pozzi ruling), and cases discussed in the No Occurrence Myth article. 35 777 S.W.2d 501 (Tex. App. 1989). 36 Id. at 505 (emphasis added). 37 280 Cal. Rptr. 388 (Ct. App. 1991) (unpublished decision). 38 Id. at 390. 39 Id. at 389.

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“shoring” used in the construction of the subterranean garage which caused sloping, cracks, and water accumulation. The insurer argued that faulty workmanship was an excluded peril, barring coverage for the claimed lost rents; but the California Court of Appeal disagreed: To the contrary, the phrase stating this exclusion goes on to clarify that “this exclusion shall not apply to damage resulting from such faulty or defective workmanship, material, construction or design.” Because damage resulting from defective workmanship is expressly covered by the policy, the conclusion is inescapable that faulty workmanship is a covered peril.40

Valero and Rosenberg illustrate that resulting damages to other property caused by a defective part or faulty workmanship is an insured loss, notwithstanding the fact that the cost of repairing or replacing the defective workmanship or defective part itself may be excluded. As previously noted, the central issue in such cases is the line of demarcation between the defective workmanship or part and proof of resulting consequential (or ensuing) damages. As discussed below, the application of the faulty workmanship exclusion and the necessary distinction between the defective part or faulty workmanship and the resulting damages also is extremely important in determining whether “resulting” loss of use or diminution in value of the project as a whole is covered. § 3.04

LESSON NO. 2: AVAILABILITY OF DIMINUTION IN VALUE/LOSS OF USE COVERAGE

While ARBR policies and their marine counterparts typically exclude coverage for the costs of repairing or replacing defective parts and faulty workmanship, it is not a foregone conclusion that such policies will categorically exclude resulting diminution in value or loss of use of the project as a whole. As noted above, the American Institute Form of marine builders risk coverage expressly covers the diminution of the “actual market value of the vessel” caused by unrepaired (or unrepairable) damage. Another form of “Institute Clauses for Builders’ Risks” contains even clearer language: UNREPAIRED DAMAGE 11.l The measure of indemnity in respect of claims for unrepaired damage shall be the reasonable depreciation in the market value of the Vessel at the time this insurance terminates arising from such unrepaired damage, but not exceeding the reasonable cost of repairs.

WELCAR Policy (Institute Clauses for Builders’ Risks).

40

Id. at 392.

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Regardless of whether the particular policy provides coverage for resulting diminution in value and/or loss of use, one must pay particular attention to the cause of the resulting damage and determine whether such losses were attributable to an excluded event or peril, such as faulty workmanship,41 or whether, as discussed above, an “ensuing” or “resulting” loss exception applies.42 Moreover, CGL policies and other types of policies, such as professional liability policies that expressly cover design-related construction flaws or “construction management” errors and omissions, usually define covered “property damage” to include “loss of use” of undamaged property as an insured risk.43 The language of ARBR policies may differ, however, such policies often limit coverage to actual physical damage. As a result, if the loss of use or diminution in value occurs solely because of the incorporation of a defective component, without any consequential physical damage to non-defective parts, then the resulting losses probably are not covered under the all risk policy, assuming the standard exclusion for the repair of defective parts applies.44 In other words, under the wording of many, if not most ARBR policies, the insured must show some tangible evidence of actual, physical damage to the insured property to trigger the policy coverage.45 However, if the “your work” exclusions in the contractor’s CGL policy can be avoided, the CGL policy can provide liability coverage (in the case of a claim by the owner) for loss of use/diminution in value that is broader than the coverage available under the ARBR policy. 41 See generally State Farm Fire & Cas. v. Superior Court, 264 Cal. Rptr. 269 (Ct. App. 1989) (ruling that insured’s claim for diminution in value of condominium complex was excluded under the terms of an all-risk property policy because it was directly caused by faulty workmanship, which was an excluded peril). 42 See Laquila, supra, 66 F. Supp. 2d at 546; Impero, supra, 654 F. Supp. at 18. 43 See Hartford Cas. Co. v. Cruse, 938 F.2d 601, 604 (5th Cir. 1991) (applying Texas law) (court concluded that the exclusion at issue only barred recovery of the costs of repairing the faulty foundation, but “does not apply to the diminution in the value of the Cruse’s home that remained after correction of [the] faulty work, and to repair costs for other property . . . to the extent that these particular items of damage require repair other than to the foundation itself”) (emphasis added); see also Riley Stoker Corp. v. Fid. & Guar. Ins. Underwriters, Inc., 26 F.3d 581, 588 (5th Cir. 1994) (applying Louisiana law) (court concluded that the work/product “business risks” exclusions in the CGL policy at issue barred recovery of the costs of repairing the defective mills and the steam generators, but allowed recovery for “delays caused by the mechanical failures,” rejecting the carrier’s arguments that because recovery for the physical property damage was barred, “the loss of use caused by the [excluded] physical injury must also be excluded”); accord Hartzell Indus., Inc. v. Fed. Ins. Co., 168 F. Supp. 2d 789, 794-96 (S.D. Ohio 2001) (court found that temporary loss of use of boiler room resulting from incorporation of defective fans installed by insured was covered under a CGL policy); Diminution in Value, supra note 5. 44 See North American, 930 S.W. 2d 829, and Trinity, 916 F.2d 26, supra. 45 Some courts considering coverage under CGL policies have held that incorporation of a defective component or faulty workmanship constitutes an immediate “physical injury to tangible property” and have allowed coverage for resulting decreases in the value of the property. See, e.g., Hauenstein v. St. Paul-Mercury Indem. Co., 65 N.W.2d 122, 124 (Minn. 1954) (ruling that use or application of defective plaster on building constituted injury to covered property).

