CONSTRUCTION BUSINESS HANDBOOK

CONSTRUCTION BUSINESS HANDBOOK

Chapter 3:PIRATES, ROVERS, AND BUILDERS RISKS: SEABORNE COVERAGE LESSONS FOR SHORE-BASED CONSTRUCTION PROJECTS

ASPEN Publishers

REPRINTED WITH PERMISSION BY ASPEN PUBLISHERS, INC.

Construction Law Library

CHAPTER 3

PIRATES, ROVERS, AND BUILDERSRISKS: SEABORNE COVERAGELESSONS FOR SHORE-BASEDCONSTRUCTION PROJECTSEdmund M. KneiselBrian K. EppsBrandon T. Grinsted

§ 3.01 Introduction

§ 3.02 Review of Key Policy Clauses

§ 3.03 Lesson No. 1: Proof of Consequential, Resulting Damage

§ 3.04 Lesson No. 2: Availability of Diminution in Value/Loss of UseCoverage

§ 3.05 Lesson No. 3: Extended Coverage for Post-Construction Damage[A] Maintenance Period Coverage[B] Delay in Start-Up Coverage

§ 3.06 Lesson No. 4: Coverage for Prevention/Mitigation of Loss(“Sue and Labor”)[A] Does Sue and Labor Coverage Apply to an Insured’s Efforts

to Prevent an Insured Loss?[B] When Does the Threat of an Insured Peril Trigger Sue and

Labor Coverage?[C] The Respective Interests of Insured and Insurer Are

Considered in Allocating Sue and Labor Costs

§ 3.07 Conclusion

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§ 3.01 INTRODUCTION

Insurance in the United States (and elsewhere) had its genesis in the work ofthe Lloyd’s underwriters in a coffee house in London, which eventually expandedinto one of the largest (and best known) worldwide insurance markets. Theoriginal Lloyd’s underwriters were specialists in marine-based risks, insuringagainst losses faced by owners of vessels during ocean voyages, i.e., the “perilsof the seas.” As the market grew, underwriters progressed beyond their originalpractice of issuing “slips” of coverage for ocean voyages, and began issuing abroad range of “cover notes” accompanied by policy forms offering coverage fora variety of non-marine based risks. While the London market has expandeddramatically, the underwriters’ core business of marine insurance has essentiallyremained unchanged.

The marine-based roots of the London market are reflected by some of thepolicy forms that are still in use, which are interesting from an historicalperspective, but contain rather arcane language of questionable relevance totwenty-first century risks. For instance, the 1979 American Institute “HullClauses” form defines the perils insured against as follows:

Touching on the Adventures and Perils which the Underwriters are contentedto bear and take upon themselves, they are of the Seas, Men-of-War, Fire,Lightning, Earthquake Enemies, Pirates, Rovers Assailing Thieves, Jettisons,Letters of Mart and Counter-Mart, Surprises, Takings at Sea, Arrests,Restraints, and Detainments of all Kings, Princes and Peoples. . . .

While some construction contractors may have experienced losses caused by fire,lighting, earthquake, and even “arrests” or “restraints” of government officials, acontractor engaged in shore-based construction might wonder what in the worlddoes this arcane language have to do with me and the coverage I need forconstruction-related risks? Aside from cases addressing what is commonly knownas the “Inchmaree Clause” in the American Institute Form, the answer probablyis “not much.”1 However, the issue of coverage for consequential damage causedby latent construction defects or faulty workmanship (the subject of the InchmareeClause) is one of the most hotly debated and often disputed areas of shore-basedconstruction insurance law. As a result, much can be learned by studying the

1 The clause, entitled “additional perils,” is named after one of the leading coverage cases inBritish marine insurance law, Thames and Mersey Marine Ins. Co. v. Hamilton Fraser and Co.,[1887] 12 A.C. 484 (HL), in which underwriters had denied coverage for damages to a vessel (theInchmaree) caused by a bursting boiler because the perils insured against did not include damagecaused by defective parts. The “Inchmaree Clause” was added to the standard marine form expresslyto provide coverage for “loss or damage to the Vessel directly caused by . . . [b]reakdown of motorgenerators or other electrical machinery and electrical connections thereto, bursting of boilers,breakage of shafts or any latent defect in the machinery or hull, (excluding the cost and expense ofreplacing or repairing the defective part). . . .” American Institute Form 65-C.

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application of consequential damages principles to claims under marine-basedpolicies, especially coverage provided by marine builders risk policy forms.

It did not take the Lloyd’s market long to expand beyond providing basiccoverage for “perils of the seas” to also issue coverage for the risks of constructingvessels that become subject to those perils. Coverage for marine construction riskstypically did not need to protect against loss by “pirates and rovers,” but thehistorical language used in marine builders risk forms is still rather awkward. Forinstance, the February 8, 1979 American Institute Builder’s Risk Clauses(hereinafter “American Institute Form”) provides as follows:

The Subject Matter of this insurance (herein referred to as the Vessel) is the hull,launches, lifeboats, rafts, furniture bunkers, stores, tackle, fitting, equipment,apparatus, machinery, boilers, refrigeration machine insulation, motor genera-tors and other electrical machinery . . . and appurtenances, including materials,plans, patterns and moulds, staging, scaffolding and similar temporaryconstruction (to the extent) only that the cost of any of the foregoing is includedin the Agreed Values incorporated in or allocated to [the vessel]. . . .

Stripped to its essentials, the London marine builders risk form, like the typicalshore-based builders risk policy, covers the entire project, i.e., the construction ofthe vessel.

Moreover, the American Institute Form provides “all risk” coverage, but issubject to a significant caveat, modeled in effect on the Inchmaree Clause, thatexcludes coverage for the cost of repairing a defective part:

This Policy insures against all risks of physical loss of or damage to the Vesseloccurring during the currency of this Policy, except as hereinafter provided.

In the event that faulty design of any part or parts should cause physicalloss of or damage to the Vessel, this insurance shall not cover the cost orexpense of repairing, replacing or renewing such parts or parts, nor anyexpenditure incurred by reasons of betterment or alteration in design.

This language may seem somewhat familiar to contractors engaged in shore-basedprojects who purchase “all risks builders risk” (ARBR) coverage, sometimesreferred to as “construction all risk” (CAR) coverage. Such policies are needed toprovide protections against construction-related loss during the course of thework, because the contractor’s liability for property damage to the work thatoccurs before the project is complete usually will not be covered by thecontractor’s commercial general liability (CGL) policy.2 Accordingly, review of

2 As noted below and as discussed at length by numerous commentators, CGL policies can beextended to include coverage for a variety of construction-related claims and occurrences if in factnegligent workmanship causes damage to other property of third parties or results in bodily injury.See infra § 3.03.

§ 3.01 2010 CONSTRUCTION LAW UPDATE

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the authorities construing marine builders risk coverage for consequential damageto the “vessel” caused by the installation of defective parts may provide helpfullessons for the shore-based contractor faced with similar claims under an ARBRor CAR policy. Typically, however, neither an ARBR nor a marine policy willcover the cost of remedying negligence in design if the only damage is to thedefective part itself and if there is no other “resulting,” consequential damagecaused by that part.

Similarly, like an ARBR policy, a marine form only insures against damagethat occurs “at the yard of the builder” (at the construction site) and during the“currency of the policy” (during the policy term). The issue of the duration ofcoverage can create controversy under marine builders risk and ARBR policies, asboth types of policies usually limit coverage to damage that occurs within thestated policy period. In addition, marine construction and ARBR policies oftencontain an alternative cut-off date for coverage measured by “completion” of thework or acceptance or sometimes even preliminary acceptance of the project. Atthat point, coverage under the project owner’s property and operational policieswill commence and insure, subject to applicable exclusions, the risks ofpost-completion damage to the property. If that damage is caused by pre-existing“construction defects,” there also may be overlapping coverage under the owner’sproperty policy, the ARBR policy, and even the products-completed operationshazard (PCOH) coverage of the general contractor’s CGL policy. Questionsregarding which of the policies apply and who is at fault (i.e., causation) can leadto protracted litigation or arbitration and significant and prolonged coveragedisputes. As noted last year by one of the authors of this article, “perhaps no areaof insurance law has created more controversy during the last twenty-five yearsthan the question of coverage for ‘defective construction.’”3

As stated a few years ago by another commentator, there is a perceptionamong insurance industry professionals that “the impact of construction defect

3 Edmund M. Kneisel and Betsy Cooke, The Products-Completed Operations Hazard: WhenCoverage Exists, Just What is Covered, 2009 Construction Law Update 161, 163 (Neal J. Sweeneyed., 2009) (hereinafter “What is Covered”). See also Edmund Kneisel and Elliot A. Fus, LiabilityCoverage for Defective Construction: The “No Occurrence Myth,” 2007 Construction Law Update115, 125-27 (Neal J. Sweeney ed., 2007) (hereinafter “No Occurrence Myth”). The insuranceindustry commentary about such coverage typically uses language referring to “constructiondefects” or “defective construction.” This language is employed to support arguments againstcoverage, such as the “no occurrence” argument that is now commonly rejected by the courts, andthe argument, perhaps derived from the Inchmaree Clause of the marine form, that absentconsequential, resulting damage to “other property,” there can be no coverage for the repair orreplacement of the “defective part” itself or to the “defective work” that caused the damage. But seePozzi Window Co. v. Auto Owners’ Ins. Co., 984 S.E.2d. 1241 (Fla. 2008) (PCOH coverage appliesto damage to the negligent construction work of an installation subcontractor, even if the damage isconfined to that work).


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claims on coverage availability and affordability has reached crisis status.”4

However, any “crisis” flowing from the courts’ interpretations of policies coveringlosses arising from construction-related damage, especially coverage provided bythe PCOH language typically included in standard CGL forms, arguably has beenbrought on by the industry itself, as part of its continuing efforts to sell anever-broadening array of coverages to the construction industry.5 In reaction to theperceived construction insurance “crisis” and in response to judicial rulingsapplying the policy language (as written), carriers have added various exclusionsto their CGL forms that bar or limit coverage, such as exclusions for “EFIS”(synthetic stucco) claims, mold claims, and other similar claims that havegenerated significant liabilities arising in some cases from class action lawsuitsagainst homebuilders and other contractors. To minimize exposure to such claims,the Insurance Services Office (ISO) has issued a form of endorsement thatsignificantly limits coverage under the standard PCOH clause by deleting the“subcontractor exception” to the exclusion for damage to “your work.” Thisexception, added to the standard CGL policy form in 1986, has been construed toinsure a general contractor against liability as a result of property damage causedby the “defective” work of a subcontractor. One version of the ISO “subcontractorexclusion” reads as follows:

EXCLUSION—DAMAGE TO WORK PERFORMED BYSUBCONTRACTORS ON YOUR BEHALF

This endorsement modifies insurance provided under the following:

COMMERCIAL GENERAL LIABILITY COVERAGE PART

Exclusion I. of Section I—Coverage A—Bodily Injury And Property DamageLiability is replaced by the following:

2. Exclusions

This insurance does not apply to:

4 Ann R. Hickman, Commentary, Construction Defect Crisis Produces Coverage-restrictingEndorsements, International Risk Management Institute (2003), http://www.irmi.com/expert/articles/2003/hickman08.aspx.

