The Impaired Property Exclusion: What Risks Are Covered By Your CGL Policy?

I have assisted insurance companies, developers, general contractors, and subs and suppliers in evaluating the scope of insurance coverages. All are often confused in evaluating risks covered by insurance policies, including the Impaired Property Exclusion. Many believe the have insurance (of some kind) and are covered for it, regardless of what the it may be. Conversely, insurance policies are complicated contracts that are carefully created by thousands of lawyers over several decades. A primary goal of insurance policies is artfully slicing away at the big promise of coverage.

Commercial General Liability Policies (“CGL Policies”) may exclude from coverage a contractor’s defective “work” and/or “product”. The owner’s property may not be destroyed, but may require repair to be used. Developers and contractors may look to the CGL Policy for coverage for losses flowing from repairs or replacement of defective work. They may be disappointed to find no insurance coverage because of complex and misunderstood exclusions, like the Impaired Property Exclusion.

In Paustian Med. & Surgical Ctr. S.C. v. IMT Insurance Co. (1), an insurance coverage claim from Clark County, a Wisconsin state appellate court analyzes the application of the Impaired Property exclusion to an HVAC contractor’s allegedly defective design and installation of an HVAC system for a “build out” of a medical facility. It presents an opportunity to evaluate how a court may or may not find insurance coverage for economic damages that may be caused, in part or whole, by a contractor’s work, product, or failure to fully perform a contract.

If you are a developer or contractor and are curious what coverages a CGL Policy may provide, and how you may become better protected against expensive risks through additional coverages, please consider reaching out to me to discuss. This analysis can become crucial to making sound business decisions based on properly calculated risk.

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The Impaired Property Exclusion Dispute in Paustian

Paustian contracted with RC Heating & Cooling (“RCHC”) to design and install an HVAC system for a build out of its existing medical clinical facility. RCHC then hired a state registered Designer of Engineering Systems to design the HVAC system. RCHC installed the HVAC system as designed. 

After the project was completed, Paustian sued RCHC and its insurer, IMT, alleging breach of contract and negligence (2). Paustian argued the HVAC system was designed with defects, build with defective materials, not installed in a workmanlike manner, not up to code, and not properly warranted. Paustian alleged damages in the form of lost income due to loss of use of the facility’s build-out areas. It also claimed losses in the form of “expenses associated with repairing and replacing the defective work” resulting from “the deficiencies in the HVAC system.”

RCHC had a CGL Policy with IMT. Paustian and RCHC alleged that RCHC’s CGL Policy with IMT provided coverage for Paustian’s losses. IMT asked the court to find that it had no duty to defend and no duty to indemnify RCHC for Paustian’s claims under the impaired property exclusion.

Wisconsin Court Analysis of the Impaired Property Exclusion

A CGL Policy provides coverage for alleged damages when an “occurrence” (3) causes “property damage” for which no exclusions apply. If an exclusion applies, the court will consider whether an exception to the exclusion applies to restore coverage. Insurance policies have very specific definitions for these terms. Courts often spend some time analyzing these definitions. Here, the court focused on the asserted Impaired Property exclusion.

The Impaired Property Exclusion allows an insurer to exclude coverage when the property has been “impaired” in one of two ways:

(1) the contractor’s failure to perform a contract; or,

(2) a defect, deficiency, inadequacy, or unsafe condition in the contractor’s “work” or “product”.

Importantly, there is an exception to this exclusion. The Impaired Property Exclusion does not apply, and thus coverage is restored, when there is loss of use to other property resulting from sudden and accidental physical injury to or destruction of “your work” or “products” AFTER having been put to its intended use.

Here, the court found the exclusion applied. The alleged damages were economic in nature and were allegedly caused by the deficient HVAC unit and deficient installation. The damages were also caused by failure to perform the contract, i.e. installing an HVAC unit that would properly heat and cool the build-out. It also appears that the particular allegations of the complaint did not invoke the exception. The court found Paustian did not address in its arguments whether the exception applied. This is curious because the initial explanation of facts suggests that the defective HVAC system caused losses after having been put to use. 

Insurance Policy Litigation Strategy – Bet The Company Litigation

In Paustian, the owner and HVAC contractor had shared interests in framing the owner’s damages and losses such that the insurance company would provide coverage. While these opposing parties may seem like odd litigation bedfellows, this is more common than you may think. Damages caused by a breach of contract are often so large that a small contractor simply cannot pay. The only lemon worth squeezing is the insurer. The owner will not get full recovery – or potentially no recovery – unless the insurer provides coverage. When attempting to resolve the matter before trial, it is valuable for the owner to have multiple defendants and insurance companies potentially on the hook.

Understanding and Applying the Impaired Property Exclusion

Insurance policies are complicated documents. The Impaired Property Exclusion is one of the most confusing CGL Policy exclusions. It is important for developers and contractors to understand how it applies. They should consider consulting an attorney early after identifying a potential dispute with an eye toward protecting their rights against their insurer and other insurers. If you believe this impaired property analysis may apply to you, please consider contacting me to discuss. 

(1) Paustian Med. & Surgical Ctr., S.C. v. IMT Ins. Co. (Wis. App. 2020). I am only privy to what was discussed in the published decision. There may have been other important facts that affected the decision.

(2) Paustian also sued the parties that designed the HVAC system and their insurer for negligence. Those claims are not at issue in this appeal.

(3) The Policy at issued defined “occurrence” as “an accident and includes repeated exposure to similar conditions,” and defines “property damage” as “physical injury or destruction of tangible property” or “the loss of use of tangible property whether or not it is physically damaged.”

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