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Injury to building caused by negligent soil analysis may constitute occurrence under CGL that is not precluded by business risk exclusions or similar limitations on coverage.

American Family Mutual Ins. Co. v. West American Insurance Co., 673 N.W.2d 65 (Wisconsin Supreme Court--January 9, 2004)

Construction defect litigation has been in something of a boom period during the past 15 years, a phenomenon of no small consternation to homeowners, builders, insurers, and state legislatures. In addition to its overall costs to society, shoddy home construction and complex litigation resulting from housing problems also produces complex and costly insurance-coverage litigation. Commercial General Liability (CGL) insurers have attempted to minimize their exposure for these claims by generally arguing that they are not responsible for mere defects in housing but only for housing problems that cause classic third-party tort injury in the manner of a building collapse that injures bystanders or adjoining property. Builders seeking coverage (supported by plaintiff homeowners and associations seeking deeper defendant pockets) have argued, with significant but mixed success, that the CGL policy is indeed triggered by many allegations of shoddy construction so long as the poor construction causes physical injury to tangible property other than the errant contractor or engineer's own work.

In general, the insurer position against coverage has been losing ground in the courts. For example, in the key California case of Vanderberg v. Superior Court, P.2d (Cal. 1999), court rejected the extreme insurer position that a CGL policy need never respond unless the claim was legally styled as a tort. Rather, the matter is controlled by policy language, which provides for coverage when an "occurrence" causes injury or damage. No particular legal styling by plaintiff is required. In many other cases, CGL coverage has been found where the work of one subcontractor caused physical injury to other parts of a building or piece of property. In addition, many of the older cases finding no coverage because damage resulted from substandard work have been correctly held to have been "legislatively overruled" by the ISO's 1986 revision of the CGL to create an exception to the "own work" exclusion where the work is performed by a subcontractor of the policyholder.

The recent Wisconsin Supreme Court case of American Family Mutual Insurance Co. v. American Girl, Inc., 673 N.W.2d 65 (January 9, 2004) continues this trend and arguably clarifies it further in favor of policyholders, also finding coverage in the case of poor soil study that creates building problems. The analysis of the Court's majority opinion is thorough, appreciative of historical context, and properly applies the insights of secondary sources of policy meaning, making more use than most courts of treatise discussion (full disclosure: my treatise was one of those cited by the Court). Because it is a sound opinion from a state high court pertaining to an issue facing many courts in a new realm, it may have significant impact. However, American Family v. American Girl was also a 3-2 opinion in that two Justices did not participate. In addition, the two dissenting Justices enthusiastically embraced what might be regarded as the strong CGL insurer position against coverage, a factor that provides some solace for insurers and a potential source of citation and argumentation.

In 1994, Pleasant Company (which later changed its name to American Girl), entered into a contract with Renschler Company for the design and construction of a large distribution center warehouse near Interstate Highway 94 in central Wisconsin. To build the "94DC," Renschler, which held an American Family policy, hired Lawson, a soils engineer to assess soil conditions for construction. Finding the soil poor for these purposes, Lawson recommended "rolling surcharging" to prepare the soil for holding buildings. Renschler accepted Lawson's analysis and recommendation.

Rolling surcharging is not, as the name suggests, a new interest or late charge strategy used by credit card companies. Rather, it refers to the process of putting large quantities of earth on top of natural ground in order to firm up the natural ground so that it is solid enough and stable enough to support the weight of new construction. The "rolling" occurs as the earth used to compress the natural ground is moved throughout portions of the property so that the owner does not need to purchase, haul, and apply the massive quantities of earth required to surcharge an entire site simultaneously.

The rolling surcharge in question occurred comparatively rapidly as the building was substantially complete in August 1994, a fact that suggests to even laypersons that perhaps the soil had insufficient time to compact and solidify due to the surcharging. In any event, after American Girl occupied the building in Fall 1994, it soon began to sink. By Spring 1995, the settlement at one end of the structure was eight inches. Things deteriorated from there. By early 1997, the settlement "approached one foot" and the building was buckling, "steel supports were deformed, the floor was cracking, and sewer lines had shifted." See 673 N.W.2d at 71. American Family was notified in August 1997. By late 1999 or early 2000, settlement had reached 18 inches and the building was dismantled. It was "undisputed that Lawson's faulty soil engineering advice was a substantial factor in causing the settlement of the 94DC." See 673 N.W.2d at 72.

American Girl filed an arbitration claim against Renschler, prompting Renschler to request defense and coverage from American Family. American Family responded with a declaratory judgment action seeking a finding of no coverage. Renschler joined several other insurers in the declaratory judgment action. The trial court found coverage under the American Family policy. The intermediate Court of Appeals held that other insurers in for the 1997 and thereafter period were absolved from coverage because "the known loss doctrine precluded coverage, because the extent of the settlement problem was known before any of those policies carne into effect." See 673 N.W.2d at 72. As to American Family CGL policies from 1994 through 1997, the appeals court held that the contractual liability or "liability assumed by contract" provision of the policies precluded coverage since Renschler and Lawson had hold harmless agreements in the Lawson subcontract.