5 As recently ruled by the Texas Court of Appeals in Houston in allowing PCOH coverage forconstruction flaws, “‘We realize that under our holding a general contractor who contracts out allthe work to subcontractors . . . can ensure complete coverage for faulty workmanship. However, itis not our holding that creates this result: it is the addition of the new [subcontractor exception]language to the policy. We have not made the policy closer to a performance bond for generalcontractors, the insurance industry has.’” Lennar Corp. v. Great Am. Ins. Co., 200 S.W.3d 651, 674(Tex. App. 2007) (quoting Kalchthaler v. Keller Constr. Co., 591 N.W.2d 169 (Wis. Ct. App. 1999)),review denied sub nom., Markel Am. Ins. Co. v. Lennar Corp., 2007 Tex. LEXIS 1102 (Dec. 14,2007). See also Edmund M. Kneisel and Jeffrey A. Hannah, Insurance for Financial Loss Causedby Defective Construction: Loss of Use and Diminution of Value as Covered Property Damage, 2001Construction Law Update 213-23 (Neal J. Sweeney ed., 2001) (hereinafter “Diminution in Value”)(discussing evolution of CGL form coverages for construction liability risks).


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I. Damage To Your Work“Property damage” to “your work” arising out of it or any part of it andincluded in the “products-completed operations hazard.”

The elimination of the “subcontractor exception” language significantlynarrows the scope of coverage available under the PCOH provisions of thestandard CGL policy.6

While new policy exclusions or limitations may limit the scope of cover-age provided by a contractor’s CGL policies, similar exclusions have not beenincorporated in marine builders risk or ARBR forms. As a result, increasingnumbers of contractors must request that their brokers/agents look beyond theCGL market and attempt to obtain coverage for construction risks under ARBR orother specialty forms. In appropriate circumstances, such policies can be modifiedto extend coverage beyond the normal project “completion” date or occupancy cutoff, thereby potentially providing significant protection against losses frompost-completion property damage that is caused by pre-existing constructionflaws. Such extended coverage, often referred to as “maintenance coverage,” mayprovide a meaningful substitute for the more limited PCOH liability insurancebecause post-completion property damage during the specified “maintenance”period that is caused by construction “defects” can be covered.7

While an exhaustive review and comparison of marine builders risk andARBR policies is beyond the scope of this article, there are, as noted above,significant “lessons” to be learned by a comparison of the coverages provided bysuch policies and the authorities construing them. In this article, we will focus onsome of the more important of those coverage lessons, including the following:

• Coverage for consequential, “resulting” damage caused by defective parts (orwork);

• Durational limits on coverage and the possibility of obtaining “extended,”maintenance period coverage for construction-related property damage;

6 The exception language eliminated by this exclusion reads as follows: “This exclusion does notapply if the damaged work or the work out of which the damage arises was performed on your behalfby a subcontractor.” See What is Covered, supra note 3.

7 Owners obviously want protection from the financial loss resulting from negligent constructionwork. The most obvious source of such protection is either the financial resources of the contractoritself (the reason for indemnity/warranty clauses in construction contracts) and/or the resources ofa third party, solvent insurer (the reason for including related insurance clauses in constructioncontracts). As illustrated by the growth of Owner Controlled Insurance Programs (OCIPs), thesource of the protection provided, whether the financial resources of the contractor or of an insurer,usually is irrelevant. Thus, especially in the case of project-related builders risk coverage, the projectowner/developer and even the company providing project financing usually are named asco-insureds or additional insureds on the ARBR policy. Issues concerning OCIP coverage andquestions of co-insured or additional insured coverage for owners, developers and contractors arebeyond the scope of this article.


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• Coverage for “diminution in value”/loss of use of the project; and

• “Specialty” provisions, such as “sue and labor” clauses in marine forms or“delay in start-up” coverages in ARBR forms that may not expresslycorrespond with the same policy language in the other form, but that canprovide a valuable coverage resource.

§ 3.02 REVIEW OF KEY POLICY CLAUSES

As discussed above, comparison of the American Institute Form8 and thetypical, shore-based ARBR form may not reveal identical or perhaps evenequivalent policy language. Nevertheless, there are enough similarities in thecoverage provided that the authorities construing marine builders risk forms canprovide useful guidance in seeking coverage under ARBR forms and vice versa.Both forms of policies protect against course of construction losses resulting fromdamage to the “vessel” or the “project” during the course of construction.Moreover, as reflected by the “defective parts” caveat to the “all risk” language ofthe traditional American Institute Form quoted above, a marine builders riskpolicy will not cover repair or replacement of the defective part itself or“betterment of design.” Similarly, an ARBR policy covering shore-based con-struction risks will also typically contain exclusions for claims limited to the costof repairing defective parts. Such exclusions may be worded as follows:

This Policy does not insure against:. . .

The cost of making good faulty or defective workmanship, material, construc-tion, designs, plans and/or specifications, but this exclusion shall not apply todirect physical loss or direct physical damage resulting from such faulty ordefective workmanship, material, construction, designs, plans and/or specifi-cations.

Such exclusions will bar or at least limit coverage for damage caused by installingimproperly designed or improperly manufactured parts; but the limitation oncoverage for the cost of repairing the defects will not entirely bar coverage, if itcan be shown, as discussed below, that failure of the defective part or parts causedconsequential, “resulting” damage. Proof of such damage, including in someinstances, significant financial exposure caused by loss of use of the vessel orplant, can trigger builders risk coverage in appropriate circumstances.

8 Recently, the London market has replaced or at least supplemented the traditional versions ofthe American Institute Form with an all-new WELCAR form. The evolution of the new form isattributable in large part to the need for coverage that expressly addresses the potentially hugefinancial and other unique risks regarding the billions of dollars being expended for offshore oil andgas exploration and extraction. See generally David Sharpe, Upstream and Offshore EnergyInsurance 231-37 (2d ed. 2009).


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The issue of whether or not a contractor (or project owner) is insured forconsequential loss of use or diminution in value of the project also has generatedconsiderable controversy and uncertainty regarding the scope of construction-related insurance coverage. Coverage for “loss of use” is a common, but oftenmisunderstood and overlooked component of the definition of “property damage”in standard property or CGL policies. Such language can be a basis for obtainingcoverage for the owner’s construction-related financial loss; or in the case ofPCOH coverage, for the contractor’s risk of liability for such loss after the projectis completed. However, the relevant language of the typical ARBR form differsand may be more restrictive. By contrast, the American Institute Form containslanguage that expressly covers diminution in value of the vessel caused byunrepaired or unrepairable damage attributable to flawed construction. The policyform is worded in the negative, but contains a positive grant of coverage for suchlosses:

No claim for unrepaired damage shall be allowed, except to the extent that theaggregate damage insured against under the policy and left unrepaired at theexpiration hereof shall be demonstrated by the Assured to have diminished theactual market value of the Vessel on that date if undamaged.

As discussed below, even if similar or equivalent language is not included in theARBR form covering the shore-based project, the insured contractor should notoverlook the possibility of triggering such coverage under the “loss of use”definition of property damage in its other policies.9

Also, assuming diminution of value/loss of use coverage is not available inthe ARBR form, contractors should consider purchasing an alternative form of“economic loss”10 coverage for “delay in start-up.” Such coverage, which issimilar to the “business interruption” coverage in an owner’s property policy,insures against the risk of financial loss resulting from a construction-related shutdown or interruption that delays the start-up of the plant or occupancy of thefacility, resulting in loss of income and profits from planned operations. Becausedelay in start-up coverage may overlap to some extent with the owner’s businessinterruption coverage, assuming the damage that causes the shutdown or partialshutdown/delay is construction-related, ARBR delay in start-up coverage canprovide valuable, supplemental coverage that, in its effect, is somewhat similar tothe “diminution in value” coverage included in the American Institute Form.Normally, however, the owner’s business interruption coverage will insure against

9 See Diminution in Value, supra note 5.10 Insurance carriers often contest extending coverage for financial risk, invoking the “economic

loss” doctrine; however, that doctrine applies to “negligence” claims in tort cases, which in somejurisdictions cannot be based on economic (financial) loss alone absent some other, compensabledamage. The doctrine should not apply to a contract-based claim for policy coverage, especiallywhere the policy contains appropriate language and the loss arises out of a covered occurrence. SeeDiminution in Value, supra note 5 at 223-26.


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all post-construction occurrences, whether construction-related or not, whereasthe ARBR delay in start-up coverage is only triggered by actual, construction-related physical damage that typically must occur during the construction periodand delay the completion of the project.

The duration of the builders risk coverage is another issue that can generatecontroversy between the policyholder, its ARBR carrier, and between the ARBRcarrier and other carriers who insure the owner against post-completion propertydamage. Obtaining some form of extended builders risk coverage may be criticalto the contractor’s financial well being because its available CGL coverage, andeven the owner’s property insurance policy, may not cover damage caused by“faulty workmanship.” As a result, the contractor should consider purchasing a“maintenance” period extension of the ARBR coverage, if available. One form ofsuch coverage, which is incorporated in the WELCAR marine builders risk form,protects the contractor when property damage occurs during the specified“maintenance period,” which may (and should) correspond with the warrantyperiod specified in the construction contract. While the coverage provided isworded as “maintenance period” coverage, such coverage can include protectionsagainst damage caused either by negligent repair work undertaken to correctwarranted flaws or by pre-existing construction flaws. The only requirement isthat the damage at issue must occur during the specified maintenance period andbe construction-related.

Another important question of coverage derives from a long-establishedprinciple of English law that has been extended, in some cases, to U.S. policiesincluding some forms of builders risk policies. “Sue and labor” clauses arecommonly used and effectively mandated by English law to be incorporated in allforms of marine risks coverages, including marine builders risk. Such clausesrequire the insured to take appropriate action, when possible, to avert or minimizeloss and in turn, obligate the carrier to reimburse the reasonable costs of takingappropriate preventive action. In relevant part, the sue and labor clause of theAmerican Institute Form reads as follows:

And in the case of any Loss or Misfortune, it shall be lawful and necessary forthe Assured . . . to sue, labor and travel for, in and about the defense,safeguard and recovery of the Vessel or any part thereof, without prejudice tothis insurance, to the charges whereof the Underwriters will contribute theirproportion. . . .

