Constructive Notes ®
Introduction
This United States District Court decision was handed down on 21 January 2024, and traversed similar ground to the SCB decision† considered by the author in the prior edition of the Construction Notes, and which was commented upon in the judgement.
The case is arguably of limited precedent value from an Australian perspective, given that it concerned a summary judgement motion filed by the insurer Ace American Insurance Company (Ace) which was ultimately declined on the basis of the court’s finding that some of the language of the insurance policy was ambiguous and in accordance with Florida law was required to be construed against the drafter (Ace) together with factual disputes which precluded a summary judgement ruling.
The case does however consider a number of arguments both in relation to what constitutes “direct physical loss or damage” so as to potentially trigger coverage under the policy as well as what might be meant by the word “improve” in the context of a LEG3 exclusion clause (which was in the terms of the 1996 rather than 2006 wording)‡, and is accordingly worthy of consideration, albeit in a number of instances more so by way of contradistinction to the likely approach of courts in this jurisdiction.
Factual Matrix
The plaintiff joint venturer is the design-build contractor (the Contractor) for a reconstruction/rehabilitation project in Miami, Florida, which includes construction of a signature bridge (the Project).
The Project included 3 main segments and in addition involved the construction of a dry concrete batch plant at the Project site designed to produce concrete for construction of various parts of the Project.
The matter involved concrete from one of the on-site batch plants operated by Contractor which was reportedly mixed with excessive amounts of fly ash with an alleged reduction in compressive strength and increased hardening time, requiring certain bridge elements to be rectified because of low strength concrete.
The at-issue concrete was poured into various Project components including roadway segments, piers, piles, footings and seal slabs, which failed to meet the required 28-day compressive strength test and hence did not meet Project specifications.
The root cause of the subject concrete’s low compressive strength remained in dispute. The Contractor’s concrete construction expert explored other potential causes of the concrete’s weakened strength and did not find any evidence that anything other than excess fly ash was the cause of the weakened concrete, although conceded that his conclusions were inconclusive.
He further testified that the contamination of the cement mix (which is an element of concrete) did not alter chemically or physically “the individual microscopic-sized particles” themselves, but rather he opined that the bulk of the cement mix was damaged by virtue of contamination with large volumes of fly ash.
He opined that the failure of the subject elements to meet the specified compressive strength rendered them structurally inadequate, and that their replacement with structurally adequate elements meeting the specified strength was necessary to comply with the original structural design, and was therefore not an “improvement”.
The Contractor had initially submitted a claim to Ace for a formwork loss which manifested when formwork collapsed (buckled) during a concrete pour. Ace granted coverage for the formwork loss which it attributed to faulty design and workmanship. It purported however to exclude from coverage costs associated with improving the original form, design, workmanship or material in accordance with the relevant exclusion clause (referred to as an Extension) which was in the form of LEG3/96.
At the time of the formwork loss, Ace was unaware that the Contractor would later be making a claim for defective concrete in the Project elements. When it did so, Ace denied coverage for that loss, reasoning that the concrete constituted a defective material due to the excess fly ash, and “[b]ecause of this defect the material was never in a satisfactory state and therefore was not damaged”.
The Insuring Agreement in the Policy was to insure against all risk of “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.
There was a broad “ensuing loss” exclusion in relation to faulty or defective workmanship, materials or supplies, which pursuant to an endorsement was “deleted and replaced” by a clause in terms of LEG 3/96 (which is in effectively identical terms to the LEG3/2006 clause save it omits the words “.…(which for the purpose of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property)….”).
There were said to be additional undisputed material facts, including that the Policy does not define “direct physical loss or damage”, nor “improve” (as used in the exclusion for “cost incurred to improve the original material”), nor did it require that the property be in an initial satisfactory state.
The Parties General Contentions
Ace said that the defective initial construction did not qualify as “direct physical loss or damage” which is required to trigger coverage under the Policy. It relied on insurance coverage cases involving COVID-19 where courts applying Florida law concluded that coverage was unavailable because there was no direct, physical, tangible alteration to the insured property.
It further described the work the Contractor performed in response to the discovery of the concrete failure as efforts to “improve” the bridge components, with the Policy excluding coverage for improvements to the covered property.
