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Transcript of 1 Construction Defect Liability and Captives International Center for Captive Insurance Education...
1
Construction Defect Liability and Captives
International Center for Captive Insurance Education Teleconference
Presenters:
Jim Boone, Alberici Group, Inc.Mike O’Neill, American Contractors Insurance Group
Pat Wielinski, Cokinos, Bosien & Young, P.C.
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Construction Defects
Introduction:
• Google search for “Construction Defects” yielded 1,821,000 hits in .61 seconds.
• Top three paid advertisers on the Google “Construction Defects” page were:
#1 Southern California Plaintiff Law Firm
#2 Construction Defects Expert Witness
#3 Northern California Plaintiff Law Firm
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Four Categories of Construction Defects
The trial courts have recognized that construction defects are tangible and can typically be grouped into the following four major categories:
Design Deficiencies
• Sometimes design professionals, such as architects or engineers, design builders and systems that, from a performance standpoint, do not always work as
intended or specified.
• The motivation for the design may be form, function, aesthetics, or cost considerations, but the completed design could result and/or manifest into a defect.
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Four Categories of Construction Defects
Material Deficiencies
• The use of inferior building materials can cause significant problems, such as windows that leak or fail to perform and function adequately, even when properly installed.
• Example: siding, windows, roofs, plumbing, HVAC
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Four Categories of Construction Defects
Construction Deficiencies(Poor Quality or Substandard Workmanship)
• Poor quality workmanship often manifests as water infiltration through some portion of the building
structure.
• Cracks in foundations, floor slabs, walls, dry rotting of wood or other building materials, termite or other pest infestations, electrical and mechanical problems, plumbing leaks and back-ups, lack of appropriate
sound insulation and/or fire-resistive construction between adjacent housing units.
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Four Categories of Construction Defects
Subsurface/Geotechnical Problems
• California, Colorado, and other parts of the country have a significant amount of expansive soil
conditions.
• As a result of this type of terrain, there have been many problems when housing subdivisions and/or developments are built into hills or other sloping areas where it’s difficult to provide a solid and/or stable foundation.
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Four Categories of Construction Defects
Subsurface/Geotechnical Problems (cont.)
• If the subsurface conditions in these subdivisions and/or developments are not properly compacted and prepare for adequate drainage, problems will
inevitably result, which can include vertical and horizontal settlement (subsidence), movement (expansion), slope failures, flooding, and in extremely
wet/rainy climates, landslides, etc.
• These types of conditions typically lead to cracked foundations, floor slabs, and other damage to a
building.
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Four Categories of Construction Defects
Subsurface/Geotechnical Problems (cont.)
• A worst-case scenario in some instances could render a building uninhabitable, as well as uninsurable.
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Risk Management for Construction ProjectsLong-Tail Liabilities
• Patent Defects
– Apparent with reasonable inspection
– Statute of limitations requires claim to be submitted within x years of project completion (usually short, e.g., 2 or 3 years)
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Risk Management for Construction ProjectsLong-Tail Liabilities
• Latent Defects
– Defect is not apparent by reasonable inspection
– More time is allowed to submit a claim, in some cases 10 years after completion (CA). For comparison purposes, AZ is 8 years, WA is 6 years (confirmed by WA Supreme Court in September 2001), and FL is 10 years.
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Statutes of Repose
State
Alaska
Alabama
Arizona
Arkansas
California
Colorado
Number of Years
Ten Years
Thirteen Years
Eight Years
Five Years
Ten Years
Six Years
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Statutes of Repose
State
Connecticut
Delaware
Dist. Of Columbia
Florida
Georgia
Hawaii
Number of Years
Seven Years
Six Years
Ten Years
Ten Years
Eight Years
Ten Years
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Statutes of Repose
State
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Number of Years
Six Years
Ten Years
Ten Years
Fifteen Years
Five Years
Seven Years
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Statutes of Repose
State
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Number of Years
Five Years
Ten Years
Ten Years
Six Years
Six Years
Ten Years
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Statutes of Repose
State
Mississippi
Missouri
Montana
Nebraska
Nevada
New Hampshire
Number of Years
Six Years
Ten Years
Ten Years
Ten Years
Eight Years
Eight Years
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Statutes of Repose
State
New Jersey
New Mexico
New York
North Carolina
North Dakota
Ohio
Number of Years
Ten Years
Ten Years
No Statute of Repose
Six Years
Ten Years
Fifteen Years
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Statutes of Repose
State
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
South Dakota
Number of Years
Ten Years
Ten Years
Twelve Years
Ten Years
Thirteen Years
Ten Years
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Statutes of Repose
State
Tennessee
Texas
Utah
Vermont
Virginia
Washington
Number of Years
Four Years
Ten Years
Nine Years
Six Years
Five Years
Six Years
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Statutes of Repose
State
West Virginia
Wisconsin
Wyoming
Number of Years
Ten Years
Ten Years
Ten Years
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Risk Management for Construction Projects• Legislative Efforts at the State Level
– Intended to improve the standards and procedures for early disposition of construction defect claims
– Outlines prelitigation procedures
– Notice and opportunity to repair laws
• See Handout for a State-By-State Analysis
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Definition of Occurrence
• Traditional: property damage neither expected nor intended from the standpoint of the insured is an accident.
