By Greg Johnson. It’s back to square one for some residential contractors.

In Grinnell Mutual Reinsurance Co. v. Wollak Construction, Inc., Civ. File No. 10-350 (RHK/LIB) (D. Minn. 10/15/2010), the federal district court, applying Minnesota law, held that the “your work exclusion” in a Commercial General Liability (“CGL”) policy issued to a general contractor did not afford coverage to the general contractor when sued for construction defects. The coverage issue was fairly simple. The Durans hired Wollak in 2006 to build a home on a lot they owned. In 2008, after construction of the home was completed, the Durans sued Wollak claiming that it committed breach of contract, breach of statutory warranty, breach of implied warranty, and negligence in its construction of their home. They identified various building code violations and other construction defects. Specifically, the underlying complaint alleged that Wollak: (a) failed to properly install windows, trim, hinges, flooring, heating, doors, shower stalls and doors pursuant to the installation instructions of the manufacturer and good building practice, and (b) failed to properly mark property lines, failed to fill in sink holes, painting, failed to properly pour concrete for patio, and failed to remove the silt fence.

The case was simple because the CGL policy issued to Wollak, the general contractor, by Grinnell did not contain the so-called “subcontractor exception” to the “your work” exclusion. Rather, the Grinnell policy simply excluded coverage for “’[p]roperty damage” to ‘your work’ arising out of it or any part of it . . .”.

To understand the case, some brief background history may be helpful:

Prior to 1986, the typical “your work” exclusion in the “standard” Commercial General Liability (CGL) policy (then referred to as the “work-performed” exclusion) provided: “This policy does not apply to . . . ‘[p]roperty damage’ to ‘your work’ arising out of it or any part of it . . .”. Because the entire construction project is the general contractor’s work, the exclusion bars coverage for the defective work of the general contractor and any subcontractor which gives rise to a claim for damage to the property which is the subject matter of the construction project. See, Bor‑Son Bldg. Corp. v. Employers Commercial Union Ins. Co. of America, 323 N.W.2d 58, 61 (Minn.1982); Knutson Constr. Co. v. St. Paul Fire & Marine Ins. Co., 396 N.W.2d 229, 235 (Minn.1986).  For example, in Knutson, the owner of an apartment complex brought suit against a general contractor to recover the cost of repairing structural damage to the complex. The general contractor then brought an insurance coverage action against its CGL insurance carriers. In upholding summary judgment for the insurers, the Minnesota Supreme Court reaffirmed its holding in Bor-Son that a CGL policy “does not provide coverage for claims of defective materials and workmanship giving rise to a claim for damage to the property itself which is the subject matter of the construction project.” Knutson, 396 N.W.2d at 235.

Because the “your work” exclusion in the general contractor’s CGL policy excludes coverage for the underlying “property damage,” any consequential losses or costs that are based on, or arise out of, the excluded “property damage,” are excluded as well. See, e.g., Federated Mutual Ins. Co. v. Concrete Units, Inc., 363 N.W.2d 751, 757 (Minn. 1985); Corn Plus Cooperative v. Continental Casualty Co., 444 F. Supp.2d 981, 988 (D. Minn. 2006) (“the Damage to Your Work exclusion bars coverage for the damages Corn Plus suffered to the welds of its expansion project . . . [and] all damages that Corn Plus has incurred or anticipates incurring based upon the cost of repair and replacement of the defective welding”), affirmed 516 F.3d 674 (8th Cir.2008). Stated another way, any damage arising from “property damage” which is explicitly excluded from the policy’s application are also not covered. See, Tinker, Comprehensive General Liability Insurance – Perspectives and Overview, 25 Fed’n Ins. Counsel Q. 217, 224-226 (1975).

In 1986, however, in recognition of the fact that general contractors have little, if any, control over the work of their subcontractors, the standard CGL policy was changed to incorporate an exception to the “your work” exclusion.  The so-called “subcontractor exception” provides:  “[t]his exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”

The subcontractor exception has the effect of restoring coverage for the defective work of a subcontractor which causes damage to property which is the subject matter of the construction project.  See, e.g., Wanzek Const. Inc. v. Employers Ins. of Wausau, 679 N.W.2d 322 (Minn. 2004); O’Shaughnessy v. Smuckler Corp., 543 N.W.2d 99, 103-05 (Minn.Ct.App.1996) (recognizing that 1986 change to the “your work” exclusion changed standard CGL policy so as to provide coverage for property damage to a general contractor’s work when that damage is caused by a subcontractor’s defective work), rev. denied (Minn. Mar. 28, 1996), abrogated on other grounds by Gordon v. Microsoft Corp., 645 N.W.2d 393 (Minn. 2002).  An example of how the “your work” exclusion applies in the context of a 1986 CGL policy issued to a general contractor is as follows:

