ALERT to General Contractors: Subcontractors Insurance Coverage May Not Protect You

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In 2006, the Pennsylvania Supreme Court decided Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co. denying coverage to a general contractor under its commercial general liability ("CGL") insurance policy for damage to a project arising out of a subcontractor’s faulty work.  Pennsylvania contractors are finally beginning to understand the impact of this decision. To date, over 50 courts in Pennsylvania have relied on the Kvaerner decision to deny coverage to contractors operating within Pennsylvania for claims arising out of a subcontractor’s faulty work. Within the past few months, three of these decisions arguably extend Kvaerner, further stripping contractors of insurance coverage that they believed was part of their subcontractor’s general liability policy.

To understand the impact of Kvaerner, it is necessary to understand standard language that appears in virtually all insurance policies.  In order for a claim to be covered under your policy it must constitute an “occurrence.” Occurrence is “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”  Normally, if there is “property damage” caused by an “occurrence,” you have coverage unless there are express exclusions. The most common exclusion that affects contractors and subcontractors is the damage to your work exclusion.  Liability policies do not insure or guarantee a contractor’s work or materials/equipment provided. However, damages caused to some other property or to a person by a subcontractor’s faulty construction work, prior to Kvaerner, had normally been covered. What the Kvaerner court did was rule that faulty construction work performed under a subcontract is not an accident; therefore, there is no occurrence and no coverage for damages caused by a subcontractor’s faulty work. As of the date of this article, courts from nine other states have had an opportunity to consider the logic of Kvaerner. Only Arkansas agreed. Kvaerner remains the law in Pennsylvania.

In December, 2008, the Pennsylvania Supreme Court had an opportunity to clarify or limit the Kvaerner holding, but declined to do so.  On April 14, 2009, the United States Court of Appeals for the Third Circuit relied on Kvaerner to deny coverage, thus solidifying the Kvaerner logic in the federal court system on cases applying Pennsylvania law. On May 13, 2009, the Pennsylvania Superior Court reinforced the Kvaerner decision and denied coverage to a contractor, despite the fact that the owner asserted fraud and negligence causes of action against the contractor in addition to the complaint for breach of contract, where the damage alleged exceeded the defective work performed under the applicable contract.

What this all means is that the standard liability insurance policies prime contractors have been requiring from their subcontractors may not provide adequate coverage to protect the contractor from claims filed by an owner for damages arising out of a subcontractor’s faulty work. In the wake of Kvaerner, insurance companies have begun offering “Kvaerner gap coverage,” which is a coverage modification or endorsement that provides coverage to contractors for damages to a building that arise from defective work performed by a subcontractor. For contractors wishing to restore their risk exposure to the pre-Kvaerner days, this coverage is absolutely essential. Contractors should contact their broker to discuss changes to coverage required to address the Kvaerner decision.

 

(Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 589 Pa. 317, 908 A.2d 888 (2006); Millers Capital Ins. Co. v. Gambone Bros. Development Co., Inc., 941 A.2d 706 (Pa. Super. 2007) app. den. 963 A.2d 471 (2008); Erie Insurance Exchange v. Abbott Furnace Company and Innovative Magnetics, Inc., 2009 Pa. Super. 88) 

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