Commercial general liability insurance (CGLI) is often used to manage risk on a construction project. However, CGL policies can contain gaps in coverage or exclusions that may leave a contractor or subcontractor without the anticipated protection. This Hartung Schroeder Practice Note addresses common business risk exclusions in CGL policies and provides guidance on how all project participants can ensure they are properly covered.
Claims for personal injury and property damage commonly occur on construction projects. Unfortunately, project participants (owners, contractors, and subcontractors) often fail to adequately address insurance coverage issues during the contract drafting process and only learn that they are not protected when a claim materializes.
Whether the owner or a third-party makes the claim, the injured party will first look to the general contractor and its insurance coverage. Therefore, contractors must both:
- Ensure that their own insurance policies are in place and afford appropriate coverage for all risks.
- Confirm that the policies of their subcontractors and sub-subcontractors do the same.
From the owner’s perspective, it is critical to obtain appropriate coverage because in the event of a loss, an owner wants to avoid any concern over whether the culpable contractor has sufficient assets to pay the claim.
- Provides an overview of the basic concepts of coverage under a commercial general liability (CGL) insurance policy.
- Explains the common “business risk” exclusions in a CGL policy.
- Identifies insurance pitfalls that often leave owners and contractors without the coverage they expected when a claim is filed.
INTRODUCTION TO CGL COVERAGE
There are many important components to insurance coverage on a construction project. Since no two projects and scopes of work are exactly the same, collaboration among the insured’s risk manager, insurance broker, and counsel is necessary to adequately assess and hedge against potential risks. Careful drafting of the insurance requirements in the subcontract is essential as the first step of protection to ensure alignment with the insured’s scope of work.
While the interpretation of certain CGL provisions varies from state to state, most CGL policies follow one of the standard formats issued by the Insurance Services Organization, Inc. (ISO), which contain many of the same basic options. In the construction industry, most CGL policies provide coverage on an occurrence by occurrence basis rather than a “claims made” basis. This means that the occurrence (as defined in the policy) giving rise to the claimed loss or damage must have happened during the policy period.
A CGL policy essentially provides coverage to the insured (contractor or subcontractor) for those sums the insured becomes legally obligated to pay as damages for:
- Bodily injury or property damage. Property damage is generally defined as physical injury to tangible property or loss of use of tangible property that is not physically injured.
- Caused by an occurrence. Most policies define an occurrence as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”While not defined in the policy itself, an accident is generally considered to be something that is not intended, expected, or anticipated. Therefore, coverage under a CGL policy is thought of in terms of negligence, as opposed to an intentional act.
- In the coverage territory. This pertains to where the occurrence giving rise to the damage happened. For example, if the policy insures a specific construction project, damages occurring off-site might not be covered.
- During the policy period. This means that the occurrence giving rise to the personal injury or property damage must happen during the policy period, even if the claim or lawsuit is filed after the expiration of the policy period.
Each of the foregoing requirements for coverage under a CGL policy has been widely interpreted by the courts and is subject to ongoing changes in interpretation.
COMMON “BUSINESS RISK” EXCLUSIONS
While there are many exclusions that can limit coverage under a CGL policy, there are a few key “business risk” exclusions related to construction work of which an owner, contractor, and subcontractor should be aware. These exclusions are primarily predicated on the fact that a CGL policy is designed to provide the insured with coverage against third-party claims for injury or damage as opposed to covering the insured for its own losses due to the need to repair or replace its own work. Parties and their counsel should carefully review all policy exclusions and consult with an insurance professional to understand their application and determine whether any exceptions to these exclusions are available through endorsements to the policy.
Some of the more common business risk exclusions include:
- “Your work” exclusion. This exclusion precludes coverage for damages to the insured contractor’s own work and materials. Essentially, coverage is not available to repair or replace the contractor’s own faulty or defective workmanship. In 1986, the language of this exclusion was clarified to confirm that it did not exclude losses arising from work performed by a party retained by the insured contractor to perform a portion of the work, such as a subcontractor, even though the subcontractor performed its work on the insured’s behalf.
