Insurers who write builders’ risk insurance might have been a little unsettled to observe a presentation entitled “Complex Issues in Builders Risk Claims” at the recent IRMI Construction Risk Conference in Chicago.

Among other things, the session covered how courts had interpreted provisions of proprietary builders' risk policies to uphold claims their carriers probably never intended to cover.

Would you believe, for example, that some insureds have successfully claimed coverage under a builders' risk policy for a loss due to the insured's own negligence?

Insurers that use the Builders' Risk forms provided in the AAIS Inland Marine Guide could take some comfort, however, in the fact that recent versions of those forms contained provisions designed to avoid some of the vulnerabilities discussed.

“AAIS cannot control how courts rule or what new interpretations may arise,” says Robert Guevara, assistant vice president of inland marine. “But, we continually try to update our language to reinforce the basic intent of the coverage as we understand it.”

The value of the Guide was demonstrated during the IRMI session, even though the Guide itself was never mentioned.

Open perils, open-ended?

For the uninitiated, builders' risk insurance is a class of nonfiled inland marine insurance that provides first-party property coverage to building owners and/or contractors for structures under construction.

Builders' risk policies typically provide coverage against perils to property (fire, wind, etc.) until work is completed. At that time, or shortly thereafter, coverage is transferred to a residential or commercial property policy.

Builders' risk policies have not traditionally been intended to provide coverage for damage caused by a contractor, which is typically covered by a commercial liability policy, or for work to correct an error in design or construction, which is typically assumed as a business risk by architects, designers, and contractors.

Yet, some courts have found coverage in builders' risk policies for losses arising from the negligence of insureds, according to Douglas Patin, an attorney with the Washington, D.C. law firm of Spriggs & Hollingsworth, who led the IRMI session.

The logic for that, Patin says, is rooted in those courts' interpretations of open perils, or “all risk,” coverage.

Most builders' risk forms, including those in the AAIS Inland Marine Guide, are written on an open perils basis, meaning that coverage is intended to apply for first-party losses caused by property perils not expressly excluded under the policy.

It is not always clear what caused damage to a structure, however, and courts are divided over how to deal with cases where it is unclear whether the cause is covered or not.

In support of insurers who argue that builders' risk policies are only intended to cover fortuitous property losses, some courts have added an “unwritten requirement” that a loss result

from at least one “extraneous” or “external” cause, according to Patin.

Other courts have held, however, that imposition of any external cause requirement violates the basic purpose of an open perils policy. That purpose is to have the insurer assume the burden of covering a loss or demonstrating that it is excluded.

In one case cited by Patin, a U.S. court rejected an insurer's claim that the policyholder failed to establish an external cause for the collapse of a storage cavern where there were no eyewitnesses.

Even in cases where builders' risk policies explicitly required some external cause for a loss to be covered, courts have ruled that such clauses cannot change the nature of open perils coverage. As one court put it, “If the loss did not result from [the expressly excluded perils], its cause was necessarily external.”

Liability exposure?

Many builders' risk underwriters can accept that logic, to an extent. Many would find it worrisome, however, to realize that, in Patin's words, “The majority of cases have held that negligence is one of the key risks intended to be covered by an all-risk policy.

“Only a minority of courts find that defects in design and construction do not qualify as external causes,” reads a handout he distributed to attendees.

Insurers may think they are protected from such claims by including exclusions for losses arising from faulty, inadequate, or defective designs, workmanship, or construction. But, that's not necessarily the case.

Builders' risk carriers have learned that courts do not agree on what constitutes defective workmanship. Patin cited a case in which an insured convinced a court that a “misjudgment” by pipe fitters did not constitute defective workmanship.

The ruling, upheld on appeal, suggests that defective workmanship is a flaw in work when carried out as intended, not an accidental occurrence caused by a lapse in judgment.

Other courts disagree, but Patin says the upshot of such rulings is that “defective workmanship exclusions may be avoided by convincing the court that damage was caused by negligence.”

Guide language

According to Patin, the reason there is no uniform court treatment of builders' risk provisions is because there is little uniformity in builders' risk policies. At the time he spoke, he was not aware that the AAIS Inland Marine Guide was a source of standard builders' risk forms, or that the Guide's Builders' Risk forms addressed some of the exposures he was describing.

Regarding the potential that negligence might be construed as an insured peril, the AAIS form reads: “We do not pay for loss caused by an act, defect, error or omission (negligent or not) . . .”

In addition, the AAIS forms have included the term “construction” in the comprehensive list of work-related functions (design, specifications, workmanship, etc.) incorporated under the defects, errors and omissions exclusion.

According to Patin, inclusion of the word “construction” in such a context has been interpreted by courts to rebuff

efforts to find coverage in a builders' risk policy for any damage related to construction work.

Causation

AAIS policy form language addresses other issues raised by Patin.

In cases where a loss arises from both an insured and uninsured peril, or where it is unclear which type of peril was the principal cause, courts have taken two different approaches, Patin said.

One approach holds that builders' risk coverage is triggered whenever any insured peril contributes to a loss, regardless of other factors. The other holds coverage is triggered only if an insured peril is the “efficient cause--the one that sets others in motion.”

In cases where certain excluded perils contribute to a loss, AAIS Builders' Risk forms state: “We do not pay for loss or damage caused directly or indirectly by one or more of the following excluded causes or events. Such loss or damage is excluded regardless of other causes or events . . .”

While that exclusion applies comprehensively to certain standard exclusions (flood, earth movement, nuclear hazard, etc.), there is coverage for ensuing losses due to covered perils (e.g., fire) for loss arising from contamination/deterioration, defects/errors/omissions, mechanical breakdown, and other perils.

Sue and labor

The Inland Marine Guide forms also seek to prevent unintended use of “sue and labor” clauses, wherein insurers compensate insureds for the cost of measures taken to limit insured losses.

Patin criticized a Florida court for ruling that a “sue and labor” clause could not be invoked unless insured damage had actually occurred. The court ruled that “any other conclusion would result in the 'sue and labor' clause becoming the primary coverage provision of the contract . . .”

Insurers would generally agree with that logic, but Patin doesn't. He cited three other cases that hold that the purpose of a “sue and labor” clause is to prevent a covered loss from occurring, whether damage has started or not.

As Patin sees it, “[the Florida court's] rationale undermines the very purpose of a 'sue and labor' clause. It makes no sense to require a party to stand by and watch damage start before one acts to prevent further damage.”

To address potential ambiguity regarding coverage for measures to protect property, the Guide's Builders' Risk forms state: “We will pay the reasonable costs incurred by you for necessary repairs or emergency measures performed solely to protect covered property from further damage . . . if a peril insured against has already caused a loss to covered property.”

Unending task

Guevara is careful to say that AAIS forms cannot anticipate every claim scenario or legal doctrine that may arise, and that AAIS cannot even guarantee how courts will interpret language that seems plain to the drafter.