July 2, 2012

Summary: Contractors' errors and omissions (E&O) coverage, available by separate policy or by endorsement to a commercial general liability (CGL) policy, provides coverage, usually a small amount, for property damage to your work or your products. This coverage may close a gap created by the business risk exclusions of the CGL policy. Contractors' E&O coverage, which is not to be confused with contractors' professional liability coverage, is generally limited to trade contractors—such as those involved in electrical and plumbing work and installation of insulation and heating and air conditioning—and usually carries low sublimits. One of the advantages of this coverage, when written in conjunction with a CGL policy, is that once it is determined that contractors' E&O is the appropriate coverage for the claim and the sublimits are paid, that is the end of what the insurer must pay. No argument prevails with respect to the contractor's CGL policy.

Topics Covered:

Introduction

CGL Policy versus contractors' E&O policy

Problems—court issues

Caveats—conclusion

Introduction

It is a well-known fact that with some limited exceptions, the Commercial General Liability (CGL) policy does not cover such business risks as damage to the named insured's work, or products, or to impaired property. The limited exceptions, which are not discussed here, deal with Exclusion J—Damage to Property; Exclusion L—Damage to Your Work; and Exclusion M—Damage to Impaired Property or Property Not Physically Injured.

It is not unheard of, however, for some insurers to provide some limited coverage to contractors for their liability having to do with damage to their work, to products they may install, or to impaired property. Since there is no shortage of claims dealing with liability emanating from construction work, the insurers willing to provide this limited coverage are likely to limit their target marketing to trade contractors—such as electricians, plumbers, and heating and air conditioning contractors—where the exposures are not catastrophic. Some insurers may even venture out to include other kinds of construction contractors, such as interior carpentry, subject to a limitation. It is not unusual to find a variety of undesirable coverages, including asbestos liability, written subject to a sublimit.

At the outset, it is important to note that contractors' E&O coverage should not be confused with contractors' professional liability insurance. This latter coverage is intended for contractors involved in construction management and design-build work.

Who first coined the policy known as contractors' E&O insurance is not important, although it is interesting that all the insurers providing it carry that same name. What is important, however, is the scope of coverage that these policies will provide.

Before delving into the characteristics of contractors' E&O coverage, it is first necessary to provide a limited review of the CGL policy because it should give those interested in analyzing contractors E&O coverage a better insight into what to look for in fulfilling the needs of their insureds who are contractors interested in purchasing this specialized coverage.

CGL Policy versus Contractors' E&O Policy

The characteristics of both the CGL and contractors' E&O policies will be discussed in this section and compared on the basis of the insuring agreement, trigger, the nature of injury covered and not covered, the nature of coverage, when coverage applies, whose work is covered, the nature of contractual liability coverage, and restrictions to occupations.

Characteristics of the CGL Policy

The majority of discussions of the CGL policy deal primarily with the standard provisions of the Insurance Services Office (ISO) form. Keep in mind, however, that many insurers rely on their own independently filed policies that often contain some provisions identical to the ISO standard, but may also include other nonstandard forms. Those insurers within the excess and surplus lines markets likewise issue standard ISO forms but may also mix and match other forms. The CGL policy can be a standard or nonstandard issue. Wherever reference is made to standard, it means the provisions of ISO.

The CGL policy is generally written on an occurrence basis, although a standard claims-made form has been available since 1986. Typically, the CGL policy consists of three primary coverages: (1) bodily injury and property damage, (2) personal and advertising injury, and (3) premises medical payments. The form does not cover exposures relating to (1) risks insurable under other policies; (2) risks subject to CGL coverage by endorsement, usually for an additional charge; and (3) risks not otherwise insurable.

The CGL policy, both standard and nonstandard, typically excludes property damage to the named insured's work, the insured's product, and impaired property.

Characteristics of Contractors' E&O Coverage

Based on the contractors' E&O policies reviewed, all are nonstandard, meaning each insurer has its own format and provisions and all are written on a claims-made basis.

Since the contractors' E&O policy is meant not to duplicate what the CGL policy covers, the policy specifically excludes liability for bodily injury, property damage, and personal and advertising injury. It also does not cover any property damage liability not excluded by the CGL policy.

