No Coverage for Tearing Down Barn Apartment that Violated Building Code

The South Carolina Court of Appeals recently held that a general liability policy excluded coverage for the homeowners’ claim that they lost the use of property when they had to remove an apartment built on top of a barn because it violated zoning ordinances. William and Frances Walde, as Assignees of Johnson Construction Co. of Aiken, Inc. v. Assoc’n Insurance Co., (S.C. Ct. App. Op. No. 5061, Dec. 2012).

Post by Insurance Chair Pete Dworjanyn

The Waldes, (homeowners) wanted to build a barn with an upstairs apartment on their property in Aiken.  They hired Johnson Construction to obtain the necessary variances from city building ordinances.  The homeowners then contracted with Johnson to construct the barn and apartment.  Eighty percent of the work had been completed when the building inspector notified Johnson that the barn did not comply with the variance or the special exception.  The city ultimately allowed the barn to remain if the apartment was removed to lower the barn’s roof.

The homeowners filed an arbitration claim against Johnson, who tendered it to his insurer, Association Insurance Company (AIC).  AIC denied coverage.  Johnson and the homeowners settled their dispute prior to arbitration.  The settlement included an assignment to the homeowners of Johnson’s rights against AIC.  The homeowners filed suit against AIC, alleging breach of duty to defend and indemnify.  The trial court granted the homeowners’ motion for partial summary judgment, holding AIC was obligated to defend Johnson, that the policy provided coverage, and that AIC was liable for fees and costs.

Property Damage – The homeowners claimed they suffered “physical injury” to property when the barn was partially demolished.  The Court of Appeals rejected that argument holding that although “physical injury” was not defined by the policy, injury is generally considered the violation of another’s legal right. Using this definition, the court ruled that the partial tearing down of the barn’s second story did not constitute an injury because the removal was a remedial measure to fix the injury caused to the homeowners when the construction put them in violation of the City’s ordinances. However, the court also held the homeowners’ allegations raised the possibility of loss of use of tangible property that had not been physically injured, because the homeowners could not fully use the property after they were informed of the barn’s noncompliance.  The court rejected AIC’s argument that the homeowners failed to allege property damage because the physical injury to the barn resulted from faulty or defective workmanship, as faulty workmanship was only relevant to the policy’s exclusions, not the definition of property damage.

Occurrence – The court next concluded the homeowners’ allegations in the arbitration demand established the possibility of an occurrence. The demand claimed that Johnson’s advice was “wrongful”.  AIC argued the use of “wrongful” meant the claims were not based on an accident that would give rise to an occurrence. The court rejected the argument, holding the allegation that Johnson “wrongly” said its plans complied with the variance and exception could be construed as alleging Johnson was mistaken or acting without due care. The opinion noted that the court must look beyond the labels describing the acts and allegation and look to the acts themselves which formed the basis of the complaint.   

Accordingly, regardless of whether the claim was for negligence, negligent misrepresentation, or breach of fiduciary duty, the allegation of erroneous representations and provision of information was unintentional, and therefore, potential acts within the terms of the policy.

Exclusion – The court concluded, however, the “your work” exclusion applied and excluded coverage.  That exclusion excludes coverage for property damage to that particular part of any property that must be restored, repaired, or replaced because the party’s work was incorrectly performed on it.  The exception to that part of the Damage to Property exclusion provides the section does not apply to property damage included in the products-completed operation hazard.  The court agreed with AIC that the homeowners’ alleged property damage was not included in the products-completed operations hazard coverage.  Regardless of whether the contract was complete (or terminated) when the homeowners lost the use of the property, the policy deems all loss of use unaccompanied by physical injury to have occurred at the time of the occurrence. 

The homeowners claimed the loss of use of property arose out of Johnson incorrectly advising them and obtaining the necessary approval from the City.  Therefore, the loss of use was deemed to have happened at the time of those incorrect performances, and before Johnson’s work was complete.  The homeowners alleged the loss of use of the barn while they were required to tear down and build a new roof; they alleged property damage to that particular part of property that must be replaced because Johnson’s permit work was incorrectly performed.

The court rejected the homeowners’ argument that their claims were not excluded because the defective work occurred before the zoning authority rather than the construction of the barn.  The argument that their claims involved a permitting defect, not a construction defect, did not allow it to escape the damage to property exclusion.

S.C. Supreme Court Rules on Statute Requiring CGL Policies to Contain a Specific Definition of “Occurrence”

S.C. Statute Requiring CGL Policies to Contain a Specific Definition of “Occurrence” Held Constitutional; Retroactive Application of Statute Held Unconstitutional

In a recent decision, Harleysville Mutual Insurance Co. v. South Carolina, (Opinion 27189, Nov. 21, 2012), the South Carolina Supreme Court held S.C. Code § 38-61-70, which addresses the definition of “occurrence” in commercial general liability policies, was constitutional; however, the retroactive application of the statute was not.