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For example, in Todd Shipyards Corp. v. Turbine Service, Inc.,46 the court determined that the “injury to work” exclusion47 in the CGL policy at issue excluded the cost of repairing or replacing the insured’s work product, which was found to have been a defective turbine, but it did not apply to the “overall damage that the incorporation of the defective work product causes to the entire [vessel].”48 As a result, the court concluded that the costs associated with the loss of use of the vessel were covered. In such a case, unless the “faulty workmanship” and/or “design defect” exclusion expressly bars coverage for the resulting diminution in value or damage to non-defective parts, it can be argued that such damages are covered, assuming there is evidence of “physical injury or damage” to other property. The argument for protection against claims for diminution in value is strongest under policies that define insured “property damage” to include “loss of use of tangible property.” Nevertheless, the reasoning employed in CGL and marine builders risk cases allowing coverage for loss of use or diminution in value may be useful in seeking coverage for this additional element of loss, if caused by construction-related physical damage covered by an ARBR policy. § 3.05

LESSON NO. 3: EXTENDED COVERAGE FOR POST-CONSTRUCTION DAMAGE

[A] Maintenance Period Coverage Because post-construction damage caused by “faulty workmanship” may not be covered by a contractor’s CGL policy, obtaining some form of extended, post-completion ARBR coverage may be critical. A good example of extended maintenance coverage is provided by the WELCAR 2001 Offshore Construction Project Policy, which reads as follows: 18.

MAINTENANCE

The cover provided hereunder shall be no wider than that contained elsewhere in the Policy. Coverage under Section I [i.e. Physical Damage Insurance] only shall continue during the maintenance period(s) specified in individual contracts but not exceeding a further 24 months from expiry date of the Project Period as set out in Item 3 of the Declarations. During such maintenance period(s), coverage is limited to physical loss or physical damage resulting from or attributable to:

46

674 F.2d 401 (5th Cir. 1982). Exclusion “O,” which is found in most standard CGL forms, excludes coverage for “property damage to work performed by or on behalf of the named insured arising out of the work or any portion thereof, or out of the materials, parts or equipment furnished in connection therewith.” Id. at 420. 48 Id. at 421. 47

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§ 3.05[B]

a.

faulty or defective workmanship, construction, material or design arising from a cause occurring prior to the commencement of the maintenance period; and

b.

operations carried out by Other Assureds during the maintenance period(s) for the purpose of complying with their obligations in respect of maintenance or the making good of defects as may be referred to in the conditions of contract, or by any other visits to the site necessarily incurred to comply with qualifications to the acceptance certificate.

Notwithstanding the above, however, coverage under Section II [i.e. Liability Insurance] shall also continue during the Maintenance Period but specifically excluding the operating risk after hand-over and only in respect of occurrences or circumstances as described in paragraphs a and b above. (emphasis added).

Subpart (a) applies to damage occurring during the maintenance period that is caused by pre-existing, construction-related flaws. Subpart (b) insures against damage caused by maintenance period “operations carried out by Other Assureds.” While Subpart (a), by its own terms, covers damage “attributable to . . . defective material,” the clause contains a caveat that the “cover provided hereunder shall be no wider than that contained elsewhere in the Policy.” As a result, underwriters may contend that the maintenance period coverage is no broader than the limited policy coverage for “defective materials;” however, the case authority has not yet addressed this issue under this relatively new form of marine-based coverage. A maintenance coverage extension similar to the language of the WELCAR form could be a valuable addition to an ARBR policy, as such coverage will protect against post-completion property damage that occurs during the specified maintenance period as a result of construction-related flaws or negligent, postcompletion maintenance (warranty) work. It is especially important to consider adding such coverage to the ARBR program given the more limited scope of PCOH coverage being made available in standard CGL policies. In addition to maintenance coverage, contractors should consider obtaining coverage for the costs and financial losses incurred as a result of an insured loss that delays completion of a project and start-up of the plant’s operations. Such coverage can be a viable substitute for the “loss of use” coverage that may not be available in the typical ARBR form. Such coverage provides an alternative resource to protect against claims for “delay” (liquidated) damages that typically are excluded from coverage by most ARBR policies. [B] Delay in Start-Up Coverage Construction-related delays can result in significant financial loss to the project owner, who cannot commence profitable production or lease the space available in the otherwise completed project. The costs of such delay may be

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accounted for in part in a liquidated damages penalty specified in the construction contract. Certainly, when a construction-related fire, explosion, collapse or other catastrophe strikes, the labor and material costs incurred to repair the physical damage can be substantial and should be covered under the ARBR policy; but these costs may be rivaled or eclipsed by the owner’s financial loss resulting from the delay in completion of the project. In addition, the contractor may incur significant delay in start-up losses, such as ongoing interest on construction loans and refinance charges; real estate taxes; insurance; legal, accounting, consulting, and developer’s fees; equipment rental; office overhead; travel expenses; inspection fees; marketing; and re-leasing expenses.49 The basic form of ARBR policy will cover the cost of repairing constructionrelated physical damage, but not the financial loss resulting from delayed completion. The question is whether such losses, if caused by an insured event, should be covered by (a) liquidated damages specified in the construction contact; (b) the owner’s property damage policy, which may include a “business interruption” component; or (c) a “delay in start-up” endorsement to the ARBR policy. In the first two of these alternatives, the risk ultimately will be borne by the contractor, either directly as a liquidated damages penalty or indirectly as a result of a subrogation claim by the owner’s business interruption insurer. Option (c) should be considered because in that instance, the risk is borne by the ARBR insurance carrier. Insurance carriers and brokers were traditionally lackadaisical in their approach to delay in start-up coverage, treating it as an afterthought that merited a generic, ambiguous endorsement or merely a check box on the declarations page.50 Standard ARBR policies typically do not provide delay in start-up coverage, but a recent decision applying New Jersey law suggests that contractors should consider pursuing such claims in appropriate circumstances. In Zurich American Insurance Co. v. Keating Building Corp.,51 the policyholder contracted to build a 27 floor, $173 million expansion to the Tropicana Hotel and Resort in Atlantic City, New Jersey. Six floors of the structure collapsed during construction, delaying the project by eight months and causing $80 million in damages. The ARBR insurer paid a portion of the damages and then filed suit, asking the court to declare that its policy did not cover the following three categories of delay losses: (1) “extended general conditions” expenses for additional administrative costs, trailers, supplies, and other costs not captured as direct costs; (2)