The Wisconsin Supreme Court reversed and found coverage, rejecting not only the contractual liability exclusion defense of American Family but also rejecting several other American Family defenses to coverage. The Court began with a review of the history of the CGL and its business risk exclusions (the "your work," "your product," and "your property" exclusions), including the 1986 revision that created the subcontractor exception to the "your work" exclusion. See 673 N.W.2d at 73. The Court also found that the "economic loss" doctrine limiting contract claimants to contract damages rather than tort damages (e.g., pain and suffering, punitive damages) did not operate to preclude insurance coverage in cases of this type. The Court observed that
 The economic loss doctrine generally precludes recovery in tort for
 economic losses resulting form the failure of a product to live up
 to contractual expectations. The economic loss doctrine is "based
 on an understanding the contract law and the law of warranty, in
 particular, is better suited than tort law for dealing with purely
 economic loss in the commercial arena."

 The economic loss doctrine operates to restrict contracting parties
 to contract rather than tort remedies for recovery of economic
 losses associated with the contract relationship. The economic loss
 doctrine is a remedies principle. It determines how a loss can be
 recovered--in tort or in contract/warranty law. It does not
 determine whether an insurance policy coverages a claim, which
 depends instead upon policy language.

 To the extent that American Family is arguing categorically that a
 loss giving rise to a breach of contract or warranty claim can
 never constitute "property damage" within the meaning of the CGL's
 coverage grant, we disagree.

See 673 N.W.2d at 75 (citations omitted, quoting Daanen & Janssen, Inc. v. Cedarapids, Inc., 216 Wis. 2d 395, 403-04, 573 N.W.2d 842 (1998), emphasis the Court's).

The American Family v. American Girl Court also rejected the insurer argument that the loss did not result from an "occurrence" since the loss had its roots in volitionally provided engineering services rather than happening because of the application of external forces or through the activities of persons outside the distribution center business project. According to the Court.
 No one seriously contends that the property damage to the 94 DC was
 anything but accidental (it was clearly not intentional), nor does
 anyone argue that it was anticipated by the parties. The damage to
 the 94 DC occurred as a result of the continuous, substantial, and
 harmful settlement of the soil underneath the building. Lawson's
 inadequate site-preparation advice was a cause of this exposure to
 harm. Neither the cause nor the harm was intended, anticipated, or
 expected. We conclude that the circumstances of this claim fall
 within the policy's definition of "occurrence."

See 673 N.W.2d at 76 (footnote omitted). Added the Court
 We agree that CGL policies generally do not cover contract claims
 arising out of the insured's defective work or product, but this is
 by operation of the CGL's business risk exclusions, not because a
 loss actionable only in contract can never be the result of an
 "occurrence" within the meaning of the CGL's initial grant of
 coverage. This distinction is sometimes overlooked, and has resulted
 in some regrettably overbroad generalizations about CGL policies in
 our law case.

 [T]here is nothing in the basic coverage language of the current CGL
 policy to support any definitive tort/contract line of demarcation
 for purposes of determining whether a loss is covered by the CGL's
 initial grant of coverage. "Occurrence" is not defined by reference
 to the legal category of the claim. The term "tort" does not appear
 in the CGL policy.

See 673 N.W.2d at 76-77 (footnotes omitted).

In reaching this result, the Wisconsin Court specifically found that neither the widely cited business risk case of Weedo v. Stone-E-Brick, Inc., 81 N.J. 233, 405 A.2d 788 (N.J. 1979) or Professor Henderson's famous article (Roger Henderson, Insurance Protection for Products Liability and Completed Operations: What Every Lawyer Should Know, 50 NEB. L. REV. 415, 441 (1971)) state that claims for property damage due to breach of contract can never be a CGL "occurrence." See 673 N.W.2d at 77. In similar fashion, the American Family v. American Girl Court also found that the damage to the distribution center was not "expected or intended" by Renschler or Lawson. See 673 N.W.2d at 79.

As to the contractual liability exclusion, the Court again rejected the insurer's argument, finding that no coverage obtained because the liability exposure of the general contractor and soil engineer was liability it would have faced regardless of any contract provisions and hence was not gratuitously assumed by the policyholder. See 673 N.W.2d at 79-80. Quoting a major insurance treatise, the Court noted that
 Although, arguably, a person or entity assumes liability (that is, a
 duty of performance, the breach of which will give rise to
 liability) whenever one enters into a binding contract, in the CGL
 policy and other liability policies an "assumed" liability is
 generally understood and interpreted by the courts to mean the
 liability of a third party, which liability one "assumes" in the
 sense that one agrees to indemnity or hold the other person

See 673 N.W.2d at 80, quoting ERIC MILLS HOLMES, HOLMES' APPLEMAN ON INSURANCE Section 132.3 at pp. 36-37. Rather, the contractually assumed liability that precludes CGL coverage "refers to a specific contractual assumption of liability [that would otherwise not exist] by the insured as exemplified by an indemnity agreement." See 673 N.W.2d at 81, citing Holmes [section] 132.3. According to the Court, this view is
 Consistent with the general purposes of liability insurance because
 it enables insurers to enforce the fortuity concept by excluding
 from coverage any policyholder agreements to become liable after the
 insurance is in force and the liability is a certainty. Limiting the
 exclusion to indemnification and hold-harmless agreements furthers
 the goal of protecting the insurer from exposure to risks whose
 scope and nature it cannot control or even reasonably foresee. The
 relevant distinction "is between incurring liability as a result of
 a breach of contract and specifically contracting to assume
 liability for another's negligence."

