Exclusions Make Contractor Coverage Elusive, Builders Say. Appeals Court Disagrees

A federal appeals court decision handed down last week is a victory for a Liberty Mutual surplus carrier, but it highlights what one attorney said is a widespread problem in the construction industry: an alleged “bait and switch” by insurers on contractor-controlled insurance programs.

“It’s very prevalent and it’s a real problem,” said Patrick Wielinski, a Dallas attorney who wrote an amicus brief in the case on behalf of Associated General Contractors of America, the National Association of Home Builders and Florida Home Builders.

In recent years, a number of insurance carriers have begun offering contractor-controlled liability insurance programs, or CCIPs or “wrap-ups” that are pitched to contractors as “improved coverage,” Wielinski said. Those policies remove a number of narrow exclusions that had previously been part of contractors’ general liability policies – but include a much broader exclusion that bars coverage for defects or property damage until the construction project is completed – something many contractors and their insurance brokers may not be expecting, he noted.

“Liberty’s careless underwriting and misapplication of its course of construction endorsement threatens the entire construction industry,” Wielinski claimed in the amicus brief.

The 11^th U.S. Circuit Court of Appeals’ decision in Liberty Surplus Insurance vs. Kaufman Lynn Construction, published March 5, found that Kaufman Lynn has grounds to ask that the insurance policy be reformed. The final policy differed significantly from the insurance application, which stressed that the construction was to be done in phases, the contractor had argued. The underwriting description also was “garbled” and misstated the work involved, Wielinski said.

But even with a reformation of the policy, Kaufman may see little relief. The 11^th Circuit also upheld the lower federal court and found that the course of construction exclusion (COCE) in the policy effectively blocked coverage until the sprawling construction project is fully completed.

“It would have been better, of course, for Liberty to draft the COCE to expressly state that there is no coverage unless and until the ‘entire project’ is completed,” the three-judge appeals court panel wrote. “But Liberty’s failure to adhere to the standards of impeccable draftsmanship here does not result in ambiguity.”

The case began five years ago, and, like many an insurance claim, stemmed from damage brought by a storm in Florida. Kaufman Lynn, a large commercial builder, had been hired to build a massive new campus in Deerfield Beach for JM Family Enterprises, one of the largest Toyota dealerships and financing operations in Florida. The work was to include new offices, a training and conference center, a dining hall, energy plant, parking garage and more. Demolition of existing buildings was also to be done.

Part of the work was completed in 2020 and Kaufman received certificates of occupancy for the office buildings, dining hall, energy plant and parking garage. JM Family moved in and began using the completed buildings, the court explained.

On Nov. 8, 2020, Tropical Storm Eta hit south Florida, causing water to leak into the buildings and triggering $3.3 million in damage.

Related: Contractor-Controlled Policies vs. Owner-Controlled. What’s Best?

For months before the storm hit, Kaufman had cited numerous problems with the work of the subcontractor that had installed the window wall system, where the water intrusion in storm Eta had originated, court documents show. The glass installer in December 2020 reportedly abandoned the project and Kaufman filed suit against the firm and other subcontractors.

In the meantime, Liberty Surplus denied Kaufman’s CCIP insurance claim, citing the course of construction exclusion. The federal district court in southern Florida agreed with Liberty’s attorneys and found that the insurer did not owe coverage, thanks to the exclusion that barred coverage until completion of the project.

The appeals court judges noted that while the policy did not define the words “project” and “completion,” the plain meaning of the words makes it clear.

“Regardless of whether we view the term ‘project’ as the policy currently describes it or as the two distinct phases set out by Kaufman in its application, the COCE’s meaning is the same,” 11^th Circuit Judge Adalberto Jordan wrote in the opinion. “Even if the first phase was finished at the time of the water damage, is undisputed that the entire project had not yet been completed.”

The lead plaintiff’s attorney could not be reached comment. But Wielinsky and his amicus brief argued that, for years, many contractors have done work in phases and have relied on CCIP policies to recognize that, as described in the insurance application. With the conclusion exclusion, contractors can be left with “yawning gaps” in coverage because a standard builder’s risk policy does not usually cover faulty workmanship and other perils that a general liability policy would.

Attorneys for the insurance company in the case said the insurer declined to comment on the court ruling or the broader questions of exclusions. But in their brief to the court, Liberty’s lawyers noted that even if the Kaufman policy had clearly referenced a phased project, the contractor did not follow the script.

“In reality … work on the two phases took place concurrently or out of order,” Liberty argued.

Some work was moved to phase 1 and other jobs to phase 2; some aspects of the project were canceled altogether, and new work was added. The leaky windows and cladding system had not been finished by the subcontractor, proving that the project was not yet complete.

And, perhaps most importantly, Kaufman failed to read the policy when it was issued and did not object to it at the time, Liberty lawyers noted.

Kaufman “had a team of professional brokers and advisors to assist in the underwriting process, including an in-house legal department, an in-house risk-management department, a surplus lines broker, and a wholesale broker,” the Liberty brief reads.

Further, Kaufman should have known that a surplus lines policy, by law, is generally less favorable than those offered by admitted carriers, Liberty said. And Kaufman’s policy provisions were tailored to the contractor and will not have a far-reaching, adverse impact on the construction industry.

Wielinski, who specializes in construction law, has penned a book about insurance for defective construction, published by IRMI, the International Risk Management Institute. In a presentation in January, he noted that case law on exclusions continues to evolve. Courts in most states are somewhat divided but have begun to recognize that exclusions are not always as encompassing as insurers may like to believe.

“Moving forward, these cases signal a significant shift in builders’ risk and CGL insurance jurisprudence, suggesting that insurers will need to draft more precise policy language and carefully consider the scope of their exclusions,” he wrote. “The trend indicates a growing judicial willingness to provide coverage for unintended and unexpected property damage, even when such damage occurs within the insured’s scope of work.”

Wielinski agreed that a big takeaway from the Kaufman case is that contractors, like other insureds, should always be sure to read the policy before signing on the dotted line.

The appellate court’s opinion gave some advice to others seeking reformation of an insurance policy. Florida law creates a five-year statute of limitations. “So, an insured in Florida may need to bring a reformation claim soon after the issuance of the policy containing the mistake or risk forever losing the ability to fix the error,” the judges noted.