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In Illinois, commercial general liability policies may now cover construction defects 

6/27/24

By: Kolton A. Reed and Kingshuk K. Roy

Background

The Illinois Supreme Court in Acuity v. M/I Homes of Chicago, LLC, 2023 IL 129087 overturned decades old precedent in holding that a subcontractor’s defective work that results in property damage to the completed project constitutes an “occurrence” under the commercial general liability (CGL) policy. In joining a majority of states, the Court ruled the defective work may be covered under the CGL policy subject to the policy exclusions.

Prior to Acuity, Illinois courts interpreted defective construction as the natural and ordinary consequence of faulty workmanship, and therefore, not an “accident” or “occurrence.” Faulty workmanship could only constitute an occurrence when it occurred to a third-party property that was not part of the project or structure under construction (i.e. outside of the scope of the subcontractor’s work). The general reasoning for this was basic, CGL policies only provide coverage for tort liability, not contract liability, and the cost for replacing defective work constitutes economic loss, not property damage.

The Case

Acuity arose when a townhome owners’ association filed an action on behalf of the townhome owners against the developer/general contractor, M/I Homes, for breach of contract and breach of implied warranty of habitability. The lawsuit alleged M/I’s subcontractors used defective materials causing water leakage, damaging portions of the townhomes other than the work of that performed by the subcontractors, including windows, patio doors, interiors etc. M/I demanded defense from Acuity as the additional insured on a CGL policy issued to a subcontractor who performed exterior work on the project. Acuity filed a declaratory action denying it had a duty to defend, in part, because the underlying lawsuit only alleged economic loss for costs to repair the defective construction, as opposed to “property damage” caused by an “occurrence.”

On this issue of first impression, the Illinois Supreme Court set out to answer whether the underlying lawsuit alleged “property damage” caused by an “occurrence” sufficient to trigger Acuity’s duty to defend. In analyzing the duty to defend, the Court found that the policy defined “property damage” as a “physical injury to tangible property,” and ruled that the alleged water damage potentially constituted “property damage” under this definition. Next, the Court found that an “occurrence” was defined in the policy as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions” and “accident” reasonably encompasses unintended and unexpected harm caused by negligent conduct of the subcontractor. Therefore, the Court ruled the complaint alleged “property damage” caused by an “occurrence” was sufficient to trigger Acuity’s duty to defend.

Application

This ruling is significant for the construction industry, because insurers can likely no longer deny a duty to defend construction defect cases relying solely on the basis that the alleged “property damage” was not caused by an “occurrence” in the traditional sense. However, whether the “occurrence” or defective work is covered by the policy is ultimately determined by the policy exclusions and exceptions. The Illinois Supreme Court in Acuity remanded the case to the trial court for further consideration of whether the exclusions in the CGL policy bar coverage. The Court highlighted certain common exclusions and exceptions, in dicta, speculating whether such exclusions and exceptions supported a finding of coverage. This may signal a liberal future application of the exclusions and exceptions in favor of granting coverage.

For more information, please contact Kolton A. Reed at kolton.reed@fmglaw.com, Kingshuk K. Roy at kingshuk.roy@fmglaw.com, or your local FMG attorney.