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Construction Defect Claims: Handbook for Insurance, Risk Management, Construction/Design Professionals

Construction Defect Claims: Handbook for Insurance, Risk Management, Construction/Design Professionals

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Construction Defect Claims: Handbook for Insurance, Risk Management, Construction/Design Professionals

460 pages
3 heures
Dec 15, 2014


Over the past 25 years or so, the property/casualty insurance industry has confronted an onslaught of construction defect claims. Since the construction sector is a critical component of our Gross Domestic Product, it is not surprising that the impact of construction defect claims on the economy is significant. In addition, the ubiquity of these claims negatively impacts the availability and affordability of insurance, particularly for new residential construction.

Managing such claims is challenging given the number of parties involved and the variety of construction contract language dealing with, among other things, indemnity obligations and insurance requirements. Risk-transfer language can be complex and has been the subject of much litigation.

This handbook provides a practical and user-friendly framework for those professionals who manage construction defects. It will assist the professional's continuing learning, critical to the professional's success, and it will provide a handy reference.
Dec 15, 2014

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Construction Defect Claims - Joseph M. Junfola, CPCU



When a dream home turns into a nightmare, litigation happens.

Alpine Bank v. Hubbell

550 F.3d 1274, 1277

(10th Cir. Colo. 2008)

Probably the most famous construction defect of them all is the Leaning Tower of Pisa in Italy. More than 700 years after completion, it still stands, albeit a bit crooked, and seemingly defying gravity. But if it wasn’t leaning, would the tower be the tourist attraction that it is today?

The construction of this bell tower for a church began in 1173 A.D. and continued in several phases over a very long period of time. There were lengthy interruptions that delayed the project’s completion, over 200 years later.

The project is unique in its design, construction, and aesthetics. The engineer, Bonanno Pisano, designed a 16,000-ton tower that is 179 feet in height on a stone base that is approximately 10 feet thick. Unfortunately, or fortunately depending on one’s perspective, it was constructed on top of a crumbly state of the ground. Apparently, the tower started to tilt sometime in 1185 A.D. and today has an inclination measured at about 15 feet.¹ Subterranean water is present and it is apparent that the soil, composed of clay and other deposits, is subsiding.

In the last century, the increasingly accurate measurements of the building and the surveys of the subsurface conducted with a wide range of devices, combined with historical and archival surveys, have shed some light on the matter. The Tower was presumably initially designed as a straight building; however, it must have begun to subside right from the first stages of the building work. The subsidence was due to the special morphological features of the ground, composed of several layers of clayey materials and silt, run through by groundwater levels at about one metre deep. These conclusions can be drawn from an observation of the soil, and the corrections made to every floor of the building. What is certain, based on the scarce information we have, is that over the centuries the oscillation of the building was minimal, since it must have eventually settled on the ground.²

Movement of the Leaning Tower of Pisa continues, as do restoration efforts to stabilize it. Incredibly, despite the design and construction issues, the tower still stands. Aside from the antiquity and beauty of the structure giving it historical value, the leaning caused by a defect in construction or design certainly enhances its value.

Construction Defects Happen

Over the last 25 years or so, the property/casualty insurance industry has confronted an onslaught of construction defect claims. California, a bellwether state in many respects, has led the way. Nevada, other western states, the southeast, and the Gulf States also figure prominently in the current construction defect landscape.

Changing demographics created, at least until the most recent economic slowdown (circa 2008 – 2014), an increased demand for housing in many areas of the country. In meeting this demand, the desire to maximize profits fueled the frequent use of questionably skilled workers and cheap, but inferior, building materials. In retrospect, the proliferation of construction defect claims was inevitable.

Since the construction sector is a critical component of our Gross Domestic Product, it is not surprising that the impact of construction defect claims on the economy is significant. California provides a prime example:

In the early 1990s, construction-defect litigation almost completely halted condominium and townhouse construction in California. As a result, the median home price in San Diego County rose by nearly 25 percent in one year.³

In addition, the ubiquity of these claims negatively impacted the availability (overall, and with favorable terms) and affordability of insurance, particularly for new residential construction. For example, in the most recent hard insurance market, residential construction activities exclusion endorsements, some absolute in impact and others limited, became more frequent.

Other Types of Insurance

While this handbook focuses primarily on the Commercial General Liability (CGL) insurance policy, it is important to be familiar with other types of insurance and noninsurance sources that may be available to pay for defective construction.