- Owned property exclusion. Coverage is not provided for damage to property that is owned or leased by the insured. This can have implications for a developer who, either directly or through an affiliated entity, acts as its own contractor in performing construction on property it owns.
- Contractual liability exclusion. This endorsement essentially excludes coverage for losses the insured is obligated to pay by reason of the assumption of liability in a contract or any claims sounding in breach of contract. This excludes claims predicated on a contractual warranty that obligates an insured to repair or replace its own defective work. However, exceptions to this exclusion allow coverage for: losses the insured would incur in the absence of a contract, such as common law tort liability; or, where the insured assumes the tort liability of another, such as an indemnification obligation in a contract, but only if the injury or damage occurred after the contract was signed.
- Residential exclusion. These endorsements vary but typically exclude coverage for the construction of condominiums. Policies for condominium construction projects are more frequently being written with this exclusion, which may completely void coverage. The problem is exacerbated by the risk that a multi-family project, such as a rental apartment building, is converted to a condominium post-construction, but prior to the expiration of any statute of limitations applicable to claims associated with latent construction defects. Owners, contractors, and subcontractors constructing any type of multi-family residential project must take precautions to ensure that their policies, as well as those purchased by others for their protection, do not include this type of residential exclusion.
CRITICAL POLICY PROVISIONS AND ENDORSEMENTS
There are certain insurance provisions and features that contractors should insist on in their own policies and in those procured by subcontractors performing work on their behalf. Subcontractors who contract-out work to sub-subcontractors should similarly require that all lower-tier contractors procure policies with these same features. Most standard CGL policy forms do not automatically include these critical provisions and endorsements must be specifically requested to obtain the proper coverage.
Additional Insured Status
Essentially all contracts require the contractor or subcontractor to obtain CGL coverage for their work. The contract should also require the contractor or subcontractor to name as additional insureds on those policies each of the following, to the extent involved in the project:
- The owner, often a single-purpose entity.
- Any separate developer, often an owner-affiliated entity.
- All construction lenders.
- Any owner’s representative.
- Any construction manager.
- All higher-tier contractors.
These project participants must be accurately named because an additional insured may make a direct and immediate claim for defense and indemnity under that particular insurance policy in the event of any occurrence that results in bodily injury or property damage covered by the policy.
Absent the additional insured coverage, the owner or a contractor against whom a claim is asserted as a result of another’s negligence or defective work must first obtain a judgment against the culpable subcontractor or sub-subcontractor before being able to make a claim to the culpable party’s insurance carrier. In the meantime, the owner or vicariously culpable contractor (or their insurance carriers) is forced to fund the cost of the defense, including attorney’s fees, along with incurring the associated remedial costs before being able to recover against the responsible party’s insurance carrier.
Products and Completed Operations
Insureds may not be aware that their CGL coverage is only in place while they are constructing the project. Once construction is complete, coverage under the policy ceases unless the insured obtains an endorsement for completed operations. While the “your work” exclusion may preclude coverage during construction, once the project is completed and turned over to the owner for its intended use, a completed operations endorsement covers future losses arising from the insured’s defective work.
Damage to property resulting from the performance of defective work may not manifest itself until years after project completion. Parties should familiarize themselves with their jurisdiction’s statute of repose, which allows claims for latent defects to be brought several years after a project’s certificate of occupancy has been issued, sometimes as much as ten years or more. This property damage will only be covered if the CGL and excess liability policies include an endorsement for completed operations coverage.
The bigger problem faced by owners and contractors is ensuring that completed operations coverage is maintained by every party that performed work on the project for the duration of time claims may still be made. It is also critical to ensure that the completed operations coverage is continued for all additional insureds during the same statutory period because the coverage for additional insureds is not automatic.
Primary and Non-Contributory Coverage
It is not unusual for policies procured by multiple project participants to be implicated by a single occurrence and to be called on to cover the same resulting property damage. This usually occurs when a subcontractor’s performance results in physical injury to other tangible property, such as the owner’s furniture or expensive fixtures like millwork, and a claim is asserted against the contractor. While the contractor’s status as an additional insured on that particular subcontractor’s policy may enable it to seek defense and indemnity under the subcontractor’s policy, the contractor may also have coverage under its own policy. Rather than defending and paying the claim, the contractor and its carrier would likely prefer that the subcontractor and its carrier provide a defense and pay the claim.
