Staying afloat in complex construction insurance waters

With the tidal wave of legal cases involving construction defects bogging down county, state and federal courts, it has become imperative that insurers “cover their behinds” from every imaginable angle — including educating insureds as to what is not covered in their policies.
he term “illusory coverage” has made its way into the vernacular of the legal and insurance industries, and the ramifications often fall into the laps of insurance producers, brokers and carriers. There, controversy often arises over what is actually covered in a policy versus what the insured assumed was covered.

Bob Marshburn, a consultant and risk manager with CertifiedRiskManagers.com, said illusory coverage is what it sounds like — an illusion — coverage that is not there. In some jurisdictions, insurers are taking the brunt of the punishment when they neglect to tell their clients what is not covered under their policies.

“It’s not enough any more to simply tell your clients what is covered,” Marshburn told a group of attendees at a July course in Las Vegas for the Certified Insurance Specialist in Construction (CISC) designation. “To avoid legal liability, insurers are also obligated — (al)though not necessarily mandated — to tell the client what coverage is not included, especially if that coverage had been provided in past policies and insureds had a ‘reasonable expectation’ that it is still covered. Documentation of disclosure is the follow-on critical step in the procedure.”

Yet insurers are concerned that customers will walk away from the table if agents focus too much on the coverage exclusions. Detailed disclosures add a degree of discomfort to the already complex transaction of providing construction coverage policies, insurers said.

Marshburn said not to fear, however, as customers will only be walking into the arms of the competition with similar limitations. “It’s not that someone else is going to provide the coverage, it’s that they’re not going to tell you they’re not. You’ve got to get that across to your clients,” he advised.

Marshburn added that the insurer who offers full disclosure on exclusions — and documents it with the client’s signature — will be more thoroughly protected against potential future litigation.

Complex construction

Attorney Robert Freedman of the West Coast firm Tharpe and Howell LLP said construction defect litigation makes for complex court proceedings because of the multiple parties involved, as well as the multiple issues and concerns regarding homebuyers’ rights.

Freedman stressed that the challenges associated with investigating allegations of defective construction in projects, which can include hundreds of homes, and the document-intensive nature of construction defect cases add to the overall complexity.

“Taking these cases to trial is extremely burdensome to the stakeholders, given that construction defect trials can take anywhere from one to six months or more, and require special courtrooms to accommodate the numerous parties to the cases,” Freedman said. “There could be 20 different defendants.”

Such a situation led Nevada to establish a separate courthouse to handle construction defect trials that can accommodate all the parties.

Judge Allan R. Earl of Las Vegas’ Eighth Judicial District Court accompanied Freedman as a keynote speaker to the two-day CISC course. Earl gave the students a snapshot of the status of construction defect litigation in his state, noting Chapter 40 of the Nevada Revised Statutes.

Nevada’s Chapter 40 is a bundle of statutory entitlements that the prevailing plaintiff may be entitled to in litigation regarding residential construction. Those entitlements include, but are not limited to, attorneys fees, interest, court costs, expert fees and other litigation expenses, which can result in actual damages being well in excess of a jury verdict.

Freedman gave the example of a homeowners association suing a developer for common area defects and damages: “(The association) typically claims cost of repair as damages,” he said. “If it wins at trial, not only is the homeowners association entitled to its cost of repair (for) damages, but it may also be entitled to its Chapter 40 entitlements, which are litigated in post-judgment proceedings and can add another 25 percent to 50 percent or more to the total loss.”

According to Freedman, insurers’ high losses in certain markets such as Nevada are driven by the combination of the use of extrapolation evidence, high cost of repair damages, potential Chapter 40 damages, high cost of defending the cases and large number of construction projects in litigation. The high exposure and complex nature of construction defect cases are resulting in an increasing amount of insurance coverage lawsuits and related appellate cases, he added.

Know your subcontractors

Under the law, the general contractor (GC) is responsible for everything that happens or does not happen at a construction site. It’s where the buck stops.

“A GC can’t get out of any lawsuit,” Marshburn said. “He has all those liabilities to contend with.”

However, a subcontractor assumes as much or more risk exposure liability as the GC. All subcontractors are subordinate to the GC. What increases the GC’s exposure and liabilities even more is the fact that subcontractors often hire subcontractors, known as sub-subs. Those arrangements have an effect on liability and also will generate a significant difference in coverage.

Marshburn stressed the need to ensure subcontractors are appropriately insured. It comes back to avoiding the new wave of litigation based on what is not covered in a policy, he added. While it is in the GC’s best interest to know to what extent all of his subcontractors and sub-subs are insured for, oftentimes, they have no idea what’s in their policies, Marshburn noted. For a GC, subcontractors are a major risk, he said.

“As risk managers, we are trained to look for exposure; identify all your exposures,” Marshburn said. “That’s the first step, because you can’t effectively insure, mitigate, manage, control, reduce or transfer if you don’t know what your exposures are.”