As is the case regarding the other subjects of coverage highlighted in thisarticle, there are “lessons” to be learned from the history, language, and caseauthority applying marine “sue and labor” principles that may be borrowed andapplied in seeking coverage for shore-based construction losses.


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§ 3.03 LESSON NO. 1: PROOF OF CONSEQUENTIAL, RESULTINGDAMAGE

As discussed in the introduction, ARBR policies and their marine counter-parts typically exclude coverage for the cost of replacing or repairing defectiveparts or faulty workmanship. However, these “faulty workmanship” exclusions donot bar coverage for the costs to repair resulting damage to non-defectiveproperty, including loss of use or diminution in value of the project as a whole.Regardless of the type of policy at issue, it is essential to distinguish between the“faulty workmanship” or “defective product” and the resulting damage. Accord-ingly, examining the significant overlap in the case law construing marine buildersrisk and CGL policies can provide valuable guidance in addressing these issuesunder ARBR policies.

For example, in Trinity Industries, Inc. v. Insurance Co. of North America,11

the insured builder sought coverage under its marine builders risk policy for sumsit paid to the owner of a vessel as a result of an arbitration concerning a “twist”in the vessel caused by the insured’s misalignment of hull sections duringconstruction. The trial court ruled that the arbitration award was within coverage;however, the Fifth Circuit reversed based on its interpretation of the phrase“physical loss or damage,” which it interpreted as requiring that an external eventchange the insured property from an initial, satisfactory state to an unsatisfactorystate. While the court recognized the unique scope of coverage in “all risks”policies, it noted that such coverage did not extend to the costs incurred incorrecting defective workmanship, at least in cases in which the defectiveworkmanship did not cause an accident resulting in physical injury to otherinsured property.12 Because the twist in the hull sections did not, in turn, lead toan accident, the court of appeals concluded that the arbitration costs were notcovered because the policy did not cover costs associated with defective, initialconstruction.

The Texas Court of Appeals reached the same conclusion in North AmericanShipbuilding, Inc. v. Southern Marine & Aviation Underwriting, Inc.,13 in whichthe insured sought coverage under a similar all risks marine policy for costsincurred in repairing faulty welds caused by improperly mixed welding gas. Thecourt of appeals, relying heavily on the Fifth Circuit’s interpretation of “physicalloss or damage” in Trinity, affirmed the trial court’s grant of summary judgmentin favor of the insurer because the defective welds did not result in an accident

11 916 F.2d 267 (5th Cir. 1990) (applying Louisiana law).12 The court distinguished cases in which the resulting loss was caused by a “discrete event,”

such as the collapse of a concrete dome or brick wall. See, e.g., Dow Chem. Co. v. Royal Indem.Co., 635 F.2d 379 (5th Cir. 1981) (collapse of concrete dome caused, in part, by defectiveconstruction of styrofoam form); Essex House v. St. Paul Fire & Marine Ins. Co., 404 F. Supp. 978(S.D. Ohio 1975) (faulty workmanship led to partial collapse of brick wall).

13 930 S.W.2d 829 (Tex. App. 1996).


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causing physical injury to insured property. In reaching its decision, the courtnoted that “[n]either the welds North American replaced nor the twisted hull inTrinity were ever in ‘an initial satisfactory state that was changed by someexternal event into an unsatisfactory state.’”14

These cases arguably ignore the fact that a marine builders risk policy issupposed to cover negligent, faulty construction—not only the external “perils ofthe seas” that might cause damage to the vessel. More recent Texas casesaddressing construction-related PCOH claims recognize a distinction between thecost of repair or replacing initial, “defective construction” and the cost ofrepairing consequential damage caused by the defective construction. Forinstance, in Lennar Corp. v. Great American Insurance Co.,15 the Texas Court ofAppeals considered claims for coverage under the PCOH provision of ahomebuilder’s CGL policy for liability claims arising out of the installation ofdefective EIFS (exterior insulation and finish system) siding in more than 400homes. The insured homebuilder sought coverage for the repair of consequentialwater intrusion damage (wood rot, mold, damage to wallpaper, paint, carpet, etc.)as well as the cost of removing the defective EIFS siding and replacing it with“traditional” stucco siding. The court held that the costs associated with repairingthe damages resulting from water intrusion were covered because the waterintrusion had caused consequential, “physical damage” to the completed homes,triggering the PCOH coverage. However, the court concluded there was nocoverage for the cost of replacing the defective EIFS absent evidence of actualphysical damage to the siding or the homes caused by the siding. The court madethe following observation:

The carriers cite North American Shipbuilding, Inc. v. Southern Marine &Aviation Underwriting, Inc., in which the court held that the insuredshipbuilder’s replacement of initially defective welds did not constitute“physical loss . . . or damage” as required for coverage under a builder’s riskpolicy. . . . The court stated that the defective welds were never in “an initialsatisfactory state that was changed by some external event into an unsatis-factory state,” but instead came into existence in a damaged state. . . . [W]eagree with its reasoning at least with respect to its interpretation of “propertydamage” because it is consistent with the definition of “property damage” inthe CGL policies, which requires “physical injury” to tangible property. SeeFid. & Deposit Co. of Md. v. Hartford Cas. Ins. Co., 215 F. Supp. 2d 1171,1183 (D. Kan. 2002). . . . Here, the EIFS was not physically injured afterapplication to the homes; the EIFS was not changed from a satisfactory stateinto an unsatisfactory state, or otherwise physically altered. Rather, the EIFS

14 Id. at 833-34.15 Cited supra note 5.


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was already in an unsatisfactory state when applied to the homes because itis inherently defective. Therefore, the defective EIFS does not constitute“property damage.”16

The majority of cases addressing construction-related damage claims(whether construing marine or shore-based ARBR policies) have held that thecosts of repairing or replacing a defective part or faulty workmanship are notcovered; however, courts will typically find coverage if the defective part or faultyworkmanship causes consequential physical damage to other parts of the insuredproject (or “vessel”). The key issue in these disputes, regardless of the type ofpolicy at issue, is identifying the line of demarcation between the defective partor faulty workmanship and the resulting damages. The ruling in PrometEngineering (Singapore) Pte. Ltd. v. Sturge and Others, (The “Nukila”)17

contains one of the more interesting and thorough discussions of this issue underU.K. marine insurance law.

The Promet court addressed the issue of the scope of coverage for resultingdamages caused by an inherent defect in the tubular “legs” of a mobile offshoreoil platform installed in the Java Sea. Four years after installation, during a routineinspection, significant cracks were discovered between the tubular legs and the“spud cans” that anchored the legs to the seabed. The cracks were caused bydefective welds. Because the cracks created a risk of collapse of the platform, thelegs were jacked up and the platform towed to port for repairs. The owner claimedcoverage under its marine policy, invoking the “Inchmaree” Clause coveringdamage to the platform caused by “latent” defects and the “sue and labour [sic]”clause of the policy.18

The trial court rejected the claim for physical damage to the platform, rulingthat “neither the columns nor the spud can had separate functions; they werephysically joined together by the welds supported by internal diaphragms andbulkheads to form one structure which enabled the platform to stand on theseabed; what happened here was that there were flaws in the weld whichdeveloped into cracks . . . it was impossible to see that at this stage anything

16 Id. at 679 (emphasis added). The outcome may differ in cases involving the negligentworkmanship of a subcontractor that damages the completed “work” of the insured generalcontractor, including the negligently installed component, as opposed to the non-negligentinstallation of a defective “part,” such as the defective EFIS siding. See supra note 3 (discussing thePozzi ruling).

17 [1997] 2 Lloyd’s Rep. 146 (C.A.).18 The Inchmaree Clause, common in marine policies for more than 100 years, covers

consequential damage to the “vessel” caused by a latent defect. See supra note 1. The policy at issuein Promet also contained an “additional perils” clause that covered damage to the “defective part”itself, if that part caused consequential damage covered by the Inchmaree Clause. Id. at 149. Thecombination of the “defective parts” clause and the defective parts “buyback” clause in the morerecent WELCAR form operate in a similar fashion. Like the Inchmaree Clause, the defective partsclause also refers to consequential damage caused by a “latent” defect.


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consequential had happened which could be characterized as damage to thevessel. . . .”19 The insured appealed, and the court of appeals reached a differentconclusion.

Lord Justice Hobhouse provided the principal ruling of the court of appeals.Because defective welds had caused the fatigue cracks at issue, Justice Hobhousehad little difficulty in concluding that the defective welds were “latent,” i.e.,unknown to the owner, and hence fortuitous: “The presence or absence of a latentdefect in the hull or machinery of a vessel is, by definition, unknown to theassured and whether or not . . . such a defect . . . will during a given period oftime . . . cause any damage is fortuitous from the point of view of the assured.”20

He then concluded that the progression of the fatigue cracks, caused by thedefective welds, constituted consequential damage to the “vessel” that triggeredcoverage:

At the commencement of the period of cover there was a latent defect in thewelds joining the underside of the top plate of each spud can to the externalsurface of the leg tube. By that time that latent defect had also given rise tominute fatigue cracks in the surface of the tube in the way of the weld whichcould also properly be described as latent defects. Those features during theperiod of cover caused extensive fractures in the full thickness of the tubeextending in places both above and below the defective weld, extensivefractures in the metal of the top plating and bulkheads of the spud cans andother fractures at other locations. This was on any ordinary use of languagedamage to the subject-matter insured, the hull etc. of Nukila.21

The court of appeals acknowledged that the insured must show a “physicalchange in the condition of the vessel” caused by the latent defect, however, thecourt rejected the proposition that the leg assembly as a whole was a “defectivepart,” concluding instead that the leg assembly was part of the hull that had beendamaged by the latently defective welds.

In the United States, the issue of coverage for resulting damages caused byconstruction flaws often arises in policies that exclude coverage for the “cost ofmakinggoodfaultyordefectiveworkmanship,materials,constructionordesign. . . .”Such exclusions usually contain an exception allowing coverage for “damageresulting from such faulty or defective workmanship, material, construction ordesign.” The intent of these provisions is to reaffirm the distinction between the

19 Id. at 147.20 Id. at 151.21 Id. at 152. Justice Hobhouse questioned whether or not it was necessary, for coverage

purposes, to identify a discrete, latently defective “part” that damaged another non-defective part.He concluded that if such a finding were necessary, the weld itself qualified as a “part”: “The weldis a part just as much as is a bracket or bulkhead or plate or the totality of the leg structure.” Id. at156. Concurring Lord Justice Ward agreed that it was not necessary or required by the policy todetermine whether or not a discrete, identifiable “part” had caused the damage, so long as thedamage at issue had been caused by a latent defect. Id. at 160.


