1. 1 Construction Defect Liability and Captives International Center for Captive Insurance Education Teleconference Presenters: Jim Boone, Alberici Group, Inc. Mike ONeill, American Contractors Insurance Group Pat Wielinski, Cokinos, Bosien & Young, P.C.

2. 2 Construction Defects Introduction: Google search for Construction Defects yielded 1,821,000 hits in.61 seconds. Top three paid advertisers on the Google Construction Defects page were: #1 Southern California Plaintiff Law Firm #2 Construction Defects Expert Witness #3 Northern California Plaintiff Law Firm

3. 3 Four Categories of Construction Defects The trial courts have recognized that construction defects are tangible and can typically be grouped into the following four major categories: Design Deficiencies Sometimes design professionals, such as architects or engineers, design builders and systems that, from a performance standpoint, do not always work as intended or specified. The motivation for the design may be form, function, aesthetics, or cost considerations, but the completed design could result and/or manifest into a defect.

4. 4 Four Categories of Construction Defects Material Deficiencies The use of inferior building materials can cause significant problems, such as windows that leak or fail to perform and function adequately, even when properly installed. Example: siding, windows, roofs, plumbing, HVAC

5. 5 Four Categories of Construction Defects Construction Deficiencies (Poor Quality or Substandard Workmanship) Poor quality workmanship often manifests as water infiltration through some portion of the building structure. Cracks in foundations, floor slabs, walls, dry rotting of wood or other building materials, termite or other pest infestations, electrical and mechanical problems, plumbing leaks and back-ups, lack of appropriate sound insulation and/or fire-resistive construction between adjacent housing units.

6. 6 Four Categories of Construction Defects Subsurface/Geotechnical Problems California, Colorado, and other parts of the country have a significant amount of expansive soil conditions. As a result of this type of terrain, there have been many problems when housing subdivisions and/or developments are built into hills or other sloping areas where its difficult to provide a solid and/or stable foundation.

7. 7 Four Categories of Construction Defects Subsurface/Geotechnical Problems (cont.) If the subsurface conditions in these subdivisions and/or developments are not properly compacted and prepare for adequate drainage, problems will inevitably result, which can include vertical and horizontal settlement (subsidence), movement (expansion), slope failures, flooding, and in extremely wet/rainy climates, landslides, etc. These types of conditions typically lead to cracked foundations, floor slabs, and other damage to a building.

8. 8 Four Categories of Construction Defects Subsurface/Geotechnical Problems (cont.) A worst-case scenario in some instances could render a building uninhabitable, as well as uninsurable.

9. 9 Risk Management for Construction Projects Long-Tail Liabilities Patent Defects –Apparent with reasonable inspection –Statute of limitations requires claim to be submitted within x years of project completion (usually short, e.g., 2 or 3 years)

10. 10 Risk Management for Construction Projects Long-Tail Liabilities Latent Defects –Defect is not apparent by reasonable inspection –More time is allowed to submit a claim, in some cases 10 years after completion (CA). For comparison purposes, AZ is 8 years, WA is 6 years (confirmed by WA Supreme Court in September 2001), and FL is 10 years.

11. 11 Statutes of Repose State Alaska Alabama Arizona Arkansas California Colorado Number of Years Ten Years Thirteen Years Eight Years Five Years Ten Years Six Years

12. 12 Statutes of Repose State Connecticut Delaware Dist. Of Columbia Florida Georgia Hawaii Number of Years Seven Years Six Years Ten Years Eight Years Ten Years

13. 13 Statutes of Repose State Idaho Illinois Indiana Iowa Kansas Kentucky Number of Years Six Years Ten Years Fifteen Years Five Years Seven Years

14. 14 Statutes of Repose State Louisiana Maine Maryland Massachusetts Michigan Minnesota Number of Years Five Years Ten Years Six Years Ten Years

15. 15 Statutes of Repose State Mississippi Missouri Montana Nebraska Nevada New Hampshire Number of Years Six Years Ten Years Eight Years

16. 16 Statutes of Repose State New Jersey New Mexico New York North Carolina North Dakota Ohio Number of Years Ten Years No Statute of Repose Six Years Ten Years Fifteen Years

17. 17 Statutes of Repose State Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Number of Years Ten Years Twelve Years Ten Years Thirteen Years Ten Years

18. 18 Statutes of Repose State Tennessee Texas Utah Vermont Virginia Washington Number of Years Four Years Ten Years Nine Years Six Years Five Years Six Years

19. 19 Statutes of Repose State West Virginia Wisconsin Wyoming Number of Years Ten Years

20. 20 Risk Management for Construction Projects Legislative Efforts at the State Level –Intended to improve the standards and procedures for early disposition of construction defect claims –Outlines prelitigation procedures –Notice and opportunity to repair laws See Handout for a State-By-State Analysis

21. 21 Definition of Occurrence Traditional: property damage neither expected nor intended from the standpoint of the insured is an accident. Recent: Property damage arising out of an insured contractor s breach of contract or warranty is natural and foreseeable and not an accident.

