The Scope of Insurance Coverage for Defective Construction

posted by Michael Fortney  |  Nov 1, 2012 11:36 AM in Construction Law

The Ohio Supreme Court issued a decision on October 16, 2012 in Westfield Insurance Co. v. Custom Agri Systems, Inc. solidifying the law in Ohio that coverage does not exist for claims of defective construction under a commercial general liability policy where the claimed damages are limited solely to the defective construction.  The Ohio Supreme Court did not specifically address whether claims of consequential damage resulting from defective construction are excluded from coverage.

The underlying dispute in that case was a contractual dispute between the Project Owner and the general contractor the Owner hired to build an animal feed manufacturing plant.  The Project Owner filed claims against the general contractor based on quality of materials and workmanship issues.  The general contractor in turn filed a third-party complaint against its subcontractor, Custom Agri Systems, Inc. (“Custom Agri”), seeking  for contribution based on the allegations of the Project Owner’s claims.  Custom Agri sought defense and indemnity from its insurer, which intervened and sought a declaration of its duty to defend and indemnify.

Specifically, the Project Owner alleged that the design of the bin was defective because the discharge openings were too small to allow discharge of the requisite volume of product.  Furthermore, the Project Owner claimed that the defectively-designed bin discharge openings caused asymmetrical flow channels, resulting in damage to the top edge and roof of the bin.  As such, the Project Owner was complaining only that the bin was defectively designed and that operation of the bin caused physical damage to the bin itself.

The district court concluded that coverage to Custom Agri was excluded by the insurance policy's exclusions.  As part of the appeal of that coverage decision, the Ohio Supreme Court was asked to determine whether claims of defective construction/workmanship brought by a property owner are claims for “property damage” caused by an “occurrence” under a commercial general liability policy?  The Ohio Supreme Court answered the question in the negative, concluding that “claims for faulty workmanship, such as the one in the present case, are not fortuitous in the context of a CGL policy like the one here.”

Central to the Ohio Supreme Court’s decision was whether the damage was caused by an “occurrence,” which was defined by the commercial general liability policy as an “accident, including continuous or repeated exposure to substantially the same general harmful conditions.” 

In defining the ordinary meaning of “accident,” the Ohio Supreme Court looked to a Kentucky  decision which held that “Inherent in the plain meaning of ‘accident’ is the doctrine of fortuity.  Indeed, ‘[t]he fortuity principle is central to the notion of what constitutes insurance[.]'”   Regarding the concept of fortuity, the Court found the following holding from the Eleventh District analysis in JTO, Inc. v. State Auto Mut. Ins. Co. instructive:

Insurance coverage is bottomed on the concept of fortuity. Applying this rule in the construction context, truly accidental property damage generally is covered because such claims and risks fit within the statistical abstract. Conversely, faulty workmanship claims generally are not covered, except for their consequential damages, because they are not fortuitous. In short, contractors' 'business risks' are not covered by insurance, but derivative damages are. The key issues are whether the contractor controlled the process leading to the damages and whether the damages were anticipated.


Coverage analysis largely turns on the damages sought.  If the damages are for the insured's own work, there is generally no coverage. If the damages are consequential and derive from the work the insured performed, coverage generally will lie. The underwriting intent is to exclude coverage for the contractor's business risks, but provide coverage for unanticipated consequential damages."

While it is clear that claims of defective construction causing damage solely to the defective construction itself are not covered by insurance, the scope of the Ohio Supreme Court's decision in Custom Agri Systems remains to be determined and refined by future court decisions.   

For example, the Ohio Supreme Court endorsed the decision in JTO, Inc., which concluded that consequential damages that derive from the work the insured performed are covered.  The contractor's defective work that caused water infiltration in that case was not an insurable “occurrence,” but the costs incurred to repair damages caused by the water infiltration were consequential damages that did constitute an insurable “occurrence.”  See also Heile v. Herrmann (also cited by Custom Agri Systems) (finding that a homeowner’s claims of defective workmanship that did not allege consequential damages stemming from that work was not an “occurrence”).

Cases in which defective construction causes damage to third-party property, work other than the work of the contractor, or other non-defective construction may still be covered by a contractor's commercial general liability policy.  As such, coverage claims should still be made by contractors and owners in cases alleging consequential damages caused by defective construction and counsel experienced in construction insurance claims should be consulted to determine the scope of coverage and the applicability of exclusions to coverage.  Contractors and owners should further look to include and enforce additional insured provisions in their construction contracts and consider whether a performance bond is appropriate for the contemplated contract work as additional protection against defective construction.


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