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July 2014

Building Code Violations Requiring Removal Of Nonhazardous Materials Do Not Constitute “Property Damage” Under CGL Policy

The California Court of Appeal, Second Appellate District, held an insurer had no duty to defend a steel subcontractor because its installation of defective tie hooks did not constitute “property damage” under a commercial general liability (CGL) policy, even though the surrounding concrete needed to be demolished when the tie hooks were removed.

In Regional Steel Corp. v. Liberty Surplus Ins. Corp, a steel subcontractor, Regional, sued JSM, the owner and general contractor of an apartment building, for withholding $545,500 in payments. JSM filed a cross-complaint against Regional for breach of contract and breach of warranties alleging Regional violated the building code by installing 90-degree seismic tie hooks into the property, rather than 135-degree tie hooks. JSM alleged it was forced to open numerous concrete walls to replace Regional’s defective work. JSM also sued another subcontractor, Webcor, which had improperly poured concrete surrounding the tie hooks. JSM alleged it was damaged because the project was delayed, resulting in loss of use and rental income. Webcor filed a cross-complaint against Regional, JSM, and the structural engineer alleging its fault was passive and secondary to Regional’s.

Regional tendered its defense of JSM’s cross-complaint to Liberty under a “wrap” CGL policy. Liberty denied coverage asserting that economic losses resulting from JSM’s opening of the concrete did not constitute “property damage” under the policy. Liberty further contended the tie hook problem did not result from an “occurrence” or accident.

Regional responded to Liberty’s denial contending Webcor was seeking indemnity for JSM’s claims that the concrete floors were out-of-level and cracked. Liberty reviewed the pleadings, motions and discovery in the underlying action and found no evidence that JSM was asserting any claims for uneven or cracked floors. Liberty denied Regional’s second tender.

The owner and subcontractors then settled the underlying action without Liberty. The parties stipulated that Regional was responsible for all damage and loss of use at the project, including the out-of-level, cracked, and damaged floors.

Regional sued Liberty for breach of contract and breach of the implied covenant of good faith and fair dealing based on its failure to defend and settle. The trial court granted Liberty’s motion for summary judgment finding it had no duty to defend Regional. The court held that the seismic hook issue did not constitute “property damage” under the policy. The court also ruled the policy excluded coverage for: (a) damage arising out of a defect in an insured’s work; (b) an insured’s failure to perform under a contract; and (c) “impaired property,” which could be restored by performing under a contract. The court further determined that JSM’s claims against Webcor involving defective concrete installation were not asserted against Regional.

The Court of Appeal affirmed the summary judgment and similarly found that Regional’s installation of defective tie hooks did not constitute “property damage.” The court discussed a conflict in the law regarding whether construction defects that are incorporated into other property constitute “property damage.” The court recognized that economic losses arising from the cost of removing or replacing defective work do not generally constitute physical injury to property. F & H Construction v. ITT Hartford Ins. Co. (2004) 118 Cal.App.4th 364, 372-373; St. Paul Fire & Marine Ins. Co. v. Coss (1978) 80 Cal.App.3d 888, 892-893. However, another line of cases holds that incorporated defective work may be considered “property damage” if it must be removed to comply with building code or health and safety standards. Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1 (asbestos); Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc. (2000) 78 Cal.App.4th 847 (wood splinters in food). The court held that Regional’s claim was distinguishable from the latter line of cases, which distinctly involved the installation and removal of hazardous materials.

The court also affirmed the trial court’s ruling on other grounds. The court found no evidence that JSM or Webcor had attributed the cracked floors to Regional. JSM’s claims also were barred by the “impaired property” exclusion, which precluded coverage for “property that has not been physically injured” arising from an insured’s performance or its failure to perform under the contract. In addition, the appellate court ruled that the parties’ cannot transform JSM’s claim into “property damage” by using recitals in a settlement agreement without Liberty’s approval. 

Lastly, the court rejected Regional’s argument that the “wrap” endorsement in the policy eliminated the policy’s requirement that a claim occur during the retroactive period.

To read the opinion, click here.

The opinion in Regional Steel Corp. v. Liberty Surplus Ins. Corp., Case No. B245961 (2014 Cal. App. LEXIS 517, is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority in California state courts.


Steven R. Inouye
Arthur Schwartz