Claims Adjuster
Best In The World Insurance Company
Anywhere, USA

Dear Sir/Madam:

Thank you for forwarding this case to our office. I have reviewed the materials provided with respect to the above captioned matter, including the motion for judgment filed in the circuit court of the State of Virginia lawsuit entitled John Doe and Jane Doe v. BCA Meadows, L.L.C. and ABC Corporation, At Law No. 22222-VA, (the "complaint"), Commercial General Liability Coverage Form CG 00 01 11 88, Declarations and Endorsements, and various other claim file materials.

According to the complaint, John Doe and Jane Doe ("claimants") allege that they entered into a contract on October 8, 1997 with BCA Meadows, L.L.C. and ABC Corporation (collectively "the insureds") for the purchase of a residential lot and the construction of a house thereon. Claimants moved into the house on April 20, 1998, and within several weeks thereafter they noted and reported to the insureds an abnormal amount of water in their backyard. The insureds allegedly attempted to fix the problem by digging holes along the back of claimants' house and drilling holes in the foundation of the house and pumping the water out. The insureds advised claimants that the problem had been fixed, and that no further repairs were necessary. However, claimants continued to have standing water outside of and under the house, and noted that the foundation and garage floor were cracking. Claimants retained other contractors and experts to look into the problem. In November 1998 claimants allegedly learned for the first time that the house had been built on up to eleven feet of uncompacted and uncontrolled earthfill not suitable for the construction of a house thereon. Claimants allege that the insureds either created the fill condition or had actual or constructive knowledge thereof. Claimants allege that the insureds had a duty to disclose this information to them.

Count one alleges statutory fraud. Count two alleges fraud. Count three alleges breach of warranty. Count four alleges implied and express warranty. Count five alleges negligence. Claimants seek compensatory damages, treble damages, punitive damages, costs and attorneys' fees.

CBA Insurance Company ("CBA") issued to ABC Corporation, 307 Needle Boulevard, Suite 1C, Newport News, Virginia, policy number 123456 with effective dates of November 19, 1997 to November 19, 1998 under Worldly Insurance Company Coverage Form WI 00 01 11 88. BCA Meadows, L.L.C. is added to the policy as a named insured by endorsement. The policy affords a per occurrence limit of $500,000, a personal and advertising limit of $500,000, a products-completed operations aggregate limit of $1,000,000, and a general aggregate limit of $1,000,000.

The relevant portions of the policy are as follows:

Your inter-office correspondence dated February 18, 2000 requests an opinion on the coverage issues involved in the above referenced matter.

Coverage under an insurance policy means the insurer's duty to defend and indemnify losses claimed under the policy. In Virginia, an insurer's duty to defend is broader than the duty to indemnify. Lerner v. General Insurance Company, 219 Va. 101 (1978). "The obligation to defend arises whenever the complaint against the insured alleges facts and circumstances, some of which, if proved, would fall within the risk covered by the policy." Brenner v. Lawyers Title Insurance Corporation, 240 Va. 185, 189 (1990). There is no duty to defend only when the allegations are clearly outside of the insurer's obligation under the contract. Parker v. Hartford Fire Insurance Company, 222 Va. 33, 35 (1981), citing Travelers Indemnity Company v. Obenshain, 219 Va. 44 (1978).

SECTION II--WHO IS AN INSURED provides that if the insured is designated as an organization other than a partnership, joint venture or limited liability company, that organization is an insured. ABC Corporation is designated as a corporation, and is thus an insured with respect to this claim. Pursuant to endorsement, BCA Meadows, L.L.C. has also been designated as a named insured, and is thus an insured with respect to this claim. Claimants do not distinguish among the insureds in their allegations of wrongdoing. Thus, although the insureds may have performed different functions, they will be addressed together for purposes of this analysis.

