Recent Developments Involving the LEG-3 Extension to Builders’ Risk Coverage
Category | Briefing Papers
By Matthew G. Nelson
Matt is an associate in the firm’s Construction Law Department. He can be reached at 612.359.8611 or mnelson@fwhtlaw.com.
Introduction
Insurance is a cornerstone of risk management and allocation on construction projects. Project contracts typically require either owners or contractors to carry builders’ risk coverage, which is often written on so-called “all-risk” forms, meaning they provide coverage for all perils or causes of loss that are not excluded by the policy terms. In addition to covering loss of or damage to materials or work-in-progress, common builders’ risk coverages include soft costs and claim preparation costs incurred following a loss, while endorsements may add coverage for business income losses or losses incurred due to delay in completion of the project, all typically subject to various sub-limits. If the policy is procured by the owner, the contractor and sub-tier contractors are generally included as additional insureds covered by builders risk policies, “as their respective interests may appear” in connection with any given loss.
Builders’ risk coverage is often referred to as “first party” coverage as it covers the work of the contractor, but the scope of protection afforded by the policy is frequently limited by “workmanship exlusions” barring coverage for the contractor’s faulty construction or design. As a consequence, the scope and outer limits of the workmanship exclusion are of particular interest to contractors, as are questions involving the restoration of coverage by “ensuing loss” exceptions to those exclusions.
Recently, federal district courts in Washington D.C. and Florida have issued decisions interpreting a particular variation on the “workmanship exclusion” known as the LEG-3 or the LEG-3 Extension. The LEG-3 is promulgated by the London Engineering Group (hence “LEG”), and is widely considered to be among the most policyholder-friendly of the various workmanship exclusions. While it has been around in one version or another for some time, these are among the first court decisions in the United States to analyze LEG-3 language, so they have important implications for owners and contractors seeking to manage project risks during construction through builders’ risk coverage.
The LEG-3 Extension
When considering particular LEG-3 language it is helpful to compare it against more common workmanship exclusion clauses. While terms and exclusions vary from policy to policy, the following provides an example of typical workmanship exclusion in an “all-risk” policy that otherwise affords coverage against “all risks of direct physical loss of or damage to insured property”:
This Policy shall not pay for loss, damage, or expense caused directly or indirectly by any of the following. Such loss, damage, or expense is excluded regardless of any other cause or event contributing concurrently or in any sequence with the loss or damage:
* * *
Faulty or defective workmanship or materials, or fault, defect, error, deficiency, or omission in design, plan, or specification, unless direct physical loss or damage by an insured peril ensues, and then this Policy will cover for such ensuing loss or damage only.
Litigation over the application of this and similar language to particular losses regularly involves such esoteric debates as whether the term “workmanship” as used in the exclusion is a verb or a noun[1], or where one loss ends and another begins[2], such as whether loss caused by water intrusion through defective workmanship constitutes an ensuing loss.[3] While the language of the LEG-3 is subject to these same debates in one form or another, it also invites other disputes over scope and application. The model LEG-3/06 language published by the London Engineering Group is as follows:
The Insurer(s) shall not be liable for
All costs rendered necessary by defects of material workmanship design plan specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) 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 cost incurred to improve the original material workmanship design plan or specification.
For the purpose of the 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 of the existence of any defect of material workmanship design plan or specification.[4]
Two recent court decisions issued in 2023 and 2024 analyze similar LEG-3 language and shed important light on the meaning and scope of this language. These cases focus on the term “improve” as used in the LEG-3, and particularly how it may be understood to operate as a limit on the “cost of replacement or rectification” that is arguably otherwise covered. These cases also reject the insurers’ attempts to add terms to the policies that are not reflected in the actual policy language.
- S. Capitol Bridgebuilders v. Lexington Ins. Co.
