Timing Is Everything

Declaratory judgment actions are frequently used to determine coverage under a commercial general liability policy for an insured legally obligated to pay a third party. Third-party liability insurance contracts are indemnity contracts whereby an insurer agrees to pay an insured for insured damages that an insured becomes legally obligated to pay a third party.

Declaratory judgment actions to determine insurance coverage for construction-defect claim damages are commonly brought in state and federal courts in the U.S., and, as the 11th Circuit explains in Greystone Const. Inc. v. National Fire & Marine Ins. Co., courts reach varying results on whether the damages are insured losses. Some courts find that a construction defect is not an occurrence because faulty workmanship is not a fortuitous event or an accident. For these courts, finding no occurrence ends the inquiry, and it is unnecessary to address the presence of property damage.

Other courts may find an occurrence if there is a third-party personal injury or physical injury to tangible property other than the construction project itself. These courts view the occurrence based on who was injured, and not on what caused the injury.

Still other courts find that a construction defect may be an occurrence, and there may be an insured loss assuming that the other requirements of the insuring agreement are met (e.g., there is property damage and no exclusion applies). In jurisdictions that recognize liability insurance coverage for construction-defect claims, allocating what damages may be insured can be a fact intensive exercise for a declaratory judgment action.

Declaratory judgment actions for insurance coverage concerning construction-defect damages typically address either the duty to defend or duty to indemnify. The duty to defend an insured is distinct from the duty to indemnify an insured for damages that a party may recover against an insured. The distinction between the two affects when to commence a declaratory judgment action based largely on what stage of an action triggers either duty.

The duty to defend is generally based on the allegations in a complaint or pleading. As the South Carolina Supreme Court points out in City of Hartsville v. South Carolina Mun. Ins. & Risk Financing Fund, some states do not limit insurers to the four corners of a complaint or pleading to determine the duty to defend.

The duty to indemnify is often based on the findings of the trier of facts (whether a jury or court renders a verdict) including, but not limited to, the kinds of damages awarded to the claimant.

If the issue is whether an insurer must defend based only on the allegations in a complaint, a declaratory judgment action filed at the commencement of the underlying construction-defect action may be ripe for a decision by a court. However, if a state allows an insurer to determine the duty to defend based on information that is outside the four corners of the complaint or a pleading, then an early declaratory judgment action may not be ripe.

In jurisdictions where the duty to defend may be determined from information that is outside the four corners of a complaint, a party may have to look to multiple sources of information that, when combined, lead to the conclusion that there is no duty to defend. Whether there is a duty to defend then becomes complicated because the determination of coverage may involve disputed facts in the underlying action. In such cases, reaching a conclusion on the duty to defend may require a decision that is based on disputed facts. Doing so raises an issue regarding whether the court hearing a declaratory judgment concerning a duty to defend is encroaching on the province of the trier of facts for the underlying action.

If the issue is whether an insurer must indemnify the insured, then a declaratory judgment action that is filed at the time of the commencement of the underlying construction-defect action may be premature for a decision by a court. One assumes here that a state does not have statutory or judicial precedent that mandates the filing of a declaratory judgment action at a certain time or at the commencement of the underlying construction-defect suit.

Federal district courts typically handle premature declaratory judgments in one of two ways. First, a district court may simply find that the court cannot adjudicate indemnity or insurance coverage because doing so is premature. Depending on the jurisdiction, the district court may choose to stay the action. Again, the duty to indemnify is based on the factual findings made by a jury or court in a liability suit, so the duty will not arise or ripen until after a verdict. In Auto-Owners Ins. Co. v. Rhodes, the South Carolina Supreme Court held it was reversible error for a trial court to adjudicate property damage coverage issues before the jury in the underlying action had rendered a verdict on liability and damages: “We hold the declaratory judgment action was procedurally proper save for a ruling on the issues regarding property damages as there are related questions of fact that must be decided by a jury on retrial.” That said, in instances where a provision excluding coverage undisputedly bars coverage for the damages, commencing a declaratory judgment action concerning indemnity may not be premature.

Second, a district court may exercise its discretion to dismiss a declaratory judgment action. In a case or controversy under the Declaratory Judgment Act, a district court “may declare the rights and other legal relations of any interested party seeking such declaration, whether or not further relief is or could be sought.” In Wilton v. Seven Falls Co., the U.S. Supreme Court “characterizes the Declaratory Judgment Act as ‘an enabling Act, which confers a discretion on the courts rather than an absolute right upon the litigant.’” In Centennial Life Ins. Co. v. Poston, the 4th Circuit further defines when a declaratory action may be proper: “[A] declaratory judgment action is appropriate ‘when the judgment will serve a useful purpose in clarifying and settling the legal relations in issue, and...when it will terminate and afford relief from the uncertainty, insecurity, and controversy giving rise to the proceeding.’” Accordingly, a federal district court may choose to dismiss a declaratory judgment action.

Overall, a determination of insurance coverage for construction-defect damages, particularly for the duty to indemnify, does not usually ripen for a declaratory judgment action until after an underlying judgment or verdict. While this result is logical and understandable, being able to determine insurance coverage for construction-defect damages early is useful in resolving the underlying construction-defect action.