Plot Thickens in South Carolina Builders Liability Brouhaha

Builders reacted with dismay in January when South Carolina’s Supreme Court voted to limit insurance policy coverage of damages caused by faulty subcontractor work in the case Crossmann Communities v. Harleysville Mutual (see “ General Liability Doesn’t Cover Bad Workmanship, South Carolina Court Rules,” Coastal Connection 1/25/11). But the state Homebuilders Association quickly mobilized to counteract the court decision, convincing the state legislature to pass a new law in May that reversed the decision’s effect. The game’s not over yet, however: days after Governor Nikki Haley signed the bill into law on May 17, Harleysville went to court on May 23 to block the new measure on constitutional grounds. To complicate the story even further, the state Supreme Court agreed to re-hear the original case, allowing new oral arguments on May 23 from a wide array of parties who had submitted friend-of-the-court briefs about the dispute. In that second hearing, the court took no notice of the legislature’s move, according to an Insurance Coverage Corner report (“ What Happened at the Crossmann Communities Rehearing?” by Michael Ethridge): “Very early in the rehearing, Chief Justice Toal announced that the Court would not permit any arguments based on the Legislation, with the implication being that the Court would not take the Legislation into consideration in reaching a decision.” The court’s revised ruling is expected this summer. In light of the legislature’s move to explicitly re-define the scope of insurance policy coverage, observers discount any new court ruling’s importance. But with Harleysville’s challenge to the new law still pending, South Carolina builders remain uncertain about what protection their liability policies can be counted on to provide — and even some ongoing lawsuits, begun before the court’s January decision was published, remain in legal limbo. Here’s a recap of events so far. In January, the South Carolina Supreme Court ruled that insurance company Harleysville was in the right when the company refused to help pay damages, or to even defend builder Crossmann Communities against homeowner lawsuits alleging faulty workmanship leading to water intrusion and consequential damage to building interiors and contents. The court’s reasoning hinged on its definition of the word “occurrence,” a common term in standard commercial general liability (CGL) policies. Courts in different states have taken different views about whether faulty subcontractor work constitutes an “occurrence” that would trigger coverage, or is instead a foreseeable event that is the builder’s own responsibility, noted the court. In South Carolina, the court ruled, damage that takes place to the building as a consequence of bad subcontractor work is not an “occurrence,” and so is not covered. (Damage suffered by a third party who’s not involved in the construction contract — say, a passerby who is injured as a result — is another matter, the court commented, and might still be covered.) Builders were shocked — because, they said, the new rule was contrary to long-established common practice. From the story “Leaky Legislation,” by Stacy Tellof in the South Carolina Builder Journal (an HBA publication): “Howard Cox of Palmetto Insurance explained that in 30 years of experience, no insurance company represented by his company has ever denied a claim on the basis of the logic of the Crossmann decision. Cox stated, ‘Bad work has never been covered or paid for under General Liability insurance, but the resulting damage has.’” But even among builders, there’s widespread confusion about what is, and what is not, covered under CGL policies. South Carolina HBA executive Mark Nix told Coastal Connection, “When the decision first came out, I was at the International Builders’ Show. I got calls just when I landed in Florida from a couple of attorneys who told me about it. And I was sitting at dinner with some builders that night, and I asked them what they thought their insurance covered; and I had 12 builders and I got 12 different answers.” And it’s not just the builders, says Nix: “even insurance brokers aren’t sure.” John Sadler is a licensed attorney whose independent insurance company, Sadler & Company, based in Columbia, S.C., specializes in insuring residential trade contractors, home builders, remodelers, and light commercial general contractors in the state. Sadler was sharply critical of the Supreme Court ruling in a January 31 blog post (“Crossmann v. Harleysville: Bad Decision For Builders In SC,” by John Sadler). “The ruling in this case is an insult to the many professional builders that I’ve advised and insured over the past 25 years,” Sadler writes. “For those builder clients that have had construction defect claims filed against them, to say that they intended and expected the construction problem to arise is not true in the majority of cases. Many of the claims were frivolous lawsuits where the true cause of the problem was lack of routine maintenance on the part of the homeowner such as lack of caulking. Other claims resulted from the use of synthetic stucco (EIFS) and similar products where the builder had no reason to believe that such products would ultimately be found to be inherently defective. However, the majority of the claims were caused by unknowing mistakes in the construction process where the builder certainly didn’t expect a problem to arise.” More to the point, argues Sadler, when first drafted by insurance industry association in the 1940’s, the standard CGL insurance policy was intended from the beginning to define coverage broadly in its simplest form. That’s why the industry has created an expanding set of “policy endorsements” that narrow the scope of the policy by excluding particular events or situations — a menu that buyers and sellers of insurance can choose from to craft an appropriate policy at a fair price. Writes Sadler: “In a free market, insurance carriers should be able to decide whether or not to write General Liability policies for builders as well as their approach to coverage for construction defect claims. Some may want to exclude all property damage arising from construction defect and others may want to provide total or partial coverage. The design of the General Liability policy allows this flexibility through the use of special policy endorsements to alter or clarify the coverages of the basic policy form. Carriers that wish to insure contractors, but avoid paying