Coverage for EIFS Claims under the Standard CGL Policy

T. Eugene Allen, III

Introduction

Exterior insulation finish system (EIFS, sometimes known as artificial stucco or fake stucco) is a building system that integrates a resinous exterior cladding with a continuous layer of insulation, wrapped around the exterior of buildings. These systems are usually comprised of five component layers: an exterior finish, a reinforcing mesh to protect the system, an insulator (normally expanded polystyrene), an adhesive substance binding the insulator to the building and a substrate to which the insulator is attached.

Generally, different manufacturers market EIFS products as systems. The system is only one component of a weather envelope or system. Unlike most other wall cladding products (such as siding or brick), the EIFS system is actually created on site and combined with other materials, such as wall framing, flashings, and the like.

The product, originally developed in Europe, became popular with American builders in the early 1980s. Unlike other exterior systems, it adjusts readily to the particular design of the building, making it very popular with architects and builders looking for new designs. The function of EIFS is to act as a barrier between the outside elements and the remainder of the structure.

In many parts of the country, especially areas that experience high heat and humidity, property owners began encountering problems with moisture entering the structure. A rash of litigation ensued in which, typically, it is claimed that installers of EIFS failed to put a base coat at the termination of the EIFS system, failed to install sealant and failed to install flashing. It is also usually alleged that the installer failed to backwrap entrances and windows and did not use proper caulking techniques where the EIFS terminated.

A typical complaint will allege that the defective installation of EIFS has caused moisture intrusion, resulting in damage to structural members, flooring and other parts of the building. Further, byproducts of moisture, such as mold and mildew, are usually alleged. Generally, it is claimed that the only way to fix the problem is to reclad the entire structure.

The usual defendants in an EIFS case are the EIFS installer, the EIFS seller or distributor, the general contractor and the EIFS manufacturer. The building owner usually claims that the EIFS product was defectively manufactured or sold as a defective product. Frequently, it is claimed that the local seller had a duty to verify the ability of the installer. It is usually alleged that the general contractor had overall responsibility and, in particular, failed to supervise the EIFS installer or verify that party’s ability to install the EIFS system.

As in other construction defect cases, the problems may not appear until many years after the installation. The plaintiff may not be the original owner of the structure. Termite infestation is sometimes alleged as an additional problem caused by the defective installation of EIFS. In those cases, it is not unusual to find a pest control company included as a defendant.

II.

Typical Allegations in Complaint

In an EIFS case, the following causes of action are frequently found:

1. Negligence or negligent supervision (EIFS installer, seller, general contractor and manufacturer);

2. Breach of express warranties (EIFS installer, seller, general contractor and manufacturer);

3. Breach of implied warranty of habitability (general contractor);

4. Breach of implied warranty of merchantability (EIFS seller and manufacturer);

5. Breach of implied warranty of fitness for particular purpose (EIFS seller and manufacturer);

6. Breach of implied warranty of workmanlike service (EIFS installer and general contractor);

7. Unfair or deceptive trade practices, usually based on deception of consumers (EIFS installer, seller, general contractor and manufacturer);

8. Strict liability (EIFS seller).

III.

Policy Provisions

Various versions of the ISO Commercial General Liability form policy may be involved, since the construction may have been completed years before the suit. The 1986 and subsequent versions (herein the “Policy”) usually have the following provisions:

The Insuring Agreement provides that:

[The insurer] will pay those sums that the insured becomes legally obligated to pay as damages because of “bodily injury” or “property damage” to which this insurance applies. We will have the right and duty to defend any “suit” seeking those damages.

The Policy applies to “bodily injury” and “property damage” only if they are caused by an “occurrence” and if the injury or damage occurs during the policy period. It contains the following exclusions providing that the policy does not apply to:

a. “Bodily injury” or “property damage” expected or intended from the standpoint of the insured . . .

b. “Bodily injury” or “property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages:

(1) Assumed in a contract or agreement that is an “insured contract,” provided the “bodily injury” or “property damage” occurs subsequent to the execution of the contract or agreement; or

(2) That the insured would have in the absence of the contract or agreement.

k. “Property damage” to:

. . .