The named insured is a general contractor who has built an apartment house with the services of numerous subcontractors. After the building is completed and put to its intended use, a defect in the building’s wiring (put in by a subcontractor) causes the building, including work of the general contractor and other subcontractors, to sustain substantial fire damage. The named insured [general contractor] is sued by the building’s owner. Prior to 1986, the general contractor’s CGL policy would not afford any coverage to the insured for the resulting damages because the entire project is the general contractor’s work.  After 1986, the exclusion would not bar the claim.  Although, the named insured’s policy excludes damage to “your work” arising out of it or any part of it, the [subcontractor exception] . . . makes it clear that the exclusion does not apply to the claim. That is because the work out of which the damage arose was performed on the named insured’s behalf by a subcontractor. * * * Thus, barring the application of some other exclusion or adverse policy condition, the loss should be covered, including the part out of which the damage arose.

O’Shaughnessy, 543 N.W.2d at 105 (quoting Fire, Casualty and Surety Bulletins, Public Liability, Aa 16-17 (The National Underwriter Co. 1993)).

Thus, as a result of the subcontractor exception in a CGL policy issued to a general contractor, the defective work of a subcontractor which causes damage to the construction project (i.e., the general contractor’s work) is not excluded (assuming the insuring clause has been satisfied and there are no other applicable exclusions).  In addition, losses that are causally related to the covered property damage are covered as well.  See, Federated Mutual Ins. Co. v. Concrete Units, Inc., 363 N.W.2d 751, 757 (Minn. 1985) (interpreting “damages because of . . . ‘property damage’” language of insuring clause to extend coverage to losses causally related to covered property damage).

Many CGL insurers, in response to the significant increase in construction defect claims, have eliminated the “subcontractor exception” to the “your work” exclusion in policies issued to residential general contractors. That was the situation in Grinnell Mutual Reinsurance Co. v. Wollak Construction, Inc.,
Civ. No. 10-350 (RHK/LIB) (D. Minn. 10/15/2010).  Thus, the case was factually identical to cases that had been decided prior to the incorporation of subcontractor exception in CGL policies, such as Bor‑Son, 323 N.W.2d 58 (Minn.1982) and Knutson Constr., 396 N.W.2d 229 (Minn.1986) where the Minnesota Supreme Court recognized that a CGL policy “does not provide coverage for claims of defective materials and workmanship giving rise to a claim for damage to the property itself which is the subject matter of the construction project.” Knutson, 396 N.W.2d at 235.  The court in Wollak observed as follows:

When the “work-performed” exclusion was replaced by the “your-work” exclusion, it added an exception to the exclusion for subcontractors’ work . . . However, where subcontractors were not involved, the [“your-work”] exclusion remained the same. * * * The “your-work” exclusion continued to bar coverage for damage to the insured’s work, including the costs to repair or replace defective work. See, e.g., Corn Plus Cooperative v. Cont’l Cas. Co., 444 F. Supp. 2d 981, 989 (D. Minn. 2006) (Doty, J.) (interpreting the “your-work” exclusion to bar coverage for faulty welding work on an ethanol plant since the welds were the insured’s work). * * * Just like the “work-performed” and “your-work” exclusions interpreted in prior cases, the instant Policy excludes coverage for damage to property that was the subject of the insured’s construction contract caused by construction defects or faulty workmanship. The Durans’ claims all arise out of or involve damage to Wollak’s own work. Accordingly, all come within the Policy’s definition of “your work” and its exclusion for “damage to your work.” Since there is no longer a subcontractor exception (or any other exception) in the exclusion, the inquiry ends here.

In an effort to avoid the exclusion, Wollak argued that the exclusion did not apply because the presence of its defective work caused property damage not just to the work itself, but to the larger property (the homeowner’s’ entire lot). Specifically, Wollak argued that its work diminished the value of the entire lot.  The court correctly held that diminution in value was not covered.  First, although not resolved on this ground, it is well established that losses which are based on, or arise out of, excluded “property damage” are likewise excluded.  (See the discussion above, and Tinker article).  Thus, any diminution in value that resulted from Wollak’s work is similarly excluded.  Second, as the federal district court noted, diminution in value does not itself constitute “property damage.”

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