Wisconsin Court of Appeals Issues Two Important Insurance Coverage Decisions

The Wisconsin Court of Appeals recently released two significant decisions affecting insurance coverage in construction defect cases.

The first, and more significant decision, Kalchthaler v. Keller Construction Company, discussed the products-completed operations hazard (PCOH) and the exception to the "property damage to work" exclusion for work performed by a subcontractor. The court held, for the first time in Wisconsin, that under circumstances the CGL policy may become virtually a performance bond.

Keller was the insured and acted as general contractor for the construction of an apartment complex for the elderly. All the work was contracted out to subcontractors. After the completion, the building leaked and caused substantial water damage to the interior. Keller's insurer (Aetne) for some reason stipulated that at least 50 percent of the responsibility for the damage could be allocated to Keller based on negligence of its subcontractors and Keller's negligent supervision of the subcontractors. This stipulation may have become virtually a performance bond.

The Court began its opinion by addressing Aetna's contention that faulty workmanship is not an "accident" and, therefore, not an "occurrence". The court rejected this and adopted the "unfortunate event" definition of an accident, citing Webster's Third New International Dictionary:

"An accident is an 'event or change occurring without intent or volition through carelessness, unawareness, ignorance, or a combination of causes and producing an unfortunate result.'"

Under this definition, when the windows leaked, it was an accident.

Having passed this hurdle, the Court then confronted the familiar exclusion which denies coverage to property which must be "restored, repaired or replaced because 'your work' was incorrectly performed on it." Although the Court acknowledged this language would exclude coverage, it held that the completed apartment building unquestionably fell with the PCOH and, therefore, coverage was restored under the exception to the exclusion. Aetna made the interesting argument that the windows were defective when they were installed and, therefore, the damage did not occur after the work had been completed but rather during the work. The Court rejected this argument as "strained".

It then addressed Aetna's second exclusion--the standard CGL provision which excludes property damage to "your work". However, most post-1986 CGL policies, such as Aetna's, contain an exception to this exclusion if the damaged work "was performed on your behalf by a subcontractor".

The Court noted that most pre-1986 cases upholding the work exclusion were probably now irrelevant. It then made the following chilling observation that on construction projects such as this, where most or all of the work is performed by subcontractors, there is insurance coverage for virtually everything:

"For some reason, the industry chose to add the new exception to the business risk exclusion in 1986 . . . We realize that under our holding a general contractor who contracts out all the work to subcontractors, remaining on the job in merely supervisory capacity, can ensure complete coverage for faulty workmanship. However, it is not our holding that creates this result: it is the addition of the new language in the policy. We have not made the policy close to a performance bond for general contractors, the insurance industry has."

This is a significant decision on insurance coverage. These two common exclusions, upon which coverage and the duty to defend were often precluded, may now be lost, creating on the one hand, traps and pitfalls for the CGL carrier, and on the other hand, new and interesting subrogation possibilities for commercial property carriers. The court did not address the "impaired property" exclusion and insurers faced with this fact situation should concentrate their efforts on attempting to exclude coverage under that language, if available.

The second decision (released the same day) is Jacob v. Russo Builders. This clarified the types of damage which will and will not be covered in a construction defect case.

In that action, Limbach Construction Company was the mason subcontractor who performed defective masonry work on the plaintiff's residence. The jury found the subcontractor causally negligent and awarded $200,000 in damages, including $110,000 for repairing the insured's brickwork; $9,800 in interior damage to the home; $5,000 to rip out and restore the landscaping in order to replace the bricks; expert witness fees of $5,000; relocation expenses of $3,000; refinancing costs of $8,000; and loss of use and enjoyment of $50,000.

All parties agreed at the outset--and the Court of Appeals joined in stating--that the CGL policy did not provide coverage for the cost of repairing or replacing the insured's defective work. The issue was which of the other damages were covered.

The Court rejected the insurer's argument that any coverage for the insured's defective work would turn the insurance policy into a "performance bond," and noted that there were damages to things other than the insured's work which is normally covered under the CGL policy. It agreed, however, that any damages incurred solely to repair the insured's defective work would not be covered. This meant that ripping out and restoring the landscaping, driveway, sidewalk and patio would not be covered under the policy because they were not injured or destroyed by the insureds defective work but were only destroyed later when the insured's defective work was repaired. Other damages which were directly caused by the insured's defective work were covered. These included relocation costs, temporary repairs, repairs to the interior of the residence, and loss of use and enjoyment of the residence.

The court could not decide, however, on an area of damages which it called a "gray" area and therefore remanded these damages for further consideration by the trial court. These included financing costs and expert fees to determine the cause of the damage. Presumably, on remand, the focus will be whether the insured's faulty work actually caused these damages, or whether they were incurred solely to repair or restore the insured's defective work.

In rendering this opinion, the Court expanded those categories of damages which creative plaintiff's lawyers may now seek in construction defect cases. These two decisions together, unless reversed by the Supreme Court, will increase the potential exposure of CGL carriers who insure those general contractors who subcontract all or a significant portion of their work, while at the same time creating subrogation "deep pockets" for commercial property carriers.

Copies of these decisions, or questions pertaining to insurance coverage issues in general may be requested from or referred to Jim Mohr at Mohr & Anderson, S.C.