The contractor in the South Capitol case[5] was hired to construct the replacement Frederick Douglass Memorial Bridge spanning the Anacostia River in Washington D.C. The bridge is a tied-arch bridge constructed with a composite deck tied to steel arches supported by cast-in-place concrete abutments and piers. The contractor poured the abutments and piers in several lifts. While pouring, the contractor vibrated the concrete while it was plastic, to consolidate it within the formwork. However, the formwork configurations limited the contractor’s access and ability to vibrate the concrete in some areas. After the concrete set, the contractor removed the formwork and discovered honeycombing and voiding, indicative of inadequate consolidation. Because voiding in particular can reduce a concrete structure’s weightbearing capacity, the contractor was forced to add temporary shoring to other elements of the bridge while it cut, demolished, and then replaced large sections of the abutments with non-defective concrete, to achieve specified weightbearing capacities.[6]
Lexington issued a “completed value builders’ risk” policy to the contractor. The policy term included the period of bridge construction, and the policy provided coverage for “all risks of direct physical loss of or damage to insured property” including “all materials, supplies, equipment, machinery, and other property…when used or to be used in or incidental to the demolition of existing structures, site preparation, fabrication or assembly, installation or erection or the construction of or alteration, renovation, rehabilitation of the Insured Project” as well as temporary work such as scaffolding, formwork, and falsework “incidental to the project.”[7] The Lexington policy contained a typical workmanship exclusion, but it was replaced by a “LEG 3 Defect Extension” as follows:
Perils Excluded, Item C. is deleted and replaced by the following:
All costs rendered necessary by defects of material workmanship, design, plan, or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) 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 cost 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 of the existence of any defect of material workmanship, design, plan, or specification.
All other terms and conditions of the policy remain the same.[8]
The contractor submitted a claim to Lexington under the policy, seeking recovery of $2.2M it incurred to repair the bridge, and Lexington denied the claim. Both Lexington and the contractor agreed that the contractor’s deficient workmanship caused the voiding which necessitated the repair, but disagreed as to, among other things, whether the LEG-3 Extension excluded coverage for the repair cost. The court characterized its effort to answer this question as “untangl[ing] the tortured language of the Extension”[9] while observing:
The LEG 3 Extension is ambiguous—egregiously so. To understand this, one need only attempt to read it. In just three sentences, Lexington managed to squeeze in a run-on sentence, an undefined term, several mispunctuations, and a scrivener’s error….The Extension is internally inconsistent and bordering incomprehensible [and the contractor’s] statement that the Extension is “convoluted” is an understatement.[10]
Given this less-than-flattering assessment, it will come as no surprise that the court granted the contractor’s motion for partial summary judgment, concluding that Lexington breached the insurance contract when it denied coverage for the contractor’s repair costs.[11] In doing so, the court observed that the LEG-3 replaced a broad workmanship exclusion with a narrower one, and thereby broadened the coverage available under the policy.[12]
First, the court determined that the contractor’s claim involved “damage” under the LEG-3, as the concrete voiding caused by the contractor’s defective workmanship was visible to the naked eye and reduced the weightbearing capacity of the bridge. Next, the court addressed the parties’ disagreement over the meaning of the term “improve,” as the LEG-3 only excluded replacement or rectification costs that are incurred to “improve the original material workmanship design plan or specification.” The contractor argued that the term “improve” as used in the LEG-3 means “making it better than originally planned” while Lexington argued that “simply patching or replacing defective components constitutes an improvement.”
The court characterized Lexington’s interpretation as meeting “the low bar of being reasonable in light of the mishmash of terms that comprise the LEG 3 Extension,” while also noting that Lexington’s view bordered on being unreasonable, because it seemed to collapse the distinction between improvement costs and replacement costs that is obviously contemplated by the LEG-3 language. In light of the ambiguity, the court construed the LEG-3 Extension against Lexington and in favor of coverage, and concluded on the undisputed facts that Lexington breached the policy when it denied the contractor’s claim for repair coverage.[13]
- Archer Western – De Moya Joint Venture v. Ace Am. Ins. Co.
The distinction between the terms “improvement” and “repair,” as used in a LEG-3 Extension, was also critical to the outcome in Archer Western[14], another recent case involving defective concrete and highway/heavy and bridge work. The contractor in Archer Western was hired to construct the I-395/S.R. 836 Reconstruction/Rehabilitation project in Miami. The project involved reconstruction of interstate and other roadways, along with a viaduct bridge. The contractor also installed temporary batch plants at the project site, to mix and furnish the concrete needed for the project.
