January 25, 2012

When Can An Action for Nuisance Be Brought Against a Public Entity?

An action for nuisance may be brought against a public entity unhampered by the TCA. Private nuisance is but one possible theory for recovery of damages caused by the invasion of one's interest in the private use and enjoyment of land. That interest may be invaded by more than one type of conduct, i.e., the conduct may be intentional, it may be unintentional but caused by negligent or reckless conduct, or it may result from an abnormally dangerous activity for which there is strict liability. One is subject to liability for private nuisance if the invasion is either:
(a) intentional and unreasonable, or
(b) unintentional and otherwise actionable under the rules controlling liability for negligent or reckless conduct, or for abnormally dangerous conditions or activities.

[Restatement (Second) of Torts, § 822 (1979).]

The conduct necessary to make the actor liable for a private nuisance may consist of an act or a failure to act under circumstances in which the actor is under a duty to take positive action to prevent or abate an interference. Restatement (Second) of Torts, § 824 (1979). An invasion is intentional if the actor purposely causes it or knows that the invasion is substantially certain to result from his conduct. An intentional invasion of another's use is unreasonable if:
(a) the gravity of the harm outweighs the utility of the actor's conduct, or
(b) the harm caused by the conduct is serious and the financial burden of compensating for this and similar harm to others would not make the continuation of the conduct not feasible.

[Restatement (Second) of Torts, § 826.].

Water discharge from a broken storm drain pipe is most likely an actionable nuisance. See, e.g., City of Oxford v. Spears, 228 Miss. 433 (1956) (There is no question that an invasion of one's interest in the use of downstream waters may constitute a nuisance); Sterling Iron and Zinc Co. v. Sparks Manufacturing Co., 55 N.J.Eq. 824 (E. & A. 1896) (New Jersey long ago recognized that the pollution of a watercourse may constitute an actionable nuisance); Bengivenga v. Plainfield, 128 N.J.L. 418 (E. & A. 1942) (municipalities were held liable for nuisance resulting in water pollution, although the legal analysis upon which liability was based, active wrongdoing, is now outdated); Borough of Westville v. Whitney Home Builders, 40 N.J. Super. 62, 68 (App. Div. 1956) (Our courts have held that the discharge of treated sewage effluent into a running stream is not necessarily an unreasonable riparian use in today's civilization, but that it may be unreasonable if the harm from doing so outweighs the benefit).

Presented with the question of whether a public entity can be liable for a nuisance as recognized by the TCA, our Supreme Court concluded that it is for two reasons: First, sections of the Tort Claims Act may be interpreted as making public entities liable for nuisance under the standards provided by the Act, and second, in light of the history of municipal liability in this area, the Supreme Court perceived no intent to eliminate this liability.

With respect to the statutory recognition and continuation of the nuisance cause of action, the two sections of the act implicated are N.J.S.A. 59:4-2 and N.J.S.A. 59:2-2. The former creates liability for injury caused by the dangerous condition of a public entity's property. Nothing in this section has been construed to impose liability upon a public entity for a dangerous condition of its public property if the action the entity took to protect against the condition or the failure to take such action was not palpably unreasonable. Thus, this section imposes liability upon a municipality in its status as property owner for nuisance where its actions can be found to be "palpably unreasonable."

In sum, an action in nuisance may be maintained against a municipality under and subject to the standards of the Tort Claims Act, so long as Plaintiff shows that the action taken or failure to act by the public entity was palpably unreasonable. See, e.g., Lyons v. Twp. of Wayne, 185 N.J. 426, 434 (2005) ("When analyzing a nuisance . . . wrongful conduct is not limited to the creation of the condition. Rather, a failure to physically remove or legally abate that condition, resulting in the physical invasion of another's property, also constitutes wrongful conduct."); Gould & Eberhardt, Inc. v. City of Newark, 6 N.J. 240, 243 (1951) ("[A] municipality does not have the right to collect surface water and discharge it upon private property in greater quantity and with greater force than would occur from natural flow, so as to cause substantial injury."); Sheppard v. Twp. of Frankford, 261 N.J. Super. 5, 8 (App. Div. 1992) (noting that injunctive relief was appropriate because unreasonable discharge of storm waters by township onto plaintiffs' property created continuing nuisance); Black v. Borough of Atlantic Highlands, 263 N.J. Super. 445, 453 (App. Div. 1993) (allowing nuisance cause of action for failing to prune crab apple trees creating dangerous condition on adjacent private property).

In Russo Farms v. Vineland Bd. of Educ., 144 N.J. 84 (N.J. 1996), the Plaintiffs brought a lawsuit against, inter alia, the Vineland Board of Education (the Board) and the City of Vineland (the City) for damages to their crops and farmland from flooding that resulted from the improper siting and construction of a public school located across the street from their property and by an inadequate drainage system on a bordering street. Plaintiffs claimed that the Board and City were liable under a nuisance theory because the Board and City's use of their property invaded plaintiffs' use and enjoyment of their land. The Court noted that invasion was a physical invasion, which ordinarily sounds in trespass, but "the flooding of the plaintiff's land, which is a trespass, is also a nuisance if it is repeated or of long duration." See also Hennessy v. Carmony, 50 N.J. Eq. 616, 618 (Ch. 1892) (throwing water on another's property once constitutes a trespass, "to continue to do so constitutes a nuisance").

When a court finds that a continuing nuisance has been committed, it implicitly holds that the defendant is committing a new tort, including a new breach of duty, each day, triggering a new statute of limitations. That new tort is an "alleged present failure" to remove the nuisance, and since this failure occurs each day that the defendant does not act, the defendant's alleged tortious inaction constitutes a continuous nuisance for which a cause of action accrues anew each day. See also Sheppard v. Township of Frankford, 261 N.J. Super. 5, 8-9 (App. Div. 1992) (noting that disposal of water runoff onto plaintiff's property created continuing nuisance).

It is pretty well settled that periodic flooding due to defective construction of a drainage system constitutes a continuing tort. The Russo Farms court held that a nuisance is continuing when it is the result of a condition that can be physically removed or legally abated. In such a case, it is realistic to impute a continuing duty to the defendant to remove the nuisance, and to conclude that each new injury includes all elements of a nuisance, including a new breach of duty. On the other hand, when the nuisance cannot physically be removed, it is unfair to impose a continuing, impossible to fulfill duty to remove the nuisance.