What is covered, depending on the individual contractors' E&O policy, is property damage to the named insured's work, the insured's product, and impaired property. The following is an example provided by an insurer offering this specialized coverage presumably as a sales pitch. A contractor completes a $35,000 electrical job. A few months after the building's occupancy, the named insured's product (faulty junction box) causes a fire that extensively damages the building. The electrician's CGL policy would cover damage to the building, but the $35,000 electrical work would be excluded. Had the electrician been able to purchase a contractors E&O policy, the remaining damages would have been covered, provided sufficiency of limits.

The Insuring Agreement

Under the standard CGL policy, the insurer agrees to pay those sums the insured becomes legally obligated to pay as damages. Reference to the words “legally obligated to pay” is broad in scope because it encompasses civil liability that can arise from either unintentional (negligent) or intentional tort under common law, statute, or contract.

The insuring agreements of the contractors' E&O policy are somewhat more limited. These policies may duplicate what the standard ISO policy says but refine the agreement more narrowly. An example is the insuring agreement that makes reference to “legally obligated to pay damages” but goes on to say that the damages must result from an insured's negligent act, error, or omission. Compared to the CGL policy, this insuring agreement is narrower because the act, error, or omission must be negligent. The contractors' E&O policy, in other words, does not encompass coverage for liability for intentional acts or intentional torts under contract.

This is not to say that all contractors' E&O policies contain this wording, but it is to say that the insuring agreements of these policies do appear to hinge coverage on errors, omissions, or negligent acts. Thus, if a contractor knowingly decides to cut a corner for purposes of cutting costs and a problem arises, the insurer could deny coverage because of the conscious, intentional act of making that decision, even though there was no expectation of a future problem. Insurers are not likely to be so precise and deny coverage on this point if the coverage is for low limits.

The Trigger

The trigger of a standard CGL policy written on an occurrence basis is at the time of injury or damage, during the policy period. When the standard claims-made policy is issued, the trigger is when notice of the claim for damages because of bodily injury or property damage is received and recorded by the insured or insurer, whichever is first.

As a general rule, contractors' E&O coverage is written on a claims-made basis, subject to all of its unique characteristics, such as prior acts, retroactive date, and extended reporting period. A claim must usually be made after the retroactive date, if any, and during the policy period or extending reporting period. These policies are like the standard claims-made form that states notice has been received when it is received in writing by the insured or insurer.

A definite advantage of these policies is the notice of circumstance provision. Briefly, sometimes insureds will learn of a circumstance that has not developed into a claim but based on the insured's perspective, a claim is likely to develop. If the insured reports this notice of circumstance, it will be considered notice to the insurer if and when that circumstance leads to a claim. Not all policies provide this notice of circumstance. Despite the advantage of this provision, insureds need to be very careful on what is described in the report to the insurer. If the circumstance is described too broadly, the insurer could laser out of the renewal a greater part of any future coverage than what actually would be covered. Another point is that the insured must make such report or the insurer could deny any future claim, based on failure to provide prompt notice.

Nature of Injury or Damage Covered

The standard CGL policy provides coverage for damages because of bodily injury, property damage, and personal and advertising injury. Property damage coverage consists of two parts: (1) physical injury to tangible property, including all resulting loss of use; or (2) loss of use of tangible property that is not physically injured. Also covered, to the extent no exclusion applies, is damage to tangible property, other than the named insured's work, product, or impaired property. However, property damage does not include electronic data.

Not covered and the reason for the need of contactors' E&O coverage is damage to the named insured's work, products, or impaired property, with some exceptions.

The contractors' E&O policy applies solely to property damage, usually defined to the same extent as the standard CGL policy. One such randomly selected contractors' E&O policy covers damages because of claims for faulty workmanship, material, design, or products, or consequential loss resulting (1) from the insured's actual or alleged error, omission, or negligent act; or (2) from a defect in material or in a product sold, either of which is installed by the insured. The form of another insurer covers damages while acting in the named insured's capacity, as described in the declarations, or from a defect in material or a product sold or installed by the insured, while acting in this capacity.

