NJ Supreme Court Holds Insurers Liable for Subcontractor’s Defective Work

Background

A condominium association hired a general contractor to develop a condominium project. The contractor hired subcontractors that improperly installed the roof, flashing, and gutters, among other things, which caused mold and water damage in common areas, individual units, and concealed interior areas of the building.

The association sought coverage from the general contractor’s insurer under its commercial general liability (CGL) insurance policy. It asserted that the consequential damages caused by the subcontractor’s faulty work was “property damage” under the general contractor’s insurance policy. The general contractor’s policy was on the Insurance Services Office, Inc.’s (ISO) 1986 standard CGL form (the 1986 ISO form).

In the insurance industry, an insured generally assumes the business risk of paying for the cost of correcting defective work (referred to as the “Your Work” exclusion). The 1986 ISO form, however, carves out an exception to this exclusion for the work of subcontractors (the subcontractor exception).

In this case, the insurer asserted there was no “property damage” or “occurrence,” both of which are required to trigger coverage under the contractor’s CGL policy. The insurer relied on Weedo v. Stone-E-Brick, Inc. (81 NJ 233 (1979)) and Firemen’s Insurance Co. of Newark v. National Union Fire Insurance Co. (387 NJ Super. 434 (App. Div. 2006)). Both of these cases supported the insurer’s position, but interpreted ISO’s 1973 standard CGL form (the 1973 ISO form).

Critical distinctions between the 1973 ISO form and the 1986 ISO form relevant to this case include:

• Different definitions for “property damage” and “occurrence.”
• The 1973 ISO form does not include the subcontractor exception.

The trial court held that the faulty workmanship was not an “occurrence” and the consequential damages were not “property damage” under the 1986 ISO form policy. The appellate court reversed, holding that the damages claimed in this case were covered because they were unintended and unexpected consequential damages, not damages for replacement costs (see Legal Update, New Jersey Appellate Court: Insurers May be Liable for Subcontractor’s Defective Work).

Analysis

The New Jersey Supreme Court affirmed the appellate court’s decision. The Supreme Court distinguished Weedo and Fireman’s because:

• Those cases interpret the 1973 ISO form rather than the 1986 ISO form applicable in this case.
• This claim is for consequential damages caused by the work, not replacement costs of the work itself.

The Supreme Court took guidance from leading cases by the Florida Supreme Court and the Fourth Circuit, both of which held that a subcontractor’s defective work may constitute an insurable occurrence and resultant damages from the faulty work is covered under the 1986 ISO form. These courts emphasized that to hold otherwise would make the subcontractor exception to the Your Work exclusion meaningless.

The Supreme Court concluded that:

• The consequential damages in this case resulted in a loss of use of the affected areas and qualify as “property damage” under the 1986 ISO form.
• The definition of “occurrence” under the 1986 ISO form requires an accident, a term not defined in the policy. So the court:
  • looked to the plain meaning of the undefined term accident;
  • decided that the term accident means unintended and unexpected harm caused by negligent conduct;
  • determined that the consequential water damage to completed, non-defective portions of work as alleged in this case fall within this definition of accident; and
  • held that because there was an accident, there is an “occurrence” under the policy.
• The Your Work exclusion would apply to exclude coverage.
• The subcontractor exception to the Your Work exclusion applies to these facts and negates the Your Work exclusion.
• Coverage exists.

Practical Implications

This case is significant for developers and construction professionals. New Jersey is one more state in line with the recent trend of courts affirming coverage under the 1986 ISO form for consequential damages caused by certain construction defects.

Counsel for developers, contractors, and insurance underwriters should review their CGL policies to determine how this decision affects their businesses.