Owners and contractors are increasingly using owner- and contractor-controlled insurance programs (OCIP and CCIP), or wrap-ups, to insure very large construction projects, usually in excess of $100 million. The wrap-up generally insures all parties in the project rather than having each party procure their own insurance.

A wrap-up offers benefits:

Savings of transaction costs, including litigation costs

Reduces premium costs that are included in contract prices

Eliminates coverage issues such as restrictive additional insured endorsements and residential work exclusions

Eliminates insufficient limits problems

Enhances risk management

A frequent problem with wrap-ups is the availability of coverage after the project is completed. Given the nature of latent construction defect claims, the defect may not be apparent until well after the project is completed, for example, when there is a manifestation of the symptom of the defect like water leaks. Consequently, the statutes of limitation are often extended, but the wrap-up policy may expire before the statutes do.

The dilemma can be explained in the context of the closing out of the projects in a reasonable period of time after completion from the standpoint of the buyer and the underwriter, the latter being concerned with IBNR (incurred but not reported) claims.

Those of us handling wrap-ups…recall the days of retro adjustments that stayed open for 8-10 years (after the project ended). Today, we find underwriters more willing to close out programs in the first few years postconstruction. For those wondering, the close out usually refers to the moment when all open claims are finally paid or the moment when the underwriter is willing to negotiate a buy out of the claims. Additionally, at this point in time, the underwriter is comfortable enough that there are no incurred but not reported claims lingering out there.

The general economic climate impacts the growth or contraction of wrap-ups. The recent sub-prime mortgage crisis, for example, has fueled a broader credit crisis that has slowed down project development in general.


A surety contract is not insurance and the protection afforded by a surety bond is different than insurance coverage. Unlike insurance, there is no transfer of risk. Based on the underlying construction contract, the surety contract is a three-party contract, the contractor-principal remains responsible for its obligation to the party it contracted with and made its promises. The surety backs it up in the event of default.

Various bonds are used in construction. One, called a performance bond (the other is a payment bond) requires the surety to step up should the contractor-principal fail to meet its obligations to construct the project according to the contract requirements.

However, a performance bond is not insurance:

The insurance policy is a contract of indemnity, while a surety bond is a guaranty of the performance of the principal’s obligations. An insurance policy is issued based on an evaluation of risks and losses that is actuarially linked to premiums. Losses are expected. In contrast, a surety bond is underwritten based on what amounts to a credit evaluation of the particular contractor and its capabilities to perform its contracts, with the expectation that no losses will occur.

Furthermore, while a performance bond and insurance are distinct there can be overlap in a construction claim:

…many claims, particularly defective work claims, may have a potential impact on both the performance bond and the CGL policy. The two seldom can be separated from each other where there is a breach of contract involving the work. Nevertheless, due to the relationships of the parties, that is the two-party relationship between the insurer and the insured, versus the principal-surety relationship involving indemnification obligations on the part of the principal to the surety, the liability policy should usually step up to the plate first in these types of losses.

The following New Jersey case further illustrates the differences between insurance and surety contracts:

While surety bonds have been included within definitions of insurance for some purposes, suretyship is not generally considered to be insurance…Suretyship is defined as:

a contractual relation resulting from an agreement whereby one person, the surety, engages to be answerable for the debt, default, or miscarriage of another, the principal…

The differences between an insurer and a surety have been described as follows:

The nature of the risk assumed by the party in the role of insurer is a major distinction between insurance and the arrangements of guaranty and surety. As a broad general rule, the risk can be characterized in terms of the degree to which the contingency is within the control of one of the parties. In the classic instance of insurance, the risk is controlled only by chance or nature. In guaranty and surety arrangements, the risk tends to be wholly or partially in the control of one of the three parties… …

There is also a difference in the liability of a classic insurer and that of a surety/guarantor. An insurer is the primary party liable upon the occurrence of the contingency, and … must bear the ultimate loss. In the classic case of surety or guaranty, on the other hand, the insurer is essentially liable secondarily (regardless of how the liability may be labeled for legal analysis). A surety is ordinarily entitled to indemnity from the principal in case the surety is compelled to perform.

The essential distinction between an indemnity contract and a contract of guaranty or suretyship is that the promisor in an indemnity contract undertakes to protect his or her promisee against loss or damage through a liability on the part of the latter to a third person, while the undertaking of a guarantor or surety is to protect the promisee against loss or damage through the failure of a third person to carry out his or her obligations to the promisee. [Couch on Insurance, supra, § 1:18.]

