Eleventh Circuit Holds Repair of Insured’s Work Not Covered Property Damage

In its recent decision Palm Beach Grading, Inc. v. Nautilus Ins. Co., 2011 U.S. App. LEXIS 14576 (11^th Cir. July 14, 2011), the Eleventh Circuit affirmed a holding by the United States District Court for the Southern District of Florida that costs associated with repair of the insured’s own work does not constitute “property damage” under a general liability policy.

The insured, A-1 Underground, had been subcontracted to construct water utilities and sanitary sewer utilities in connection with a larger construction project.  A-1 later abandoned the project, forcing the general contractor, Palm Beach Grading (“PBG”) to hire a second subcontractor to complete the work.  The second subcontractor determined that A-1’s work associated with a sewer line was defective, requiring the subcontractor to dig up and replace the line.  PBG later sued and obtained a judgment against A-1.  PBG then commenced suit against A-1’s general liability carrier, Nautilus, seeking recovery of the repair costs.

The Eleventh Circuit acknowledged that under Florida law, faulty work can constitute an “occurrence.”  The court nevertheless agreed with the lower court that the repair costs associated with A-1’s faulty work did not constitute third-party property damage as required under the policy.  In so holding, the Eleventh Circuit relied on the decisions by the Florida Supreme Court in U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d 871 (Fla. 2007) and Auto-Owners Ins. Co. v. Pozzi Window Co., 984 So.2d 1241 (Fla. 2008), in which the courts concluded that a general liability policy only covers the costs of repairing damage resulting from an insured’s defective work, not the cost of repairing the or removing the defective work itself.  Because PGB’s claim was limited to repairing the sewer line, as opposed to damage caused by the sewer line (such as resulting sinkholes or back-ups), the underlying suit did not allege “property damage” triggering coverage under the Nautilus policy.

Sixth Circuit Holds Supplier is a Subcontractor Under Business Risk Exclusion

In its recent decision Mosser Constr. v. Travelers Indem. Co., 2011 FED App. 0481N (6^th Cir. July 14, 2011), the United States Court of Appeals for the Sixth Circuit, applying Ohio law, had occasion to consider what constitutes a “subcontractor” for the purpose of a “your work” exclusion in a general liability policy. 

The insured, Mosser, was a general contractor hired to construct an addition to a waste water facility plant.  As part of its work, Mosser was required to place structural backfill beneath and around the new building.  The contract specifically required that Mosser use backfill meeting the size and grading requirements for AASHTO #57 coarse aggregate.  Mosser contracted with a supplier for the purchase of the required fill, which the supplier happened to have available in stock. The supplier never visited the construction site and, in fact, was not even involved in the delivery of the fill to the site.  The backfill ultimately proved to be defective, resulting in damage to the newly constructed facility.

Mosser’s general liability carrier, Travelers, denied coverage for the resulting property damage claim made against Mosser based on a standard “your work” exclusion applicable to:

l.          Damage To Your Work

"Property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard".

The exclusion, however, is subject to the following standard exception:

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

Mosser argued that the exception applied to the exclusion since the supplier of the fill should be considered a subcontractor.  Travelers, on the other hand, argued that subcontractor has a well-understood meaning within the construction industry that is typically limited to contractors that actually perform work on a project.  As such, argued Travelers, a supplier of materials to be used in a construction project cannot qualify as a subcontractor.

Noting that no Ohio court had addressed the definition of subcontractor for the purpose of the “your work” exclusion, the Sixth Circuit looked to case law in other jurisdictions.  The court acknowledged that several courts had concluded that a material supplier can qualify as a subcontractor when that supplier fabricates the purchased material to some degree of customization, or otherwise performs some work on site.  In other words, a supplier must do something more than merely provide standard inventory items. 

In light of this case law, the Sixth Circuit concluded that the undefined term “subcontractor” was ambiguous and therefore must be construed in a manner most favorable to Mosser.  The court, however, refused to draw a bright line, as argued by Mosser, that all suppliers of material are necessarily subcontractors.  For example, explained the court, a hardware store selling standard-inventory nails is not a subcontractor.  Rather, when a supplier does not perform any actual work on site, it will be considered a subcontractor only when it “must manufacture the material according to specifications supplied by the general contractor, and, its materials contract with the general contractor must explicitly incorporate terms from the master contract or otherwise explicitly indicate that the materials at issue are manufactured or supplied specifically for the master contract's project.”

Turning to the specific facts in Mosser, the court concluded that while the supplier happened to have the requested fill in stock, such was a mere coincidence and that the supplier would have had to custom fabricate such fill had it not been in stock.  Just as significant for the court was the fact that the purchase order entered into between Mosser and the supplier specifically referenced the underlying general contract for which the fill would be required.  Thus, “[a]lthough [the supplier] may have produced all or part of the backfill before entering into the purchase order with Mosser, the circumstances of this case are enough to nudge [the supplier] over the line separating mere material suppliers from subcontractors.”

While the Mosser court was careful to avoid the bright-line advocated by the insured, i.e., that all suppliers are subcontractors, the court’s decision nevertheless has the potential to have significant insurance coverage ramifications, both in terms of the business-risk exclusions as well as for additional insured issues.