(5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage" arises out of those operations; or

(6) That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.

. . . Paragraph (6) of this exclusion does not apply to “property damage” included in the “products-completed operations hazard.”

l. “Property damage” to “your product” arising out of it or any part of it.

m. “Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

n. “Property damage” to “impaired property” or property that has not been physically injured, arising out of:

(1) A defect, deficiency, inadequacy or dangerous condition in “your product” or “your work;” or

(2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.

This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to “your product” or “your work” after it has been put to its intended use.

The Policy contains the following pertinent definitions:

1. “Bodily injury” means bodily injury, sickness or disease sustained by a person, including death resulting from any of these at any time.

. . .

5. “Impaired property” means tangible property, other than “your product” or “your work,” that cannot be used or is less useful because:

a. It incorporates “your product” or “your work” that is known or thought to be defective, deficient, inadequate or dangerous; or

b. You have failed to fulfill the terms of a contract or agreement; if such property can be restored to use by:

a. The repair, replacement, adjustment or removal of “your product” or “your work;” or

b. Your fulfilling the terms of the contract or agreement.

6. “Insured Contract” means:

. . .

f. That part of any other contract or agreement pertaining to your business . . . under which you assume the tort liability of another party to pay for “bodily injury” or “property damage” to a third party or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.

. . .

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

. . .

11. a. “Products-completed operations hazard” includes all “bodily injury” and “property damage” occurring away from premises you own or rent and arising out of “your product” or “your work” except:

(1) Products that are still in your physical possession; or

(2) Work that has not yet been completed or abandoned.

b. “Your work” will be deemed completed at the earliest of the following times:

(1) When all of the work called for in your contract has been completed.

(2) When all of the work to be done at the site has been completed if your contract calls for work at more than one site.

(3) When that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project.

Work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed.

12. “Property damage” means:

a. Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or

b. Loss of use of tangible property that is not physically injured. All such loss shall be deemed to occur at the time of the “occurrence” that caused it.

. . .

14. “Your product” means:

a. Any goods or products, other than real property, manufactured, sold, handled, distributed or disposed of by:

(1) You . . .

“Your product” includes:

a. Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of “your product;” . . .

15. “Your work” means:

a. Work or operations performed by you or on your behalf; and

b. Materials, parts or equipment furnished in connection with such work or operations.

“Your work” includes:

a. Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of “your work;” and

b. The providing of or failure to provide warnings or instructions.

IV.

General Rules of Policy Construction

Exclusions in a policy are to be read independently of each other, and not cumulatively.[1] Thus:

[i]f any one exclusion applies there should be no coverage, regardless of inferences that might be argued on the basis of exceptions or qualifications contained in other exclusions. There is no instance in which an exclusion can properly be regarded as inconsistent with another exclusion, since they bear no relationship with one another.[2]

The duty to defend is broader than the duty to indemnify under an insurance policy. The insurer's duty to defend depends upon whether the facts alleged in a complaint, if proved, would afford coverage.[3]

General Overview of Construction Defect Coverage

Since construction defect claims are typically found to be within the “Insuring Agreement” of the CGL policy, coverage disputes concerning those claims often focus on the policy exclusions, which limit the coverage granted in the insuring agreement. The exclusions address a basic issue: How does the policy exclude from coverage damages resulting from “business risks?”

Generally, a liability insurer is not obligated to pay for the faulty workmanship of its insured.[4] The risks insured under the CGL policy are distinct from the simple risk of doing business.[5] Most of the business risk exclusions draw the line between covered and uncovered claims according to the nature of the harm caused, rather than the nature of the conduct causing the harm. Construction defects are generally the result of poor workmanship or poor design. The coverage determination usually depends upon whether the resulting harm was damage to the insured’s own work, which is generally not covered, or damage to the work of others, which is covered.