New Jersey Property-Liability Ins. Guar. Ass’n v. Hill Intern., Inc., 395 N.J. super. 196, 202-203 (App. Div. 2007)

A surety contract is not an insured contract for purposes of covering contractual indemnity under a CGL policy. The surety bond will generally include an indemnity agreement favoring the surety. A surety contract is not specified as an insured contract in the CGL policy, nor is it an assumption of tort liability.

Managing the Claims

Managing such claims is challenging given the number of parties involved and the variety of construction contract language dealing with indemnity obligations and insurance requirements, including additional insured obligations. Risk-transfer language in contracts can be complex and has been the subject of much litigation. Whether you are a contractor or design professional, being confronted with a construction defect claim can be a daunting and frustrating experience. Even if covered by insurance, you are burdened with deductibles, coverage controversies, and vital time away from your business.

Managing the claims is not limited to managing the construction defect claim after it occurs. It is more encompassing and, because it is, includes construction and design professionals as well as risk management and insurance professionals. Managing the construction defect claim begins well before the construction actually begins.

Handbook Framework

It is hoped that this handbook will provide a practical and user-friendly framework for those professionals who manage construction defects…one which provides a solid foundation upon which an understanding of the critical issues can be attained. To facilitate this foundational framework, the significant issues will be discussed. An attempt is made to distill as much information as possible. Understanding core issues is most important and facilitates the further understanding of, but not necessarily agreement with, different interpretations of these issues.

The legal rulings cited in this program were selected for their instructional value, i.e. to illustrate the principles and concepts discussed, so they necessarily include non-published decisions. This workbook is not a compendium of case law, nor should it be. But a well-written and thorough opinion provides knowledge and guidance, and furthers the aims of this handbook.

Continuing Learning

Proficiently handling construction defect claims requires ongoing learning. There simply is no getting around this. And there are no excuses. In addition to traditional courses and seminars, advances in technology have made learning much more accessible and convenient. Keeping current is critical to your success. The one constant in the construction defect arena is change. Arguably, one of the most prolific sources of change in insurance coverage law involves the CGL policy and construction defect claims.

It is hoped that this handbook will assist in these learning efforts and provide a handy reference when managing the construction defect claim. While an attempt is made to provide the latest and most current state of the issues, the very fluid nature of construction defect claims necessitates constant revision and updating, and this handbook will continue to undergo such updating.

Continuing learning is critical to the practitioner’s success, and it takes many forms.⁹ Arguably, it is the most critical component. There are plenty of excellent seminars, workshops, webinars, and courses available locally and nationally.

There are many ways to learn, especially given the convenience of numerous and reliable Internet sites, but be careful. The Internet contains the largest compilation of unedited information in the world. It is a Venus flytrap for the unwary – and a gold mine for the appropriately suspicious.¹⁰

Used with caution, the Internet is an excellent resource for learning and research. It has a couple of weaknesses, though. First, the information could be dated. Second, it is often inaccurate.¹¹ It is wise to double-check if the age of the source is important. And you need to evaluate the source for any biases.

One more thing…the practitioner should not be content with his/her current state of knowledge. Complacency is risky given the fast-moving world of construction defect claims. While the following deals with issues a little bigger than construction defect claims, it drives home the point:

If thou thinkest that thou knowest many things and understandest them very well; know also that there be far more things which thou knowest not. Be not high-minded, but rather acknowledge thine own ignorance. Why wilt thou prefer thyself before another, since there will be found many more learned, and more skilful in the Law than thou art? If thou wilt know or learn anything profitably, love to be unknown, and to be esteemed as naught.¹²

Disclaimers and Caveats

The author takes full responsibility for this handbook and the views expressed do not necessarily reflect the opinion or policy of his employer, its parent, or any affiliates. Nor does the program constitute legal advice. For that, you will need a lawyer.

The author has tried to resist the extraordinary temptation to caveat his way through this handbook. It would be easy to do so, given the complexity and extremely fluid nature of construction defect claims and, had he given in, this handbook would be riddled with them.

The following caveat, therefore, will apply throughout…

…analysis of any claim requires an examination of the facts, the policy, and the law.

Chapter 1

What is a Construction Defect Claim?

Ahh, home crap home!

Walter Fielding, Jr.

The Money Pit, 1986

Universal Studios

What is a Construction Defect?

Before we address the construction defect claim, let’s first explore the construction defect.