This issue may be exacerbated in the event of a catastrophic failure of major building components resulting in damages that exceed the limits of primary coverage and implicate the excess insurance policies of culpable lower-tier contractors. Even if the lower-tier contractors’ primary carriers agree to indemnify the contractor, their excess carriers may argue that the contractor’s own primary coverage must first be exhausted before the excess carrier will agree to contribute to pay the loss.
All subcontracts (and sub-subcontracts) must, therefore, mandate that policies procured include a provision confirming that they are primary and non-contributory with other potentially-implicated policies, such as the contractor’s primary policy. Absent this language, the higher-tier contractor for whom work is being performed may not receive the protection it thought it paid for when contracting with its subcontractor.
ENFORCEMENT AND CONFIRMATION
Contractors and subcontractors must ensure that they are protected not only by their own CGL policy coverage but by all parties performing work on their behalf. Even where a sophisticated contractor or subcontractor uses form contracts that were properly vetted by counsel well-versed in coverage issues, these forms must be continually updated to address State court holdings that may impact the interpretation of standard policy provisions and changes in state statutes governing the scope and validity of indemnification and insurance provisions in construction contracts.
There are several steps a contractor can take to avoid a situation where an insurance carrier disclaims coverage when a claim is made or a lawsuit filed.
Flow-Down of Insurance Requirements
Contractors and subcontractors must ensure that each of their agreements contains a flow-down of all insurance requirements in their own contracts to all lower-tier contractors. These insurance requirements should specify:
- The same types and limits of coverage.
- That the policies name as additional insureds the owner and its lenders and affiliated entities, the contractor, and those subcontractors on whose behalf work is being performed.
- That all coverage be primary and non-contributory.
- That the carrier will provide ample notice (usually 30 days) of an intention to cancel the policy for non-payment or other reasons.
- A flow down of insurance requirements not only for CGL coverage, but worker’s compensation, automobile, and any other coverage the particular project or risk requires.
Adequate insurance protection is required even where a lower-tier contractor is also obligated to indemnify other project participants for damages and losses arising from or related to their work. Given the proliferation of anti-indemnity statutes in most jurisdictions, an owner or contractor cannot rely on indemnification alone. However, many anti-indemnity statutes expressly do not impact or limit coverage under insurance contracts that may provide coverage where the lower-tier contractor is contractually obligated to indemnify another for negligence or where indemnified parties are also named as additional insureds.
Obtain Proof of Coverage
Contractually mandating the proper insurance is only the first step. An owner or senior-tier contractor must also enforce those requirements and confirm that the required coverage was actually secured. Without confirmation, gaps and mistakes in coverage can occur.
However, confirming that all project participants have procured the required coverage can be extremely challenging, especially on larger projects. Many contractors and subcontractors do not obtain evidence of coverage from all entities furnishing labor, services, and materials to a project. More often the evidence obtained is either insufficient or does not accurately describe the coverage actually in place.
Identify All Project Participants
Subcontracts frequently require the lower-tier contractor to either self-perform the scope of work or identify all entities discharging their contractual duties. However, these lists are usually prepared at the start of the project and may prove to be inaccurate or incomplete as assigned work changes during the course of the project. To obtain an accurate list of all those performing work, contractors should start by monitoring the service of notices (often in connection with lien laws) where required by state statutes.
An additional step at the project level is also recommended. Contractors should require their job site supervisors to log all individuals and entities working on the project on a daily basis and use that list to routinely confirm that they have procured the required insurance coverage.
Another possible way to address this concern is for all contractors and subcontractors to contractually condition payment to lower-tier contractors on meeting their administrative responsibilities to submit appropriate proof that all required insurance coverage was procured at the start of the project, including proof of payment of all premiums, and provide evidence that coverage is maintained during the life of the project, including confirmation of renewal of policies.
