U.S. District Court of Colorado Interprets Insurance Policy’s Faulty Workmanship Exclusion and Exception for Ensuing Damage

Recently, the United States District Court for the District of Colorado interpreted a faulty workmanship exclusion in a property insurance policy in The Lodge at Mountain Village Owner Association v. Eighteen Certain Underwriters of Lloyd’s of London, 22 U.S Dist. Ct LEXIS 48883*, decided on March 18, 2022.  The Court held that the faulty workmanship exclusion at issue extended to preclude coverage for later ensuing damage that arose from the faulty workmanship, even though the damage was weather related, because faulty workmanship was the primary cause of the ensuing damage.

The claims in The Lodge at Mountain Village arose from maintenance work performed on log siding at three multi-unit condominium buildings in Telluride.  The maintenance work to the log siding included staining, finishing, and chinking repairs to joints between the logs.  About a year after completion of the work, The Lodge at Mountain Village Owners Association (“The Lodge”) notified the maintenance contractor that logs were extremely weathered and that its work was defective.  The Lodge retained an expert who prepared a report stating that the log finish and underlying wood was deteriorating because of the contractor’s work and that some areas were not properly protected from exposure to snow, rain, and brine from ice-melting salt.  The Lodge pursued and settled its claims against the contractor.

A year after filing suit against the contractor, but before settling those claims, The Lodge filed an insurance claim with its first-party property insurance carrier.  The insurance policy provided coverage for “All Risks of Direct Physical Loss or Damage except as hereinafter excluded.”  With respect to applicable exclusions, the policy stated that it did not insure against “the cost of making good defective design or specifications, faulty material, or faulty workmanship, unless physical loss or damage by a peril not excluded ensues and then this policy shall only cover for such ensuing loss or damage . . .”  The policy also excluded “ordinary wear and tear” and “gradual deterioration,” with the same language that “unless physical loss or damage by a peril not excluded ensues and then this policy shall only cover for such ensuing loss or damage.”  The insurance carrier denied the loss pursuant to the exclusions for faulty material, faulty workmanship, gradual deterioration, and ordinary wear and tear.  The Lodge then had its expert provide an additional report, which described damage that was due to the failed chinking sealant and that areas with failed chinking had increased moisture due to rain and melting snow events.  The Lodge provided this letter report to its insurance carrier and asked that it reopen the claim, describing the loss as damage that resulted from faulty workmanship, but noting that the damage ensued after the faulty workmanship.  The insurance carrier denied the claim a second time.

The Lodge then filed suit against its insurance carrier and the independent insurance adjuster that investigated the claim, asserting claims of breach of contract, statutory bad faith, and common law bad faith.  The parties agreed that the damage arose from faulty workmanship.  The question addressed by the Court was whether the ensuing damage was covered by the insurance policy.  The Lodge’s argument was essentially that the contractor did not cause the damage itself, but that it was caused by later moisture intrusion from rain and snow.  The Court noted that, though courts around the country have reached mixed results regarding ensuing damage caused by excluded perils, they all agree with the principle that “the exception cannot be allowed to swallow the exclusion.”  Therefore, the Court found that the cause of the damage claimed by The Lodge was the construction defect, not a later covered peril.  There was no dispute that the damage to the logs was caused by the contractor’s failure to properly seal the logs, which led to water penetrating behind them, which the Court found to have unambiguously fallen within the exclusion for faulty workmanship.  The court noted that, to read the policy as The Lodge requested, would have resulted in coverage for the very damage caused by the construction defect, which was excluded under the policy.  In other words, it would allow the exception to swallow the exclusion.

The Court went on to analyze whether the damage would similarly be excluded by the ordinary wear and tear and gradual deterioration exclusions.  The Lodge argued that the damage was due to moisture from rain and snow.  The Lodge had described such damage in its complaint and discovery responses as resulting from “slow, hidden, and repeated intrusion of water,” which was “slow and discrete,” and “gradual and progressive.”  Based on this description, the Court found that The Lodge’s argument that the damage was due to later rain and snow intrusion would similarly result in a lack of coverage for the damage because it would fall under the policy’s exclusion for gradual deterioration.

The Court also held that another basis to dismiss The Lodge’s breach of contract claim against the insurer was that The Lodge had failed to notify the insurer of the claim until at least 24 months after it discovered the damage.  The Court held that it was undisputable, as a matter of law, that The Lodge did not notify its insurance carrier of the claim within a reasonable time as required by the insurance policy.  Therefore, the Court dismissed The Lodge’s breach of contract claim for this additional reason.