Accordingly, the continued flooding of a landowner’s property would be considered an actionable continuous nuisance. See Russo Farms, supra, 144 N.J. at, 97-105 (holding that TCA permits nuisance and negligence causes of action for damages caused on private property by dangerous condition on public entity's property created by school drainage and municipal storm-water drainage system); Medford Lakes, supra, 90 N.J. at 591-96 (allowing action for nuisance for damage to lake caused by discharge from municipally owned and operated sewage treatment plant); Saldana v. DiMedio, 275 N.J. Super. 488, 499 (App. Div. 1994) (allowing cause of action against municipality for dangerous condition on its property for fire that spread from city-owned abandoned building to privately-owned property); Sheppard v. Township of Frankford, 261 N.J. Super. 5 (App. Div. 1992) (in a nuisance case that involved a public entity's disposal of storm-water runoff onto private property the court found a continuous nuisance existed where the storm-water drainage system at issue "enhanced, concentrated, and sped up the flow of the storm water into the drainage ditch," thereby causing flood damage on the plaintiff's property).

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February 26, 2009

Fourth and Fifth Circuits Reign in “Business Risk” Doctrine: Rulings in Favor of Coverage Under General Contractors’ CGL Insurance Policies Add Clarity, Signal Return to “Plain Language”

The "business risk" doctrine has become a fixture of insurance coverage law, with profound implications for insured contractors and plaintiff property owners involved in construction-defect litigation. Concisely stated, the doctrine holds that “faulty workmanship standing alone, resulting in damage only to the work product itself. . .” falls outside the ambit of coverage provided by a CGL policy. Firemen's Ins. Co. of Newark v. National Union Fire Ins. Co., 387 N.J.Super. 434, 449 (App. Div. 2006) (citations and internal quotation marks omitted). See also 4 Bruner & O'Connor Construction Law § 11:37.

 
A review of the decisional law advancing this principle reveals a lack of consensus with respect to its rationale and application. A particularly uneven treatment of the “business risk” distinction is found in cases where damages are confined to an insured contractor’s work product but extend, qualitatively, beyond mere faulty workmanship. Consider the following example:
 
A residential developer undertakes the construction of a wood-framed apartment building. The exterior of the building is clad in a synthetic stucco system, which, due to faulty workmanship, allows water infiltration into the building’s main walls. This water infiltration, in turn, causes damage to contiguous building materials (stud framing, sheathing, interior finishes, etc.), which are otherwise defect-free. No damage is sustained beyond the building itself.
 
Purchasers of the building file suit against the developer seeking recovery for (1) the cost of replacing the defective synthetic stucco system; and (2) the cost of repairing the consequential damages to the underlying building materials.
 
The developer submits to its insurer a claim for defense and indemnity under a CGL policy covering “property damage” caused by an “occurrence” and featuring the standard “business risk” exclusions.

 

A reoccurring controversy in insurance coverage law is whether the damages in item 2—the cost of repairing consequential loss stemming from a defective component in the insured’s work product—are covered under a CGL policy. To the extent such damages affect only the “work product itself,” they would seem, at least facially, to come within the preclusive ambit of the “business risk” doctrine—they are not damage to “other” or “third-party” property. However, a more thoroughgoing analysis, as presented in two recent Federal Circuit opinions—Stanley Martin Companies, Inc. v. Ohio Cas. Group, 2009 WL 367589 (4th  Cir. Feb. 12, 2009) and Mid-Continent Casualty Co., v. JHP Development, Inc., --- F.3d ----, 2009 WL 189886 (5th Cir. Jan. 28, 2009)—leads to a different conclusion. These cases shed new light on the contours and limitations of the “business risk” doctrine, distinguishing between the defects in an insured’s work product, which generally are excluded from coverage, and the consequential injuries stemming from those defects to other parts of the same work product. According to the recent decisions, the latter category of damages is not necessarily excluded.

 
In Stanley Martin, decided February 12, 2009, the Fourth Circuit Court of Appeals determined that damages caused by defective trusses supplied by a subcontractor and used in the construction of new townhouses constituted a covered “occurrence” within the meaning of the general contractor’s CGL policy. In keeping with the standard coverage form, the policy at issue defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Stanley Martin, supra, at 1. The underlying litigation stemmed from mold damage, originating from the defective trusses, and spreading to other, non-defective, components of the buildings. No damage was sustained beyond the building itself.

 
Applying Virginia law, the lower court had determined that the alleged damages did not come within the scope of the relevant policy because the general contractor’s “remediation costs arose out of damage to [its] own ‘work’ caused by the faulty workmanship of its subcontractor[.]” Id. at 2. This exigency, in the court’s view, “was not ‘unexpected’ or an ‘accident.’” Id. It was an anticipated, and therefore uninsured, risk of doing business.
 

In the decision reversing the lower court’s ruling, the Court of Appeals confronted a divergence of opinion in the Fourth Circuit with respect to the proper application of the “business risk” principle to such circumstances. Four years prior, the Fourth Circuit had addressed a similar set of facts in Travelers Indemnity Co. of America v. Miller Building Corp., 142 F. App’x 147 (4th Cir. 2005). Apparently relying on the “business risk” distinction, the Miller court held that the consequential injuries to the building, which “allegedly [were] a result of the subcontractor’s defective performance,” were confined to the building itself and, therefore, “not considered to be ‘unexpected’ or caused by an ‘occurrence.’” Stanley Martin, supra, at 2 (quoting Miller, supra, at 149) (internal quotation marks omitted). Because, in the court’s view, the damage to the general contractor’s work did not constitute an “occurrence,” it did not trigger the insurers duty to indemnify.