The Contractor disagreed with Ace’s characterisation of the defective initial construction, citing case law involving insurance coverage disputes involving contaminated products. It argued that the COVID-19 cases were inapposite, and cited the SCB case involving it said a similar policy and its application to a bridge construction project, in which the insured’s summary judgement motion was granted with the court finding the COVID-19 cases to be “unpersuasive”.
It also proffered another argument being that the cement and fly ash used to create concrete are distinct properties which were in a satisfactory and undamaged state before they were mixed together to form the defective concrete.
As to the Ace’s contention in relation to “improvement” the Contractor said that it was not seeking costs incurred to improve the Project’s original work, design and/or materials, but instead that its efforts were solely to “repair” the damage.
“Framed by [an] inevitable paradox” (that as the concrete was defective from the start it could be argued that any [non defective] work done to shore up the concrete and other components would constitute an improvement, whereas it was logical to conclude that “repair” would necessarily “result” in an improvement even if that were not the goal), the Contractor contended that the language of the Policy was ambiguous meaning under Florida insurance policy interpretation law the language should be construed against Ace and in favour of coverage.
Consideration by the Court of the Insuring Clause and the LEG3 Provision*
The court had to construe the Policy under Florida law which meant that the Policy should be read “as a whole, endeavouring to give every provision its full meaning and operative effect”. After setting out a number of further relevant principles of insurance policy construction under Florida law, the Magistrate Judge observed:
“As the Florida Supreme Court has explained, an “all-risk policy” does not extend coverage to “every conceivable loss” SA Palm Beach, LLC, 32 F.4th at 1357.”
The Court noted that Ace’s motion requested that the Court find that the Policy does not cover the damage at issue because the Contractor could not meet its burden of proving covered loss. The Court noted that the summary judgement motion did not concern the initial formwork claim, which Ace had already paid, subject to the deductible. In noting that the losses for which coverage is provided are clearly dependent upon the specific language of the builder’s risk policy, the Magistrate Judge observed [at page 32]:
“Builder’s risk insurance is a type of property insurance coverage, not liability insurance or warranty coverage – and should not be transformed into a guarantee against design and construction defects”, and “The purpose of this type of insurance is to provide protection for fortuitous loss sustained during the construction of the building”.
In applying the rules of interpretation, and “assuming for the sake of discussion” that the COVID-19 cases “control” a non-Covid-19 scenario, the Court said that the Contractor had to establish that each of the 16 bridge elements constructed with inadequate cement, which resulted in low-strength concrete, sustained “direct physical loss or damage” – but that damage (1) must involve an “actual” and “tangible” “alteration” to the property and (2) cannot be caused “solely by virtue or [sic] the existence of any defect of material, workmanship, design, plan or specification”.
The author would observe at this juncture that what appears at (2) above suggests that the Magistrate Judge, with respect, misconstrued the rider to the LEG 3/96 exclusion by importing notions of causation into the clause for which there is clearly no warrant. This continued to inform the Judge’s thinking as would become apparent when Ace’s decision to meet the earlier formwork claim was discussed later in the judgement.
In seeking to address these requirements, the Court noted Ace’s argument that the bridge elements did not sustain a distinct, physical, tangible alteration because they were never properly constructed in the first place and were always in a state of low strength.
Significantly the scenario here was not one where the defective components collapsed and damaged or destroyed adjacent property which had been properly constructed. Instead it was a case of defective initial construction with there being no event which changed the concrete placed in the 16 bridge components from a satisfactory to unsatisfactory state.
Ace pointed to non binding case authorities outside of the Covid-19 cases (which the Contractor contended were inapposite) which had held that defective initial construction does not qualify as “direct physical loss or damage”.
For example in Trinity Indus., Inc v Ins.Co. Of N. Am., 916 F.2d 267 (5th Cir.1990), the court reasoned as follows:
“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-for example, the car was undamaged before the collision dinted the bumper. It would not ordinarily be thought to encompass faulty initial construction.”
