Insurance procured by contractors and owners is never intended to cover the risk of defects in design or workmanship, but depending upon the wording of the particular policy purchased, damage to the work that follows as a result of defective design or workmanship might be covered.
In RLI Ins. Co. v. Willbros Const., LLC, 2011 U.S. Lexis 115100, a pipeline contractor constructing a natural gas pipeline hired a subcontractor to perform directional boring for the pipeline under a river. The subcontractor was responsible for performing the boring work and for installing the pipeline within the limits of the bore tunnel. When the subcontractor completed the boring work and began pulling the pipe under the river, it damaged the pipe and the entire work had to be abandoned in place.
Because the prime determined that the subcontractor’s boring work was defective, it required the subcontractor to perform a second bore alongside of the first. However, believing the cost of the prime contractor-supplied pipe was an insurable loss, the prime filed a claim under its Commercial General Liability (CGL) policy for $1,567,530.09. In response to the claim, the insurer filed a declaratory judgment action in federal court against the prime contractor seeking a ruling that the loss was not covered by the policy.
In a motion aimed at disposing of the entire case, the insurer argued that the cause of the loss was defective work performed by a subcontractor, and it cited the Defects, Errors, and Omissions language in the policy that expressly excludes the loss. The provision states that:
We do not pay for loss caused by:
1. An act, defect, error or omissions (negligent or not) related to:
- a) Design or specifications;
- b) Workmanship or construction; or
- c) Repair, renovation or remodeling
2. A defect, weakness, inadequacy, fault or soundness in materials.
The insurer relied upon Exclusion 1-b above and argued that the damage to the pipe was the result of faulty workmanship and, specifically, the manner in which the subcontractor performed the boring work.
The prime contractor, on the other hand, argued that even if the subcontractor’s boring work was faulty, the loss is nevertheless covered. The prime emphasized the distinction between costs of correcting the faulty work, which it agreed was not covered pursuant to Exclusion 1-b, and damage caused by faulty work, which it contended was covered in accordance with an exception to that exclusion. In particular, the prime contractor pointed to a sentence following the exclusionary language cited by the insurer, which states, “[but] if a defect, error, or omission described above results in a covered peril, we do cover the loss or damage caused by that peril.”
For purposes of the insurer’s motion, the court assumed that the subcontractor performed defective boring work. It held, however, that even so, the cost of replacing the pipe damaged by that boring work fell within the exception the prime contractor cited. This decision held up on appeal.
The language the prime contractor cited in the RLI Insurance case is commonly referred to as an “Exception to an Exclusion,” and often follows exclusionary language applicable to defects in design and workmanship. CGL and Builder’s Risk policies vary in how defects in design and workmanship are addressed. All such policies exclude the cost of making good or repairing work that was either designed or constructed in a faulty manner. The variance in coverage occurs with respect to whether damage resulting from a defective design or defective workmanship is similarly excluded. An example of language clearly excluding all damages associated with a defective design or workmanship is as follows: “We will not pay for loss caused by or resulting from faulty, inadequate or defective design, specifications, workmanship, repair, construction, renovations, remodeling, grading or compaction.”
Contractors should always review CGL and Builder’s Risk policies that cover their projects. When procuring a policy, contractors should obtain pricing for both types of policies and should conduct a cost-benefit analysis before deciding which policy to purchase. Similarly, project management personnel need to be familiar with these policies so that opportunities to recover such losses are not overlooked.