Defining Undefined Loss Exposures in Green Construction

May 29, 2012

A green heating system that doesn’t heat. LEED-certified units that meet fewer than half the requirements for certification. Clients suing construction firms because of lost tax breaks from promised green buildings.

Welcome to green construction. Even as the green construction movement is taking wing, legal experts are warning of the dangerous territory ahead.

Some such territory includes lawsuits like this: A builder is sued by the client because the client lost a tax break for Leadership in Energy and Environmental Design (LEED) certification, because the building ultimately did not meet the LEED level asked for by the client. Other lawsuits include a luxury condominium complex in Battery Park City, N.Y., where its owners are suing developers for $1.5 million for fraud and breach of contract, stating the building isn’t as green as advertised.

Probably the most prominent lawsuit was one filed against the U.S. Green Building Council (USGBC) by Henry Gifford, owner of Gifford Fuel Savings. He claimed the organization committed fraud, created unfair competition, practiced deceptive trade practices and engaged in false advertising. The crux of the complaint was Gifford’s contention that green energy was not more efficient than regular energy options. The $100 million suit was dismissed because the court found that the plaintiffs in the class action suit did not show USGBC caused them any harm. Still, Gifford has managed to get the industry talking about what constitutes green and just what is bought when one purchases a LEED-certified property.

What seems to be the most telling statement by the ruling judge Leonard Sand spells out one of the primary issues with green construction: “Because there is no requirement that a builder hire LEED-accredited professionals to attain LEED certification, it is not plausible that each customer who opts for LEED certification is a customer lost to plaintiffs.”

The Uncertainty of ‘Green’

That speaks to the crux of the green problem. What makes a building green and who’s deciding it? That question still goes unanswered as courts and insurers alike struggle to wrap definitions around green construction. For a building to be certified as a LEED design, it must meet a checklist of requirements, and the point values assigned to each requirement determines the level of certification.

Aside from a LEED certification, the definition of “green” becomes a bit more dicey. According to the California Department of Resources Recycling and Recovery (CalRecycle), “A green building, also known as a sustainable building, is a structure that is designed, built, renovated, operated or reused in an ecological and resource-efficient manner. Green buildings are designed to meet certain objectives such as protecting occupant health; improving employee productivity; using energy, water and other resources more efficiently; and reducing the overall impact to the environment.”

Just what those objectives are and what constitutes “resource-efficient” use has yet to be defined clearly.

Feds Offer No Help

Don’t look to the federal government to clarify things.

The Environmental Protection Agency’s own definition of green building, presented in 2008, is “the practice of maximizing the efficiency with which buildings and their sites use resources – energy, water and materials – while minimizing building impacts on human health and the environment, throughout the complete building life cycle – from siting, design, and construction to operation, renovation and reuse.”

There’s a reason for being vague, and Stephen Del Percio thinks it’s a good thing.

Del Percio, a construction and real estate attorney in New York who blogs regularly on green property issues, thinks the definition should match the needs of the owner and any regional circumstances. He explains: “In the desert Southwest, a green building could be one that doesn’t consume a lot of water.” He said LEED certification now comes in a regional credit system to address where the building sits and what those needs are.

Even who is ultimately deciding what the standard is has question marks surrounding it. Lawyers, in Stuart Farber’s view, are working out the details case by case and contract-by contract. Farber, CEO and chair of Preferred Concepts, an insurance services and program administration firm, said there’s plenty to work out. Including direct financial loss, zoning and ordinance noncompliance, lawsuits and legal entanglements are beginning to blossom.

“Many lenders, both mortgagees and in some cases leases, are requiring a targeted LEED rating,” Farber said. “If that is not met, where’s the breach? Where’s the damage? Who pays for it? And who’s responsible?”

Also, the owner of the green building is paying for green construction, Farber said, which comes at a higher price tag. Materials costs, construction techniques, industrial hygiene, and LEED architect/engineering help jack-up the costs quickly. All of these elements and more become relevant when upgrading or building within green standards.

How this affects insurance is still fleshing itself out. Insurers, he said, are writing endorsements and providing property insurance specific to the green construction exposures. While such coverage will be at a premium, that premium may be modestly higher. Farber has a client currently who will pay just 5 percent over a standard endorsement due to the size and level of green in the building.

Premiums aside, what constitutes loss seems to be the larger question. Farber gives the example of an expectation of a gold-standard building, but having a silver-standard property delivered. “Is the damage based on the loss of the gold, or is it limited to the costs of bringing that up to the gold standard?” he asked.

Separating what is a green-related loss and a traditional loss is a sticking point for many insurers. Jim Cooper, co-chair of the Policyholder Insurance Group at Gardere Wynne Sewell LLP, said insurers will often deny coverage for building defects or when something goes wrong that damages the building itself or the product installed. Cooper, who works with builders and contractors, said he hasn’t seen much case law just related to LEED or green projects.

The Million-Dollar Question

How do we determine damages? With few cases to turn to for precedent, experts think that answer is a long way from perfected. Cooper said he would examine a defect in this way: “Is that the product not working or the product damaging something?” The former is a product claim; the latter could be a green claim if “the failure to work properly diminishes the value of the building or causes the owner to evacuate the building for a significant amount of time.”

Cooper said many green property policies do cover loss of use and can cover diminution of value. What he sees as challenging is finding the property damage.

Del Percio sees the same problem. “If a building doesn’t earn certification, do you look at what the per square foot value of a LEED rating is versus a non-LEED? The real problem has been there hasn’t been a case where this kind of scenario has played out.”

Without clear parameters, insurance adjusters and the insurance industry are left to define damages on a case-by-case basis. Forget looking to claims history – according to Del Percio, there have been only very few claims to date under insurance policies. Most of those claims have related to advanced building systems used in green construction.

The challenge for adjusters and the insurance industry, he said, is to understand what those technologies are, how they work, and what their performance shortcomings have been.

“Most of the issues that sustainable construction presents are within new technologies and advanced technologies that people may not have familiarity with at this point,” he added.

Contracts, he believes, will be the ultimate deciding factor. “How [green] is defined is going to be in the contract between the owner and professional.”

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