See Trilogy on the Meaning of Subcontractor.

Business Risk Exclusions

The general contractor brought an action as an additional insured against the subcontractor's commercial general liability insurer to recover the cost to repair the subcontractor's faulty workmanship. This case is Auto Owners Insurance Company v. Gay Construction Company, 774 S.E.2d 798 (2015).

Gay Construction, a general contractor, was hired on a project involving the reconstruction of a swimming pool for the Piedmont Park Conservancy. As part of this project, Gay was tasked with constructing a terrace above a newly constructed restroom and other areas. Gay subcontracted the pouring of concrete to Gunby Construction, and it subcontracted with Dai-Cole to install a waterproofing membrane and a drainage mat to prevent leakage into the restrooms under the terrace.

After the work was completed, the park officials complained that water was leaking into the space below the terrace. Gay investigated the problem and found that the leak was caused by the improper application of the waterproofing membrane. After unsuccessful attempts to have Dai-Cole repair the membrane, Gay performed the work itself. In all, Gay spent more than $126,000 in repairs. Gay then filed a first-party claim seeking reimbursement for the repair costs from Dai-Cole's insurer, Auto Owners Insurance Company. Gay considered itself to be an additional insured under Dai-Cole's policy.

Auto Owners denied coverage and Gay filed a lawsuit. The trial court denied the insurer's motion for summary judgment and the insurer appealed.

The Court of Appeals of Georgia, First Division, declared that the claim is barred by the business risk exclusions of the general liability policy because the exclusions excluded liabilities for the repair or correction of defective work from the scope of coverage. The court said that Georgia courts have clearly defined the risks that the business risk exclusions are intended to remove from coverage, typically examining the following facts of each case when reviewing business risk exclusions: the type and extent of construction work that the contractor is performing at the time of the accident; and, the extent that the damages resulting from the contractor's accident may exceed the contractor's contractual duties. In short, the court asked itself the following question: will the payment of insurance proceeds effectively cause an insurance company to guarantee the contractor's work?

If the answer to the question is yes, the court said that the business risk exclusions apply and the claim is denied. However, if the court finds that the payment of proceeds results from a negligent act causing damage above and beyond the original contractual obligations or to other property, the exclusions do not apply. The court then went on to discuss construction and the business risk exclusions.

The court noted that there are two kinds of risks that are incurred by a contractor. The first is the business risk borne by the contractor to replace or repair defective work to make the project conform to the agreed contractual requirements. This type of risk is not covered by the general liability policy, and the business risk exclusions in the policy make this clear. The second is the risk that the defective or faulty workmanship will cause injury to people or damage to other property. Because of the potentially limitless liability associated with this risk, it is the type for which commercial general liability insurance is contemplated.

In this instance, the claim asserted by Gay involved only corrections to and resulting repairs for faulty workmanship and the court said that this is precisely the type of claim generally barred by the business risk exclusions. Here, the insurer (Auto Owners) did not guarantee the work of Dai-Cole and the business risk exclusions in the policy removed from coverage the defective workmanship by Dai-Cole that caused damage to the project. Furthermore, the exclusions expressly excluded property damage to the work of a named insured arising out of the work, and the policy contemplated the possibility of qualifying an additional insured as a named insured under the policy.

The judgment of the trial court was reversed.

Editor's Note: The Court of Appeals of Georgia offers a very good analysis of the business risk exclusions in relation to a claim for property damage at a construction site. The court concludes that the business risk exclusions are designed to exclude coverage for defective workmanship by the insured builder causing damage to the construction project itself, and further, to limit the exclusions to only that work performed by the named insured (Dai-Cole) would permit Gay Construction as an additional insured more coverage than that granted to Dai-Cole as the policy holder, and would effectively require the insurer to financially guarantee Dai-Cole's work.

Negligence Claim Based on Alleged Failure to Properly Advise

The crop-loss insured filed a lawsuit against the insurer for breach of policy and against the insurance agent for negligence based on the alleged failure to properly advise the insured about coverage needs and failure to secure adequate coverage. This case is SMS Planting Company v. Farm Bureau Mutual Insurance Company of Arkansas, 463 S.W.3d 714 (2015).

SMS is a farming operation. It contacted Sessions (the insurance agent) about crop-loss insurance. Sessions supplied an insurance policy to SMS with a policy issued by Farm Bureau. The policy was a named-peril policy providing coverage for direct loss caused by, among other things, lightning or windstorms.

After the policy was in effect, there was a loss of electrical power to SMS's four grain bins where rice was stored. The power outage caused the aeration and drying system in the bins to stop working. Although there was no physical damage to the bins or the machinery, SMS believed that the outage was caused by a windstorm or lightning, and the outage caused the stored rice to be stained. Ultimately, SMS was unable to sell the rice for its contracted price because of the staining.

SMS put in a claim for loss and the insurer denied coverage. SMS then sued the insurer and Sessions. The insurer was sued for failure to pay the loss and Sessions was sued for negligence in failing to procure a policy that would cover the damages. The circuit court entered summary judgment for the insurer and Sessions. The insured appealed.