For example, in C.D. Walters Construction Co. v. Fireman’s Insurance Co.,[6] the South Carolina Court of Appeals said that the CGL policy does not cover faulty workmanship but rather faulty workmanship that causes an accident. In Walters, the insured had agreed to excavate and prepare a pond on the claimant’s property. The complaint against the insured alleged that the insured cut and damaged trees that he had been instructed to avoid and that he had dug a ditch against the claimant’s specific instructions. The court concluded that the damage sought by the claimant was to that particular part of the claimant’s property on which the insured was working, and did not involve accidental injury to other property.[7] In Isle of Palms Pest Control Co. v. Monticello Insurance Co.[8] the court stated:

A general liability policy is intended to provide coverage for tort liability for physical damage to the property of others; it is not intended to provide coverage for the insured’s contractual liability which causes economic losses. It is for this reason that a general liability insurance policy typically does not cover claims of faulty workmanship, but instead covers claims of faulty workmanship that causes an accident.[9]

VI.

Insuring Agreement and Definition of Occurrence

The CGL policy requires the happening of an “occurrence,” which is defined as an accident including continuous exposure to conditions. Some courts have found that negligent performance of work by a contractor is an occurrence.[10] In Stroup Sheet Metal Works, Inc. v. Aetna Casualty & Surety Co.,[11] the South Carolina Supreme Court held that a complaint alleging faulty workmanship did not allege an “occurrence” or accident. In Stroup, it is important to note that there were no allegations of negligence against the insured. Therefore, the court had an easy time in concluding that the action was only for breach of contract due to faulty workmanship, and therefore not covered under the policy. In the EIFS cases, the portion of the definition of “occurrence” relating to continuous exposure to conditions is usually the situation alleged to have caused the damages in question.

VII.

Definition of “Property Damage”

The CGL policy defines “property damage” to mean:

a. Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or

b. Loss of use of tangible property that is not physically injured. All such loss shall be deemed to occur at the time of the “occurrence” that caused it.

If the faulty workmanship causes physical injury to tangible property, other than the work itself, courts generally find “property damage” within the policy.[12] The issue of whether “property damage” has occurred may arise in the context of a defective product being incorporated into tangible property. Some courts have held that this constitutes “property damage.”[13] Generally, coverage for the incorporation of defective products into tangible property is determined not on the basis of whether a defect exists, but rather by whether consequential damages have occurred as a result of the defect.[14]

In EIFS cases, the complaint usually alleges that the incorporation of the allegedly defective EIFS caused damage to other components of the structure.

VIII.

Diminution in Value of the Structure

The CGL policy defines property damage as “physical injury to tangible property, including all resulting loss of use of that property.” There appears to be a split of authority as to whether the term “property damage” includes tangible property that has been diminished in value irrespective of any actual physical injury to that property. Usually, the complaint alleges physical damage to components of the structure in addition to depreciated value.

The majority of courts that construed the 1973 version of the CGL policy have held that intangible damages, such as diminution of value, do not constitute property damage.[15] For example, in Aetna Life & Casualty Insurance Co. v. Patrick Industries, Inc.,[16] the insured, a supplier, sued its CGL insurer that refused coverage for the supplier’s settlement with a manufacturer to whom the insured supplied defective particle board that was incorporated into the manufacturer’s campers. The court of appeals, reversing the lower court, held that the CGL policy did not cover diminution in value of the campers that contained the defective components supplied by the insured. The Indiana court recited the history of the “property damage” definition under the 1966 and 1973 versions of the ISO policy. The prior version did not include the word “physical,” that was added in 1973. The majority of courts construing the 1966 version held that depreciation was included under that policy’s definition of “property damage.”[17] In Marathon Plastics, Inc. v. International Insurance Co.,[18] the court held that damage to the completed product, exclusive of the value of the defective component, did constitute damage to tangible personal property within the meaning of the policy.

