Is It Flip-Flopping Or Flop-Flipping? Clarifying Construction Defects Law In South Carolina

By Stephen P. Groves, Sr.

Crossmann Communities of North Carolina v. Harleysville Mutual Ins. Co., ___ S.C. ___, ___ S.E.2d ___ (2011)
(Sup.Ct. Opinion No. 26909, filed 7 January 2011)

By 3:30 p.m. in the afternoon of Friday, 7 January 2011, many of the attorneys practicing construction defects law in this State had left their offices and headed home for what they thought would be a quiet weekend. Needless to say, it did not turn out to be as quiet as they anticipated. At approximately 3:44 p.m. that day the South Carolina Supreme Court issued its decision in Crossmann Communities v. Harleysville – the latest and, possibly the greatest, installment in the Supreme Court’s jurisprudence involving litigation over the application of commercial general liability insurance coverage to construction defect claims. All-in-all, things look a bit differently now than they did before Friday afternoon.

Harleysville issued a commercial general liability insurance policy (the “CGL Policy”) to Crossmann Communities providing liability coverage to several condominium projects in Myrtle Beach, South Carolina. As seems to be the norm, the condominiums suffered from significant faulty workmanship and negligent construction. Eventually the homeowners sued Crossmann Communities for negligence, breach of express warranties, breach of implied warranties; unfair trade practices; and breach of fiduciary duty. They sought actual and punitive damages, diminution in value, and loss of use. Crossmann Communities settled the underlying actions for approximately $16.8 million and then sought coverage under the CGL Policy. After Harleysville denied the claim Crossmann Communities filed an insurance coverage declaratory judgment action seeking coverage. Crossman Communities prevailed at the trial level but, on appeal, the Supreme Court reversed, concluding there was no "occurrence" under the CGL policy.

The Supreme Court first discussed the history of the standard CGL Policy, noting “CGL policies are not intended to insure business risks that are the normal, frequent, or predictable consequences of doing business . . .[and, therefore,] . . . the policies do not insure the work itself, but rather, they generally insure consequential risks.” Crossmann Communities v. Harleysville, Slip Op., p.3 (citing Century Indemnity Co. v. Golden Hills Builders, Inc., 348 S.C. 559, 565-66, 561 S.E.2d 355, 358 (2002) (quoting Rowland H. Long, LL.M., The Law of Liability Insurance, § 3.06[1] (2001)). Additionally, the Supreme Court recognized that the standard CGL Policy was revised in 1986 to include the so-called “subcontractor exception” to the “Your Work” Exclusion. Crossmann Communities v. Harleysville, Slip Op., p.3. This provision has been interpreted by a number of courts to provide liability insurance coverage to a general contractor for a subcontractor’s faulty workmanship and/or defective construction. See generally U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d 871 (Fla. 2007); Lamar Homes, Inc. v. Mid-Continent Casualty Co., 242 S.W.3d 1 (Tex. 2007). See also generally Auto Owners Insurance Co., Inc. v. Newman, 285 S.C. 187, 684 S.E.2d 541 (2009).

While Crossmann Communities argued that the "subcontractor exception" applied to provide it coverage under the CGL Policy, the Supreme Court concluded the “ ‘subcontractor exception’ [wa]s relevant only if there [wa]s a finding of initial coverage. [Therefore], any property damage for which [Crossmann Communities sought] coverage must have been caused by an occurrence before the [CGL] [P]olicy [wa]s triggered.” Crossmann Communities v. Harleysville, Slip Op., pp.3-4.

In a candid appraisal of the struggles courts across this county have faced when interpreting CGL policies in general, and the "subcontractor exception" to the "your work" exclusion, in particular, the Supreme Court found that the several different approaches courts have used effectively “result[ed] is an intellectual mess.” Crossmann Communities v. Harleysville, Slip Op., p.4. Seeking to lend clarity to this muddled mess, the Supreme Court concluded any inquiry in this area must initially focus on the term "occurrence" in the CGL Policy.

The Court acknowledged that the term "occurrence" necessarily carries with it some important fortuity underpinnings, notwithstanding the fact the CGL Policy specifically defines the term “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions." Crossmann Communities v. Harleysville, Slip Op., p.4. Nevertheless, the Supreme Court noted this “fortuity” notion must be viewed through the lens of “faulty workmanship” in the construction defects context. The Supreme Court went on to discuss the “majority” rule (i.e.; claims of faulty workmanship and/or defective construction, standing alone, do not constitute occurrences which trigger coverage under a CGL policy, but damage to a third-party’s property triggered coverage) and the “minority” rule (i.e.; claims of faulty workmanship and/or defective construction constitute an occurrence, regardless of what property is damaged, as long as the insured did not expect or intend the resulting damage). Crossmann Communities v. Harleysville, Slip Op., pp.4-5. (As an aside, regardless of which “rule” is applied there is no coverage for the costs associated with replacing and/or repairing a defective component of the project since those claims do not constitute "property damage" under a CGL policy.).

