20 May 2024
Key court rulings highlight challenges of LEG3 defects exclusions
In a very short space of time, the insurance industry has seen two cases of defects claims brought to court in the USA. Both claims involve LEG3 defects exclusions for under-strength concrete and have concluded in favour of the insured, causing significant concerns for insurers.
We previously provided a summary on the South Capital Bridgebuilders (SCB) judgement. This case revolved around the interpretation of “damage”.
In this case LEG3/06 was the applicable clause on the policy and there was no further damage definition within the core CAR policy wording. As a consequence the judge, operating under Illinois law, referred to Black’s Legal Dictionary and determined that there had been “a bad effect on something” – namely the decreased load-bearing capacity of the bridge - and therefore cover was granted. Further to this, the court referenced the wording of the LEG3 clause; noting their view that “it was undoubtedly obvious or apparent that there was a detrimental change in condition.”
A full summary of this case can be found in our previous article here.
Archer Western - De Moya Joint Venture vs. ACE American Insurance Co
The case of Archer Western – De Moya Joint Venture v. ACE American Insurance Co involved the construction of a highway structure where remediation efforts were necessary due to defective concrete used in certain elements of the project's structures.
The summary judgement for this latest case can be found here. In both cases, much attention has been drawn to the application of the LEG3 exclusion* whereas the crux of both cases appears to centre on the definition of “damage” applied to the loss event. It should be remembered that legal judgements in these types of cases are influenced by the jurisdiction overseeing the hearing. The legal precedent might not be directly applicable to cases in other jurisdictions but there are fundamental concepts and drafting issues that should be considered wherever you operate.
The ACE v Archer construction project involved the replacement and reconstruction, and some new construction, across multiple structures along key highways in Florida, USA.
Significant concrete was needed to complete the works, and an onsite batching plant included a pressurised fly ash silo and mechanical system which was designed to allow specified amounts of fly ash to be added to concrete batches. During the construction works, a faulty pressure relief valve on a project batch plant released excessive amounts of fly ash into the batched concrete during the mixing process. The contaminated cement mix was subsequently combined with water to produce concrete batches and transported to various pour sites around the project. The impact of the high fly ash content in this case was reduced compressive strength and increased hardening times. Structures completed utilising these concrete batches were deemed by the claimant to be damaged by virtue of the reduced compressive strength and a claim for the costs of the remediation works was made to ACE, the Construction All Risks / Builders’ Risk (CAR) insurer.
The claimant’s case seems to be best summed up, verbatim, by the below:
“The JV contends it is not seeking coverage solely for defective work, but rather damage caused by the defective work (i.e., the Plant).
Specifically, as evidenced by the facts highlighted in Plaintiff’s presentation, due to the Plant’s malfunction during the batching process:
(1) the insured raw cement mix became damaged by contamination with excess fly ash;
(2) the damaged cement mix then combined with water and other elements to form damaged concrete batches; and
(3) the damaged concrete batches were then incorporated into various Project structures causing damage to
(a) adjacent components such as rebar, forms, steel, etc., and
(b) the structural integrity of the highway superstructures.
Thus, based on the plain language of the Policy construed as a whole, Plaintiff’s claim encapsulates “physical loss or damage” to insured property not otherwise excluded.”
Below we highlight some of the critical arguments that affected the outcome of this case.
What constitutes a defect? What is damage?
If project works have been built or designed incorrectly and no damage has occurred then most insurers would consider that there would be no cover granted under a CAR policy hence the wide-ranging definition of “damage” in the SCB case caused such consternation.
Since the LEG3 defects exclusion clause was amended in 2006 (in response to another contentious claim involving a concrete pour (referenced here)), many in the insurance and broking community have taken “damage” to mean a “patent detrimental change in the physical condition of the Insured Property” as per the added amendment to LEG3/06. And yet this definition is contained only within this specific exclusion (if selected for coverage) and many insurance policies do not contain any definition of “damage” within the operative clause of the policy which outlines the overall cover granted by the policy.
The absence of such a definition was clearly an issue in the SCB case and similarly here there are opposing views as to whether damage has actually occurred in this case.
"Patent detrimental change in the physical condition of the Insured Property"
Contamination? Defective materials? Physical loss or damage?
The operative clause of the policy in this case was stated to insure “direct physical loss or damage to property of every kind and description intended to become a permanent part of, or consumed in, the fabrication, assembly, installation, erection or alteration of the Insured Project.”.
Many insurers have strong views that this, and the SCB case, were just examples of the presence of defective materials, with no resultant damage to the contract works. Within this judgement, the claimant made a series of arguments to suggest that this was an incorrect assessment and was ultimately successful.
The ambiguity and the nuances of what determines “damage” in cases involving the formation of concrete are quite well summed up in excerpts from Dr. Radlinski’s findings in this case, whose comments could be construed to support either side’s arguments:
On the one hand he noted that
- the contamination of the cement mix with excess fly ash did not alter the chemical or physical alteration of “the individual microscopic sized particles” themselves;
Which would suggest no patent detrimental change in state to the constituent parts. And yet he also confirmed:
- the bulk of the cement mix was damaged by virtue of contamination with large volumes of fly ash.
