The Illusion of Coverage Under a Builder’s Risk Policy

The policy didn’t exactly say “all damages are covered unless caused by a peril that is excluded” and “all damages are excluded unless caused by a peril that is covered ” But that description isn’t very far off. And a contractor’s actions causing damage to the work in progress, which most contractors would expect to be covered by a builder’s risk policy, resulted in damage that was excluded.

More detail is appropriate. A subcontractor performed welding beyond the plane of the exterior façade, on the eighteenth floor. Despite protections, some welding slag damaged windows below. The GC and sub replaced the damaged windows and sought coverage under the builder’s risk policy procured by the owner.

The carrier denied coverage and litigation began.

The policy had the following provisions for coverage, exclusions, and one "Exception" to the exclusions (emphasis added below):

PERILS COVERED

"We" cover risks of direct physical loss or damage unless the loss is limited or caused by a peril that is excluded.

PERILS EXCLUDED

2. "We" do not pay for loss or damage that is caused by or results from one or more of the following:

c. Defects, Errors, And Omissions —

(1) "We" do not pay for loss or damage consisting of, caused by, or resulting from an act, defect, error, or omission (negligent or not) relating to:

a) design, specifications, construction, materials, or workmanship; . . .

But if an act, defect, error, or omission as described above results in a covered peril, "we" do cover the loss or damage caused by that covered peril. [the “Exception”]

(2) This exclusion applies regardless of whether or not the act, defect, error or omission:

a) originated at a covered "building or structure"; or

b) was being performed at "your" request or for "your" benefit.

A federal district court judge held that the loss was excluded, and the contractor appealed to the Fifth Circuit Court of Appeal. That court affirmed the lower court, denying coverage.

The parties had agreed that the damage fell within the exclusions, but disagreed as to whether the Exception placed the damage back into the range of covered perils. The contractor argued that the Exception applied, and also argued that the Exception and the exclusions were ambiguous, taken together. Unfortunately, the contractor had not made the ambiguity argument in the lower court, and the Court of Appeal held that this argument had been waived.

Construing the Exception, the court held that that it would apply if an independent covered peril resulted from an excluded peril. And, critical to its analysis, the court also held that the slag was an “inseparable” element of welding. Thus, there was no independent peril that caused damage to the windows, but only the excluded peril of an “act” “relating to” “construction.”

Damage to the work itself resulting from construction activity is something that happens from time to time on projects. It is typically considered to be the sort of damage covered by a builder’s risk policy. That such coverage was not available here undoubtedly came as a surprise to the contractor. One can argue that the policy in this case read more like a standard property damage policy, and not a builder’s risk policy.

The contractor also argued that the policy was illusory. The insurer argued otherwise, pointing to damage that might arise, for example, from acts of nature, or a fire “unrelated to construction activities,” or “if a vehicle backed into a pillar of the building.” The court accepted these scenarios as proof that there were, indeed, situations where the policy would afford coverage, and so it was not illusory. Damage caused by construction? Not covered.

This had to come as a shock to the contractor here, and most other contractors would react the same way. Another reason why the time and cost required to review pertinent insurance policies may get added to the price of construction projects.

The case is Balfour Beatty Constr. v. Liberty Mut. Fire Ins. Co., 2020 U.S. App. LEXIS 24544 (5^th Cir., Aug. 3, 2020).