22. 22 l. Property Damage to your work arising out of it or any part of it and included in the products-completed operations hazard. This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor. Your Work Exclusion

23. 23 Subcontractor Exception Major inroad to the Business Risk Doctrine Subcontractor is broadly construed to include many entities Key to completed operations coverage Source of classic judicial statements of coverage for defective work

24. 24 Restrictive Endorsement CG 22 94 Exclusion 1. of Section I – Coverage A – Bodily Injury and Property Damage Liability is replaced by the following: This insurance does not apply to: Property damage to your work arising out of it or any part of it and included in the products-completed operations hazard.

25. 25 Additional Insured Endorsement CG 20 10 11 85 WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liablity arising out of your work for that insured by or for you.

26. 26 Additional Insured Endorsement CG 20 10 10 93 WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured.

27. 27 No More Sole Negligence Coverage Relevant 2004 Endorsement Language Section II – Who Is An Insured is amended to include as an additional insured the person(s) or organization(s) shown in the Schedule, but only with respect to liability for bodily injury, property damage or personal and advertising injury caused, in whole or in part, by: 1.Your acts or omissions; or 2.The acts or omissions of those acting on your behalf; in the performance of your ongoing operations for the additional insured(s) at the location(s) designated above. © ISO Properties, Inc., 2004

28. 28 Additional Insured Endorsement CG 20 37 07 04 WHO IS AN INSURED is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your work at the location designated and described in the schedule of this endorsement performed for that insured and included in the products-completed operations hazard.

29. 29 Restrictive Endorsements Habitational Exclusions Excludes residential construction as defined in the endorsement Varies from insurer to insurer Apartments, assisted living, condos, co-ops, hospitals, hotels, military housing, nursing homes, single family, dorms, townhouses, tract housing

30. 30 CGL-Common Restrictive Endorsements Mold Silica Lead EIFS Subsidence Employment Practices

31. 31 Controlled Insurance Programs - Pros 1.Reduce insurance costs through a.Projectwide buying power b.Improved loss experience c.Elimination of redundant coverages and premiums d.Reduced litigation between insurers

32. 32 Controlled Insurance Programs - Pros 2.Lower expense factors 3.Improved insurance coverages and uniform policy limits

33. 33 Controlled Insurance Programs - Pros 4.Superior claims management a.Uniform and coordinated claims handling b.Aggressive claim settlement c.Thorough investigation and supervision of claims d.Resist questionable claims e.Common defense – avoids legal blackmail f.Can contribute to superior customer relationships

34. 34 Controlled Insurance Programs - Pros 5.Utilizes the general contractors relationship and experience with quality subcontractors

35. 35 Controlled Insurance Programs - Cons 1.Complicated 2.Extended period of involvement after completion of project, the tail 3.Administrative intense 4.Substantial risk 5.Volatile costs 6.Unexpected cancellation from markets

36. 36 Self-Insured Retention

37. 37 Self-Insured Retention Plan Characteristics SIR applies on a per-occurrence basis to both indemnity and expense. Insurer is under no obligation to defend, until the SIR amount has been funded. In-house vs. TPA to handle losses within the SIR. Tax Treatment - Premiums are deductible when paid. SIR losses deductible when paid.

38. 38 Risk Retention Group

39. 39 Risk Retention Group Plan Characteristics May need a front for certificates. In-house TPA claim handling. Thinly capitalized. Limited risk retention capability. Dependent on reinsurance.

40. 40 Single-Parent Captive Insured Owner Captive Reinsurer Front/Excess Insurer Claimants Shareholder Dividends Capitalization Insurance Premiums Claim Settlements Fronting Security Reinsurance Premium Reimbursement of Loss Excess of Retention

41. 41 Single-Parent Captive An insurance subsidiary created by the insured that allows the firm to participate in the underwriting risk and investment profits associated with the firm's risk financing program. The captive is capitalized and premiums are paid to the captive. The captive will retain a level of risk and purchase reinsurance for limits in excess of its retention.

42. 42 Single Parent Captive Tax issues: –Premiums generally deductible for federal income taxes –Dividends taxed similar to any stockholder's dividend –Return premiums taxed as ordinary income at the parent's rate

43. 43 Single-Parent Captive Fronting issues: –Workers compensation requires a front –Certificate holders may require a front for liability lines –Fronting costs are similar to the basic charges in a retro plan –Wind-down/runoff issues

44. 44 Entity Structuring and Alter Ego Risks Entity selection Sole proprietorship or dba Partnership Corporation Limited liability company

45. 45 Entity Structuring and Alter Ego Risks Liability protection offered by corporations and LLCs

46. 46 Entity Structuring and Alter Ego Risks Use of single purpose entities (SPEs)