COVERAGE A--BODILY INJURY AND PROPERTY DAMAGE LIABILITY affords coverage for damages the insureds become legally obligated to pay as a result of certain "bodily injury" or "property damage" only if it arises out of an "occurrence" (paragraph 1.b), which is defined as an "accident" (paragraph 12 of SECTION V), subject to Exclusion a., which excludes "bodily injury" or "property damage" expected or intended from the standpoint of the insureds. In discussing the meaning of "occurrence", Virginia courts focus on the insured's intent to act or perform the act and inflict the harm which gives rise to liability. Johnson v. Insurance Company of North America, 232 Va. 340 (1986); Morris v. Travelers Indemnity Company, 31 Va. Cir. 306 (1993). An "accident" or "occurrence" refers to an incident that is unexpected from the viewpoint of the insured. Utica Mutual v. Travelers Indemnity Company, 223 Va. 145, 147 (1978). In the instant matter, claimants allege that the insureds were negligent in the construction of claimants' home. Claimants have thus alleged an "occurrence". However, claimants have also alleged that the insureds committed fraud by intentionally withholding information concerning latent defects from claimants with the intent to mislead them. Such conduct does not constitute an "occurrence" and could trigger the application of Exclusion a. CBA should reserve its right to decline to provide a defense or indemnification for any damages which do not result from an "occurrence" or which were expected or intended by the insureds.

"Bodily injury" or "property damage" is necessary, under Insuring Agreement paragraph 1.a. of COVERAGE A, to trigger COVERAGE A. "Bodily injury" is defined in SECTION V--DEFINITIONS as "bodily injury, sickness or disease sustained by a person, including death resulting from any of these at any time." Claimants have alleged that they have sustained mental distress. The Virginia courts have not specifically addressed whether emotional distress unaccompanied by physical manifestation qualifies as "bodily injury" under a policy of insurance. SECTION V defines "property damage" as "physical injury to tangible property, including all resulting loss of use of that property" or "loss of use of tangible property that is not physically injured." The defective construction is alleged to have resulted in cracking of the foundation and garage floor. Thus, claimants have alleged "property damage" caused by an "occurrence" under COVERAGE A. However, claimants also seek damages because of fraud. Damages awarded pursuant to claimants' fraud claims would be damages for purely economic loss, and would not constitute "property damage". Accordingly, CBA should reserve its right to decline to provide a defense or indemnification for any damages sought which do not qualify as "bodily injury" or "property damage."

Exclusion b. excludes from coverage any "bodily injury" or "property damage" that the insureds are obligated to pay as a result of assumption of liability in a contract or agreement. However, this exclusion does not apply to liability for damages that the insureds would have in the absence of the agreement. The insureds are alleged to have entered into a contract to provide a new home to claimants which was constructed in an above average fashion. Although claimants have not set forth a count for breach of contract, they have implicitly alleged that the insureds breached their construction contract. However, the insureds do not assume any liability in the alleged agreement. Additionally, the liability which claimants seek to impose upon the insureds is liability the insureds would have in the absence of the agreement. Therefore, Exclusion b. would not apply to bar coverage in the instant matter.

COVERAGE A is also subject to Exclusion j.(2), which excludes property damage to premises the insureds sell, if the property damage arises out of those premises. The complaint alleges that claimants entered into a contract to purchase the house with both insureds. Thus, the house may be considered premises that the insureds sells. However, Exclusion j.(2) does not apply to premises which are the insureds' work, and which were never occupied, rented or held for rental by the insureds. As will be discussed later in this opinion, the house qualifies as the insureds' work. Based upon the information known to date, the insureds never occupied, rented or held the property for rental. Accordingly, Exclusion j.(2) does not apply to the facts alleged.

Exclusion j.(5) excludes from coverage any "property damage" to the particular part of real property on which the insureds or contractors or subcontractors working directly or indirectly on the insureds' behalf are performing operations, if the "property damage" arises out of the operations. The language of the exclusion requires the "property damage" to occur at the same time as operations are being performed. Claimants are suing the insureds for damages which were discovered and/or occurred after claimants purchased the property. They are not suing the insureds for damage caused by the insureds while they were working on the property. Thus, Exclusion j.(5) has not been triggered by the facts alleged.