IX.

Allegations of Strict Liability

A complaint may allege an insured seller is strictly liable for any defects caused by the allegedly defective product. As previously noted, policy exclusions focus on the nature of the harm caused, rather than the specific basis for the claim. In other words, if the insured’s product causes damage to other property, then coverage may exist. Consequently, coverage for the strict liability claim should depend upon the nature of the damage alleged.

Applicability of Particular Exclusions

A. The “Contract” Exclusion

The typical CGL policy will exclude:

(1) Assumed in a contract or agreement that is an “insured contract,” provided the “bodily injury” or “property damage” occurs subsequent to the execution of the contract or agreement; or

(2) That the insured would have in the absence of the contract or agreement.

Causes of action for breach of express and implied warranties are frequently alleged in EIFS cases. The contract exclusion was relied upon by the court in TGA Development, Inc. v. Northern Insurance Co.[19] In that case, applying Minnesota law, the court found no coverage for a claim arising from the construction of a unit in an office building. The claim against the insured included allegations of breach of warranty. The appellate court affirmed the lower court grant of summary judgment to insurer, based upon the contractual liability exclusion. It should be noted there was no negligence claim against the insured.

The contract exclusion says that it does not apply to liabilities the insured would have in the absence of a contract or agreement. This exclusion, therefore, may not apply to implied warranties alleged to have arisen by law, rather than by contract. This exclusion, however, should avoid coverage for the claim for breach of express warranties.

B. The “Your Product” Exclusion

The typical CGL policy excludes:

l. “Property damage” to “your product” arising out of it or any part of it.

. . .

14. “Your product” means:

a. Any goods or products, other than real property, manufactured, sold handled, distributed or disposed of by:

(1) You . . .

“Your product” includes:

a. Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of “your product;” . . .

The South Carolina Court of Appeals upheld a denial of coverage based, in part, on this exclusion in Nautilus Insurance Co. v. Long.[20] There the insurer brought a declaratory action against its insured, a roofing contractor. The insured had contracted to put a new roof surface on an existing building. During the work, rainwater from a heavy storm leaked through the roof “because the roofing company failed to cover the roof surface.”[21] The rainwater allegedly caused considerable damage to the building (a hospital) and the equipment in the building.

The building owner sought a declaration that the insurer could be liable for the loss of a warranty from the roofing material manufacturer based on the roofer’s failure to cover the roof. The lower court ruled the insurer had a duty to defend the negligence action against its insured but that the policy did not cover the loss of the warranty from the roofing manufacturer. The Court of Appeals agreed, relying on the “your product” and “your work” exclusions. The property damage in question, the loss of the right to the twenty year roof warranty, was to the very work performed by the insured and it arose out of the work.

Although the court did not reference a contract exclusion, the court said that the insurer did not provide coverage for “contractual liability of the insured for any type of economic loss resulting from the failure of the product or completed work not being that for which the hospital board bargained.”[22] The court went on to hold that the “product” that the insured contracted to supply was the roof that was to carry a twenty-year warranty. It held that the insurer was not responsible for the loss of this warranty. This exclusion should avoid coverage for any claims of damage to the EIFS product itself. It probably does not avoid coverage for damage to other portions of the structure as a result of “product” defects.

C. The “Your Work” Exclusion

A CGL policy will ordinarily exclude:

m. “Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

15. “Your work” means:

a. Work or operations performed by you or on your behalf; and

b. Materials, parts or equipment furnished in connection with such work or operations.

“Your work” includes:

a. Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of “your work;” and

b. The providing of or failure to provide warnings or instructions.

