Available Protections Against Construction Defects

A construction project imposes several risks. One of the most daunting is the risk of construction defects, particularly those caused by faulty workmanship. Commercial general liability policies (“CGL”) and performance bonds are two common products utilized to mitigate this risk. While they have similarities, they are quite different and provide different coverage and protections.

A CGL policy is a two-party contract between the insured and the insurance company and provides liability coverage against claims related to bodily injury or property damage. A performance bond is a tripartite contract between the surety company (surety), the principal (contractor), and obligee (owner). The performance bond guarantees the surety will complete the project according to the bonded contract’s terms should the principal default. In further contrast, the insurance company is to indemnify and defend the insured, whereas the principal is obligated to indemnify and defend the surety as well as reimburse the surety in full for all losses incurred as a result of issuing the performance bond.

Whether the CGL policy provides coverage for a construction defect or resulting damage is dependent upon the policy’s terms and exclusions, along with how your jurisdiction defines an “occurrence.” Wisconsin courts do not recognize a construction defect or faulty workmanship as an “occurrence”; however, it can lead to an occurrence thereby triggering coverage for damage resulting from the defective work but not the defective work itself.

The definition of “occurrence” was recently before the Wisconsin Supreme Court in the case of 5 Walworth LLC v. Engerman Contracting, Inc. 2023 WI 51. The matter involved claims arising from the alleged faulty installation of an in‑ground swimming pool, which caused the pool to crack and water to leak into the surrounding area.

The Court held that while the contractor’s faulty work was not itself an occurrence, coverage was triggered because the resulting “cracks, leakage, and soil damage could constitute accidents caused by improper installation.” Id., ¶36.

Conversely, subject to the obligee fulfilling its obligations under the bonded contract and the conditions precedent under the bond being satisfied, a performance bond will cover the cost to repair the faulty work. Should the surety pay for damage resulting from the faulty workmanship, Wisconsin courts will hold that the surety is entitled to subrogation against the CGL insurer.

Practical Tips for Stakeholders:

• Review Your Policy: Regularly review the terms and exclusions of your CGL policy to ensure it provides adequate coverage for your specific needs.
• Review the Performance Bond and Construction Contract: Thoroughly review the terms and conditions of the bond and construction contract to ensure a full understanding of the obligations under both and conditions precedent to trigger the surety’s obligations.
• Legal Consultation: Consult with legal experts in construction law to understand how state-specific definitions and rulings, like those in Wisconsin, might impact your coverage under your CGL policy and protections under a performance bond.
• Risk Management: Implement robust risk management practices during the construction process to minimize the likelihood of defects and faulty workmanship.
• Documentation: Maintain thorough documentation of all construction activities and communications to support any claims made under your CGL policy and performance bond.

In summary, a CGL policy manages the risk of damage to property other than the contractor’s faulty workmanship itself, while the performance bond manages the risk associated with both. For owners, contractors, and other stakeholders in the construction industry, understanding the nuances between these protections is critical. This knowledge ensures that projects are adequately protected, and risks are effectively mitigated.