Virginia follows the majority of jurisdictions in holding that the cost of repairing defective workmanship is not intended to be covered by a general liability policy of insurance. The Supreme Court of Virginia cited extensively to Weedo v. Stone-E-Brick, Inc., 81 N.J. 233 (1979) in concluding in Nationwide Mutual Insurance Company v. Wenger, 222 Va. 263, 267-268 (1981) that a CGL policy is not intended to act as a performance bond:

In Weedo, the New Jersey Supreme Court engaged in an extended analysis of the policies underlying the general comprehensive liability policy. When a contractor performs work, warranties arise both under his contract and by operation of law. (Citation omitted). Since the contractor can control the quality of his own work, it is fair to hold him liable when the work is faulty. (Citation omitted). Thus, the risk is that the contractor may incur liability under warranty is a normal part of doing business.

A second type of risk that arises from construction is injury to people and damage to property other than the completed work itself. (Citation omitted). For example, stucco improperly applied to the exterior of a building may fall and injure a passerby or dent an automobile. (Citation omitted). Unlike the first type of risk, where liability is limited to the cost of replacement or repair, the second category of risk subjects the contractor to unlimited liability. For this reason, the contractor turns to the insurance industry to underwrite these risks. (Citation omitted.)

See, also, American Fire & Casualty Insurance Company v. Doverspike, 36 Va. Cir. 263 (1995).

Exclusion j.(6) excludes from coverage any "property damage" to the particular part of any property that must be restored, repaired or replaced because the insureds' work was incorrectly performed on it. However, Exclusion j.(6) does not apply to "property damage" included in the "products-completed operations hazard." Claimants are suing the insureds for damages which were discovered and/or occurred after claimants purchased the property. As will be discussed below, the damage claimed falls within the "products-completed operations hazard.*" Therefore, CBA should not rely on Exclusion j.(6) when determining its obligations under the policy.

Exclusion k. to COVERAGE A excludes "property damage" to the insureds' product arising out of the product or any part of the product. The insureds' product is defined in SECTION V. as "any goods or products, other than real property, manufactured, sold, handled, distributed or disposed of" by the insureds, and also includes any warranties or representations made regarding the fitness, quality and performance of such product. In the instant matter, the insureds' product is the house, which is real property. The policy definition excludes real property from constituting the insureds' product. The products exclusion therefore does not apply, and CBA should not rely upon this exclusion in determining its duties to the insureds.

Exclusion l. excludes "property damage" to the insureds' work arising out of the work or any part of it if the damage is included in the "products-completed operations hazard." The insureds' work is defined as work or operations performed by the insureds and any materials, parts or equipment furnished in connection with the work. A "products-completed operations hazard" is defined to include all "property damage" that occurs away from premises the insureds own or rent and that arises out of the insureds' product or work, except (1) products that are still in the insureds' physical possession and (2) work that has not yet been completed or abandoned. The insureds' work is deemed completed at the earliest of the following times: (1) when all of the work called for in the insureds' contract has been completed; (2) when all of the work to be done at the site has been completed if the contract calls for work at more than one site; or (3) when that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project. The definition clarifies that work which may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed. A similar version of this exclusion has been applied by the Virginia Supreme Court in Nationwide Mutual Insurance Company v. Wenger, 222 Va. 263 (1981). Courts of other jurisdictions have routinely applied this exclusion. See, Boyer Metal Fab, Inc. v. Maryland Casualty Company, 90 Or. App. 103, 107 (1988), pet. for rev. den. 305 Or. 672 (1988); Alverson v. Northwestern National Casualty Company, 559 N.W.2d 234, 236 (S.D. 1997). The complaint does alleges that the defects were not discovered until after claimants purchased the house and started living in it. The house had been put to its intended use by claimants before any of the damage was discovered, and the damage occurred away from premises the insureds own or rent and arose out of the insureds' work. The damage thus falls within the "products-completed operations hazard". However, Exclusion l. does not apply if the damaged work or the work out of which the damage arises was performed on the insureds' behalf by a subcontractor. The file materials do not reflect whether subcontractors performed any of the defective work for which the insureds are being sued. It is possible that some of the damaged work was done by sub-contractors, or that some of claimants' personal property has been harmed. Such "property damage" would not be subject to Exclusion l. CBA should reserve its right to decline to provide a defense or indemnification for "property damage" to the insureds' work arising out of the work or any part of it if the damage is included in the "products-completed operations hazard."