Since the Court dismissed The Lodge’s breach of contract claim against its insurance carrier, there was no basis for its bad faith claims against the carrier as a matter of law.  This opinion upholds the U.S. District Court’s inclination to interpret insurance policy language strictly, and to not permit an insured to use an exception to an exclusion to serve as a means for the insured to get around an exclusion.  Also, it provides guidance to policyholders that damage arising from defective workmanship will not be covered where there is a faulty workmanship exclusion unless there is a subsequent loss legitimately caused by a covered peril.

For additional information regarding The Lodge at Mountain Village Owner Association v. Eighteen Certain Underwriters of Lloyd’s of London case, or Colorado construction law, generally, you can reach Carin Ramirez by e-mail at ramirez@hhmrlaw.com or by telephone at (303) 987-7140.

Colorado’s Workers’ Compensation Act and the Construction Industry

In general, issues relating to employment law occur in all industries. However, some issues are more likely to be raised in certain employment contexts. For example, office work environments tend to give rise to harassment and discrimination claims while wage and hour disputes and workplace safety claims are common in the oil and gas industry. In the construction industry, employers must be especially cognizant of discrimination and harassment claims, employee misclassification claims, workplace safety issues, and wage and hour claims. In the context of workers’ compensation claims, construction projects often create unusual situations due to the contractual relationships between the parties.

Even relatively simple construction of a single-family residence involves several levels of contracting, including between the owner and general contractor, between the owner or general contractor and design team, between the general contractor and subcontractors, and between the prime subcontractors and lower tiered sub-subcontractors. In most circumstances, this would not be an issue. However, when an injured worker makes a workers’ compensation claim, the contractual relationships among the various entities involved in a project can have a significant impact on which party or parties could be liable for the injury.

Under Colorado’s workers’ compensation scheme, an employee injured while performing services within the purpose and scope of his or her employment is entitled to receive compensation for any medical expenses and lost wages. See C.R.S. § 8-40-101, et seq. The purpose of this law is to ensure that the employee receives timely compensation without having to invest time and money into filing a lawsuit. To protect the employer, workers’ compensation is the exclusive remedy for the employee, provided the employer has workers’ compensation insurance and the injury is not intentionally self-inflicted. To further ensure the employee is compensated for an injury, Colorado provides any person or entity conducting business by contracting out work is considered a statutory employer and is liable for workers’ compensation. If the statutory requirements are met, workers’ compensation is the exclusive remedy for each statutory employer.

In a construction context, this workers’ compensation scheme can create issues for the various parties involved. If, for example, an employee of a plumbing subcontractor is injured by falling debris from the roof, the plumbing subcontractor, the general contractor, and the property owner would be statutory employers for the purposes of a workers’ compensation claim. Further, once the compensation claim is paid, the plumbing subcontractor, general contractor, and property owner would be protected from claims resulting from the injury, regardless of which entity paid the claim. This includes subrogation claims brought by a workers’ compensation carrier. However, subcontractors who are not in the same chain of contracting as the plumbing subcontractor could be sued for negligence and/or premises liability. In the example above, both the workers’ compensation carrier and the injured employee could sue the roofing subcontractor and any other subcontractor who may have been involved. The responsible subcontractors would not be able to seek contribution or indemnity from the plumbing subcontractor, general contractor, or property owner because of the protections afforded by Colorado’s Workers’ Compensation Act.

To protect themselves against workers’ compensation related claims, subcontractors must ensure that they have adequate insurance coverage for personal injury matters. If a subcontractor subcontracts out a portion of its scope of work, it must ensure that every entity in the chain of contracting has adequate insurance coverage. This requires more than simply requesting a certificate of insurance. The subcontractor may want to consider having an attorney or its insurance broker review the policy to ensure coverage is adequate or get an affirmative acknowledgement from the carrier that coverage exists. Otherwise, a subcontractor could discover that the entity which caused the injury does not have adequate coverage only after an incident occurs, thereby exposing the subcontractor to a potential claim.

For additional information regarding the effect of Colorado’s Workers’ Compensation Act on the construction industry, feel free to reach out to Jordan Kaplan by e-mail at kaplan@hhmrlaw.com or by telephone at (303) 987-9811.

