Litigating Insurance Coverage for Construction Defect Claims
Ron White
June 4, 2011
Resolving construction defect claims often turns on the availability of insurance to pay for the repairs. However, disputes sometimes arise between builders and their insurance companies over the question of whether or not the insurance policy covers the construction defects being claimed. In other words, will the insurance company pay for the cost of repairs. In addition to the coverage dispute, the question of whether the insurance company will pay the attorney fees and other costs of defending the lawsuit can also come into play. Generally speaking, the insurers obligation to defend is greater than its obligation to cover the claim since a defense must be provided if there is a possibility for coverage whereas the payment of the cost of repairs is only required if the policy language actually covers the claims and there are no applicable exclusions in the policy. All of this means that if the insurer denies coverage or a defense, a builder can be engaged in 2 lawsuits at the same time when construction defect claims arise: (1) the construction defect lawsuit with the homeowners and (2) the insurance coverage lawsuit with the insurance company. A recent Arizona case shows how this can happen. (Click here to read the recent opinion in Lennar Corporation v. Transamerica Insurance Company.)
In the early 1990's, Lennar Corporation, a Fortune 500 home builder, oversaw the development of 105 homes in Glendale, Arizona. According to the opinion, nearly all of the homes in the development had construction defects. Lennar made some repairs but the complaints continued and eventually several of the homeowners filed suit and others threatened litigation. In December 1998, Lennar tendered the claims to its various insurance companies that had issued commercial general liability policies. In October 2000, two of the insurers, Transamerica and USF&G, filed a complaint seeking a declaratory judgment that they owed no duty to defend or indemnify Lennar. Lennar filed a cross-complaint against its insurance companies for breach of contract and bad faith.
In July 2003, the trial court granted summary judgment in favor of the insurers, dismissing all of Lennar's claims based on the court's conclusion that the defects in the homes did not constitute an "occurrence" within the meaning of the policies. The Arizona Court of Appeals reversed, holding the homeowners' allegations of damage resulting resulting from faulty construction were sufficient to allege an "occurrence" under the policies. A year later, the insurers filed another summary judgment motion on Lennar's bad faith claim. The motion was based on the proposition that, as matter of law, the trial court's initial ruling in their favor on the occurrence issue established that the insurers had a reasonable basis for denying coverage. The trial court agreed and entered summary judgment on the bad-faith cause of action.
Lennar appealed but now it was more than 15 years after the homeowners starting complaining about the construction defects and Lennar had settled with all of the homeowners and all but three of the insurers. The appellate court reversed the trial court, holding that an erroneous grant of summary judgment does not conclusively establish that coverage is fairly debatable. As a result the case was remanded to the trial court where the case will now finally go to trial on the breach of contract and bad faith causes of action, or it may settle.
LESSONS LEARNED
- As construction defect cases are so expensive to litigate and the cost of repair is so high, it is important to lock in the coverage and defense issues as soon as possible. Some law firms have the capacity to both defend construction defect claims and provide insurance coverage counsel. Some are not expert in both fields. Assuming there is a denial of coverage or a reservation of rights, you may want to retain outside coverage counsel as early in the process as possible. Preferably one with experience securing insurance coverage for construction defect claims.
- The Lennar case has some additional points that are beneficial to policyholders. First, the court opened the door for juries to consider additional evidence on the question of whether the insurers acted reasonably in challenging Lennar's claims based on the meaning of "occurrence" in the policies. "On remand, in addition to the policy itself, the superior court may decide to admit extrinsic evidence such as judicial opinions interpreting the policy language and evidence of the understandings of these insurers and the insurance industry in general concerning the meaning of the disputed policy language." The court said the "subjective beliefs" of the insurers may also be relevant. "Also relevant may be evidence of prior positions these insurers have taken in other cases and their knowledge of positions other insurers or industry groups have taken in similar cases."
- Second, the appellate court held that an insurer's duty to investigate a claim continues unabated even if there is a coverage dispute.
[T]he saga of this litigation illustrates the injury an insured may suffer when (as Lennar alleges here) an insurer sues over the meaning of a disputed policy term and effectively ignores its obligation to investigate the claim during ensuing protracted legal proceedings.
It will be interesting to follow this case now that it has been remanded to the trial court for further proceedings. If the case does not settle, it will go to trial. If it goes to trial, will there be another appeal? And another trial? A Fortune 500 Company like Lennar can afford to stay in the fight as long as it takes. Most smaller construction companies would have a hard time outlasting an insurance company in protracted insurance coverage litigation. In Arizona, at least, the discovery of both objective and subject evidence of insurer conduct and the possibility that such evidence may be admissible could help resolve coverage disputes earlier which would help resolve construction defect cases more effectively.
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