Legislation in Hawaii Invades the Separation of Powers, Changes the Meaning of Words in Private Contracts and Hurts Consumers

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BY ALLEN R. WOLFF – “No State shall pass any ex post facto Law, or Law impairing the Obligation of Contracts.”  United States Constitution, Article I, section 10.

This principal was so important to the founding fathers that they put it in the Constitution.  But our constitutional protection from ex post facto laws and governmental interference in private contracts is currently under attack by the construction industry and their lobbyists in the Hawaii State Legislature.

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In 2000-01, the Kalia Tower was built at the Hilton Hawaiian Village in Waikiki.  The twenty-five story hotel was shuttered in 2002 when mold was found throughout the building.  It was gutted and reconstructed and reopened about one year later.  Hilton sued and settled with the contractors and others for its losses.  In that process, an insurance dispute arose between one of the contractors and an insurer.  The insurer declined to cover the loss paid by the contractor to Hilton.  I was the attorney who represented that insurer.

The contractor sued the insurer and after nearly three years of litigation, the trial judge ruled in favor of the insurer.  The contractor appealed.  Three judges of the appeals court then considered the case for more than a year.  One of those judges was a former insurance commissioner for the State of Hawaii who had also led the State of Hawaii’s Department of Commerce and Consumer Affairs.

In 2010, the appeals court issued a unanimous decision holding that the standard form insurance contract between the insurer and the contractor did not require the insurance company to pay for expenses resulting from the contractor’s shoddy workmanship. https://www.courts.state.hi.us/docs/opin_ord/ica/2010/may/ica29402.pdf.   That decision was not further appealed.  As a result, after more than four years of court action and consideration by four different judges (one in the trial court and three in the appeals court), all of whom reached the same conclusion, that decision stands today as the law of the land in Hawaii.

The judge who authored the opinion summarized the Court’s unanimous ruling as follows: “we hold that under Hawai’i law, construction defect claims do not constitute an “occurrence” under a CGL policy.  Accordingly, breach of contract claims based on allegations of shoddy performance are not covered.”  The translation from “insurance speak” is that sloppy work by the contractor is not an accident that should be paid for by the insurance company.

One year later, a larger issue has emerged.  The issue now is not about the Kalia Tower, or the facts of the case, or the unanimous decisions of all of the judges who considered the case.  It is about one branch of government seeking to interfere with private contracts in an ex post facto way that simultaneously encroaches upon the authority of another branch of government to interpret those private contracts.  This challenges two fundamental principals protected by the Constitution: the separation of powers and the private right of contract.

Legislation has been introduced (HB 839 and HB 924) in the Hawaii State Legislature, aggressively supported by contractors and their lobbyists, that would statutorily change the definition of an “occurrence” in an insurance contract.  The proposed legislation would require that the definitions contained in the insurance contract, a private contract between two parties, be ignored if they exclude coverage for a contractor’s poor workmanship.  Such definitions have been included in insurance contracts for many years because insurance policies are not, and never have been, intended to pay liability because a contractor cut corners or performed shoddy work.  Insurance policies are intended to cover accidents– true and bona fide unforeseeable events that cause injury or harm to others.

There is a simple reason why insurance policies cover unforeseeable events and not contractors who get sued because they took shortcuts.  Insurance companies are in the business of taking on someone else’s risk; they are not in the business of guaranteeing the quality of a contractor’s work.  Insurance companies do not have the ability to assess the risk that a contractor will put poorly trained people on the job or will inadequately supervise them.  Accordingly, the risk that workers will cut corners or perform shoddy work is a risk that remains with the party best able to manage and control that risk, the contractor.

The insurance company, meanwhile, takes on the risk of truly unforeseen accidents occurring.  The likelihood and expense associated with such risks can be statistically predicted in ways that make it possible for an insurance company to price the risk it is taking on and charge a premium in exchange for taking on that risk.  If such risk, by legislative act, is expanded to include shoddy workmanship, then the insurance company will be turned into a guarantor of the quality of the contractor’s work.  The cost to an insurance company for taking on such risk will be significantly greater.  Insurance companies have to stay in business by making enough money to cover the risk they take on and so increased premiums should be expected.

The legislative efforts of the contractors and their lobbyists are extreme.  HB 839 would require the Courts in Hawaii to “presume” that an insurance policy covers construction defects and it completely rewrites the law governing the interpretation of insurance contracts.  Both HB 839, which has been deferred, and HB 924 which is advancing, would enact the law retroactively, making it apply to insurance policies that have already been issued.  The effect of doing so would be to rewrite insurance contracts after the parties have entered into them, despite the fact that the courts in Hawaii have already ruled on the interpretation of those contracts.  Retroactive changes in the law not only offend the principles of fairness that we all live by, they are unconstitutional.

The attempt to legislatively nullify the appeals court’s interpretation of the language in a standard form insurance contract will not be good for Hawaii.  Insurance companies will have to make adjustments if this legislation becomes law.  Insurance companies will realize that in Hawaii, their exposure to risk is no longer limited to unforeseeable accidents but has been expanded to require them to pay out because of shoddy workmanship.

Insurers can be expected to respond in one of two ways: either they will no longer issue such insurance in Hawaii or they will charge more for it.  In the first scenario, fewer insurance companies will mean less competition and higher prices for insurance.  In the second scenario, greater risk to the insurance companies will mean higher prices for insurance.  In either scenario, the higher prices for insurance will be passed along to the contractors and then to their customers.  In the end, building costs will rise and the Hawaii consumer will pay for this legislation.

The threat of this legislation should concern every person who has ever signed a contract.  If, after the fact, the legislature can redefine the words in a private contract of insurance, what stops the legislature from being lobbied to do that for any contract?  Could cell phone providers have the legislature redefine a cell phone “plan year” to be only six months long?  If so, then customers would pay the same amount to get only six months of service instead of twelve.  Presto!  The cell phone companies double their revenue and the government doubles the taxes it receives from cell phone contracts.

The possibilities for bad results are limitless when lobbyists and the legislature interfere with the rights of parties to a private contract and the separation of powers established by the Constitution.

Allen R. Wolff is an attorney at Olshan Grundman et al. in New York City.
https://www.olshanlaw.com/attorney_profiles/wolff.php

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