Given the fact that these policies are nonstandard, they must be viewed very carefully to make sure they apply to the kind of exposure that confronts the contractor. If a contractor does electrical work, the insurer will likely want to limit its coverage to that specialty and not be surprised to learn that the contractor also does metal roofing or installation of fiber optics.

It is good when a contractors E&O policy covers damage to impaired property because it is a widely misunderstood term, even though defined. It may even be misunderstood in relation to a contractors' E&O policy because this policy is limited to damage to the named insured's product or work. Damage to other property is not covered because it should be covered by a CGL policy. When impaired property is covered, it encompasses tangible property, other than the named insured's product or work that cannot be used or is less useful because it incorporates the named insured's product or work that is known or thought to be defective, deficient, inadequate, or dangerous, subject to one additional proviso: the property can be restored to use by repair, replacement, adjustment, or removal of the named insured's product or work.

Assume, for example, that after a plumbing contractor installs pipes over which concrete is poured for the flooring, a defect in the work is suspected (faulty hookup) because of low water pressure. The concrete flooring, which is property that cannot be used because it incorporates the named insured's work (plumbing) should be covered, along with replacement of the faulty piping.

In light of the unique coverage that the contractors' E&O policy provides, the kinds of exclusions, other than for bodily injury, personal and advertising injury, and property damage other than to the named insured's product or work, may appear to be somewhat unusual. For example, these specialty policies do not apply to liability assumed by the insured under any written or oral contract, other than liability for damages the insured would have in the absence of such contract or agreement; delay or the failure to complete a project on time; any error or omission in the preparation of estimates; infringement of copyright, trademark, or patent, unfair competition, piracy, or theft; intentional injury; manufacturer's warranties; pollution; professional liability; and subcontracted work. Some of these exclusions may appear to be unnecessary, such as intentional injury, if coverage is limited to negligent acts. Infringement of copyright, trademark, or patent also would appear to be unnecessary when a policy limits its coverage to tangible property. These kinds of exclusions may be inserted simply to clarify to the named insured the nature of coverage.

When Coverage Applies

Unless a CGL policy is modified with CG 21 04, Exclusion—Products-Completed Operations Hazard, coverage applies for liability stemming from an occurrence while work is in progress, as well as after work is completed or a product has been relinquished.

Contractors' E&O liability coverage, on the other hand, applies only after work has been completed or a product has been relinquished. No coverage applies while work is in progress.

Scope of Contractual Liability Covered

The standard CGL policy automatically covers five types of agreements: (1) lease of premises; (2) easement agreements; (3) agreements required by municipalities, other than work done for those entities; (4) sidetrack agreements dealing with railroads; and (5) elevator maintenance agreements. Unless one of two limitation endorsements are issued, contractual liability coverage also applies to tort liability assumed under contract (subparagraph f. of the “insured contract” definition). The two endorsements are CG 21 39, Contractual Liability Limitation endorsement, which limits coverage to the five preceding agreements, and CG 24 26, Amendment of Insured Contract Definition, which limits coverage to partial fault.

The extent of tort liability assumed coverage, however, will also depend on any applicability of an anti-indemnity statute. Some statutes permit the assumption of sole fault, others limit liability assumed to partial fault, and still others will not permit the transfer of the consequences of sole or partial fault to others.

The point here is that the CGL policy provides some contractual liability coverage. The contractors E&O policy, on the other hand, does not provide contractual liability coverage. However, it does typically cover liability that would apply in the absence of any contract or agreement.

Whose Work Is Covered—Occupation Restriction

The CGL policy typically applies to work performed by or on behalf of the named insured by a subcontractor, for example. However, by endorsement, the CGL policy coverage can be limited solely to work of the named insured. The contractors' E&O policy, on the other hand, limits liability coverage solely to work or products of the named insured. Professional liability, however, is commonly excluded. Professional liability is not commonly excluded under a CGL policy, but an endorsement is available for that purpose.

Coverage is not restricted under the CGL policy to the occupation of the named insured or to the classifications shown in the policy declarations. It is possible, however, to limit coverage in a variety of ways. Examples are by issuing CG 21 44, Limitation of Coverage to Designated Premises or Projects, and CG 21 53, Exclusion—Designated Ongoing Operations. Insurers in the excess and surplus lines market are known to issue endorsements limiting coverage solely to the kind of work entailed in the classification(s) listed.