 
The Fourth Circuit reached the opposite conclusion a year later in French v. Assurance Co. of America, 448 F.3d 693 (4th Cir. 2006). In that case, the court distinguished between the subcontractor’s defective work and the damage caused to the surrounding components, which were, in themselves, defect-free. The coverage dispute stemmed from the circumstances presented in the introductory fact pattern—a residential developer hired a subcontractor to clad the exterior of a new home with synthetic stucco system known as “Exterior Insulation Finishing System” (“EIFS”). Defects in the EIFS allowed moisture intrusion that caused damage to the home’s underlying structure. While acknowledging that the subcontractor’s defective work was, in and of itself, an excluded business risk, the court determined that the damage caused by that defective work to the surrounding non-defective components did constitute “an accident, and therefore a [covered] occurrence under the initial grant of coverage of the [CGL policy].” Stanley Martin, supra, at 2 (quoting French, supra, at 704-05) (internal quotation marks omitted). In reaching this conclusion, the court reasoned that, “[a]s delivered per the construction contract,” the surrounding components were “defect-free,” such that their subsequent damage was unexpected. Id.

 
Faced with these diverging opinions, the Stanley Martin court rejected Miller and endorsed French as the controlling iteration of the “business risk” distinction. The bifurcation of the insured’s work between defective and non-defective components was, in the court’s view, well “grounded in the plain language of the policy and the interplay between the policy’s broad definition of an ‘occurrence’ and the policy’s ‘your work’ exclusion” which excepted subcontractor work. See Stanley Martin, supra, at 2 (quoting French, supra, at 703 (internal quotation marks omitted). At oral argument, the insurer in Stanley Martin tried to distinguish French on the basis that the moisture intrusion that damaged the home’s non-defective structure was a separate event that could constitute an occurrence. The mold at issue in Stanley Martin, on the other hand, was present in the townhouses as soon as the trusses were installed. The court found this argument unpersuasive, characterizing it as a “labored distinction [that] places more weight on the policy language than it can bear.” Id. at 2. Because there was “no allegation that the general contractor either expected or intended that its subcontractor would perform defective work or that the spread of mold beyond the defective trusses was expected or intended,” the court determined that these events were “occurrences” capable of triggering coverage under CGL policy. Id. at  3 (internal quotation marks and citations omitted).

 
The Fifth Circuit’s January 28, 2009 decision in Mid-Continent also addressed the application of the “business risk” principle in the context of a construction defect case. Mid-Continent focused, not on the meaning of the word “occurrence,” but rather on the scope of the standard “business risk” exclusion for damage to “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” Id. at 3. Like the Stanley Martin court, the Fifth Circuit emphasized a distinction between the defective and non-defective components of the insured’s work product. Factually, the coverage dispute stemmed from an insured developer’s construction of a four-story, wood-framed residential building with inadequate water-sealants and retaining walls. As a consequence of these deficiencies, large quantities of water penetrated the interior of the structure through the ceilings and walls, under doors, and at other points, damaging contiguous building materials, which were, in themselves, defect-free. After receiving a demand for defense and indemnity, the developer’s CGL insurer filed a declaratory judgment action seeking, among other things, a declaration that coverage was barred by the above-quoted “business risk” exclusion. Id. at 3. The Fifth Circuit Court of Appeals framed the issue in the following manner: 
 
Whether the exclusion bars recovery for damage to any part of a property worked on by a contractor that is caused by the contractor’s defective work, including damage to parts of he property that were the subject of only non-defective work, or whether the exclusion only applies to property damage to parts of the property that were themselves the subject of the defective work.
 

Id. at 6. Examining the plain language of the exclusion, the court determined that only property damage “to parts of the property that were themselves the subjects of the defective work [was] excluded.” Id. at  6 (emphasis added). The court rejected as unpersuasive the approach taken in another jurisdiction in which consequential damages to non-defective components were necessarily deemed an excluded “business risk.” Id. at 7 (declining to follow Century Indemnity Co. v. Golden Hills Builders, Inc., 384 S.C. 559 (2002)). Such an approach, the court reasoned, improperly subordinates analysis of the policy’s language to a presumption about the underlying purpose of CGL coverage. Id. at 7. “The mere fact that a policy is designated as a ‘commerical general liability’ insurance policy is not grounds for overlooking the actual language of that policy.” Id. The court therefore cabined its discussion to the terms of the policy before it and determined that the consequential losses in question went beyond the “particular part of the [the contractor’s] work” containing defects. Thus, the “business risk” exclusion was inapplicable and coverage obtained.
 

Stanley Martin and Mid-Continent continue a discernable trend in favor of coverage where an insured contractor’s faulty workmanship results in damage to otherwise non-defective work product. While it can generally be said the faulty workmanship is, itself, an anticipated risk of doing business, the consequences flowing from such workmanship are not so easily categorized. The Fourth and Fifth Circuit decisions reflect a growing recognition across jurisdictions that broad-stroked applications of the “business risk” rule—which is essentially an insurance industry trade concept—must not supercede analysis of the plain language of insurance contracts. See Zacarias v. Allstate Ins. Co.  168 N.J. 590, 595 (2001) (“In the first instance, the words of an insurance policy are to be given their plain, ordinary meaning.”) See also 4 Bruner & O'Connor Construction Law § 11:37. Absent a particular policy exclusion, the logical basis for differentiating between consequential loss to an insured’s work product and consequential loss to other property remains tenuous, and all but a shrinking minority of jurisdictions have either abandoned or qualified the distinction.

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October 23, 2007

Builder's Risk Policy Does Not Cover Damage to City Sewer Pipe

Plaintiff WHP9, the developer of a multi-building residential project in North Bergen, secured a builder’s risk policy from defendant Centennial Insurance and liability insurance from another carrier before beginning construction. WHP 9, Inc. v. Centennial Ins. Company, A-1454-06T1 (App. Div. October 23, 2007). Plaintiff’s application for the builder’s risk coverage stated the development’s value when complete as $6 million, without reporting the municipality’s sewer pipe or its cost in any way.

While driving piles for footings, a subcontractor punctured a 36-inch cast iron sewer line that ran beneath the property. The damage was discovered in 2002, and the municipality issued a stop work order in March 2003. Plaintiff’s liability insurer defended plaintiff in the municipality’s damage suit, ultimately settling with the municipality.

Asa a result of the stoppage, Plaintiff incurred lost rental income and other expenses exceeding $3 million. Defendant denied coverage under the builder’s risk policy, maintaining that the sewer pipe was not covered property within the policy’s terms:

Covered property means your property or the property of others for which you are liable, consisting of

a. Buildings or structures as described in this Coverage Form Declarations while under construction, erection, or fabrication, including the cost of foundations and underground property such as pipes, flues, drains, electrical wires, piers, and pilings; and excavation, grading, and filling; if such costs are included in the completed value of the project.

