As we settle into a new year, one thing remains the same: Understanding the definitions and conditions in your insurance policy is critical.

In a Dec. 8 decision, the U.S. District Court for the Northern District of Florida in Ohio Security Insurance Co. v. E Kelly Enterprises Inc. held that an insurer had no duty to defend or indemnify a general contractor and no duty to indemnify a subcontractor for damages from defective work on a naval base, based on the policy's definition of "suit," "property damage," and allocation requirements.

The decision highlights the importance of numerous issues in the context of commercial general liability policies, including the nuances of policy definitions, obtaining insurer consent when necessary, and allocation between covered and uncovered claims.

Background

In October 2014, Whitesell-Green Inc., or WGI, a general contractor, was awarded a contract by the Navy to renovate buildings at the Naval Air Station in Pensacola. The general contractor subcontracted work to various subcontractors, including metal framing and drywall to a subcontractor named E Kelly Enterprises Inc., or EKE.

Ohio Security Insurance Co. issued three CGL policies to WGI, with EKE as an additional insured. Under these policies, Ohio Security agreed to pay "those sums" that the general contractor or EKE were legally obligated to pay because of "property damage." The policies also required Ohio Security to defend Whitesell-Green and subcontractor against any "suit" seeking such damages.

The Construction Dispute

In late 2016 and early 2017, the Navy issued noncompliance notices to WGI after discovering defects in work performed by various subcontractors, including EKE. These notices cited deficiencies in workmanship. Around February 2017, the general contractor sent EKE a notice of default for allegedly defective work, demanding that EKE repair the work at its own cost. EKE refused and ceased working on the project.

To address the defects, the Navy, the general contractor and the subcontractors, including EKE, established a "Repair and Recovery Protocol" consisting of five phases: (1) investigation, (2) repair, (3) joinder, (4) mediation and (5) arbitration.

WGI notified Ohio Security of the Navy's claims of defective work and requested a defense for itself and for EKE for the protocol. Ohio Security denied WGI's request for a defense but agreed to defend EKE in the mediation phase, subject to a reservation of rights.

During mediation, WGI and the Navy settled. The settlement required WGI to: (1) spend millions to correct defective work, including damage to otherwise nondefective work and the existing structure; (2) forgo installing anti-terrorism force protection, resulting in significant financial loss; and (3) provide the Navy with extended warranty obligations.

Subsequently, WGI initiated arbitration against its subcontractors, including EKE, to recover costs from the settlement with the Navy. During arbitration, Ohio Security continued to defend EKE under a reservation of rights. The arbitration panel found total losses of $12.3 million for WGI, with $4.3 million attributed to EKE.

The Coverage Dispute

In December 2022, before the arbitration panel issued its final award, Ohio Security filed a declaratory judgment action against WGI and EKE seeking a ruling that it was not required to indemnify them and moved for summary judgment. The court granted Ohio Security's motion.

Lack of Coverage for the General Contractor

Regarding WGI, Ohio Security argued it had no duty to defend or indemnify because (1) there was no suit to trigger coverage and (2) the Navy's deficiency notice did not allege "property damage." The court agreed.

First, Ohio Security argued that there was no suit to trigger coverage. The policy defined "suit" to include "[a]ny other alternative dispute resolution proceeding in which [covered damages] are claimed and to which the insured submits with [Ohio Security's] consent." While the court agreed the protocol qualified as an alternative dispute resolution proceeding, it found Ohio Security did not consent to WGI's participation.

The court explained that Ohio Security's mere awareness of the protocol, or the fact that it did not instruct WGI not to participate, was not enough to establish consent. The court also emphasized there was no evidence that Ohio Security was involved in WGI's decision to join the protocol, provided a defense or representation to the WGI during the process, or participated in the negotiations and settlement of the Navy's claims.

Second, Ohio Security argued that even if the protocol qualified as a "suit," it still had no duty to defend WGI because the Navy's deficiency notices did not allege any "property damage." The court analyzed this issue even though it agreed with Ohio Security that no "suit" existed.

The policies defined "property damage" as "physical injury to tangible property, including all resulting loss of use of that property" and "loss of use of tangible property that is not physically injured." The court noted that this definition covers situations where faulty workmanship or defective work causes damage to otherwise nondefective parts of the project. However, if there was no damage beyond the defective work itself, then there was no "property damage" under the policy.

The court agreed with Ohio Security, finding that neither of the Navy's deficiency notices alleged that the identified defects caused "property damage" as defined by the policies, i.e., by causing damage to other nondefective work, damage to the preexisting structure, or damage to completed or partially completed work. The court also rejected any findings of property damage made during the arbitration, explaining that those findings were irrelevant to whether the original complaint itself alleged property damage.

Lack of Coverage for EKE

With respect to EKE, Ohio Security argued that it had no duty to indemnify because, among other things, WGI and EKE did not ensure the arbitration panel specifically allocated damages between covered and uncovered claims.

Under Florida law, a party seeking recovery under a settlement or judgment must separate the amounts attributable to covered versus uncovered claims and the failure to do so prevents recovery.

The court found that the panel's award included amounts that would not have been covered by the policy, such as issues with EKE's own work and its breach of contract. The court further noted that the panel was not limited to awarding damages only for covered claims.

As a result, the court held that coverage was precluded, and Ohio Security was not required to indemnify EKE as an additional insured.

Takeaways

Cases such as this demonstrate how important it is for policyholders to understand a policy's definitions and comply with all requirements and conditions. Failing to do so may preclude coverage, even for substantial losses.

1. Understanding Definitions

Terms like "suit" and "property damage" are found in almost every CGL policy, but their specific definitions matter. In this case, coverage was denied based on how those words were defined and applied. Policyholders should review how terms are defined in their policies and understand what is required to trigger coverage.

2. Getting Consent

Many times, policyholders may think of insurer consent only in the context of settlements. However, policies may also require insurer consent for other actions, such as participating in alternative dispute resolution proceedings, for the matter to qualify as a covered suit. Without proper consent, coverage may not be triggered. Policyholders should review their policies carefully to understand all instances where consent is required.

3. Allocation

In some jurisdictions, including Florida, if an award against a policyholder does not allocate the amounts attributable to covered claims versus noncovered claims, the insurer is not required to pay. This makes it crucial for policyholders to ensure that any settlement, arbitration or court award clearly distinguishes between covered and uncovered damages.

Policyholders should keep these issues in mind to ensure compliance with all policy requirements and increase the likelihood of coverage.

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The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.