In Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 308 Conn. 760 (2013), a case decided by the Connecticut Supreme Court this past summer, the Court addressed issues of first impression concerning the interpretation of commercial general liability (“CGL”) insurance policies, and the duty to defend in the context of such policies. In particular, the Court considered the following three questions of law that were certified to it from the United States District Court for the Northern District of Alabama, Southern Division:

1. Does damage to a project, which was caused by defective construction or faulty workmanship associated with the construction project, constitute “property damage” resulting from an “occurrence” triggering coverage under a CGL policy?

2. Can an insurer’s alleged bad faith conduct in investigating an insurance claim provide the basis for a bad faith action under Connecticut law?

3. Does Alderman v. Hanover Ins. Group, 169 Conn. 603 (1975), apply to pre-suit settlement cases where the insurer wrongfully denies coverage, but where only some of the underlying claims would have been covered under the CGL policy?

The lawsuit giving rise to the Capstone decision was a declaratory judgment action that was initiated by Capstone Building Corporation and Capstone Development Corporation (“Capstone” or “the plaintiffs”) against American Motorists Insurance Company (“AMICO”). The action presented questions pertaining to the interpretation of CGL policies under Connecticut law for which there was no controlling precedent. The underlying conflict arose from the construction of a student housing complex at the University of Connecticut (“UConn”) where the plaintiffs served as general contractor and project developer. UConn purchased a CGL policy for the housing project which insured the plaintiffs and their work. AMICO was the issuing insurer’s successor in interest.
The housing project was completed and certified by the project’s architect. However, a few years later UConn discovered defects with the project. Most notably, UConn discovered there were elevated levels of carbon monoxide throughout the housing project. As a result, UConn sent Capstone a letter advising it that an investigation had revealed the source of the defect was insufficient exhausting and ventilating systems for individual hot water heaters in the residential units. Capstone forwarded the letter to AMICO demanding a defense in connection with UConn’s claims. AMICO, however, declined the tender based upon its position that coverage was barred because Capstone’s liability, if any, arose out of Capstone’s “own work.”
The CGL policy procured by UConn provided that “any entity you [i.e., the Named Insured] are required in a written contract … to name as an insured (the Additional Insured) is an Insured but only with respect to liability arising out of ‘your work’ for the Additional Insured, or acts or omissions of the Additional Insured in connection with the general supervision of ‘your work.’” The CGL policy’s definition of “your work” included “work or operations performed by you or on your behalf….” The CGL policy’s general insuring provisions covered damages resulting from bodily injury or property damage if the bodily injury or property damage is caused by “an occurrence” that takes place in the “coverage territory” and occurs during the “coverage period.”
The Supreme Court addressed each of the three certified questions, in turn, as follows:

