llinois Joins the Majority of States on Coverage for Defective Work

In a significant decision by the Supreme Court of Illinois in Acuity v. M/I Homes of Chicago, LLC, Illinois joins the majority of jurisdictions recognizing that defective work in construction can constitute “property damage” caused by an “occurrence” and trigger a general liability insurer’s coverage obligations under standard commercial general liability (CGL) insurance policies.  In so holding, the Court reversed prior rulings that only damage to third-party property could trigger the insuring clause of the standard CGL.

The underlying litigation arose from claims of alleged construction defects in a residential townhome development against M/I Homes. The townhome owner’s association (HOA) filed an action against M/I Homes for breach of contract and breach of the implied warranty of habitability. The HOA alleged that M/I Homes’ subcontractors caused construction defects by using defective materials, conducting faulty workmanship, and failing to comply with applicable building codes,  which allegedly caused water intrusion and damage to the townhomes and other property.

M/I Homes tendered the underlying case to Acuity as an additional insured on a CGL policy that Acuity issued to H&R Exteriors, Inc., one of M/I’s subcontractors.  Acuity denied defense to M/I Homes and filed a declaratory judgment action seeking a declaration that it had no duty to defend.  On cross-motions for summary judgment in the declaratory judgment litigation,  Acuity argued the damages sought by the HOA related solely to the defective construction of the townhomes and did not allege damage to any property beyond the buildings.  Illinois appellate courts had previously held defective construction did not constitute an “occurrence” because a construction defect was a “natural and ordinary consequence” of the construction process and, therefore, not an accident. 

M/I Homes argued the HOA’s complaint in the underlying situation sufficiently alleged “property damage” caused by an “occurrence” to trigger Acuity’s duty to defend. The circuit court granted Acuity’s motion for summary judgment on the basis that the faulty work was not an “occurrence” because it was not an “accident.” On appeal, the appellate court found that the underlying complaint sufficiently alleged damage to “other property.” The appellate court broadly construed the complaint and found the allegations were sufficient to trigger Acuity’s duty to defend.

On further appeal, the Supreme Court noted that Illinois case law on the issue was “in flux” and had developed from “cases that have approached the coverage question based on a myriad of rationales and factors” where “much of the analysis has not been directly tied to the principles of contract interpretation but instead on various policy considerations.”  The Court sought to bring “clarity to these issues” and “return to first principles and apply a disciplined legal framework from which we can arrive at the correct legal analysis and the correct result.” 

First, the Court addressed the insuring agreement of the CGL and explained the “initial grant of coverage depends on whether there has been an allegation of ‘property damage’ that is caused by an ‘occurrence’ within the meaning of the CGL policy language.” The complaint in the underlying HOA case alleged “water damage to the interior of units” caused by faulty exterior work and defective materials, which the Court found sufficiently alleged “property damage” as defined in the CGL policy.  The Court explicitly rejected the principle posited by Acuity “that 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.”  The Court described this principle as “erroneous” and “not grounded in the language of the initial grant of coverage in the insuring agreement.” 

As to the “occurrence” element, which the CGL policy defines as an “accident,” the Court held, “that the term “accident” in the policies at issue reasonably encompasses the unintended and unexpected harm caused by negligent conduct.” The Court noted the HOA’s complaint alleged “that inadvertent construction defects accidently caused property damage to the completed townhomes” and that “[n]either the cause of the harm . . . nor the harm . . . was intended, anticipated, or expected.” The Court rejected Acuity’s assertion that “damage to any portion of the completed project caused by faulty workmanship can never be an accident because it is the natural and probable consequence of doing business.” The Court held that property damage that results from inadvertent faulty work can be caused by an “accident” and therefore constitute an “occurrence” for purposes of the initial grant of coverage under the insuring agreement.  The Court remanded the case to the trial court to consider any potentially applicable exclusions and to resolve whether Acuity has a duty to defend.

The Acuity ruling is a significant development for the construction industry. Trial and appellate courts in Illinois had long held there was no coverage under a CGL for property damage to the project itself arising out of defective construction and found coverage only in isolated instances where there was damage to other real property or to personal property.  Under Acuity, Illinois now joins the majority of jurisdictions recognizing CGL coverage for unexpected and unintended property damage arising from faulty workmanship in construction projects.