49

Jonathon C. Held & Lisa A. Enloe, Builders Risk—Measuring Delay at 2 (June 1, 2009), http://www.heldenloe.com/news/BuildersRiskMeasuringDelay.pdf; Tony D’Amico, Soft Cost or Delay in Opening: Insure for the Potential Exposure, Adjusting Today (2009), http://www. adjustersinternational.com/atpdf/3034_SoftCosts.pdf. 50 Roger D. Branigin, Daniel N. West, & Chris Tymchuck, Coverage for Delay and “Soft Costs” Under Builder’s Risk Policies: Avoiding the Pitfalls, ABA TIPS Practice Section, Property Insurance Law Committee Annual Spring Meeting at 3-4 (May 15, 2009). 51 513 F. Supp. 2d 55 (D.N.J. 2007).

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§ 3.05[B]

“contractor’s delay expenses” for idled labor and equipment; and (3) storage costs and increases over time in the prices of wages and material costs. Three policy provisions played a central role in the coverage dispute. First, the property damage insuring clause provided broad coverage for “all risks of direct physical loss or damage to the Insured Project.” Second, the policy contained an exclusion barring coverage for: Consequential loss, damage or expense of any kind or description including but not limited to loss of market or delay, liquidated damages, performance penalties, penalties for non-completion, delay in completion, or noncompliance with contract conditions, whether caused by a peril insured or otherwise, however the foregoing shall not exclude Delay in Completion Coverage when it is endorsed to the Policy.52

Third, the policy included a “Delay in Completion Coverage” endorsement that provided coverage for the owner’s “loss of gross earnings, rental income and ‘soft costs/additional expenses’ associated with a delay in the building’s construction schedule.”53 The insurer argued that the general insuring clause only covered the direct costs of repairing or replacing the damaged property and not the contractor’s “soft costs” resulting from the delay in completion. The court found no such limitation in the broad language of the all-risks insuring clause. In addition, and seemingly more important to the court, the same insurer had issued more restrictive ARBR policies that restricted coverage to costs incurred to “rebuild, repair, or replace such part of the property herein described as has been damaged or destroyed.”54 This evidence established that, if the insurer had “intended to limit its obligations under the Policy to only obligations to repair costs for the damaged portion of the Project, . . . [it] could have used language imposing this type of coverage restriction.”55 Turning to the consequential damage exclusion, the court rejected the insurer’s argument that the expenses were “the epitome of [uninsured] consequential losses as they are losses that ‘do not flow directly and immediately from the act of the party, but only from some of the consequences or results of such acts.’”56 First, the court found that the collapse was an insured peril and that under the doctrine of efficient proximate cause, it was immaterial that “an excluded peril (a ‘consequential loss’) was involved in the chain of events that led to the loss (the [Disputed] Costs).”57 Second, the court found that the exclusion at issue only barred coverage for penalties associated with a delay in completion, 52

Id. Id. 54 Id. 55 Id. 56 Id. 57 Id. 53

at 70 (emphasis added). at 60. at 69. at 70 (quoting Black’s Law Dictionary (6th ed. 1990)).

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not additional contractor costs, and that it was further limited to “purely economic losses that are separate and apart from regular construction costs. . . .”58 For all of these reasons, the court held that the policy covered “the extra costs that [the contractor] paid to complete the project, without regard to whether the costs involve work at the project away from the immediate area of the collapse.”59 Because the owner’s claims for financial loss were not at issue, the court did not address the “Delay in Completion” endorsement, but ruled that the ARBR insurer had a duty to reimburse all of the disputed expenses that the contractor had incurred. In the wake of Keating, “insurers have taken a more sophisticated approach under which the various types of soft costs are compartmentalized into groups that can be treated differently for purposes of defining the nature and scope of coverage.”60 Because this is a recent development, there is no uniform policy language specifically addressing it. A further complication is that the types of “soft costs” a contractor may incur vary greatly in character and amount from project to project. Contractors and developers may be certain, however, that the typical ARBR carrier will vigorously contest coverage for such losses and for the owner’s financial losses, absent the purchase of a specific delay in start-up endorsement. The key for insureds is to pay careful attention to the proposed policy language and tailor the coverage to the specific project at hand. Disputes often arise even when the policy contains coverage for delay damage. Thus, as other commentators have noted, “[m]easuring delay from a loss under a builders risk insurance policy is perhaps the most complicated of all time element measures in the claims world.”61 Not surprisingly, therefore, carriers often argue that factors other than the insured loss caused or contributed to the delay, such as the repair or replacement of uninsured property or the correction of an uninsured condition such as a design flaw, bad weather, or slow and undependable subcontractors.62 To avoid the considerable difficulty of distinguishing uninsured causes of delay from insured causes and insured elements of delay damages, contractors should closely track the status of a project before and after a loss occurs, so that the source of all delays can be precisely determined. Moreover, it is important to monitor the scheduled completion date and, if necessary, modify it in light of significant delays. Some ARBR policies identify the anticipated completion date and will allow that date to be modified to account for delays that are unassociated with a covered loss. Failing to monitor and change the anticipated completion date may significantly impact determination of the delay period and even bar policy coverage, absent an appropriate policy amendment to account for the revised completion date. 58

