Two recent California appellate court opinions have interpreted “faulty workmanship” exclusions as they apply to construction defect lawsuits. These exclusions are standard ISO exclusions in commercial general liability policies that exclude coverage for property damage to: (1) “that particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the ‘property damage’ arises out of those operations” (exclusion j(5)); (2) “that particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it” (exclusion j(6)); and (3) “`property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard’” (exclusion l). Until recently, these exclusions were usually interpreted by California courts to represent an expression of a general principle of insurance law that insurers are not warrantors of their insureds’ products. See Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal.App.4th 1, 110-111 (1996). In this context, California courts have recognized that “the risk of replacing and repairing defective materials or poor workmanship has generally been considered a commercial risk which is not passed on to the liability insurer.” Maryland Cas. Co. v. Reeder, 221 Cal.App.3d 961, 972 (1990).
A few months ago, we reported on an unpublished Ninth Circuit decision that reiterated this interpretation of the exclusions, Archer Western Contractors, Ltd. v. National Union Fire Insurance Company of Pittsburgh, Pennsylvania, 2017 WL 816891 (9th Cir. March 2, 2017). That decision included a concurrence from Judge Andre M. Davis, who noted that, although he concurred in the result, he would have certified the matter to the California Supreme Court because of a dispute among the California appellate districts with respect to the meaning and application of these exclusions. This concurrence seems to have been prescient, as two recent decisions out of the Fourth Appellate District underscore a deepening inconsistency in California appellate court decisions addressing the application of the “faulty workmanship” exclusions.[1]
The first decision is Pulte Home Corp. v. American Safety Indem. Co., 2017 WL 372504517 (August 30, 2017). Regarding the faulty workmanship exclusions, American Safety argued that its policies expired during the period of Pulte’s ongoing operations and that, pursuant to exclusions j(5) and j(6), any possible damages during its policy period were excluded. The linchpin of American Safety’s argument was the contention that a general contractor or developer’s “work” includes all work at the site, including that of the subcontractors. Pursuant to this argument, a general contractor/developer, such as Pulte, would never have coverage for property damage that began before the entire project was completed. The Court of Appeal noted several other California appellate decisions from other appellate districts supported American Safety’s interpretation, but chose not to follow those decisions. As the Supreme Court has not addressed this particular issue, it was within the Court’s purview to take such a position. As noted by the concurrence in the Archer Western case, this split among the appellate districts is precisely why this issue is ripe for a Supreme Court decision.
Having decided that Pulte’s work was not the entire project, the Court rejected American Safety’s no coverage position on the grounds that, as to j(5), the trial court record did not include a showing that all of the damages occurred at a particular location where a subcontractor was working or that, as to j(6), the damages all occurred because work was incorrectly performed. The Court noted that the damages could have arisen from improper materials, rather than incorrect work. Ultimately, once the Court rejected the argument that Pulte’s work encompassed the entire project, American Safety lost because the Court of Appeal undertook a narrow construction of the application of the “faulty work” exclusions.
The second decision is Global Modular, Inc. v. Kadena Pacific, Inc., 2017 WL 394822917 (Sept. 8, 2017). In that case, the Department of Veterans Affairs hired Kadena Pacific as the general contractor for construction of a Center for Blind Rehabilitation in Menlo Park, California. Kadena subcontracted with Global Modular to install 53 modular units. Kadena hired a separate contractor to install roofs on the units; Global contracted to deliver the roofless modular units. The units were supposed to be delivered in the summer, but for reasons not discussed in the decision, the delivery did not occur until the fall, which exposed them to the elements during rainy season. Kadena evidently contracted with Global for temporary tarping to try to prevent damage inside the units, but the tarps failed and extensive damages occurred. Subsequently, Kadena remediated the damages and completed the project. Kadena refused to pay Global. Global filed suit for payment and Kadena countersued for its remediation expenses. Ultimately, a jury awarded Kadena $1 million against Global for the remediation costs.
North American Capacity Insurance Company (“NAC”) insured Global and filed a separate lawsuit against Kadena seeking a declaration that NAC’s policy did not require it to indemnify Global for the jury award. NAC argued, in part, that exclusions j(5) and j(6) applied to eliminate any potential coverage for Kadena. NAC argued that, because the tarping and the entirety of the modular units, including the damaged interiors, were Global’s work, and because the damage occurred before Global completed its work, the exclusions barred coverage. In contrast to the insurer’s position in the Pulte case, NAC did not argue that a general contractor’s “work” encompassed an entire project, including the work of its subcontractors. In Global Modular, Global was the only subcontractor and actually performed all of the work at issue.
