Insurance Law Hawaii

Hawaii Court Finds No Bad Faith, But Negligent Misrepresentation Claim Survives Summary Judgment in Construction Defect Action

   Judge Mollway, U.S. District Court Judge for the District of Hawaii, found the insurer was not in bad faith for allegedly leading its insured to believe that construction defects would be covered under the policy. The court, however, allowed the insured's negligent misrepresentation claim to survive summary judgment. Ill Nat'l Ins. Co v. Nordic PCL Constr., 2013 U.S. Dist. LEXIS 151748 (D. Haw. Oct. 22, 2013).

   The insurer denied coverage when Nordic was sued for construction defects related to its construction of two Safeway stores in Honolulu. Prior to the issuance of the policies the Ninth Circuit had issued its opinion in Burlington Ins. Co. v .Oceanic Design & Constr., Inc., 398 F.3d 940 (9th Cir. 2004), which predicted that Hawaii appellate courts would rule that construction defects were not "occurrences." Nevertheless, Nordic's witnesses contended when the policies were purchased, they believed construction defects were covered. Specifically, Nordic thought the policies provided completed operations coverage for property damage arising out of Nordic's subcontractors' work. 

   Nordic further contended that only after the Hawaii Intermediate Court of Appeals decided in Group Builders, Inc. v. Admiral Ins .Co., 123 Haw. 142 (Haw. Ct. App. 2010) that construction defect claims did not constitute an "occurrence" did the insurer change its position and decide the policies did not cover construction defects. 

   The insurer now sought dismissal of Nordic's counterclaim for bad faith denial of coverage based on the insurer's reliance upon intervening case law. The insurer argued that under Act 83, implemented by the Hawaii legislature after Group Builders, it had to consider the Burlington decision, which was issued before the policies were entered. The court held that, even assuming the insurer believed that the policies covered property damage caused by subcontractors' defective work, the insurer did not act in bad faith. The insurer provided Nordic with a defense subject to a reservation of rights and filed a declaratory relief action for a ruling that there was no coverage under the policies given the Burlington decision. 

   Nordic's counterclaim also alleged negligent misrepresentation because the insurer knew that Nordic expected the policies to cover claims for property damage arising out of their subcontractor's work. Nordic argued that even after Burlington was decided in 2004, insurers routinely defended and settled claims regarding property damage arising out of subcontractors' work. Further, the premium charged for additional coverage for subcontractors' work indicated there was such coverage. The court agreed with Nordic and denied the insurer's motion for summary judgment on this counterclaim.

   Finally, the court also denied the insurer's summary judgment motion for dismissal of Nordic's claim for reformation of the policies. Nordic alleged there was a mutual mistake as to whether the policies covered claims that both parties believed were covered. Nordic introduced evidence demonstrating that insurers in general were covering such claims and suggesting that the insurer did not initially intend to deny coverage based on Burlington. Under these circumstances, a reasonable jury could infer that, at the time the policies were issued, the insurer meant to cover claims arising out of the defective work of Nordic's subcontractors. 

Judge Kobayashi Determines No Coverage for Construction Defect Claim

   Judge Kobayashi of the U.S. District Court, District of Hawaii, largely followed earlier precedent established by Judge Mollway in finding no coverage for construction defect claims. See Evanston v. Nagano, 2012 WL 3800320 (D. Hawaii Aug. 31, 2012).

   Evanston issued several liability policies to the insured contractor from 2002 and 2011. The insured entered a contract to build a residence in Honolulu. The homeowners were not happy with their home after the work was completed. They filed suit, alleging that the project was delayed and the construction was "riddled with defects." The complaint included claims for breach of contract and breach of warranties. Negligence was not alleged. Evanston defended, but under a reservation of rights. 

   Evanstonfiled suit for a declaratory judgment and moved for summary judgment. It argued that the underlying complaint alleged numerous breaches of the contract and numerous defects in the construction of the home, but did not allege negligence. Evanston noted that all of the underlying claims arose from the insured's intentional conduct.

   The insured argued that Act 83 meant the court must look to Hawaii case law at the time the policies were issued. The Act stated, in part, "the meaning of the term 'occurrence' shall be construed in accordance with the law as it existed at the time that the insurance policy was issued." The insured further argued that Hawaii case law at the time the policy was issued favored coverage.

   The court agreed with Evanston. The operative case law when the policies were issued were those relied upon by the Ninth Circuit in Burlington Ins. Co. v. Oceanic Design & Constr. Inc., 383 F.3d940, 946 (9th Cir. 2004) and Group Builders, Inc. v. Admiral Ins. Co., 123 Haw. 142, 148-49, 321 P3d 67, 73-74 (Haw. Ct. Appeal 2010). These cases led Burlington and Group Builders to conclude that construction defects did not arise from an occurrence, but from a breach of contract, meaning there was no coverage.

