Texas Supreme Court Holds Exclusion Inapplicable to Construction Defect Claim

In its recent decision in Ewing Constr. Co. v. Amerisure Ins. Co., 2014 Tex. LEXIS 39 (Tex. Feb. 27, 2013), the Supreme Court of Texas addressed certified questions from the United States Court of Appeals for the Fifth Circuit regarding the scope of the Contractual Liability exclusion in the context of a construction defect claim.  The court was asked to determine whether a general contractor that enters into a contract agreeing to perform its work in a good and workmanlike manner “assumes liability” for damages arising out of the contractor’s defective work, thereby triggering the Contractual Liability exclusion.

Ewing Construction Company (“Ewing”) entered into a contract with Tuluso-Midway Independent School district (“TMISD”) to serve as the general contractor for a construction project at a school in Corpus Christi, Texas. Among other things, Ewing was to renovate and build additions to a tennis court, which Ewing did through its subcontractors.  The contract required Ewing to perform that work in a “good and workmanlike manner.”  Not long after construction was complete, cracking and flaking problems began and TMISD filed suit against Ewing asserting claims for breach of contract and negligence.

Amerisure Insurance Company issued a commercial general liability policy to Ewing for the time period at issue.  Ewing tendered its defense of the TMISD suit to Amerisure, which it denied based on the Contractual Liability exclusion. The Contractual Liability exclusion of the Policy stated in relevant part:

2.   Exclusions

      This insurance does not apply to:

                                    …

b.   Contractual Liability

“bodily injury” or “property damage” for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages:

(1) That the insured would have in the absence of the contract or agreement; or

(2) Assumed in a contract or agreement that is an “insured contract”

Ewing filed suit against Amerisure in the U.S. District Court for the Southern District of Texas, seeking a declaration that Amerisure breached its duties to defend and indemnify Ewing for any damages awarded to TMISD. Amerisure counterclaimed, seeking a declaration that it owed Ewing neither a duty to defend nor a duty to indemnify. Although Amerisure conceded that Ewing established coverage under the policy’s insuring agreements, it took the position that policy exclusions, in particular the Contractual Liability exclusion, precluded coverage and negated its duties to defend and indemnify.

The district court relied on Gilbert Texas Constr. Co. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010) in holding that no coverage was owed under the policy. The district court determined that Gilbert stood for the proposition that the Contractual Liability exclusion applies when an insured enters into a contract and assumes liability for its own performance under that contract. The district court concluded that TMISD’s pleadings established that pursuant to the contract between TMISD and Ewing, Ewing agreed to be liable for failing to perform under the contract if the work was deficient. The district court therefore concluded that the Contractual Liability exclusion applied to preclude coverage.

On appeal, the Fifth Circuit initially affirmed the district court’s judgment on the duty to defend, but later vacated and remanded the case with respect to the duty to indemnify to await the results of the underlying suit. Ewing petitioned for rehearing. The Fifth Circuit withdrew its opinion and certified two questions to the Supreme Court of Texas:

1.   Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good an workmanlike manner, without more specific provisions enlarging this obligation, “assume liability” for damages arising out of the contractor’s defective work so as to trigger the Contractual Liability Exclusion.

2.   If the answer to question one is “Yes” and the contractual liability exclusion is triggered, do the allegations in the underlying lawsuit alleging that the contractor violated its common law duty to perform the contract in a careful workmanlike, and non-negligent manner fall within the exception to the contractual liability exclusion for “liability that would exist in the absence of contract.”

The Texas Supreme Court carefully examined Gilbert and concluded that “assumption of liability” in the context of the exclusion meant that the insured had assumed a liability for damages that exceeded the liability it would have under general law. The Court defined “good and workmanlike” and “negligence” as having the same substantive meaning. The Court acknowledged that Ewing had a common law duty to perform its contract with skill and care.  Reasoning that the claims asserted by TMISD did not seek recovery for damages that exceeded the liability Ewing would have under general law, the Court concluded that the exclusion did not apply to preclude coverage.

The Court also rejected the notion that its holding would have the effect of transforming CGL policies into performance bonds. The Court observed that because the policy contained other exclusions that may apply to bar coverage in a case for breach of contract due to faulty workmanship, its ruling was consistent with the view that CGL policies are not performance bonds.

Sixth Circuit Holds Faulty Workmanship Is Not An Occurrence

In its recent decision in Liberty Mutual Fire Ins. Co. v. Kay & Kay Contracting LLC, 2013 U.S. Dist. LEXIS 23587 (6th Cir. Nov. 19, 2013), the United States Court of Appeals for the Sixth Circuit, applying Kentucky law, had occasion to consider whether a subcontractor’s allegedly faulty preparation of a building pad, and the resulting settling and structural damages to the building constructed on the building pad, constitutes an “occurrence.”

