Fourth Circuit Opens Door for Coverage for Construction Defect Claims under Virginia Law

March 2, 2009

On February 12, 2009, the U.S. Court of Appeals for the Fourth Circuit reversed a district court and held that liability insurance issued to a general contractor covered mold damage to a group of town homes caused by the faulty work of a sub-contractor. Stanley Martin Cos., Inc. v. Ohio Casualty Group, No. 07-2102, United States Court of Appeals for the Fourth Circuit (February 12, 2009). The Court, in Stanely Martin Cos., applied the same reasoning as set forth in its 2006 decision, French v. Assurance Co. of America, 448 F.3d 693 (4th Cir. 2006)(interpreting Maryland law) and casts doubt on the remaining viability of Travelers Indem. Co. of America v. Miller Building Corp., 142 F. App’x 147 (4th Cir. 2005) (unpublished) (interpreting Virginia law).

In Stanley Martin Cos., the policy holder, a general contractor, sought $1.7 million from Ohio Casualty under an umbrella liability policy for costs incurred to repair damage caused by mold infiltration. An investigation of the mold damage indicated that the mold originated from defective trusses and gypsum firewalls installed by a sub-contractor. Ohio Casualty denied coverage, asserting that the damage was not caused by an “occurrence” as required by the policy.

Following the dictates set forth in Miller Building, the District Court for the Eastern District of Virginia agreed with Ohio Casualty’s position. The district court held that under Virginia law damage to the contractor’s own “work” — whether caused by the contractor or one of its sub-contractors — did not constitute an “occurrence.” Because the remediation costs arose from damage to Stanley Martin’s own “work,” the court determined that the property damage was neither unexpected nor unintended. Thus, the court held that there was no coverage under the Ohio Casualty policy.

The Fourth Circuit rejected this interpretation. Instead, the Court held that there is a distinction between damage caused by the insured’s own faulty workmanship and damage to the insured’s work caused by the faulty workmanship of a sub-contractor. The Court’s analysis compared the policy’s broad definition of an “occurrence” against the policy’s “your work’ exclusion. The Court noted that the “your work” exclusion exempted damage to the insured’s work that arises from faulty workmanship of a sub-contractor:

The import of the “your work” exclusion and its subcontractor exception is not that the exclusion creates coverage. Rather, the import is that the exception lends insight into the baseline definition of “occurrence” from which the parties and courts interpreting CGL policies should operate.

Thus, damage to the insured’s non-defective work that was caused by the sub-contractor’s faulty workmanship was unexpected and unintended.

The Fourth Circuit, however, did not open the door entirely. The insured’s obligation to repair and replace the damaged trusses and firewall (the work of the subcontractor) was “not unexpected or unforeseen under the terms of its building contracts” and did not trigger a duty to indemnify. The Court held that coverage was available only for any property damage that extended beyond the trusses and firewall. The Court remanded the case back to the district court for a factual determination of the extent of damage beyond the trusses and fire walls and the cost to remediate such additional damage.

The Stanley Martin decision is important for builders and general contractors faced with construction defect claims in Virginia. Under the Miller Construction case, damage to the policy holder’s work caused by faulty construction, irrespective of whether the faulty workmanship was performed by the insured or one of its subcontractors, was not unexpected or unintended. Now, costs incurred in repairing damage to the policy holder’s own non-defective work caused by the faulty workmanship of a sub-contractor are now recoverable. This decision also highlights the need to accurately determine the extent of damage caused by the faulty workmanship. Contractors facing claims of construction defects should prepare scope documents that will identify the remediation costs associated with damage to work other than that of the sub-contractor whose faulty work caused the damage in the first instance.