• CGL Exclusions for Contractual Liability - The Existence of a Contract Does Not Dictate the Exclusion
  • March 20, 2015 | Author: Michael A. Hodgins
  • Law Firm: Bernstein Shur - Portland Office
  • Just when contractors think they have insurance coverage for a claim under their Commercial General Liability policy, they find they do not, often because of the application of one of many policy exclusions. Contractors are understandably confused. Sometimes these policy exclusions can prove elusive even for the same court, in a single case.

    On October 29, 2014, after a unanimous ruling in June 2014 that there was no insurance coverage for the cost to repair cracking interior and foundation walls, or damages relating to an improperly installed HVAC system, the U.S. Court of Appeals for the 5th Circuit granted rehearing, and withdrew its earlier decision in the case of Crownover et al v. Mid-Continent Casualty Company on appeal from the Northern District of Texas. The appeals court reissued a decision which held that the insurance policy did indeed provide coverage for the damages, because the “contractual-liability exclusion” was not applicable. The true beneficiary of this decision was the homeowner, who spent several hundred thousand dollars in repairs of the defective work. The contractor has since filed for bankruptcy and is out of the picture for potential payment, so the insurance coverage was the only available avenue for the homeowner to receive compensation for the repairs.

    In the initial claim between the owner and the contractor, an arbitrator ruled that the contractor was liable for breach of the express warranty in the contract to repair defective or non-conforming work. Based upon the restriction of the damages award to this specific contractual provision, the U.S. District Court then found in favor of the contractor’s insurer, Mid-Continent Casualty, in a suit by the homeowner against the contractor’s insurance carrier, because liability to the homeowner arose “under the contract.” Therefore, the claim and resulting damages were logically subject to the policy exclusion for any obligation to pay damages “by reason of the assumption of liability in a contract or agreement.”

    Although the Court of Appeals initially agreed with that finding, the court reversed itself in October after withdrawing its earlier decision, affirming a line of cases holding that one has not “assumed liability” under a contract, if that same liability would have existed under the common law, or general law. This later (and final) decision was based upon language in the policy that creates an exception to the exclusion, for “liability" [t]hat the insured would have had in the absence of the contract or agreement.” In this case, because the obligation to perform work in a workmanlike manner and correct defective work already exists at common law, this obligation was not extended by contract, despite the “express warranty” language. The policy exclusion did not apply because there was no assumption of additional liability.

    At first blush this may appear to be a distinction of common law tort vs. contract principles, but it is not. The common law principles relied upon by the court remain common law contract principles, such as the obligation to perform the contracted work in a workmanlike manner, and the remedy for the cost of the repairs. The true issue for the application of this policy exclusion is whether the potentially responsible party has assumed liability through express contractual language that exceeds the liability it would have incurred under the common law. For example, an agreement to defend and indemnify a third party whose acts the contractor was not otherwise responsible. The CGL exclusion for contractual liability applies to liability that is assumed only by virtue of the specific contract. As the Court of Appeals said, “[t]he issue is not whether the relevant duty is contractual; it is whether the contractual duty represents an expansion of liability.” (emphasis in the original decision)

    If you have had experience with CGL coverage issues, you might ask why the exclusion for damage to “Your Work” does not apply. The insurer raised this argument, in addition to the contractual liability exclusion, among others. The court held that the exclusion for damage to the contractor’s own work did not apply because there was a further exception to that exclusion for work performed on behalf of the contractor, by a subcontractor, such as the foundations and HVAC work in this case. In an interesting twist, the exception to the exclusion was removed from later CGL policies covering this insured contractor, but the exception was included in the operative policy at the time the defective work and damage occurred.