Denver’s Proposed Solution to the Affordable Housing Crisis

Over the past ten years, Colorado has seen a population growth of almost 15 percent, with many residing in Denver.  In fact, in 2020, Denver ranked among the top five cities for inbound growth in the United States.  At the same time, from 2010 through 2020, the state’s production of new housing decreased by 40 percent.  The decrease in supply, coupled with the increase in demand has exasperated the already rising cost of housing in the state.  This, along with other external factors such as job loss due to the COVID pandemic, has resulted in a statewide housing crisis.

The City of Denver is proposing a revision to the municipal code that would expand affordable housing through three main tools: (1) increasing “linkage fees,” (2) requiring new multi-family development to designate a percentage of units to be affordable, and (3) offering zoning and financial incentives.  The proposal addresses both rental housing and ownership opportunities.  Although it is essential to combat the housing crisis and increased homelessness in the region, it is equally important to understand the impacts the proposed affordable housing ordinance would have on developers, if and when enacted.  

Increased Linkage Fees

In addition to funds received through donations and tax-based contributions, affordable housing permanent funds are raised from the affordable housing linkage fee revenue fund.  These funds are set to be used for the production and preservation of rental housing as well as rental assistance.  The amendment proposes increasing the linkage fee paid before the issuance of a building permit for any new construction or improvements that increase the gross square footage of an existing structure.  The fee, which applies to residential, commercial, and industrial construction, is calculated per square foot, at a rate depending on structure type.  For example, the proposal increases the linkage fee for low-density residential from $0.66 to $1.77 per square foot, whereas the fee for buildings with industrial or agricultural uses increases from $0.40 to $0.96 per square foot.  Fees for mixed-use development are to be proportioned based on the square footage for each use.  The proposal estimates that the linkage fee will go into effect on July 1, 2022, and increase each year based on the rate of inflation.

Linkage fees do not apply to the construction of contractual commitments dated and properly recorded prior to July 1, 2022.  This exception only applies while original development continues; any redevelopment contracted after such time will be subject to the proposed rates.  Additionally excluded from the linkage fee requirement are construction projects including (1) those that provide required affordable housing on the property, (2) affordable housing projects built with federal, state, or local funding, (3) charitable projects aimed at providing housing assistance, (4) buildings used solely for government or education purposes, (5) projects due to involuntary demolition, (6) additions of 400 square feet or less to single-unit or two-unit dwellings, and (7) accessory dwelling units. Additionally, linkage fees may be waived upon an applicant showing that the required amount of fees exceeds the amount that would be needed to mitigate the actual demand for affordable housing created by the development.

Mandatory Affordable Housing

The proposed amendment affects multi-family residential development.  New residential developments consisting of 11 or more units at one location must develop a minimum percentage of income-restricted units (IRU) within the structure.  The minimum percentage of IRUs depends on location.  High market areas are neighborhoods in the top quarter of highest rent or sales prices and land values, and typical market areas are all other regions not recognized as high market.  To comply with mandatory affordable housing, a high market area development must designate a minimum of 10 – 15 percent of the units as income-restricted.  Development in a typical market area must designate a minimum of 8 – 12 percent of its units as income-restricted.  These development requirements apply to both rental units and for-sale properties.  If developers choose to forgo the minimum IRU requirements they will be subject to the alternative fee-in-lieu requirements.  Fee-in-lieu costs range between $250,000 and $478,000, depending on the location of the new development and the type of dwelling structure.  The fee is then multiplied by the required number of IRUs excluded from the development.  For example, if an apartment complex proposed for a typical market area only designates 10 units out of 200 to be income-restricted, the applicant would be required to pay a $2.5 million fee-in-lieu before receiving a building permit.  However, if an applicant can show its proposed development meets the city’s five-year housing plan and comprehensive plan goals, the developer may negotiate an alternative to the mandatory affordable housing requirements.

Incentives

The proposal allows for permit fee reductions, reduced minimum vehicle parking requirements, and linkage fee exemptions for street-level commercial structures to incentivize developers to comply with minimum IRU requirements.  The proposal provides added incentives for developers which choose to include a higher percentage of IRUs than required by the ordinance.  Such developments will be entitled to an increase in building height and floor area ratios than is regularly provided for in zoning laws, in addition to increased vehicle parking exemptions.  Developed IRUs must be maintained for a minimum of 99 years to qualify.