After discussing general construction defects law, the Supreme Court acknowledged it had “recently addressed issues involving CGL coverage and faulty workmanship in L-J, Inc. v. Bituminous Fire and Marine Ins. Co., 366 S.C. 117, 621 S.E.2d 33 (2005)[,] and Auto Owners Ins. Co., Inc. v. Newman, 285 S.C. 187, 684 S.E.2d 541 (2009).” Crossmann Communities v. Harleysville, Slip Op., p.6. On the one hand, in L-J, the Supreme Court addressed a situation where the insured sought coverage solely for damages to repair faulty workmanship and defective construction. Conversely, in Newman, the insured’s claims involved damages for both the faulty workmanship and defective construction and for damages to other property resulting from the same faulty workmanship and defective construction. The Supreme Court concluded there was no coverage in L-J, but there was coverage in Newman.

Looking to the necessary “fortuity” underpinnings of the term “occurrence”, the Supreme Court unequivocally admitted that its finding of an “occurrence” in Newman “without regard to the fortuity component of an ‘accident’ was error.” Crossmann Communities v. Harleysville, Slip Op., p.7. Nevertheless, the Court concluded the “analytical framework of "property damage" in Newman remain[ed] sound, provided there [wa]s in the first instance an ‘occurrence’.” Crossmann Communities v. Harleysville, Slip Op., p.7. See generally National Underwriter Co., Fire, Casualty & Surety Bulletins, Public Liability, A 3-14 (2001) (providing examples of situations where faulty workmanship causes an "occurrence," which results in "property damage" only to the project itself).

Furthermore, the Supreme Court then revisited L-J and Newman, reaffirming its position from L-J that faulty workmanship does not constitute an "occurrence" in a CGL policy. The Court, however, looking to the examples cited the National Underwriter Company, concluded that “faulty workmanship can cause an ‘occurrence’ under a CGL policy.” Crossmann Communities v. Harleysville, Slip Op., pp.8-9. Given this basis, the Court faced the question: “When faulty workmanship directly causes further damage to non-defective components of an insured's project, does this necessarily constitute an occurrence?” Crossmann Communities v. Harleysville, Slip Op., p.8.

Recognizing the fortuity principles incumbent in an “occurrence”, as well as the CGL Policy’s stated definition of an “occurrence” ("an accident, including continuous or repeated exposure to substantially the same general harmful conditions."), the Supreme Court turned its attention to the term “accident”. The Court noted that while the CGL Policy did not define “accident”, the Court had long defined the term “ ‘as an unexpected happening or event, which occurs by chance and usually suddenly, with harmful results, not intended or designed by the person suffering the harm or hurt.’ " Crossmann Communities v. Harleysville, Slip Op., p.8 (citing Collins Holding Corp. v. Wausau Underwriters Insurance Co., 379 S.C. 573, 578, 666 S.E.2d 897, 900 (2008) (citing Green v. United. Insurance Co. of America, 254 S.C. 202, 205, 174 S.E.2d 400, 402 (1970)). The Court also cited other cases and authorities which noted an “unexpected” or “unforeseen” nature of an “accident”.

Applying this new definition of an "occurrence" to the homeowners’ various construction defect claims, the Supreme Court concluded the damages alleged therein were not caused by and/or the result of an "occurrence" under the CGL Policy. The Court concluded that:

The natural and expected consequence of [the subcontractor’s faulty workmanship] in negligently installing siding to [the] condominiums [wa]s water intrusion and damage to the interior of the units. There [wa]s no fortuity element present under this factual scenario. We hold that where the damage to the insured's property is no more than the natural and probable consequences of faulty workmanship such that the two cannot be distinguished, this does not constitute an occurrence.

Crossmann Communities v. Harleysville, Slip Op., p.9.

Additionally, the Supreme Court took the opportunity to clarify its holding in L-J, by finding that the term “work product” “encompasse[d] only the alleged negligently constructed component and not the non-defective components” (i.e.; not the entire building and/or project as some cases have held and as Justice Pleicones suggested in his Newman dissent). Crossmann Communities v. Harleysville, Slip Op., p.9.

In conclusion, the Supreme Court summed up its present view of the applicability of liability insurance coverage to construction defects claims as follows:

In . . . analyzing whether a claim is covered under a CGL policy, we first focus on whether there has been an "occurrence." Damage that does not arise from a fortuitous event is not an occurrence. Damages to the insured's project that are the natural and probable consequences of faulty workmanship do not constitute an "occurrence." For faulty workmanship to give rise to potential coverage, the faulty workmanship must result in an occurrence, that is, an unintended, unforeseen, fortuitous, or injurious event. If there has been an occurrence, then we will look to whether there has been "property damage" as defined by the policy.

Crossmann Communities v. Harleysville, Slip Op., pp.9-10. The Court overruled Newman “to the extent it permitted coverage for faulty workmanship that directly causes further damage to property in the absence of an "occurrence" with its fortuity underpinnings.