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A Construction Defect Coverage Case Worth Noting

Author: Randy Maniloff

That title may give the impression that I don't think most construction defect coverage cases are important. That's not so. They are obviously very important to the parties involved. But so many do not add anything new to the overall body of law in the area. Many are repetitive – with the court simply taking its settled law, on whether faulty workmanship qualifies as an "occurrence," and applying it to the next tale of a construction project gone bad. Indeed, I can't even remember the last time I discussed a construction defect coverage case in CO, except for ones involving an unusual endorsement.

But the California Court of Appeals's recent decision in Global Modular, Inc. v. Kadena Pacific, Inc., No. E063551 (Cal. Ct. App. Sept. 8, 2017) is not in this category. It involves companion exclusions j(5) and j(6) – frequently arising, but not always clear, provisions.

In addition, the Kadena Pacific court described the issue as one of first impression, and looked to case law nationally in reaching its decision. That, and being a published opinion from a California appeals court, gives the decision the potential to be turned to by courts all over looking for guidance on exclusions j(5) and j(6). For these reasons, I selected Kadena Pacific for an appearance in this issue of CO.

The coverage issues in Kadena Pacific arise out of a curiously planned construction project. I'll let the court describe it: "The United States Department of Veterans Affairs hired Kadena Pacific, Inc., as the general contractor to oversee construction of its Western Blind Rehabilitation Center in Menlo Park. Kadena hired Global Modular, Inc., to build, deliver, and install the 53 modular units that would comprise the rehabilitation center. Because Kadena had hired a different subcontractor to install the roofing, Global agreed to deliver the units covered only by a roof deck substrate—a three-fourths of an inch base sheet of plywood."

The decision to use a separate subcontractor to install the roofing didn't work out so well, as the court explained: "Kadena had originally scheduled delivery of the units for the summer months, but delivery was delayed until October and November. This meant the roofless units were exposed to the elements during the rainy season, equipped with only a plywood substrate. Despite Global's efforts to protect the units by covering them with plastic tarps, the interiors suffered water damage from October through January. In February, Kadena and Global mutually agreed to terminate their contract and Kadena oversaw the remediation of the water-damaged interiors and completion of the project."

Some settlements took place between Kadena and Global, as well as a trial over the damages. Putting aside some rigmarole, to get to the point here, coverage litigation ensued between Global and its liability insurer, North American Capacity Insurance Company, over the cost to repair and replace the damage to the structures – drywall, insulation, framing -- caused by the intrusion of rain water.

The insurer did not dispute that the repair and replacement costs satisfied the policy's insuring agreement: the wet interior components were property damage caused by an occurrence—rain. The issue on the table was the potential applicability of exclusions j(5) and j(6).

The trial court in the coverage action held that exclusions j(5) and j(6) were ambiguous and could reasonably be interpreted to exclude damage to only the particular component of Global's work that was defective. And, here, none of the drywall, insulation, framing, or ducting Kadena repaired or replaced was defective. Thus, exclusions j(5) and j(6) did not apply.

The California Court of Appeal affirmed. To truly appreciate the decision you need to read it. But I'll set out the key aspects here:

Exclusion j(5) applies to property damage to "[t]hat particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the 'property damage' arises out of those operations."

The parties' disagreed over the meaning of the phrase "are performing operations." The insurer argued that the phrase refers to works in progress and therefore exclusion j(5) applies when the property damage occurs before construction is complete. That's not an unusual insurer interpretation of exclusion j(5).

Kadena saw it differently, arguing that "the phrase is more narrow, referring only to the particular component Global was physically working on at the time of the property damage. Under that interpretation, so Kadena's argument went, the exclusion did not apply to the water intrusion damages because the intrusion occurred during heavy rains when Global was not working on the units.

It's an interesting argument and the court, finding guidance from the Fifth Circuit and Supreme Court of Missouri, bought what Kadena was selling: "We conclude the use of the active, present tense construction 'are performing operations' indicates the exclusion applies only to damage caused during physical construction activities. Had the policy drafters intended the exclusion to apply more broadly to damage to any of the insured's work in progress, we would expect the provision to say something along the lines of, 'property damage to that particular part of real property on which your operations are not yet complete' or even 'property damage to your work arising out of your operations.' The drafters use this kind of broad language elsewhere in the policy, such as in exclusion l, which excludes '[p]roperty damage' to 'your work' arising out of it or any part of it and included in the 'products-completed operations hazard.' This provision precludes coverage for damage to any of the insured's work once it has been completed or abandoned. We find it telling exclusion j(5) employs a much more narrow construction, restricting the excluded damage to only that particular part on which the insureds are performing operations." (emphasis in original).

The court next turned to exclusion j(6), which applies to property damage to "[t]hat particular part of any property that must be restored, repaired or replaced because 'your work' was incorrectly performed on it." Putting aside a couple of other issues, the court, again guided by the same decisions from the Fifth Circuit and Missouri high court, applied a narrow interpretation: "the 'particular part' Global performed the incorrect work 'on' was the plywood substrate, not the interior parts of the units for which Kadena sought repair/replacement costs. Those parts—the drywall, insulation, framing, and ducting—were not defective and were not the subject of Global's incorrect work, and as a result, their repair and replacement costs do not fall under exclusion j(6)."

The court noted that, "while no California case has interpreted the phrase 'that particular part' as it appears in exclusion j(6), the cases interpreting the phrase in other CGL policy provisions reject the idea that it extends to the insured's project as a whole or to the entire area affected by the insured's defective work." The court held that, if exclusion j(6) "applies only to the particular component of the insured's work that was incorrectly performed and not to the insured's entire project," it did not apply here. After all, "the only arguably defective components or parts of Global's work are the plastic tarps, as they failed to keep the water out."

I expect to see Kadena Pacific become a go-to case for policyholders nationally that are arguing for a narrow interpretation of exclusions j(5) and j(6).

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This article is reprinted with permission of its author, Randy Maniloff, as it appeared in the October 11 issue of his Coverage Opinions newsletter (Volume 6, Issue 8). Maniloff is an attorney with White and Williams, LLP located in Philadelphia, PA. Visit Coverage Opinions here: www.coverageopinions.info. 

Last Updated: October 27, 2017

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