construction defect claims, merely need to add the ISO policy endorsement entitled “Exclusion – Damage To Your Work Performed By Subcontractors On Your Behalf” (CG2294). This endorsement has been in widespread use since 2004 and has proven to be very effective in denying construction defect claims.... At the present time, several carriers in South Carolina are using special property damage endorsements that they drafted to provide partial coverage to builders for construction defect claims. Most of these endorsements take the form of excluding coverage for property damage to the faulty work itself, but providing coverage for resulting property damage to non-faulty work. Many within the building community think that this is an acceptable compromise.” Says the HBA’s Mark Nix, “If you want to have some of these provisions in the contract that take out some of the coverage, that’s fine, as long as the builder knows what he’s paying for. But the way things have been, you can ask different insurance agents, and even they would tell you — if I had six different insurance agents, I’d get six different answers about what’s covered.” And problems arise when insurance companies want to avoid paying for damages in connection with policies written before the CG2294 endorsement, narrowing the defined coverage, became widely used. That’s when insurance providers may fall back on hair-splitting about what is, or is not, an “occurrence.” South Carolina’s new law is intended to cut off that option for the insurance industry. But there’s a hitch: insurance company Harleysville, which has sued to block the law, may have a viable case grounded in both the U.S. and the South Carolina constitutions. The legal blog “Insurance Coverage Corner” has a thumbnail sketch of Harleysville’s complaint (“ Constitutional Challenge to the South Carolina Legislation Defining Occurrence,” by Katherine W. Sullivan). On the one hand, Harleysville argues, “To the extent the statute is applied retroactively, it violates the separation of powers doctrine set forth in Article I, § 8 of the South Carolina Constitution: Article I, § 8 ‘prohibits the legislature from overruling a decision by the Supreme Court.’” And, contends Harleysville, the new law also violates the Contracts Clause of the U.S. Constitution, which provides that "No law impairing the obligation of contracts shall be passed.” The statute, Harleysville argues, “purports to retroactively alter and impair CGL insurance contracts already in existence prior to the enactment of the bill." If Harleysville succeeds in attacking the retroactive nature of the law, that won’t stop the law from more clearly and precisely defining coverage for future insurance contracts. That’s a beneficial effect, argues Frank Norris of insurance agency Frank B. Norris and Co. Norris told the South Carolina Builder Journal, “Something is wrong when insurance companies cannot issue a liability policy that the builder can understand, much less the insurance agent. Something is wrong when multiple state supreme courts spend thousands of hours of legal time trying to interpret the CGL policy issued by the Insurance Service Office in 1986.” Said Norris: “We represent one insurance company that has an endorsement that we like that clarifies coverage. Faulty work is not covered, but the resulting damage is covered. We wish other companies would take this same position and not hide behind the Crossmann decision when adjusting claims.” But Mark Nix says that for builders, it’s important for the new law to have a retroactive effect — at least enough to bring some order to the process for cases that were already in the works when the Supreme Court’s January opinion was released. Nix says, “We had several cases that we knew of, already in litigation or going into some other part of the process, where insurance companies just stopped — they said, ‘We’re not meeting anymore, because of this case. We’re leaving it high and dry.’ Even though they had been paying, or representing the builder through attorneys — they just walked away.” For Nix and the builders he represents, the legislature’s action doesn’t interfere with an existing contract — on the contrary, he argues, the law simply reaffirms the previously existing understanding of the contracts entered into in good faith by both sides. Says Nix: “That’s the biggest point we put to the legislators. You know, we paid for a product, we were told ‘This is what it covers’ — and if you look at a historical view of it, it shows that it’s covered in the past. Well, why would it change at this point?” In the end, the Supreme Court’s decision after the re-hearing may narrow the scope of Harleysville’s victory anyway — taking the company off the hook for damages in Crossmann’s case, but without the sweeping implications for other builders and other insurance companies in other construction projects. Some observers argue that the court should have restricted its ruling to a narrower scenario in which the work was so plainly defective that its damaging consequences would in fact have amounted to an ordinary contract violation, rather than an unforeseen incident — deciding the case, in effect, on the facts rather than on the law. That way, builders could still retain clear coverage for the sort of typical product failures or “unknowing mistakes” John Sadler describes. Supreme Court Justice Costa M. Pleicones, in a short concurring opinion, made a gesture toward such a finer distinction between unforeseen bad outcomes, and the foreseeable results of bad work — and he said that Crossmann’s work in the buildings at issue had plainly crossed that line. Wrote Pleicones, “the homeowners allege ‘negligent construction on many fronts, including improper installation of siding, windows, flashing at the windows, walkway floor sheathing, and wind resistant tie down straps; deterioration of structural columns and structural components; failure to completely install the building wrap; flooding of units; water infiltration; failure to properly attach handrails; failure to properly construct emergency stairs; termite infestation and destruction; and defective storm water drainage system.’ This complaint alleges nothing more than negligent acts constituting faulty workmanship, not an ‘occurrence.’” Argues Frank Norris, “Our state supreme court should have warned insurance companies that Crossmann was an unusual case. The work was so shoddy that resulting damage was to be expected. But it should not have applied across the board for other cases.”