What Your Liability Policy Defends and What It Does Not

Why this matters

A shop gets sued and the owner's first thought is whether the policy will pay the claim. That is the second question. The first is whether it will pay the lawyer, and the answer is yes far more often than owners expect, including on claims the policy would never pay a dollar of damages on.

The gap between those two duties is the most valuable and least understood thing a general liability policy does. Miss it and you hire your own defence for a suit the carrier was obliged to defend, which on a mid-sized claim costs more than the claim. The other half of this card is the exclusion that decides most trade claims, drawn along the boundary between your own work and everything your work touched. Coverage is state law and policy language varies, so this is how the machinery works, not an opinion about your policy; a coverage lawyer is a different specialist from the one the carrier appoints.

Two duties, and the broad one is the one that saves you

The duty to indemnify is the promise to pay a judgment or settlement. It turns on what actually happened, so it cannot be determined until the end.

The duty to defend is the promise to provide and pay for a lawyer. It turns on what is ALLEGED, which is knowable on day one, and it is broader on purpose. In most states, where any claim in the suit is potentially covered, the carrier must defend the entire action, including counts that are plainly not covered. How that determination gets made differs. Texas applies the eight-corners rule, comparing the complaint against the policy and nothing else, narrowed in 2022 by Monroe Guaranty v. BITCO General to allow extrinsic evidence that goes solely to coverage, does not overlap the merits of liability and conclusively establishes the coverage fact. California is broader, letting extrinsic facts in on whether a defence is owed.

Two consequences follow, both in your favour. A meritless suit is still a covered suit: the customer who alleges the water damage came from your work gets you a defence even if you are certain it came from the upstairs neighbour, because the trigger is the allegation, and that is exactly the case where an owner sure of their innocence decides not to bother the carrier.

And a complaint mixing covered and uncovered theories still gets defended as a whole. A plaintiff's lawyer who pleads negligence, breach of contract and misrepresentation in one document has not defeated your defence, even though contract and intentional-conduct counts are usually outside indemnity.

First, was there an accident at all

Before any exclusion is reached the policy has to be triggered, and that turns on whether there was an "occurrence", which the form defines as an accident. Whether defective workmanship is an accident is not settled law. A substantial group of states holds it is not, which defeats coverage for the resulting damage and not merely the rework: Pennsylvania in Kvaerner Metals v. Commercial Union (2006) and Kentucky in Cincinnati Insurance v. Motorists Mutual (2010), with Arkansas reaching the same result at common law. A handful legislated the opposite for construction policies: Colorado at Revised Statutes section 10-4-110.4, with Arkansas, Hawaii and South Carolina. Find out which line your state is on before reasoning from any exclusion: where faulty work is not an occurrence the exclusions never get argued.

The your-work exclusion decides most trade claims

The standard commercial general liability occurrence form carries exclusions captioned Damage to Property, Damage to Your Product and Damage to Your Work, and their letters have moved across editions, so cite the caption rather than a letter to your broker.

The rule they produce is worth memorising because it answers most questions before you ask: the cost of redoing your own defective work is not covered; damage your defective work caused to other property generally is. Insurance is not a warranty on your workmanship and was never meant to be. Fixing your own bad joint is a business cost. The ruined floor under it is a liability claim.

One exception matters enormously to shops that use subcontractors. The Damage to Your Work exclusion, within the products-completed operations hazard, carries an exception where the damaged work, or the work out of which the damage arises, was performed on your behalf by a subcontractor. Defective work by your own employee is your problem; the same defect performed by a sub you hired may be covered. Ask whether that exception is intact in your policy, because some carriers endorse it away with one line on a form nobody reads.

The other four that bite a trade shop

Contractual liability. Liability you assumed by contract is excluded, with a carve-back for what the policy defines as an insured contract. This is why the indemnity clause a general contractor hands you matters to your insurance as well as your lawyer: an indemnity broader than the insured-contract definition is an obligation you owe with no policy behind it.

Employment-related practices. Discrimination, harassment and wrongful termination are excluded from general liability in the standard market, usually by endorsement. They need employment practices liability coverage, which most small shops do not carry and assume they have, discovered on the day a charge arrives. Nor does it answer wage and hour: most employment practices forms exclude Fair Labor Standards Act and state wage claims, or cover defence only to a sublimit, so misclassification, off-the-clock work, missed breaks and final pay are uninsured in the standard market.

Professional liability. Where your work includes design, engineering, load calculations or system specification, the advice component is usually excluded and needs its own errors and omissions policy. Design-build shops and anyone who sizes equipment for a customer should raise it with their agent.

Care, custody and control. Damage to property in your care, custody or control is typically excluded, which reaches further than owners think where the shop is holding, moving or storing the customer's equipment.