The more difficult determination is usually whether the claim alleges damage only to the insured’s work or other property damage caused by the insured’s work. Two recent cases illustrate this problem. In Sapp v. State Farm Fire & Casualty Co.,[23] the appellate court affirmed a lower court judgment in a declaratory action brought by a contractor’s insurer. The insured was hired to conduct repairs and renovations to the claimant’s home. As part of the work, the insured made repairs to floor joists and installed hardwood flooring. Apparently, the insured failed to adequately protect the hardwood flooring from a moisture problem under the home. The court recited the general principle that the “business risk” exclusions are designed to exclude coverage for defective workmanship by the insured, stating that:

[t]he insured, as a source of goods or services, may be liable as a matter of contract law to make good on products or work which is defective or otherwise unsuitable because it is lacking in some capacity. This may even extend to an obligation to completely replace or rebuild the deficient product or work. This liability, however, is not what the coverages in question are designed to protect against. The coverage applicable under the CGL policy is for tort liability for injury to persons and damage to other property.[24]

The claimant argued that the only “work” that would fall under the exclusion would be the failure of the insured to address and correct the water problem prior to installing the hardwood floor. The court disagreed, holding that all the claimed damages related directly to the cost of repair or replacing the alleged negligent work of the insured -- the failure to correct the moisture problem and the negligent installation of the floors. Any damages to the house during the removal of the floor, and the restoration of the house to its condition prior to the work, were merely incidental to the claimed damages from the services the insured negligently performed and for which he contracted.

A contrasting decision is Pekin Insurance Co. v. Richard Marker Associates, Inc.[25] There, the appellate court reversed a lower court judgment in favor of the insurer in a declaratory action. The underlying complaint alleged that the insured negligently installed a HVAC system that did not operate properly, so that resulting condensation caused extensive water damage to window trim, furniture, carpeting, flooring and walls.

The Illinois court also recited the basic rule that the CGL policy is intended to provide coverage for damage other than costs associated with repairing or replacing the insured’s defective work. The court went further and said that the CGL policy does not cover an accident of faulty workmanship but rather faulty workmanship that causes an accident, and found that such was alleged by the underlying complaint. The claim was that the faulty workmanship caused an accident in the form of continuous or repeated condensation that dripped and damaged furniture. The court said this was more than an allegation that the building itself was defective. Therefore, it held that the allegations of the underlying complaint potentially fell within the policy coverage so as to give the insurer duty to defend.

The EIFS applicator traditionally installs the foam board and the “lamina” acrylic glue coating that is about a sixteenth of an inch thick. In most cases, the structural sheathing to which the foam board is applied and the studs supporting the sheathing are generally installed by others. In residential construction the framing crew would install the studs and the sheathing board. The EIFS installer would then attach the foam board and the synthetic coating. In all probability the only components included within the EIFS installer’s work would be foam board and the lamina. Everything else would be the other subcontractor’s work. This division of work is crucial to coverage under a number of the exclusions.

The CGL policy’s definition of “your work” includes “warranties . . . made at any time with respect to the fitness, quality, durability, performance or use of ‘your work’.” If the “contract” exclusion does not preclude coverage for the allegations of breach of implied warranties of fitness and use for a particular purpose, then the “your work” exclusion should accomplish this and prevent these causes of action from being covered.

D. The “Property Damage” Exclusion

Exclusion (k) is generally referred to as the property damage exclusion. It probably will not affect the typical EIFS case. Courts have limited exclusion (k)(5)’s application to damage that occurs while operations are being performed by the insured.[26]

E. The Impaired Property Exclusion

The typical CGL policy excludes:

m. “Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

Exclusion (m) is sometimes referred to as the “impaired property” exclusion. It avoids coverage for property damage to “impaired property” or property that has not been physically injured arising out of the insured’s work. “Impaired property” is defined as tangible property, other than the insured’s work, that is less useful because it incorporates the insured’s work that is claimed to be defective, if such property can be restored to use by the repair or replacement of the insured’s work. While other “business risk” exclusions focus on the cost of repair of the insured’s own work, the general focus of this exclusion is the insured’s work causing non-physical damage to other property.