Exclusion m. excludes from coverage any "property damage" to "impaired property" or property not physically injured arising out of a defect or deficiency in the insureds' product or work. "Impaired property" is defined as tangible property, other than the insureds' product or work, that cannot be used or is less useful because it incorporates the insureds' product or work. Although Virginia courts have not interpreted this particular exclusion, it has been routinely applied by courts of other jurisdictions. J.Z.G. Resources, Inc. v. King, 987 F.2d 98 (2d Cir. 1993); William Crawford, Inc. v. Travelers Insurance Company, 838 F. Supp. 157, 158-59 (S.D.N.Y. 1993); Baywood Corporation v. Maine Bonding & Casualty Company, 628 A.2d 1029 (Me.1993); Willets Point Contracting Corporation v. Hartford Insurance , 75 A.D.2d 254 (1980), aff'd 53 N.Y.2d 879 (1981); American States Insurance Company v. Brooks Construction, No. 14980-3-III, 1997 Wash. App. LEXIS 788 (May 22, 1997); Schwindt v. Underwriters at Lloyd's of London, 81 Wash. App. 293 (1996), rev.den. 130 Wash.2d 1003 (1996). The complaint does not allege that there is any impaired property, and it is unlikely that any exists, as the insureds' defective work is the house. However, because of the possibility that impaired property might exist, CBA should reserve its right to decline to provide a defense or indemnification pursuant to Exclusion m. for "property damage" to impaired property arising out of a defect or deficiency in the insureds' work.

Exclusion n. excludes coverage for damages incurred for the loss of use, withdrawal, recall, inspection, repair, or replacement of the insureds' product or work, if the product or work is withdrawn from use by any person because of a known or suspected defect, deficiency, inadequacy or dangerous condition. This exclusion is commonly known as the "sistership" or "product recall" exclusion. It operates to exclude coverage for the cost of "preventative or curative action" when the insureds withdraw a product in situations in which a danger is merely apprehended. It does not exclude coverage for the actual damage caused by the very product or work giving rise to such an apprehension. Although Virginia courts have not interpreted this exclusion, courts of other jurisdictions have routinely applied it. See, e.g. Wyoming Sawmills, Inc. v. Transportation Insurance Company, 282 Or. 401, 409 (1978); Olympic S.S. Co. v. Centennial Insurance Company, 117 Wash.2d 37 (1991). In the present case, the damage claimed is to the defective house. As there is no damage apprehended to products or work other than the house, Exclusion n. does not apply.

Under COVERAGE B--PERSONAL INJURY AND ADVERTISING INJURY LIABILITY, CBA agrees to pay those sums that the insureds become legally obligated to pay as damages because of "personal injury" or "advertising injury" to which the insurance applies. An "advertising injury" can only result from an offense committed in the course of advertising the insureds' goods, products or services, and is not implicated by the facts alleged. However, COVERAGE B also affords coverage for "personal injury" caused by an offense arising out of the conduct of the insureds' business. "Personal injury" is defined in SECTION V--DEFINITIONS to include the wrongful eviction from, wrongful entry into, or invasion of the right of private occupancy of a room, dwelling or premises that a person occupies by or on behalf of its owner, landlord or lessor. Claimants allege they have been forced to move out of the house as a result of the damage. This loss of use does not constitute a constructive eviction, as constructive eviction requires a landlord-tenant relationship which does not exist in the present case. Buchanan v. Orange, 118 Va. 511 (1916). In the present case, no claim for constructive or wrongful eviction or any other offense falling within the definition of "personal injury" or "advertising injury" has been pled or is suggested by the facts alleged. Thus COVERAGE B is not implicated in this case.

