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BMK Obtains a Third Circuit Court of Appeals Ruling Affirming Insurance Coverage for “Faulty Workmanship” Performed by the Insured’s Subcontractor

BMK Obtains a Third Circuit Court of Appeals Ruling Affirming Insurance Coverage for “Faulty Workmanship” Performed by the Insured’s Subcontractor

May 08, 2017

SUMMIT, N.J., April 18, 2017 – Kenneth L. Moskowitz and Steven R. Rowland recently won an important insurance coverage decision on an appeal to the United States Court of Appeals for the Third Circuit — a decision which should have the general effect of expanding coverage for those contractors who rely upon subcontractors to perform part of their work-scope.

In its April 18, 2017 decision, the Third Circuit found in favor of BMK’s client, USA Container Co., Inc. (“USA Container”), affirming a federal District Court ruling that the property damage at issue constituted a covered “occurrence,” and rejecting the argument of the insurer, Travelers Property Casualty Company America (“Travelers”), that the subcontractor’s “faulty workmanship” was not covered by the insured’s Commercial General Liability (“CGL”) policy.

By way of background, USA Container contracted with a customer, a Dutch supplier/distributor of agricultural products, to transfer the customer’s bulk corn syrup from railroad cars into 55 gallon drums in preparation for transoceanic shipment to the end-users, i.e., the customers of USA Container’s customer.  USA Container, in turn, subcontracted the drumming operation to Passaic River Terminal (“Passaic River”), but unfortunately the subcontractor negligently damaged the corn syrup by overheating it during the transfer from the railroad cars to the 55 gallon drums.  After the foreign end-users rejected the damaged corn syrup, USA Container’s customer was able to mitigate its damages by selling the product at a reduced price, but USA Container’s customer nonetheless incurred a loss of nearly $800,000.

After being sued by USA Container’s customer, the subcontractor went out of business and was judgment-proof.  USA Container was also the subject of a claim by its customer, and USA Container sought coverage under its CGL policy with Travelers. After Travelers disclaimed coverage, USA Container and its customer settled the customer’s claim for $732,000, with USA Container undertaking to pay $425,000, with the balance to be paid from the proceeds of any insurance recovery.

In disclaiming coverage, Travelers argued that under New Jersey law “faulty workmanship” was not to be an “occurrence” as defined in the CGL and, therefore, was not covered.  In arguing that “faulty workmanship” was not covered under the CGL, Travelers relied extensively on Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979) (“Weedo”) — what had been regarded as a seminal New Jersey Supreme Court case that has been cited over the last thirty-five years for its broad statements limiting the scope of CGL policies and, in particular, that such policies were not intended to cover claims arising from the insured’s own “faulty work.”  Travelers argued in both the District Court and on appeal to the Third Circuit that, pursuant to Weedo, such claims are non-covered “business risks” that must be absorbed by an insured as a cost of “doing business.”

The District Court rejected Travelers’ arguments and held that USA Container’s claim was covered under the plain language of CGL.  The Third Circuit then affirmed the District Court’s finding that Passaic River’s inadvertent or “accidental” damage of the insured’s customer’s corn syrup constituted an “occurrence” under the CGL — which it held to be an “unintended and unexpected harm caused by negligent conduct.”  In its ruling, the Third Circuit acknowledged that its decision conflicted with its prior non-precedential decision in Pennsylvania National Mutual Ins. Co. v. Parkshore Development, 403 Fed. Appx. 770 (3d Cir. 2010), finding that an intervening decision of the New Jersey Supreme Court, Cypress Point Condominium Association, Inc. v. Adria Towers, LLC, 226 N.J. 403 (2016) (“Cypress Point”), had rejected the notion that “faulty workmanship” was not an “occurrence.”

The Third Circuit went on to hold that a CGL policy is a contract and acknowledged that, subsequent to Weedo, the language of the CGL policy had been changed in an effort to make it a more attractive product to those insureds who rely upon subcontractors.  The Third Circuit held further that the New Jersey Supreme Court’s recent ruling in Cypress Point meant that Weedo’s broad statements concerning “business risks” were no longer valid.  Going forward, New Jersey courts — and federal courts construing New Jersey law — were instructed to make coverage determinations based on the plain language of the CGL rather than on any purported unwritten principles that were not expressly made a part of the CGL.  In interpreting the language of the CGL policy’s insuring clause — the initial grant of coverage — the Cypress Point court directed that so long as there was no intention by the subcontractor to cause damage, its “faulty workmanship” is an “occurrence” that is covered absent the applicability of an express policy exclusion.

The Third Circuit affirmed the District Court’s finding that there had been an “occurrence” based on the “unintended and unexpected” harm definition articulated in Cypress Point.  Notably, the District Court’s use in the USA Container litigation of the “unintended and unexpected” test pre-dated the Cypress Point decision and, as such, was one of the first cases in New Jersey to recognize that because Weedo concerned a different form of CGL policy — the 1973 form, an older policy with narrower coverage — the case’s broad generalizations no longer could be reconciled with the newer version of the policy that had been purchased by USA Container.

The USA Container decision is a watershed event in that it represents the first time that a federal appellate court has ruled that the Parkshore Development case — which relied upon Weedo — is no longer valid or controlling.  As a result, the Third Circuit has recognized that New Jersey law — which in Weedo originated the notion that “faulty workmanship” was not covered by a CGL — has now joined the “strong trend in the case law” nationwide holding that faulty workmanship falls within the basic terms of coverage under the current form of CGL.

For further information about Travelers Property Casualty Co. v. USA Container, Inc., please feel free to contact either Kenneth L. Moskowitz, Esq. (klm@bmk-law.com) or Steven R. Rowland, Esq. (srowland@bmk-law.com), or call either of us at 973-376-0909.

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