The Magistrate Judge (informed it would seem by the view he expressed above at (2)) in concluding that Ace’s position was “fundamentally” inconsistent said [at page 39]:
“Ironically, Ace did provide coverage for the Formwork losses, finding that the loss was attributable to defective workmanship under the so-called “LEG-3” provision… Moreover, Ace’s coverage for the Formwork losses seems contrary to its argument that Trinity precludes coverage for the cost of repairing initially defective construction. In addition Ace’s coverage appears inconsistent with its view that there is no coverage here because Plaintiff’s repair work improved the property….”.
The author would respectfully suggest that there is in fact no inconsistency between Ace’s position, given that the Formwork loss manifested when the formwork collapsed during a concrete pour.
In that earlier loss, while Ace granted indemnity for the reasonable costs associated with removing the hardened concrete from the original pour, repouring the concrete, repairing/replacing damaged forms, and reinstalling the forms in the design that existed on the date of loss (subject to the $250,000 LEG3 deductible), it advised that as the cause of the loss was attributable to faulty design and workmanship, the costs associated with improving the original form, design, workmanship or material were excluded from cover.
Back to the present claim, the Magistrate Judge noted Ace’s contention (citing mostly out-of-circuit non-binding cases) that to constitute “direct physical loss or damage”, an external event is also required, with all-risk insurance policies limiting recovery to “those losses in which the cause is “external” to the structure insured” as opposed to an “internal” or “inherent” defect in the item of property which is damaged”.
The Contractor on the other hand stressed the point that the Policy conferred expansive “all-risk” coverage to “property of every kind and description” intended to be used in the Project, noting that it was the batching failure of items of covered property on-site which resulted in excessive levels of fly ash mixing with the cement paste and ultimately producing the low strength concrete. In doing so it emphasised its position that the raw cement mix was damaged by contamination with excessive fly ash and analogised that scenario to food spoilage and contamination law.
Meanwhile, the Contractor also relied heavily on the SCB case, which the Magistrate Judge noted was “strikingly similar” and which he thus thought warranted a comprehensive discussion.
Having undertaken that exercise, the Court took from that case as follows [at page 47]:
“In other words, property does not need to be in an initial satisfactory state to be capable of sustaining damage, as ACE has proposed here. In fact, the court was unimpressed with the insurer’s argument that the policy requires some “initial satisfactory state”, noting that the insurer did not explain how the cases are analogous or why they should be considered persuasive…”.
The Court went on to say [at page 48]:
“ACE relies upon Trinity for its argument that the insured property must initially have been in a satisfactory state. But Trinity is a non-binding, out of circuit case applying Louisiana law, not Florida law. In addition, the policy there does not include a similar broad definition of insured property (i.e.”of every kind and description”). Furthermore, ACE had admitted that the cement and fly ash were in a satisfactory state before being mixed. Additionally the LEG3 language was not present”.
And then:
“The SCB Court also rejected three of the primary arguments which ACE makes here: (1) that insured property must be altered, not merely defectively constructed, to constitute physical loss or damage** (2) the concrete components did not become defective because they were defective from the start, when they were fabricated; and (3) the incorporation of defective components into a larger project does not constitute damages” [sic]. The SCB Court classified the insurer’s arguments as unpersuasive, and those reasons could apply here, as well”.
The Magistrate Judge went on to say when referring to the SCB case [at page 49]:
“First, it noted that “a change that results in a reduction in the weight bearing capacity of a bridge is an ‘alteration’ to that bridge…. Similarly, ACE has not explained how concrete, which failed its 28-day test, is anything other than a compromise to the physical integrity to the bridge components on which the cement was poured. The JV’s expert witness has offered his opinion on how the bulk of the cement mix was damaged by virtue of contamination with excess volumes of fly ash. The Undersigned is not prepared to accept ACE’s argument that damage to the cement did not involve a physical alteration… The same theory applicable to raw cement could also logically apply to the concrete batches. According to Plaintiff’s argument, when the contaminated cement mix was later combined with water to produce weakened concrete batches, those concrete batches were damaged”.
Respectfully, it is difficult to see how the statements made above sit comfortably with the comments earlier in the judgement [at page 32] that Builders risk insurance should “not be transformed into a guarantee against design and construction defects”. They would be unlikely to find favour in this jurisdiction.