   The insured urged the court to consider Hawaii case law indicating construction defects are covered under a liability policy, including Sentinel Ins. Co. v. First Ins. Co., 76 Haw 277, 875 P.2d 894 (1994); Hurtig v. Terminix Wood Treating & Contracting Co., 67 Haw. 480, 692 P.2d 1153 (1984); and Sturla, Inc. v. Firemans' Fund Ins. Co., 67 Haw. 203, 684 P.2d 960 (1984). In Ill. Nat'l Ins. Co. v. Nordic PCL Constr., Inc., 2012 WL 1492399 (D. Haw. April 26, 2012), Judge Mollway felt she was constrained to follow the Ninth Circuit's decision in Burlington. Judge Mollway also believed that both Burlington and Group Builders must have taken the cases cited by the insured into account. Accordingly, Judge Kobayashi felt that Group Builders and Burlingtonwere accurate descriptions of the law as it existed in Hawaii in 2002, when the first policy was issued by Evanston in 2002.

   Here, all the claims in the underlyng action or claims that arise from the construction contract. Such claims were not occurrences under Hawaii law, meaning there was no coverage under the policies.

 

 

 

 

Federal District Court Continues to Find Construction Defects do Not Arise From An Occurrence

   Coverage for construction defects continues to be hotly contested in Hawaii state and federal courts. In a recent decision, Judge Mollway felt bound to follow the Ninth Circuit's decision in Burlington Ins. Co. v. Oceanic Design & Constr., Inc., 383 F.3d 940, 944 (9th Cir. 2004), where the court found construction defect claims arise from breach of contract, not from an occurrence. Judge Mollway's most recent decision on the issue is Illinois Nat. Ins. Co. v. Nordic PCL Constr., Inc., 2012 U.S. Dist. LEXIS 58464 (D. Haw. April 26, 2012).

   Nordic constructed a grocery store for Safeway. In addition to the grocery store, Nordic built a 165-space rooftop parking deck, retail shops and related improvements. After opening for business in 2007, Safeway experienced significant leaks. Safeway demanded that Nordic repair the parking deck. Nordic sent the demand letter to the insurer, who agreed to appoint counsel subject to a reservation of rights.

   Safeway filed suit against Nordic in state court alleging, among other things, breach of contract and negligence. The insurer provided Nordic with a defense, but Nordic hired independent counsel.

   The insurer filed for declaratory relief in federal district court. Nordic counterclaimed for breach of contract, breach of the covenant of good faith and fair dealing, misrepresentations and omissions of material fact, and bad faith. The insurer moved to dismiss the counterclaim.

   Regarding the breach of contract claim, the court was bound by Burlington. Consequently, the court agreed with the insurer that the underlying damage was not caused by an "occurrence" as defined in the policy and was therefore not covered. In response to the argument that Burlington and the Hawaii Intermediate Court of Appeals decision, Group Builders, Inc. v. Admiral Ins. Co., 123 Haw. 142, 231 P.3d 67 (Ct. App. 2010), failed to follow a trilogy of Hawaii Supreme Court cases - Sentinel Ins. Co., Ltd v. First Ins. Co. of Haw., Ltd., 76 Haw. 277, 875 P.2d 894 (1994);Hurtig v. Terminix Wood Treating & Contracting, Co., 67 Haw. 480, 692 P.2d 1153 (1984); and Sturla, Inc v. Fireman's Fund Ins. Co., 67 Haw. 203, 684 P.2d 960 (1984) - the court merely presumed that Burlington and Group Builders took the Supreme Court cases into account.

   Nor was the court influenced by H.B. 924, which said "the meaning of the term 'occurrence' shall be construed in accordance with the law as it existed at the time that the insurance policy was issued." The policy here was issued in 2007, after the Burlington decision in 2004. Therefore, the breach of contract claim was dismissed. With respect to the "occurrence" based portion of that claim, the dismissal was with prejudice.

   Count II, alleging a breach of the covenant of good faith and fair dealing, was dismissed with leave to amend. Count III, alleging fraud and negligent misrepresentation, was also dismissed with leave to amend. Count IV, the bad faith count, was dismissed only to the extent it was based on fraud.