But this does not include existing buildings or structures to which improvements, alterations, repairs or additions are being made.

Plaintiff contended that the sewer pipe was covered as “property of others for which you are liable.” The trial court disagreed, and the Appellate Division affirmed, noting that the sewer pipe was not declared as property under construction, erection or fabrication and that the policy explicitly excluded coverage for “existing . . . structures to which . . . alterations, repairs or additions are being made . . . . “ Finding the policy language to be clear and unambiguous, and within an insured’s reasonable expectations, the appellate court confirmed the trial court’s denial of coverage.

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October 8, 2007

Appellate Division Enforces Terms of Association’s Insurance Policy

In an unpublished decision, the Appellate Division recently enforced an insurer’s duty to indemnify and defend a condominium association for damages resulting from an occurrence during the policy period even though they were not discovered until after the policy had expired. Steinbauer v. East Coast Acquisitions, LLC, 2007 WL 2593007 (App. Div. September 11, 2007).

In March 2003, Ramapo Ridge Condominium Association Phase II (“the association”) discovered that a pipe had burst and flooded an abandoned unit. After the municipality declared the unit unsafe, Sirius American Insurance Co. (“Sirius”), which insured the association under a property damage and general liability policy effective from July 2002 through July 2003, undertook to repair and remediate the damaged unit, which was thereafter acquired by East Coast Acquisitions (“East Coast”) at a foreclosure sale. After additional repairs and upgrades, East Coast conveyed the unit to the plaintiff in July 2004. When plaintiff’s plumber entered a common area crawl space to install a dryer vent line, he discovered mold. Ultimately, in November 2004, plaintiff sued East Coast and the association, among others.

The association demanded defense and indemnification from Sirius. All parties agreed that the damages were caused by the 2003 flooding. Nonetheless, Sirius declined coverage, arguing that its indemnification was only triggered if the property damage occurred during the policy term and the third party sued during the policy term. It relied on the following policy language:

COVERAGE E [-] LIABILITY TO OTHERS
A. We pay for the benefit of the insureds, up to the applicable limit(s) of liability (See Part II D) shown in the Declarations, those sums that insureds become legally liable to pay as damages because of bodily injury or property damage insured here.
Such bodily injury or property damage must:
• Occur during the policy term, and
• Be caused by an occurrence that takes place within the applicable coverage territory: See General Conditions 6.

. . .

Occurrence
Occurrence means an accident, including continuous or repeated exposure to substantially the same general harmful conditions.

. . .

Property Damage
Property damage means the following, caused by a covered occurrence:
• Direct physical injury to tangible property, including loss of use of such property (the loss of use is deemed to occur at the time of such direct physical injury).
• Loss of use of tangible property that is not physically injured: all such loss of use is deemed to occur at the time of the occurrence causing the loss.

The court rejected Sirius’s argument. Because the occurrence (the flooding) occurred within the policy period, the court held Sirius liable for all resultant damages, even remediation of the crawl space mold that was not discovered until after the end of the policy period.

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June 29, 2007

To determine who is responsible for repair or replacement, read your documents

In an unpublished case addressing a peculiar repair, the Appellate Division recently reiterated one of the basics of common interest ownership: When in doubt, read your documents. Waldstein v. Highview at Hawthorne Ass’n, Inc., A-2281-05T1 (June 12, 2007).

Shortly after purchasing their town home as a resale in 2003, Plaintiffs Jay and Kathleen Waldstein discovered a broken sewer pipe was leaking water and sewage below the concrete slab that formed the lowest floor of their town home. Further investigation revealed that the pipe had ruptured when the slab failed as a result of a construction defect: the interior foundation of the home had never been built. Plaintiffs repaired the sewer pipe and rebuilt the floor slab, then requested reimbursement from the Homeowners’ Association.

After the Association declined payment, the plaintiffs brought a declaratory judgment action, asking the court to determine that the Association was responsible for the cost of the repairs and to award them fees and costs. The trial judge declined to do so, finding that, the Declaration of Covenants and Restrictions applicable to the development included no provision making the Association responsible for such a repair. On appeal, the Appellate Division agreed.

Plaintiffs relied on a provision of the Declaration that reads as follow:

Each townhouse Owner, by acceptance of ownership, agrees and covenants that if his townhouse, including any party walls, shall be fully or partially destroyed by fire or otherwise, the Association shall reconstruct said townhouse expeditiously, pursuant to plans approved by the Board of Trustees. Any such reconstruction shall be subject to all other applicable provisions of this Declaration and applicable governmental regulations.

Plaintiffs also pointed out Declaration provisions requiring the Association and the Owners to carry fire and casualty insurance as well as extended coverage.

The appellate judges rejected Plaintiff’s argument, limiting the Association’s responsibility to reconstruct under the cited provision to situations in which a townhouse is fully or partially destroyed by fire or similar casualty. Because Plaintiff’s repairs were necessitated by defective construction, the Association was not required to repair or reconstruct.

The court also rejected Plaintiff’s alternative argument that the Association was required to reimburse them since it maintained a reserve account for repair, replacement and improvement. Analyzing the Declaration as a whole, the judges concluded that the reserves were explicitly intended to fund repair, replacement and improvement of common property and the exteriors of the townhouses. No provision required the Association to fund the repair and reconstruction of an interior structural flaw in a town home, caused by a construction defect.

Finally, the court rejected Plaintiff’s argument that an easement provision granting the Association the right to enter a town home to repair breaks of leakage in the water, sewer or sprinkler systems that threaten damage to common property obligated the Association to reimburse them, finding that no evidence suggested that the leak below Plaintiff’s town home threatened the common property in any way.

The Waldsteins’ futile attempt to pass their repair bills on the Association is another reminder that no one formula sets forth responsibility for repairs and maintenance in common-interest communities. New Jersey law permits sponsors and developers great flexibility in designing the maintenance provisions of their communities, and the many variations in governing documents reflect factors such as marketing decisions, architectural requirements, and site anomalies, among others. Careful reading and analysis of the governing documents, that is, the Declaration or Master Deed, is always the first step in determining responsibilities for performing and paying for repairs.

