Appeal from the United States District Court for the Southern District of Indiana, Indianapolis Division. No. 1:05-cv-0617-RLY-TAB-Richard L. Young, Judge.
The opinion of the court was delivered by: Easterbrook, Chief Judge.
Before EASTERBROOK, Chief Judge, and WOOD and WILLIAMS, Circuit Judges.
Sheehan Construction Co. was the general contractor for the Crystal Lake residential subdivision in Indianapolis. A few years after moving in, the owners began to notice moisture in places that should have been dry. An investigation traced the problem to defective work by one of Sheehan's subcontractors. Litigation in state court ended with a settlement of about $2.8 million. Sheehan wants its insurer, Westfield Insurance Co., to indemnify that expense. (The settlement assigned to the homeowners Sheehan's rights in the policy, but for simplicity we refer to Sheehan.) Westfield declined and filed this declaratory-judgment action. Indiana supplies the rules of decision.
Westfield's policy covers commercial general liability-that is, bodily injury and property damage attributable to accidents. The policy would indemnify Sheehan for loss caused by construction machinery that damaged adjacent property or for an injury to a passer by caused by a misplaced nail. But indemnifying a general contractor for negligent work performed by a subcontractor is something else again. The moral hazard would be considerable: the prospect of indemnity would lead the general contractor to save money by hiring substandard subcontractors, then turning to the insurer to fix the customers' homes. The district court held that several definitions and exclusions in Westfield's policy show that its coverage is limited to accidents of the sort we have mentioned, and it granted judgment in Westfield's favor. 580 F. Supp. 2d 701 (S.D. Ind. 2008). To simplify the exposition we assume for the sake of argument that the sort of loss the homeowners encountered was "property damage" caused by an "occurrence" and shall examine the effect of the policy's "your work" exclusion.
The policy does not cover property damage to a contractor's own work. An exclusion says that " '[p]roperty damage' to 'your work' arising out of it or any part of it and included in the 'products--completed operations hazard' " is outside the policy's scope. It adds that this exclusion applies to "[t]he cost of repairing or replacing:"
(1) "Your work" defectively or incorrectly done by you; or
(2) "Your product" manufactured, sold or supplied by you; unless the "property damage" is caused directly by you after delivery of "your product" or completion of "your work" and resulting from a subsequent undertaking.
The "work" or "product" o f a general contractor is the whole project, so this language directly addresses the homeowners' loss. (The water did not damage separate property in the homes, such as TV sets or furniture.) But Sheehan replies that the problem stemmed not from its work but from the work of a subcontractor, and it observes that the insurance industry's standard-form commercial general liability policy was revised in 1986 to remove subcontractors' work from the definition of "your work" in this clause.
The standard form changed in 1986 by adding the phrase "[t]his exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor." But Sheehan did not purchase a policy on that form. It bought one that lacks the "does not apply to subcon-tractors' work" language. An endorsement to Westfield's policy has a definitional clause, under which "your work" includes:
(1) Work or operations performed by you or on your behalf; and
(2) Materials, parts or equipment furnished in connection with such work or operations.
Emphasis added. The italicized phrase means that sub-contractors' work is included in the scope of "your work". This leaves only the question whether water damage is within the scope of the policy's "products--completed operations hazard". That's another defined term comprising "all 'bodily injury' and 'property damage' occurring away from premises you own or rent and arising out of 'your product' or 'your work' except" for "[p]roducts that are still in your physical possession" and a list of other exclusions from this exemption. This "products--completed operations hazard" definition is designed to ensure that the policy covers accidents that occur while construction is under way, but not property damage caused by poor workmanship in a completed building. But that's exactly the sort of claim that was made and settled in the underlying litigation.
Sheehan scarcely tries to argue that the policy's actual language covers the loss that the ...