The FDOT specifications allowed for the substitution of fly ash for a certain portion of Portland cement in the concrete mix. During the project, a pressure relief valve at one of the batch plants malfunctioned, allowing excessive amounts of fly ash to be added to the dry mix of cement, aggregate, and sand. This “contaminated” concrete mix was then combined with water, used in several pours throughout the project, and incorporated into project components such as roadway sections, footings, piles, and piers.[15]
When utilized in correct proportion to other elements of a concrete mix, fly ash can extend and improve the workability of fresh concrete and result in stronger hardened concrete. But too much fly ash in a mix can produce low-strength concrete with reduced compressive strength.[16] Indeed, the “contaminated” concrete used by the contractor caused portions of the roadways and bridge structures to fail to achieve specified 28-day strength thresholds, and the contractor undertook efforts to remove and replace the defective concrete.
Before starting the project, the contractor obtained an “all-risk” builders’ risk policy from Ace. The policy insured “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” for the duration of the project construction.[17] As in South Capitol, the contractor’s builders’ risk policy replaced the standard workmanship exclusion with a LEG-3 Extension:
The following changes are made to ACE 0219, Part D, Excluded Causes of Loss, 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 cost 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 of the existence of any defect of material, workmanship, design, plan, or specification.[18]
Around the time that the contractor was placing defective concrete, it also experienced formwork buckling while pouring a pier. The contractor submitted a claim to Ace to cover costs incurred to remove and replace the concrete and steel components damaged by the formwork buckling. An adjuster reviewed the formwork loss and opined “This is LEG 3 language (we cover ensuing damages and the defective portion itself, however, we do not pay any improvement costs to fix the defect),” and Ace accepted the formwork loss.[19] However, when the contractor also sought coverage for its costs incurred to remove and replace the concrete “contaminated” by excessive fly ash from other components of the project, Ace rejected the claim. Ace took the position that the LEG-3 Extension excluded coverage for such defective material “because it was never in a satisfactory state and was therefore not damaged.”[20] The contractor sued, and Ace moved for summary judgment.
The court denied Ace’s motion, concluding that issues of fact and policy ambiguities necessitated a trial.[21] First, the court observed that Ace’s “initial satisfactory state” argument had its genesis in a Fifth Circuit case, in which the “physical loss or damage” requirement of an insuring clause was described 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 dented the bumper. It would not ordinarily be thought to encompass faulty initial construction.[22]
The insurer’s position boiled down to this: something cannot become damaged if it is defective from the start. The court rejected this argument, reasoning that all-risk builders’ risk policies cover loss or damage of every kind unless otherwise excluded and, if defective construction could not constitute such damage, arguably the workmanship exclusion would be wholly unnecessary in the first instance.[23]
Turning next to the LEG-3 Extension’s specific requirement that insured property will not be considered “damaged solely by virtue of the existence” of defective workmanship or material, the court further reasoned that, as in South Capitol, the damage to the insured property arguably did not exist solely because the concrete was defective. Instead, the damage to insured property arguably could be characterized as the reduced structural integrity of the roadway and bridge components, which resulted from the incorporation of the defective concrete into those components.[24]
Finally, the court also sided with the contractor’s position that the LEG-3 Extension is ambiguous as to whether its use of the term “improve” should be construed to exclude the cost to repair the as-built roadway and bridge components or, instead, merely to exclude the cost of rebuilding them to standards exceeding the original plan or design. The court again relied heavily on the analysis is South Capitol to conclude that the LEG-3 Extension is ambiguous on this point. To underscore the conflict, the court observed that Ace’s decision to accept the formwork loss, but subsequent denial of the concrete-contamination loss, were diametrically opposed and “reasonable jurists and jurors could view” Ace’s different positions on the two losses “to be fundamentally inconsistent.”[25]
Conclusion and Takeaways
The LEG-3 Extension is widely viewed as the most policyholder-friendly of the workmanship exclusions. Despite the “mishmash” of “egregious” ambiguities, it has commonly been understood to afford coverage for ensuing loss and costs to repair an insured’s defective work, while excluding only the costs incurred to improve upon originally specified design, materials, or workmanship. However, some insurers have started to challenge the conventional view.