Downfall

One downfall of the City’s housing affordability proposal is that it fails to alleviate the pressures and added costs that construction defect litigation places on developers and contractors.  Developers have expressed a need for relief from these added costs to successfully and affordably complete affordable housing projects.  The Colorado General Assembly briefly touched on the constraints of construction defect laws in its 2022 affordable housing tasks force report.  The task force expressed concerns that exemptions from construction defect laws would displace the balance between consumer and developer rights.  However, as developers continue to raise concerns regarding the effects the state’s strict construction defect litigation has on the affordability of development, it increasingly becomes important for the City to address such matters.  Developers who wish to see such exemptions included in the proposed affordable housing ordinance may submit comments during the public review process.

Public Review

The proposed affordable housing ordinance is currently available for public review.  Interested parties may submit comments and concerns to the City of Denver from now through March 14, 2022.  Comments are accepted through the City’s open forms, which can be found here.  The City will review the comments and release an updated proposal by the end of March 2022, after which interested parties will be allowed to speak at a public hearing held in front of the Denver Planning Board and the Denver City Council.  The proposal will not go into effect until a final version is adopted by the Denver City Council.  Additional information on the proposed expansion of affordable housing requirements can be found here.

For additional information regarding Denver’s affordable housing initiative, or Construction law in Colorado, you can reach Taylor Ostrowski by telephone at (303) 653-0047 or by e-mail at Ostrowski@hhmrlaw.com.

Contractual warranty agreements may preclude future tort recovery

When a buyer purchases a product that is later discovered to be defective, the court offers a remedy to make the buyer whole.  Such remedies can arise either out of a contract, including express and/or implied warranties, or under common law through a tort theory.  However, what happens when a buyer has already received the remedy specified in the contractual warranty, only to discover the product manufacturer misrepresented the quality of its product by failing to disclose a defect?  Can the buyer subsequently recover for the same product under a tort theory of recovery?  The Colorado Court of Appeals analyzed such questions in its December 2021 decision in Dream Finders Homes, LLC v. Weyerhaeuser NR Co., 2021 COA 143.

In Dream Finders, the court examines the rights of sophisticated buyers who purchased defective products and received a warranty from the product manufacturer with purchase. The court specifically determines whether such buyers may recover under the tort theory product misrepresentation and failure to disclose when the buyers have already received the remedy specified and the warranty expressly excludes the type of damage the buyer now seeks.

The case involved two main parties, including Weyerhaeuser, a product manufacturer which designed and sold engineered joists with a fire-resistant coating to be used in residential construction, and Dream Finders, a home builder, which purchased and utilized Weyerhaeuser’s fire-resistant joists in homes it constructed and sold. Upon purchase of the joists, Dream Finders received two warranties, from Weyerhaeuser to wit: a general warranty delivered with all Weyerhaeuser products and a specific warranty relating to the joists providing that Weyerhaeuser would pay reasonable costs for repair or replacement of the covered joists for any delamination, separation, or inadequacy that might occur in the joists. The reasonable costs were to be capped at three times the cost of the joists themselves. The specific warranty also expressly stated that Weyerhaeuser would not be responsible for incidental, indirect, or consequential damages.

Three months after Dream Finders started purchasing and installing the joists into its homes, Weyerhaeuser received third-party reports indicating that the joists, which were coated with a formaldehyde-based resin, emitted a chemical-like odor that caused eye and throat irritation.  In compliance with the specific warranty, Weyerhaeuser offered remediation options to builders which installed the affected joists.  Dream Finders opted for a mechanical removal option. Weyerhaeuser complied with the request and paid for all remediation costs, which ended up being significantly greater than three times the product cost.  After the remediation was completed, Dream Finders sued Weyerhaeuser for breach of express and implied warranty, negligence, negligent failure to warn, negligence per se, strict product liability, violation of Colorado’s Consumer Protection Act (the “CCPA”), negligent misrepresentation, and fraudulent concealment.  In its claims, Dream Finders alleged that Weyerhaeuser knew that its products contained a urea-formaldehyde resin but failed to disclose the known hazardous levels of formaldehyde in the joists.  Dream Finders alleged that it incurred over $20 million in damages, including remediation costs and costs incurred because of delayed home sales.  

In evaluating the case, the Court first considered the economic loss rule, which bars recovery under tort claims for purely economic losses stemming from a breach of contract.  While Colorado law provides that construction professionals owe homeowners independent, common law, duties of care to homeowners, which do form the basis for tort-based negligence claims safe from the reaches of the economic loss rule, the Court refrained from extending this duty to a builder, which only owned the homes briefly before selling them to the ultimate purchasers. The Court held that the economic loss rule limited Dream Finders’ ability to recover damages arising from tort claims because it and Weyerhaeuser already completed the contractually mandated remedy for the defective joists.