Obtain Proper Proof of Coverage
Owners or contractors often find it difficult to obtain reliable evidence of required coverage. Many construction professionals rely on certificates of insurance to confirm that the coverage has been procured and are surprised when a carrier disclaims coverage based on the actual provisions of the policy.
Because an insurance certificate is generally prepared and executed by an insurance broker, a carrier may argue that the broker does not have the authority to change the policy terms in the absence of an executed endorsement issued by the carrier. Therefore, even if a certificate of insurance identifies additional insureds or states that the CGL policy is primary and non-contributory, the owner or contractor relying on the certificate alone may learn that the coverage identified was not actually purchased.
The only true evidence of insurance coverage is what is contained in the policy issued, including all endorsements. Claims submitted to carriers in reliance on coverage reflected in certificates of insurance are often rejected and the certificates proven to be wrong or, even worse, fraudulent. While the better alternative is for the owner or senior-tier contractor to obtain a copy of each complete policy, including all endorsements, this can be a logistical nightmare depending on the number of subcontractors on a particular project.
Some contractors on larger projects only obtain complete documentation from high-risk trades, often leaving themselves at risk for work performed by other trades. Other contractors employ specially trained staff that solely focus on gathering policies and analyzing evidence of coverage. These present business risks and considerations that should be carefully weighed and addressed by construction professionals at the start of a project.
Personnel tasked with gathering and reviewing insurance documentation must be properly trained as many traps exist. For example, some insurance companies recently started using a different endorsement for additional insured coverage. While the new endorsement confirms an entity’s additional insured status, it only does so for ongoing operations and does not provide critical completed operations coverage for the additional insured. In these instances, an owner or contractor sued for property damage resulting from a subcontractor’s defective work manifested following completion of the subcontractor’s work and acceptance of the project would then not be covered.
In this instance, a named additional insured must confirm that the policy also contains a second separate endorsement covering it as an additional insured for completed operations coverage. Both endorsements must be executed for those named as additional insureds to have coverage for any potential liability for latent defects during the entire period of any statute of repose. This is particularly important since the time for bringing a claim against a subcontractor’s performance bond surety may expire, whether by contract or statute, years before the statute of repose allowing for claims for latent defects in that subcontractor’s work. This may leave a gap between a contractor’s potential liability and its ability to seek recourse from its subcontractor’s surety, making insurance coverage an important tool to hedge risk.
Confirm Continuation of Coverage
Monitoring renewal of completed operations coverage for the period of any statute of repose is especially difficult after project completion. It can become a full-time job to ensure that all subcontractors and, in some instances, sub-subcontractors, continually renew coverage through the statute of repose. This is particularly true given that in tough economic times, many contractors go out of business. Financially frustrated contractors may fail to take necessary steps to ensure the insurance coverage contracted for remains in place following project completion.
Despite the difficulties, continuing to monitor and enforce these contractual insurance requirements after project completion is as important as doing so before the project starts. Whether contractors manage the risk proactively or reactively, it will be costly. However, the overall cost tends to be higher when an uninsured or underinsured claim occurs than when the risk is proactively managed and mitigated up front.
Make Safety and Insurance Coverage a Priority
A contractor can hedge risks by letting all lower-tier contractors know, as early as the bid process, that risk management is a priority for the contractor and the project.
It can also use the subcontractor pre-qualification process and questionnaire forms as proactive tools. A contractor has the opportunity to convey to prospective subcontractors its commitment to safety, risk management, and insurance by asking key questions and requesting specific information:
- In the safety section of the form, contractors can request information related to the subcontractor’s:
- full-time safety personnel;
- return-to-work programs;
- drug testing policy;
- safety disciplinary plan;
- Occupational Safety and Health Administration (OSHA) violations; and
- experience modification factor.
- In the insurance section, the contractor can specify the key endorsements required, such as:
- additional insured;
- primary insurance;
- waiver of subrogation; and
- notice of cancellation.
This conveys to a prospective subcontractor the general and specific insurance requirements for specialized trades and prepares it to procure compliant coverage should it be awarded the work.