Defective Workmanship Standing Alone Is Not an Occurrence

The insured general contractor that subcontracted welding work on a silo that collapsed due to faulty welding brought an action against its general liability insurer seeking reimbursement for property damage caused by subcontractor's faulty work. The district court granted the insurer's motion for summary judgment and this appeal followed. This case is Lexicon, Inc. v. ACE American Insurance Company, 2010 WL 5293808 (C.A.8 Ark. ).

Lexicon built a battery of silos in the West Indies. Months after completion, one of the silos collapsed because of faulty welding work done by Lexicon's subcontractor, Damus Limited. The collapse caused millions of dollars in property damage; the silo and its contents were destroyed and nearby equipment was damaged. Lexicon reimbursed the owner of the silo for its damages and spent millions of dollars to clean up the site, re-erect the silo, and replace damaged property. The insured notified its insurer, ACE American, of the loss but the insurer refused to reimburse Lexicon. The insured then sued its insurer alleging the insurer is obligated under commercial general liability policies to cover the claim for property damage. The insurer filed a declaratory judgment action.

The district court held that, under governing Arkansas law, property damage resulting from the faulty work of a subcontractor is not an occurrence for purposes of a general liability policy. The district court concluded that the insurer was not obligated to reimburse Lexicon for any property damage. The insured appealed.

The circuit court noted that Arkansas law is in line with the majority of states in holding that faulty workmanship, standing alone and resulting in damages only to the work product itself, is not an accident; it is a foreseeable occurrence, and performance bonds exist to insure the contractor against claims for the repair or replacement of faulty work. However, the court said that the district court mistakenly concluded that the policy did not obligate the insurer to reimburse Lexicon for any property damage caused by the silo's collapse. Coverage for damage to the silo itself, the actual work product, is justifiably denied, but absent some applicable exclusion in the policy, ACE is obligated to reimburse Lexicon for all the other property damage. Under Arkansas law, the court said, it was foreseeable that the faulty subcontractor work would damage the silo, but not foreseeable that faulty work would cause millions of dollars in collateral damage.

In an aside, the insured alleged that the work product itself was the faulty welds, not the silo. The appeals court disagreed and said that the purchase order and subcontract required Damus to build the entire silo and the welds were merely a component of the work product.

The decision of the district court was affirmed in part and reversed in part.

Editor's Note: The damage to property exclusions and the business risk exclusions continue to cause coverage disputes between the insured and the insurer. This case is cited to point out, as did the United States Court of Appeals, Eighth Circuit, that Arkansas law and the majority opinion in the United States is that faulty workmanship standing alone is not an occurrence and not covered by the standard CGL form. If the insured's work damages another's property, that is meant to be covered by the liability policy, but damage to the work itself is not going to be covered.

A problem arises with this decision, however, that needs to be addressed. The Circuit Court glossed over the subcontractor exception to the “your work” exclusion, saying only that the exception would afford coverage for certain property damage resulting from faulty subcontractor work. In fact the entire silo was built by the subcontractor, and the subcontractor exception to the “your work” exclusion means that the exclusion does not apply if the damaged work was performed by a subcontractor. In other words, the silo was the subcontractor's work, the damage arose out of that work, and the subcontractor exception means the named insured's liability for the damaged silo is covered by the CGL form. Coverage for the insured should have been extended to the entire loss in this instance.