No case has stirred the construction and insurance coverage community in Hawaii quite like Burlington Ins. Co. v. Oceanic Design & Constr., Inc. Together with the economic loss doctrine, this case, if followed in state courts, could signal the death knell for insurer participation in many construction defect cases and have a substantial and serious consequence on the construction industry.
Background
A standard CGL policy provides coverage typically when there is “bodily injury” or “property damage” that was caused by an “occurrence.” Whether a construction defect is an “occurrence” is a hotly contested issue, with a startling range of decisions and a relative lack of uniformity. Standard CGL policies define an “occurrence” as an accident, including continuous and repeated exposure to substantially the same general harmful conditions. The absence of a definition of “accident” has sprung a tremendous wave of litigation.
In interpreting whether a construction defect meets the definition of an “accident,” there appears to be three general lines of reasoning.
“No Coverage for Your Property” Analysis
First, an older majority of courts hold that a construction defect satisfies the “occurrence” requirement only if there is damage to “other property” aside from the contractor’s “own work.” The roots of these cases trace to the seminal case, Weedo v. Stone-E-Brick, Inc., a case involving a pre-1986 CGL policy. There, the court explained:
When a craftsman applies stucco to an exterior wall of a home in a faulty manner and discoloration, peeling and chipping result, the poorly-performed work will perforce have to be replaced or repaired by the tradesman or by a surety. On the other hand, should the stucco peel and fall from the wall, and thereby cause injury to the homeowner or his neighbor standing below or to a passing automobile, an occurrence of harm arises which is the proper subject of risk-sharing as provided by the type of policy before us in this case.
Courts drawing from Weedo typically refuse to find coverage when the injury is the insured’s own “faulty” work. Notably, Weedo, examined the typical exclusions contained in a CGL policy to reach its conclusion that damage to the contractor’s own work is not covered. Standard CGL exclusions that often apply to construction defect claims: Exclusion j (“Damage to Property”), Exclusion l (“Damage to Your Work”), Exclusion m (“Damage to Impaired Property or Property Not Physically Injured”), and Exclusion n (“Recall of Products, Work or Impaired Property”). These exclusions are commonly called the “business risk” exclusions.
Later courts adopted Weedo’s outcome but confused its rationale. These courts focused on the definition of an “occurrence” to explain why construction defects to the builder’s work were excluded, needlessly blurring the “business risk” exclusions and the definition of an “occurrence.” Problematically, concluding that faulty work is not an occurrence, rather than an business risk exclusion, courts may unnecessarily deny coverage when there may be applicable exception to the business risk exclusions. Thus, by failing to conduct a literal reading of the pertinent policy, these courts have incorporated a broad construction of the business risk exceptions into the definition of an “occurrence” regardless of the policy language itself.
Moreover, this reasoning does not follow from a straightforward interpretation of the word “accident.” No one can logically argue that damage to one’s own property/work is per se not an “accident,” and that conversely damage caused to another’s person’s property/work is per se an “accident.” In other words, this approach creates an artificial distinction between what is and what is not covered that is divorced from the meaning of an “occurrence” or an “accident.”
“No Coverage for Breach of Contract” Analysis
A second line of cases generally reasons that “[a] breach of contract cannot constitute an occurrence because there is no accident or fortuitous loss.” These courts appear to follow a series of California appellate decisions that focused on the underlying claims and held that no breach of contract allegation fell within the scope of coverage. In a nutshell, this line of reasoning focuses on the rationale that an insured should expect the natural and ordinary consequences of its own conduct. “[C]ourts adopting this approach deny coverage for such claims without regard to the express terms of any of the policy exclusions. Rather, they hold that because a construction contractor has control over the quality of its workmanship, claims for damages to the work caused by faulty workmanship do not constitute an ‘accident.”
A Hawaii federal district court case seemingly adopted this reasoning in WDC Venture v. Hartford Accident & Indemnity Company, and is illustrative. In WDC, a party sought indemnification for a complaint alleging, among other things, breach of contract and negligence. Adopting the reasoning stated in two cases, Stanford Ranch, Inc. v. Marlyand Cas. Co. and Toombs NJ Inc. v. Aetna Cas. & Sur. Co., the WDC court held that all of the underlying claims were premised on a contractual relationship. Next, the WDC court determined that it was “contrary to precedent and to public policy to allow indemnification for a breach of contract claim.”
To allow indemnification under the facts presented here would have the effect of making the insurer a sort of silent business partner subject to great risk in the economic venture without any prospects of sharing in the economic benefit. The expansion of the scope of the insurer’s liability would be enormous without corresponding compensation.
Ironically, the “wooden distinction” between underlying tort and breach of contract claims was later rejected by the California Supreme Court in Vandenberg v. Superior Court. Further, a reasonable layperson, cognizant that he or she is purchasing a “general liability” insurance policy, would not conclude such coverage term only refers to liability pled in tort, and thus entirely excludes liability pled on a theory of breach of contract . . . .
Moreover, the arbitrariness of the distinction between contract and tort . . . is evidence when we consider the same act may constitute both a breach of contract and tort . . . . Predicating coverage upon an injured party’s choice of remedy or the form of action sought is not the law of this state . . . .
The Vandenberg decision plainly overrules Stanford Ranch, Inc., which was one of the primary cases supporting the decision in WDC.
“Look to the Policy” Analysis
The third and more recent line of cases focuses on the express terms of the of the insurance contract, eschewing vaguer public policy arguments and distinctions between tort and contract claims, in favor of following contractual language.
