Interpreting Kentucky law, the Sixth Circuit determined that the contractor who failed to complete a project was entitled to a defense in an action brought by its performance bond carrier. Phoenix Ins. Co., et al. v. Wehr Constructors, Inc., 2025 U.S, App. LEXIS 9258 (6th Cir. April 18, 2025).
Wehr entered into a contract with St. Claire Medical Center to construct a Medical Services Pavilion as an addition to the main hospital facility. A standard form issued by the American Institute of Architects, AIA document form A101-1997, was used. (Construction Agreement). Section 14.2 of the form contained a termination clause that allowed St. Claire to terminate the contract if Wehr committed a "substantial breach," provided that the architect on the project certified that sufficient cause existed (the Termination Clause). If the Termination Clause was invoked, Wehr would not be entitled to the remaining unpaid balance of the contract and St. Claire could seek damages from Wehr if the cost of completing the project exceeded the unpaid balance.
Wehr secured a performance bond for the project from Travelers Surety. The bond obligated Travelers Surety to complete the project if Wehr failed. to satisfactorily perform under the Construction Agreement. Under Kentucky law, Travelers Surety could recover from Wehr any amount that Travelers Surety paid to satisfy Wehr's liability or debts on the project.
Problems arose. St. Claire claimed Wehr missed deadlines, neglected to complete required inspections, and failed to properly supervise the subcontractors on the project. This resulted in defects to the building's facade, air and moisture barrier, floor tiling, and fire-stopping mechanism. Mold conditions were present in the entire facility.
St. Claire requested that the project architect certify that Wehr had substantially breached the Construction Agreement. The architect agreed Wehr was guilty of a substantial breach of the Construction Agreement. The architect also determined that St. Claire was entitled to withhold the remaining $2.2 million balance of the contract and that, between the likely damages and unpaid liens on the project, "this could be a $10+ million problem." St. Claire then terminated the Construction Agreement.
Wehr requested coverage from insurers issuing three policies: (1) a general-commercial liability policy from Phoenix Insurance Company; (2) a professional liability policy from St. Paul Surplus Lines Insurance Company; and (3) an "umbrella" excess policy from Travelers Property Casualty Company of America (Travelers Property).
St. Ciaire sued Travelers Surety to enforce obligations under Wehr's performance bond. St. Claire did not name Wehr as a defendant and did not seek any relief from Wehr.
Travelers Surety moved for permissive joinder of Wehr to join Wehr as a party because Travelers Surety's obligation to perform under the bond was strictly dependent on whether Wehr breached the Construction Agreement. The district court granted the motion.
The insurers filed a declaratory judgment action requesting that the district court decide the parties' rights and obligations under the three insurance policies. Wehr filed a motion for partial summary judgment that Phoenix and St. Paul had a duty to defend Wehr in the St. Claire suit. The district court denied the motion . It held that Phoenix's duty to defend Wehr applied only to suites seeking damages directly against Wehr, meaning that the policy was not triggered by St. Claire's litigation. Although Wehr did not seek summary judgment against Traveler's Property, the district court decided Travelers Property also did not have a duty to defend Wehr. The parties stipulated that the insurers had neither a duty to defend nor a duty to indemnify Wehr. The stipulation preserved Wehr's right to appeal the district court's order. Wehr appealed.
On appeal, the Sixth Circuit noted that St. Claire asserted claims against Travelers Surety for property damages arising from Wehr's faulty construction. Under Kentucky law faulty construction did not constitute an "occurrence" if the poor workmanship was not an accident. Wehr argued that St, Claire's complaint fell into two categories: (1) Wehr's faulty workmanship on the addition that it contracted to build, and (2) consequential damages caused by that faulty workmanship to preexisting portions of the main hospital facility that were not involved in the project. St. Claire alleged there was "water condensation/mold damage to the preexisting hospital facilities that were not the subject of the work being performed."
Kentucky cases did not address whether there was no coverage for damages to building owned by the same property owner but separate from the construction project. This created an ambiguity meaning that the damages to the preexisting building alleged in St. Claire's lawsuit were the type of damages that might be covered by Phoenix's policy.
Nevertheless, Phoenix argued that its duty to defend was not triggered because the lawsuit that alleged the damages did not assert claims directly against Wehr. To comport with Wehr's reasonable expectations of coverage, the policy had to be interpreted to include a defense of suits alleging breaches by Wehr and in which Wehr was a party. Travelers Surety could recover from Wehr a judgment entered against Travelers Surety in the St. Claire litigation. The only opportunity that Phoenix had to meaningfully defend Wehr in this dispute was during the St. Claire litigation, even though no claims were directly asserted against Wehr. For these reasons, Phoenix had a duty to to defend Wehr in the St. Claire lawsuit once Wehr was joined as a party.
St. Paul's duty to defend, however, was not triggered because Wehr did not agree in the Construction Agreement to perform as the construction manager. The St. Paul policy covered losses if the named insured had agreed in a written contract to perform in the capacity of a construction manager.
Therefore, the court affirmed the district court's ruling regarding St. Paul, but reversed its decision regarding Phoenix. The district court's decision regarding Travelers Property was remanded for further proceedings on whether Travelers Property had a duty to defend.