Iowa High Court Holds Damage Caused By Subcontractor’s Faulty Workmanship May Constitute Accidental Occurrence.

The Iowa Supreme Court, applying Iowa law, held that property damage resulting from defective workmanship by a policyholder’s subcontractor may constitute an “occurrence” triggering coverage for water damage.

The policyholder, Westlake Investments LLC (“Westlake”), purchased a 300 unit apartment complex in West Des Moines, Iowa.  Shortly thereafter, Westlake discovered widespread water damage to the complex.  Westlake sued the general contractor and developers for lost profits, repair costs, and damages under both tort and contract theories.

The general contractors and developers had $1 million in primary insurance from Arch Insurance Group (“Arch”), and $20 million in excess coverage from National Surety Corporation (“NSC”).  Arch defended the general contractors and developers.  A $15.6M judgment was entered in favor of Westlake.  Arch paid its $1 million in limits and certain third parties paid other amounts.  Ultimately, $12.86 million of the judgment remained unpaid, which Westlake attempted to collect from excess insurer NSC.  NSC refused to pay the judgment and filed a declaratory judgment action against Westlake.

The main issue addressed by the Iowa Supreme Court was whether faulty workmanship by a policyholder’s subcontractor can constitute an “accident” under a modern CGL policy.  This required a two-step process:  (1) determining the meaning of “accident,” which was undefined in the NSC policy; and (2) whether faulty workmanship by a policyholder’s subcontractor can constitute an “accident” as a matter of law.

As to the first issue, Westlake argued that “accident” must be interpreted subjectively and means “an unplanned, sudden, and unexpected event . . . determined from the viewpoint of the insureds and what they intended or should reasonably have expected.”  In response, NSC argued that “accident” means “an undesigned, sudden and unexpected event” and claimed the term should be interpreted objectively.  The court agreed with Westlake, based on the court’s interpretations of the “expected or intended” and “sudden and accidental” exclusions in prior cases.  In those instances, the court interpreted and applied the exclusions subjectively – from the standpoint of the insured:  “Applying the same logic, we conclude that in the context of a modern standard-form CGL policy … the term “accident” means ‘an unexpected and unintended event.’”

The court next considered NSC’s claim that defective workmanship cannot constitute an “accident” as a matter of law.  The court acknowledged prior precedent that “defective workmanship standing alone, that is, resulting in damages only to the work product itself, is not an occurrence under a CGL policy.”  However, the court held there is a distinction between whether a CGL policy provides coverage for a policyholder’s faulty workmanship, as compared to whether a CGL policy provides coverage for a policyholder’s subcontractor’s faulty workmanship that resulted in damage not only to its own work but to other property:  “Westlake proved defective installation of the building wrap and flashings resulted in water penetration that caused widespread consequential damage to interior building components that were not defective, including the wood framing, drywall, insulation, carpet, nails, staples, and other metal fasteners inside the walls.  Westlake also established the defective work that led to the claimed damages was performed by insureds’ subcontractors, not the insureds themselves.”

Based on these proofs, the court ultimately held:  “Reading the [NSC] policy as a whole, we conclude it plainly contemplates coverage for some property damage caused by defective work performed by an insured’s subcontractor.  In short, interpreting the term “accident” or the term “occurrence” so narrowly as to preclude coverage for all property damage arising from negligent work performed by an insured’s subcontractor would be unreasonable in light of the policy language as a whole.”  National Surety Corp. v. Westlake Investments, LLC, No. 14–1274 (Iowa June 10, 2016).