Hawaii ICA Finds Construction Defects Are Not Occurrences

   Ever since the Ninth Circuit made an Erie guess in Burlington Ins. Co. v. Oceanic Design & Constr. Inc., 383 F.3d 940 (9th Cir. 2004), that the Hawai'i appellate courts would find that construction defects do not constitute an occurrence under a CGL policy, coverage practitioners have waited for an answer.  Today, the Hawai`i Intermediate Court of Appeals did so, determining construction defect claims are not occurrences.  See Group Builders, Inc. v. Admiral Ins. Co., No. 29402 (Haw. Ct. App. May 19, 2010) [decision here].

   The case arises out of mold damage discovered at the Hilton Hawaiian Village's Kalia Tower.  The Tower was completed in May 2001.  In mid-2002, extensive mold growth was discovered in the guest rooms, forcing closure of guest rooms on floors 5 through 25.  An investigation revealed numerous construction defects in the Tower, some of which contributed to or caused the mold growth.

   Hilton filed suit in 2003 against numerous defendants, including the subcontractor responsible for insulation in the Tower, Group Builders.  Group was insured by Admiral.  When Group sought a defense for Hilton's suit, Admiral refused.  Group sued, but the circuit court concluded there was no evidence of property damage caused by an occurrence and granted Admiral's motion for summary judgment.

   On appeal, the ICA noted there was no dispute that the mold damage and resulting loss of use qualified as "property damage."  But was there an "occurrence" under the policy?  The policy defined "occurrence" as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions."   

   Adopting the majority rule and confirming the Ninth Circuit's prediction in Burlington, the ICA held that breach of contract claims based on allegations of shoddy performance were not covered under CGL policies.  Further, tort-based claims, derivative of the breach of contract claims, were also not covered.

   This case is undoubtedly on its way to the Hawai`i Supreme Court.

Ninth Circuit Ratifies Burlington's Mistake

Burlington Insurance Company wins again.  The Ninth Circuit of Appeals issued an unpublished decision a few months ago entitled Burlington Insurance v. Steve's Ag Services, which appears to perpetuate some of the logic flaws in the original Burlington decision.  Although the court refused to explain the underlying facts (instead simply stating "the parties are familiar with the facts . . . ."), the case stems from an administrative proceeding arising out of AG Service's logging without proper permits.  A second claim for indemnification was also filed against AG Service by the landowner.

The court noted that the damages sought in the administrative proceeding were for the "value of the timber taken."  The CGL policy had  an exclusion for property damage to any "particular part of any property that must be restored because 'your work' was incorrect performed on it."  Thus there was no duty to indemnify or duty to defend.

Further, the court concluded there was no obligation to indemnify the landowner because an occurrence is defined as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions."  Repeating the earlier Burlington logic and citing a Hawaii Supreme Court case, the court stated a "breach of contract claim precludes accidental conduct." 

This analysis is plainly wrong.  One could easily breach a contract through accidental conduct.  For example, one could show up to a construction site on the wrong date, order the wrong supplies, etc.  These "accidental" acts meet the policy definition of an "occurrence" regardless of whether they breach a contract or not.  What the court's holding really stands for is the proposition that a CGL policy will never have to cover a breach of contract claim -- language not contained in the policy and clearly contrary to the parties' intent.

The Ninth Circuit's citation to Hawaiian Holiday Macadamia Nut Co. v. Indus Indem. Co., 76 Hawaii 166, 872 P.2d 230, 233 (1994) also materially misstates the holding in that case.  The Macadamina Nut Co. decision held that "[t]he question of what is an 'accident' must be determined by addressing the question from the viewpoint of the insured."  The facts, in that case, stated that there was a breach of contract "based on intentional acts performed by Hawaiian Holiday to defraud" the plaintiffs."  Thus the Hawai`i Supreme Court actually analyzed the underlying acts and determined if there was an accident.  The allegations of a "breach of contract" was immaterial.  It was the "intentional" allegation that was relevant.

State Court Trend: Moving Away from Burlington

An article recently came out in the "Construct" journal, put out the Construction Litigation Committee of the ABA, entitled "State Courts Trend: Coverage for Faulty Workmanship."  This article is similar to an earlier blog post analyzing the Ninth Circuit decision entitled Burlington Ins. Co. v. Oceanic Design & Constr., Inc. (9th Cir. 2004) and concludes:

In short, courts generally conclude that claims requiring only the replacement of the subcontractor's defective work -- and no more -- are not covered under a CGL policy because there is no property damage.  Only when the claim involves extraneous damage caused by the subcontractor's work will the property damage term be satisfied and thus provide potential coverage.

. . .

The majority of state supreme courts that have confronted these coverage issues have concluded that the insurance industry intended to expand coverage for unintentional property damages caused by subcontractors to the contractor-insured's completed project.

This article does not appear to analyze Burlington, but references several relatively new 2007 cases.

No Coverage for Construction

        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.