Typically, the contractors' E&O policy limits coverage to the contractor's capacity as described in the policy. A contractor who describes his work as a heating and air conditioning contractor will not have coverage for roofing or carpentry work. The reason for this restriction is that the coverage is not for all contractors but solely with certain trade contractors where the exposure to liability is not as great as it is with other work of contractors.

Problems—Court Issues

Not surprisingly, given the selective underwriting and relatively low limits applied to contractors' E&O coverage, there have not been many disputes that have culminated in court decisions.

One dispute, however, was Yeager v. Polyurethane Foam Insulation, LLC, 808 N.W.2d 741 (Wis. App). It is unclear whether the plaintiff was a project owner or general contractor but will be referred to here as the general contractor. In constructing a new home, the general contractor hired the services of insulation contractor (PFI). After the work was completed, however, the general contractor was under the belief that the insulation work was incorrectly performed and, therefore, sued PFI for breach of contract and warranty. The insurer, Society, that issued a CGL policy to PFI denied coverage in light of the fact that the faulty workmanship of PFI was not an occurrence and was specifically excluded.

Contractors' E&O coverage was issued to the CGL policy by endorsement. The endorsement provided that the insurer would pay “those sums that [PFI] becomes legally obligated to pay as damages covered by this insurance because of contractors' errors and omissions to which this insurance applies.” This endorsement, which was for a limit of $10,000, also stated that the insurer's right and duty to defend ended when the insurer had used up that amount in the payment of judgments or settlements for contractors errors and omissions.

The insurer conceded that the contractors E&O endorsement provided coverage for the claims made against its named insured, PFI, but also claimed there was no other coverage available under the CGL policy. The insurer offered to pay the $10,000 limit to the court, in fulfillment of its obligation under that endorsement, but also maintained that once that amount was paid it had no further duty to defend PFI.

The court ruled that the CGL policy did not apply and that the posting of the $10,000 limit extinguished all other obligations under the policy. The general contractor maintained that the court erred in making that decision. The court held that the general contractor had no standing to challenge the court's ruling on the insurer's duty to defend since the general contractor was not a party to the contract.

Another case involving a contractors' E&O coverage issue, where the insurer successfully denied coverage under that policy, including the contractor's CGL policy is General Cas. Co. of Wisconsin v. Rainbow Insulators, Inc., 798 N.W.2d 320 (Wis. App). This was a duty-to-defend case involving defects in the construction of a condominium building that caused acoustical problems for residents. KBS was the general contractor for the project and hired subcontractors that included E&A Enterprises, Inc. (E&A).

KBS filed a third party complaint against E&A and its insurer, Acuity, alleging that E&A breached its contract through faulty installation of metal resilient channels that act as sound barriers, and by refusing to correct the faulty installation. KBS claimed that the errors of E&A resulted in two categories of damage: (1) the loss of use and enjoyment of the condominium units by residents, and (2) the physical destruction of ceilings required to fix the noise problem. The insurer, which issued both a CGL and contractors' E&O coverage, asserted that its policies did not cover the allegations of KBS, the general contractor, against E&A. The circuit court granted summary judgment to the insurer and E&A appealed the court's order unsuccessfully.

While the court found that both allegations for loss of use of tangible property and physical destruction of the ceilings were determined to be “property damage,” as defined by the policy, both were also found not to be covered by the CGL policy because of the exclusion for damage to the named insured's work. Without coverage under the CGL policy, the argument turned to the contractors' E&O policy that this same insurer issued (and that the court referred to as a professional liability policy).

The E&O policy provided coverage for “damages because of property damage to your product, property damage to your work, property damage to impaired property or recall expense that arises out of your product, your work, or any part thereof.” The contractors' E&O policy used the same definitions as the CGL policy for “property damage” and “your work.” Since KBS alleged “property damage” that fit within the “your work” exclusion, the court concluded that the E&O policy provided initial coverage.