Id. at 71. Id. at 72. 60 See Coverage for Delay and “Soft Costs” Under Builder’s Risk Policies: Avoiding the Pitfalls, supra note 50 at 10. 61 See Builders Risk—Measuring Delay, supra note 49 at 2. 62 Id. at 10-11. 59

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§ 3.06

§ 3.06

LESSON NO. 4: COVERAGE FOR PREVENTION/MITIGATION OF LOSS (“SUE AND LABOR”)

An area of significant overlap between shore-based and marine insurance is “sue and labor” coverage. The classic form of sue and labor clause in marine policies and some ARBR policies reads as follows: In case of loss or damage, it shall be lawful and necessary for the Insured to sue, labor and travel for in an about the defense, safeguard and recovery of the insured property hereunder or any part thereof without prejudice to this insurance, nor shall the acts of the Insured or the Company in recovering, saving, and preserving the property insured in case of loss or damage be considered a waiver or an acceptance of abandonment. The expenses so incurred shall be borne by the Insured and the Company, proportionately to the extent of their respective interests.63

This clause is an outgrowth of an English marine insurance clause, which is “so old that its origin is obscured by antiquity.”64 The marine clause, dating as far back as 1613,65 reads as follows: In case of any loss or misfortune, it shall be lawful and necessary for the Assured, their factors, servants and assigns, to sue, labor and travel for, in and about the defense, safeguard and recovery of the said vessel, or any part thereof, without prejudice to this insurance; the charges whereof we, the Assurers, will contribute to the rate and quantity of the sum herein insured.66

The purpose of sue and labor coverage is to “encourage and . . . bind the assured to take steps to prevent a threatened loss for which the underwriter would be liable if it occurred, and when a loss does occur to take steps to diminish the

63

See, e.g., Swire Pac. Holdings, Inc. v. Zurich Ins. Co., 284 F.3d 1228 (11th Cir. 2002) (quoting sue and labor clause in builders risk policy); Kevin Dorse and Daniel D. McMillan, When Accidents Happen During Construction: Will Your Builders Risk Insurance Cover the Damage?, Construction Briefings No. 2005-6 (2005) (same); 4 Philip L. Bruner & Patrick J. O’Connor, Bruner & O’Connor on Construction Law § 11:115:60 (2002) (same). 64 Am. Merch. Marine Ins. Co. of N.Y. v. Liberty Sand & Gravel Co., 282 F. 514, 520 (3d Cir. 1922). 65 Reliance Ins. Co. v. The Escapade, 280 F.2d 482, 488 n.11 (5th Cir. 1960). 66 Id. at 484.

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amount of the loss.”67 Sue and labor coverage is consistent with U.S. common law principles, as courts in several states have ruled that an insured has the duty to exercise reasonable care to protect insured property against insured losses.68 As a result, many courts will impose a corresponding, implied duty on the insurer, who has benefited from the policyholder’s actions to minimize loss, by requiring reimbursement of the expenses that the insured incurred, even in the absence of an express sue and labor clause.69 Other jurisdictions have not recognized such claims. As a result, in those jurisdictions, the presence or absence of express sue and labor language may be critical to a claim for recovery of the expenses of mitigating a potential loss. Assuming the policy covers sue and labor costs, there are at least three, discrete issues that typically arise in connection with such claims. First, does sue and labor coverage apply to an insured’s efforts to prevent an insured loss, or only to an insured’s efforts to mitigate damage after an insured loss has occurred? Second, assuming that sue and labor coverage does apply to prevention of a threatened, rather than actual loss, when is the threatened, insured loss sufficiently probable or imminent to trigger coverage? Third, are sue and labor expenses covered in a “mixed motives” context, where the insured acts to prevent or minimize both insured and uninsured losses, such that the expenses incurred should be apportioned, and, if so, how? [A] Does Sue and Labor Coverage Apply to an Insured’s Efforts to Prevent an Insured Loss? U.S. courts commonly hold that “‘the sue and labor clause is a separate insurance and is supplementary to the contract of the underwriter to pay a particular sum in respect to damage sustained.’”70 This is true in the sense that an insured may recover all reasonable sue and labor expenses “without regard to the amount of the loss or whether there has been a loss or whether there is salvage, and even though the underwriter may have paid a total loss under the main 67 Id. at 488 n.11 (5th Cir. 1960) (citing White Star S.S. Co. v. N. British & Mercantile Ins. Co., 48 F. Supp. 808, 812-13 (D. Mich. 1943)). 68 See, e.g., Blasser Bros., Inc. v. N. Pan-Am. Line, 628 F.2d 376, 386 (5th Cir. 1980) (“An insured has the duty to exercise the care of a prudent, uninsured owner to protect insured property so as to minimize or prevent the loss for which the insurer would be liable.”). 69 See, e.g., Slay Warehousing Co., Inc. v. Reliance Ins. Co., 471 F.2d 1364 (8th Cir. 1973) (finding common law sue and labor duty despite absence of clause in inland marine policy); Demers Bros. Trucking, Inc. v. Lloyd’s, London, 600 F. Supp. 2d 265, 274-75 (D. Mass. 2009) (recognizing common law equivalent of sue and labor coverage); S. Cal. Edison Co. v. Harbor Ins. Co., 148 Cal. Rptr. 106, 111 (Ct. App. 1978) (explaining that sue and labor clause “makes express the implied correlative duties between insured and insurer. . . .”); Witcher Constr. Co. v. St. Paul Fire & Marine Ins. Co., 550 N.W.2d 1, 8 (Minn. Ct. App. 1996) (finding implied duty of insured to prevent insured losses, and corresponding duty of insurer to reimburse for resulting expenses). 70 Reliance, 280 F.2d at 488 n.11 (quoting White Star, 48 F. Supp. at 812-13).