• Recent: Property damage arising out of an insured contractor’s breach of contract or warranty is natural and foreseeable and not an accident.
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l. ‘Property Damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’
This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.
Your Work Exclusion
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Subcontractor Exception
• Major inroad to the “Business Risk Doctrine”
• “Subcontractor” is broadly construed to include many entities
• Key to completed operations coverage
• Source of classic judicial statements of coverage for defective work
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Restrictive EndorsementCG 22 94
Exclusion 1. of Section I – Coverage A – Bodily Injury and Property Damage Liability is replaced by the following:
This insurance does not apply to:
“Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”
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Additional Insured Endorsement CG 20 10 11 85
WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liablity arising out of “your work” for that insured by or for you.
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Additional Insured Endorsement CG 20 10 10 93
WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured.
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No More Sole Negligence Coverage
Relevant 2004 Endorsement Language
Section II – Who Is An Insured is amended to include as an additional insured the person(s) or organization(s) shown in the Schedule, but only with respect to liability for “bodily injury”, “property damage” or “personal and advertising injury” caused, in whole or in part, by:
1. Your acts or omissions; or
2. The acts or omissions of those acting on yourbehalf; in the performance of your ongoingoperations for the additional insured(s) at the
location(s) designated above.
© ISO Properties, Inc., 2004
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Additional Insured Endorsement CG 20 37 07 04
WHO IS AN INSURED is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of ‘your work’ at the location designated and described in the schedule of this endorsement performed for that insured and included in the ‘products-completed operations hazard.’
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Restrictive EndorsementsHabitational Exclusions
• Excludes “residential” construction as defined in the endorsement
• Varies from insurer to insurer
• Apartments, assisted living, condos, co-ops, hospitals, hotels, military housing, nursing homes, single family, dorms, townhouses, tract housing
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CGL-Common Restrictive Endorsements
• Mold
• Silica
• Lead
• EIFS
• Subsidence
• Employment Practices
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Controlled Insurance Programs - Pros
1. Reduce insurance costs through
a. Projectwide buying power
b. Improved loss experience
c. Elimination of redundant coverages and premiums
d. Reduced litigation between insurers
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Controlled Insurance Programs - Pros
2. Lower expense factors
3. Improved insurance coverages and uniform policy limits
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Controlled Insurance Programs - Pros4. Superior claims management
a. Uniform and coordinated claims handling
b. Aggressive claim settlement
c. Thorough investigation and supervision of claims
d. Resist questionable claims
e. Common defense – avoids “legal blackmail”
f. Can contribute to superior customer relationships
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Controlled Insurance Programs - Pros
5. Utilizes the general contractor’s relationship and experience with quality subcontractors
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Controlled Insurance Programs - Cons
1. Complicated
2. Extended period of involvement after completion of project, the “tail”
3. Administrative intense
4. Substantial risk
5. Volatile costs
6. Unexpected cancellation from markets
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Self-Insured Retention
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Self-Insured RetentionPlan Characteristics• SIR applies on a per-occurrence basis to both
indemnity and expense.
• Insurer is under no obligation to defend, until the SIR amount has been funded.
• In-house vs. TPA to handle losses within the SIR.
• Tax Treatment - Premiums are deductible when paid. SIR losses deductible when paid.
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Risk Retention Group
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Risk Retention GroupPlan Characteristics• May need a front for certificates.
• In-house TPA claim handling.
• Thinly capitalized.
• Limited risk retention capability.
• Dependent on reinsurance.
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Single-Parent Captive
InsuredOwner
CaptiveReinsurer
Front/ExcessInsurer Claimants
ShareholderDividendsCapitalization Insurance Premiums
ClaimSettlements
Fronting SecurityReinsurance
Premium
Reimbursementof Loss Excess
of Retention
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Single-Parent Captive
• An insurance subsidiary created by the insured that allows the firm to participate in the underwriting risk and investment profits associated with the firm's risk financing program.
• The captive is capitalized and premiums are paid to the captive.
• The captive will retain a level of risk and purchase reinsurance for limits in excess of its retention.
