For insurers attempting to restrict coverage under a LEG3 clause, a recent federal district court decision just made that more difficult. In a favorable ruling for policyholders, the court in South Capitol Bridgebuilders v. Lexington Ins. Co., No. 21-cv-1436 (RCL) (D.D.C. Sept. 29, 2023), recently found that under Illinois law, the LEG3 clause was “egregiously” ambiguous and construed it against the insurer in favor of coverage.

A LEG3 clause is a policy provision that purports to exclude coverage for loss or damage due to defects, but limiting that coverage restriction to the costs associated with improving the original material, workmanship, design, plan, or specification. While LEG3 clauses are designed to preserve coverage for property damaged by defects, they are sometimes invoked by insurers to deny coverage.

South Capitol Bridgebuilders involved a builders risk claim for damage to a bridge where “poor vibration of concrete resulted in construction malformations known as ‘honeycombing’ and ‘voiding,’ which harmed the structural integrity of the bridge.” After the contractor submitted a claim under its builders risk policy, the insurer (Lexington) denied coverage, so the contractor filed suit.

The LEG3 clause on which the insurer relied provided:

This policy shall not pay for loss, damage or expense caused directly or indirectly by any of the following.

* * * * *

All costs rendered necessary by defects of material workmanship, design, plan, or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification.

For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, design, plan, or specification.

In a searing rebuke of the LEG3 clause, the South Capitol Bridgebuilders court stated:

The LEG 3 Extension is ambiguous—egregiously so. To understand this, one need only attempt to read it. In just three sentences, Lexington managed to squeeze in a run-on sentence, an undefined term, several mispunctuations, and a scrivener's error. The Extension is internally inconsistent and bordering incomprehensible. [The Insured’s] statement that the Extension is “convoluted” is an understatement.

The court further explained that the LEG3 clause’s exclusion of costs incurred to “improve” the original work was also ambiguous in itself. It was not clear from the language of the exclusion whether excluded “improvements” meant true upgrades to the original work, or mere replacements of the defective components. As the court rhetorically questioned, “[a]fter all, if something broken gets fixed, hasn't that thing been improved?”

Under the insurer’s interpretation, simply patching or restoring the defects was an improvement, and thus excluded by the LEG3 clause. The insured, however, argued for a different interpretation—that the LEG3 clause should only exclude those costs associated with true upgrades, such as replacing defective concrete with “solid gold.”

These competing interpretations formed the basis of the court’s finding that the clause was ambiguous. Setting aside the imprecise language of the clause, the court found there was more than one reasonable interpretation of its impact on coverage. Thus, the clause was deemed ambiguous and interpreted against the drafter-insurer.

South Capitol Bridgebuilders is the first U.S. court opinion to clearly reject the enforceability of a LEG3 clause as an exclusion. And although this decision interpreted the clause under Illinois law, its reasoning is applicable in California and beyond.