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Lawsuits against contractors often allege defective workmanship and subsequent damage to a structure and/or damage to property within that structure. Commercial general liability policies are not always clear, however, in just what kinds of damage would be covered in such scenarios. Obviously, the definition of terms such as “property damage” and “occurrence” within the language of a policy is instructive, but even so called definitions can be unclear or ambiguous, when applied to novel facts. When an insurer’s duty to defend a contractor for a potential claim worth millions of dollars is on the line, the proper interpretation of policy terms is critical.

In August 2011, the First District of the Illinois Appellate Court rendered its decision in Milwaukee Mutual Insurance Company v. J.P. Larsen, Inc., 2011 Ill.App.LEXIS 872, 2011 IL App. (1st) 101316. Appellant Milwaukee Insurance provided Appellee Larsen with commercial general liability insurance. Larsen had been hired as a subcontractor by Weather-Tite, Inc. (“Weather-Tite”) to apply sealant to windows installed in a condominium building. Water damage subsequently occurred after leaks were discovered. After being sued by Weather-Tite for contribution and breach of contract for failing to add Weather-Tite as an additional insured to its commercial general liability policy, Larsen tendered its defense to Milwaukee Insurance. Milwaukee Insurance denied the defense tender of Larsen, claiming there was no coverage under the policy as the relative pleadings alleged only construction defects and was neither “property damage” nor an “occurrence” under the policy.

Milwaukee Insurance filed a complaint for declaratory judgment, asking the court to determine whether it was required to provide a defense to Larsen.  It was subsequently determined that Milwaukee Insurance was obligated to defend Larsen.  In making its decision, the court stated several important principles that would guide its decision.  First, the court noted that it would be their goal to give effect to the intent of the contracting parties by relying on the language included in the insurance contract.  They also noted that it would construe the insurance policy as a whole, giving plain and ordinary meaning to the terms in order to give effect to every provision.  Should the policy terms be unambiguous, they will be applied as written.  Conversely, if the terms are ambiguous, they will be construed against the drafter of the policy, Milwaukee Insurance.

The court went on to note that in determining an insurer’s duty to defend, the allegations in the underlying complaint must be compared to the policy language. Those allegations must be liberally construed in favor of Larsen as the insured.  Where an insurer such as Milwaukee Insurance relies on a provision that it contends will exclude coverage and allow them to reject a tender of defense, the court must review that provision and ensure that the policy’s exclusion prevents coverage.  Where the pleading alleges multiple theories of liability, and where some theories of liability would be excluded while others would not be, the insurer is still obligated to defend as long as one theory of liability might possibly fall within the scope of the policy’s coverage.

In order to determine whether Milwaukee Insurance had an obligation to defend Larsen, the court turned to the condominium association’s pleading against Weather-Tite, on which Weather-Tite’s allegations against Larsen were based. The association alleged that because of severe water infiltration due to faulty construction, damage was caused to the condominium common elements, the units, as well as personal property of individual unit owners. Necessary repairs were estimated between $4 million and $8 million.  The court then looked at whether the damages alleged by the plaintiff in this case fell within the meaning of “property damage” as defined by the policy.  The policy defined “property damage” as physical injury to tangible property, including all resulting loss of use of that property.

The question was whether “property damage” as defined by the policy actually occurred in this case.  The court stated that comprehensive general liability policies are intended to protect insureds from liability for injury or damage to persons or property of others.  However, they are not intended to pay the costs associated with repairing or replacing the insured’s defective work and products, which are purely economic losses.  Further, coverage for the cost of replacing or repairing defective work would almost transform such an insurance policy into something similar to a performance bond.  If such insurance proceeds could be used for damage caused by defective workmanship, a contractor could be initially paid by a customer for his services and then paid by an insurance company to repair or replace the work.  This would be unfair to the insurer as it could not bring suit against the contractor for defective construction in contrast to a surety on a performance bond.

Since the condominium association’s complaint alleged that in addition to the personal property of individual unit owners being damaged, the association would also have to make repairs to correct the construction or design defects, the court noted that the damages alleged were not merely construction defects that would indeed constitute economic losses not covered under the policy. Although the complaint alleged $4 million to $8 million in costs that would be required to repair the defects, the additional property damage suffered by individual unit owners was in addition to that sum.

Next, the court considered whether the “property damage” resulted from an “occurrence” within the meaning of the policy.  Milwaukee Insurance argued the complaint did not allege an “occurrence” as the defects alleged were the consequence of faulty workmanship.  Further, it argued that the damage alleged in the complaint was not caused by an “accident.”  “Occurrence” was defined in the policy as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”  Although “accident” was undefined in the policy, other courts have defined that term as an unforeseen occurrence, usually of a sudden or unexpected event.  Prior decisions have held there is no occurrence when a subcontractor’s defective workmanship necessitated removing and repairing work.  However, the court further noted that damage to something other than the project itself does constitute an occurrence under a commercial general liability policy. Examples of such other property would include damage to furniture, clothing or other items within a structure.  Thus, because the complaint alleged damage to personal property separate from the project itself, an “occurrence” was sufficiently plead and as a result, Milwaukee Insurance had a duty to defend Larsen in the Third Party Action.