Insurer Beware:  Defective Workmanship Claims and CGL Implications

Posted on: July 8th, 2016

The Iowa Supreme Court recently issued an important decision as it relates to coverage of defective workmanship claims.  In National Surety Corp. v. Westlake Investments, LLC., an owner of an apartment complex (Westlake) and its excess carrier (National Surety) squared of as to who was obligated to pay, if anyone, for water penetration into Westlake’s apartment complex.  The developers and general contractor (the insureds) had a primary CGL policy with Arch Insurance Group. After the water problems were discovered, Westlake sued the insureds and the insureds sued the architect and subcontractors. Those parties reached a settlement. As part of that settlement, the insureds assigned their claims against National Surety to Westlake. National Surety then filed a declaratory judgment action arguing there was no coverage. Westlake counterclaimed with a breach of contract claim and sought declaratory judgment.

The issue was whether defective work performed by an insured’s subcontractor constituted an “occurrence” under the policy. Westlake argued defective work constituted an “occurrence.” National Surety argued it did not. The district court concluded the defective work could be considered an accident and thus, an “occurrence,” under a post-1986 standard-form CGL policy written to a general contractor. The Iowa Court of Appeals agreed.

The Iowa Supreme Court affirmed. First, the Court distinguished Pursell Construction v. Hawkeye-Security Ins., 596 N.W.2d 67 (Iowa 1999) based on the fact that the defective work in Pursell was performed by the insured, and not the insureds’ subcontractors – a fact National Surety did not dispute. Then, the Court considered the policy as a whole, paying special attention to the exceptions and exclusions. It reasoned that coverage for the property damage at issue was the only way to give meaning to the subcontractor exception to the “your work” exclusion. Next, the Court reasoned that its interpretation was also consistent with the history and development of the standard-form CGL policy. It noted that coverage for subcontractors became necessary as their work became more integral in the construction industry. The standard-form CGL policy was revised to include endorsements providing this coverage and higher premiums were imposed. The Court then cited numerous cases from other jurisdictions interpreting similar post-1986 CGL policies that had concluded defective work by a subcontractor could constitute an occurrence triggering coverage.

Three justices (Waterman, Cady, and Mansfield) dissented. They reasoned the majority had left out a crucial part of the definition of an “accident” constituting an occurrence under Iowa precedent, in which accident was defined as “an undesigned, sudden, and unexpected event.” They stated, “[t]here is nothing sudden about the gradual infiltration of rainwater through leaky window frames over several seasons. . .” The dessenters cited Liberty Mut. Ins. Co. v. Pella Corp., 650 F.3d 1161, 1175-76 (8th Cir. 2011) for the proposition that under Iowa law, such an event is not a covered occurrence. The basic premise of their position was that “[t]he majority in effect convert[ed] the liability insurance policy into a home warranty.”

National Surety Corp., v. Westlake Investments, LLC, No. 14-1274 (Iowa June 10, 2016).

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