Insurance Law Alert: Incorporation of Defective Work Does Not Result in Covered Property Damage in California Construction Claims

In Regional Steel Corp. v. Liberty Surplus Ins. (No. B245961, filed 5/16/14, ord. pub. 6/13/14), a California appeals court held that the insured’s use of the wrong steel seismic reinforcement hooks in construction of a mixed-use building was not an occurrence, and did not result in covered property damage.

Regional Steel was the structural steel subcontractor on a 14-story mixed-use project in North Hollywood, California. Regional supplied plans which were approved by the developer and its structural engineers for installation of steel reinforcements, including seismic reinforcement hooks, to be encased in concrete. During construction, City inspectors determined that the plans called for the wrong hooks, necessitating repairs to finished portions of the work and delays in further construction. This ultimately resulted in a lawsuit between the developer, Regional Steel, the concrete subcontractor, the structural engineer and a quality assurance inspector.

The project was insured under a wrap policy issued to the developer, with Regional named as an additional insured. The court rejected an argument that the wrap endorsement fundamentally changed the insurance, and the issue boiled down to whether incorporation of the wrong hooks, the damage caused by tearing out concrete to replace the hooks, or the resulting loss of use, triggered coverage. Liberty asserted that no damage to property was alleged and the purely economic losses caused by the need to reopen the poured concrete to correct the tie hook problem did not constitute “property damage” within the meaning of the policy. Liberty further posited that the tie hook problem did not constitute an “occurrence” within the meaning of the policy because the alleged damage was not caused by an accident.

The Regional Steel court noted a conflict in the law on whether construction defects that are incorporated into a whole property constitute property damage for purposes of a CGL policy. The court said that one line of cases “states the basic rule” of denying coverage for the cost of removing and replacing defective work or material, because such costs are considered economic loss and not physical injury to the property. (Citing F&H Construction v. ITT Hartford Ins. Co. (2004) 118 Cal.App.4th 364.) The other line of cases suggests that incorporation of a defective part constitutes property damage within the meaning of a CGL policy. (Citing Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc. (2000) 78 Cal.App.4th 847.)

The Regional Steel court distinguished the cases holding that incorporation of defective parts results in covered property damage as only involving hazardous materials, such as asbestos incorporated into a building or wood shavings adulterating food products. The court found those cases inapposite because they involved contamination by hazardous materials, and did not involve the incorporation of defective workmanship into a construction project. The court said that California cases consistently hold that with regard to construction claims, coverage does not exist where the only “property damage” is the defective construction, and damage to other property has not occurred.

The Regional Steel court also held that the “Impaired Property” exclusion barred the possibility of coverage, saying that: “Under that exclusion, there is no coverage for property damage to ‘property that has not been physically injured’ arising out of the [sic] Regional’s negligent failure to perform its contractual obligations based on installation of defective tie hooks. JSM’s action alleged that Regional negligently installed improper tie hooks and thus the underlying suit arose from deficiencies in Regional’s performance of its work or from Regional’s failure to perform a contract in accordance with its terms, or both.”

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June 17, 2014