In a case of first impression, the United States District Court for the District of Columbia (applying Illinois law) rejected a LEG3 exclusion as ambiguous. See S. Capitol Bridgebuilders “SCB” v. Lexington Ins. Co., 2023 U.S. Dist. LEXIS 176573 (D.D.C. Sep. 29, 2023). The London Engineering Group (“LEG”) is a consultative body for insurers of engineering class risks. Nearly 30 years ago, LEG introduced a series of defects exclusions, including LEG1, LEG2, and LEG3 (which was revised in 2006). Each provides increasing levels of coverage, with LEG3 being the broadest. Generally, while preserving some coverage, LEG3 purports to exclude costs incurred to improve defects of “material workmanship, design, plan, or specification.” Until now, despite frequent usage in builder’s risk policies internationally, there has been a clear lack of judicial guidance relative to LEG3.
In S. Capitol Bridgebuilders, the insured was hired to build Frederick Douglas Memorial Bridge in Washington DC and procured a builder’s risk insurance policy. In building and integrating the supportive structures of the bridge, the insured’s poor vibration of concrete resulted in construction malformations known as “honeycombing” and “voiding,” which harmed the structural integrity of the bridge. This required the insured to replace sizable portions of the bridge’s supportive structures. The insured subsequently submitted an insurance claim seeking indemnity for related costs which the insurer denied for two reasons: (ii) lack of direct physical damage, and (ii) reliance on the policy’s version of a LEG3 exclusion (referred to as the LEG 3 Defect Extension throughout the opinion):
This policy shall not pay for loss, damage or expense caused directly or indirectly by any of 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 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.
The Claimed Damage Was Within the Scope of Coverage
First, the Court determined that the claimed damage was within the scope of coverage. Given that “damage” was undefined, the Court turned to the “plain, ordinary, and popular meaning of the term, as well as the parties’ intent and “overall purpose of the contract.” The Court stated that “damage” included the costs of fixing the concrete flaws that weakened the bridge. “A decreased weightbearing capacity is surely an injury, or at the very least a bad effect, on the bridge and its supporting structures.” Considering that the insured purchased an all risks policy for the construction of a bridge, “[o]ne such risk, inherent in any complex construction project, is damage from errors in workmanship.”
The insurer unsuccessfully argued that the LEG 3 Defect Extension defined “damage” in a way that conclusively excluded defects caused by material workmanship. The insurer directed the Court to the final paragraph of the provision, which stated 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.” The Court disagreed:
But “caused by” and “solely by virtue of the existence” are not the same. The Extension does not suggest that property cannot be “damaged” if there were defects in material workmanship somewhere in the causal chain. Instead, it indicates that defects of material workmanship in and of themselves are insufficient to constitute damage.
The Insurer Failed to Demonstrate that an Exclusion Was Applicable
After the insured had established coverage under the policy, the burden then transferred to the insurer to demonstrate that an exclusion applied. In rejecting the insurer’s reliance on the LEG 3 Defect Extension, the Court stated:
The LEG 3 Extension is ambiguous—egregiously so. To understand this, one need only attempt to read it. In just three sentences, [the insurer] 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 on incomprehensible. [The insured’s] statement that the Extension is “convoluted” is an understatement.
The Court acknowledged that the provision excluded replacement or rectification costs incurred to “improve” the original workmanship. In this context, the next inquiry concerned what it meant to “improve” the original workmanship. The insured suggested it meant “making it better than originally planned, and the insurer argued it meant “simply patching or replacing defective components constitutes an improvement.”
The Court noted that the insurer’s position had “intuitive appeal,” such that “repairing or replacing a defective component can technically be considered an improvement—unless that component is replaced with something worse.” However, the Court ultimately determined that “to improve means to make a thing better than it would have been if it were not for defective work.” It explained that the language explicitly distinguished the “cost incurred to improve” work from “the cost of replacement or rectification.” Accordingly, the Court stated that since the LEG 3 Defect Extension was subject to more than one reasonable interpretation, it was ambiguous requiring construction against the drafter-insurer.
Although the LEG exclusions are not new, they are seldomly litigated. As a result, S. Capitol Bridgebuilders is a landmark decision which will likely create some uncertainty in the construction insurance marketplace where, as the Court noted, potential defects are inherent in any complex project.
Policyholders and insurers, alike, should remain mindful that most claims present unique issues depending upon the policy’s particular language and factual circumstances. Lastly, it is important to note that while the decision is largely adverse to insurers, it only reflects one court’s perspective. Nevertheless, this decision has the potential to reshape the landscape for LEG3 wordings.