S.C. Court of Appeals Finds D&O Endorsement Excludes Coverage for Defective Construction Claims

A D&O endorsement excluded coverage for claims alleging damage to other property as a result of defective design or construction. According to a May 8, 2013 opinion of the S.C. Court of Appeals, coverage for allegations against the insured for breach of fiduciary duty, however, was not excluded.

 

In Pulliam v. Travelers Indemnity Co., individual unit owners (“owners”) in Kensington Place, a condominium development, filed suit against the property owners association (“KPOA”) for breaches of fiduciary duty and negligence in failing to (1) adequately inspect, repair, and maintain the property’s common elements, (2) inform owners of the conflict of interest in a developer-controlled POA, and (3) establish a reserve fund to pay for repairs.

 

Subsequently, the owners filed a declaratory judgment action seeking a determination of whether the policy issued to KPOA by Travelers covered their claims against KPOA. Travelers moved for summary judgment, arguing the owners’ claims were for “property damage,” which was excluded under the D&O endorsement.[1] The owners also sought summary judgment, arguing the claims were not excluded because they claimed economic loss based on breaches of duty and negligence, not “property damage.” The circuit court ruled in favor of the owners, reasoning that, based on Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Co., 395 S.C. 40, 717 S.E.2d 589 (2011), damages for correction of initial defective construction were covered, while other property damage caused by such defective construction was not.

 

On appeal, Travelers argued (1) the circuit court erred in relying on Crossmann to determine what constituted “property damage” with the D&O endorsement exclusion; and (2) additional policy exclusions also prevented coverage for the owners’ claims.

 

Property Damage Exclusion: “Property damage” was defined in the policy as “physical injury to tangible property, including all resulting use of that property; loss of use of tangible property that is not physically injured; or diminution of property value.” Noting the policy in Crossmann also defined “property damage” as “physical injury to tangible property,” the Court of Appeals found it was not improper for the circuit court to look to Crossmann for guidance as this case also required the court to consider allegations relating to initial defects and further resulting damage, although under a different type of policy.[2] Nevertheless, the court concluded the application of the principles set forth in Crossmann did not correlate adequately to the facts and the policy to support the circuit court’s conclusion in its entirety. Specifically, the circuit court concluded, as in Crossmann, that the cost to repair and replace construction defects did not constitute “physical injury to tangible property.” Unlike in Crossmann, this conclusion resulted in a finding that coverage was not excluded.  Reviewing the underlying complaint, however, the court determined the circuit court erred in finding the D&O endorsement provided coverage for correction of initial defective construction because (1) KPOA did not exist when the alleged defective work was done; and (2) any further deterioration that could arguably be attributed to KPOA would at most constitute diminution in value, which was specifically excluded under the endorsement. As to the allegations regarding KPOA’s failure to establish a reserve fund and breach of a fiduciary duty to warn of the conflict of interest, the court concluded that the alleged resultant damages did not involve physical injury and, consequently, were not excluded under the property damage exclusion.

 

Additional Policy Exclusions: Travelers also argued a number of other exclusions applied to preclude coverage for the owners’ claims regarding breach of fiduciary duty and the failure to establish a reserve fund. Section I(D)(3)(b) of the endorsement excluded coverage for damages resulting from “[a]ny dishonest, fraudulent, criminal or malicious act, error or omission committed by or with the knowledge of any insured.” The owners alleged KPOA “placed the interest of the developer ahead of the owners” in failing to properly maintain the property or establish a reserve fund. Reasoning that, although the act of placing the developer’s interests before the owners may constitute a breach of fiduciary duty, it does not allege dishonest, fraudulent, criminal or malicious action, the court found the provision did not bar coverage for the remaining claims.

 

Section I(D)(3)(f) excluded coverage for damages resulting from “[t]he failure of any insured to enforce the rights of the Named Insured against the builder, sponsor or developer of the property designated in the Declaration.” Travelers argued this exclusion applied because the complaint alleged KPOA failed to enforce the owners’ rights against the developers by putting the developers’ interests ahead of the owners’ interests. The court rejected this argument, reasoning the underlying complaint did not allege KPOA failed to enforce rights, but rather, alleged a failure to establish the reserve fund and to warn of conflicts of interest.

 

Section I(D)(3)(i) excluded coverage for damages resulting from “[a]ny claim or ‘suit’ made by any insured against another insured.” “Insured” was defined to include “those who were directors, trustees or officers when the ‘wrongful act’ took place.” Travelers argued seven of the owners who had served as past board members of KPOA were “insureds” under the endorsement and thus could not participate in the underlying lawsuit. The wrongful acts alleged against KPOA occurred from 1997-2006, during which time none of the owners were on the board. Accordingly, the court found this argument to be without merit.

 


[1] The parties agreed the allegations were based on “wrongful acts” as contemplated by the D&O endorsement.

 

[2] In Crossmann, the court stated: “With respect to the first quoted definition of ‘property damage,’ the critical phrase is ‘physical injury,’ which suggests the property was not defective at the outset, but rather was initially proper and injured thereafter. We emphasize the difference between a claim for the costs of repairing or removing defective work, which is not a claim for ‘property damage,’ and a claim for the costs of repairing damage caused by the defective work, which is a claim for ‘property damage.’”

 

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