In the worst of times, insurance can be a building owner’s best friend. But if the policy doesn’t cover what you think it covers, you’ll quickly be facing a nightmare — and an expensive one at that.

In addition to property insurance, which covers damage to your property by someone else, nearly all buildings carry comprehensive general liability (CGL) policies that protect the building owner against others’ claims of injury or damage. But what you may not realize is that the standard terms in these policies are defined quite differently by many states. What you don’t know could cost you.

What Can Happen?

Imagine a hypothetical scenario in which a builder installs stucco on the curbside wall of an office building. Six months later, during a severe rain storm with high winds, stucco falls off the wall and lands on a pedestrian. Rainwater then seeps into the building, causing not only structural damage but also a six-week shutdown of several floors of the building and the consequent loss of rent from the office building’s tenants.

Before this incident, the builder bought CGL coverage from XYZ Assurance. This policy includes some standard requirements, including that an occurrence that has caused damage is identified and a customary completed operations exclusion, which exempts the insurance company from having to replace whatever the customer was contractually required to install.

The situation grows more complex when the pedestrian sues both the office building and the construction company for bodily injury caused by the falling chunk of stucco. In return, the owner of the office building sues the builder for breach of warranty, defective workmanship and negligence, seeking indemnification (adequate compensation for financial losses), contribution and the costs of structural repairs and lost rental.

The builder turns to its insurer, XYZ, demanding coverage against these claims. But the insurance company refuses to provide indemnity or legal defense, asserting that an occurrence did not cause the damage. The result: a declaratory judgment suit between XYZ and the builder to interpret the terms of the insurance policy. But who is in the right?

How Your Location Impacts Coverage

The answer — and the outcome of the suit — depends on which state’s law applies. Were the damages to the pedestrian and the building owner caused by an “occurrence” as the builder’s insurer understands it? Can mere poor workmanship constitute an occurrence? The states are split.

Pennsylvania, for example, says no.

In 2006, the state Supreme Court noted that standard policy language defines an occurrence as an accident — i.e., an unexpected event caused by a degree of fortuity. Poor workmanship, even if it’s presented as a negligence claim, is not an unexpected accident. To claim otherwise would transform a CGL policy into a performance bond.

In 2007, the Pennsylvania courts held that rainfall also doesn’t constitute an occurrence because it’s not unexpected, even if the rain damages the interior of a building due to a stucco contractor’s faulty workmanship.

Ohio, Kentucky, Massachusetts, Mississippi and Arkansas have all adopted a similarly restrictive view since 2008, so the outcome of our hypothetical case in these states would end in the insurance company’s favor.

However, other states have declared the opposite.

In 1959, the California Supreme Court held that the faulty installation of defective doors constituted an accident and that water damage to the building (not including replacement of the faulty doors themselves, which are excluded by the completed operations exclusion) and the consequent loss of use were covered by the policy after all. They defined an accident as an “unexpected, unforeseen or undesigned” event. Certainly a construction failure must be unintended to qualify for coverage. Other than blatantly obvious accidents waiting to happen, damages to third parties from faulty workmanship appear to fall within the scope of California’s CGL coverage. Indiana, Georgia, Texas and Florida recently reaffirmed this position.

New Jersey, on the other hand, expanded CGL coverage even further. Since at least 1979, the state has held that defective workmanship that results in bodily injury to a person or damage to someone else’s property is a covered occurrence in a CGL policy even if the defect develops gradually rather than a sudden event.

In 2011, South Carolina held for coverage in a similar progressive property damage case where the damage was caused by the policyholder’s subcontractor, using a “time on risk” analysis to apportion damages. Maryland, Kansas and Wisconsin adopted the same subcontractor exception.

What If My Company Operates in Multiple States?

Which state’s law applies to our hypothetical case? The answer depends on several factors.

The law of the state where the accident occurred is generally not applicable unless the policy specifically identifies a site-specific risk. The declaratory judgment suit that results doesn’t seek damages from the accident itself, but instead asks the court to interpret the provisions of an insurance contract.

The conflict of laws principles (rules that determine whose legal system applies to the dispute) are then applied. In contract cases, most states follow the governmental interest test to determine which state’s CGL precedent applies. This test includes:

• If the parties mutually understood that a specific site was the location of an insured risk, the law of that state will apply unless it is shown that some other state has a superior interest in the outcome.

• Does the policy identify a site-specific risk? If operations are covered in only one jurisdiction, a site-specific risk is inferred. However, if the policy covers operations in multiple states, then the mere fact that a particular state is listed doesn’t justify an inference of site-specific coverage in that state. In that case, the site of the insured risk must be expressly designated. Operations in multiple states can make multiple designations of site-specific risk for different locations.

• If the policy doesn’t include any site-specific provisions, the courts will look to a handful of factors to determine which state has the most interest in the case. These include where the insurance contract was formed, where the contract was negotiated, where it will be performed and where the accident occurred. The domicile of the insured and the insurer are considered as well.

The policyholder’s place of performance is the state where it maintains its business office or where it mailed or electronically transferred its payments for insurance premiums. The insurance company performs in the forum state (the state whose courts will hear and decide the dispute) where it may be required to proffer a defense, which may or may not be the state where the accident occurred. Courts weigh these factors qualitatively, and as can be expected, the nuances of this process vary widely between states.

How can you protect yourself? The most important lesson is to know where you stand — be aware of the law governing the occurrence clause in your home state, plus any states where you’re about to start construction. Make sure you include site-specific designations in your policy endorsements, even multiple designations for different projects. Cover your bases before the outset of any project as a proactive defense against future claims. •