An important case for contractors and subcontractors has surfaced at the Michigan Supreme Court. Skanska USA Building, Inc. v. M.A.P. Mechanical Contractors, Inc. raises the question: is property damage coverage under a standard commercial general liability policy when the damage results from a construction defect? Courts throughout the country have been divided on this issue.
Michigan has historically taken the position that coverage does not exist, unless the property damage that occurred was to property other than the insured’s own work. Michigan appellate courts have considered whether coverage exists when the claim is made by an insured which was seeking coverage to repair and replace its own defective work. Skanska supra presents a slightly different situation. In this case the claim at issue was made by Skanska as an additional insured under the commercial general liability policy of its subcontractor M.A.P. Mechanical Contractors. There is no clear indication how the Michigan Supreme Court will rule on this issue. On one hand it could expand the existing precedent to cover the factual situation presented. On the other, this case could result in a change in the law resulting in Michigan following the national trend to afford coverage for construction defects under standard commercial general liability policies. Either outcome presents some practical considerations for contractors and subcontractors.
First, this case could affect the cost of commercial general liability insurance for contractors and subcontractors working in Michigan. One would expect insurance carriers to consider the type and extent of losses they are exposed to when pricing their policies. Construction defects are certainly one such exposure. All other things being equal, this means that states whose laws expose insurers to coverage liability for construction defects would arguably have a higher cost than states, such as Michigan, whose law on this issue does not create such exposure. So, a change in the law of Michigan regarding coverage could result in insurers increasing their pricing for standard commercial general liability cover.
Second, this case could increase contractor and subcontractor exposure to increased risks of loss. Most construction contracts allocate risk to the party that is in the best position to prevent the risk or mitigate a resulting loss. They also operate to transfer risks to third-party insurers. Indemnification provisions and waivers of subrogation are commonly used to accomplish these risk allocation and transfer goals. If the Michigan Supreme Court determines that coverage does exist in this situation, these contract provisions should work well to transfer the risks from construction defects to commercial general liability carriers. However, these same contract provisions may result in contractors and subcontractors indemnifying others for risks that they cannot in turn transfer to an insurance carrier should the Court resolve this issue differently. This places contractors and subcontractors at risk of assuming risks that cannot be transferred.
Third, this case could result in changes to how Michigan handles loss allocation. Loss allocation arises when a loss that is covered by insurance exceeds the limits of a first line policy, such as a CGL policy, leaving the remainder of the loss to be allocated either to other first line policies, if horizontal exhaustion rules are used, or to the insured’s excess insurance line in a vertical exhaustion model. Determining the proper type of coverage and coverage limits is important when drafting construction contracts. Most people presume that vertical exhaustion applies. However, Michigan law is not definitive on that point. This creates the risk that contractors and subcontractors manage project risk under one theory only to find that another theory applies. This could result in contractors and subcontractors incurring costs that they did not expect such as policy deductibles, self-insurance retention, and first line claims for those operating in a captive insurance program.
In sum, the Skanska appeal has broader implications than most would believe. A final opinion will likely resolve the question of whether coverage exists in these situations. It is not clear how that will affect insurance pricing, the ability to allocate and transfer risk, and whether there are other unanticipated risks associated with covered claims. Sophisticated contractors and subcontractors will endeavor to understand these issues further and reevaluate their current contract documents, insurance coverages, and risk management strategies. Prudent contractors and subcontractors will engage their professional service providers to develop an informed understanding of how these issues may affect them, what strategies may be deployed as a result, and how to adapt as these issues are resolved.