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May 17, 2007

Federal Court in Texas Court Finds a Duty to Defend Construction Defect Claims based on Diminution in Value

A federal district court in Houston, interpreting Texas law, found that an insurance company had a duty to defend its insured, a manufactured home builder, against claims brought by a lender which funded 676 loans used to purchase homes. The case is Nautilus Insurance Co. v. ABN-AMRO Mortgage Group, Inc. Slip Op. 2006 WL 3545034 (S.D.Tex. 2006). Emerson Manufactured Homes, Ltd. and a related group of entities were defendants in two lawsuits. One suit was brought in state court by 928 individuals against Emerson for negligence and defective construction, among other claims. The other suit was brought by ABN-AMRO Mortgage Group, the lender for 676 of the homes in the state court matter, which alleged that Emerson negligently sold defective homes at inflated prices. Emerson’s insurance company, Nautilus, denied all coverage, claiming that neither of the two underlying suits alleged facts that are potentially covered by the applicable policies, therefore Nautilus had no duty to defend or indemnify Emerson in those matters. Nautilus filed the instant action in federal court seeking a court determination that there was no coverage under its policies, and therefore no duty to defend or indemnify. Id. at *1.

Generally speaking, an insurance company must defend its insured (hire a lawyer) if, looking at the “four corners” of the complaint, there are any claims that are potentially covered by the policy. If the pleadings against the insured allege anything that could possibly be covered, the insured is owed a defense. The duty to indemnify is separate, and not as broadly construed. The duty to indemnify arises once facts are established that the insured is liable for damages that are covered by the policy. Id. at *2-3. The Nautilus policy in question is a fairly standard General Liability policy, which obligates the insurance company to “pay those sums that the insured becomes legally obligated to pay as damages because of property damage.” The policy only applies to “property damage caused by an occurrence.” “Occurrence” means “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Id. at *3. Nautilus argued that ABN-AMRO had not alleged anything accidental about Emerson’s conduct. The Court disagreed, finding the allegations of “negligent construction” to be sufficient to count as allegations of non-intentional or accidental conduct. Id. at *4-5

Next, the Court analyzed whether or not the damages amounted to covered “property damage” under the policy. ABN-AMRO did allege that the homes were negligently constructed, and negligently attached to their foundations. It also claimed that the defects caused water damage to the homes and other types of damage to the structures. Id. at *5. However, the actual damages to the structures were not suffered by ABN-AMRO, who was only a lender, rather those damages were suffered by the homeowners themselves. ABN-AMRO argued that it was damaged because the homes were worth far less than they should have been due to the defects, and that since this diminution in value was caused by the property damage, for which Nautilus’s insured was responsible, then the language of the policy which extends coverage for damages that the insured is obligated to pay “because of property damage”, then it covers all those damages that flow from the property damage caused by Emerson. The Court agreed. Id. *5-6

Unfortunately for ABN-AMRO, its run of good luck stopped there. The Court found that the damage was excluded under the “your work” and “your product” exclusions. These exclusions disclaim coverage for damage to the insured’s work or his product. The “your work” exclusion has an exception for work done by a subcontractor. Tragically, there was no evidence that Emerson used any subcontractors to either build or place the homes. Id. at *7. The Court found that it was possible to interpret ABN-AMRO’s complaint such that it alleged damage to property that would not be considered Emerson’s “work” or “product”, but that was limited to the ground itself. There would be no coverage for defects to the homes, the cost to repair those defects, and the damage that they caused to the buyers or to the lender. Id. at *8.

Finally, the court analyzed Nautilus’ duty to defend under the complaint in the Homeowner lawsuit. For the same reasons, the Court found that the damages were excluded from coverage by the “your work” and “your product” exclusions in the policy. However, the Court found that the diminution in value of the property, excluding the homes themselves, may be covered. Id. at *9-10.

This is yet another example of how coverage restrictions and exclusions can gut a construction defect claim. In this case, these manufactured homes were poorly built, then poorly erected on site, obviously causing massive damage to themselves and the contents of the homes. Many of the homes were so bad that the buyers abandoned them, leaving them for the bank. But because of the wording of the policy, and because the home builder did not use subcontractors, the bank and the buyers are literally left out in the cold. The good news is that this analysis can assist other homeowners in later cases. If the diminution in value of the property is covered under a standard CGL policy, and the standard measure of damages for diminution is cost to repair, then a builder may be liable for the overall cost to repair on a project, without the need to find “consequential” or “resultant” damage.

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May 3, 2007

Oregon Appellate Court Rejects Economic Loss Doctrine in Two Construction Cases

As we have written before, an ancient legal principle known as the Economic Loss Doctrine is often trotted out by defendants in Construction Defect cases as a way of avoiding responsibility for their actions. The rule is used differently in different states. In some states, you cannot make a negligence (tort) claim for anything other than personal injury or damage to personal property. Tort claims for damage to real property are out. In other states, like New Jersey, the Economic Loss Doctrine is interpreted to says that you cannot make a negligence (tort) claim for damage to a product, when the product only harms itself. See DiIorio v. Structural Stone and Brick Company, Inc., 368 N.J. Super.134 (App. Div. 2004).

I. Harris

Two recent cases in Oregon involved the Economic Loss Doctrine as well. First, Harris v. Suniga, et. al., 209 Or.App.410, 149 P.3d 224 (Ct. App. 2006) the owners of an apartment complex sued the builder over defects in the buildings. The owners had bought the complex from the original owner, but they had no dealings with the original builder, and did not have a contractual relationship with the builder that would have given rise to a breach of contract claim. Id. at 413. The complex was built in 2002, then sold by the original owner to the plaintiffs. Soon after the sale, the plaintiffs discovered that the builder had failed to install the required flashing on the decks, concrete walkways, landings, gutters, laminates and bellybands. They also claimed that the builder had improperly installed certain wall caps, and trim around the windows. As a result of these defects, the plaintiffs alleged that the buildings suffered significant dry rot, which would cost $376,000 to repair. Id. Defendants answered, then claimed that the negligence claim was barred by the Economic Loss Doctrine.

