Illinois Supreme Court Redefines Construction Insurance Coverage

General liability insurance, also known as business liability insurance, is pivotal in the construction world as it helps cover claims of bodily injury or property damage. But that may change in Illinois as the state’s Supreme Court held commercial general liability (CGL) policies can provide coverage in Illinois for damage caused by inadvertent construction defects. 

In Acuity, a Mutual Insurance Co. v. M/I Homes of Chicago LLC, the Illinois Supreme Court held that homebuilder M/I Homes may be covered against allegations that its subcontractors caused water damage “by using defective materials, conducting faulty workmanship and failing to comply with applicable building codes.” Accordingly, the Supreme Court held that property damage that results from inadvertent faulty work can be caused by an “accident” and therefore constitutes an “occurrence” for purposes of the initial grant of coverage under the insuring agreement.

Here’s What Happened: The Supreme Court dismissed the notion that there could be no property damage, as defined by the policy, unless the underlying complaint alleged damage to something beyond the townhomes that M/I Homes constructed. Although faulty workmanship is not considered property damage, the court held that under the language of a CGL policy, “resulting water damage to the interior of the completed units plainly constitutes physical injury to tangible property.”

The court also rejected the insurance company’s argument that “damage to any portion of the completed project caused by faulty workmanship can never be caused by an accident because it is always the natural and probable risk of doing business.” The court held that “the unintended and unexpected harm caused by negligent conduct” is an “accident” and therefore an “occurrence” that can be insured under a CGL policy. The court did not decide whether Acuity had a duty to defend M/I Homes in the underlying suit. Instead, the court remanded the case to the trial court to consider whether certain exclusions in the CGL policy may preclude the duty to defend.

What they’re saying: “This decision reverses a previous tendency among Illinois courts to find no coverage for faulty workmanship either because it is inherently not accidental or because there was no damage beyond the insured defendant’s scope of work,” reads a Barnes & Thornburg article.

Why It Matters: A material supplier or a subcontractor might say the change doesn’t affect them since it’s the GC’s insurance. But credit professionals should be worried about it because if the GC transfers insurance identity to the subcontractor, then it becomes their problem. In a process called transfer of indemnity, owners and general contractors (GC) mitigate risk by transferring the risk of liability down the ladder of supply, meaning that the other party’s insurance will cover it if the GC’s insurance policy won’t be covered. 

“These problems are being forced upon them by language in contracts, subcontracts and purchase orders to name a few,” said Chris Ring of NACM Secured Transaction Services (STS). “In order to mitigate their risk, the GC is going to try to have the indemnity transferred down to other parties and indemnify them for any liability purposes on a construction project from the owner to the GC, to the subcontractors and then down to the material suppliers.”

Once a statutory change happens in one state, it’s not uncommon for other states to follow suit. “It’s good news for a material supplier because it grants coverage for someone else’s defect or fault,” said Ty Knox, ICCE, director of credit and risk at EFCO Corp. (Des Moines, IA). “The bad news is that if you are a heavy user of commercial general liability insurance, the premiums are going to reflect this additional risk because it is something that they historically didn’t cover. So, they’re going to have to underwrite for or prepare for that moving forward with the Illinois High Court ruling. I can see this affecting material suppliers and the construction industry with increased premiums when we’re buying commercial general liability policies.”

From a legal standpoint, the decision is only the beginning. “Essentially, inadvertent construction defects fall under the initial grant of coverage subject to possible exclusions which is not yet decided,” a legal correspondent shared.