The insurer, Acuity, argued that its contractors' E&O policy did not provide initial coverage because KBS failed to allege damages due to property damage. The court disagreed. The insurer's next point of attack was to deny coverage based on one of the exclusions titled “delay,” which excluded coverage for damages arising out of any delay, as well as failure by the named insured or anyone acting on its behalf to perform the contract or agreement in accordance with its terms. The court held that by its terms, the delay exclusion applied because KBS's allegations were based on E&A's failure to perform according to the terms of the construction contract between KBS, the general contractor, and E&A, the subcontractor.

E&A argued that the E&O form provided coverage for KBS's allegations, despite the contract exclusion, because the alleged property damage arose out of E&A's negligent acts, errors, or omissions. In other words, E&A asserted that, because KBS alleged that negligent conduct caused E&A to breach the contract, the policy provided coverage. E&A cited 1325 North Van Buren, LLC v. T-3 Group, Ltd., 716 N.W.2d 822 in support of its argument. However, reliance on this case failed because the policy there did not contain a contract exclusion.

E&A also argued that the interpretation of the contract exclusion was absurd because it would render the E&O coverage meaningless, that every time an insured enters into a contract, it would lose coverage for any negligent acts, errors, or omissions in work performed under that contract. The court disagreed that its interpretation of the contract exclusion was incorrect because it would render the policy useless. The court explained that although KBS's specific allegations in this case fit the contract exclusion, it would not defeat coverage in every scenario. The exclusion, said the court, applied only if the insured or anyone acting on behalf of the insured “[d]elay[s] or fail[s] . . . to perform the contract in accordance to its terms.” It did not exclude all claims of any sort, the court added, that might arise during the course of work performed under a contract as E&A suggested.

The court offered the following example of where the contract exclusion would be inapplicable: because contractors owe common law duties of care to those with whom they contract, as to all other persons, the contract exclusion would not operate to preclude E&O coverage arising from a tort claim that involved conduct that was not a delay or failure to perform under a contract term. The court added that “in Wisconsin, one always owes a duty of care to the world at large.”

The court of appeals therefore concluded that the complaint did not allege facts that, if proven, would have resulted in coverage under either of the two insurance coverages for KBS's allegations, the your work exclusion in the CGL policy, and the contract exclusion in the E&O form. Accordingly, the insurer also did not have a duty to provide defense.

Caveats—Conclusion

After reading this article on the contractors' E&O policy or endorsement, what may beg a question is what should be considered when in the market for this coverage? The following considerations might be recommended in pondering the purchase of contractors' E&O coverage:

•Because these policies or endorsements cover business risks, which commonly are assumed by insureds and can amount to large claims, consider the insurer offering the coverage. A standard line insurer might be more advantageous than an excess and surplus lines insurer. Longevity of the insurer is also important.

• Be sure not to confuse contractors' E&O coverage with contractors' professional liability, which is intended for such exposures as construction management and design-build work.

• Knowledge of CGL policy provisions is important because it may be easier to determine whether the E&O coverage is appropriate for the contractor.

• Even though the same insurer of contractors' E&O coverage issues the CGL policy, do not assume all gaps between the two policies are eliminated. Also, do not assume that if the CGL policy does not apply, the E&O coverage will. Remember the foregoing discussion of General Casualty Company of Wisconsin v. Rainbow Insulators, Inc.

• Since property damage under the contractors' E&O policy or endorsement must occur after the work (impaired or otherwise) is completed, it may sometimes be difficult to determine when damage first occurred and, as a result, generate a coverage problem.

• The contractors' E&O coverage limits coverage to negligent acts, errors, or omissions. The CGL policy covers any act (intentional or unintentional), error, or omission unless an exclusion applies.

• Contractors' E&O coverage varies by insurer. While it is not a large market, some coverage is broad and other forms are narrow. The forces, therefore, must be reviewed carefully with the perspective contractor in mind.

• Do not rely on the title of exclusions. An E&O policy with a delay exclusion should exclude only liability arising from a delay or failure to complete a contract on time. If the policy or endorsement also excludes liability arising from the failure to complete a contract, it should be avoided, to the extent possible. A problem is that contractors' E&O coverage exists in a limited market, for certain kinds of contracts, and usually for low sublimits.