At the outset, it is important to realize that structures can fail for reasons other than construction and design defects:

…all buildings have an expected lifespan and even the structures of the ancient world will erode into a mound of sand given enough time. The eventual failure of a structure is an expected result rather than a manifestation of a construction defect.¹³

While design and construction professionals can fail to meet standards of care resulting in construction defects and damages, structures are simply not built to last forever and neither are they required to be perfect in design and construction. The question, then, is whether the failure is due to normal wear and tear, the result of the expiration of the useful life of the structure, a maintenance problem, or one actually due to a construction and/or design defect.¹⁴

Construction defects often are initially latent, with a later manifestation of symptoms of the defect. They can also be patent, that is, they are readily apparent.¹⁵ This is important for a number of reasons including the impact on statutes of limitations and repose, and the trigger of coverage, both of which will be covered later.


Construction defects can be defined by statute. For example, in Nevada, NRS 40.615 defines a constructional defect as…

…a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or an addition to an existing residence, or of an appurtenance. The term includes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed that is proximately caused by a constructional defect.¹⁶

Florida’s Chapter 558.002, defines a construction defect in this way:

…a deficiency in, or a deficiency arising out of, the design, specifications, surveying, planning, supervision, observation of construction, or construction, repair, alteration, or remodeling of a dwelling, any appurtenance to the dwelling, or the real property to which the dwelling or appurtenance is affixed resulting from:

(a) Defective material, products, or components used in the construction or remodeling;

(b) A violation of the applicable codes in effect at the time of construction or remodeling which gives rise to a cause of action pursuant to s.553.84;

(c) A failure of the design of a dwelling to meet the applicable professional standards of care at the time of governmental approval; or

(d) A failure to construct or remodel a dwelling in accordance with accepted trade standards for good and workmanlike construction at the time of construction.¹⁷

A Working Definition

For our purposes, here is a working definition:

A construction defect can be defined as a failure of the construction to perform in an intended or expected way. This failure to perform can, but not necessarily, cause physical injury to the work itself and/or other property or work. Construction defects include defects in design, faulty work, defective building products/material, and various types of soil failure.

Design defects include:

Improper site selection

Building/system does not work as designed

Defective plans, specifications, selection of improper materials

Defective (physical) construction includes:

Faulty workmanship

Poor quality

Noncompliance with codes, specifications, plans, product manufacturer instructions, buyer’s expectations, industry standards

Material or products used in a project may be defective, inferior, or inadequate.

Soil defects can be categorized separately and include expansive and saturated soils, and improper grading, fill, compaction, and defective testing.

Some usual suspects in construction defect claims include:

Saturated, expansive, and poorly compacted soil

Improper reinforcement of foundation systems, failure to properly prepare for utilities, failure to properly install anchor bolts, crawl space moisture, and improper foundation waterproofing

Defects in civil engineering and site drainage

Framing defects encompassing shear panels, absence of fire stopping, out-ofplumb and out-of-plane walls, and balcony deck framing

Plumbing defects that include the failure to ream ends of copper pipes that are cut and failure to isolate pipes from framing¹⁸

Construction defects can be grouped into the following defect categories: site, building envelope, structural, heating/ventilation/air conditioning, electrical, plumbing, and fire/life safety systems.¹⁹

Why do construction defects seem to be occurring more frequently? A number of reasons have been offered: an abandonment of the traditional design approach where the architect would utilize established…standards and details…that were similar and consistent, i.e. ‘tried and true’; untested new business materials that are limited in application; inadequate design detail; a change in the contractor’s role from Master Builder to master broker with the latter’s emphasis on low initial cost and higher profits overriding the goal of a product free of defects; the priorities of getting the project done as quickly as possible and maximizing profit; the overall lack of quality assurance and quality control, and the lack of effective coordination resulting in scheduling and sequencing problems.²⁰

Construction Basics

Knowing what a construction defect is requires knowing some construction basics. Understanding the basics, including the relationships among building systems, is important to determining what is covered, in whole or in part, in addition to getting a handle on liability and damages. To facilitate this basic understanding, our discussion is limited to residential construction, is general, and by no means is exhaustive.

The Contract

The construction contract includes the original contract and any amendments and change orders that operate to clearly specify a change to the contract. Its purpose is threefold:

(1) to make it clear what is to be done, (2) to make it clear how long it will take, and (3) to show how much it will cost. Although it can take a lot of words to cover those items, a good construction contract will leave the parties with no doubt about the exact price

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