Time to get a “LEG” up on construction disputes?
By Joseph S. Harrington, CPCU
Few areas of insurance generate as many disputes as construction defects and/or faulty workmanship.
Property damage claims that arise from contractor errors entail a myriad of fact scenarios involving piles of rubble, saturated fixtures, or smoldering ruins, further complicated by a variety of changing and conflicting court rulings.
That’s why agents and brokers are finding more of their construction clients asking about “LEG” endorsements, both for their own purposes and on behalf of their customers’ risk managers.
LEG endorsements, named for the London Engineering Group, an organization formed by British insurers, are widely used in course of construction insurance in Europe, gaining traction in Canada, and slowly entering the U.S.
Shifting stands in general liability Decades ago, property damage caused by a contractor’s faulty design and/or workmanship was widely regarded as a business risk that was not appropriate for coverage under a commercial general liability policy.
As a result, standard CGL policies contain several exclusions that preclude coverage for losses caused by the insured’s faulty workmanship. Those exclusions, however, typically include an exception that preserves coverage for damage caused by the insured’s subcontractors.
The legal climate regarding faulty workmanship has changed. According to a 2013 report from General Reinsurance, 26 state supreme courts had issued rulings establishing that a damage caused by a construction defect (but not the defect itself) could be construed as an “occurrence” that triggered coverage under a CGL policy. Of those 26 courts, seven had reversed their positions on the issue since 2006.[i]
Yet six state supreme court rulings at the time of the report held that construction defects are not occurrences for the purpose of CGL coverage, and 18 states and the District of Columbia did not have a definitive ruling on the matter.
Occurrence According to the report’s authors, the “pro-insurer” (no CGL coverage) position essentially holds that faulty work is not accidental; the “pro-policyholder” position (triggering CGL coverage) holds that the resulting damage is not intended.
If a court determines that a construction defect or faulty workmanship qualifies as an insured “occurrence,” it must determine when the occurrence happened. This adds another complication.
Courts that use an “injury-in-fact” theory consider damage to have occurred when the faulty work was done; courts that use a “manifestation” approach deem the damage to have occurred when it first became apparent.
The injury-in-fact approach has practical limitations, according to attorney Steven Pearson of the law firm Cozen O’Connor, because it is often difficult to determine when the faulty work was done. The second approach avoids that problem but “has the effect of transforming all policies into claims-made policies.”[ii]
Builders risk Lack of consistency regarding the application of CGL coverage complicates claims handling for construction work insured under builders risk or course of construction policies, which provide open-perils property coverage for a structure and its components as the structure is being built.
Builders risk policy forms generally are not regulated and commonly incorporate proprietary features but typically include exclusions for damage to the insured’s work caused by faulty workmanship. Those exclusions typically include exceptions, however, that preserve coverage for damage to other property caused by an insured peril that results from the faulty workmanship.
Hence, a builders risk policy typically would not pay to replace wiring that was improperly installed by the insured but would pay for fire damage to other covered property caused by the faulty wiring.
Builders risk has some inherent limitations. Coverage typically expires once a project is completed, and even in that limited time, coverage typically extends only to damage by an insured peril to covered property.
Enter LEGs
Those limitations will remain whether or not builders risk insurers in the U.S. choose to use the LEG endorsements. Issued in 1996 and revised in 2006, LEG endorsements allow construction insurers to choose among three levels of coverage for construction defects and faulty workmanship:
- LEG1 effectively excludes coverage for all loss or damage “due to defects of material workmanship, design, plan, or specification.”
- LEG2 excludes coverage only for “that cost which would have been incurred if replacement or rectification of the insured property had been put in hand immediately prior to the said damage.”
- LEG3 excludes coverage only for “that cost incurred to improve the original material workmanship, design, plan, or specification.”[iii]
Thus there is a progression from no coverage under LEG1, to coverage under LEG2 for all but the “pure” costs of rectifying the error, to coverage under LEG 3 for all but the costs to improve the original design or work. As the application of an exclusion is narrowed, coverage is broadened.
LEG endorsements on their own won’t eliminate disputes, but they will reduce their scope and substitute premium-supported risk recovery for many of them.
Although LEG endorsements have been a topic of discussion at recent construction and inland marine insurance conferences (builders risk being a class of inland marine insurance), it is far from certain that U.S. carriers will embrace them, as they would deviate from their long-established approach to construction defects.
Nonetheless, LEG endorsements offer the prospect of reducing (not eliminating) disputes over construction defects and substituting premium-supported coverage for some of them. It’s no surprise that your clients may be asking about these endorsements.
[i] Paul Kelejian, claims executive, and Elizabeth Benet, business development specialist, General Reinsurance, “Contractors and Construction Defects—Expanding Coverage, Expanding Solutions,” Insurance Issues, September 2013, accessed at http://www.genre.com/knowledge/publications/insurance-issues-2013-09-cc-en.html
[ii] Steven Pearson, “Construction Defect Coverage: Emerging Issues,” presentation for the 2015 PLRB Regional Adjusters Conference, http://www.plrbclaimsconference.org/handouts/smallmeetings/ConstructionDefectCoverage-PPT.pdf
[iii] Laurie Montoya, National Construction Property Director, Zurich North America, “Builders Risk and the Impact of LEG-3,”presentation to the 2016 IRMI Construction Risk Conference, https://www.irmi.com/docs/default-source/crc-handouts/2016-crc-handouts/builders-risk-and-the-impact-of-leg-3.pdf?sfvrsn=14