The Court determined that the relief sought by Dream Finders was identical under both tort and contract theories.  To come to this conclusion the Court compared both the tort duties and contractual duties owed by Weyerhaeuser.  Generally, a tort duty can be distinguished from a contractually arising duty when the tort duty extends beyond the scope of duty provided for in the contract.  Dream Finders and Weyerhaeuser agreed that Weyerhaeuser complied with the terms and conditions of its warranty and that because of this compliance, Dream Finders received the benefit for the contract-based bargain.

Because Dream Finders had already received the agreed-upon contractual benefit and expressly chose to contract away any other rights to recover, the Court precluded Dream Finders from recovering anything further. Even though only one of Dream Finders’ entities entered into the warranty agreement with Weyerhaeuser, the Court held that the warranty still controlled under Colorado law.  C.R.S. § 4-2-318 provides that a manufacturer’s warranty “extends to any person who may reasonably be expected to use, consume, or be affected by the goods and who is injured by breach of warranty.”  The Court maintained that the warranty, therefore, impeded recovery under the economic loss rule because, even though one of the entities did not expressly enter into the warranty agreement, its coverage by the warranty was implied by statute.

The economic loss rule does not bar recovery for damages based on pre-contractual fraud where the fraud induced a plaintiff to enter the contract, as discussed in Van Rees v. Unleaded Software, Inc., 373 P.3d 603 (Colo. 2016).  However, in Dream Finders, the alleged claims arose from post-contractual conduct and did not fraudulently induce Dream Finders to enter the warranty agreement.  Because of this fact, Weyerhaeuser did not owe Dream Finders a separate duty apart from those specified in the warranty contract.  The Court concluded, therefore, that the economic loss rule disqualified Dream Finders from recovering anything under its tort-based claims.

There are limitations to the economic loss rule and the Court affirmed that it does not bar CCPA claims.  However, the Court ruled that Dream Finders failed to prove all elements of its CCPA claim.  Additionally, CCPA claims were created to protect individual consumers who are at a bargaining disadvantage compared to more sophisticated buyers, such as Dream Finders.  

Judge Jaclyn Brown issued a warning at the end of the Court’s decision, stating that the expansion of the economic loss rule has the frightening propensity to encourage a contracting party to act fraudulently during the contractual relationship and then attempt to escape liability by hiding behind the rule. Judge Brown further emphasized that the economic loss rule should not apply to cases where the damages arise from an intentional act as it would be bad policy for courts to shield intentional tortfeasors from liability.  Judge Brown’s fears have not yet come to fruition, but we anticipate future Colorado court decisions will further mold the trajectory of the economic loss rule.

Dream Finders now serves as a reminder of the importance of contracts and warranty clauses and why both product manufacturers and contractors should take a close look at what rights are provided or relinquished when entering into such agreements.

For additional information regarding the Dream Finders case or Colorado construction law, you can reach out to Taylor Ostrowski by telephone at (303) 653-0047 or by e-mail at ostrowski@hhmrlaw.com.

HHMR will work for diapers!

This year, HHMR is stepping up to help HomeAid Colorado’s Builders for Babies Diaper Drive.  As you can imagine, the requirement for support to families in need is now greater than ever. Due to the critical shortage of diapers available to those who require help, the annual Builders for Babies Diaper Drive will be running through June 21^st!

Normally, Builders for Babies is a one-day collection event. This year, HomeAid Colorado kicked off early to help address the dire need for diapers for struggling families.  All donations collected during this campaign will be distributed to our nonprofit partners that focus on alleviating poverty and ending homelessness.  Diapers purchased now will be allocated to diaper banks around Colorado in a timely manner.  HomeAid Colorado has partnered with ABBY & FINN, a Colorado owned company, to simplify the process and distribution of diapers.

This year, HHMR will provide up to three hours of general consulting, risk management consulting, or contract review to Colorado construction professionals which donate a ¼ pallet of diapers (2,625 diapers) through ABBY & FINN’s donation page.  At a cost of $682.50, this is a substantial discount off of our normal hourly rate.  Please reach out to David McLain at (303) 987-9813 or mclain@hhmrlaw.com if you are interested.  Before purchasing diapers, we want to ensure that we can clear a conflict check and determine that your needs fit within our core competencies.  We are excited to work with you to help alleviate Colorado’s terrible diaper shortage.  If you are not interested in this offer, we still urge you to click on ABBY & FINN’s donation page to support this incredible effort.  Please note that this offer may be limited at any time, depending on demand.  