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policy.”71 Even policy deductibles and self-insured retentions may not apply because, as one court explained, “[i]t is inconsistent to place an affirmative obligation of this nature on the insureds for the benefit of the insurer and then additionally to require the insureds to pay for the first $100,000 of the cost in providing this benefit.”72 Despite the somewhat unique characteristics, if not the unique language employed, sue and labor coverage is “tied irrevocably to the basic insurance policy” because the aim of the insured’s efforts must be the prevention or mitigation of a covered loss.73 Accordingly, there is no right of reimbursement for expenses incurred to defend, safeguard, and otherwise protect insured property against uninsured risks.74 This fundamental limitation is “necessary to prevent the clause from becoming an all-purpose indemnity clause for which the parties have not contracted.”75 Many sue and labor claims have been dismissed because the insured’s actions did not prevent or mitigate an insured loss.76 For instance, in GTE Corp. v. Allendale Mutual Insurance Co.,77 the insured telecommunications company spent $350 million to prevent a shutdown of its computer systems, a result of the much-feared “Y2K” threat to stored computer data resulting from the use of two-digit year codes in software that could not distinguish between 1900 and 2000. The insured sought coverage for the preventive measures undertaken under its property damage and business interruption policy, which contained a sue and labor clause. The Third Circuit dismissed the claims for coverage under the general insuring clauses, finding that the Y2K problem fell within the scope of exclusions for defective design and inherent vice. The insured argued that the sue and labor clause provided an independent basis for coverage; but the court disagreed, finding that limiting the sue and labor clause by the policy’s exclusions was “necessary to avoid rendering the exclusionary provisions meaningless; an alternative interpretation would permit GTE to recover for improvements and measures taken to address a host of uninsured risks.”78

71

White Star, 48 F. Supp. at 812-13. Am. Home Assurance Co. v. J.F. Shea Co., 445 F. Supp. 365, 369 (D.D.C. 1978). 73 Reliance, 280 F.2d at 488 n.11 (internal quotation marks and citation omitted). 74 S. Cal. Edison Co., 148 Cal. Rptr. at 112. 75 Int’l Commodities Export Corp. v. Am. Home Assurance Co., 701 F. Supp. 448, 454 (S.D.N.Y. 1988). 76 See, e.g., Tillery v. Hull & Co., 717 F. Supp. 1481, 1486 (M.D. Fla. 1988) (dismissing sue and labor claim for expenses to repair ship damaged during forfeiture, explaining that “[a]s these damages are not covered by the policy, expenses incurred in mitigating them for the benefit of the insurance company are not recoverable under the sue and labor clause.”); Young’s Market Co. v. Am. Home Assurance Co., 481 P.2d 817, 820-21 (Cal. 1971) (affirming dismissal of sue and labor claim for expenses to contest confiscation of liquor cargo belonging to insured because confiscation, if it had occurred, would not have resulted in loss insured by all-risk cargo policy). 77 372 F.3d 598, 618 (3d Cir. 2004). 78 Id. 72

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There is little dispute that a sue and labor clause will cover mitigation efforts undertaken after an insured loss has occurred.79 Furthermore, in marine cases, it is “trite law” in the U.K. that sue and labor coverage is triggered “when the peril has arisen or is imminent—when the vessel is in the grip of a peril.”80 However, in the U.S., this principle is not well established, as illustrated by two cases addressing the issue of whether or not the sue and labor coverage should be limited to mitigation of actual loss that already has occurred rather than prevention of potential loss. In Wolstein v. Yorkshire Insurance Co.,81 the insured owner of a partially constructed yacht incurred expenses to protect the yacht from vandalism and severe winter weather, after discovering that the builder had abandoned the project. The insured sought coverage as an additional insured under the defaulting builder’s marine builders risk policy. The trial court held that the plaintiff did not have a sue and labor claim because no insured loss had actually occurred, ruling that costs incurred to prevent a loss are not covered. The court of appeals reversed, ruling that “a covered loss does not have to occur in order to invoke coverage under the sue and labor provision. Rather, actions taken to prevent a [future] covered loss will suffice to invoke coverage.”82 Two years later, the Supreme Court of Florida reached the opposite result in Swire Pacific Holdings, Inc. v. Zurich Insurance Co.83 In Swire, the insured owner of a new condominium complex spent $4.5 million to correct design defects. The owner then sought reimbursement, as an additional insured, under the sue and labor clause of the ARBR policy. The owner argued that the corrective work prevented the entire building from collapsing, which would have been an insured peril. The Supreme Court of Florida held that the plain language of the policy phrase “[i]n case of loss or damage” limited the ARBR coverage to mitigation efforts taken when a covered loss had already occurred or commenced and that there was no coverage for the costs of preventing a future loss. The Swire court arguably failed to consider whether or not the arguably vague phrase “[i]n case of loss or damage” provides meaningful guidance concerning coverage for reasonable loss prevention efforts. If not, the phrase is ambiguous and should be construed strictly against the drafter (the insurer) and in favor of coverage. The essential purpose of mitigation principles is to encourage insureds to act reasonably to protect the insured property from loss. Some insurers have modified the sue and labor clause wording by replacing the phrase “[i]n case 79