47. 47 Entity Structuring and Alter Ego Risks Attacks on the protection of the entity Alter ego (aka piercing the corporate veil) Enterprise liability Parent-subsidiary relationships Substantive consolidation

48. 48 Entity Structuring and Alter Ego Risks Practical tips for minimizing alter ego risks Adequate capitalization Observe formalities –Separate bank accounts, letterhead, contracting procedures –Meetings, minutes, resolutions

49. 49 Entity Structuring and Alter Ego Risks Intercompany relationships –Use of employees –Loans –Intercompany services –Transfers of assets Adequate insurance

50. 50 Entity Structuring and Alter Ego Risks Dissolution strategies Post-dissolution liability of the entity Post-dissolution liability of the partners, shareholders, members Does the developer really want to dissolve the entity?

51. 51 Alternative Dispute Resolution (ADR) Provisions Contracts Alternative dispute resolution (ADR) provisions –Provision governing disputes between the owner or developer and the design professionals/subcontractors –Residential: Provision governing disputes involving homeowners or HOA –Alternatives: Mediation Bench trial, with waiver of jury trial Binding arbitration Rent-a-judge, special master

52. 52 Quality Control Programs Why Are QC Programs Important? 1.A risk management best practice – avoid designed in defects and errors during construction 2.May be required by the developers CGL insurance program

53. 53 Quality Control Programs QC during the design phase Objectives: Maximize constructability of the plans, consistency, code compliance, and appropriate product, material, and systems selections

54. 54 Quality Control Programs Develop procedures for peer review of plans and specifications Establish criteria for selecting and managing peer review consultants, including methods for managing the paper trail

55. 55 Quality Control Programs QC during construction operations Objectives: Inspect a statistically relevant sample of units and common area construction and document correct as-built conditions

56. 56 Quality Control Programs Establish criteria for selecting and managing QC consultants

57. 57 Quality Control Programs Obtain consultant guidance on the following: –Which components should be inspected? –When to inspect (stages of construction)? –Appropriate sample size –Procedures for identifying defects and for obtaining and documenting corrections –Some or all of these components may be dictated by the developers CGL insurance program

58. 58 Quality Control Programs Role of superintendents; obtaining contractor and subcontractor buy-in

59. 59 Quality Control Programs Training of subcontractors

60. 60 Quality Control Programs Consider risk-specific QC initiatives –Windows –Roofs –Other building envelope issues, particularly moisture intrusion –Acoustical issues –Other issues, rated by litigation claims potential

61. 61 Quality Control Programs Handling field changes or repairs during construction

62. 62 Quality Control Programs Red flags: –Value engineering –Design-build trades (may be outside coverage of developers CGL due to professional services exclusion)

63. 63 Warranties Another powerful but underutilized risk management tool Legal and practical consequences –Opportunity for disclosure and education –Reinforce ADR structure –Set and manage owners expectations –Owner maintenance

64. 64 Warranties Warranty as the roadmap for performing customer service Performance standards –Qualitative –Quantitative

65. 65 Warranties Exclusions –Normal wear and tear –Acts of third parties or the homeowner –Lack of required maintenance –Acts of God –Claims covered by homeowners insurance

66. 66 Warranties Stand-alone dispute resolution provisions –Notice, access, inspection, testing, repair –Mediation followed by binding arbitration

67. 67 Warranties Duration of the warranty One-year warranties increasingly are outdated, may depend on particular system Relationship of the express warranty to statutes of limitations and statutes of repose

68. 68 Warranties Transferability to subsequent purchasers Binding on subsequent purchasers?

69. 69 Design and Implement Customer Service Program Why customer service is critical: Radar function and litigation avoidance

70. 70 Design and Implement Customer Service Program When does the customer service process begin and end? Walk-through – the handoff Relationship between customer service and statutes of limitations/statutes of repose Repairs toll (stop the running of) statutes of limitations

71. 71 Design and Implement Customer Service Program Documentation – practical tips Get it in writing Make your record Be objective (dont editorialize or speculate) Be precise about dates (tolling of statutes of limitations) Develop a customer service database and tracking system

72. 72 Design and Implement Customer Service Program Develop issue-specific protocols for high-risk claims Water intrusion Mold Acoustical Soils Other

73. 73 Design and Implement Customer Service Program Train customer service representatives on maintenance manuals and warranties

74. 74 Record Retention Policies Why is record retention important for developers? Long tail liabilities Delayed manifestation of defects Statutes of repose Critical to defense of claims, prosecution of cross- claims, and insurance recovery

75. 75 Record Retention Policies Effective record retention allows developers to: Identify potentially responsible parties Identify potential witnesses Compile contracts and insurance information from other parties Marshal the developers direct insurance resources

76. 76 Record Retention Policies Effective record retention allows developers to: Retrieve QC inspection records to demonstrate correct as-built conditions Help establish defenses, such as statutes of limitations and comparative fault