HB 20-1046 - Private Retainage Reform - Postponed Indefinetely

On Tuesday, February 18th, the Colorado House Business Affairs & Labor Committee voted 10-0 to postpone indefinitely House Bill 1046.  If it had been enacted, HB 1046 would have required, for all for all construction contracts of at least $150,000:

• A property owner to make partial payments to the contractor of any amount due under the contract at the end of each calendar month or as soon as practicable after the end of the month;
• A property owner to pay the contractor at least 95% of the value of satisfactorily completed work;
• A property owner to pay the withheld percentage within 60 days after the contract is completed satisfactorily;
• A contractor to pay a subcontractor for work performed under a subcontract within 30 calendar days after receiving payment for the work, not including a withheld percentage not to exceed 5%;
• A subcontractor to pay any supplier, subcontractor, or laborer who provided goods, materials, labor, or equipment to the subcontractor within 30 calendar days after receiving payment under the subcontract; and
• A subcontractor to submit to the contractor a list of the suppliers, sub-subcontractors, and laborers who provided goods, materials, labor, or equipment to the subcontractor for the work.

The bill did not apply to contracts with public entities or to a contract concerning one multi-family dwelling of no more than 4 units or one single-family dwelling. A person who failed to make a required payment would have been required to pay 1.5% interest per month until the debt is fully paid. In a lawsuit to enforce the bill, the prevailing party iswould have been awarded attorney fees and costs. 

In response to the indefinite postponement of the Bill, the Colorado Contractors Coalition put out a announcement reading:

The Colorado Contractors Coalition | CCC announce that they will table efforts to pass HB20 1046, Private Retainage Reform stating that most of the 2020 objectives have been achieved and a path forward post the current Colorado legislative session is underway. 

 Tuesday, February 18, 2020, the House Business Affairs Committee heard a motion from Representative Valdez, primary sponsor, to postpone indefinitely the bill. Representative Kraft-Tharp, Chair thanked him for his work and that she spoke to all parties involved who have agreed to work together in the interim for a solution to this very real problem.
 

CCC and their lobby team Valdez Public Affairs are pleased with the response to HB20 1046 with much of the Colorado construction industry in support of the legislation. The work prior to the 2021 Colorado General Assembly will focus on the banking and construction development community. 

Scott Deering, ASAC Legislative Chair and CCC Vice Chair | Absolute Caulking & Waterproofing, Inc., commented “Though we hoped to celebrate the passage of HB20-1046 this year, we know that rarely is a bill passed the first year it is introduced. We accomplished a great deal this session including unprecedented industry support for this effort. Members of the CO legislature and stakeholders have committed to continue to work with us on this very important issue. Our goal remains to allow subcontractors to be able to invest their earned capital into their businesses.” 

CCC is fully engaged in partnership with Valdez Public Affairs as we advocate for the membership of the Coalition on several issues before the 2020 Colorado General Assembly. Rob Willis, CCC Chair | BT Construction stated, “We have a full agenda that will take us through adjournment May 6. We will be working on private retainage reform in the interim and focus on candidates and campaigns leading up to the 2020 General Election November 3.” 

CCC established in 2017 to influence state and local policy makers to support public policy that provides for the improvement and betterment of the subcontractor business community. Members are American Subcontractors Association Colorado, Associated Wall and Ceiling Industries, Colorado Roofing Association, National Utility Contractors Association Colorado and Rocky Mountain Steel Construction Association.

For additional information regarding the 2020 Colorado Legislative Session or construction law in Colorado, you can reach David McLain at (303) 987-9813 or by e-mail at mclain@hhmrlaw.com.

Admissibility of Expert Opinions in Insurance Bad Faith Trials

In 2010, Hansen Construction was sued for construction defects and was defended by three separate insurance carriers pursuant to various primary CGL insurance policies.[i]  One of Hansen’s primary carriers, Maxum Indemnity Company, issued two primary policies, one from 2006-2007 and one from 2007-2008.  Everest National Insurance Company issued a single excess liability policy for the 2007-2008 policy year, and which was to drop down and provide additional coverage should the 2007-2008 Maxum policy become exhausted.  In November 2010, Maxum denied coverage under its 2007-2008 primarily policy but agreed to defend under the 2006-2007 primarily policy.  When Maxum denied coverage under its 2007-2008 primary policy, Everest National Insurance denied under its excess liability policy. 

