On July 9, 2015, in Cypress Point Condominium Association, Inc. v. Adria Towers, LLC, a New Jersey appellate court held that an insurer may be liable for consequential damages resulting from a subcontractor's defective work under a commercial general liability policy (No. A-2767-13T1, ). This decision effectively overrides the Third Circuit's unpublished opinion in Pennsylvania National Mutual Casualty Insurance Co. v. Parkshore Development Corp., which insurance underwriters relied on to deny the claims of developers and general contractors (403 Fed. Appx. 770 (3d Cir. 2010)).

The plaintiff was a condominium association that hired the defendant as a general contractor to develop a condominium project. The defendant hired multiple subcontractors to perform the construction work.

The subcontractors failed to properly install the roof, flashing and gutters among other things, which led to water damage in common areas, individual units and concealed interior areas of the building.

The plaintiff sought coverage from the general contractor's insurer under its commercial general liability (CGL) insurance policy. The general contractor's carrier used the Insurance Services Office, Inc.'s (ISO) 1986 standard CGL form.

Within the insurance industry, if a general contractor must replace defective work, those replacement costs are an uninsurable business risk regarded as the cost of doing business (often referred to as the "Your Work" exclusion). The insured assumes the business risk of paying for the cost of repairs to fix the defective work. The 1986 ISO form carved out an exception to this exclusion for work performed by subcontractors.

The defendant claimed there was no property damage or occurrence under the general contractor's CGL policy. The insurer's arguments relied on Weedo v. Stone-E-Brick, Inc. (81 NJ 233 (1979)) and Firemen's Insurance Co. of Newark v. National Union Fire Insurance Co. (387 NJ Super. 434 (App. Div. 2006)). Both of these cases interpreted the ISO's 1973 standard CGL form, which contained different definitions of property damage and occurrence.

The trial court held that there was no property damage or occurrence to trigger coverage under the policy. After denying a motion for reconsideration, the plaintiff appealed only the issue of whether consequential damages caused by the subcontractors' defective work constituted property damage and an occurrence under the policy.

On appeal, the plaintiff argued that:

As an initial matter, the appellate court determined that under the plain language of the 1986 ISO form, consequential damages from defective subcontractor work constitute property damage and an occurrence under the CGL policy. It was obvious to the court that the defective work led to water-damaged property. The appellate court stated that there was an occurrence because it would be unreasonable to believe that the subcontractors either expected or intended for the defective work to cause physical injury to personal property.

The appellate court distinguished Weedo because it dealt with costs to replace defective work clearly covered under "Your Work" exclusion rather than consequential damages resulting from work. The Weedo case was further inapplicable because it interpreted the 1973 ISO form rather than the 1986 ISO form, which contained different language and definitions.

The appellate court also distinguished Firemen's because it interpreted the 1973 ISO form and involved replacement damages flowing from a business risk rather than consequential damages.

Both Weedo and Firemen's actually support the plaintiff's position, as each emphasized the difference between replacement costs and consequential damages under CGL policies.

The appellate court also emphasized the significance of the differences between the 1973 ISO form and the 1986 ISO form. The 1986 ISO form contains an exception to an exclusion, which prevents the denial of coverage for damages that arise from the performance of work on the general contractor's behalf by a subcontractor. The inclusion of the subcontractor exception demonstrates that the parties intended for consequential damages caused by defective subcontractor work to be covered by the policy. Before 1986, there was no distinction between defective work performed by subcontractors and general contractors, and both were excluded from coverage.

The appellate court ultimately held that the damages sustained were the unintended and unexpected consequential damages caused by the subcontractors' defective work, rather than the costs to replace the defective work. As such they constituted property damage and an occurrence under the CGL policy. This decision was based on the developer's reasonable expectation that the subcontractors' work is treated differently than the general contractor's work.

Policyholders and insurance underwriters doing business in New Jersey should review their CGL policies to determine the applicability of this case.

The appellate court noted that its decision brings New Jersey in line with the majority rule on this issue and refutes the Third Circuit's contrary holding Pennsylvania National.

Counsel for developers, general contractors and underwriters should continue to monitor if this case is appealed to the Supreme Court of New Jersey.

For a further discussion of CGL policies and their exclusions, see Practice Note, Managing Construction Risk through Commercial Liability Insurance.