General liability carriers specializing in contractor insurance for builders and drywall subs are “sweating it out” over the potentially massive claims dollars that could be paid out in litigation, settlement, and adverse jury verdicts arising from Chinese drywall.
However, due to the impact of little known policy exclusions, and evolving case law in many states, general liability carriers may escape liability for all or a significant percentage of claims leaving builders and trade subs facing huge uninsured losses and potential bankruptcy.
From the point of view of the homeowner, these claims will not likely be covered by homeowners property insurance. And, to the extent that the damages are not covered by the general liability policies of builders, subs, and distributors, homeowners will incur devastating out of pocket losses.
Per House Damage Could Be Astronomical
There is a lot at stake for all parties because the damages on a per house basis are likely to be astronomical. The lawsuit papers will allege that the fumes from the defective Chinese drywall have resulted in corrosion damages to all metal parts of the house including electrical systems, copper piping, HVAC and other metal fixtures. In addition, it will be alleged that the non metal parts of the house have been damaged by foul smelling and noxious sulfur dioxide fumes.
Some experts may claim that the drywall can be sealed, but this approach is questionable and unlikely to be accepted by home owners. Most lawsuits will likely ask for the total removal and replacement of all drywall and electrical systems as well as other building materials that may have been contaminated by the fumes.
Next, add damages for remediation or replacement to household contents for exposure to corrosive and foul smelling fumes. Top this off with the possibility of bodily injury claims due to adverse health consequences to occupants due to exposure.
Pollution Liability Exclusions
All contractor general liability policies include a standard exclusion for liability arising from the “actual, alleged or threatened discharge, seepage, release or escape of pollutants’,” “Pollutants” are defined as any solid, liquid, gaseous, or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, and waste. “Based on this broad definition, the carriers will take the position that the fumes released from Chinese drywall fall under the policy definition of “pollution.”
Fortunately, the standard policy language includes an exception to the exclusion for pollution that results from the products or completed operations of an insured. In other words, the insurance carrier can’t use the pollution exclusion to deny a claim when the pollution arises after the house has been sold.
Unfortunately, many general liability policies that are sold to contractors include a Total Pollution Exclusion that does not allow the exception that is mentioned in the above paragraph. The presence of the Total Pollution Exclusion (or similar exclusion) on a policy will allow the insurance carrier to take the position of denial of all damages and legal defense. The success of such a position will be determined by the allegations in a specific lawsuit as well as case law. The successful use of the Total Pollution exclusion, if upheld by the courts, will have a devastating impact on all defendants.
Property Damage Exclusions and Emerging Case Law
In the event that the Total Pollution Exclusion is not present on the general liability policy or if it is not ultimately upheld by the courts, the claims adjusters will have a fallback position in their quest to deny a significant percentage of Chinese drywall claims.
As a result of the construction defect crisis, most General Liability carriers specializing in builders insurance began to insert special policy exclusions around five years ago to escape liability for construction defect claims.
The most common exclusion entitled “Exclusion: Damage To Work Performed By Subcontractors On Your Behalf” (CG2294), virtually eliminates all property damage liability for damage to the builder’s faulty work itself (drywall) and resulting damage to the builder’s non faulty work (corrosion to electrical systems, copper piping, HVAC, and other metal fixtures).
Existing case law in many states has resulted in claim denials for construction defect under the theory that property damage to a builder’s work is not considered to be an “occurrence” or accident and thus the policy should not act as a warranty. Therefore, the end result in these states is the same as the application of exclusion CG2294.
However, general liability coverage under the builder’s insurance policy will still likely apply to property damage to contents and bodily injury claims by occupants. Since most lawsuit papers are likely to allege at least some covered damages, coverage will still be triggered for the entire legal defense for all claims at the expense of the insurance carrier.
As concerns drywall subcontractors, their general liability policies will not cover property damage to their work (drywall) but will cover resulting property damage to other parts of the house and contents. Their policy will also cover bodily injury to occupants. In addition, their policy will likely trigger a full legal defense of all claims.
Assuming that both the builder and drywall sub have general liability insurance in force continuously from the completion of the job to the filing of the lawsuit papers, their combined policies won’t likely cover the cost to tear out and replace the drywall. Such a repair job represents a huge undertaking and will be very expensive.
U.S. Suppliers and Chinese Manufacturers
U.S. suppliers of Chinese drywall will undoubtedly participate in these lawsuits with both builders and drywall subs. Plans for class action lawsuits are already under way. Under a worst case scenario, some U.S. suppliers may run out of general aggregate limits under their general liability policies and it is unlikely that Chinese manufacturers will share in these claims due to the difficulties in enforcing judgments against foreign manufacturers.
Builders Can Protect Themselves
Builders are advised to protect themselves from future construction defect and pollution claims by implementing the following practices:
- Implement mandatory subcontractor agreements with all subs including insurance requirements for general liability, hold harmless/indemnification provision, and a requirement for all subs to participate in arbitration proceedings.
- If the builder’s general liability policy includes the Exclusion-Damage To Your Work Performed By Subcontractors On Your Behalf (CG2294) or a similar exclusion, find out if the insurance carrier provides a buyback for an additional premium charge.
- Ask the insurance agent if any insurance carriers are available that don’t use exclusion CG2294 or have a less severe version that covers resulting property damage to the builder’s non faulty work.
- Purchase a Pollution Liability policy.
John Sadler is president of Sadler & Company Inc., which has a contractor insurance division that specializes in insuring home builders, remodelers, and light commercial general contractors in the Southeast. This article previously appeared in Sadler’s blog on the Web site, www.contractor-insure.com. It also appeared in the June 15, 2009, edition of Insurance Journal – South Central Region.
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