Ohio Supreme Court Guts Construction Insurance Protection
The Ohio Supreme Court issued a seminal decision further limiting insurance coverage for construction defects in Ohio Northern University v. Charles Construction Services, Inc., Slip Op. 2018-Ohio-4057. The decision, issued Oct. 9, 2018, held that the general contractor was not entitled to a defense or coverage on a claim relating to construction defect, even for resulting damages — contrary to the majority of other states.
The case was brought by the university/owner against its general contractor, Charles Construction, after the project’s completion when the university discovered evidence of water intrusion and moisture damage. In the course of remediation, Ohio Northern University found serious structural defects. Charles Construction’s insurer successfully intervened in the case and asserted that it had no duty to defend or indemnify. It relied on the earlier Supreme Court decision in Westfield Ins. Co. v. Custom Agri Systems, Inc., 133 Ohio St. 3rd 476, 979 N.E. 2d 269 (2012). In that earlier case, the Court had held that construction defects are not “occurrences” as defined in the contractor’s commercial general liability policy. While that decision provoked much consternation, closer examination revealed that the damage the insurer was asked to cover related to the insured contractor’s own work, not that of a subcontractor. Such work is typically not covered due to the “your work” exclusion in standard CGL policies.
The trial court ruled in favor of the insurer, that the defective work by the subcontractor was not an occurrence and, therefore, the insurer had no duty to defend and no duty to indemnify its insured general contractor. The Third District Court of Appeals reversed that decision. It found that Custom Agri confirmed, “the well-established principles that CGL policies are not intended to protect against a “contractor’s own defective work.” (emphasis added). To determine whether coverage applied, it looked to the completed operations provision of the policy. It found coverage for the extensive damages caused by a subcontractor’s defective work under an express exception to the “your work” exclusion. In this circumstance, damages caused to one subcontractor’s work by another subcontractor’s defective work should be covered by the CGL policy. The Court explicitly rejected the insurer’s position that “property damage” cannot constitute an “occurrence” as a matter of law.
The Court of Appeals’ well-reasoned opinion deftly addressed the Custom Agri decision. It placed Ohio, however temporarily, in alignment with a strong majority of state supreme court decisions on this important issue. It fell on deaf ears at the Ohio Supreme Court. For the High Court, it all boiled down to whether a subcontractor’s defective work can be considered an "occurrence." "[P]olicies are not intended to protect owners from ordinary business risks that are normal, frequent or predictable consequences of doing business that the insured can manage. Here we cannot say that the subcontractors’ faulty work was fortuitous." Ohio N. Univ., 2018-Ohio-4057, at 29.
The contractor had presented compelling evidence that the insurer must have anticipated coverage for post-completion defect claims. Its premiums confirmed that the insurer was paid for completed operations coverage. The Court’s analysis ignored this fact. It paid no attention to decisions of the vast majority of other states. Precedent in those jurisdictions clearly indicates that the “occurrence” requirement was satisfied since a subcontractor’s work caused water infiltration that damaged other non-defective work. Among the contractor’s most cogent arguments was that there is only one reason for the exception to the “your work” exclusion. The reason is that the exception intends to bring damages caused by a subcontractor’s work within the policy’s coverage. To this, the Court turned a blind eye.
The impact of this decision is very significant. Contractors defending post-completion claims by owners are not even owed a defense by the insurer. Anyone with significant industry experience knows that effective settlement of these disputes invariably rests on insurance. This is true even where the contractor and subcontractors are solvent. Where the responsible players are judgment proof, insurance coverage is the general contractor’s and owner’s only recourse.
The next question is how general contractors and owners protect themselves from damages caused by construction defects. One hopes that industry associations can lobby the General Assembly to change the law and reverse the Court’s decision. That could understandably take some time. Fortunately, there is an insurance industry track record for offering solutions to restrictive judicial pronouncements. Ironically, insurance companies are now offering endorsements that clarify the definition of “occurrence” so as to assure a broad grant of coverage. One publicly available endorsement deems “property damage” to be caused by an occurrence if:
- The “property damage” is entirely the result of work performed on your behalf by a subcontractor that is not a Named Insured;
- The work performed by the subcontractor is within the “products-completed operations hazard”; and
- The “property damage” is unexpected and unintended from the standpoint of the insured.
General contractors should discuss such coverage with their insurers. Owners should require that their contractors obtain such an endorsement. Absent an effective endorsement to protect against this very real risk, general contractors will find themselves paying for their defense costs when such claims are made — and those costs can be substantial — and owners may find themselves with insolvent contractors and no insurance to protect them against the risk.
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