In any event the Magistrate Judge then said [at page 50]:
“Second, the SCB Court found the insurer’s authorities to be inapposite. As noted it found the COVID-19 cases dissimilar…”, noting that “…the court concluded, the insurer could not persuasively explain ‘how a reduction in the weightbearing capacity of the bridge is anything other than a “compromise to [its] physical integrity”.
The Magistrate Judge then went on to note an additional feature here which he said undermined Ace’s position but which was not present in the SCB case. The Judge was referring to Ace’s coverage position concerning damage to adjacent components which it had paid under the policy, and which he described as “inconsistent”.
The author has earlier opined that no inconsistency is apparent, with the Magistrate Judge’s misapprehension of the position, seemingly arising from his [with respect] erroneous view of the operation and effect of the rider to the LEG3 exclusion. The Judge then referred to this “seemingly illogical coverage analysis” stating [at page 52]:
“Of course, if ACE paid for the JV to repour concrete, then the new concrete would arguably be an improvement (albeit a necessary one) over the defective concrete. But ACE says the LEG 3 provision does not pay for improvements”.
The Court then noted [at page 53] the Plaintiff’s reliance on “a few other cases” to bolster its position that incorporation of damaged concrete into a larger system constitutes property damage, including Pavarini Construction Co. (Se) Inc. v. ACE Am. Ins. Co., 161 F Supp. 3 d 1227, 1230 (S.D. Fla. 2015). In that case, the insured defectively installed concrete masonry walls and reinforcement steel which compromised the building’s structural integrity leading to various cracking.
The court found the insurer responsible for defective work which caused the cracking to otherwise non-defective property. Perhaps unsurprisingly Ace sought to distinguish this case (and others) presumably on the basis that they were illustrations of where defective work or materials resulted in actual physical damage which compromised the structural integrity of otherwise non-defective property.
Turning to the LEG 3 exclusion, the Magistrate Judge stated [at page 55]:
“The so-called LEG3 provision effectively expands coverage by deleting exclusions (paragraphs 19 and 20) and replacing them with narrower exclusions (and an additional deductible).”
In finding that the provision narrowed an earlier exclusion “…. which is another way of saying that the provision expanded coverage”, the Court adopted an approach unlikely to be followed by an Australian court, given that the clause in question was entitled “Excluded Causes of Loss” and replaced a more-limiting exclusion (the original clauses being “deleted and replaced”). In any event, the Court found [at page 58] that the endorsement generated a functional extension, or broadening of coverage.
Although the Court also suggested that the LEG provision applies for the purpose of the entire Policy, it is of course only the rider which has such application. In any event, the Court appeared [at page 57] to then note the distinction drawn by the SCB Court, which to that point appeared to have eluded it, which was that “caused by” and “solely by virtue of the existence” are “not the same”.
It went on to say [again at page 57]:
“Based on this distinction in language, the court held “[t]he [e]xtension does not suggest that property cannot be ‘damaged’ if there were defects in material workmanship somewhere in the causal chain. Instead, it indicates that defects of material workmanship in and of themselves are insufficient to constitute damage… Therefore the extension’s exclusions language was inapplicable because the insured was not seeking reimbursement “solely for defective work” but, instead, the insured’s “defective work that led to ….decreased structural integrity of the bridge..”.
And then [at page 58 – noting that this raised the existence of a factual dispute best not resolved in a summary judgement context]:
“Similar to the analysis in SCB, the JV here says it is not seeking reimbursement of costs solely for the defective material. Rather, the Plaintiff’s claim is that the fly ash which contaminated the cement consequently led to defective concrete which in turn led to the impaired structure of the bridge components”.
The Court then turned its attention to the SCB Court’s consideration of the scope of the exception with its reference to costs incurred to “improve” the original workmanship.
Observing that the court focused on the practical realities flowing from the use of the term “improve”, it noted [at page 59] their finding that the provision was ambiguous because it was “subject to more than one reasonable interpretation”, concluding that the insured’s reading was “more plausible” and construing it against the drafter of the policy Lexington in favour of coverage to the insured pursuant to Illinois law.
The Magistrate Judge noted that in light of the fact that SCB undermined Ace’s position and provided support for the Contractor’s interpretation, Ace attempted to distinguish it. It did so primarily by arguing that SCB involved resulting damage to property other than the defective concrete – a bridge which was not independently defective.