In 2016, pursuant to a settlement agreement between Hansen Construction and Maxum, Maxum retroactively reallocated funds it owed to Hansen Construction from the 2006-2007 Maxum primary policy to the 2007-2008 Maxum primary policy, which became exhausted by the payment.  Thereafter, Hansen Construction demanded coverage from Everest National, which continued to deny the claim.  Hansen Construction then sued Everest National for, among other things, bad faith breach of contract.

In the bad faith action, both parties retained experts to testify at trial regarding insurance industry standards of care and whether Everest National’s conduct in handling Hansen Construction’s claim was reasonable.  Both parties sought to strike the other’s expert testimony as improper and inadmissible under Federal Rule of Evidence 702.

In striking both sides’ expert opinions, the U.S. District Court Judge Christine Arguello set forth the standards for the admissibility of expert opinions in Federal Court:

Under Daubert, the trial court acts as a “gatekeeper” by reviewing a proffered expert opinion for relevance pursuant to Federal Rule of Evidence 401, and reliability pursuant to Federal Rule of Evidence 702.[ii]  The proponent of the expert must demonstrate by a preponderance of the evidence that the expert’s testimony and opinion are admissible.[iii]  This Court has discretion to evaluate whether an expert is helpful, qualified, and reliable under Rule 702.[iv]

Federal Rule of Evidence 702 governs the admissibility of expert testimony. Rule 702 provides that a witness who is qualified as an expert by “knowledge, skill, experience, training, or education” may testify if:

(a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue;

(b) the testimony is based on sufficient facts or data;

(c) the testimony is the product of reliable principles and methods; and

(d) the expert has reliably applied the principles and methods to the facts of the case.

Fed. R. Evid. 702.

In deciding whether expert testimony is admissible, the Court must make multiple determinations. First, it must first determine whether the expert is qualified “by knowledge, skill, experience, training, or education” to render an opinion.[v]  Second, if the expert is sufficiently qualified, the Court must determine whether the proposed testimony is sufficiently “relevant to the task at hand,” such that it “logically advances a material aspect of the case.”[vi]  “Doubts about whether an expert’s testimony will be useful should generally be resolved in favor of admissibility unless there are strong factors such as time or surprise favoring exclusions.”[vii] 

Third, the Court examines whether the expert’s opinion “has ‘a reliable basis in the knowledge and experience of his [or her] discipline.’”[viii]  In determining reliability, a district court must decide “whether the reasoning or methodology underlying the testimony is scientifically valid.”[ix]  In making this determination, a court may consider: “(1) whether a theory has been or can be tested or falsified, (2) whether the theory or technique has been subject to peer review and publication, (3) whether there are known or potential rates of error with regard to specific techniques, and (4) whether the theory or approach has general acceptance.”[x] 

The Supreme Court has made clear that this list is neither definitive nor exhaustive.[xi]  In short, “[p]roposed testimony must be supported by appropriate validation—i.e., ‘good grounds,’ based on what is known.”[xii] 

The requirement that testimony must be reliable does not mean that the party offering such testimony must prove “that the expert is indisputably correct.”[xiii]  Rather, the party need only prove that “the method employed by the expert in reaching the conclusion is scientifically sound and that the opinion is based on facts which sufficiently satisfy Rule 702’s reliability requirements.”[xiv]  Guided by these principles, this Court has “broad discretion” to evaluate whether an expert is helpful, qualified, and reliable under the “flexible” standard of Fed. R. Evid. 702.[xv] 

With respect to helpfulness of expert opinions, Judge Arguello explained:

Federal Rule of Evidence 704 allows an expert witness to testify about an ultimate question of fact.[xvi]  To be admissible, however, an expert’s testimony must be helpful to the trier of fact.[xvii]  To ensure testimony is helpful, “[a]n expert may not state legal conclusions drawn by applying the law to the facts, but an expert may refer to the law in expressing his or her opinion.”[xviii] 

“The line between a permissible opinion on an ultimate issue and an impermissible legal conclusion is not always easy to discern.”[xix]  Permissible testimony provides the jury with the “tools to evaluate an expert’s ultimate conclusion and focuses on questions of fact that are amenable to the scientific, technical, or other specialized knowledge within the expert’s field.”[xx]

However, “an expert may not simply tell the jury what result it should reach....”[xxi]  Further, “expert testimony is not admissible to inform the trier of fact as to the law that it will be instructed to apply to the facts in deciding the case.”[xxii]  Similarly, contract interpretation is not a proper subject for expert testimony.[xxiii] 

Finding that all three of the experts intended to offer opinions that were objectionable on the basis of helpfulness, Judge Arguello granted both parties’ motions to exclude the expert testimony of the opposing experts. 

