Tenth Circuit: General Contractor Entitled to Liability Coverage for Construction Defect by Subcontractor

As per George A. Fuller Co. v. United States Fid. & Guar. Co., 200 A.D.2d 255 (1st Dep't 1994)*, New York courts have long held that damage to a contractor's own work product caused by a construction defect does not constitute a covered "occurrence" under standard commercial general liability insurance policies. This rule is based in part on policy exclusions for such damage, typically referred to as the "Your Work" exclusion.

Recently, however, the US Court of Appeals for the Tenth Circuit (which hears appeals from Kansas, Oklahoma, New Mexico, Wyoming, and Utah), held in a 2-1 decision that under New York law, a general contractor was entitled to coverage for damage to its work product caused by one of its subcontractors because the policy at issue contained an exception to the Your Work exclusion for damage arising from a subcontractor's careless work (referred to as the "Subcontractor Exception," see Black & Veatch Corporation v. Aspen Insurance (UK) LTD; Lloyd's Syndicate 2003, 882 F.3d 952 (10th Cir. 2018). The Tenth Circuit's decision is not binding upon the New York courts.

In Black & Veatch, a construction company was hired to build several jet bubbling reactors, which are used to clean exhaust from coal-fired power plants. Black & Veatch subcontracted with Midwest Towers, Inc. for internal components of the reactors. However, Midwest Towers' work caused the internal components to deform, crack, and even collapse. As a result of the defective work, Black & Veatch ultimately paid over $225 million to repair and replace the internal components of the reactors and sought insurance coverage for the costs of repairs and replacements.

The policy at issue contained a standard insuring agreement and Your Work exclusion, which excluded coverage for property damage to Black & Veatch's own completed work. The exclusion contained a Subcontractor Exception, which provided that the exclusion did not apply if the damaged work or the work out of which the damage arose was performed on Black & Veatch's behalf by a subcontractor.

Black & Veatch recovered $3.5 million from its primary insurer and sought recovery of $72 million from its excess insurer, which denied coverage. Black & Veatch sued the excess insurer, and on cross-motions for partial summary judgment, the US District Court for the District of Kansas ruled in favor of the insurer, holding that damage arising from construction defects was not an "occurrence," as defined by the Aspen Policy, unless the damage happened to something other than Black & Veatch's work (i.e., the reactors). The court, noting the policy contained a provision for New York law to apply to all coverage disputes, relied heavily upon the Fuller decision in ruling for the excess insurer.

On appeal, the Tenth Circuit reversed and held that Black & Veatch was entitled to coverage. Significantly, the court acknowledged that there appear to be differing decisions by state courts in New York as to whether the rule in Fuller remains good law. Nevertheless, the Tenth Circuit predicted, despite a one-judge dissenting opinion, that the New York Court of Appeals would hold that the subject damage from faulty subcontractor work triggers coverage under the policy. The Tenth Circuit differentiated Fuller based on, among other things, the fact that the policy at issue in Fuller did not contain the Subcontractor Exception.

The dissenting opinion pointed to the general rule in New York (as stated in Fuller) that standard commercial general liability policies do not cover construction defects to an insured's own work, whether or not the defects are caused by the insured or its subcontractors, and the fact that New York's intermediate appellate courts have upheld this rule. The dissent argued that since there is a debate as to the clarity of New York law, the Tenth Circuit should certify the question to the New York Court of Appeals for an answer.

The Tenth Circuit's interpretation of a policy governed by New York law veers from New York's general rule that damage caused by construction defects are not covered by commercial general liability policies, as such damage does not constitute an "occurrence," and would not be binding upon the New York courts. It should be noted that Black & Veatch's insurer filed a petition to the Tenth Circuit for reconsideration and requested all of the judges of the court to rehear the appeal, as opposed to a three-judge panel. That petition was denied on March 9, 2018.

Illinois Court: No Bad Faith by Insurer if Bona Fide Dispute Over Coverage

Recently, an Illinois appellate court held that an insurer cannot be held liable for bad faith where there is a bona fide dispute concerning coverage, even if the court later rejects the insurer's position (see Dominick's Finer Foods v. Indiana Ins. Co., 2018 IL App (1st) 161864, ¶ 8 (First District, Fourth Division March 1, 2018 -- supermarket entitled to coverage for premises-liability claim arising from parking lot shooting). The court's holding is consistent with the rule in many states.

Meet the Team

This Legal Alert was written by Stacy A. Marris and edited by Sanjeev Devabhakthuni. Stacy is a junior associate in Barclay Damon LLP's Insurance Coverage and Regulation Practice Area. Sanjeev is a senior associate in the firm's Insurance Coverage and Regulation, Torts and Products Liability Defense, and Professional Liability Practice Areas.

* Anthony J. Piazza, who is Chair of Barclay Damon LLP's Insurance Coverage and Regulation Practice Area, represented the prevailing party in the Fuller case.