The Court began its analysis with the general rule of negligence: All persons are liable in negligence if their conduct unreasonably creates a foreseeable risk of harm to others. Id at 415. The Court then traced the history of the Economic Loss Doctrine, discussing cases that held that a plaintiff could not recover in tort for injuries to a third person, and where the alleged beneficiary of a will could not sue an attorney who failed to draft the will to include a gift to the plaintiff. The general rule is that one seeking recovery for only “economic losses” in negligence can only do so if there has been a breach of duty beyond the ordinary tort duty to exercise reasonable care to avoid foreseeable harm. Id. at 417. “Economic Loss” under Oregon law refers to “financial losses such as indebtedness incurred, or financial losses to intangibles, as distinguished from damages for injury to person or property. Relying on an earlier case where negligence claims by subsequent purchasers were allowed against a builder, the court held “we know of no reason why the ambit of liability for negligence in the transfer of real property should be limited by privity of contract.” The court concluded that damage to real property was not “economic loss”, even where the property was an apartment complex, and the purchasers clearly did not intend to live in the property. This analysis undercuts the flawed reasoning in an often-cited case Easling v. Glen-Gery Corp., 804 F.Supp. 585 (D.N.J. 1992), where the court barred tort claims against the builder as asserted by the subsequent purchaser of an apartment complex.

II. Bunnell

In another opinion issued just 11 days later, the Oregon Court of Appeals again refused to dismiss a homeowner’s claim against the builder on Economic Loss grounds. In Bunnell v. Dalton Construction, Inc., 210 Or.App. 138, 149 P.3d 1240 (Ct. App. 2006), the Court held that subsequent purchasers of a single family home (not the original owners) could sue the builder in negligence for defects in the home, even when they knew of the defects when they purchased the home. Citing the Harris case above, the Court stated “[D]eterioration to the physical structure of a building because of defective construction is property damage and not economic loss.” Id. at 142. The trial court’s dismissal of the homeowner’s negligence claim was reversed.

The Bunnell case goes a long way toward protecting consumers and encouraging responsible builders to take appropriate steps when building homes and to stand behind their work if defects are discovered later. The fact that Oregon’s Court of Appeals has not seen fit to delve into the murky issues of the UCC and product liability law as they relate to construction defects makes these two decisions much easier to understand and better law. New Jersey’s case law on this subject is over complicated by discussions of alternate remedies, the existence of UCC or contract claims, and a perverse desire to define a “product”. As these Oregon opinions show, the New Jersey courts have gone down a road that results in much less clarity and predictability in the law. Local courts would do well to review these Oregon opinions and to adopt the Court of Appeals’ reasoning.

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December 27, 2006

Insurance Companies Must Give Specific Notice of a Change in Coverage

In the unpublished opinion of the Honorable Robert P. Contillo, J.S.C. in Supreme Tank, Inc., et al. v. Evanston Insurance Co., et al., BER-C-81-06, Chancery Division, Bergen County, September 18, 2006, the court determined that an insurance company cannot change the coverage provided to an insured without giving specific, direct, notice to the insured. In this case, the insurance company, Evanston, provided insurance coverage to a company engaged in the business of installing and removing underground oil storage tanks, ATS. ATS was insured with Evanston from 2002 through 2005. In 2004, Evanston changed the coverage from $2 million to $1 million but failed to directly notify ATS of the change. In December of 2005 a devastating explosion took place while ATS was removing an underground oil tank. The explosion killed three people and destroyed a 24 unit apartment building.

Evanston attempted to enforce the 2005 policy which contained only $1 million of coverage. ATS argued that it was unaware of the change in coverage until after the explosion occurred, when Evanston claimed to be responsible for only $1 million in coverage. The court found that Evanston had a non delegable duty to notify its insured of a material change in coverage. Therefore, notice to the wholesale broker of Evanston’s policies was insufficient to provide notice to the insured. The court stated that:

not every insured would fully appreciate what changes had been made. But any sentient adult would know that changes had been made. The insurers fiduciary duty includes this de minimus duty - which averts much mischief and grievous consequences - of simply altering your insured that the insurer has worked a change in coverage.

[Slip op. at 12.]

Evanston had failed to send even a simple letter alerting ATS to the change, and instead relied upon notice given to its wholesale broker. The court found this to be an imperfect chain of information. The court then found that the modifications in coverage by Evanston were improper, and should not be enforced. As such, the failure to alert the insured of the change in the 2004 policy, required that the pre-2004 policy limit of $2 million be restored.

This case has a direct correlation to many construction defect cases, in which an insurance company alters a contractors’ insurance policy to exclude a specific type of product or activity. Without direct notice to the insured, and arguably without a reduction in premiums, the insurance company will be bound by the policy in effect prior to the change. For example, several insurance companies have attempted to exclude coverage to contractors for the installation Exterior Insulation and Finish Systems (EIFS). Under the above case law, the insurance company would have to directly notify the insured contractor of such a significant change in its policy, or it would be bound by previous policies that did not contain such an exclusion.

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December 26, 2006

Financial Implications of Construction Law: Insurance

We have all heard Cuba Gooding in Jerry Maguire screaming the phrase "Show me the money!" The developer is often a shell with no assets. It may even be bankrupt. The subcontractors often are unknown or, if known, may operate out of the back of a pick-up truck and have no tangible assets. The design professionals typically have no substantial assets either. The manufacturer of defective building products may be out of business, bankrupt or have liens against its assets in favor of a commercial lender. Faced with such scenarios, plaintiffs are often in despair about how they are going to recover millions of dollars in damages for defective materials or deficient workmanship. They are especially concerned about laying out enormous sums for legal and expert fees and costs, with no idea where the money is going to come from to pay their damages. One of the most important things counsel does is show the client where the money is going to come from. The answer is—insurance.

Builders, their subcontractors and design professionals usually have commercial general liability (“CGL”) insurance policies that pay for property damage when there is an occurrence as defined under the policy. The property damage cannot be damage to the workmanship or materials provided by the particular contractor who did the work in question. Thus, if the roofer was negligent in applying terra cotta roof tiles over sheathing applied by the framing contractor and the tiles get damaged, that is not property damage covered under the roofer's CGL, because it is damage to the materials and workmanship of the roofer.

