Academic journal article Defense Counsel Journal

The Construction Defect Hot Potato: The Interplay between the Performance Bond and CGL Policy - a Surety's Perspective

Academic journal article Defense Counsel Journal

The Construction Defect Hot Potato: The Interplay between the Performance Bond and CGL Policy - a Surety's Perspective

Article excerpt

OWNERS OF PROJECTS under construction protect against unexpected loss by requiring contractors to provide certain types of insurance, including a current commercial general liability policy ("CGL"). A CGL policy protects the owner from the negligent acts of the contractor causing property damage or bodily injury during the performance of the contract and for a limited period of time thereafter. All public owners and many private owners also require the contractor to provide performance and payment bonds to protect against the risk that the contractor will fail to complete the project or fail to pay his subcontractors. These two forms of financial protection can sometimes overlap, making critical an understanding of what protection they provide and the circumstances under which each form of protection is available.

A surety called upon to complete a project also needs to have a thorough understanding of insurance coverage in place in the event that the original contractor's negligence caused property damage or bodily injury. When a newly installed roof leaks, damaging the drywall and interior finishes, a property owner's typical first reaction is to call his insurance company and make a claim for the damage. If any of these occurrences happen while a surety is completing the project following default in performance by a contractor, then the surety needs to ensure its principal gives notice of a claim under the policy.

Insurance may not be the only source of recovery for the owner where defective work performed by the bonded contractor results in damage to the building or parts of the project. If a surety bond has been required of the general contractor or subcontractor, and the damage is the result of defective work by the contractor providing the bond, recourse may also be available against the performance bond. The surety who corrects defective work as part of a completion effort should evaluate whether the costs associated with correcting the defect or addressing the damage caused by the defect can be recovered from an insurance carrier. This article discusses the inherent differences between insurance and suretyship, highlighting the distinctions that arise in claims made for defective workmanship under a CGL policy or under a surety performance bond.

I. The Construction Defect Hot-Potato

A. Is There Overlap Between Insurance and Suretyship?

In general, a CGL policy provides coverage for the negligence of a contractor which results in injuries to people or property belonging to someone else. It does not provide indemnity for pure breaches of contract by the insured, even those arising out of the faulty workmanship of the insured. The standard CGL form widely used throughout the construction industry, prepared by the Insurance Services Office ("ISO"), covers "property damage," including "loss of use" of property caused by an "occurrence." (1) Under this definition, defective work causes property damage to a covered property if it damages the materials involved, the property surrounding the defective work, or causes a loss of use of the property. CGL does not cover the cost of replacing or correcting the defective work itself--in the above scenario, the roof--except to the extent that the materials themselves are damaged. Most importantly, the ISO CGL limits recovery to damage caused by an "occurrence," which is typically defined as an accident. The ISO CGL policy contains several important exclusions, including an exclusion for failure by the insured to complete the construction work.

A seminal decision summarized coverage provided by a CGL policy as follows: "[u]nder well-established case law, a CGL policy does not cover faulty workmanship, only faulty workmanship that causes damage to other property." (2) The distinction is that the CGL policy covers damage resulting from an accident caused by faulty workmanship, not damage resulting from the costs required to correct the faulty workmanship itself. …

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