Navigating the waters of insurance policies for condo construction projects

Listen to this article

In the aftermath of the housing boom, there has been an increase in construction defect litigation, especially for condominium projects. Those claims frequently involve water intrusion resulting from improper construction methods, or the use of defective siding, roofing, windows or other materials.

So, how can a building owner best protect against these issues? After all, most contractors don’t have the financial means to remedy substantial construction defects.

Insurance would seem like the logical answer, provided it actually covered the loss; however, seemingly obvious problems may not be covered.

There are insurance programs, such as the so-called “wrap policies,” designed specifically for condo projects. Under a wrap policy, all parties – including the owner, the contractor and subcontractors – participate in a single insurance program controlled by the owner or the contractor.

This can be an efficient way to manage insurance on a project, but the policy is only as good as its coverage. Too often, those who participate don’t actually take the time to understand the limitations on coverage. And those limitations can make the policy frustrating.

One reason why some folks don’t take time to understand the policy is because the document may be up to an inch thick, double-sided, and contain fine print from beginning to end. Navigating through a policy may seem like it requires some kind of special training or doctorate degree. To most people, insurance policies are just that: a tedious, boring and tough read.

The first step in understanding the scope of coverage is to realize that an insurance policy is like an onion. It starts with a set of documents that call out various definitions and coverages in the generic, all-inclusive form. Then a second set of documents known as the “exclusions” limit the very types of coverages expected from the first set of documents.

The concept is not much different than an average auto or homeowner’s policy, which most readers will admit they regularly renew despite not having read it or reviewed it in years (or ever). Slowly but surely, layers of coverage can be peeled away to reveal the policy’s scope. Trying to determine what is left after applying the exclusions is an art that neither insureds nor insurers have been able to master given the flood of insurance litigation in the construction defect world.

So, are construction defects covered? That depends on whether the issue constitutes an “occurrence” and “property damage” as defined in a policy. And identifying “property damage” can be trickier than one may initially think.

For example, a construction defect may result in excessive noise traveling between condo walls. The defect does not physically impact real estate, but does it constitute “property damage”? A case could be argued either way. The good news from the insured’s perspective is that if the definition in the policy is ambiguous, the case law holds that the language of the policy will be construed against the insurer.

But even assuming the damage qualifies as an “occurrence,” there will be other hurdles to overcome before coverage is triggered – i.e., the exclusions.

For example, a “completed work exclusion” may provide, in essence, that insurance does not guarantee the contractor’s workmanship.

Then there may be a so-called “ongoing work” exclusion that excludes coverage for damage caused to property while the work is being performed. So, if testing of the portion of the work (e.g., acoustical testing) during construction indicates that work is defective, the owner may not be able to trigger insurance to fix the problem.

In addition, there could be a “cross-claims exclusion,” which, under a wrap policy, prevents plan participants from suing one another for issues that otherwise would be covered by insurance. In other words, there must be damage to – and a claim from – a third party for coverage.

While this may seem counterintuitive (defective construction is defective construction no matter who is damaged or brings a claim, right?), this is how the insurance game is played. And in some cases, building owners don’t understand what their policy actually covers until it is too late.

So, how does a building owner stay protected from damages resulting from shoddy construction work?

First, perform due diligence on the contractor to determine its reputation and financial backing. For obvious reasons, some contractors (and owners, too) form “shell” entities with no assets for a particular project, leaving the owner with a judgment against a contractor worth less than the paper the judgment is written on.

Second, procure and maintain insurance, but be sure to understand what coverage is being purchased. At least take time to sit down with an insurance broker, an attorney or a knowledgeable friend who can give a layperson’s translation of what the policy actually covers.

Then denial-of-coverage letters won’t arrive unexpectedly. And there will be no need to ask an insurance broker: “Why did I spend all that money on insurance if it doesn’t really cover what I thought it would cover?”

Marcus Eyth is a construction law and government contracts attorney in the Portland office of Davis Wright Tremaine LLP. Contact him at [email protected] or 503-241-2300.