Construction Defect: How to Minimize Loss in a Complex Landscape

As a general or specialty contractor, your business aims to deliver a quality project safely, on time, and on budget. However, if your work is found to be defective, whether because of an expedited deadline, inferior materials, or lack of skilled labor, you may expose your business to construction defect claims.

A construction defect results from a failure to design or construct in a manner that is considered reasonable in terms of workmanship and/or an owner’s expectations. A claim for damages resulting from these types of deficiencies is a construction defect claim.

Why should businesses be vigilant about avoiding construction defects? Doug Cauti, chief underwriting officer for Liberty Mutual’s construction unit, explains:

"Construction defect claims can affect a contractor’s reputation, its profits, and its ability to maintain insurance coverage. When a company is sued for construction defect, the insurer has the duty to both defend and indemnify the business, covering legal costs as well as any awarded financial damages. Even if a suit is dismissed, the related legal fees can make a claim expensive. Therefore, a construction company with a history of defect claims may find it more difficult to compete and cost-effectively manage risk."

Why Construction Defect Claims Are Challenging

Additional factors that contribute to the challenging nature of construction defect claims include:

  • Uncertain and varying legal climate: Court interpretations of commercial general liability policies can vary by jurisdiction. In some states, courts do not consider construction defects to be accidental occurrences covered by standard general liability policies. Other states have passed legislation to classify construction defects as occurrences under the general liability policies, or have adopted broader interpretations of when coverage may apply.
  • Complex litigation: The number of defendants, changing anti-indemnity statutes, and the number and types of policies that could potentially cover a claim add to a construction defect case’s complexity and time and cost to defend. Defense costs can represent a significant portion of a claim’s total cost.
  • Scope of damages: Many factors can affect the monetary value of a claim, such as the extent of the damage, how liability is assigned if there are multiple defendants, and whether the claim is for property damage, bodily injury, or both.
  • Varying statutes of repose: A statute of repose prohibits legal action against a contractor after a certain period of time following the completion of a construction project. These statutes can vary from four, 10, or even 20 years, depending on the state. Given that timespan, locating the project documents needed to defend a case can be difficult, especially if a business does not have a strong records retention program.

“It’s common to discover damage or defects long after a project is finished,” notes Cauti. “As a result, a business can find itself defending a claim for a project that has long been closed and off the books. One large construction defect claim can cripple a business if it doesn’t have the right risk management plan.”

How to Minimize the Damage

Contractors can follow these steps to minimize the financial and reputational damage stemming from construction defects and related claims:

1. Check your coverage and contracts. Construction projects often include multiple stakeholders, such as the general contractor, designer, engineer, subcontractors, and material suppliers. Assigning accountability if certain aspects of a project are subpar can be difficult without clear guidelines in place. In addition, your business may find that it has sufficient coverage in some locations, but not in others, depending on the jurisdiction. Prior to starting a new project, work with your insurer, legal counsel, and agent or broker to:

  • Review the limits, exclusions, and exceptions of your general liability policy. You may need higher limits in certain states. In addition, some policies may cover faulty workmanship only if completed by subcontractors.
  • Consider excess, professional, and pollution liability as well as property policies to minimize the risk of coverage gaps. Having additional protection can safeguard your business in the event of a large claim or if an incident is not covered by your general liability policy. This comprehensive coverage is especially important if your business is involved in design-build, building information modeling, or integrated project delivery work.
  • If your business is involved in owner-controlled or contractor-controlled insurance programs (OCIPs/CCIPs), or “wrap ups”, confirm that there are no gaps between the wrap up coverage and your liability policies.
  • Review contractual language, and clarify your legal and financial responsibilities. Some states may limit a contractor’s ability to transfer certain liabilities, responsibilities, and risks to subcontractors.
  • Confirm that all stakeholders, including the architect, subcontractors, and suppliers, are contractually responsible for their own work, subject to state indemnity provisions. Also check that these parties have sufficient insurance coverage. In some states, responsibilities for a construction defect may rest with the designer or material manufacturer through their professional liability insurance policies.

2. Implement a comprehensive quality control program. Collaborating with colleagues on a continuous quality control program is one of the best ways to avoid construction defect claims, improve safety, and limit costs associated with delayed delivery dates and rework.

  • Involve all parties early on, and form a quality committee to develop the project’s program and document it in writing.
  • Hold pre-construction meetings to review plans and specifications and discuss potential issues. Completing constructability reviews, prework site assessments, and performance mock-ups can also facilitate collaboration and mitigate problems during construction.
  • Have qualified personnel conduct regular inspections of work and materials throughout the project.
  • Maintain project-related records, such as inspections, materials, delivery schedules, and stakeholder names and responsibilities. Also, develop a formal process to document specification changes, approvals, and verifications of work. Having comprehensive records may help your business avoid litigation.

3. Control claim-related costs. Construction defect litigation can be time-consuming and expensive. In addition to the claim for damages, which can be extensive for larger projects, there are also legal and non-legal expenses to defend against the claim. Some ways to mitigate costs:

  • Inform your insurer of potential claims immediately, and be ready to provide project-related records. Your claims handler can help guide and participate in the information-gathering process.
  • Partner with your claims handler to keep a close eye on the appropriate use of resources. For example, engaging attorneys at the right time can help minimize legal fees and expenses. Paying attention to costs for non-legal resources, such as forensic engineers, consultants, and expert witnesses, is also important. Construction defect claims typically have higher non-legal expenses than other types of construction claims do.
  • Consult with your insurer about when a settlement strategy might be the right solution. While receiving a favorable verdict can be satisfying, it may not provide the best financial outcome. Knowing when to settle can save your company time and money and enable your company to move forward.

Your business may not be able to completely prevent construction defects, but you can work closely with your insurer, legal counsel, and agent or broker to better protect your business from potential claims. With a comprehensive risk management plan in place, you can focus on delivering quality work, growing your profits, and a maintaining a strong reputation.

Was this relevant to your business?

  • Yes
  • No

The illustrations, instructions, and principles in this material are general in scope and, to the best of our knowledge, current at the time of publication. No attempt has been made to interpret any referenced codes, standards, or regulations nor to identify all potential risks or requirements.