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Construction Insurance Bulletin

DOES YOUR BUSINESS HAVE COVERAGE FOR “IMPAIRED PROPERTY”?

By July 1, 2010No Comments

A contractor gets a job to install the systems that will control the bank of eight elevators in a new 20-story hotel. The contractor obtains the components from the distributor, installs them without any problems, and moves onto the next job. However, prior to opening, the hotel’s owners find that none of the elevators are working. Diagnosing and repairing the problem will delay the hotel’s opening by at least two weeks and possibly more. The owners sue the general contractor who built the hotel and hired the sub; the GC in turn sues the sub. The sub submits a claim to its Liability insurance company, but the company denies coverage.

The same subcontractor gets an identical job for a new apartment building. This time, the elevators work during testing, but two months after the building opens, they grind to a halt between floors. An investigation reveals damage to the wiring leading from the control panels; the inspectors determine that the control panels short-circuited, causing a power surge that damaged the wires and shut down the elevators. Again, lawsuits follow and the sub forwards the claim to its insurance company. This time, the company pays the claim.

Why did the company deny the first claim but not the second? The answer lies in a provision in the Liability policy known as “the Impaired Property Exclusion.”

The standard Commercial General Liability insurance policy covers the insured’s liability for damage to tangible property and for the loss of use of undamaged tangible property. It also creates a category of property called “impaired property.” This is tangible property (other than the insured’s product or work) that is either less useful or cannot be used at all because it includes the insured’s product or work, and that work is “known or thought to be defective, deficient, inadequate or dangerous.” In both of the examples above, the buildings are impaired property. They cannot open with inoperable elevators, and the reason the elevators are inoperable is that they include the subcontractor’s components and the components are not working properly.

The impaired property exclusion states that the insurance does not apply to property damage to impaired property or property that has not suffered physical injury, if the damage arises from a defect or other problem with the insured’s product or work. There is also no coverage if the damage arises from the insured’s failure to live up to the terms of a contract. The hotel was unable to open because a defect in the contractor’s components prevented the elevators from working. Because the hotel had not suffered physical injury and the damage resulted from a defect in the contractor’s work, the insurance did not cover the contractor’s liability.

The exclusion has an important exception, however. The insurance will apply to the loss of use of other property if it arose from sudden and accidental injury to the insured’s product or work after it has been put to its intended use. The elevators in the apartment building initially worked; they didn’t break down until after the building opened. Because the damage arose out of damage to the contractor’s work after it was put to its intended use, the insurance covered the contractor’s liability.

The impaired property exclusion removes coverage when merely replacing the defective part will solve the problem, but it provides coverage when a defective part damages other property and necessitates repairs. The distinction can be subtle, but it determines whether a contractor has insurance for thousands of dollars in damages.