The Court of Appeals of Arkansas, Division IV, noted that the insurer argued that it was undisputed that there was no wind damage or lightning damage to any of the grain bins and so, there was no direct loss within the meaning of the policy. SMS countered that summary judgment was not appropriate because the testimony created material issues of fact that wind or lightning caused the power failure. The court said that the dispositive issue was whether SMS suffered a direct loss by a covered peril. It was the burden of the insured, SMS, to make an initial prima facie case that its damages were covered under the terms of the insurance policy. In this instance, the court found that one could infer that the wind caused the power outage and so, the insured gets the benefit of the doubt, and summary judgment in favor of Farm Bureau was improper.

As for the insurance agent, the court noted that SMS argued that it had a special relationship with Sessions such that Sessions had a duty to provide SMS with adequate coverage and to advise it of any limitations of coverage. SMS further argued that whether a special relationship existed is a question of fact, making summary judgment inappropriate. The appeals court agreed.

The ruling of the circuit court was reversed and the case was remanded.

Editor's Note: The Court of Appeals of Arkansas rules that genuine issues of material fact pertaining to the cause of loss remained and so, summary judgment in favor of the insurer and the insurance agent was not appropriate.

Employee Dishonesty and Insured Property

3M Company brought an action against the insurer seeking coverage for the loss of the returns that 3M says it earned on certain of its investments but then lost through the fraud of its investment advisors. This case is 3M Company v. National Union Fire Insurance Company of Pittsburgh, 2015 WL 5687879.

3M began investing its employee-benefit plan assets in WG Trading Company. Unfortunately, WG was operating a Ponzi scheme and over many years, the partners in WG Trading fraudulently diverted hundreds of millions of dollars for their personal use and to conceal the fraud. After the fraudulent activities were discovered, the WG partners pled guilty to federal criminal charges. 3M was able to recover every penny of the capital contributions that it had invested in WG Trading. However, 3M argued that it nevertheless suffered a loss because at least some of its capital was invested by WG in legitimate vehicles and produced legitimate earnings, and 3M was never paid those legitimate earnings.

3M was insured under a blanket crime policy issued by National Union Fire and 3M sought coverage for its lost earnings under this policy. 3M sought coverage under the employee dishonesty insuring agreement that states the insurer shall be liable for direct losses of money, securities, or other property caused by theft or forgery by any employee of any insured. The insurer argued that 3M is not entitled to coverage under this provision because 3M is estopped from contending that its investment generated legitimate returns that can be quantified and attributed to 3M, and so, 3M cannot prove that it suffered a direct loss. Moreover, said the insurer, even if 3M suffered a direct loss as a result of legitimate earnings on investments being stolen, 3M did not own those earnings at the time they were stolen, which is a condition of coverage. National Union also argued that neither partner of WG Trading was an employee of 3M, another condition of coverage.

The United States District Court, Minnesota, noted the insurer's contention that the employee dishonesty insuring agreement is explicitly made subject to the fact that the insured property must be either owned by the insured, held by the insured in any capacity, or be property for which the insured is legally liable. National Union made the point that any legitimate earnings are not covered property because they were not owned by 3M, held by 3M in any capacity, or property with respect to which 3M was legally liable.

The insured countered that the ownership provision is irrelevant to its claim for coverage under the employee dishonesty insuring agreement because the ownership provision only applies to insured property, and the insuring agreement does not use the term “insured property” or limit its coverage to such property. Instead, 3M argued that the employee dishonesty insuring agreement covers direct losses of money, securities, or other property caused by theft or forgery. And, the insuring agreement defines a theft to mean the unlawful taking of money, securities, or other property.

The court did not agree with the insured's position.

The court said that the problem with 3M's argument is that it treats the ownership provision as though it defined the term “insured property”, and the court said that this is not the case. The court said that the provision is not intended to define insured property but simply uses the term “insured property” to limit the coverage afforded by the policy. The phrase “insured property” can only be understood as a shorthand way of saying “property whose loss is insured under this policy”. Thus, the court ruled that the coverage under the employee dishonesty provision is limited to the three types of property that it describes.

The court then addressed the question of whether the lost earnings for which 3M seeks indemnification qualify as one of the three types of property described in the insuring agreement. 3M contended that it owned the lost earnings. National Union argued that what 3M owned was a limited-partnership interest in WG Trading, and that up until the point at which earnings were distributed to the partners, the earnings of WG Trading were owned by WG Trading and not by 3M. The court agreed with National Union's interpretation.

The court noted that under Delaware law, it is crystal clear that a limited partner such as 3M has no interest in specific limited partnership property. Under Delaware law, even though 3M had a general right to receive distributions from WG Trading, 3M did not own any specific earnings or any other specific limited partnership property.

The court concluded that, because any lost earnings were not owned by 3M within the meaning of the policy, National Union is not obligated to indemnify 3M. Accordingly, National Union's motion for summary judgment was granted.

Editor's Note: The U.S. District Court, Minnesota, interprets the employee dishonesty insuring agreement and finds that the insured (a Delaware corporation) does not have coverage for its claim for lost earnings. The lost earnings did not meet the provision's requirement that it applied to covered property.