However, if the deficient installation of the roof tiles allowed water to penetrate the roof tiles and damage the sheathing underneath that was installed by someone else (i.e., the framing contractor), then that is property damage covered under the roofer's CGL. This is known as consequential property damage. It does not matter whether the contractor is still in business, is bankrupt, a dead-beat, or ran off to Fiji and cannot be found. As long as there was a CGL in place when the deficient work was done and the insurance company is still in business, then there is coverage—and a pocket to pay for the damages. In fact, if the contractor cannot be found, the plaintiff can often get the court to allow the plaintiff to serve the carrier for the absent defendant with the complaint and force the carrier to defend, and ultimately pay damages for, the absent contractor. Obviously, this is a gross over-simplification of an extremely complex analysis and the exclusions and other language of the policies will have to be carefully evaluated by experienced counsel before any conclusions about coverage can be reached.. Nevertheless, counsel should be mindful of the availability of insurance coverage as an avenue of recourse for clients who have been badly hurt by deficient workmanship and/or defective building products.

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October 27, 2006

The Commodification of Insurance Defense Practice

Professor Herbert M. Kritzer's upcoming law review article on the practice of insurance defense lawyers "The Commodification of Insurance Defense Practice" is something that everyone involved in construction defect litigation, or contemplating construction defect litigation should review. It is very beneficial for litigants to understand how the relationship between the three players who will be involved for each Defendant entity (insurance carrier; contractor-policyholder; defense attorney) works, and where the loyalties and long-term relationships lie. Oftentimes, a particular attorney does a great deal of work for an insurance company, and he has never worked for his Subcontractor client before, and never will again. You can guess which master the attorney is tempted to serve.

Prof. Kritzer spent several months working as a paralegal in an insurance defense firm, working on various garden variety matters that an insurance defense firm would handle: auto accidents, personal injury, products liability, subrogation and coverage. This mix of business is typical of a mid-sized to large insurance defense firm, although there are many that specialize in one type of work. It has been our experience in New Jersey that the majority of defense lawyers in construction defect (CD) cases are not specialized construction defect attorneys, and they practice in a firm similar to the one that Prof. Kritzer wrote about.

The study described a law firm under pressure from the insurance carriers, where there was an extreme focus on case turnover, cost-consciousness, and tension between carriers and the attorneys that they paid to defend policy holders. Due largely to the "loss-leader" billable rates that carriers are able to get from these law firms, there is tremendous pressure on the law firms to work the files as little as possible, to delegate as much of the work as possible to non-lawyers or to junior lawyers who cost the firm less. These firms also give great weight to the bottom line out-of-pocket expense to the carrier, since the insurance company is always trying to reduce the amount of money it pays for attorneys and for indemnifying its policy holders. Insurance companies are, after all, publicly traded and highly regulated. There is a tremendous amount of scrutiny over their cash flow. Prof. Kritzer also found that there was a tremendous ministerial burden on the lawyers to produce budgets and litigation plans up front, then to try to stick to those prognostications as much as possible. Along with these demands and the low hourly rates, there are often very few assurances of loyalty from the carriers, who frequently threaten to move the files to a competing law firm for any (or no) reason. In this uncertain pressure-filled environment, the insurance defense attorney is expected to place the needs of his client (the policy holder) first, and not take any actions which would jeopardize the policy holder's insurance coverage.

I spent many years as an insurance defense lawyer doing construction defect defense, and Prof. Kritzer's observations and conclusions ring true in many ways. The firms that specialize in CD cases are often able to justify slightly higher hourly rates, so some of the economic pressure is reduced. Also, many insurance defense firms, and CD specialists included, seem to ascribe to that old saw: "We lose money on every billable hour, but we make up for it with volume." Firms are often reluctant to start talking about settlement until a file has been billed sufficiently, and this can often mean years of discovery and motion practice. As a party in a CD case, you will often find that the case takes on a life of its own, once the defense attorneys start churning the file, even if nothing they are doing seems to be helping their cause. Of course a healthy and competitive market for insurance defense attorneys tends to counteract this phenomenon. A surefire marketing strategy for a CD defense firm is to show how much less time and money they spend defending a case than their competitors. If a carrier is hesitant about which attorneys to use, or it feels that other firms unnecessarily pad their bills, this race to the bottom is often very persuasive.

I have found that the handling of any given case depends largely on the experience and attitude of the individual adjuster assigned to the file, along with the experience and skill of the attorney handling the case. A good attorney can usually tell early on in the life of the case whether it is defensible, or whether it should be settled. A good adjuster instinctively knows how to evaluate these cases, and trusts his defense attorney to both push him in the right direction, and to provide sufficient analysis and documentation to support his decisions. Adjusters have to justify expenditures to their superiors, and they can only get away with spending money on a case if the attorneys will help them explain why paying money to settle the case is smarter than risking an adverse result at trial. While Prof. Kritzer=s experience of penny-pinching and second-guessing is certainly common, there are many adjusters who have faith in their attorneys and will follow their advice, even if that advice means that the case should settle for the policy limits, or be defended through a trial.

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September 20, 2006

Importance of Triggering Insurance Coverage

As a follow up to Don Brenner's earlier post on the recent Appellate Division decision in Firemen's Insurance Company of Newark v. National Union Fire Insurance Company, it is important to stress that the success of a construction defect case depends on the plaintiff's claims triggering insurance coverage for the defendants.

Generally, contractors take advantage of the corporate form to shield their personal assets from victimized homeowners, and if they haven't, you can be sure that they don't have enough assets available to pay for the damage they have caused. That is why insurance coverage is important. If a claimant can get the contractor's insurance company to step to the plate and agree to defend and indemnify the contractor, the insurance policy provides a ready source of cash to pay settlements or judgements. The key is to make a claim that will "trigger" that insurance policy. One of the most important factors that should be considered is the concept of "resultant damage". Unless there is some sort of damage to the structure that has resulted from the defective workmanship of the builder or his subcontractors (rotted walls, deteriorated structural members, cracking, collapse) or some damage to the contents of the building, a construction defect plaintiff may have a difficult time getting the contractors' insurance carriers to pay.