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Single Parent Captive
• Tax issues:
– Premiums generally deductible for federal income taxes
– Dividends taxed similar to any stockholder's dividend
– Return premiums taxed as ordinary income at the parent's rate
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Single-Parent Captive
• Fronting issues:
– Workers compensation requires a front
– Certificate holders may require a front for liability lines
– Fronting costs are similar to the basic charges in a retro plan
– Wind-down/runoff issues
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Entity Structuring and Alter Ego Risks
Entity selection
• Sole proprietorship or dba
• Partnership
• Corporation
• Limited liability company
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Entity Structuring and Alter Ego Risks
• Liability protection offered by corporations and LLCs
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Entity Structuring and Alter Ego Risks
• Use of single purpose entities (SPEs)
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Entity Structuring and Alter Ego Risks
Attacks on the protection of the entity
• Alter ego (aka piercing the corporate veil)
• Enterprise liability
• Parent-subsidiary relationships
• Substantive consolidation
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Entity Structuring and Alter Ego Risks
Practical tips for minimizing alter ego risks
• Adequate capitalization
• Observe formalities
– Separate bank accounts, letterhead, contracting procedures
– Meetings, minutes, resolutions
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Entity Structuring and Alter Ego Risks
• Intercompany relationships
– Use of employees
– Loans
– Intercompany services
– Transfers of assets
• Adequate insurance
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Entity Structuring and Alter Ego Risks
Dissolution strategies
• Post-dissolution liability of the entity
• Post-dissolution liability of the partners, shareholders, members
• Does the developer really want to dissolve the entity?
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Alternative Dispute Resolution (ADR) Provisions Contracts• Alternative dispute resolution (ADR) provisions
– Provision governing disputes between the owner or developer and the design professionals/subcontractors
– Residential: Provision governing disputes involving homeowners or HOA
– Alternatives:
• Mediation• Bench trial, with waiver of jury trial• Binding arbitration• Rent-a-judge, special master
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Quality Control Programs
Why Are QC Programs Important?
1. A risk management best practice– avoid “designed in” defects and errors during construction
2. May be required by the developer’sCGL insurance program
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Quality Control Programs
QC during the design phase
Objectives:
Maximize constructability of the plans, consistency, code compliance, and appropriate product, material, and systems selections
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Quality Control Programs
• Develop procedures for peer review of plans and specifications
• Establish criteria for selecting and managing peer review consultants, including methods for managingthe paper trail
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Quality Control Programs
QC during construction operations
Objectives:
Inspect a statistically relevant sample of units and common area construction and document correct as-built conditions
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Quality Control Programs
• Establish criteria for selecting and managing QC consultants
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Quality Control Programs
• Obtain consultant guidance on the following:
– Which components should be inspected?
– When to inspect (stages of construction)?
– Appropriate sample size
– Procedures for identifying defects andfor obtaining and documenting corrections
– Some or all of these components may be dictated by the developer’s CGL insurance program
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Quality Control Programs
• Role of superintendents; obtaining contractor and subcontractor buy-in
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Quality Control Programs
• Training of subcontractors
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Quality Control Programs
• Consider risk-specific QC initiatives
– Windows
– Roofs
– Other building envelope issues, particularly moisture intrusion
– Acoustical issues
– Other issues, rated by litigation claims potential
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Quality Control Programs
• Handling field changes or repairs during construction
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Quality Control Programs
• Red flags:
– Value engineering
– Design-build trades (may be outsidecoverage of developer’s CGL due to professional services exclusion)
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Warranties
Another powerful but underutilized riskmanagement tool
• Legal and practical consequences
– Opportunity for disclosure and education
– Reinforce ADR structure
– Set and manage owners expectations
– Owner maintenance
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Warranties
Warranty as the roadmap for performing customer service
• Performance standards
– Qualitative
– Quantitative
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Warranties
Exclusions
– Normal wear and tear
– Acts of third parties or the homeowner
– Lack of required maintenance
– Acts of God
– Claims covered by homeowners insurance
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Warranties
Stand-alone dispute resolution provisions
– Notice, access, inspection, testing, repair
– Mediation followed by binding arbitration
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Warranties
Duration of the warranty
• One-year warranties increasingly are outdated, may depend on particular system
• Relationship of the express warrantyto statutes of limitations and statutesof repose
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Warranties
Transferability to subsequent purchasers
Binding on subsequent purchasers?
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Design and Implement Customer Service ProgramWhy customer service is critical:
• Radar function and litigation avoidance
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Design and Implement Customer Service ProgramWhen does the customer service process begin and end?
• Walk-through – the handoff
• Relationship between customer service and statutes of limitations/statutes of repose
• Repairs toll (stop the running of) statutes of limitations
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Design and Implement Customer Service ProgramDocumentation – practical tips
• Get it in writing
• Make your record
• Be objective (don’t editorialize or speculate)
• Be precise about dates (tolling ofstatutes of limitations)
• Develop a customer service databaseand tracking system
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Design and Implement Customer Service ProgramDevelop issue-specific protocols for high-risk claims
• Water intrusion
• Mold
• Acoustical
• Soils
• Other
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Design and Implement Customer Service Program• Train customer service representatives on
maintenance manuals and warranties
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Record Retention Policies
Why is record retention important for developers?
• Long tail liabilities
• Delayed manifestation of defects
• Statutes of repose
• Critical to defense of claims, prosecution of cross-claims, and insurance recovery
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Record Retention Policies
Effective record retention allows developers to:
• Identify potentially responsible parties
• Identify potential witnesses
• Compile contracts and insurance information from other parties
• Marshal the developer’s direct insurance resources
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Record Retention Policies
Effective record retention allows developers to:
• Retrieve QC inspection records to demonstrate correct as-built conditions
• Help establish defenses, such as statutes of limitations and comparative fault