Generally, to qualify as “impaired property,” the property must be capable of being restored to use by the “repair, replacement, adjustment or removal of ‘your work’.” If repair or replacement of the insured’s work cannot restore the property in question, it will not qualify as “impaired property.” For example, in Action Auto Stores v. United Capital Insurance Co.,[27] the court held that this exclusion did not preclude coverage. The insured was sued for negligent installation of a gasoline container system, which resulted in pollution of surrounding property. There was no evidence that the damage done to surrounding property could be remedied by the repair or replacement of the insured’s work and this prompted the court’s ruling. Some courts have ruled that earlier versions of exclusion (m) precluded coverage only for breach of contract or warranty claims.[28]

Exclusion (m) contains an exception for the loss of use of other property arising out of “sudden and accidental physical injury to your work after it has been put to its intended use.” This exception has not been analyzed in detail by the courts, so there are few clear guidelines as to when it will apply.

The impaired property exclusion may preclude coverage for any alleged diminution in value of a structure. This would be true, if the structure could be restored to use by the repair or replacement of the insured’s work.

F. Intentional Act Exclusion

The CGL policy usually excludes coverage for:

a. “Bodily injury” or “property damage” expected or intended from the standpoint of the insured . . .

In some jurisdictions, application of the intentional act exclusion requires a two-step analysis. The first question is whether the act causing the loss was intentional, and the second is whether the results of the act were intended.[29]

It may be seen that this reasoning makes it very difficult to opine that the intentional act exclusion will avoid coverage. However, if a complaint alleges intentional misrepresentations by an insured seller as to the effectiveness of the EIFS product and of the installer’s ability to apply the insulation system, the logical result of such a misrepresentation could be the insured’s selling of the product. It can certainly be argued that any consequences that flowed from the insured’s product could have been anticipated by the insured.

XI.

Trigger of Coverage

Although various courts have used a variety of coverage trigger theories, the current trend (for an occurrence policy) seems to be a continuous trigger approach.

A. Triggered Continuously From Time of Injury-Causing Event

Under this theory, coverage may be triggered at any point from the time of the underlying injury-causing event until the damage is complete. This allows coverage under any policy in effect during this entire time. Some courts have adopted this theory because of the CGL language providing coverage for “continuous or repeated exposure to conditions.”[30] However, this approach can conflict with the policy language providing that the damage must occur during the policy period.

B. Triggered at the Time of Injury-In-Fact

Under this theory, coverage is triggered whenever the damage can be shown in fact to have first occurred, even if it is before the damage became apparent. The policy in effect at the time of the injury in fact covers all the ensuing damages.[31]

C. Triggered Continuously From Time of Injury-In-Fact While Damage Progresses

Some courts have found that an injury-in-fact continuous trigger does not penalize the insured by requiring a manifestation of damage during the policy period. Nor does it penalize the insurer by extending coverage from the time of the underlying event when no injury has yet occurred. Of course, this theory will allow the allocation of risk among insurers when more than one policy is in effect during the progressive damage.[32]

XI.

Conclusion

Although the allegations of individual complaints will vary, the following general observations of coverage may be appropriate:

· Negligence causes of action will be covered for allegations of damage to components of the building other than the EIFS system. Depreciation of the building may not be covered, depending upon the particular jurisdiction.

· Allegations of breach of express or implied warranties should not be covered.

· Allegations of strict liability should be covered for consequential damages to components of the building other than the EIFS system.

· Allegations of unfair trade practices involving the deception of consumers generally should not be covered, since such allegations necessarily involve intentional conduct. In some jurisdictions, however, courts may require higher standards for denial of coverage, based upon claims that the conduct, although intentional, caused unexpected consequences.

It should be obvious from the preceding discussion that EIFS cases are rife with coverage and trigger of coverage issues. Courts will continue to grapple with methods of determining and allocating risk in this burgeoning area of construction law.

ENDNOTES