See 673 N.W.2d at 81, quoting Olympic, Inc. v. Providence Washington Ins. Co., 648 P.2d 1009, 1011 (Wash. 1982) and citing JEFFREY W. STEMPEL, LAW OF INSURANCE CONTRACT DISPUTES Section 14.14 p. 14-141 (2d ed. 1999 & Supp. 2003).

The American Family v. American Girl Court also rejected the business risk defenses to coverage, finding that the injuries claimed by American Girl due to construction problems did not stem from mere dissatisfaction with Renschler's resulting building product but instead were for damages caused to American Girl's property due to injuries inflicted by the defective construction and soil preparation. Although much of the injuries claimed by American Girl were because of damage to the policyholder's "own work" in building the distribution center, the Court found that the clear language of the policy, provides coverage through an exception to the "your work" exclusion when "the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor." See 673 N.W.2d at 82-83. In adopting this view, the American Family v. American Girl Court embraced the analysis of two leading cases in the area, Kalchthaler v. Keller Construction Co., 224 Wis. 2d 387, 591 N.W.2d 169 (Ct. App. 1999) and O'Shaughnessy v. Smuckler Corp., 543 N.W.2d 999 (Minn. Ct. App. 1996). The Court observed that
 This interpretation of the subcontractor exception to the business
 risk exclusion does not "create coverage" where none existed before,
 as American Family contends. There is coverage under the insuring
 agreement's initial coverage grant. Coverage would be excluded by
 the business risk exclusionary language, except that the
 subcontractor exception to the business risk exclusion applies,
 which operates to restore the otherwise excluded coverage.

See 673 N.W.2d at 83.

The dissenting Justices argued (quite erroneously in my view) that the American Girl claim against contractor Renschler was not covered because it sounded in contract rather than tort and because it resulted from intentionally undertaken activity (the building project). Much of the position of the dissenting Justices on these issues is clearly outside the mainstream views of courts and commentators (although it was, nonethless reflective of 40 percent of the participating Supreme Court's view on the subject). Regarding the role of business risk exclusions, the dissent argued a position less outside the mainstream in contending that there should be no coverage because coverage under the circumstances would run counter to the "purpose of a CGL policy." According to dissenting Justice Roggensack, the CGL policy
 is written to cover the risks of injury to third parties and damage
 to the property of third parties caused by the insured's completed
 work. It is not written to cover the business risk of failing to
 provide goods or services in a workmanlike manner to the second
 party to the contract.

See 673 N.W.2d at 92 (citations omitted).

Although this statement is generally true, it fails both to appreciate that the degree of misfeasance by a contracting party can do more than fall below acceptable standards of workmanship, it can also cause collateral covered damage (e.g., to other property, cessation of business operations and lost profits) that might be covered under a CGL policy. More important, this portion of the Dissent appears to completely overlook both the 1986 addition of the subcontractor exception to the your work exclusion (the Dissent's passage quoted above cited a pre-1986 case applying now-outdated CGL language) and overlooks the degree to which the subcontractor exception restoring coverage is consistent with the fortuity concept and the purpose of the CGL.

Poor workmanship is generally not covered under a CGL because this strips the contractor policyholder of the incentive it should have to perform a job well. Although the subcontractor exception arguably also reduces contractor incentive to supervise subcontractors, it also recognizes the business realities of a construction project. Even the best general contractor and policyholder cannot reexamine everything done by a subcontractor. This would add great cost to building projects. Imagine a general contractor going over every inch of electrical wiring or every plumbing connection in a large home, warehouse, or factory. As a practical matter, the general contractor to a large degree is at the mercy of its subcontractors just as the homeowner or business is at the mercy of a general contractor.

Under these circumstances, it is appropriate to spread the risk of construction problems causing physical injury and damage through insurance, which allows for risk distribution and pooling and financing of this aspect of modern construction through premium payments imposed on builders (and customers as the premium payments are undoubtedly passed on through higher construction prices). If a general contractor/policyholder chronically chooses poor subcontractors, the insurance industry has implicitly decided that this should be addressed by refusing to provide insurance to the builder or raising its premiums rather than precluding coverage for damage caused by subcontractor's work. In the alternative, individual insurers such as American Family could remove the subcontractor exception to the your work exclusion, although they appear to have declined to do so.

Jeffrey W. Stempel

University of Nevada, Las Vegas
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Title Annotation:Recent Court Decisions; Commercial General Liability
Author:Stempel, Jeffrey W.
Publication:Journal of Risk and Insurance
Geographic Code:1USA
Date:Jun 1, 2004
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