BatesCarey’s Kristi S. Nolley  and Lindsey D. Dean discuss the recent Pennsylvania decisions, Atain Ins. Co. v. Xcapes, et al. and Nautilus Ins. Co v. 200 Christian St. Partners LLC, which delve into the distinction between uncovered faulty workmanship and potentially covered resulting property damage.

Faulty workmanship, by itself and in the absence of consequential damage to other property, is in many jurisdictions not covered under a general liability policy because it is not a fortuitous event, and therefore not a “accident.”  This principle was reinforced in a recent decision from the U.S. District Court for the Eastern District of Pennsylvania.  A few days prior to that decision, however, the Third Circuit, also applying Pennsylvania law, affirmed another decision demonstrating that otherwise uncovered faulty workmanship may trigger a duty to defend where such workmanship results in unforeseeable “bodily injury” or “property damage,” or where a product used in the construction actively malfunctions.

Atain Ins. Co. v. Xcapes, et al., No. 2:19-CV-05346, 2020 WL 4196004, at *3 (E.D. Pa. July 20, 2020)

In Atain, a homeowner retained the insured home improvement contractor, XCapes, to perform masonry work at their home in Newtown, Pennsylvania.  The homeowners paid the contractor $28,300 before the work began. Once work started, the homeowners immediately noticed workmanship issues.  Despite these red flags, the homeowners entered into a second contract for work on their pool and patio area for $41,700 and advanced another $28,000 before work began.  Unsurprisingly, the homeowners were dissatisfied with the contractor’s work on the pool and refused to pay the balance on the contract.  The contractor stopped work, leaving the pool and patio unfinished and the prior masonry work in disrepair.  The homeowners filed a lawsuit against the contractor seeking damages for the contractor’s failure to perform the agreed-upon work, alleging they lost money by paying for work that was never done and that their property was damaged by work that was done incorrectly.

The contractor’s general liability insurer agreed to defend the insured under a reservation of rights and filed coverage litigation seeking a declaration that it had no duty to defend or indemnify because the allegations in the lawsuit were limited to the insured’s own faulty workmanship. Applying the well-recognized principle that faulty or defective workmanship does not constitute an “occurrence,” the Eastern District of Pennsylvania held that the policy afforded no coverage. The court rejected the contractor’s argument that the underlying complaint alleged damage to property outside the scope of the contracted-for work.  The court found that, even if the homeowner alleged some damage outside the scope of the parties’ agreement, such damage could still be attributable to faulty workmanship if that damage was a “foreseeable result” of that faulty workmanship.  

The District Court’s decision in Atain confirms that, faulty workmanship, in and of itself, is a non-fortuitous event that typically is not a covered “occurrence” under a general liability policy.  However, days before Atain was decided, the Third Circuit affirmed another decision by the Eastern District of Pennsylvania in Nautilus, holding that claims of resulting property damage may bring otherwise uncovered allegations of faulty workmanship back within the scope of a general liability policy’s insuring agreement.    

Nautilus Ins. Co v. 200 Christian St. Partners LLC, No. 19-1506, 2020 WL 4018309 (3d Cir. July 16, 2020)

In Nautilus, a developer, 200 Christian Street Partners, LLC, constructed luxury homes in Philadelphia, Pennsylvania.  Two homeowners filed lawsuits against the developer alleging that their homes were defectively constructed and, although marketed as “luxury” homes, were “riddled with construction defects.”  The homeowners alleged that the developer misrepresented that it did not “skimp” on construction, when, in fact, the homes were constructed with faulty materials.  The homeowners asserted that the use of faulty materials, including windows and moisture barriers, caused damage to the homes.  The homeowners alleged causes of action for violations of consumer protection law, violations of the Pennsylvania Real Estate Seller Disclosure Law, breach of the implied warranty of habitability, breach of express warranty, negligent construction, negligent supervision/training of employees and subcontractors, and civil conspiracy.

The developer’s general liability insurer agreed to defend it under a reservation of rights but filed a declaratory judgment action, arguing that the allegations in the underlying lawsuits stemmed from the insured’s faulty workmanship, which was not a covered “occurrence.”  The District Court disagreed and denied the insurer’s motion for judgment on the pleadings, finding that the lawsuits also alleged product-related tort claims, which were separate and apart from the developer’s faulty workmanship.  The District Court found that, in addition to allegations of faulty workmanship, the homeowners in Nautilus alleged the developer used faulty materials that resulted in property damage and physical injury.  Given the breadth of the allegations, the District Court concluded that the homeowners’ complaints potentially alleged an “occurrence.” 

The insurer appealed, and, in a very brief opinion, the Third Circuit affirmed the District Court’s ruling in favor of the developer.  The Third Circuit concluded that the underlying complaints contained more than mere allegations of faulty workmanship, but also included allegations of use of faulty materials and the active malfunction of products, which were “sufficiently fortuitous as to constitute an ‘occurrence.’”

Despite the voluminous decisions across the country addressing this issue, coverage for construction defect claims continues to be a hot button issue in insurance coverage.  As illustrated by Atain and Nautilus, cases that may seem similar at first glance can garner very different results depending upon whether the underlying complaint involves only faulty workmanship, or alleges unforeseeable resulting property damage outside the scope of the insured’s work or the improper use of a product that actively malfunctions.  Even for those cases that may trigger an insurer’s duty to defend based upon allegations of resulting damage, an insurer may still contest indemnity coverage for damages or that portion of a settlement that compensates a claimant for the faulty workmanship itself.  An insurer should look closely at the terms of any resulting settlement or judgment and assess whether it may be entitled allocate between amounts for faulty workmanship versus amounts to compensate for unforeseeable resulting damage.

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