The Illinois Supreme Court recently handed down a landmark decision in Acuity v. M/I Homes of Chicago, LLC, 2023 IL. 129087_N.E.3d_(2023), finding that property damage that arises from the defective work can be caused by an accident that qualifies as an occurrence under an insurance policy. With this decision, Illinois joins the majority of states finding that this type of damage constitutes an occurrence. The holding is significant because it does away with a hallmark Illinois rule that damage to third-party property is required to establish property damage caused by an occurrence. In effect, this decision will alter how insurance carriers in the state handle construction defect claims moving forward. Business risk exclusions may now become the central inquiry as insurers examine whether a duty to defend is present.
Background of the Case
This case arises from a allegation of construction defects in a residential townhome development in the village of Hanover Park, Illinois. The original developer of the property was Neumann Homes, but M/I ended up taking on the development of the project. M/I built more townhomes and sold all of the properties after assuming Neumann Homes' assets and liabilities.
The board of directors for the townhome owners' association (Association) brought a claim on behalf of the owners for breach of contract and breach of implied warranty of habitability. The suit was filed against M/I Homes as the general contractor, developer and seller of the townhomes. The lawsuit alleged that subcontractors hired by M/I used defective materials, produced faulty workmanship and failed to follow relevant building codes. The Association claimed that due to this the townhomes suffered physical consequences to the exterior of the building as well as "leakage and/or uncontrolled water and/or moisture in locations in the buildings where it was not intended or expected." The allegations stated that these defects caused substantial damage to the townhomes.
The Association also stated that M/I Homes did not intentionally cause the construction defects and did not actually perform any of the work that resulted in defects. All of the work in question was completed by subcontractors hired by M/I. The Association requested damages sufficient to cover repairing the defects as well as funds to cover the damage that the defects caused to the underlying property.
M/I demanded a defense from Acuity Insurance as an additional insured on a commercial general liability policy that Acuity issued to one of the subcontractors, H& R Exteriors, Inc. Acuity denied that it had a duty to defend M/I Homes and filed this declaratory judgment action against M/I Homes and the Association. Acuity argued that the complaint failed to allege any property damage caused by an occurrence and thus it did not have a duty to defend. M/I Homes filed a counterclaim requesting a declaration that there was a duty to defend because the allegations in the complaint fall within the coverage of the CGL policy. Both sides filed motions for summary judgment.
The parties agreed on appeal that under current Illinois law there could be no “property damage” caused by an “occurrence” under the policy unless the underlying complaint alleged property damage to something beyond the townhome construction project. The court noted, however, that this rule was driven by public policy rather than a close reading of the insurance policy in question. The court also pointed out that most other states have taken a different approach than Illinois on this question. The appellate court concluded that the underlying complaint "clearly alleges, in broad terms, that there was damage to other property." Thus, the allegations were sufficient to trigger Acuity's duty to defend. The case law on this issue is not consistent and the Supreme Court set out to clarify this point of contention in Illinois courts.
Issue Before the Court
Did Acuity, a mutual insurance company, have a duty to defend its additional insured, M/I Homes of Chicago, LLC (M/I Homes), under a subcontractor’s commercial general liability (CGL) policy, in a case filed by a townhome owners’ association for breach of contract and breach of an implied warranty of habitability?
The Duty to Defend
Generally, an insurer has a duty to defend its insured against a lawsuit unless the circumstances underlying the case do not fall within the parameters of the policy's coverage. Valley Forge Insurance Co. v. Swiderski Electronics, Inc. 223 Ill.2d 352, 363 (2006). If the language of the policy is unclear or could be construed in more than one way, courts must construe the policy strictly in favor of the insured. Travelers Insurance Co. v. Eljer Manufacturing, Inc. 197 Ill.2d 278, 293 (2001).
The initial grant of coverage lays out what is covered under the policy at issue. The CGL policy in this case states that Acuity will pay "those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies." It goes on to say, "This insurance applies to property damage only if the property damage is caused by an occurrence." Thus, the court had to determine whether an allegation of property damage caused by an occurrence had taken place.
Property Damage
The Acuity policy defines property damage as "physical injury to tangible property, including all resulting loss of use of that property." Courts have defined "physical injury" as "property that is altered in appearance, shape, color, or in other material dimension." Travelers Insurance v. Wjer Manufacturing, Inc. 197 Ill.2d 278, 301 (2001). Diminution in value, or other intangible type losses, do not constitute physical injury.
In the case at hand, the townhomes sustained water damage from alleged construction defects. The insured alleged that the leaks and moisture damage occurred due to the subcontractor's faulty work and use of defective materials. Under the definition of "property" in the policy, the interior units have sustained tangible damage as they have been altered in appearance, shape and/or color.
Occurrence
"Occurrence" is defined in the policy as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." An Illinois Appellate Court defined the word accident as "an unforeseen occurrence, usually of an untoward or disastrous character, or an undesigned, sudden or unexpected event of an inflictive or unfortunate character." Stoneridge Dev. Co. v. Essex Insurance Co., 382 Ill. App.3d 731,749 (2008). The case law also clearly states that "the natural and ordinary consequences of an act do not constitute an accident." Id. At 750.
In the case at issue, the court found that the Association's complaint did not claim that the subcontractors intentionally performed substandard work that caused the water damage. Rather, the Association claims that inadvertent construction defects accidentally caused the property damage. The cause of the harm as well as the harm itself were not intended, anticipated, or expected. Acuity argued that damage 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 rejected Acuity's argument on this point. It reasoned that the business risk is articulated in the exclusions section of the policy rather than in the initial grant of coverage. It stated, "To hold that all construction defects that result in property damage to the completed project are always excluded would mean that the exclusions in the policy related to business risk become meaningless."
The argument that there could not be property damage caused by an occurrence under the policy unless the underlying complaint alleged property damage to something beyond the townhouse construction project was rejected at the appellate level and affirmed by the Illinois Supreme Court. The court then turned to consideration of exclusions.
Business Risks & Exclusions
The policy provides that "this insurance does not apply to property damage expected or intended from the standpoint of the insured. "As discussed above, both parties acknowledge that the damage was not expected or intentional. Therefore, this exception does not preclude a duty to defend.
The parties only considered the initial grant of coverage and failed to discuss any applicable exclusions or exceptions contained in the policy. The court made mention of several exclusions in the policy to support its determination that a subcontractor's defective work that results in property damage to the completed project may be covered depending upon the various exclusions and exceptions contained in the insurance contract.
The Supreme Court remanded the case to the trial court for further consideration of the policy exclusions and how those may impact Acuity's duty to defend.
Key Takeaways
- The duty of insurers to defend an insured is no longer dependent upon the existence of property damage based upon an occurrence.
- With this decision, commercial general liability policies in Illinois may now potentially cover construction defect cases.
- The ruling reverses precedent in Illinois courts which allowed a denial of coverage by insurers for faulty workmanship based on the argument that it is natural consequence of most construction work and is not accidental.