SDV Insights

A California Court of Appeal recently released a policyholder-friendly decision clarifying the meaning of the often-arising Faulty Workmanship exclusions — j.(5) and j.(6).  The court emphasized the importance of policy language and took a plain-meaning approach to interpret the exclusions.  It found that exclusion j(5) narrowly applies only to damage occurring during active physical construction activities and that j(6) narrowly applies only to the specific part of the insured’s work that the insured performed defectively.

Last month, in Global Modular, Inc. v. Kadena Pacific, Inc.,¹ a California Court of Appeal clarified the meaning of the frequently asserted j.(5) and j.(6) exclusions of the standard commercial general liability policy, an issue the court deemed one of “first impression” for the state. The court took a close look at how courts nationwide handle the exclusions and relied on the policy language to come to a policyholder-friendly decision.

Kadena Pacifi c, Inc. (Kadena) was the general contractor for the construction of a rehabilitation center in Menlo Park, California. Kadena hired Global Modular, Inc. (Global) to build, deliver and install modular units that would form the rehabilitation center. Kadena hired a different subcontractor to install roofing for the units and, as a result, Global agreed to deliver the units without a traditional roof but with a roof deck substrate made from a thin layer of plywood. In the contract between the parties, Global assumed responsibility for any loss or damage to the units until final acceptance by Kadena.

As is often the case, the project was delayed for various reasons and Global delivered the units in October and November instead of during the summer months as originally planned. This meant that the units, only covered by the plywood substrate, were exposed to rain between October and January. Global attempted to protect the units using plastic tarps, but, despite best efforts, the units sustained water damage. After agreeing to mutually terminate the contract between the parties, Kadena remediated the damage and completed the units. Global sued Kadena for failure to pay and Kadena countersued Global for breach of contract. Before trial, Kadena and Global agreed to a partial settlement. Included in the settlement was Kadena’s promise to release all claims arising from the project, except for those covered by Global’s insurance policy with North American Capacity Insurance Company (NAC). The parties proceeded to trial on those issues. After a jury found Global contractually liable for the damage, coverage litigation ensued between Kadena and NAC, both pursuing a declaration regarding whether the damages were covered under the policy.

Kadena and NAC did not dispute that the cost of repair and replacement that resulted from the water damage was covered under the policy. Instead, at issue was whether faulty workmanship exclusions j.(5) and j.(6) applied.

Specifically, exclusion j.(5) excludes coverage for “that particular part” of property on which the insured and its subcontractors “are performing operations,” if the property damage arises out of those operations. The parties disagreed over the meaning of the phrase “are performing operations.”

NAC argued that the water damage was excluded because the phrase refers to ongoing “works in progress,” and Global’s work was not yet complete at the time the damage occurred. Kadena argued the phrase was more limiting and only applied to the “particular component” that an insured is physically working on at the time the damage occurs. Under Kadena’s interpretation, because Global was not physically working on the units when the water intrusion occurred, the exclusion would not apply.

The Court of Appeal looked to the policy language, applied the ordinary meaning of the language of the exclusion, and found that the active present tense of the phrase “are performing” and the limiting nature of the exclusion for damage to the “particular part of the property on which the insured was performing operations” was indicative of an intent to apply only to damage caused during physical construction activities. The court sided with Kadena and held that the exclusion did not apply to the facts at issue, as Global was not on site or engaged in physical construction activities when the water intrusion occurred. 

The court next focused on NAC’s second argument: that exclusion j.(6) applied to the damage. Exclusion j.(6) excludes coverage for “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” The parties disagreed over the meaning of “that particular part” and “work . . . incorrectly performed.”

NAC argued that the exclusion applied because the damage was a result of inadequate waterproofing. According to NAC, the process of waterproofing was the “work . . . incorrectly performed” and the units were the “particular part” that must be repaired. Kadena, on the other hand, argued that the phrase “work . . . incorrectly performed” refers to the insured’s defective work on a product, not the insured’s failure to carry on a process. Kadena also pointed out that, even if it did incorrectly perform the waterproofing, the “particular part” it was working on was the plywood substrate, not the drywall, insulation, framing or ducting of the modular units, i.e., the “particular parts” that were damaged but not defective.

The Court agreed with Kadena. It looked to the dictionary definition of “particular” and “part” and explained that the phrase is intended to limit the application of the exclusion to a distinct part of a construction project. That the incorrect work must be performed on that particular part is also limiting. The court held that the exclusion’s narrow language indicates that the exclusion refers to the specific part of the insured’s work that the insured performed defectively as opposed to the general area of the construction site that might have been affected by the insured’s work.

Notably, in a section of its own in the opinion, the Court addressed the general insurance and business policy arguments set forth by NAC. NAC took the position that, if the Court ruled in favor of coverage, it would “turn the industry on its head” because CGL policies exist to insure the risk of damage to third parties and are not intended to insure against business risks that exist because of the insured’s own faulty workmanship. While NAC is generally correct in that CGL policies are not intended to insure business risks, the court explained that it cannot overlook the clear meaning of the policy language. The insuring clause makes no distinction between insured and third-party risks, nor does anything in the exclusionary language indicate an intent to apply broadly to any damage to the insured’s work before completion.

The court also looked into other issues disputed by the parties, such as coverage for delay damages, attorney’s fees, and whether the amount awarded at trial could be offset by previously agreed-upon settlement damages based on issues not discussed at trial.

Global Modular not only demonstrates the importance of policy language in resolving coverage disputes, but is also set to become extremely impactful nationwide in faulty workmanship cases. The California Court of Appeal applied standard insurance policy interpretation rules that cannot be overlooked in making coverage determinations.

For more information, please contact Tiffany Casanova at tlc@sdvlaw.com or 203-287-2108.

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¹ 2017 WL 3948229 (Cal. App. Ct. Sept. 9, 2017). 

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