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Prudent contractors protect themselves from liability arising out of their work on a construction project by maintaining standard commercial general liability (CGL) insurance. What contractors often do not realize, however, is that a CGL policy generally does not provide coverage for claims by dissatisfied owners for the cost to repair or replace allegedly defective work. Such claims, which can present a significant exposure to a contractor, instead are governed by the contract between the contractor and client.

As a result, the terms of the warranty and indemnification language in construction contracts is hugely important and frequently overlooked. It is essential for contractors to understand the limitations of their liability insurance coverage, and to pay particular attention to the drafting of their contracts, seeking professional legal help where needed.

CGL Policy Insuring AgreementThe CGL policy is written primarily to cover liability for claims resulting from accidents caused by the insured. The Insuring Agreement of the policy states the policy covers bodily injury and property damage caused by an “occurrence.” The policy defines an occurrence as “an accident.” Wisconsin courts have applied the commonly understood definition of accident, interpreting the term to generally mean an event that is not “anticipated, expected, or intended.” Thus, in its initial grant of coverage in the CGL policy, the insurance company agrees to cover claims against the contractor for injuries or property damage that result from the contractor’s unintentional conduct.

Contractors undoubtedly do not intend to cause construction defects or hand over a project that suffers from faulty workmanship. To that extent, the defective work can be considered an accident, and therefore a covered occurrence under the CGL policy. However, insurance companies argue, and courts often agree, that defective construction (damage resulting from faulty workmanship alone) is not an accident. Under this theory, “a CGL policy does not cover faulty workmanship, only faulty workmanship that causes damage to other property,” according to Kalchthaler v. Keller Constr. Co.  and other similar cases.

CGL Policy ExclusionsThe CGL policy includes certain key exclusions that are intended to bar coverage for claims based on the insured’s liability for faulty work. These exclusions are commonly referred to as “business risk exclusions,” because the risk of faulty workmanship is a business risk that is allocated by contract between the contractor and the client through the construction contract. Among other things, the business risk exclusions bar coverage for property damage to the insured’s own work or property while the construction project is ongoing. The “your work” exclusion also bars coverage for damage to the insured’s own work after the project has been completed.

Claims for defective work, such as leaky basements or windows, are common in the industry and in case law. The damage claimed can be extensive and often the nature and extent of the damage is hotly disputed, leading to costly litigation. Contractors can minimize the risk and expense of these claims by understanding there are limitations to their basic liability coverage and addressing those risks through alternative insurance arrangements, as well as by limiting their liability with a well-drafted construction contract.

Contractors should be aware, for example, that while CGL policies generally exclude coverage for damage to the insured’s own work, there is an important exception for work done by subcontractors. Under the “subcontractor exception,” the “your work” exclusion generally does not bar coverage for claims against a general contractor for faulty work completed on behalf of the contractor by a subcontractor. This exception can be of enormous assistance to a general contractor faced with a costly claim for defective work done by a contractor who, in today’s climate, may no longer be in business, much less be able to correct or pay for the faulty work.

Warranties and IndemnificationContractors should pay special attention to warranty and indemnification language in their construction contracts. The purpose of a warranty is to limit the contractor’s responsibilities in the event the work does not meet the customer’s expectations. Similarly, indemnification clauses can be used to shift the risk of defective work to other contractors and to allocate the risk among multiple parties who may be responsible for the final product. Where claims of alleged construction defects arise, there is no substitute for a well-written contract to determine the parties’ respective rights and obligations. Proper drafting on the front end can save substantial expense on the back end.

Understanding the scope and limitations of your insurance coverage is an important part of the process of minimizing your liability for construction defect claims. Such claims, whether of merit or not, can present a significant financial exposure. It is essential that contractors take the necessary steps to see that they are properly insured and that they are adequately protected by their construction agreements. Seeking counsel from experienced insurance and legal professionals can be crucial.

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