Make No Assumptions Regarding Insurance Coverages and Contract Terms; Evaluate and Manage Business Risks to Protect Your Cash
Contracts remain the primary way construction project participants manage, allocate, and limit risk on projects. Contract terms typically address risks relating to insurance coverage, payment for work, correction of defective work, warranty repairs, and countless other construction operations. Industry participants must invest the time to understand the details and proactively evaluate and manage business risks to protect their assets and cash. Updating and understanding the terms and conditions of Project contract documents, including subcontract forms, bonds, and liability insurance policies, is critical for effective construction risk management.
Not surprisingly, many industry participants do not understand critical contract terms. Indeed, even sophisticated contract managers and lawyers typically do not appreciate all of the nuances of intricate contract language, not to mention the interplay between various form agreements that include layers of conflicting provisions in complex contract documents and project manuals. Far too often, project participants use outdated, cut-and-pasted forms assuming that the terms adequately cover the main points. As a result, they assume that risks are adequately shifted to an entity who can pay the bill when, in fact, their own assets and project profitability remain in peril.
Standard construction contract and subcontract forms also rely on various types of insurance to manage construction risks.
Far too many players mistakenly assume that the comprehensive general liability insurance required in those contract and subcontract forms covers defective workmanship. They are wrong.
Ohio law clearly distinguishes between “business risks”, which generally are not covered by traditional insurance policies, and “insurable risks”, which involve “fortuitous” events causing “sudden and accidental” injury to persons and property. Business risks, including the added cost of removing and replacing defective or non-conforming work, are best covered through damage limitation clauses, surety bonds, and cash deducts or retainage holdbacks. Insurance risks, on the other hand, cover personal injury and property damage attributable to a sudden and accidental event.
A recent Ohio Supreme Court case rammed home the point that traditional commercial general liability insurance policies do not protect against risk of loss on account of defective workmanship. In October, 2012, the Court held in Westfield Insurance Co. v. Custom Agri Systems, Inc., 2012-Ohio-4712, 2012 WL 4944305 (Ohio Oct. 16, 2012), that a subcontractor’s defective work was not an “occurrence” under a subcontractor’s insurance policy, and it rejected a contractor’s claim to recover the cost of repair under that policy. In so holding, the Supreme Court confirmed the long-held understanding that insurance does not actually protect against purely business risks, such as a contract breach attributable to one party’s failure to properly perform.
Specifically, the Court concluded that defective construction generally does not satisfy the definition of an “occurrence” because it was not an “accident.” Courts in previous cases defined “accidental” as an “unintended” or “unexpected” result. According to the Supreme Court, faulty workmanship claims, which would involve warranty-related work or failure to follow specifications among other things, are not “fortuitous” and, therefore, are not covered by a standard subcontractor comprehensive general liability insurance policy.
Ohio’s construction industry should brace itself for a new era of coverage determinations in a wide variety of construction problems. Insurers may be more prone to deny obligations to defend or indemnify policy holders in litigation where the only damages involve the cost of removal or replacement of the insured’s own work or materials.
The existence of an “occurrence” likely will require allegations and evidence of damage to other property, products, or work of third parties. In such an event, policy holders should prepare themselves for a significant fight with the carrier and its coverage counsel.
The Court’s decision should prompt all industry participants to re-evaluate their risk transfer practices and contract provisions. There definitely are different types of policies available on the market, some of which may define accident differently. Anyone seeking protection against risk of loss, however, must accept that blindly relying on a policy of insurance is not enough. Prudent project participants will require copies of the policies and actually will evaluate the policy language to confirm the actual scope of coverage afforded. They will avoid generic contract language and will implement alternatives to provide meaningful protection against the risk of non-conforming work. A properly written performance or warranty bond, for example, provides a layer of meaningful protection covering repair and remediation costs. Even those bond forms, however, must be carefully coordinated with the other contract terms to confirm the best and broadest coverage for specific risks.