American Family Mut. Ins. Co. v. American Girl, Inc. is illustrative. In this case, the Wisconsin Supreme Court held that there was coverage where a building was constructed on loose soil because of negligent advice by a soil engineering subcontract, resulted in “sinking, buckling, and cracking” of the building. First, the Wisconsin court noted that the threshold question was whether the claim was for “‘property damage’ caused by an ‘occurrence’ within the meaning of the CGL policies’ general grant of coverage. Answering in the affirmative, the Wisconsin court stated that the definition of “property damage” was “physical injury to tangible property” and that such damage had occurred where there was sinking, buckling, and cracking. Also, an “occurrence” was “an accident, including continuous or repeated exposure to substantially the same general harmful condition.” Because the damage to the building was caused by faulty advice by the soil engineering subcontractor, the damage was “accidental, not intentional or anticipated, and it involved the ‘continuous or repeated exposure’ to the ‘same general harmful condition.’” Thus, there was “property damage” caused by an “occurrence” as defined by the CGL policies.
Second, the Wisconsin court determined that the economic loss doctrine did not preclude coverage. The economic loss doctrine generally operates to confine contracting parties to contract rather than tort remedies for recovery of purely economic losses associated with the contract relationship. The doctrine does not determine insurance coverage, which turns on the policy language. That the property damage at issue here is actionable in contract by not in tort does not make it “non-accidental” or otherwise remove it form the CGL’s definition of “occurrence.”
Accordingly, the fact that claims sounded only in contract, rather than tort, did not operate to exclude coverage. Notably, the court then analyzed each of the business risk exclusions and determined that none applied. By remaining faithful to the contract language rather distinctions between contract and tort unexpressed in the contract, arguably American Girl yields a fairer result that gives the parties the benefit of their bargain.
Burlington
Recently, the Ninth Circuit Court of Appeals held that a CGL did not cover “disputes between parties in a contractual relationship over the quality of the work performed.” The facts of Burlington are relatively straight-forward. Oceanic Design & Construction, Inc. (“Oceanic”) was the named insured under a standard-form CGL policy issued by Burlington Insurance Company (“Burlington”). Oceanic contracted to build a single-family residence in Honolulu, Hawaii. Construction was completed, but not to the satisfaction of the homeowners. Oceanic filed suit against the homeowners for late payment. The homeowners counterclaimed alleging Oceanic had breached its contract by, inter alia, (1) failing to properly prepare the soils and/or foundation of the residence; (2) building a structure which was unable to support foreseeable loads; and (3) committing other acts and omissions amounting to misfeasance, malfeasance, and nonfeasance.
The Ninth Circuit Court of Appeals, attempting “to predict how the Hawaii Supreme Court would decide the issue[,]” framed the issue as whether Hawaii courts would recognize claims for a “negligent breach of contract.” The court noted that the Hawaii Supreme Court had previously held that allegations of an intentional breach of contract did not meet the definition of an “occurrence” so as to trigger a duty to defend.
Relying on Francis v. Lee Enters., Inc., which considered whether Hawaii recognized a tortious breach of an employment claim, the court determined Hawaii would not recognize a claim for a negligent breach of contract. Specifically, Hawaii law will not allow tort recovery in the absence of conduct that (1) violates a duty that is independently recognized by principles of tort law and (2) transcends the breach of the contract.
Applying Francis, the court concluded the homeowners’ “other acts” allegation could not be read to constitute an occurrence under Hawaii law. The counterclaim alleged Oceanic breached its contractual duty by constructing a residence substantially inferior to the standard of care and quality called for under the contract. Other than this “contractual duty,” the court believed there was no allegation of an “independent duty” that would support a negligence claim.
If Oceanic breached its contractual duty by constructing a substandard home, then facing a lawsuit for that breach is a reasonably foreseeable result. Our reading comports with the rational underlying a CGL policy . . . . Allowing recovery for disputes between parties in a contractual relationship over the quality of work performed would convert this CGL policy into a professional liability policy or a performance bond.
Thus in essence, the court held that claims that stemmed from or was related to a contract could not trigger coverage unless a specific and independent basis sounding in tort was alleged.
The court also rejected an argument that emotional distress could have been inflicted in the absence of a contractual relationship. Instead, the court observed but for the contractual relationship between Oceanic and the homeowners, the homeowners would not have a claim for negligent infliction of emotional distress. Thus it was not a covered occurrence under the policy.
Burlington equated “occurrence” to “negligence,” i.e., if there is no cause of action for negligence that is related to a breach of contract, then there cannot be an “occurrence.” The distinction between contract and negligence is not one drawn from the policy language. Hawaii has not traditionally focused on the tort/contract distinction but ratherhas asked whether the “injury” is “expected or reasonably foreseeable result of the insured’s own intentional acts or omissions.” In contrast, negligence is “[t]he failure to exercise the standard of care that a reasonably prudent person would have exercised in a similar situation[.]” In other words, one can have an “occurrence” or an “accident” even in the absence of any negligence (or negligent breach of contract). The contract/tort distinction is immaterial; the only real question is whether the injury was an expected or reasonably foreseeable result.
Burlington, if followed by state courts in Hawaii, would effectively deny coverage in virtually all construction defect claims brought in the state. Briefly, under the economic loss doctrine, in Hawaii, when a party is “in privity of contract . . ., economic loss damages are limited to contractual remedies, and a negligence action may not be maintained.” Hence, parties to a contract (as in most construction-related jobs) are limited to contractual remedies for economic loss and may not also avail themselves to tort remedies. In other words, the combined application of Burlington (no coverage for contractual claims) and the economic loss doctrine (only contractual remedies are permitted) would mean that there would be no coverage for any economic loss in the construction context. This result seemingly gives the CGL insured far less coverage than either the insurer or the insured intended.