Kadena and NAC filed cross-motions for summary judgment. The trial court ruled in favor of Kadena, finding the jury award was covered. The trial court determined that, because the damage occurred before Global completed its work, only the ongoing operations exclusions could possibly apply, but then held that they did not apply based on the facts presented.
The Court of Appeal upheld the trial court’s decision. Initially, the Court agreed that exclusion l (“your work”) did not apply because Global had not completed its work. The Court then narrowly construed the ongoing operations exclusions and found them inapplicable. As to exclusion j(5), the Court read the exclusion as only applying “if the damage arises out of Global’s operations and applies only to damage to the particular part of real property on which Global was performing operation at the time of the damage.” (Emphasis added.) Applying this interpretation, the Court held that exclusion j(5) could not apply because the damages occurred during heavy rains when Global “was not working on the units.” Under the Court’s interpretation, exclusion j(5) only applies to damage that occurs simultaneously with the insured performing work on the precise location where the damage occurs. This is a more restrictive reading of exclusion j(5) than other California appellate courts have previously applied, and it raises questions regarding whether this interpretation renders the exclusion practically meaningless in California.
The Court of Appeal supported its conclusion by comparing the language in exclusion j(5) with the policy language in exclusion l. The Court noted that exclusion l, which applies to completed operations, would have excluded the damage because it broadly excludes damage “to ‘your work’ arising out of it or any part of it.” Although this language arguably is dicta, it does support the argument that CGL policies do exclude all damage to an insured’s own work with respect to completed operations claims.
As to exclusion j(6), NAC argued that the tarps were Global’s “work” performed “on” the Global modular units and therefore the damage to the units was excluded from coverage. The Court of Appeal applied a close reading of the exclusion to once again limit its application. The Court held that exclusion j(6) only excludes “the specific part of the insured’s work on which the insured performed faulty workmanship and not, more broadly, to the general area of the construction site affected by the insured’s work.” The Court thus determined that Global’s only defective work was on the tarps and that the exclusion would not have applied to the damages to the insured’s other work caused by the defective tarps. It apparently did not matter that the interior units were immediately under the tarps. The Court of Appeal did not consider the policy’s broad definition of “your work” that extends to “work or operations performed by you or on your behalf” in reaching its decision.
One argument that was not addressed by the Kadena court might have led to a different result. The opinion states: “NAC does not dispute the repair/replacement costs fall under the policy’s insuring clause because the wet interior components constitute property damage cause by an occurrence – rain.” This is important because a strong argument could have been made that the repair and replacement of Global’s work was not “property damage” and therefore is uncovered for that reason. California courts that have interpreted the defined term “property damage” have previously held that the repair and replacement of an insured’s own defective work or product is not “physical injury to tangible property” and is a purely economic loss that does not trigger coverage under a general liability policy. Waller v. Truck Ins. Exch., Inc., 11 Cal.4th 1, 17-18 (1995); Kazi v. State Farm Fire & Cas. Co., 24 Cal.4th 871, 879- 881 (2001); Collett v. Insurance Co. of the West, 64 Cal.App.4th 338, 343-344 (1998); New Hampshire Ins. Co. v. Vieira, 930 F.2d 696, 697 (9th Cir. 1991); Maryland Cas. C. v. Reeder, supra, 221 Cal.App.3d at pp. 969-971. As the Kadena Court did not address this argument, the argument that the repair and replacement of the insured’s own work is not covered “property damage” is arguably unaffected by this decision.
These latest cases further complicate the question of when faulty workmanship exclusions apply to construction defect cases in California. The Pulte decision illustrates the split among the appellate districts regarding the scope of a general contractor/developer’s “work” under these exclusions. Some Court of Appeal decisions have held the entire project is the general contractor/developer’s “work” and others, like the Pulte Court, have held the scope of the “work” subject to the “faulty work” exclusions is more limited. The decision in Kadena offers exceptionally limited interpretations of the ongoing operations exclusions, to the point that they arguably have no practical application. Perhaps the California Supreme Court may review these issues. For now, however, the courts in California and elsewhere continue to struggle with the application of the “faulty work” exclusions for damages to “your work” in construction defect cases. These opinions illustrate that it is easy to articulate the concept that CGL policies do not act as bonds for warranty claims against contractors, but is extraordinarily difficult to implement.
[1] Notably, a third decision addressing these issues, also involving Pulte and American Safety, was issued by a federal district court in the Southern District in Pulte Home Corporation v. American Safety Indem. Co., 2017 WL 4050347 (S.D.Cal. Sept. 13, 2017). We do not discuss this decision here because it was based on Ohio law and is distinguishable on that basis.
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