The Appellate Division of the Superior Court of New Jersey recently decided an insurance case where a Condo Association successfully sued the developer and contractors who built the project. The Association got a verdict of almost $1 Million against the builder. One of the Association's primary claims had to do with improper or missing fire blocks (fire-resistant partitions in attics and between floors designed to slow the spread of fires). The Association's Complaint did not allege that any damage resulted from the improper construction.

One insurance company agreed to pay, and then brought suit against the other insurance companies to force them to contribute. The insurance carriers argued that, since the Association had only proven that the contractors had performed their work incorrectly, but had not proven that the incorrect workmanship caused any damage, then there was no "occurrence" of property damage which would trigger insurance coverage. Furthermore, the carriers argued, even if the faulty workmanship amounted to "property damage" under the policies, the "your work" exclusion in the applicable polices excluded coverage for damage to the contractors' work product, which was the buildings themselves.

The Superior Court declined to make a ruling on whether or not the "your work" exclusion would prohibit coverage since it determined that there was no "property damage," there was no reason to decide whether the exclusion applied. The Court held, in line with previous New Jersey cases, that since the improper fire block construction had not caused any damage to the property yet, and the only problem was that the fire blocks were improperly done, and that they might cause damage in the future, this was not "property damage" and therefore there was no insurance coverage. "The risk of replacing and repairing defective materials or poor workmanship has generally been considered a commercial risk which is not passed on to the liability insurer. Rather liability coverage comes into play when the insured's defective materials or work cause injury to property other than the insured's own work or products."

We will watch this issue as it continues to arise in New Jersey cases, and will continue to argue that innocent homeowners should be given the benefit of the doubt in insurance coverage cases, since there is often no other source of funds to help them repair poorly constructed and damaged homes.

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September 7, 2006

How To Win The Battle and Lose The War

A recent opinion of the New Jersey Superior Court, Appellate Division, in the matter of Firemen's Insurance Co. of Newark v. National Union Fire Insurance Co. (Docket No. A-1687-02T5) (approved for publication August 16, 2006), 185 N.J.L.J. 777, August 28, 2006 at pg. 41, illustrates how the plaintiff must make sure that there is going to be insurance coverage before taking on a construction litigation case. In Firemen's Insurance Co., suit was filed by the Society Hill Condominium Association, Inc. against various defendants for defects in construction of the condominium. The damage centered around the cost of replacing substandard fire walls. There was apparently no proof that the damage to the fire walls was causing damage to any other building components such as sheathing, framing, etc. The plaintiff spent the time and money to litigate the case all the way through trial and recovered a substantial judgment against several defendants in that construction defect litigation case. The insurance companies for the defendants prevailed in a subsequent declaratory judgment action which was intended to determine whether there was coverage under the defendants' insurance policies.

In evaluating these types of insurance claims, the Appellate Division noted that courts typically focus on the "property damage" and the "occurrence" definitions in the applicable defense insurance policies. An "occurrence" was defined in the policy as Aan accident . . . which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured. "Property damage" is "physical injury to or destruction of tangible property . . . including the loss of use thereof resulting therefrom, or loss of use of tangible property which has not been physically injured or destroyed if such loss of use is caused by an occurrence during the policy period." The policies also contained exclusions for property damage to the insureds' products arising out of such products and property damage to work performed by or on behalf of the named insured arising out of the work, or out of materials, parts or equipment furnished in connection therewith.

The Appellate Division held that there was no coverage under the defense insurance policies because the plaintiff could not establish either an "occurrence" or "property damage" within the meaning of the policies. The court reasoned that property damage does not include inferior materials or poor workmanship. Thus, in order for the plaintiff to prevail on its claims against the defense insurance policies, the plaintiff would have to prove that there was damage to other property beyond the damaged fire walls. Since the plaintiff was unable to prove that there had been damage to "other property" beyond the damaged fire walls, the court determined that there was no "occurrence" and no "property damage" for purposes of the insurance policies and, therefore, the insurance companies were not required to indemnify the defendants. Thus, even though the plaintiff prevailed at trial and obtained a substantial judgment against the defendants, there is no coverage under the defendants' insurance policies.

Before bringing suit in a construction litigation context, it is imperative that the plaintiff undertake a careful analysis of insurance coverage. Otherwise, the plaintiff can find itself in the unenviable position of spending hundreds of thousands of dollars in attorneys' fees and expert fees over the course of three or four years of litigation, prevail after weeks or months of trial, only to find that there is no insurance coverage with which to pay the judgment that the plaintiff ultimately gets. If the defendants are judgment-proof, either because they are out of business, bankrupt or simply have inadequate assets with which to satisfy the judgment, the plaintiff could be left at the end of the day without a remedy.

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September 5, 2006

Contractors Certificate of Insurance

Cvetkovic vs. N.J. Water Supply Authority

It is common for contractors working on large-scale construction projects to require their subcontractors to provide a “Certificate of Insurance.” These certificates are commonly issued by insurance brokers and are intended to confirm to the prime contractor that the subcontractor maintains insurance.

In Cvetkovic vs. N.J. Water Supply Authority,  a New Jersey Appellate Court has decided, as a matter of first impression in New Jersey, that a certificate of insurance which contains a disclaimer that the certificate was issued “as a matter of information only and confers no rights upon the certificate holder” nor does it “amend, extend or alter the coverage afforded by the policies” does not establish insurance coverage for the contractor receiving the certificate.

The Court confirmed the limited weight these commonly issued certificates should be afforded, due to the expansive disclaimers included on most form certificates.

In practice, a party seeking proof of insurance, in the construction context, or otherwise, should not rely merely upon the certificate of insurance as evidence of insurance coverage. Further, if the contractor seeks coverage under the subcontractor’s policy, the contractor must require an endorsement issued by the insurance carrier showing that the certificate holder has been added to the insurance policy as an additional insured. Without this endorsement, the certificate holder is left largely unprotected, and should not draw comfort from the certificate, which alone can be of little or no value.

Thus, if a party seeks confirmation that its subcontractor has insurance coverage, the party should require an actual copy of the policy with confirmation from the insurance carrier that it is in full force and effect. If the party is seeking liability protection as an additional insured, an endorsement which so provides is required.

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