See, e.g., Cont’l Food Prods., Inc. v. Ins. Co. of N. Am., 544 F.2d 834, 837 n.1 (5th Cir. 1977); Am. Merch. Marine Ins. Co. of N.Y. v. Liberty Sand & Gravel Co., 282 F. 514, 520 (3d Cir. 1922); Reliance, 280 F.2d at 488 n.11; John S. Clark Co. v. United Nat’l Ins. Co., 304 F. Supp. 2d 758, 766 (M.D.N.C. 2004). 80 See, e.g., Linelevel Ltd. v. Powszechny Zaklad Ubezpieczen, S.A., [2005] 2 Lloyd’s Rep. 534, 547 (Q.B.D.). 81 985 P.2d 400, 409-10 (Wash. Ct. App. 1999). 82 Id. 83 845 So. 2d 161, 169 (Fla. 2003).

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of loss or damage” with the phrase “[i]n case of actual or imminent loss or damage. . . .”84 If such language is included, the question becomes how to determine when the risk of future loss or damage is sufficiently “imminent” to trigger the sue and labor coverage. [B] When Does the Threat of an Insured Peril Trigger Sue and Labor Coverage? Because sue and labor coverage applies only to the prevention or mitigation of covered losses, the peril that the insured prevents arguably must be one that would have materialized within the policy period. The only U.S. case to consider this issue is Port of Seattle v. Lexington Insurance Co.,85 which involved another failed effort by an insured to obtain coverage for Y2K-related computer remediation work. The insured invoked the sue and labor clause of a policy that covered damage to “active data processing media.”86 The Washington Court of Appeals affirmed the trial court’s dismissal of the sue and labor claim because the insured did not prevent a loss within the coverage period, but instead “sought to prevent losses that would occur on or after January 1, 2000, after the policies expired.”87 In that case, there was no question regarding when the possible covered loss, if any, would occur. Other courts have allowed coverage for sue and labor expenses without direct proof that the insured loss could occur within the policy period. Thus, as discussed above, the insured in Wolstein v. Yorkshire Insurance Co.88 sought reimbursement of the expenses incurred to protect a partially constructed yacht from vandalism and severe winter weather. The insurer contested coverage because there was no evidence that vandalism or severe winter weather was imminent. The court rejected this argument, ruling that a reasonableness standard should be applied: To require that a risk be imminent before coverage results would create a dilemma for the assured. The assured would be placed in the unenviable position of determining whether there was enough evidence to support the immediacy of their action and thus allow reimbursement from their insurance policy, or whether they should refrain from acting and risk that damage will occur and that insurance coverage will be denied because they failed to act to

84 See, e.g., GTE Corp., 372 F.3d at 606 (quoting sue and labor clause in property damage policy); J.F. Shea Co., 445 F. Supp. at 366 (same as to clause in builder’s all-risk policy). 85 48 P.3d 334, 340 (Wash. Ct. App. 2002). 86 Id. at 337. 87 Id. at 338-39. 88 985 P.2d at 401.

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prevent the casualty. On the other hand, an assured should be able to determine what [preventive] actions and expenses are reasonable without too much difficulty.89

Applying this standard, the court held that a genuine issue of material fact existed concerning whether a prudent, uninsured owner “would have also taken action to secure and heat an abandoned partially completed yacht in an outdoor Wisconsin boatyard in winter.”90 Thus, according to Wolstein, the standard sue and labor clause provides coverage for the prevention of an insured peril, without regard to the imminence of the insured peril, so long as the circumstances were such that a reasonable, uninsured person would have acted in the same manner to protect the property from loss. It is unclear whether the form of clause that provides coverage “in case of actual or imminent loss or damage,” which was designed to broaden the scope of the sue and labor coverage, also has the arguably unintended consequence of rejecting the reasonableness standard adopted in Wolstein. However, that is exactly what has happened in the state of Washington. In Washington Mutual Bank v. Commonwealth Insurance Co.,91 after an engineering firm reported that one of a bank’s buildings was at risk of imminent collapse, the insured bank incurred substantial costs to evacuate the building. A second engineering report, conducted after the evacuation, concluded that the building was not in fact in danger of collapse. Construing a sue and labor clause covering “actual or imminent loss or damage covered by the policy,” the Washington Court of Appeals held that (1) imminent means “ready to take place: near at hand: impending: hanging threateningly over one’s head: menacingly near”; (2) the standard for determining imminent collapse is objective, not subjective; and (3) the policy did not provide coverage because the second report confirmed there was no imminent danger of collapse. Citing Wolstein, the court ruled that “a reasonable but incorrect perception of imminence of covered loss does not suffice as a basis for coverage under the sue and labor provision.”92 The case provides a definition of “imminent” and holds that there is no sue and labor coverage for false emergencies, but otherwise sheds little light on how to measure the imminence of the loss. The opinion in Buczek v. Continental Casualty Insurance Co.93 provides some additional guidance regarding the imminence of loss issue in a risk of collapse case. In Buczek, the insured condominium association sought to recover the cost of replacing 34 decayed foundation pilings, after noticing that the

89

Id. at 410. Id. As discussed below, measuring the reasonableness of the mitigation efforts based on what a “prudent uninsured” would do is a well-established principle of U.K. maritime law. 91 No. 56396-3-1, 2006 WL 1731318 (Wash. Ct. App. June 26, 2006). 92 Id. at *5. 93 378 F.2d 284 (11th Cir. 2004). 90

