Tuesday, April 19, 2011

Faulty Workmanship as "Occurrence"

Jimcor Agencies was fortunate to have Bernie Heinze, Esq., Executive Director of AAMGA (American Assoc. of Managing General Agents) in our offices to teach a class last week.  One of the industry issues that was discussed during the class was Bernie's prediction the "faulty workmanship" inclusion into the CGL coverage grant would be a trend on which our industry needs to stay abreast.  In following up a few days after the class, Bernie sent around the opinion of the Western District of PA Federal Court and some background... as well as supporting documents and comments thanks to Randy J. Maniloff, White and Williams LLP, Philadelphia, PA.

"It is no secret that, since the Pennsylvania Supreme Court’s 2006 decision in Kvaerner, policyholders in Pennsylvania that have sought coverage for defective workmanship (whether construction defect or otherwise) have not fared well. The Western District of Pennsylvania recently ended the policyholder drought. But, a close look at the decision shows that the worm has hardly turned for policyholders confronting the faulty workmanship/“occurrence” issue.

In National Fire Ins. Co. of Hartford v. Robinson Fans, the court addressed coverage for an insured, Robinson Fans, that designed, manufactured and sold three industrial fans to Archer-Daniel-Midlands Co. ADM filed suit against Robinson Fans alleging that the equipment “failed catastrophically” on account of design defects. Robinson Fans at 1. The insurer undertook Robinson’s defense under a reservation of rights. At issue before the court in the subsequent coverage action was summary judgment on whether the failure of a defective product was an “occurrence.” Id. at 2.

The court readily acknowledged that, under Kvaerner, “the definition of ‘accident’ required to establish an ‘occurrence’ under the policies cannot be satisfied by claims based upon faulty workmanship. Such claims simply do not present the degree of fortuity contemplated by the ordinary definition of ‘accident’ or its common judicial construction in this context. To hold otherwise would be to convert a policy for insurance into a performance bond. We are unwilling to do so, especially since such protections are already readily available for the protection of contractors.” Id. at 5 (quoting Kvaerner). All of this is strikingly similar to the Lexicon case we discussed in AK and the Crossman opinions we discussed during the classes from Arkansas and South Carolina, respectively

The Robinson Fans court also concluded that, based on other decisions it examined, Pennsylvania law does not recognize the applicability of a CGL policy to a breach of contract claim. Id. With that as a backdrop, the court then distinguished Kvaerner, and other cases that have followed Kvaerner, from the defective fans before it. The decision’s money paragraph is as follows:
[T]here is a discernible distinction between a product that actively malfunctions, which could give rise to an “accident,” and flawed product related work done in performance of a contract, which cannot. Cases suggest a material difference between a claim that stems from a “breach[] [of] duty imposed by mutual consensus” -- or an alleged failure to live up to bargained-for standards -- and one that stems from breaches of standards of care imposed by law as a matter of social policy, independent of the parties’ bargain. See CPB Int’l, 2007 U.S. Dist. LEXIS 86506, at *19. The former constitutes uncovered “contractual claims of poor workmanship,” even if couched as negligence; the latter, however, may be a covered “active malfunction.” Cf. Erie Ins. Exchange v. Abbott Furnace Co., 972 A. 2d 1232, 1238 (Pa. Super. Ct. 2009) (emphasis in original). In other words, negligent or defective design, in a case in which the product is designed pursuant to and in accordance with a contract, is necessarily part and parcel of the contract performance. In contrast, if a product was negligently or defectively designed, and then supplied pursuant to a subsequent contract, the design work might be measured against tort standards of care rather than agreed-upon terms.

Id. at 6-7 (emphasis added).

The Robinson Fans court then cited several decisions that it believed supported this distinction The take-away from the court’s rule is this:
If the failure of the insured’s work or product was caused by the insured’s faulty design, and its obligation of proper design was one that the insured undertook in its contract, then the insured breached its contract and any damage was not caused by a occurrence.

On the other hand, if the failure of the insured’s work or product was caused by the insured’s faulty design, and such design predated the contract, i.e., was not an obligation undertaken specifically on account of the contractual relationship, then the insured did not breach its contract, but, rather, breached a duty imposed by social policy. In this case, any damage was caused by a occurrence.

Turning the facts at issue, the Robinson Fans court held as follows:
Here, the underlying complaint states a claim entitled, “negligence in design.” In so doing, it avers that the insured “agreed to provide” equipment that conformed with ADM’s performance specifications; “designed” the equipment, at some unspecified point in the case chronology; and “selected materials for and manufactured the equipment.” Further, the complaint states that the “negligence” and “design defects” caused “catastrophic failure” of the equipment. The complaint lacks any factual allegation that the insured undertook to design the equipment pursuant to mutual consensus or agreement, or instead, for example, supplied a fan designed long before Robinson and ADM contracted. Therefore, there is no basis for decisively concluding either that the complaint alleges failure to exercise care in duties imposed by contract, or those imposed extra-contractually by law. One possibility is equally as likely as the other.
Id. at 10.

While Robinson Fans was a win for the policyholder, it does not turn Pennsylvania law on its head.

First, it was a duty to defend decision. The court made clear that its decision was tied to a broad duty to defend standard and that when it comes to any potential indemnity obligation, the result may be much different. The court stated: “I cannot rule out the possibility that something other than faulty workmanship is blamed for the equipment failure. Therefore, because I must liberally construe the underlying complaint in favor of the insured, I conclude that it possibly pleads a triggering “occurrence,” rather than faulty workmanship.” Id.

Second, even if the failure of the fans constitutes an occurrence, for indemnity purposes, because it is determined that the design work predated the contract, i.e., the contract was not for the design, it seems likely that coverage would still be precluded by the “your product” exclusion (or “your work” exclusion in other contexts).

Third, faulty workmanship cases are more likely to involve construction defects alleged against contractors, which are not as likely to have design components, but, rather, allege failure to perform work as promised, i.e., the breach of contract claim that Robinson Fans held is not an occurrence (although now look out for “artful pleading” to trigger a duty to defend).

Fourth, in reaching its decision, the court relied on two New Jersey decisions and two Pennsylvania decisions that pre-dated Kvaerner.

A curious aspect of the Robinson Fans opinion is footnote 6: “Moreover, while the faulty workmanship alone is not covered, faulty workmanship that causes an accident may lead to coverage. L-J, Inc. v. Bitumous Fire and Marine Insurance Co., 567 S.E. 2d 489, 492-493 (S.C. 2002).” This statement suggests that the Robinson Fans court never received the Gambone memo. Further, South Carolina law has come a long way since L-J, especially after the recent Crossman decision. South Carolina is probably the last state that should be cited these days when attempting to make any pronouncement of coverage for faulty workmanship."
Thank you Bernie for your in depth analysis of this issue during our CE Class.  Thank you Randy for your insight and comments.

If you have any questions please contact Jimcor Agencies, Randy J. Maniloff or AAMGA for more information.
http://www.jimcor.com/
http://www.aamga.org/
maniloffr@whiteandwilliams.com