Just when you breathed a sigh of relief
after completing that major construction project on time and under
budget with no disputes from the developer or general contractor,
you find yourself served with a state court complaint alleging
defective design or construction and negligence, along with breach
of the construction contract and breach of warranty. The developer
and general contractor cross-claim against you. Before you have a
chance to pull Ken Kupchak or Anna Oshiro’s business card out of
your Rolodex, your Delaware-incorporated insurance company has filed
a suit against you in federal court, asking the court to declare
that the state court lawsuit is not covered under your Commercial
General Liability policy therefore leaving you without an attorney
and without the indemnity. Before you have an opportunity to read
Alan Van Etten’s latest article on insurance coverage in
construction cases, the federal judge has ruled against you, citing
the recent Ninth Circuit decision in Burlington Insurance Company v.
Oceanic Design and Construction, Inc., and saying that the alleged
defective construction work was a breach of contract that was not
covered under your insurance policy.
How did this happen? Is this the insurance that you paid for? Is
this the end? How can you organize your insurance coverage to avoid
this decision?
The Burlington case is a little confusing so a review of the facts
is warranted. In that case, a construction company built a
single-family residence in Honolulu for a homeowner. When
construction was complete, the homeowner refused to pay because they
were not satisfied with the work. The construction company filed
suit against the homeowner, who promptly filed a counter-suit
against the construction company for breaching the construction
contract for improper foundation preparation, improper building and
other related claims.
The construction company tendered the defense of the counter-suit to
its insurer, Burlington. Burlington filed an action in federal
court, requesting the court to declare that the defective
construction claims were not covered under the Commercial General
Liability policy and therefore it had no duty to defend the lawsuit
and indemnify the company for monetary damages. The federal judge
agreed with Burlington and the construction company appealed. The
Ninth Circuit affirmed the lower court’s decision.
The Ninth Circuit based its opinion on Hawaii state court decisions
and, because no Hawaii court had been faced with that exact issue,
it had to predict how the Hawaii Supreme Court would address the
issue. The Ninth Circuit reasoned that property damage from
defective construction was not included within the definition of
property damage from an “occurrence” in the Commercial General
Liability policy because, in Hawaii, recovery for torts (personal
injury or property damage) is not available for breach of contract
claims. Therefore, the Ninth Circuit predicted that Hawaii courts
would not find a duty to defend or duty to indemnify in Commercial
General Liability policies.
With no contrary Hawaii state court decisions, federal courts will
have to follow Burlington. If a construction company is incorporated
here and its insurer is incorporated elsewhere, the federal court
has “diversity jurisdiction” to hear the insurance coverage dispute.
Burlington applies, and the construction company loses insurance
coverage.
So, should the construction company want the best opportunity at
keeping its insurance coverage for construction defect claims, it
would have to stay in state court where Burlington is not a binding
decision.
One strategy to avoid the Burlington decision, at least until the
matter is resolved by the Hawaii state courts, is to find a way to
defeat the federal court’s diversity jurisdiction. Federal courts
only have jurisdiction to hear cases involving federal laws
(anti-trust, patent, admiralty) or when the parties are from
different states. In order to stay in state court, a construction
company incorporated in Hawaii would need to have an insurance
policy, either directly or as an additional insured on another
policy, from an insurance company incorporated in Hawaii; or a
construction company incorporated elsewhere would have to use an
insurer incorporated in its state of incorporation or an insurance
company incorporated in Hawaii (in that case, the construction
company would need to file suit in state court before the insurance
company had the opportunity to file in federal court).
While this may seem more confusing than the CGL policy itself,
certain steps may be taken to ensure at least a fighting chance to
retain your insurance coverage and defense until such time as Hawaii
state courts address the Burlington decision.
The decision can be downloaded in pdf format from the Ninth Circuit's website here.