Post by Insurance Chair Pete Dworjanyn

South Carolina Code § 38-61-70, effective May 17, 2011, provides that commercial general liability policies insuring construction professionals for liability arising from construction related work shall contain, or be deemed to contain, a definition of “occurrence” that includes (1) an accident, including continuous or repeated exposure to substantially the same general harmful conditions and (2) property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself.  The section, as written, applies to any pending or future dispute over coverage that would otherwise be affected by the section as to all commercial general liability insurance policies issued in the past, currently in existence, or issued in the future.

The law was prepared in response to the South Carolina Supreme Court’s January 7, 2011, initial opinion in Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Company.  In that initial opinion, which never became final, the Court held that insurance issued to Beazer Homes did not provide coverage for claims arising out of damaged condominiums caused by faulty workmanship because “the damaged to the insured’s property [was] no more than the natural and probable consequences of faulty workmanship.”  The opinion indicated there was no fortuity element present and, for faulty workmanship to give rise to potential coverage, the faulty workmanship must result in occurrence – an unintended, unforeseen fortuitous or injurious event. The initial opinion overruled the Court’s decision in Auto Owners Insurance Company, Inc. v. Newman, 385 S.C. 187, 684 S.E.2d 541 (2009).

On May 23, 2011, less than a week after § 38-61-70 became effective, the Supreme Court heard arguments on the petition for rehearing, which was granted July 7.  On August 22, 2011, the Supreme Court issued a new opinion, which became the final opinion, and found in favor of coverage based on an “occurrence.” Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Company, 395 S.C. 40, 717, S.E.2d 589 (2011). The Court reaffirmed its decision in Newman and clarified that negligence or defective construction resulting in damage to otherwise non-defective components may constitute property damage, but defective construction would not.

Harleysville filed a direct action against the State under the Supreme Court’s original jurisdiction, challenging the constitutionality of § 38-61-70.  In Harleysville Mutual Insurance Co. v. South Carolina, (Opinion 27189, Nov. 21, 2012), the Supreme Court held the statute was constitutional, but that retroactive application of the statute was not. The Court first held that the enactment of the statute did not violate the doctrine of separation of powers.  The General Assembly acted and ratified that section in response to the Court’s January 2011 opinion.  The Supreme Court theorized that if that opinion had been that Court’s final opinion, the doctrine might be implicated; however, given that the August Crossmann opinion replaced the January Crossmann opinion, the General Assembly did not retroactively overrule the Court’s interpretation of a statute. The Court next concluded the statute did not constitute special legislation or violate equal protection.  The Court did hold, however, that the retroactive application of the statute was an unconstitutional violation of the state and federal Contract Clauses. The South Carolina constitution provides:

“No bill of attainder, ex post facto law, law impairing the obligation of contracts, nor law granting any title of nobility or hereditary emolument, shall be passed, and no conviction shall work corruption of blood or forfeiture of estate.”

The Court held that the Act introducing the legislation impaired contractual relationships by mandating all CGL policies be legislatively amended to include a new statutory definition of occurrence and by applying this mandate retroactively, finding the statute fundamentally changes the definition of occurrence.

In Auto Owners v. Newman, the Supreme Court suggested “that a CGL policy may provide coverage where faulty workmanship causes third party bodily injury or damage to other property besides the defective work,” leaving open the possibility there may be instances where coverage might not be provided.  Newman examined the interaction of the traditional definition of occurrence with the faulty workmanship exclusion in the insurance contract, “Occurrence, as we confirmed in Crossmann II, traditionally means “accident” or “a continuous or repeated exposure to substantially the same general harmful conditions.” The Harleysville v. South Carolina Court opined that in § 38-61-70, the legislature expanded the traditional definition of occurrence to also mandate the inclusion of faulty workmanship.

The effect of the opinion is likely limited to pre-May 17, 2011, policies which contain a definition of occurrence more limited than the standard CGL policy definition of an accident, including continuous or repeated exposure to substantially the same general harmful conditions. If a policy contains that definition, an interpretation of the policy is subject to that provided by the Court in Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Company.

Claims Made vs Occurrence Liability Insurance Policies

Most casualty insurance policies (general liability, automobile, workers' compensation) pay for events that occur during the policy period. For example, an auto insurance policy will pay for an accident that occurs while the policy is in force.

Directors and officers liability insurance policies, professional liability and employment practices liability policies, however, pay for lawsuits filed during the policy period; the wrongful act could have occurred years before. Claims-made policies respond only when a suit is filed, or when a strong threat of a suit exist.

Occurrence policy: pays based on the date of the accident or occurrence.
Claims-made policy: pays based on the date of the lawsuit.

The downside of a claims-made policy comes if the policy is cancelled.

Example: A directors and officers liability insurance policy is put in force January 1, 2004, and is renewed in 2005 and 2006. In 2007, however, the insured decides to end the coverage, as the premium has increased. Six months later, a letter from an attorney arrives announcing a lawsuit for discrimination in hiring that occurred in 2006. No coverage. Although the policy was in force at the time of the alleged discrimination, the policy was not in force when the suit was filed.

The solution to the above problem is the extended reporting period feature found in claims-made policies. For an additional premium (paid at the time the policy is cancelled) coverage is extended for incidents that occurred during the policy period but for which no claim was filed until after cancellation.