Insurer Has Duty to Cover Contractor from Owner's Property Damage Claims Due to Defective Subcontractor Work

On January 23, 2017, Ohio’s Third District Court of Appeals ruled that an insurer has a duty to defend and indemnify a contractor against claims made by a project owner for property damage allegedly resulting from defective work performed by the contractor’s subcontractors.

See Ohio Northern Univ. v. Charles Constr. Serv., Inc., 2017 Ohio App. LEXIS 258 (Hancock Cty. Jan. 23, 2017).

In so holding, the Third District rejected the insurer’s argument that claims of defective work (regardless of who performed the work) were never covered under a commercial general liability (CGL) policy because “defective work” could not constitute an “occurrence.” The CGL insurer made this argument based on language from the Ohio Supreme Court’s 2012 opinion in

Westfield Ins. Co. v. Custom Agri Systems, Inc., 133 Ohio St. 3d 476, 2012-Ohio-4712.

In the case before the Third District, Ohio Northern University (the “Owner”) contracted with Charles Construction Services, Inc. (the “Contractor”) to build a new luxury hotel on the Owner’s campus. The Contractor, in turn, subcontracted most of the work to various subcontractors (the “Subcontractors”). After the project was completed, the Owner discovered evidence of water intrusion and moisture damage. When the exterior façade was removed, additional structural defects were discovered.

The Owner sued the Contractor, and the Contractor sued its Subcontractors. The Contractor’s insurer, The Cincinnati Insurance Company (the “Insurer”), intervened in the lawsuit, seeking a declaration that it had no obligation to defend or indemnify the Contractor. The trial court agreed, and granted summary judgment in favor of the Insurer. The Contractor appealed.

The Insurer and the trial court relied upon the following language from the Ohio Supreme Court’s 2012 decision in

Custom Agri: “[C]laims of defective construction or workmanship brought by a property owner are not claims for ‘property damage’ caused by an ‘occurrence’ under a commercial general liability policy.” 

Id. at ¶ 21. InCustom Agri, the Ohio Supreme Court was answering a question certified to it by the federal Sixth Circuit Court of Appeals. Thus, the Ohio Supreme Court did not consider all of the terms and conditions of the CGL policy, but rather only the provisions relevant to the certified question. In particular, the Ohio Supreme Court did not consider or analyze the “Products-Completed Operations Hazard” provisions.

The Third District agreed with the Owner and Contractor that the CGL policy did provide a defense and indemnity for the Owner’s claims of property damage resulting from Subcontractors’ defective work. In so holding, the Third District noted the following:

    • The Owner’s allegation was that the property damage occurred after the project was completed
  • The Owner alleged that the property damage was caused by the defective work of the Subcontractors (not defective work by the insured Contractor)
  • The exclusion for damage to property while the Contractor or Subcontractors were working did not apply because it only applied to damage caused while work was in progress
  • The exclusion for property damage caused by the Contractor’s work (i.e., “your work”) did not apply, because there was an exception to this exclusion that covered the Contractor’s work when it was performed by a Subcontractor
  • The Contractor paid supplemental premiums to obtain the “Products-Completed Operations Hazard” coverage

In short, the Third District concluded that the Insurer had an obligation to defend and indemnify the Contractor under the “Products-Completed Operations Hazard” provisions of the CGL policy because: (1) the property damage occurred after the project was completed, and (2) the claims involved property damage caused by work performed by the insured Contractor’s Subcontractors.

The Third District also noted that the Insurer’s interpretation of the CGL policy (that defective work could never constitute an occurrence) would render entire portions of the policy meaningless or unnecessary, which would violate fundamental rules of contract law. Likewise, under fundamental rules of contract law, any ambiguity is construed against the Insurer.

The Court also noted that if insurers did not want to insure this type of risk, they could remove the exception to the exclusion, which covers property damage when the work is performed by the insured’s subcontractors.

As can been seen from this discussion of coverage provisions, exclusions, and “exceptions to the exclusions,” questions of CGL insurance coverage are not easily analyzed or understood. Courts often disagree on the interpretation of such policies, and the change of a few words can make a huge difference in the determination of insurance coverage.

Regardless, owners, contractors and subcontractors should consider tendering any project-related claims to all potentially applicable policies, and they should carefully consider what the policy covers (and does not cover) when obtaining the insurance and agreeing to perform work on a project. In addition, any denial of insurance defense or indemnity should be carefully examined and contested where appropriate. Insurance policies are not designed to insure the contractor against its own defectively-performed work, but they are intended to cover other risks.