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cost to repair or replace defective parts that were never in a “satisfactory state,”which is not typically covered, from the costs incurred in repairing resulting or“ensuing loss” damage to non-defective property caused by the defective part,which is covered.22

For instance, in Laquila Construction, Inc. v. Traveler’s Indemnity Co.,23 theinsured contracted to provide concrete of a certain minimum strength forconstruction of a new building. Construction on the project was halted after it wasdiscovered that the concrete was below the required minimum strength. Some ofthe work that was previously completed had to be removed and later reinstalledin order to remove and replace the defective concrete slab on the fifth floor. Theinsured made a claim under its ARBR policy for the costs of repairing the slab aswell as the costs of shoring the height of the building while the corrective worktook place. The insurer denied coverage based on the following exclusion:

1. PERILS EXCLUDED. . .

(b) Cost of making good faulty or defective workmanship or material, but thisexclusion shall not apply to physical damage resulting from such faulty ordefective workmanship or material.24

The insured argued that the “resulting loss” provision covered the costs associatedwith the removal and reinstallation of the additional building materials because,according to the insured, the defective concrete “physically damaged the insuredproperty (the structural slab and/or the building as a whole) because it wasphysically incorporated into the larger entity and could only be removed at acost.”25 The court disagreed, finding that the mere removal of the defectiveconcrete slab did not constitute physical loss or damage to covered property.Importantly, the court noted that, had the defective concrete collapsed anddamaged other, non-defective property, those losses would qualify as coveredensuing losses under the policy. As discussed in the concluding sections of thisarticle, the outcome might have differed if the policy had contained a “sue andlabor” clause covering loss prevention costs.

A similar result was reached in Allianz Insurance Co. v. Impero,26 in whichthe insured sought coverage under its ARBR policy for the cost of repairing voidsin a concrete wall which were caused by a subcontractor’s failure to perform

22 All-risk policies that refer to “resulting” loss or damage are functionally equivalent to policiesreferring to “ensuing” loss or damages. See, e.g., Continental Cas. Co. v. Landmark Hotels, LLC,184 F. App’x 649, 650 (9th Cir. 2006) (noting that resulting loss provision operated precisely likeensuing loss provision); Wright v. Safeco Ins. Co. of Am., 109 P.3d 1, 7 (Wash. Ct. App. 2004)(holding that “ensuing loss provisions are exceptions to policy exclusions . . .”).

23 66 F. Supp. 2d 543 (S.D.N.Y. 1999), aff’d, 216 F.3d 1072 (2d Cir. 2000).24 Id. at 544 (emphasis added).25 Id. at 545.26 654 F. Supp. 16 (E.D. Wash. 1986).


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appropriate “slump” tests on the concrete mixture. The faulty workmanshipexclusion at issue eliminated coverage for the “[c]ost of making good faulty ordefective workmanship, material, construction or design, but this exclusion shallnot apply to the damage resulting from such faulty or defective workmanship,material, construction or design. . . .”27 Because the defective concrete in thewalls did not cause any damage to any other portion of the structure or property,the court held that the loss was not covered. The court explained that, “when acontractor assumes the obligation of completing a structure in accordance withplans and specifications and fails to perform properly, he cannot recover under theall-risk policy for the cost of making good his faulty work.”28 As in Laquila, thecourt noted that a different result may have been reached if the wall had collapsedand caused damage to other portions of the project or equipment.29

Likewise, in Vermont Electric Power Co. v. Hartford Steam Boiler Inspec-tion & Insurance Co.,30 the insured sought coverage under its all risks policy fordamages to transformers caused by a design defect. The policy at issue containedthe following exclusion:

This policy does not insure against loss caused by any of the following.However, any ensuing loss not excluded or excepted in this policy is covered.

C. Faulty, inadequate, or defective:. . .

(2) design, specifications, workmanship, repair, construction, renovation,remodeling, grading, compaction . . . of part or all of any property, on or offthe described premises.31

The insured argued that coverage should be allowed because the design defect hadcaused “ensuing loss” damages to the transformers.32 The court rejected thisargument:

This case presents precisely the type of situation in which the loss is directlyrelated to the original excluded risk. Characterizing the damage to thetransformers as an ensuing loss would supersede Continental’s exception forlosses caused by design defect. As Continental’s policy unambiguouslyexcludes coverage for such losses, Continental’s motion for summary judg-ment is granted.33

27 Id. at 17.28 Id. at 18.29 Id. See also GTE Corp. v. Allendale Mut. Ins. Co., 372 F.3d 598, 605 (3d Cir. 2004) (court

ruled that “cost of making good” exclusion in an all-risks policy applied to costs incurred inredesigning computer equipment to avoid Y2K issue because there was no allegation that designflaw caused damage to other property).

30 72 F. Supp. 2d 441 (D. Vt. 1999).31 Id. at 445.32 Id.33 Id.


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Laquila, Impero, and Hartford Steam hold that an insured will not be able torecover the costs incurred in repairing defective parts or workmanship absentevidence of actual property damage that can be characterized as a resulting or“ensuing” loss. Careful review of policy language and case authority is important,however, as some courts have recognized that damage to a non-defective part orproduct caused by the negligent installation of that product can be covered.34

Moreover, if the defective part or faulty workmanship causes consequentialdamage to other property, most courts hold that the insured may recover all thecosts associated with the resulting damage, including, in some cases, the costs ofremedying the cause of the loss.

For example, in National Fire Insurance Co. v. Valero Energy Corp.,35 theTexas Court of Appeals held that an exception in the ARBR policy for damages“arising as a consequence” of faulty workmanship covered a loss resulting fromthe use of inadequately designed machine components. During the testing phaseof an oil refinery expansion project, a citrate scrubber sustained substantialdamage because of a faulty design. As a consequence, the insured had to shutdown the refinery to make repairs and alterations. The ARBR policy at issueexcluded the cost of making good faulty workmanship, materials, construction ordesign, but excepted from the exclusion “physical loss or damage arising as aconsequence of faulty workmanship, material, construction or design.”36 The courtreasoned that the loss at issue could be characterized in one of two ways: (1) theuse of inadequate components required the insured to replace them to “makegood” the faulty design; or (2) as a consequence of the faulty design and theinadequacy of the components, there was physical damage to the componentsnecessitating their replacement. Adopting a reasonable construction of theexclusionary clause favoring the insured, the court concluded that the loss hadoccurred “as a consequence of” the faulty design, thereby bringing the loss withinthe scope of coverage.

Similarly, in Rosenberg v. First State Insurance Co.,37 the insured obtainedan ARBR policy for a commercial building under construction. The policycovered lost rents due to “untenantability, caused by damage to or destruction ofthe building . . . by the peril(s) insured against during the term of this policy.”38

In addition, the policy contained the standard form of exclusion for “making goodfaulty or defective workmanship” with the exception for “damage resulting fromsuch faulty or defective workmanship. . . .”39 The insureds did not complete thebuilding on schedule due to damage resulting from the premature removal of

34 See supra note 3 (discussing Pozzi ruling), and cases discussed in the No Occurrence Mytharticle.

35 777 S.W.2d 501 (Tex. App. 1989).36 Id. at 505 (emphasis added).37 280 Cal. Rptr. 388 (Ct. App. 1991) (unpublished decision).38 Id. at 390.39 Id. at 389.


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“shoring” used in the construction of the subterranean garage which causedsloping, cracks, and water accumulation. The insurer argued that faulty work-manship was an excluded peril, barring coverage for the claimed lost rents; but theCalifornia Court of Appeal disagreed:

To the contrary, the phrase stating this exclusion goes on to clarify that “thisexclusion shall not apply to damage resulting from such faulty or defectiveworkmanship, material, construction or design.” Because damage resultingfrom defective workmanship is expressly covered by the policy, the conclu-sion is inescapable that faulty workmanship is a covered peril.40

Valero and Rosenberg illustrate that resulting damages to other propertycaused by a defective part or faulty workmanship is an insured loss, notwith-standing the fact that the cost of repairing or replacing the defective workmanshipor defective part itself may be excluded. As previously noted, the central issue insuch cases is the line of demarcation between the defective workmanship or partand proof of resulting consequential (or ensuing) damages. As discussed below,the application of the faulty workmanship exclusion and the necessary distinctionbetween the defective part or faulty workmanship and the resulting damages alsois extremely important in determining whether “resulting” loss of use ordiminution in value of the project as a whole is covered.

§ 3.04 LESSON NO. 2: AVAILABILITY OF DIMINUTION INVALUE/LOSS OF USE COVERAGE

While ARBR policies and their marine counterparts typically excludecoverage for the costs of repairing or replacing defective parts and faultyworkmanship, it is not a foregone conclusion that such policies will categoricallyexclude resulting diminution in value or loss of use of the project as a whole. Asnoted above, the American Institute Form of marine builders risk coverageexpressly covers the diminution of the “actual market value of the vessel” causedby unrepaired (or unrepairable) damage. Another form of “Institute Clauses forBuilders’ Risks” contains even clearer language:

UNREPAIRED DAMAGE

11.l The measure of indemnity in respect of claims for unrepaired damageshall be the reasonable depreciation in the market value of the Vessel at thetime this insurance terminates arising from such unrepaired damage, but notexceeding the reasonable cost of repairs.

WELCAR Policy (Institute Clauses for Builders’ Risks).

40 Id. at 392.


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Regardless of whether the particular policy provides coverage for resultingdiminution in value and/or loss of use, one must pay particular attention to thecause of the resulting damage and determine whether such losses were attributableto an excluded event or peril, such as faulty workmanship,41 or whether, asdiscussed above, an “ensuing” or “resulting” loss exception applies.42 Moreover,CGL policies and other types of policies, such as professional liability policiesthat expressly cover design-related construction flaws or “construction manage-ment” errors and omissions, usually define covered “property damage” to include“loss of use” of undamaged property as an insured risk.43

The language of ARBR policies may differ, however, such policies oftenlimit coverage to actual physical damage. As a result, if the loss of use ordiminution in value occurs solely because of the incorporation of a defectivecomponent, without any consequential physical damage to non-defective parts,then the resulting losses probably are not covered under the all risk policy,assuming the standard exclusion for the repair of defective parts applies.44 Inother words, under the wording of many, if not most ARBR policies, the insuredmust show some tangible evidence of actual, physical damage to the insuredproperty to trigger the policy coverage.45 However, if the “your work” exclusionsin the contractor’s CGL policy can be avoided, the CGL policy can provideliability coverage (in the case of a claim by the owner) for loss of use/diminutionin value that is broader than the coverage available under the ARBR policy.