Ace argued [as noted at page 60] that in this case, it involved “defective concrete pours – nothing more”, there being no alteration to non-defective aspects of the Project because “there is no allegation that any other properly constructed elements suffered a loss of weight bearing capacity” (overlooking so the court thought, the expert opinion).
Ace argued that the Contractor was seeking costs incurred solely to rectify defective material or workmanship – not resulting damage or loss of capacity to some other aspect of the Property. In addition Ace argued that the repairs were to improve the property – a circumstance in which coverage is not provided.
The Magistrate Judge however reaffirmed his view that the term “improve” is ambiguous and therefore must be construed against Ace.
Further, he noted that consistent with SCB, the Contractor contended that it was not seeking coverage solely for defective work, but rather damage caused by the defective work (i.e. the Plant – specifically its malfunction during the batching process).
Noting that Ace urged the contrary position, the Magistrate Judge concluded [at page 62] that the issue was one more appropriate for resolution by a jury at trial, and that given the significant factual disputes and ambiguous language in the Policy, Ace’s primary position
Conclusion
It should be appreciated that applicable Federal Rule of Civil Procedure 56 provides “summary judgement is appropriate where there is no genuine issue as to any material fact” and that the moving party is “entitled to judgement as a matter of law”.
Accordingly while the SCB decision was of some import due to the fact that it granted summary judgement in favour of the insured, the failure to grant summary judgement in this case in favour of Ace as the insurer seeking a finding of no coverage, does not finally determine anything, other than that the requirements for a grant of summary judgement were not met in this instance.
While in this case, the Court was concerned with Florida law which requires a distinct, demonstrable, physical alteration of the property, more akin to the test for “physical damage” in the Australian jurisdiction (although those words do not answer the question of the applicable test to be invoked), there are a number of readily discernible differences in approach by the Florida court, which means the case is of very limited guidance, in so far as a case can ever really be of guidance when arguments are ventilated at length but ultimately not determined.
Further, even allowing for the more onerous test for “physical damage”, it seems clear that the threshold for that requirement would not be met in Australia, on the postulated facts of this decision.
Some of the comments made by the Judge are perhaps surprising, in that in wishing to treat the LEG3 clause as an expansion of cover, he seemed to favour a very limited view of what was meant by “improvement”, even though the broader view advocated for by the successful insured in the SCB case, appeared to have been preferred by that court. The author observes that the more narrow view would appear to be at odds with the notion of the LEG3 exclusion providing broad defect cover to the insured.
Further the Court affirmed the view that the LEG3 provision does provide coverage for costs incurred for the repair of defective workmanship, material, design, plan or specification, as long as the work is not to improve the original material, workmanship, design, plan or specification.
By seemingly however misconstruing the effect of the rider by importing causal notions into its operation, the Court appeared unduly influenced by Ace’s conduct in earlier granting cover in what it regarded as an analogous circumstance. Arguably the rider, properly construed, only had work to do (if any) in circumstances of the subject claim and not the earlier Formwork claim.
† South Capital Bridgebuilders v Lexington Insurance Company [Case No 21 – cv-1436 (RCL)]
‡ The wording of both versions of the LEG3 clause can be found at www.londonengineeringgroup.com.
*The Insuring clause provided: ‘PART A, INSURING AGREEMENT, This Policy, subject to the terms, conditions and exclusions stated herein, or endorsed hereto, insures against all risk of 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, as defined in the Declaration Page for which values have been declared and deposit premium paid.’
The Exclusion clause provided: ‘The following changes are made to ACT 0219, Part D, Excluded Causes of Loss, [paragraphs] 19 and 20 are deleted and replaced by the following: “This policy does not insure any costs rendered necessary by defects of material, workmanship, design, plan, or specification and should damage occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that costs incurred to improve the original material, workmanship, design, plan or specification. For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue or the existence of any defect of material, workmanship, design, plan, or specification.’ The deductible applicable to this coverage is $100,000.’
**[respectfully a strange comment, given that the footnote to that passage of the judgement notes: “But the court there was not using Florida law, which, as already noted, requires a distinct, demonstrable, physical alternation of the property…”.]
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