First, the Court concluded that defective construction or faulty workmanship which causes damage to nondefective property may constitute an occurrence under the CGL policy. The Court further held, however, that if the property damage is the result of an insured’s defective work, it is excluded from coverage, but the escape of carbon monoxide in and of itself does not qualify as property damage. Finally, the Court determined that property damage caused by a subcontractor’s defective work may be covered under the exception to the “your work” exclusion.
Whether faulty workmanship can be the basis for a claim under a CGL policy was an issue of first impression for the Court. The Court reasoned that, because negligent work is unintentional from the point of view of the insured, it may constitute an “accident” or “occurrence” under the plain terms of the CGL policy.
Second, the Court addressed the question regarding bad faith conduct in the investigation of claims. Justice Rogers’ opinion qualified the question, noting that the Court understood it solely to refer to a cause of action sounding in bad faith based on the claims investigation conducted by an insurer as opposed to an insurer’s breach of its duties to defend and to indemnify under a CGL policy. The Court explained that, pursuant to Renaissance Management Co. v. Connecticut Housing Finance Authority, 281 Conn. 227, 240 (2007), a bad faith action must allege the denial of the receipt of an express benefit under the policy. Accordingly, based on the facts presented in Capstone, the Court did not recognize a cause of action based solely upon an insurer’s alleged failure to investigate a claim because the CGL policy at issue provided that the decision of whether and how to investigate a claim lie exclusively with the insurer. This holding appears to place a higher burden upon policyholders bringing bad faith actions based on an insurer’s alleged failure to investigate and provides insurers with wide latitude in terms of claims investigations.
Finally, with regard to the issue whether Alderman v. Hanover, 169 Conn. 603 (1975) applies to pre-suit settlement cases where the insurer wrongfully denies coverage, but where only some of the underlying claims would have been covered under the CGL policy, the Court held that, although an insurer that has breached its duty to defend is generally liable for the amount of the settlement plus costs, the policyholder has the burden of proving that the settlement is reasonable and proportionate to the insurer’s liability under the CGL policy. In so holding, the Court noted that in Capstone, there were many claims brought by UConn pre-suit that eventually were settled in one global settlement. Arguably, many of those claims would not have triggered AMICO’s duty to defend, while other claims did trigger the duty to defend. Alderman and Missionaries of the Co. of Mary, Inc. v. Aetna Casualty & Surety Co., 155 Conn. 104, 113 (1967), on the other hand, involved only a single claim, in each suit, that was asserted against the insured by the claimant. In each case, that single claim triggered the insurers’ duty to defend. As such, the insurer that wrongfully denied its policyholder a defense would be on the hook for the entire pre-suit settlement. To the contrary, in Capstone, the Court determined that because the settlement included claims that would not have triggered the insurer’s broad duty to defend, the policyholder was saddled with the burden of proving that the settlement was reasonable and in proportion with the insurer’s liability under the CGL policy.

The Court noted that an insurer cannot avoid paying a settlement based on the grounds that the policyholder was not liable, but expressly stated that an insurer may argue that, in light of its policyholder’s defenses to liability, the amount of the settlement was unreasonably high. The “reasonableness standard,” according to the Court, should apply to the allocation of settlement costs between claims because, in the Court’s view, “holding an insurer liable for the settlement of claims which it had no duty to defend is per se unreasonable.” Capstone, 308 Conn. at 816. Thus, in a hearing contesting the reasonableness of a settlement involving multiple claims, the issue to be decided will be the reasonable allocation of that settlement in proportion to the claims for which the insurer had an independent duty to defend.
The Capstone opinion obviously is important for several reasons. The decision is instructive in the context of construction defect cases and the application of the “your work” exclusion and the subcontractor exception to the exclusion. Further, the holding eviscerates, in large part, bad faith claims based on a failure to investigate where the policy expressly vests the insurer with discretion concerning the decision whether to investigate a claim. Perhaps most importantly, however, the Capstone decision represents a departure from the well-established rule in Connecticut that where an insurer breaches the duty to defend, it is liable for payment of any reasonable settlement, and the costs of effectuating that settlement, up to the policy limits. The Court in Capstone recognized that strict adherence to the rule in Missionaries, where multiple claims are involved, some of which are covered and some of which are not covered, can create coverage by estoppel. The allocation approach adopted by the Court avoids the creation of coverage by estoppel while at the same time, “it preserves the penalties. . . for abandoning the insured before an action has been filed.” Capstone, 308 Conn. at 814. The question left unanswered by Capstone, however, is whether or not its holding concerning the reasonableness/allocation approach is limited to pre-suit settlements, or whether the reasonableness/allocation approach likewise will apply where an insurer wrongfully fails to defend subsequent to the filing of suit. If the Court intended the reasonableness/allocation approach to apply where an insurer wrongfully fails to defend subsequent to the filing of suit – and the Court’s decision in this regard is unclear given its citation to both pre-suit and post-suit settlement cases – then in those instances where a multi-count complaint contains several uncovered claims, an insurer could refuse to defend provided its exposure for the potentially covered claims was not significant.