SECTION IV - COMMERCIAL GENERAL LIABILITY CONDITIONS, Subsection 4. Other Insurance provides that CBA obligations are limited if other valid and collectible insurance is available to the insureds for a covered loss under Coverages A or B. The file materials reflect that the claim has also been reported to Travelers Insurance Company under the insureds' builder's risk policy of insurance. If the insureds do have applicable builder's risk insurance, the CBA policy will apply on an excess basis and CBA will not have a duty to defend the insureds. I recommend additional investigation regarding the insureds' builder's risk coverage, at which time it may be determined whether the subject policy will apply to the insureds on a primary or excess basis, and what method of sharing applies. CBA's obligations in this regard will be determined by the nature, scope and extent of other coverage.

With regard to the relief sought by claimants, the Insuring Agreement at paragraph 1.a. of each of COVERAGE A and COVERAGE B obligates CBA to pay those sums that the insureds become legally obligated to pay as covered damages. Claimants seek compensatory damages, treble damages, punitive damages, costs and attorneys' fees. Paragraphs 5, 6 and 7 of SUPPLEMENTARY PAYMENTS - COVERAGES A AND B provides that CBA will pay costs, pre-judgment interest and post-judgment interest assessed in suits it defends. However, the policy does not address attorneys' fees and Virginia courts have not addressed the issue of whether attorneys' fees awarded against the insureds constitute covered damages. Courts of other jurisdictions which have addressed the issue have held that attorneys' fees are not covered as damages. See, e.g., Cutler/Orosi Unified School District v. Tulare County School Districts Liability/Property Self Insurance Authority, 37 Cal. Rptr.2d 106 (Cal. App. 1994); Butler & Binion v. Hartford Lloyd' s Insurance Company, 957 S.W.2d 566 (Tex. App. 1995). Virginia courts have held that punitive damages may be covered by insurance if the policy does not specifically exclude such damages. United Services Automobile Association v. Webb, 235 Va. 655 (1988). A similar conclusion would most likely be reached regarding treble damages. However, treble and punitive damages are sought pursuant to the claims for fraud and statutory fraud. As was discussed above, the damages sought for fraud and statutory fraud do not constitute damages for "bodily injury" or "property damage" caused by an "occurrence" and thus are not covered. Therefore, CBA should reserve its right to decline to provide indemnification for any item of relief that does not properly constitute damages.

In summary, claimants have alleged "property damage" caused by an "occurrence", and thus have triggered CBA defense obligations. However, as the insureds may have builder's risk insurance which would apply on a primary basis and relieve CBA of its defense obligations, CBA should not commit to providing the insureds with a defense until the other insurance coverage has been investigated. Additionally, CBA should reserve its right to decline to provide indemnification for any damages which were not caused by an "occurrence" or which were expected or intended by the insureds. CBA should reserve its right to decline to provide indemnification for any damage which does not constitute bodily injury or property damage. CBA should also reserve its right pursuant to Exclusion l. to decline to provide indemnification for "property damage" to the insureds' work arising out of the work or any part of it if the damage is included in the "products-completed operations hazard." Additionally, CBA should reserve its right to decline indemnification pursuant to Exclusion m. for "property damage" to impaired property arising out of a defect or deficiency in the insured's work. Finally, CBA should reserve its right to decline to provide indemnification for any item of relief that does not properly constitute damages. A proposed letter to counsel for the insureds is enclosed.

Very truly yours,

SHAPIRO & ASSOCIATES

*See Discussion of the products-completed operations hazard discussed with reference Exclusion 1. infra.