One loss, walked through the policy

A plumbing shop replaces a water heater in a finished basement. Six weeks later the supply connection fails overnight. The customer sues. Break the claim into what it is made of, as shares of the total, because the policy answers each piece separately.

Redoing the shop's own work, 15 percent of the claim. The connection, the fittings and the labour to put the installation right. Damage to Your Work: not covered, and no policy was going to pay it.

Building damage, 55 percent. Flooring, drywall, cabinetry and the finished ceiling below. Physical injury to tangible property other than the shop's work, caused by an occurrence: this is what the policy is for.

The customer's stored goods, 20 percent. Boxed household items ruined on the basement floor. Third-party property, covered on the same basis; a different answer if the shop had been storing those goods, which is where the care, custody and control exclusion lives.

A refund of the contract price, 10 percent. Not property damage at all: an economic loss sounding in contract, and the policy does not insure the customer's disappointment with the deal.

So roughly three quarters of the claimed amount is potentially covered, a quarter is not, and the shop pays the quarter. That arithmetic assumes a state where the failed connection counts as an occurrence; where it does not, the building damage goes uncovered with the rework. But the defence covers the whole suit, including the refund count and the misrepresentation count the customer's lawyer added, because at least one claim is potentially covered. That is the part worth internalising: the shop is not funding that defence up front. Whether the carrier claws any of it back later is a state question. Under Buss v. Superior Court (Cal. 1997) it can, seeking costs allocable solely to claims never even potentially covered; other states reject reimbursement outright. It is one of the things a reservation of rights letter sets up.

One fact changes the first bucket. If the failed connection was made by a subcontracted plumber rather than the shop's employee, the subcontractor exception can pull that 15 percent back into coverage under the products-completed operations hazard, a swing turning on who held the wrench.

Notice, the reservation of rights, and who picks the lawyer

Notice is a condition, not a courtesy. Report the claim or suit in writing, with the papers attached, as soon as you have it. Whether late notice forfeits an otherwise covered claim varies by state, many requiring the insurer to show prejudice and others not, and none of that is a reason to test it. Notify every carrier that could owe a defence, not just the one you think applies. On an occurrence policy that is the carrier on risk when the damage happened, not when the suit arrived or the work was done. On the water heater above, six weeks after installation, that can be a prior policy period or a prior carrier.

A reservation of rights letter is not a denial. It says the carrier will defend while reserving the right to deny indemnity later, and it lists the provisions it is reserving on. Read that list: it is the carrier telling you which parts of the claim it expects not to pay, strategic information nobody else gives you for free.

The reservation creates a conflict, and some states give you a remedy. The lawyer is appointed and paid by the carrier while it argues some outcomes are not covered, and the way facts get developed can steer the case toward the uncovered theory. California answers it with independent counsel at the insurer's expense under Civil Code section 2860, Cumis counsel after the case that produced it. Two limits in the same statute disappoint owners who act on the headline: (c) caps what the insurer owes independent counsel at the rate it actually pays its own panel firms in that community, not what your lawyer charges, and (b) says no conflict arises merely because you are sued for more than the policy limits, or as to allegations it denies coverage for outright. Other states handle it differently or not at all; ask your own lawyer when a reservation letter arrives with a long list.

Two more practical points. The carrier normally controls settlement, subject to policy terms, so the decision to settle may not be yours. And appointed defence counsel represents you, not the carrier, so you can and should talk to them about strategy though someone else pays the bill.

The ten-minute read of your own policy, done before anything happens

Pull the declarations page and find five things. The per-occurrence limit and the aggregate, because the aggregate is what a bad year consumes. The deductible or self-insured retention, what you pay before anything responds. Whether products-completed operations is included, since most trade claims arrive after the job is finished and that is the part that responds. Whether the policy is occurrence-based or claims-made, which decides whether next year's claim about this year's work falls to this year's policy. And the endorsement list, where a residential construction exclusion, a subcontractor-warranty condition or the removal of the subcontractor exception sits.

Take that list to your agent once a year with one question: what does this policy not do that a shop like mine gets sued for. Policy selection belongs to the insurance cards.

References

• Standard ISO commercial general liability occurrence form: the duty to defend, the Damage to Your Work exclusion and its subcontractor exception within the products-completed operations hazard, contractual liability with the insured-contract carve-back
• California Civil Code section 2860 and Buss v. Superior Court (Cal. 1997), independent counsel and defence-cost reimbursement; the Texas eight-corners rule as narrowed by Monroe Guaranty v. BITCO General (Tex. 2022); the state split on whether faulty workmanship is an occurrence, at common law and by statute
• See related: Business Insurance Basics, Liability Insurance Deep, General Liability vs Professional Liability, What Additional Insured Actually Means for You, A Customer Files a Claim Against Your Business
• See related: You Have Been Served: The First Two Weeks, Preserving Evidence the Moment a Dispute Starts