41 See generally State Farm Fire & Cas. v. Superior Court, 264 Cal. Rptr. 269 (Ct. App. 1989)(ruling that insured’s claim for diminution in value of condominium complex was excluded underthe terms of an all-risk property policy because it was directly caused by faulty workmanship, whichwas an excluded peril).

42 See Laquila, supra, 66 F. Supp. 2d at 546; Impero, supra, 654 F. Supp. at 18.43 See Hartford Cas. Co. v. Cruse, 938 F.2d 601, 604 (5th Cir. 1991) (applying Texas law) (court

concluded that the exclusion at issue only barred recovery of the costs of repairing the faultyfoundation, but “does not apply to the diminution in the value of the Cruse’s home that remainedafter correction of [the] faulty work, and to repair costs for other property . . . to the extent that theseparticular items of damage require repair other than to the foundation itself”) (emphasis added); seealso Riley Stoker Corp. v. Fid. & Guar. Ins. Underwriters, Inc., 26 F.3d 581, 588 (5th Cir. 1994)(applying Louisiana law) (court concluded that the work/product “business risks” exclusions in theCGL policy at issue barred recovery of the costs of repairing the defective mills and the steamgenerators, but allowed recovery for “delays caused by the mechanical failures,” rejecting thecarrier’s arguments that because recovery for the physical property damage was barred, “the loss ofuse caused by the [excluded] physical injury must also be excluded”); accord Hartzell Indus., Inc.v. Fed. Ins. Co., 168 F. Supp. 2d 789, 794-96 (S.D. Ohio 2001) (court found that temporary loss ofuse of boiler room resulting from incorporation of defective fans installed by insured was coveredunder a CGL policy); Diminution in Value, supra note 5.

44 See North American, 930 S.W. 2d 829, and Trinity, 916 F.2d 26, supra.45 Some courts considering coverage under CGL policies have held that incorporation of a

defective component or faulty workmanship constitutes an immediate “physical injury to tangibleproperty” and have allowed coverage for resulting decreases in the value of the property. See, e.g.,Hauenstein v. St. Paul-Mercury Indem. Co., 65 N.W.2d 122, 124 (Minn. 1954) (ruling that use orapplication of defective plaster on building constituted injury to covered property).


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For example, in Todd Shipyards Corp. v. Turbine Service, Inc.,46 the courtdetermined that the “injury to work” exclusion47 in the CGL policy at issueexcluded the cost of repairing or replacing the insured’s work product, which wasfound to have been a defective turbine, but it did not apply to the “overall damagethat the incorporation of the defective work product causes to the entire[vessel].”48 As a result, the court concluded that the costs associated with the lossof use of the vessel were covered. In such a case, unless the “faulty workmanship”and/or “design defect” exclusion expressly bars coverage for the resultingdiminution in value or damage to non-defective parts, it can be argued that suchdamages are covered, assuming there is evidence of “physical injury or damage”to other property. The argument for protection against claims for diminution invalue is strongest under policies that define insured “property damage” to include“loss of use of tangible property.” Nevertheless, the reasoning employed in CGLand marine builders risk cases allowing coverage for loss of use or diminution invalue may be useful in seeking coverage for this additional element of loss, ifcaused by construction-related physical damage covered by an ARBR policy.

§ 3.05 LESSON NO. 3: EXTENDED COVERAGE FORPOST-CONSTRUCTION DAMAGE

[A] Maintenance Period Coverage

Because post-construction damage caused by “faulty workmanship” may notbe covered by a contractor’s CGL policy, obtaining some form of extended,post-completion ARBR coverage may be critical. A good example of extendedmaintenance coverage is provided by the WELCAR 2001 Offshore ConstructionProject Policy, which reads as follows:

18. MAINTENANCE

The cover provided hereunder shall be no wider than that contained elsewherein the Policy. Coverage under Section I [i.e. Physical Damage Insurance] onlyshall continue during the maintenance period(s) specified in individualcontracts but not exceeding a further 24 months from expiry date of theProject Period as set out in Item 3 of the Declarations. During such mainte-nance period(s), coverage is limited to physical loss or physical damageresulting from or attributable to:

46 674 F.2d 401 (5th Cir. 1982).47 Exclusion “O,” which is found in most standard CGL forms, excludes coverage for “property

damage to work performed by or on behalf of the named insured arising out of the work or anyportion thereof, or out of the materials, parts or equipment furnished in connection therewith.” Id.at 420.

48 Id. at 421.

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a. faulty or defective workmanship, construction, material or designarising from a cause occurring prior to the commencement of themaintenance period; and

b. operations carried out by Other Assureds during the maintenanceperiod(s) for the purpose of complying with their obligations inrespect of maintenance or the making good of defects as may bereferred to in the conditions of contract, or by any other visits to thesite necessarily incurred to comply with qualifications to theacceptance certificate.

Notwithstanding the above, however, coverage under Section II [i.e. LiabilityInsurance] shall also continue during the Maintenance Period but specificallyexcluding the operating risk after hand-over and only in respect of occurrencesor circumstances as described in paragraphs a and b above. (emphasis added).

Subpart (a) applies to damage occurring during the maintenance period thatis caused by pre-existing, construction-related flaws. Subpart (b) insures againstdamage caused by maintenance period “operations carried out by Other As-sureds.” While Subpart (a), by its own terms, covers damage “attributable to . . .defective material,” the clause contains a caveat that the “cover providedhereunder shall be no wider than that contained elsewhere in the Policy.” As aresult, underwriters may contend that the maintenance period coverage is nobroader than the limited policy coverage for “defective materials;” however, thecase authority has not yet addressed this issue under this relatively new form ofmarine-based coverage.

A maintenance coverage extension similar to the language of the WELCARform could be a valuable addition to an ARBR policy, as such coverage willprotect against post-completion property damage that occurs during the specifiedmaintenance period as a result of construction-related flaws or negligent, post-completion maintenance (warranty) work. It is especially important to consideradding such coverage to the ARBR program given the more limited scope ofPCOH coverage being made available in standard CGL policies. In addition tomaintenance coverage, contractors should consider obtaining coverage for thecosts and financial losses incurred as a result of an insured loss that delayscompletion of a project and start-up of the plant’s operations. Such coverage canbe a viable substitute for the “loss of use” coverage that may not be available inthe typical ARBR form. Such coverage provides an alternative resource to protectagainst claims for “delay” (liquidated) damages that typically are excluded fromcoverage by most ARBR policies.

[B] Delay in Start-Up Coverage

Construction-related delays can result in significant financial loss to theproject owner, who cannot commence profitable production or lease the spaceavailable in the otherwise completed project. The costs of such delay may be

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accounted for in part in a liquidated damages penalty specified in the constructioncontract. Certainly, when a construction-related fire, explosion, collapse or othercatastrophe strikes, the labor and material costs incurred to repair the physicaldamage can be substantial and should be covered under the ARBR policy; butthese costs may be rivaled or eclipsed by the owner’s financial loss resulting fromthe delay in completion of the project. In addition, the contractor may incursignificant delay in start-up losses, such as ongoing interest on construction loansand refinance charges; real estate taxes; insurance; legal, accounting, consulting,and developer’s fees; equipment rental; office overhead; travel expenses; inspec-tion fees; marketing; and re-leasing expenses.49

The basic form of ARBR policy will cover the cost of repairing construction-related physical damage, but not the financial loss resulting from delayedcompletion. The question is whether such losses, if caused by an insured event,should be covered by (a) liquidated damages specified in the construction contact;(b) the owner’s property damage policy, which may include a “businessinterruption” component; or (c) a “delay in start-up” endorsement to the ARBRpolicy. In the first two of these alternatives, the risk ultimately will be borne bythe contractor, either directly as a liquidated damages penalty or indirectly as aresult of a subrogation claim by the owner’s business interruption insurer. Option(c) should be considered because in that instance, the risk is borne by the ARBRinsurance carrier.

Insurance carriers and brokers were traditionally lackadaisical in theirapproach to delay in start-up coverage, treating it as an afterthought that meriteda generic, ambiguous endorsement or merely a check box on the declarationspage.50 Standard ARBR policies typically do not provide delay in start-upcoverage, but a recent decision applying New Jersey law suggests that contractorsshould consider pursuing such claims in appropriate circumstances. In ZurichAmerican Insurance Co. v. Keating Building Corp.,51 the policyholder contractedto build a 27 floor, $173 million expansion to the Tropicana Hotel and Resort inAtlantic City, New Jersey. Six floors of the structure collapsed during construc-tion, delaying the project by eight months and causing $80 million in damages.The ARBR insurer paid a portion of the damages and then filed suit, asking thecourt to declare that its policy did not cover the following three categories of delaylosses: (1) “extended general conditions” expenses for additional administrativecosts, trailers, supplies, and other costs not captured as direct costs; (2)

49 Jonathon C. Held & Lisa A. Enloe, Builders Risk—Measuring Delay at 2 (June 1, 2009),http://www.heldenloe.com/news/BuildersRiskMeasuringDelay.pdf; Tony D’Amico, Soft Cost orDelay in Opening: Insure for the Potential Exposure, Adjusting Today (2009), http://www.adjustersinternational.com/atpdf/3034_SoftCosts.pdf.

50 Roger D. Branigin, Daniel N. West, & Chris Tymchuck, Coverage for Delay and “Soft Costs”Under Builder’s Risk Policies: Avoiding the Pitfalls, ABA TIPS Practice Section, Property InsuranceLaw Committee Annual Spring Meeting at 3-4 (May 15, 2009).

51 513 F. Supp. 2d 55 (D.N.J. 2007).

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“contractor’s delay expenses” for idled labor and equipment; and (3) storage costsand increases over time in the prices of wages and material costs.