Marshburn’s not-so-veiled warning shouts that in the end, a contract (i.e. insurance policy) covers whatever the court says it covers. As a key component in the majority of construction coverage, he pointed out how critical a part the subcontractors’ insurance needs play in the process, based on the indemnity obligations they inherit.

Of all the entities typically involved in a construction project, each has its own unique exposure that can result in financial loss. Risks include everything from workers, tools, vehicles and completed operations.

Legal liability

To understand contracts and contractual liability, Marshburn said it is crucial to understand the relationships between all parties involved during and even after construction.

The insurance process begins at square one, with the landowner who may or may not also be the developer. The GC enters the picture by signing a contract, which in turn brings subcontractors into the fold, each of whom must also be insured individually or cooperatively (joint or several).

Marshburn said 46 out of the 50 states practice a combination of joint and several liability, where each entity is individually insured while each being at least partially liable for any damages that may occur during the job as a whole.

The GC works in concert with an architect who translates the owners’ needs into the building requirements — also considered a risk exposure, as subcontractors must adhere to building specifications that must be accurate, detailed and precise to preclude liability. Although again, the GC is ultimately responsible for the methods and means used to complete a project in accordance with the plans, specifications and structural documents (blueprints) drawn up by the architect.

The architect leads the complex chain of events and entities to the door of a variety of engineers (mechanical, electrical, structural, HVAC, soils) and many others who both create extra elements of risk and add further layers of liability to the insurer’s workday. As a liaison between the GC and zoning code officers, fire departments, planning officials and engineers, the architect plays a very important role in liability prevention during project development through implementation all the way to successful completion.

Legal liability is the responsibility or obligation of one party to another party that is enforceable in a court of law. Marshburn pointed out, “Liability policies respond when the insured incurs legally binding responsibility.”

Legal liability can be imposed by tort (common law — based on that which is equitable and fair); by passed legislation or statute; or enforced by a legal contract.

Tort law is civil wrongdoing arising out of unintentional acts, Marshburn said. He added that the insurance industry does not deal with intentional torts.

“To compensate a person for personal or bodily injury, insurers give them money,” Marshburn said. “For those who think monetary value cannot be placed on a human life … it happens every day in the courts. Is it fair value? Probably not.”

Construction defect suits can hold contractors liable under many different theories: breech of contract; fraud negligence; and strict liability, Marshburn said. Contracts can be written or verbal, and that is important knowledge for the insurer, because liability can be incurred from both written and verbal contracts, he added.

“On a standard unmodified commercial general liability policy for the definition of an insured contractor, an insured contract covers written and oral,” Marshburn said.

Categories of damage

Construction insurers are concerned with two types of damages: compensatory and punitive. Damages are usually compensated with money.

Marshburn cautions insurers with multi-state jurisdictions to closely monitor regulatory and legislative differences from state to state. Punitive damages are not insurable in every state.

Compensatory damages are financial payments in an amount sufficient to restore the injured party to the condition they were in before the injury occurred. There are two categories of compensatory damage, including special damages and general damages

“Special damages (actual cost) are specifically the damages that actually compensate the injured person or persons for the dollars and cents that they spend — actual loss, medical, loss of earnings, rehab, etc.,” Marshburn said. “These are pure compensatory damages.”

General damages are not so easy to put a number on, he noted. “General damages are intangible; a little vaguer.” For instance, claims of pain and suffering can refer to spousal or sexual issues and complications. Loss of consortium can be other than spousal, and can apply to other family members, according to Marshburn.

“How do you put a dollar figure on pain and suffering?” Marshburn asked. “It’s not easy. Sometimes through tort liability, sometimes through the workers’ compensation system saying this is what that’s worth. It depends on different states and legislative changes.”

Punitive or exemplary damages are a means used to punish the entity that caused damage, loss or injury.

“The court attempts to punish the person or organization that caused the damage to a degree that is somehow connected or measurable to the level of reprehensibility demonstrated,” Marshburn explained. “For example if the loss could have easily been prevented by spending three extra dollars per unit and there are documents to prove this, the court is going to make an example of you by awarding punitive damages.”

Above all, the insurer must take into consideration, especially during the underwriting process, statutes of limitations for construction insurance.

“This is very important stuff to construction firms,” Marshburn cautioned.

Statutes of limitations set forth the maximum period of time after a certain event — injury or damage — occurred, during which a lawsuit can be filed. The time period begins the minute the injury occurs. Statutes of limitations are state-specific, and insurers must be familiar with each state’s regulations in which they operate. Marshburn said enforcement of statutes of limitations can be either avoided or extended (tolled) by a number of equitable factors such as the age of the injured party.

In California, the statute of limitations for bodily injury runs out after two years and the state allows three years for property damage liability. However the time period for the statute of limitations can be extended because of someone’s age.

“If you’re alleging bodily injury to a child, in most states you have until the youngest child reaches the age of majority (usually 18) plus the two years,” Marshburn said. “This is the exception, not the rule.”

Topics Lawsuits Carriers Legislation Construction Nevada