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structure swayed in high winds and that the pilings were discolored. The policy covered “collapse” of a building caused by “hidden decay.” The trial court and Eleventh Circuit agreed that the term “collapse” means not only actual collapse, but also “any serious impairment of structural integrity that connotes imminent collapse. . . .”94 The trial evidence established that 90 mph winds would cause the building to collapse, and that such winds sometimes hit the shore at issue. The trial court ruled that “even a risk that might be a one in ten, or one in twenty year risk, is still a very serious and imminent risk. The fact the event may or may not occur in any given point in time doesn’t mean the risk is not imminent.”95 The Eleventh Circuit disagreed, finding that a wind which might occur once every ten or twenty years is not an imminent risk. According to the Eleventh Circuit, evidence of an “imminent” collapse required proof that the walls are cracking, moaning loudly, and bulging inward. The Buczek opinion, if extended to all cases in which recovery of loss prevention costs is limited to “imminent” risks, would bar coverage for most loss prevention efforts except in the rarest of instances when the insured loss is “about” to occur. However, in Buczek, the policy at issue only covered the “collapse” of a building, which the court construed expansively to also include imminent (rather than actual) collapse. In this setting, where the court had already expanded the insuring clause to include imminent collapse, it makes sense that the court would in turn narrowly construe the concept of imminence to avoid broadly rewriting the “collapse” coverage. As a result, the court’s limiting language might not be applied in a case in which the policy expressly includes, in addition to a “collapse” hazard, separate sue and labor coverage. Maritime cases provide additional guidance on the issue of when sue and labor coverage is triggered by an actual or imminent peril.96 In Integrated Container Service Inc. v. British Traders Insurance Co., Ltd.,97 Lord Justice Eveleigh rejected the insurer’s argument that it had no obligation to reimburse the insured because it was not “very probable” that damage to the insured property would have occurred in the absence of the insured’s efforts. Like the Washington court in Wolstein, Justice Eveleigh concluded that because the right to recover expenses is a corollary to the duty to act to mitigate loss, the same reasonableness standard should apply to both. Accordingly, an insured may “recover the cost of such measures as were reasonably taken for the purpose of averting or minimizing a loss when there was a risk that insurers might have to bear that loss.”98 Assuming the “reasonableness” and “imminent loss” standards can be satisfied,

94

Id. at 290 (citing Fantis Foods, Inc. v. North River Ins. Co., 753 A.2d 176, 183 (N.J. Super. 2000)). 95 Id. at 291. 96 See, e.g., 2 Lloyd’s Rep. at 547; Royal Boskalis Westminster v. Mountain, [1999] Q.B. 674 (C.A.). 97 [1984] 1 Lloyd’s Rep. 154 (C.A.). 98 Id.

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another key question remains: Did the loss prevention expenses incurred primarily benefit the insured, with only secondary benefits to the insurer, and if so, how should the reimbursement of those costs be allocated? [C] The Respective Interests of Insured and Insurer Are Considered in Allocating Sue and Labor Costs What happens when the sue and labor effort prevents a loss that would be insured and that the carrier would have to pay, while also benefiting the possibly uninsured financial interests of the insured? The U.S. courts that have considered this issue, have ruled that sue and labor expenses are recoverable only if the immediate and primary effect of the expenditure is to prevent or minimize the risk of an insured loss, not an uninsured problem. In Southern California Edison Co. v. Harbor Insurance Co.,99 the insured incurred expenses to “mud jack” two units of a coal-fired power plant that experienced excessive settlement due to faulty design and construction. Conceding that the “cost of making good faulty workmanship” exclusion applied, the insured nevertheless argued that the mud jacking prevented insured consequential damage to the superstructure and should be covered under the sue and labor clause. The court disagreed, concluding that “the recovery under a sue and labor clause is tied irrevocably to the obligations undertaken by the insurer in the basic insurance policy,” and that “the means used by Edison to prevent or mitigate such damages were excluded from recovery under the policy.”100 Noting also that “only mitigation expenses which are for the primary benefit of the insurer are recoverable under a sue and labor clause,”101 the court concluded that the only reason the structure was threatened was because of the design defect and that the mud jacking was primarily for the benefit of the insured. Similarly, in Swire Pacific, after deciding that the policy’s design defect exclusion barred the insured’s claims, the district court considered whether the insured could recover under the policy’s sue and labor clause.102 The insured argued that “its expenses should be covered because its actions primarily benefited the insurer, by potentially preventing [an insured] collapse of the building. . . .”103 The district court adopted Edison’s “primary beneficiary” test, ruling that the direct purpose of the sue and labor effort was to correct the uninsured design deficiencies, and that the possible prevention of an insured collapse of the building was merely an incidental benefit that did not trigger the sue and labor coverage. In its order certifying the question to the Supreme Court of Florida, the Eleventh Circuit suggested that the sue and labor clause only applied to mitigation efforts 99

148 Cal. Rptr. 106 (Ct. App. 1978). Id. at 112. 101 Id. at 113 (citation omitted). 102 139 F. Supp. 2d 1374 (S.D. Fla. 2001). 103 Id. at 1384. 100