Three policy provisions played a central role in the coverage dispute. First,the property damage insuring clause provided broad coverage for “all risks ofdirect physical loss or damage to the Insured Project.” Second, the policycontained an exclusion barring coverage for:

Consequential loss, damage or expense of any kind or description includingbut not limited to loss of market or delay, liquidated damages, performancepenalties, penalties for non-completion, delay in completion, or non-compliance with contract conditions, whether caused by a peril insured orotherwise, however the foregoing shall not exclude Delay in CompletionCoverage when it is endorsed to the Policy.52

Third, the policy included a “Delay in Completion Coverage” endorsement thatprovided coverage for the owner’s “loss of gross earnings, rental income and ‘softcosts/additional expenses’ associated with a delay in the building’s constructionschedule.”53

The insurer argued that the general insuring clause only covered the directcosts of repairing or replacing the damaged property and not the contractor’s “softcosts” resulting from the delay in completion. The court found no such limitationin the broad language of the all-risks insuring clause. In addition, and seeminglymore important to the court, the same insurer had issued more restrictive ARBRpolicies that restricted coverage to costs incurred to “rebuild, repair, or replacesuch part of the property herein described as has been damaged or destroyed.”54

This evidence established that, if the insurer had “intended to limit its obligationsunder the Policy to only obligations to repair costs for the damaged portion of theProject, . . . [it] could have used language imposing this type of coveragerestriction.”55

Turning to the consequential damage exclusion, the court rejected theinsurer’s argument that the expenses were “the epitome of [uninsured] conse-quential losses as they are losses that ‘do not flow directly and immediately fromthe act of the party, but only from some of the consequences or results of suchacts.’”56 First, the court found that the collapse was an insured peril and that underthe doctrine of efficient proximate cause, it was immaterial that “an excluded peril(a ‘consequential loss’) was involved in the chain of events that led to the loss (the[Disputed] Costs).”57 Second, the court found that the exclusion at issue onlybarred coverage for penalties associated with a delay in completion,

52 Id. at 70 (emphasis added).53 Id. at 60.54 Id. at 69.55 Id.56 Id. at 70 (quoting Black’s Law Dictionary (6th ed. 1990)).57 Id.


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not additional contractor costs, and that it was further limited to “purely economiclosses that are separate and apart from regular construction costs. . . .”58 For all ofthese reasons, the court held that the policy covered “the extra costs that [thecontractor] paid to complete the project, without regard to whether the costsinvolve work at the project away from the immediate area of the collapse.”59

Because the owner’s claims for financial loss were not at issue, the court did notaddress the “Delay in Completion” endorsement, but ruled that the ARBR insurerhad a duty to reimburse all of the disputed expenses that the contractor hadincurred.

In the wake of Keating, “insurers have taken a more sophisticated approachunder which the various types of soft costs are compartmentalized into groups thatcan be treated differently for purposes of defining the nature and scope ofcoverage.”60 Because this is a recent development, there is no uniform policylanguage specifically addressing it. A further complication is that the types of “softcosts” a contractor may incur vary greatly in character and amount from projectto project. Contractors and developers may be certain, however, that the typicalARBR carrier will vigorously contest coverage for such losses and for the owner’sfinancial losses, absent the purchase of a specific delay in start-up endorsement.The key for insureds is to pay careful attention to the proposed policy languageand tailor the coverage to the specific project at hand.

Disputes often arise even when the policy contains coverage for delay dam-age. Thus, as other commentators have noted, “[m]easuring delay from a lossunder a builders risk insurance policy is perhaps the most complicated of all timeelement measures in the claims world.”61 Not surprisingly, therefore, carriersoften argue that factors other than the insured loss caused or contributed to thedelay, such as the repair or replacement of uninsured property or the correction ofan uninsured condition such as a design flaw, bad weather, or slow and unde-pendable subcontractors.62 To avoid the considerable difficulty of distinguishinguninsured causes of delay from insured causes and insured elements of delaydamages, contractors should closely track the status of a project before and aftera loss occurs, so that the source of all delays can be precisely determined.Moreover, it is important to monitor the scheduled completion date and, ifnecessary, modify it in light of significant delays. Some ARBR policies identifythe anticipated completion date and will allow that date to be modified to accountfor delays that are unassociated with a covered loss. Failing to monitor and changethe anticipated completion date may significantly impact determination of thedelay period and even bar policy coverage, absent an appropriate policyamendment to account for the revised completion date.

58 Id. at 71.59 Id. at 72.60 See Coverage for Delay and “Soft Costs” Under Builder’s Risk Policies: Avoiding the Pitfalls,

supra note 50 at 10.61 See Builders Risk—Measuring Delay, supra note 49 at 2.62 Id. at 10-11.


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§ 3.06 LESSON NO. 4: COVERAGE FOR PREVENTION/MITIGATIONOF LOSS (“SUE AND LABOR”)

An area of significant overlap between shore-based and marine insurance is“sue and labor” coverage. The classic form of sue and labor clause in marinepolicies and some ARBR policies reads as follows:

In case of loss or damage, it shall be lawful and necessary for the Insured tosue, labor and travel for in an about the defense, safeguard and recovery of theinsured property hereunder or any part thereof without prejudice to thisinsurance, nor shall the acts of the Insured or the Company in recovering,saving, and preserving the property insured in case of loss or damage beconsidered a waiver or an acceptance of abandonment. The expenses soincurred shall be borne by the Insured and the Company, proportionately tothe extent of their respective interests.63

This clause is an outgrowth of an English marine insurance clause, which is “soold that its origin is obscured by antiquity.”64 The marine clause, dating as farback as 1613,65 reads as follows:

In case of any loss or misfortune, it shall be lawful and necessary for theAssured, their factors, servants and assigns, to sue, labor and travel for, in andabout the defense, safeguard and recovery of the said vessel, or any partthereof, without prejudice to this insurance; the charges whereof we, theAssurers, will contribute to the rate and quantity of the sum herein insured.66

The purpose of sue and labor coverage is to “encourage and . . . bind theassured to take steps to prevent a threatened loss for which the underwriter wouldbe liable if it occurred, and when a loss does occur to take steps to diminish the

63 See, e.g., Swire Pac. Holdings, Inc. v. Zurich Ins. Co., 284 F.3d 1228 (11th Cir. 2002) (quotingsue and labor clause in builders risk policy); Kevin Dorse and Daniel D. McMillan, When AccidentsHappen During Construction: Will Your Builders Risk Insurance Cover the Damage?, ConstructionBriefings No. 2005-6 (2005) (same); 4 Philip L. Bruner & Patrick J. O’Connor, Bruner & O’Connoron Construction Law § 11:115:60 (2002) (same).

64 Am. Merch. Marine Ins. Co. of N.Y. v. Liberty Sand & Gravel Co., 282 F. 514, 520 (3d Cir.1922).

65 Reliance Ins. Co. v. The Escapade, 280 F.2d 482, 488 n.11 (5th Cir. 1960).66 Id. at 484.


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amount of the loss.”67 Sue and labor coverage is consistent with U.S. common lawprinciples, as courts in several states have ruled that an insured has the duty toexercise reasonable care to protect insured property against insured losses.68 As aresult, many courts will impose a corresponding, implied duty on the insurer, whohas benefited from the policyholder’s actions to minimize loss, by requiringreimbursement of the expenses that the insured incurred, even in the absence ofan express sue and labor clause.69 Other jurisdictions have not recognized suchclaims. As a result, in those jurisdictions, the presence or absence of express sueand labor language may be critical to a claim for recovery of the expenses ofmitigating a potential loss.

Assuming the policy covers sue and labor costs, there are at least three,discrete issues that typically arise in connection with such claims. First, does sueand labor coverage apply to an insured’s efforts to prevent an insured loss, or onlyto an insured’s efforts to mitigate damage after an insured loss has occurred?Second, assuming that sue and labor coverage does apply to prevention of athreatened, rather than actual loss, when is the threatened, insured loss sufficientlyprobable or imminent to trigger coverage? Third, are sue and labor expensescovered in a “mixed motives” context, where the insured acts to prevent orminimize both insured and uninsured losses, such that the expenses incurredshould be apportioned, and, if so, how?

[A] Does Sue and Labor Coverage Apply to an Insured’s Efforts toPrevent an Insured Loss?

U.S. courts commonly hold that “‘the sue and labor clause is a separateinsurance and is supplementary to the contract of the underwriter to pay aparticular sum in respect to damage sustained.’”70 This is true in the sense that aninsured may recover all reasonable sue and labor expenses “without regard to theamount of the loss or whether there has been a loss or whether there is salvage,and even though the underwriter may have paid a total loss under the main

67 Id. at 488 n.11 (5th Cir. 1960) (citing White Star S.S. Co. v. N. British & Mercantile Ins. Co.,48 F. Supp. 808, 812-13 (D. Mich. 1943)).

68 See, e.g., Blasser Bros., Inc. v. N. Pan-Am. Line, 628 F.2d 376, 386 (5th Cir. 1980) (“Aninsured has the duty to exercise the care of a prudent, uninsured owner to protect insured propertyso as to minimize or prevent the loss for which the insurer would be liable.”).

69 See, e.g., Slay Warehousing Co., Inc. v. Reliance Ins. Co., 471 F.2d 1364 (8th Cir. 1973)(finding common law sue and labor duty despite absence of clause in inland marine policy); DemersBros. Trucking, Inc. v. Lloyd’s, London, 600 F. Supp. 2d 265, 274-75 (D. Mass. 2009) (recognizingcommon law equivalent of sue and labor coverage); S. Cal. Edison Co. v. Harbor Ins. Co., 148 Cal.Rptr. 106, 111 (Ct. App. 1978) (explaining that sue and labor clause “makes express the impliedcorrelative duties between insured and insurer. . . .”); Witcher Constr. Co. v. St. Paul Fire & MarineIns. Co., 550 N.W.2d 1, 8 (Minn. Ct. App. 1996) (finding implied duty of insured to prevent insuredlosses, and corresponding duty of insurer to reimburse for resulting expenses).