For additional information about the Hansen Construction v. Everest National Insurance Company matter, or construction litigation in Colorado, you can reach Dave McLain at (303) 987-9813 or by e-mail at mclain@hhmrlaw.com.

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[i] Hansen Construction, Inc. v. Everest National Insurance Company, 2019 WL 2602510 (D. Colo. June 25, 2019).

[ii] See Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 589–95 (1993); see also Goebel v. Denver & Rio Grande W. R.R. Co., 215 F.3d 1083, 1087 (10^th Cir. 2000).

[iii] United States v. Nacchio, 555 F.3d 1234, 1241 (10^th Cir. 2009); United States v. Crabbe, F. Supp. 2d 1217, 1220–21 (D. Colo. 2008); Fed. R. Evid. 702 advisory comm. notes.

[iv] See Goebel, 214 F.3d at 1087; United States v. Velarde, 214 F.3d 1204, 1208–09 (10^th Cir. 2000).

[v] Nacchio, 555 F.3d at 1241.

[vi] Norris v. Baxter Healthcare Corp., 397 F.3d 878, 884, 884 n.2 (10^th Cir. 2005).

[vii] Robinson v. Mo. Pac. R.R. Co., 16 F.3d 1083, 1090 (10^th Cir. 1994) (quotation omitted).

[viii] Norris, 397 F.3d at 884, 884 n.2 (quoting Daubert, 509 U.S. at 592).

[ix] Id. (quoting Daubert, 509 U.S. at 592–93).

[x] Norris, 397 F.3d at 884 (citing Daubert, 509 U.S. at 593–94).

[xi] Kumho Tire Co. v. Carmichael, 526 U.S. 137, 150 (1999).

[xii] Daubert, 509 U.S. at 590.

[xiii] Bitler v. A.O. Smith Corp., 400 F.3d 1227, 1233 (10th Cir. 2004) (quoting Mitchell v. Gencorp Inc., 165 F.3d 778, 781 (10th Cir. 1999)).

[xiv] Id.

[xv] Velarde, 214 F.3d at 1208–09; Daubert, 509 U.S. at 594.

[xvi] United States v. Richter, 796 F.3d 1173, 1195 (10^th Cir. 2015).

[xvii] Fed. R. Evid. 702.

[xviii] Richter, 796 F.3d at 1195 (quoting United States v. Bedford, 536 F.3d 1148, 1158 (10^th Cir. 2008)); see, e.g., Killion v. KeHE Distribs., LLC, 761 F.3d 574, 592 (6^th Cir. 2014) (report by proffered “liability expert,” which read “as a legal brief” exceeded scope of an expert’s permission to “opine on and embrace factual issues, not legal ones.”).

[xix] Richter, 796 F.3d at 1195 (quoting United States v. McIver, 470 F.3d 550, 562 (4^th Cir. 2006)).

[xx] Id. (citing United States v. Dazey, 403 F.3d 1147, 1171–72 (10^th Cir. 2005) (“Even if [an expert’s] testimony arguably embraced the ultimate issue, such testimony is permissible as long as the expert’s testimony assists, rather than supplants, the jury’s judgment.”)).

[xxi] Id. at 1195–96 (quoting Dazey, 403 F.3d at 1171).

[xxii] 4 Jack B. Weinstein et al., Weinstein’s Federal Evidence § 702.03[3] (supp. 2019) (citing, e.g., Hygh v. Jacobs, 961 F.2d 359, 361–62 (2d Cir. 1992) (expert witnesses may not compete with the court in instructing the jury)).

[xxiii] Id. (citing, e.g., Breezy Point Coop. v. Cigna Prop. & Cas. Co., 868 F. Supp. 33, 35–36 (E.D.N.Y. 1994) (expert witness’s proposed testimony that failure to give timely notice of loss violated terms of insurance policy was inadmissible because it would improperly interpret terms of a contract)).