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taken “when a covered loss had already occurred or was in the process of occurring,” not efforts “to prevent a covered loss from ever arising.”104 Because the Supreme Court of Florida agreed with the Eleventh Circuit’s statement, it did not specifically address the issue of who “primarily benefited” from the insured’s repairs.105 Once again, helpful “lessons” may be learned from reviewing sue and labor clauses in maritime policies, one form of which provides that sue and labor costs “shall be borne by the Insured and the Company, proportionately to the extent of their respective interests.” Such a clause might avoid the “all or nothing” outcomes of the foregoing cases by allowing apportionment of sue and labor costs in accord with the “respective” interests of the insured and insurer in preventing loss.106 Another form of apportionment clause permits coverage when sue and labor expenses are incurred “in saving or attempting to save the subject-matter insured and other property. . . .”107 Under this clause, an insured’s sue and labor effort would be fully reimbursable if it involved an effort to save other, insured property. The analysis in such a case is rather straightforward, assuming “it is possible arithmetically to apportion the expenses . . . incurred for the benefit of the insured, as opposed to the uninsured, property.”108 This long-standing principal of marine insurance law may be explained, as follows: [I]f by [a] peril insured against the subject-matter of insurance is brought into such danger that without unusual or extraordinary labour or expense a loss will very probably fall on the underwriters, and if the assured or his agents or servants exert unusual or extraordinary labour, or if the assured is made liable to unusual or extraordinary expense in or for efforts to avert a loss, which, if it occurs, will fall on the underwriters, then each underwriter will, whether in the result there is a total or partial loss, or no loss at all, not as part of the sum insured, but as a contribution independent of and even in addition to the whole sum insured, pay a sum bearing the same proportion to the cost or expense incurred as the sum they would have had to pay if the probable loss had occurred. . . .109

104

248 F.3d 1228 (11th Cir. 2002). See also John S. Clark Co. v. United Nat’l Ins. Co., 304 F. Supp. 2d 758 (M.D.N.C. 2004). Citing Swire and Edison, the North Carolina district court held that sue and labor expenses are recoverable only when the loss prevention effort relates to a covered loss and confers a direct and immediate benefit upon the insurer. Applying this test, the court held that the insured had incurred the expenses at issue “directly and primarily to correct and repair its own [uninsured] faulty workmanship,” and that the insurer benefited only incidentally to the extent the efforts prevented “another collapse . . . at some unknown point in the future.” Id. at 768. 105 845 So. 2d at 169. 106 See WELCAR 2001 Offshore Construction Project Policy; and supra note 63 and accompanying text. 107 See Institute Form ¶ 20.4 (emphasis added). 108 Royal Boskalis Westminster NV v. Mountain, [1999] Q.B. 674, 738-39. 109 Lohre v. Aitchison, [1878] 2 Q.B.D. 558, 566 (C.A.) (emphasis added).

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In other words, the insurer should reimburse sue and labor costs in proportion to its interest in the total, potential loss it otherwise would have paid. Application of this apportionment principal110 is reasonable and seems inherently “fair” where, as often is the case, sue and labor efforts benefit the insured, but also eliminate the expense that the carrier would incur when, absent the loss-prevention work, a partially insured loss would likely occur. § 3.07

CONCLUSION

While “pirates and rovers” may not be a significant hazard faced by many shore-based construction projects, contractors, risk managers and their counsel should not overlook the authorities applying marine builders risk concepts, which often overlap and involve the same types of risks (faulty workmanship/defectively designed parts/uncertain damage or loss of use caused by latent flaws) that generate uncertainty and controversy for shore-based construction projects. Similarly, as discussed above, the principles of coverage that apply in the marine or shore-based builders risk context also may be applied to other forms of policies, including the CGL coverage for a contractor’s liability for damage/injury caused by construction-related flaws, professional liability coverage for defective design, and the owner’s property insurance coverage for physical damage/loss of use of the project. If indeed there is a “crisis” in connection with construction-related coverage, it is a crisis that the insurance industry has brought upon itself. Underwriters and producers are motivated to generate premium income by selling a variety of policies that are supposed to provide “peace of mind” to contractors and project owners who assume potentially huge financial risks in undertaking major construction projects (and smaller projects too). Not surprisingly, contractors and owners faced with such losses have sought in ever-increasing numbers to convert the “peace of mind” purchased from their insurers into financial proceeds. Insurers’ claims agents, their supervisors and lawyers often rarely communicate with underwriters/producers who generate and sell the coverage forms in the first place. As a result, the claims side of the policy equation has developed a variety of imaginative theories, such as the “no occurrence myth,” the economic loss defense, the “business risks are not insurable” defense, and the “exceptions to an

110

Especially in cases involving under-insured property, it is the longstanding U.K. maritime rule that sue and labor costs must be borne by the insured and insurer in proportion to their respective interests, i.e., the amount insured versus the total value of the property. See, e.g., Cunard Steamship Co. Ltd. v. Marten, [1902] 2 KB 624, 629 (explaining “well-established basis of every adjustment of suing and labouring expenses” as being that underwriters are to bear expenses only “in the proportion of the amount underwritten to the whole value of the property or interest insured”); see also Royal Boskalis, [1999] Q.B. at 738-39 (“I do not believe there to be any doubt that where ship or cargo is under-insured, sue and labour expenses will only be recoverable in the same proportion that insured value bears to actual value.”).

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exclusion cannot create coverage” argument that have been accepted by some courts as a basis for denying coverage for construction-related losses. The task of the carrier’s claims representative is to review coverage claims and assert sometimes imaginative theories that eliminate or at least minimize the carrier’s financial loss under the policies its underwriters issued. By contrast, the job of a contactor’s risk manager (and counsel) is to maximize actual value and recoverable proceeds of the various construction-related coverages that the contractor purchased. In doing so, it is appropriate and may be essential in pursuing coverage to “borrow” from authorities that apply the sometimes arcane, but historically well-established principles governing marine builders risk coverage. In an appropriate case, application of those principles may increase the potential for obtaining coverage for shore-based construction losses.

109