70 Reliance, 280 F.2d at 488 n.11 (quoting White Star, 48 F. Supp. at 812-13).


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policy.”71 Even policy deductibles and self-insured retentions may not applybecause, as one court explained, “[i]t is inconsistent to place an affirmativeobligation of this nature on the insureds for the benefit of the insurer and thenadditionally to require the insureds to pay for the first $100,000 of the cost inproviding this benefit.”72

Despite the somewhat unique characteristics, if not the unique languageemployed, sue and labor coverage is “tied irrevocably to the basic insurancepolicy” because the aim of the insured’s efforts must be the prevention ormitigation of a covered loss.73 Accordingly, there is no right of reimbursement forexpenses incurred to defend, safeguard, and otherwise protect insured propertyagainst uninsured risks.74 This fundamental limitation is “necessary to prevent theclause from becoming an all-purpose indemnity clause for which the parties havenot contracted.”75

Many sue and labor claims have been dismissed because the insured’sactions did not prevent or mitigate an insured loss.76 For instance, in GTE Corp. v.Allendale Mutual Insurance Co.,77 the insured telecommunications companyspent $350 million to prevent a shutdown of its computer systems, a result of themuch-feared “Y2K” threat to stored computer data resulting from the use oftwo-digit year codes in software that could not distinguish between 1900 and2000. The insured sought coverage for the preventive measures undertaken underits property damage and business interruption policy, which contained a sue andlabor clause. The Third Circuit dismissed the claims for coverage under thegeneral insuring clauses, finding that the Y2K problem fell within the scope ofexclusions for defective design and inherent vice. The insured argued that the sueand labor clause provided an independent basis for coverage; but the courtdisagreed, finding that limiting the sue and labor clause by the policy’s exclusionswas “necessary to avoid rendering the exclusionary provisions meaningless; analternative interpretation would permit GTE to recover for improvements andmeasures taken to address a host of uninsured risks.”78

71 White Star, 48 F. Supp. at 812-13.72 Am. Home Assurance Co. v. J.F. Shea Co., 445 F. Supp. 365, 369 (D.D.C. 1978).73 Reliance, 280 F.2d at 488 n.11 (internal quotation marks and citation omitted).74 S. Cal. Edison Co., 148 Cal. Rptr. at 112.75 Int’l Commodities Export Corp. v. Am. Home Assurance Co., 701 F. Supp. 448, 454 (S.D.N.Y.

1988).76 See, e.g., Tillery v. Hull & Co., 717 F. Supp. 1481, 1486 (M.D. Fla. 1988) (dismissing sue and

labor claim for expenses to repair ship damaged during forfeiture, explaining that “[a]s thesedamages are not covered by the policy, expenses incurred in mitigating them for the benefit of theinsurance company are not recoverable under the sue and labor clause.”); Young’s Market Co. v.Am. Home Assurance Co., 481 P.2d 817, 820-21 (Cal. 1971) (affirming dismissal of sue and laborclaim for expenses to contest confiscation of liquor cargo belonging to insured because confiscation,if it had occurred, would not have resulted in loss insured by all-risk cargo policy).

77 372 F.3d 598, 618 (3d Cir. 2004).78 Id.

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There is little dispute that a sue and labor clause will cover mitigation effortsundertaken after an insured loss has occurred.79 Furthermore, in marine cases, itis “trite law” in the U.K. that sue and labor coverage is triggered “when the perilhas arisen or is imminent—when the vessel is in the grip of a peril.”80 However,in the U.S., this principle is not well established, as illustrated by two casesaddressing the issue of whether or not the sue and labor coverage should belimited to mitigation of actual loss that already has occurred rather thanprevention of potential loss.

In Wolstein v. Yorkshire Insurance Co.,81 the insured owner of a partiallyconstructed yacht incurred expenses to protect the yacht from vandalism andsevere winter weather, after discovering that the builder had abandoned theproject. The insured sought coverage as an additional insured under the defaultingbuilder’s marine builders risk policy. The trial court held that the plaintiff did nothave a sue and labor claim because no insured loss had actually occurred, rulingthat costs incurred to prevent a loss are not covered. The court of appeals reversed,ruling that “a covered loss does not have to occur in order to invoke coverageunder the sue and labor provision. Rather, actions taken to prevent a [future]covered loss will suffice to invoke coverage.”82

Two years later, the Supreme Court of Florida reached the opposite result inSwire Pacific Holdings, Inc. v. Zurich Insurance Co.83 In Swire, the insured ownerof a new condominium complex spent $4.5 million to correct design defects. Theowner then sought reimbursement, as an additional insured, under the sue andlabor clause of the ARBR policy. The owner argued that the corrective workprevented the entire building from collapsing, which would have been an insuredperil. The Supreme Court of Florida held that the plain language of the policyphrase “[i]n case of loss or damage” limited the ARBR coverage to mitigationefforts taken when a covered loss had already occurred or commenced and thatthere was no coverage for the costs of preventing a future loss.

The Swire court arguably failed to consider whether or not the arguablyvague phrase “[i]n case of loss or damage” provides meaningful guidanceconcerning coverage for reasonable loss prevention efforts. If not, the phrase isambiguous and should be construed strictly against the drafter (the insurer) and infavor of coverage. The essential purpose of mitigation principles is to encourageinsureds to act reasonably to protect the insured property from loss. Some insurershave modified the sue and labor clause wording by replacing the phrase “[i]n case

79 See, e.g., Cont’l Food Prods., Inc. v. Ins. Co. of N. Am., 544 F.2d 834, 837 n.1 (5th Cir. 1977);Am. Merch. Marine Ins. Co. of N.Y. v. Liberty Sand & Gravel Co., 282 F. 514, 520 (3d Cir. 1922);Reliance, 280 F.2d at 488 n.11; John S. Clark Co. v. United Nat’l Ins. Co., 304 F. Supp. 2d 758, 766(M.D.N.C. 2004).

80 See, e.g., Linelevel Ltd. v. Powszechny Zaklad Ubezpieczen, S.A., [2005] 2 Lloyd’s Rep. 534,547 (Q.B.D.).

81 985 P.2d 400, 409-10 (Wash. Ct. App. 1999).82 Id.83 845 So. 2d 161, 169 (Fla. 2003).


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of loss or damage” with the phrase “[i]n case of actual or imminent loss ordamage. . . .”84 If such language is included, the question becomes how todetermine when the risk of future loss or damage is sufficiently “imminent” totrigger the sue and labor coverage.

[B] When Does the Threat of an Insured Peril Trigger Sue and LaborCoverage?

Because sue and labor coverage applies only to the prevention or mitigationof covered losses, the peril that the insured prevents arguably must be one thatwould have materialized within the policy period. The only U.S. case to considerthis issue is Port of Seattle v. Lexington Insurance Co.,85 which involved anotherfailed effort by an insured to obtain coverage for Y2K-related computerremediation work. The insured invoked the sue and labor clause of a policy thatcovered damage to “active data processing media.”86 The Washington Court ofAppeals affirmed the trial court’s dismissal of the sue and labor claim because theinsured did not prevent a loss within the coverage period, but instead “sought toprevent losses that would occur on or after January 1, 2000, after the policiesexpired.”87 In that case, there was no question regarding when the possiblecovered loss, if any, would occur.

Other courts have allowed coverage for sue and labor expenses withoutdirect proof that the insured loss could occur within the policy period. Thus, asdiscussed above, the insured in Wolstein v. Yorkshire Insurance Co.88 soughtreimbursement of the expenses incurred to protect a partially constructed yachtfrom vandalism and severe winter weather. The insurer contested coveragebecause there was no evidence that vandalism or severe winter weather wasimminent. The court rejected this argument, ruling that a reasonableness standardshould be applied:

To require that a risk be imminent before coverage results would create adilemma for the assured. The assured would be placed in the unenviableposition of determining whether there was enough evidence to support theimmediacy of their action and thus allow reimbursement from their insurancepolicy, or whether they should refrain from acting and risk that damage willoccur and that insurance coverage will be denied because they failed to act to

84 See, e.g., GTE Corp., 372 F.3d at 606 (quoting sue and labor clause in property damagepolicy); J.F. Shea Co., 445 F. Supp. at 366 (same as to clause in builder’s all-risk policy).

85 48 P.3d 334, 340 (Wash. Ct. App. 2002).86 Id. at 337.87 Id. at 338-39.88 985 P.2d at 401.


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prevent the casualty. On the other hand, an assured should be able todetermine what [preventive] actions and expenses are reasonable without toomuch difficulty.89

Applying this standard, the court held that a genuine issue of material fact existedconcerning whether a prudent, uninsured owner “would have also taken action tosecure and heat an abandoned partially completed yacht in an outdoor Wisconsinboatyard in winter.”90 Thus, according to Wolstein, the standard sue and laborclause provides coverage for the prevention of an insured peril, without regard tothe imminence of the insured peril, so long as the circumstances were such thata reasonable, uninsured person would have acted in the same manner to protectthe property from loss.

It is unclear whether the form of clause that provides coverage “in case ofactual or imminent loss or damage,” which was designed to broaden the scope ofthe sue and labor coverage, also has the arguably unintended consequence ofrejecting the reasonableness standard adopted in Wolstein. However, that isexactly what has happened in the state of Washington. In Washington MutualBank v. Commonwealth Insurance Co.,91 after an engineering firm reported thatone of a bank’s buildings was at risk of imminent collapse, the insured bankincurred substantial costs to evacuate the building. A second engineering report,conducted after the evacuation, concluded that the building was not in fact indanger of collapse. Construing a sue and labor clause covering “actual orimminent loss or damage covered by the policy,” the Washington Court ofAppeals held that (1) imminent means “ready to take place: near at hand:impending: hanging threateningly over one’s head: menacingly near”; (2) thestandard for determining imminent collapse is objective, not subjective; and (3)the policy did not provide coverage because the second report confirmed therewas no imminent danger of collapse. Citing Wolstein, the court ruled that “areasonable but incorrect perception of imminence of covered loss does not sufficeas a basis for coverage under the sue and labor provision.”92 The case provides adefinition of “imminent” and holds that there is no sue and labor coverage forfalse emergencies, but otherwise sheds little light on how to measure theimminence of the loss.

The opinion in Buczek v. Continental Casualty Insurance Co.93 providessome additional guidance regarding the imminence of loss issue in a risk ofcollapse case. In Buczek, the insured condominium association sought to recoverthe cost of replacing 34 decayed foundation pilings, after noticing that the

89 Id. at 410.90 Id. As discussed below, measuring the reasonableness of the mitigation efforts based on what

a “prudent uninsured” would do is a well-established principle of U.K. maritime law.91 No. 56396-3-1, 2006 WL 1731318 (Wash. Ct. App. June 26, 2006).92 Id. at *5.93 378 F.2d 284 (11th Cir. 2004).


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structure swayed in high winds and that the pilings were discolored. The policycovered “collapse” of a building caused by “hidden decay.” The trial court andEleventh Circuit agreed that the term “collapse” means not only actual collapse,but also “any serious impairment of structural integrity that connotes imminentcollapse. . . .”94 The trial evidence established that 90 mph winds would cause thebuilding to collapse, and that such winds sometimes hit the shore at issue. The trialcourt ruled that “even a risk that might be a one in ten, or one in twenty year risk,is still a very serious and imminent risk. The fact the event may or may not occurin any given point in time doesn’t mean the risk is not imminent.”95 The EleventhCircuit disagreed, finding that a wind which might occur once every ten or twentyyears is not an imminent risk. According to the Eleventh Circuit, evidence of an“imminent” collapse required proof that the walls are cracking, moaning loudly,and bulging inward.

