Policyholder Pulse
The London Engineering Group’s LEG 3 exclusion—one of three standard form provisions issued by the London Engineering Group addressing coverage arising from construction or design defects—is an increasingly common defects exclusion found in Builder’s Risk and other policies covering projects under construction. LEG 3 is popular due to its reputation in the industry as providing the broadest form of cover available and excluding only “improvements.” Insureds typically accept additional premiums and/or higher deductibles in order to obtain this provision in their policies.
The LEG 3 exclusion states:
The Insurer(s) shall not be liable for
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 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.
There are many treatises and articles discussing the proper application of the LEG 3 exclusion, with opinions on both sides of the policyholder/insurer divide depending on the source and audience. But until very recently, there was no published case law in the United States, or around the globe, addressing the application of the LEG 3 exclusion. This lack of precedent has given insurers ample room to deny claims by asserting that the scope of what is excluded as an “improvement” under LEG 3 is actually quite broad.
Last month, the U.S. District Court for the District of Columbia in the case of South Capitol Bridgebuilders v. Lexington Insurance Company, No. 21-CV-1436 (RCL), 2023 WL 6388974 (D.D.C. Sept. 29, 2023), provided some much needed guidance. The court analyzed the language of the LEG 3 exclusion and applied it to a claim for property damage resulting from defective workmanship.
The Underlying Facts
South Capitol Bridgebuilders involved the construction of the Frederick Douglas Memorial Bridge in Washington, D.C. During construction of the cast-in-place structure, plaintiff South Capitol Bridgebuilders (SCB) failed to properly “vibrate” the concrete, a process necessary to ensure that the concrete reaches all areas of the formwork. This resulted in malformations—essentially holes in the concrete—which impacted the structural capacity of the bridge. SCB sought coverage under its Builder’s Risk policy for shoring costs incurred to prevent a collapse and the permanent repair work. The carrier, Lexington Insurance Company, denied the claim citing an absence of physical damage and the policy’s LEG 3 exclusion. After its request that Lexington reconsider its position was denied, SCB filed suit alleging breach of contract and bad faith.
The Court’s Coverage Analysis
Consistent with the prevailing view articulated by courts throughout the country that damage need not have a visible manifestation, the court rejected Lexington’s argument and found that the “decreased weightbearing capacity” and “decreased structural integrity of the bridge” constituted damage—a term undefined in the policy itself. The court further noted that a finding of damage was consistent with the overall purpose of the contract between the parties and the coverage that SCB purchased. Damage from defective workmanship was an inherent risk in any complex construction project. The court found that by purchasing “all risk” coverage, SCB had a reasonable expectation that structural damage resulting from defective workmanship would be covered.
The court next considered whether Lexington had satisfied its burden to prove that the LEG 3 exclusion applied, focusing on the parties’ arguments regarding what constitutes an “improvement” under the exclusionary language. The court agreed that the only costs excluded under the provision are those incurred to “improve” the original materials, workmanship, or design (whichever was defective). SCB suggested that an improvement was something better than originally planned, and the court gave an example of replacing defective materials with solid gold. Lexington’s argument, however, was that fixing any defective element, by definition, constitutes an improvement.
The court held that, as used in LEG 3, “to improve means to make a thing better than it would have been if it were not for defective work.” In other words, if, but for the defective workmanship, the bridge would have had sufficient structural integrity, the costs incurred to achieve sufficient structural integrity are not “improvements.” Additionally, the court noted that LEG 3 explicitly distinguishes the “cost incurred to improve” the work from “the cost of replacement or rectification,” rejecting Lexington’s argument that the cost to improve and the cost to replace or rectify were essentially the same.
Ultimately, although noting that SCB had the better of the two arguments, the court found that LEG 3 was “internally inconsistent” and “ambiguous—egregiously so.” The court explained:
To be sure, SCB’s reading is more plausible. Nonetheless, Lexington’s argument—while far from convincing—meets the low bar of being reasonable in light of the mishmash of terms that comprise the LEG 3 Extension. As a result, the Court holds that the Extension is ambiguous as to whether it excludes coverage.
While this case was decided under Illinois law, the court’s recognition that exclusionary language only precludes coverage when it is clear and unambiguous, and that ambiguous policy language must be construed strictly against the insurer, is followed by courts throughout the country. As such, the court found that because the language of LEG 3 was ambiguous, Lexington had breached its contractual obligations and granted summary judgment in SCB’s favor. The court also denied Lexington’s summary judgment motion seeking dismissal of SCB’s bad faith claim.
A Win for Policyholders
Word of the decision in South Capitol Bridgebuilders has spread quickly, and it is already being cited by policyholders in proceedings throughout the country. Not surprisingly, the decision has also led to calls from insurers to revise LEG 3’s language to clarify—likely by narrowing—the coverage afforded. But for policyholders with the current version of the LEG 3 exclusion, a federal court has now confirmed that the broadest form of coverage available for damage arising out of defective construction or design provides what policyholders always expected.
While this decision provides an immediate avenue to push back on insurers that argue the LEG 3 exclusion applies more broadly, policyholders should remain mindful of their policy’s particular language. The “all risk” policy in South Capitol Bridgebuilders differentiated between improvements and repairs or rectifications and lacked a definition of “damages,” which certainly played an important role in the court’s holding. Still, this decision is a win for policyholders that will undoubtedly lead to insurers throughout the industry seeking modifications to the LEG 3 language to narrow the current coverage provided.