When purchasing or renewing commercial general liability (CGL) policies there is often talk about “what is covered.” But the moral of this article is that it can be more important to discuss “what is not covered.” And by this I am referring to policy exclusions.
Exclusions play a critical role in every CGL policy. When coverage is denied, it is more often than not due to an exclusion. Yet too often I find that the policy holder is unaware of the exclusion prior to the denial. I believe this calls for a shift in focus.
The reason exclusions play such an important role is relatively simple. All CGL policies begin with essentially the same concept: that the insurance carrier will defend and indemnify the policy holder if he/she/it becomes legally liable for bodily injury or property damages. Because this concept affords broad coverage for a wide variety of claims, the policies typically have multiple exclusions.
By carving a much narrower scope of coverage, these exclusions define the true extent of the policy. Indeed, it is impossible to determine whether a claim is covered without proper examination of the exclusions. For this reason they deserve a significant amount of attention.
To illustrate the importance of this principle, I will discuss one exclusion that has particular relevance for those in the real estate development industry: the sunset clause. The sunset clause is a clause providing that insurance coverage will cease after a specified point in time. In and of itself this sounds fairly innocuous because, obviously, we can’t expect coverage to continue forever. The problem is that insurers can and sometimes do use these clauses to limit coverage in ways that can leave policy holders in very precarious situations.
Insurers know when claims are likely to be filed. By writing exclusions like sunset clauses they can limit their risk, and increase the profitability of policies in ways that are not readily apparent to the unwary. Drawn by cheaper premiums, policy holders may not realize the exclusion is there, or may not understand the full effect of the exclusion. Ignorance is bliss—unless and until a claim is filed.
One of the most significant costs of real estate development, and one of the most significant reasons to purchase a CGL policy, is construction defect claims. In my home state of California it seemed like nearly every development constructed within recent memory was involved in some form of litigation regarding construction defect claims before the real estate market crashed a few years ago, particularly with respect to residential properties. This drove insurance premiums through the roof, forcing some in the industry out of business.
The thing to know about this litigation, for purposes of the sunset clause, is that each U.S. state has passed legislation limiting the period of time in which it can be filed, called the statute of limitations. In California the litigation can, and fairly often will, be filed up to 10 years after substantial completion of construction. So if a sunset clause precludes coverage any time prior to this, you may be liable.
This is why sunset clauses can be devastating if there’s a claim. Some preclude coverage even before the completion of construction. These clauses are particularly onerous because experience has shown that construction defect claims virtually always arise after the completion of construction. A clause like this can render a policy virtually worthless for the claims. This can be very disappointing, especially when considering the fact that premiums for policies with these clauses can easily cost hundreds of thousands of dollars.
Of course, construction defect claims filed before the period specified by the sunset clause may generally be covered. And if asked, those in the business of selling insurance may be quick to verify that point, as assurances that tend to persuade customers to bind coverage are usually provided quite readily. But the period of coverage that is precluded by the sunset clause will likely be a critical period of coverage, and can lead to serious consequences.
This isn’t to lay blame on the insurance industry, however. To meet a strong demand for lower premiums, insurers must write exclusions that limit risk to a reasonable level. And while it is often normal to provide a substantial amount of information to your broker in procuring your policy, he/she still may be unfamiliar with other important aspects of your business sufficiently enough to realize that an exclusion is an issue. In such a case, the exclusion may never be mentioned, and I am sad to say this can and does happen.
Circling back to the moral of this article, do not assume that exclusions potentially affecting your business will automatically be brought to your attention before your CGL policy is bound. Take the time to review the exclusions, and ask questions. Time spent going over the exclusions can pay for itself many times over down the road.
Christian Graham is a licensed practicing attorney in California, and serves as general counsel for the national firm Advanced Retail Solutions. He can be reached at [email protected]