The Buczek opinion, if extended to all cases in which recovery of lossprevention costs is limited to “imminent” risks, would bar coverage for most lossprevention efforts except in the rarest of instances when the insured loss is “about”to occur. However, in Buczek, the policy at issue only covered the “collapse” ofa building, which the court construed expansively to also include imminent (ratherthan actual) collapse. In this setting, where the court had already expanded theinsuring clause to include imminent collapse, it makes sense that the court wouldin turn narrowly construe the concept of imminence to avoid broadly rewriting the“collapse” coverage. As a result, the court’s limiting language might not beapplied in a case in which the policy expressly includes, in addition to a “collapse”hazard, separate sue and labor coverage.

Maritime cases provide additional guidance on the issue of when sue andlabor coverage is triggered by an actual or imminent peril.96 In IntegratedContainer Service Inc. v. British Traders Insurance Co., Ltd.,97 Lord JusticeEveleigh rejected the insurer’s argument that it had no obligation to reimburse theinsured because it was not “very probable” that damage to the insured propertywould have occurred in the absence of the insured’s efforts. Like the Washingtoncourt in Wolstein, Justice Eveleigh concluded that because the right to recoverexpenses is a corollary to the duty to act to mitigate loss, the same reasonablenessstandard should apply to both. Accordingly, an insured may “recover the cost ofsuch measures as were reasonably taken for the purpose of averting or minimizinga loss when there was a risk that insurers might have to bear that loss.”98

Assuming the “reasonableness” and “imminent loss” standards can be satisfied,

94 Id. at 290 (citing Fantis Foods, Inc. v. North River Ins. Co., 753 A.2d 176, 183 (N.J. Super.2000)).

95 Id. at 291.96 See, e.g., 2 Lloyd’s Rep. at 547; Royal Boskalis Westminster v. Mountain, [1999] Q.B. 674

(C.A.).97 [1984] 1 Lloyd’s Rep. 154 (C.A.).98 Id.


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another key question remains: Did the loss prevention expenses incurred primarilybenefit the insured, with only secondary benefits to the insurer, and if so, howshould the reimbursement of those costs be allocated?

[C] The Respective Interests of Insured and Insurer Are Considered inAllocating Sue and Labor Costs

What happens when the sue and labor effort prevents a loss that would beinsured and that the carrier would have to pay, while also benefiting the possiblyuninsured financial interests of the insured? The U.S. courts that have consideredthis issue, have ruled that sue and labor expenses are recoverable only if theimmediate and primary effect of the expenditure is to prevent or minimize the riskof an insured loss, not an uninsured problem.

In Southern California Edison Co. v. Harbor Insurance Co.,99 the insuredincurred expenses to “mud jack” two units of a coal-fired power plant thatexperienced excessive settlement due to faulty design and construction. Conced-ing that the “cost of making good faulty workmanship” exclusion applied, theinsured nevertheless argued that the mud jacking prevented insured consequentialdamage to the superstructure and should be covered under the sue and laborclause. The court disagreed, concluding that “the recovery under a sue and laborclause is tied irrevocably to the obligations undertaken by the insurer in the basicinsurance policy,” and that “the means used by Edison to prevent or mitigate suchdamages were excluded from recovery under the policy.”100 Noting also that“only mitigation expenses which are for the primary benefit of the insurer arerecoverable under a sue and labor clause,”101 the court concluded that the onlyreason the structure was threatened was because of the design defect and that themud jacking was primarily for the benefit of the insured.

Similarly, in Swire Pacific, after deciding that the policy’s design defectexclusion barred the insured’s claims, the district court considered whether theinsured could recover under the policy’s sue and labor clause.102 The insuredargued that “its expenses should be covered because its actions primarily benefitedthe insurer, by potentially preventing [an insured] collapse of the building. . . .”103

The district court adopted Edison’s “primary beneficiary” test, ruling that thedirect purpose of the sue and labor effort was to correct the uninsured designdeficiencies, and that the possible prevention of an insured collapse of the buildingwas merely an incidental benefit that did not trigger the sue and labor coverage.In its order certifying the question to the Supreme Court of Florida, the EleventhCircuit suggested that the sue and labor clause only applied to mitigation efforts

99 148 Cal. Rptr. 106 (Ct. App. 1978).100 Id. at 112.101 Id. at 113 (citation omitted).102 139 F. Supp. 2d 1374 (S.D. Fla. 2001).103 Id. at 1384.

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taken “when a covered loss had already occurred or was in the process ofoccurring,” not efforts “to prevent a covered loss from ever arising.”104 Becausethe Supreme Court of Florida agreed with the Eleventh Circuit’s statement, it didnot specifically address the issue of who “primarily benefited” from the insured’srepairs.105

Once again, helpful “lessons” may be learned from reviewing sue and laborclauses in maritime policies, one form of which provides that sue and labor costs“shall be borne by the Insured and the Company, proportionately to the extentof their respective interests.” Such a clause might avoid the “all or nothing”outcomes of the foregoing cases by allowing apportionment of sue and labor costsin accord with the “respective” interests of the insured and insurer in preventingloss.106 Another form of apportionment clause permits coverage when sue andlabor expenses are incurred “in saving or attempting to save the subject-matterinsured and other property. . . .”107 Under this clause, an insured’s sue and laboreffort would be fully reimbursable if it involved an effort to save other, insuredproperty.

The analysis in such a case is rather straightforward, assuming “it is possiblearithmetically to apportion the expenses . . . incurred for the benefit of the insured,as opposed to the uninsured, property.”108 This long-standing principal of marineinsurance law may be explained, as follows:

[I]f by [a] peril insured against the subject-matter of insurance is brought intosuch danger that without unusual or extraordinary labour or expense a losswill very probably fall on the underwriters, and if the assured or his agents orservants exert unusual or extraordinary labour, or if the assured is made liableto unusual or extraordinary expense in or for efforts to avert a loss, which, ifit occurs, will fall on the underwriters, then each underwriter will, whether inthe result there is a total or partial loss, or no loss at all, not as part of the suminsured, but as a contribution independent of and even in addition to the wholesum insured, pay a sum bearing the same proportion to the cost or expenseincurred as the sum they would have had to pay if the probable loss hadoccurred. . . .109

104 248 F.3d 1228 (11th Cir. 2002). See also John S. Clark Co. v. United Nat’l Ins. Co., 304 F.Supp. 2d 758 (M.D.N.C. 2004). Citing Swire and Edison, the North Carolina district court held thatsue and labor expenses are recoverable only when the loss prevention effort relates to a covered lossand confers a direct and immediate benefit upon the insurer. Applying this test, the court held thatthe insured had incurred the expenses at issue “directly and primarily to correct and repair its own[uninsured] faulty workmanship,” and that the insurer benefited only incidentally to the extent theefforts prevented “another collapse . . . at some unknown point in the future.” Id. at 768.

105 845 So. 2d at 169.106 See WELCAR 2001 Offshore Construction Project Policy; and supra note 63 and accompa-

nying text.107 See Institute Form ¶ 20.4 (emphasis added).108 Royal Boskalis Westminster NV v. Mountain, [1999] Q.B. 674, 738-39.109 Lohre v. Aitchison, [1878] 2 Q.B.D. 558, 566 (C.A.) (emphasis added).

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In other words, the insurer should reimburse sue and labor costs in proportion toits interest in the total, potential loss it otherwise would have paid. Application ofthis apportionment principal110 is reasonable and seems inherently “fair” where,as often is the case, sue and labor efforts benefit the insured, but also eliminate theexpense that the carrier would incur when, absent the loss-prevention work, apartially insured loss would likely occur.

§ 3.07 CONCLUSION

While “pirates and rovers” may not be a significant hazard faced by manyshore-based construction projects, contractors, risk managers and their counselshould not overlook the authorities applying marine builders risk concepts, whichoften overlap and involve the same types of risks (faulty workmanship/defectivelydesigned parts/uncertain damage or loss of use caused by latent flaws) thatgenerate uncertainty and controversy for shore-based construction projects.Similarly, as discussed above, the principles of coverage that apply in the marineor shore-based builders risk context also may be applied to other forms of policies,including the CGL coverage for a contractor’s liability for damage/injury causedby construction-related flaws, professional liability coverage for defective design,and the owner’s property insurance coverage for physical damage/loss of use ofthe project.

If indeed there is a “crisis” in connection with construction-related coverage,it is a crisis that the insurance industry has brought upon itself. Underwriters andproducers are motivated to generate premium income by selling a variety ofpolicies that are supposed to provide “peace of mind” to contractors and projectowners who assume potentially huge financial risks in undertaking majorconstruction projects (and smaller projects too). Not surprisingly, contractors andowners faced with such losses have sought in ever-increasing numbers to convertthe “peace of mind” purchased from their insurers into financial proceeds.Insurers’ claims agents, their supervisors and lawyers often rarely communicatewith underwriters/producers who generate and sell the coverage forms in the firstplace. As a result, the claims side of the policy equation has developed a varietyof imaginative theories, such as the “no occurrence myth,” the economic lossdefense, the “business risks are not insurable” defense, and the “exceptions to an

110 Especially in cases involving under-insured property, it is the longstanding U.K. maritime rulethat sue and labor costs must be borne by the insured and insurer in proportion to their respectiveinterests, i.e., the amount insured versus the total value of the property. See, e.g., Cunard SteamshipCo. Ltd. v. Marten, [1902] 2 KB 624, 629 (explaining “well-established basis of every adjustmentof suing and labouring expenses” as being that underwriters are to bear expenses only “in theproportion of the amount underwritten to the whole value of the property or interest insured”); seealso Royal Boskalis, [1999] Q.B. at 738-39 (“I do not believe there to be any doubt that where shipor cargo is under-insured, sue and labour expenses will only be recoverable in the same proportionthat insured value bears to actual value.”).


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exclusion cannot create coverage” argument that have been accepted by somecourts as a basis for denying coverage for construction-related losses.

The task of the carrier’s claims representative is to review coverage claimsand assert sometimes imaginative theories that eliminate or at least minimize thecarrier’s financial loss under the policies its underwriters issued. By contrast, thejob of a contactor’s risk manager (and counsel) is to maximize actual value andrecoverable proceeds of the various construction-related coverages that thecontractor purchased. In doing so, it is appropriate and may be essential inpursuing coverage to “borrow” from authorities that apply the sometimes arcane,but historically well-established principles governing marine builders risk cover-age. In an appropriate case, application of those principles may increase thepotential for obtaining coverage for shore-based construction losses.


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Documents

CONSTRUCTION BUSINESS HANDBOOK