The insurer, ACE looked to deny the claim on a number of bases that were rejected by the courts. ACE used text from a previous case to contend that the language “physical loss or damage” strongly implies that there was an initial satisfactory state that was changed by some external event into an unsatisfactory state”. However, the case in question was a non-binding, out-of-circuit case applying Louisiana law, not Florida law. In addition, the policy in that case did not include a similar broad definition of insured property (i.e., “of every kind and description”). ACE did admit as part of the proceedings that the cement and fly ash were in a satisfactory state before being mixed and clearly the resultant concrete produced was not to the specifications intended nor was it usable for its intended purpose. The defective valve could also be deemed to be the external event, but this didn’t seem to form part of the judgement based on the summary judgement reviewed.
ACE also referenced a case of defective welds not being covered by a CAR policy, but the counterarguments were:
1. the faulty welding product was brought to the site by an outside supplier, who was not the insured; and
2. the weld product was not produced at the insured's project site, so it did not constitute property covered under the policy.
Comparing the weld case to this one, the claimant points out that the damage was to raw cement mix, concrete batches and adjacent produce elements -- all of which qualify as covered property that it (the insured) produced at the onsite plant.
The claimant compared the loss circumstances with case law relating to contamination and analogises it to food spoilage and contamination case law whereby the judge ruled that “accidental introduction of an adulterant is a physical event that causes injury or damage just as surely as the damage resulting from the collision of two automobiles”.
Wider damage?
Per our introductory comments, something which is merely defective is generally considered by insurers as not being damaged, as long as everyone is clear on, and comfortable with, what those two words mean. In order to trigger coverage under a CAR policy, whichever defects clause you are using, damage needs to have occurred. We have discussed above whether the cement/concrete itself underwent a patent detrimental change in state, or similar. But what about the remainder of the structures that had been partly constructed with good concrete?
Insurers defending the case will point to the fact that the sections already poured with good concrete may not qualify for coverage under the policy; after all, these portions have not in themselves undergone such a patent detrimental change in state. However, as noted within the case, and with similarities to the preceding contamination arguments, the larger structures of which the good concrete was part of were deemed, as a result, to have undergone such a detrimental change in state. Among other opinions, Dr. Radlinski concluded that "[t]he incorporation of the damaged cement in concrete/grout batches placed in the subject elements had detrimental effect on their physical properties, including compressive strength and rate of hardening, due to altered composition and microstructure of the binder.” He also explained that “the subject auger cast grout piles were rejected due to impaired structural capacity associated with the incorporation of the damaged cement."
In addition to the SCB case, the claimant relied on a few other cases to bolster its position that the incorporation of damaged concrete into a larger system constituted property damage.
Other Influencing Factors
Other aspects referred to within the summary judgement contained in the links at the start of this note include:
- Suggestions of late notice to the insurers; which did not appear to preclude the claim;
- Suggestions of a lack of evidence or certainty regarding the faulty valve; which did not appear to preclude the claim;
- The fact that ACE had already settled a claim for a formwork loss which the judge deemed to be “diametrically conflicting” with ACE’s coverage analyses for the losses.” and;
- Further to the SCB case, it is noted that ambiguity in a contract wording (by Floridian law at least) will be construed against the insurer and in favour of the insured.
Final words
Much of the noise emanating from both the SCB and ACE v Archer cases have been directed towards the drafting of the LEG3 clause which could undoubtedly be improved – a focus group is undertaking this exercise currently. And yet the crux of these cases will still concentrate on the definition of damage within the policies and how they have been structured and drafted in general. Businesses working on international projects should always be conscious of the law and jurisdiction in which you operate, as clearly this has also influenced these recent results.
As an aside, within the summary judgement, the case references the confusion which can exist around defects cover being given by way of an “exclusion”. This is because both the LEG and DE defects clauses start by excluding all cover relating to defects and then state what cover is brought back in (depending on the level of cover selected). International London-based broker broadform policies do not typically exclude damage from defects within the operative clause. However, other “off-the-shelf” policies do, hence why the drafting in cases such as this can appear more convoluted than is necessary and lead to ambiguity and confusion.
Defining and assessing the point of “damage” for concrete and other materials formed onsite needs close attention and again we would recommend working with an insurance advisor/broker with a good working knowledge of both insurance law, policy drafting and of your technical construction processes. And of course openness and clarity between insured, broker and insurers as to the intention of policy coverage at the outset is in everyone’s interests if you want to avoid lengthy arguments and legal fees. Insurance buyers have a range of defects clauses to choose from and the most applicable available clause should be discussed with their insurance advisor/broker.
If you would like to discuss the above or any other aspect of construction insurance, please feel free to get in contact via the details below.
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