Thus far, the insurers mounting these challenges have not fared well. The recent South Capitol and Archer Western cases are among the first decisions issued by United States jurisdictions to analyze the LEG-3 Extension. Both cases rejected the insurers’ attempts to graft an “initial satisfactory state” requirement onto the policy language, while also concluding that the LEG-3 Extension is ambiguous. Due to the differing case postures, the South Capitol court construed the ambiguity in favor of coverage on undisputed facts, and granted the contractor’s motion, while the Archer Western court relied on the ambiguity and disputed facts to deny Ace’s motion.
These decisions suggest that clarifications are in order, if policyholders and insurers wish to accurately capture their shared intent when utilizing a LEG-3 endorsement. Until then, these decisions should be an important resource for policyholders with LEG-3 endorsements, in the event they find themselves submitting claims after experiencing workmanship-related losses. If repair work occasioned by defective workmanship does not involve improvements beyond the originally specified designs, material, or workmanship, then losses subject to the LEG-3 Extension should be promptly adjusted and settled, so that policyholders can avoid or minimize delay, disruption, or other impacts, and move their projects forward.
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[1] See, e.g., Kroll Constr. Co. v. Great Am. Ins. Co., 594 F.Supp. 304, 307 (N.D. Ga. 1984) (“’Faulty or defective workmanship,’ then, means the faulty or defective execution of making or doing something.”); Allstate Ins. Co. v. Smith, 929 F.2d 447 (9th Cir. 1991) (“faulty workmanship” means the “flawed quality of the product worked upon”); City of Oak Harbor v. St. Paul Mercury Ins. Co., 159 P.3d 422, 425 (Wash. Ct. App. 2007) (whether faulty workmanship refers to a faulty process or faulty product, exclusion applied because contractor’s negligent dredging also produced a faulty product).
[2] See, e.g., Rocky Mountain Prestress, LLC v. Liberty Mut. Fire Ins. Co., 960 F.3d 1255, 1261-1262 (10th Cir. 2020) (The “resulting-loss exception to a defective-workmanship exclusion does not provide coverage for the costs of repairing or replacing defectively designed or constructed parts of a structure; rather, the exception only restores coverage for damage sustained when the defective workmanship becomes the cause of additional, separate damage.”); See also Ingenco Holdings, LLC v. Ace Am. Ins. Co., 921 F.3d 803, 806-807, 818-819 (9th Cir. 2019) (Damage to one part of a nitrogen rejection unit at gas purification plant caused by faulty workmanship performed on different part of the same nitrogen rejection unit, covered as an ensuing loss).
[3] See, e.g., Friedberg v. Chubb & Son, Inc., 691 F.3d 948, 953-954 (8th Cir. 2012) (“The better view of Minnesota law, however, is that the ensuing-loss provision excludes from coverage the normal results of defective construction” such as water intrusion damage) (cleaned up).
[4] Available at: https://www.londonengineeringgroup.com/resource-library.
[5] 2023 WL 6388974 (D. D.C. September 29, 2023).
[6] Id. at *2-3.
[7] Id. at *1.
[8] Id. at *2.
[9] Id. at *6.
[10] Id. at *6, 9.
[11] Id. at 11.
[12] Id. at *9.
[13] Id. at *10-11.
[14] 2024 WL 1250179 (S.D. Fla. January 12, 2024).
[15] Id. at *8.
[16] Id. at *6-7.
[17] Id. at *4.
[18] Id. at *5. Note, this is LEG-3/96 language, instead of the LEG-3/06 language involved in South Capitol. See https://www.londonengineeringgroup.com/resource-library.
[19] 2024 WL 1250179, at *9.
[20] Id.
[21] Id. at *27.
[22] Id. at *16-17, citing and quoting Trinity Indus., Inc. v. Ins. Co. of N. Am., 916 F.2d 267, 270-271 (5th Cir. 1990).
[23] 2024 WL 1250179, at *20-21.
[24] Id. at *24-27.
[25] Id. at *17, 26-27.