Builder’s risk insurance is a type of property insurance that covers damage to a project under construction. A builder’s risk policy is a no-fault form of insurance—it doesn’t matter who is responsible for the loss, builder’s risk will typically cover the loss.
There are times where a contractor’s faulty workmanship may cause a loss to a project covered under builder’s risk insurance. That can raise the following question—does builder’s risk cover the costs to repair or replace defective work on a project?
Much like many construction insurance coverage questions, the answer depends on the language of the builder’s risk policy. Many times, a builder’s risk policy will have an exclusion for faulty workmanship.
But some builder’s risk policies also have an endorsem*nt that expands coverage—the LEG 3 provision. The LEG 3 provision is a type of extra coverage that an insured can purchase. It adjusts the coverage available under a builder’s risk policy to include certain losses and damages associated with defective work. (LEG is the abbreviation for the London Engineering Group, which is an association ofinsurers providing a forum for discussion and education addressing insurance topics.)
In January 2024, a Florida federal court issued a lengthy opinion analyzing whether a builder’s risk policy with a LEG 3 provision covers the costs associated with replacing/repairing defective work.
The Facts—Abridge and roadway project with defective concretecomponents.
In Archer Western – De Moya Joint Venture v. Ace American Insurance Co., a design-build contractor was tasked with completing an $840-million roadway project that includes the construction of a signature bridge in the heart of Miami.An insurer issued a builder’s risk policy for the project. The policy had a LEG 3 provision, which providedcoverage for “replacement or repairs for costs created by defects of material [or] workmanship.”
As a part of the work, the contractor had two on-site concrete batch plants that it owned and operated. During construction, batches of concrete were mixed with excessive amounts of fly ash. That excessive fly ash led to concrete batches that had reduced compressive strength.The low strength concrete was then poured into various components of the project, including piers, piles, and footings that failed to meet the required compressive strength test.
The contractor incurred costs to repair the deficient concrete components, which resulted in the submission of a $3.6 million claim to the builder’s risk insurer. The insurer denied the claim as one not covered under the policy. The contractor then sued the insurer to obtain coverage under the builder’s risk policy.
The Lawsuit–The contractor seeks a declaratory judgment that the costs associated with the defective concrete are covered under the builder’s risk policy.
After the contractor had its claim denied, the contractor sued the insurer to force the insurer to pay the repair/replacement costs associated with the low strength concrete. After nearly a year and a half of litigation, the insurer filed a motion for summary judgment seeking a ruling that the contractor’s costs associated with the defective concrete were not covered under the builder’s risk policy.
The insurer made several arguments, including the following: (1) to constitute a covered physical loss or damage, the insured property must be altered, not merely defectively constructed; (2) the LEG 3 provision does not cover costs to “improve” the original workmanship; and (3) there is no coverage because the project was damaged “solely byvirtue of the existence” of a defect ofmaterial or workmanship.
(1) The court found that the damage to the cement involved a “physical alteration.”
The insurer argued that there was no coverage because there was no “physical alteration” to the project. The court noted that a reduction in the weight-bearing capacity of a bridge is an alteration to the bridge. The court also noted that the insurer had not “explained how concrete, which failed its 28-day [compressive strength] test, is anything other than a compromise to the physical integrity to the bridge components on which the cement was poured.” Thus, the court wrote that it “was not prepared to accept [the insurer]’s argument that damage to the cement did not involve a physical alteration.”
(2) LEG 3 does not cover costs to “improve” the original workmanship and material, but the court found that language ambiguous and construed it against the insurer.
The insurer contended that there was no coverage for the defective work because although the LEG 3 provision provided coverage for “replacement or repairs for costs created by defects of material, workmanship, design, plan, or specification,” the LEG 3 provision “does not cover costs to ‘improve’ the original material, workmanship, design, plan, or specification.”
In that regard, the LEG 3 provision provided the following:
This Policy does not insure any costs rendered necessary by defects of material, workmanship, design, plan, or specification and should damage occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material, workmanship, design, plan or specification.
In considering the exception for improvements, the court repeatedly cited to another recent federal court case—S. Capitol Bridgebuilders v. LexingtonIns. Co., Case No. 21-cv-1436 (D.D.C. Sep 29, 2023)—to conclude that what constitutes an “improvement” under the LEG 3 provision is ambiguous. The court noted the following quote from theSCBcase:
Sure, repairing or replacing a defective component cantechnicallybe considered an improvement-unless that component is replaced with something worse. However, the context of the [e]xtension suggests that to improve means make a thing better than it would have been if it were not for defective work. In fact, the [e]xtension explicitly distinguishes the ‘cost incurred to improve’ work from ‘the cost of replacement or rectification.'” [The insurer’s] suggestion that the two are coextensive is unavailing.
Since the term “improve” is subject to more than one reasonable interpretation, the term was ambiguous and had to be construed against the insurer under Florida law. Thus, the court rejected the insurer’s argument that there was no coverage because the correction of the defective work was an excluded improvement under the LEG 3 provision.
(3) Thejury will have to decide whether the project was damaged “solely byvirtue of the existence” of a defect ofmaterial or workmanship.
The insurer also argued that there was no coverage because the defective initial construction of the concrete barred the contractor from proving a “direct physical loss or damage.” In that regard, the insurer noted that the LEG 3 provision provided the following:
For purposes of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue or [sic] the existence of any defect of material, workmanship, design, plan, or specification.
Based on that language, the insurer noted that “the LEG 3 Extension defined ‘damage’ as something involving more than damage ‘solely by virtue or existence of any defect of material, workmanship, design, plan, or specification.'”
The contractor argued that it was “not seeking to recover for damage ‘solely’ by virtue or existence of any defect of material, workmanship, design, plan, or specification.” Instead, the contractor contended that the fly ash contaminated the cement, which led to defective concrete that resulted in the impaired structural integrity of the bridge components that had to be repaired or replaced.
The court noted that while the insurer may “quibble about the facts and challenge [the contractor]’s expert about the consequences of the fly ash tainting the comment which was used to manufacture the concrete,” the insurer’s “challenges illustrate the existence of a factual dispute which is best not resolved in a summary judgment context.” Thus, one of the issues that the jury will have to decide at trial is whether the damage to the project arose “solely by virtue of the existence of any defect or [sic] material, workmanship, design, plan, or specification.”
Bottom Line: If a builder’s risk policy has a LEG 3 provision, the policy may cover costs incurred to repair or replace defective work under certain circ*mstances.
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