10th Circuit Holds Damage To Insured’s Work Caused By Subcontractor’s Faulty Workmanship A Covered “Occurrence” Under New York Law
In Black & Veatch Corp. v. Aspen Ins. (UK) Ltd., No. 16-3359, 2018 U.S. App. LEXIS 3342, 2018 WL 843284 (10th Cir. 2018), the U.S. Court of Appeals for the Tenth Circuit, applying New York law in a construction defect coverage case, held that where a policy contains a “Subcontractor Exception” to a “Your Work” exclusion, property damage to an insured’s work product caused by a subcontractor’s faulty workmanship constituted a covered “occurrence”, and coverage was not precluded under the “Your Work” exclusion.
Black & Veatch Corporation (“Black & Veatch”) contracted with American Electric Power Service Corporation (“American Electric”) for Black & Veatch to engineer, procure, and construct several jet bubbling reactors, which were designed to eliminate contaminants from exhaust emitted by coal-fired power plants. Black & Veatch subcontracted certain engineering and construction aspects to Midwest Towers, Inc. (“Midwest Towers”). Deficiencies in the components provided by Midwest Towers and constructed by Midwest Tower’s subcontractors caused internal components of seven of the jet bubbling reactors to deform, crack, and sometimes collapse.
Pursuant to American Electric and Black & Veatch’s subsequent settlement agreements, Black & Veatch was obligated to pay more than $225 million to repair and replace the internal components of the jet bubbling reactors. Prior to the loss at issue, Aspen Insurance (UK) Ltd. and Lloyd’s Syndicate 2003 (collectively, “Aspen”) had entered into an insuring contract with Black & Veatch (the “Aspen Policy”). Aspen denied coverage, asserting in subsequent litigation that Black & Veatch’s expenses arose from property damages that were not covered “occurrences” under the Aspen Policy, because the only damages involved were to Black & Veatch’s own work product.
The Decision Below
After Aspen denied coverage, Black & Veatch sued for breach of contract and declaratory judgment. Applying New York law, the U.S. District Court for the District of Kansas agreed with Aspen that the damage to the jet bubbling reactors was not an “occurrence” under the Aspen Policy because the damages occurred to Black & Veatch’s own work product—the jet bubbling reactors— and therefore were not covered under the Aspen Policy.
On appeal, the U.S. Court of Appeals for the Tenth Circuit concluded that the New York Court of Appeals would hold that the damage to the jet bubbling reactors was an “occurrence” under the Aspen Policy, because the damage was accidental, and that a contrary reading would render the Subcontractor Exception and Endorsement 4 surplusage, in violation of New York law.
The insuring agreement of the Aspen Policy provided as follows:
We [the Insurer] will pay on behalf of the “Insured” those sums in excess of the [liability limit provided by other insurance policies] which the “Insured” by reason of liability imposed by law, or assumed by the “Insured” under contract prior to the “Occurrence”, shall become legally obligated to pay as damages for: (a) “Bodily Injury” or “Property Damage” . . . caused by an “Occurrence”[.]
The Aspen Policy defined “occurrence” as “an accident . . . that results in ‘Bodily Injury’ or ‘Property Damage’ that is not expected or not intended by the ‘Insured.’” (emphasis added). Although the Aspen Policy did not define “accident”, the New York Court of Appeals held in Cont’l Cas. Co. v. Rapid-American Corp., 80 N.Y.2d 640 (N.Y. 1993), that damages are accidental so long as they are “unexpected and unintentional.” Consequently, coverage may be barred under New York law “only when the insured intended the damages”, regardless of the fact that an insured might have foreseen the possibility that its subcontractor would build a defective product. Because Black & Veatch did not “expect or intend” that its subcontractor, Midwest Towers, would cause the damages at issue, and there was no evidence that Black & Veatch increased the likelihood of such damages through reckless cost-saving or other measures, the damages at issue constituted an “accident,” and therefore an “occurrence,” under the Aspen Policy.
The Aspen Policy also contained the following “Your Work” exclusion:
This policy does not apply to . . .
“Property Damage” to “Your Work” arising out of it or any part of it and included in the “Products/Completed Operations Hazard.”
“Your Work” was defined as “work operations performed by you or on your behalf” by a subcontractor.
The “Your Work” exclusion was subject to an exception, which provided that “[the ‘Your Work’ exclusion] does not apply if the damaged work or the work out of which the damage arises was performed on [Black & Veatch’s] behalf by a subcontractor” (the “Subcontractor Exception”).
A second exclusion, known as “Endorsement 4”, excluded coverage for property damage to the “particular part of real property” that Black & Veatch or its subcontractors were working on when the damage occurred.
The Tenth Circuit concluded that it would be redundant to exclude coverage for property damage to Black & Veatch’s own work (as stated in the “Your Work” exclusion) if the definition of “occurrence” precluded coverage for such damages in the first instance. Similarly, the Court reasoned that there would be no reason to provide an exception to the “Your Work” exclusion when “the damaged work . . . was performed . . . by a subcontractor” if the basic insuring agreement did not encompass those damages in the first place. Finally, there would be no reason for “Endorsement 4” to exclude coverage only for damage to a “particular part” of the jet-bubbling reactors if there was no coverage for damage to the insured’s work in the first instance.
Aspen asserted that, under New York’s First Department’s decision in George A. Fuller Co. v. United States Fidelity and Guaranty Co., 200 A.D.2d 255 (1st Dept. 1994) (“Fuller”), CGL insurance policies are “not intended to insure against faulty workmanship or construction”, and therefore the Aspen Policy did not cover the damages at issue. The Tenth Circuit distinguished Fuller, noting that the policy before the Fuller court excluded damages to “that particular part of any property that must be restored, repaired or replaced” due to work that was performed incorrectly either by “you [the insured] or on your behalf [by a subcontractor].” In this case, the Aspen Policy expressly provided coverage for damages to an insured’s work arising from a subcontractor’s faulty workmanship.
Finally, because the damages at issue arose out of the work of Black & Veatch’s subcontractor, Midwest Towers, the Court found that the “Your Work” exclusion was inapplicable. In particular, the “Subcontractor Exception” in the Aspen Policy provided that the “Your Work” exclusion “does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”
Learning Points: The Black & Veatch court held that, under New York law, property damage that is not “expected or intended” by the insured was an “accident”, and therefore also constituted an “occurrence” under the CGL policy at issue. Further, while the “Your Work” exclusion precluded coverage for damages arising from Black & Veatch’s or its subcontractor’s work, the “Subcontractor Exception” brought the claim back within the scope of coverage, because the damages at issue were caused by the work of a subcontractor.
The Black & Veatch decision is consistent with the current trend of decisions by many state courts holding that construction defects may constitute an occurrence under a CGL policy. See Cherrington v. Erie Ins. Prop. & Cas. Co., 745 S.E.2d 508, 518 n.19 (W. Va. 2013) (summarizing cases from Arizona, California, Connecticut, Florida, Georgia, Indiana, Kansas, Minnesota, Mississippi, Missouri, Montana, North Dakota, South Dakota, Tennessee, Texas, and Wisconsin); see also Cypress Point Condo. Ass’n v. Adria Towers, L.L.C., 143 A.3d 273 (N.J. 2016) (holding that consequential damage resulting from defective workmanship performed by subcontractors constituted both an “occurrence” and “property damage” under the terms of the policies.).