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Pennsylvania Stands Out Nationwide in Coverage Disputes Regarding Faulty Workmanship

September 1, 2010

Pennsylvania – Insurance Coverage

Key Points:

  • Pennsylvania provides the broadest grounds for an insurer to disclaim coverage for claims of defective workmanship of any state in the country.
  • Coverage defenses include "reasonably foreseeable" consequential damage to other property.
  • "Product incorporation" cases are not an "occurrence" in Pennsylvania.
  • Many insurers are manuscripting endorsements for their Commercial General Liability Policies, which provide coverage for work done by subcontractors. 

 

I recently saw a map that someone had prepared of the United States where each state was colored either blue or red to distinguish whether the courts provide coverage for claims of faulty workmanship. It looked like something from CNN's coverage of the elections, with roughly half of the states in each color. Pennsylvania, of course, fell into the category of states where faulty workmanship claims are not covered. Pennsylvania has stood out in this category for several years, ever since the State Supreme Court issued its landmark ruling in Kvaerner v. Commercial Union. The decision was so definitive that the term "Kvaerner State" emerged within the industry to refer to whether an individual state's law would cover claims for defective workmanship.

In Pennsylvania, Kvaerner was only the beginning. Subsequent decisions from the intermediate and federal courts sitting in Pennsylvania surprisingly extended the holding in Kvaerner to restrict coverage not only for claims relating to the insured's own defective workmanship, but also to damage to any other property which the insured's defective workmanship affected. This extension of Kvaerner was first made by the Pennsylvania Superior Court in a case alleging defective stucco work, Millers Capital Ins. Co. v. Gambone. In Gambone, the Superior Court followed Kvaerner in holding that the costs of replacing the stucco were not covered, but it went a step further in holding that damages to the interior of the home due to water intrusion were also not covered because they were a "reasonably foreseeable consequence" of the insured's defective workmanship. This is where Pennsylvania started to really stand out on the national map. No other state had made such a broad extension of the Kvaerner doctrine, and many in the industry expected that the Pennsylvania Supreme Court would reverse Gambone with respect to this extension.

The Supreme Court declined to review Gambone, and subsequent decisions continued to enforce the "consequential damages are not covered" aspect of the holding. Then, the Eastern District of Pennsylvania applied Kvaerner to a product incorporation case in Nationwide v. CPB Intl. Now this was truly groundbreaking. No other court in the country (save a little known Middle District of Pennsylvania decision from several years prior, Keystone Mining) had held that there was no "occurrence" when a defective product is incorporated into another product, thus, rendering the whole product defective. Again, we expected the Third Circuit would reverse, and we were surprised when the court affirmed CPB with a strongly worded memorandum decision. Following CPB, the Pennsylvania Superior Court also found no occurrence in a product incorporation case in Erie Insurance Co. v. Abbott Furnace.

In June, the Third Circuit laid to rest any question as to the reach of Kvaerner in Pennsylvania. In Specialty Surfaces International, Inc. v. Continental Casualty Co., the court held that the insured's defective work product's damage to other property in an athletic field construction was not an "occurrence." The court discussed the consequential damage issue as raised by Gambone and other decisions and stated that the law of Pennsylvania was unquestionably that Kvaerner extends to property other than the insured's own defective workmanship so long as it is a reasonably foreseeable consequence of the insured's defective work.

This is not to say that all is now quiet on the defective workmanship front. Kvaerner and Gambone also articulated a position adopted in several states, that because defective workmanship is not an "occurrence," the language in the ISO CGL policy expressly covering defective workmanship caused by "your subcontractors" is rendered a nullity. As such, the assurance made by many underwriters and agents that a contractor would be covered "for his subs" is negated by these courts.

In response to the uproar from agents and underwriters, many insurers have drafted manuscript "Kvaerner endorsements." These endorsements re-write the policy to expressly state that defective workmanship by a subcontractor which causes property damage is an "occurrence." There are three problems with these endorsements. First, the original policy carve-out for subcontractors only applies to property damage claims arising from completed operations. In other words, a claim for property damage which is open and obvious to the claimant while the insured is still conducting operations would not, under the original policy wording, trigger the carve-out. It is unlikely that agents and underwriters were making this distinction when assuring a contractor that he would be "covered for his subs." The Kvaerner endorsements generally only add coverage for subcontractors into the definition of an "occurrence" for completed operations.

Second, the endorsements are generally silent as to their retroactive effect. Some carriers take the position that only policies with the endorsement added will provide the enhanced coverage. Others are taking the position that the endorsement is a clarification of existing coverage and that the claims should be covered on all policies regardless of the time of issue. This, of course, creates confusion.

Third, and most significantly, all of the Kvaerner endorsements that I have reviewed are different! This sets the stage for a potential new wave of litigation over the intent of the endorsements. Of course, the Kvaerner endorsements are a reflection of the industry intent to provide enhanced coverage in Pennsylvania, not to restrict it. However, in carrier versus carrier disputes, and in choice of law disputes, the issue of what is actually covered is bound to create problems.

Additionally, the full extent of the application of Kvaerner and Gambone in Pennsylvania is not yet complete. I had one very sharp client opine that in the Specialty Surfaces case, an argument could potentially be made that a bodily injury claim arising from the defective playing field could be a "foreseeable consequence" of the defective workmanship. Further, most if not all of the decisions to date have addressed claims between parties in contractual privity with one another. Could the foreseeable consequence standard be extended to include anticipated third party beneficiaries of a contract, such as a homeowner or a customer?

There are clearly more developments in this area of law on the way. In the meantime, Pennsylvania enjoys (or regrets) the distinction of being the most conservative state in the nation on the availability of coverage for defective workmanship claims.

*Eric, a shareholder who works in the Philadelphia, Pennsylvania, office, can be reached at (215) 575-2688 or eafitzgerald@mdwcg.com.

Defense Digest, Vol. 16, No. 3, September 2010

Affiliated Attorney

Eric A. Fitzgerald CPCU, CLU
Assistant Director, Professional Liability Department
(215) 575-2688
eafitzgerald@mdwcg.com

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