Liberty Mutual issued a CGL insurance policy to Kay & Kay as the named insured and included MW Builders as an additional insured (“the contractors”). Wal-Mart contracted with MW Builders as a general contractor to build a new Wal-Mart store. MW Builders in turn subcontracted with Kay & Kay to perform site preparation work and construct the building pad for the new store. After Kay & Kay completed the building pad and constructed the building, Wal-Mart notified MW Builders that there were cracks in the building’s wall. Wal-Mart demanded that MW Builders remedy these issues and fix the resulting damage. MW Builders in turn demanded that Kay & Kay remedy these issues and indemnify MW Builders from Wal-Mart’s claim. MW Builders and Kay & Kay reached an agreement and executed a new and separate contract under which Kay & Kay agreed to perform the remedial work demanded by Wal-Mart. Meanwhile, Liberty Mutual filed a complaint seeking a declaratory judgment against the contractors alleging that their claims were not covered under the CGL policy, in relevant part, because there was no “occurrence” alleged.

The CGL policy at issue contained the standard coverage language found in a standard Insurance Services Office form.  The policy provided: “This insurance applies to ‘bodily injury’ and ‘property damage’ only if…[t]he ‘bodily injury’ or property damage’ is caused by an ‘occurrence’ that takes place in the ‘coverage territory’… .” The policy defined “occurrence” to mean “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The policy did not define the term “accident.”

The parties filed cross-motions for summary judgment on the limited issue of whether there was an “occurrence” alleged in the claim. After a hearing, the district court denied Liberty Mutual’s motion for summary judgment and granted the contractors’ motion. Liberty Mutual appealed.

Relying on Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W. 3d 69, 73 (Ky. 2010), the court noted that, standing alone, claims of faulty workmanship are not “occurrences” under CGL policies. The contractors argued that the damage was not Kay & Kay’s allegedly defective building pad (the work product itself), but was instead the collateral damage to the building (other property), which was the work of third-party contractors. The Court recognized that in order for there to have been an “occurrence”, there had to have been an “accident.” Following Cincinnati, the court concluded that the plain meaning of the term accident implicated the doctrine of fortuity, and it recognized that fortuity consists of intent and control.

After a careful examination of Cincinnati, the Court held that the facts of the case did not present an “accident” that would trigger coverage as an “occurrence” under the CGL policy issued by Liberty Mutual. The Court emphasized the importance the Cincinnati court put on “control” in analyzing the question of fortuity, and noted that the damages that occurred in this case were within the control of Kay & Kay; Kay & Kay was hired to prevent the settling and resultant structural damage that occurred. “In other words, the possibility of the type of damage in this case was exactly what Kay & Kay was hired to control.” The Court reversed the judgment of the district court and remanded the case with instructions to grant judgment for Liberty Mutual.

Alabama Supreme Court Holds Faulty Workmanship May Be An Occurrence

In its opinion in Owners Insurance Company v. Jim Carr Homebuilder, LLC, 2013 Ala. LEXIS 122 (Ala. Sept. 20, 2013), the Supreme Court of Alabama the court had the occasion to consider what constitutes an “occurrence” as defined under a CGL policy in the context of a construction defect claim.

Thomas and Pat Johnson hired JCH, a licensed homebuilder, to construct a new home in January 2006. Within a year of completion the Johnsons noticed several issues with water leakage which resulted in damage to other parts of the home. After JCH’s attempts at remedying the water infiltration issues were unsuccessful, the Johnsons sued for breach of contract, fraud, and negligence. JCH promptly tendered its defense to Owners Insurance Company, its general liability insurer. Owners provided counsel under a reservation of rights. After the dispute between the Johnsons and JCH was settled through arbitration, the trial court granted JCH’s motion for summary judgment holding that Owners policy covered the entirety of the arbitrator award.

On appeal, Owner’s argued that the property damage was not an “occurrence” as defined in the policy and as such no coverage would apply. In accordance with previously established principles, the court noted that whether faulty workmanship constitutes an “occurrence” depends on the nature of the damage caused by the faulty workmanship. On its own, however, faulty workmanship is not an “occurrence.”  The court further clarified that “faulty workmanship performed as part of a construction or repair project may lead to an occurrence if that faulty workmanship subjects personal property or other parts of the structure outside the scope of that construction or repair” to harmful or damaging conditions.

The court differentiated between instances in which a contractor is retained to perform work on an existing structure and the existing structure is damaged, and when a new structure is built and defective work results in damage to the new structure.  Where the contractor is hired to construct the entire structure, and a claim for damage to that structure results from the contractor’s defective work, the contractor is not entitled to coverage as the claim does not constitute an “occurrence.”

Georgia Supreme Court Holds Defective Work Is An Occurrence

In Taylor Morrison Servs. v. HDI-Gerling Am. Ins. Co., 2013 Ga. LEXIS 618 (July 12, 2013), the Georgia Supreme Court addressed whether a construction defect claim constitutes an “occurrence” for purposes of satisfying the insuring agreement of the CGL Policy.  The court was called upon to make that determination pursuant to a certified question from the United States Court of Appeals for the Eleventh Circuit.  

In the underlying lawsuit, Taylor Morrison, a homebuilder, was sued in California by sixteen homeowners claiming that the concrete foundations of their homes was improperly constructed.  The plaintiffs alleged that the failure of the foundations caused physical damage to their homes, including water intrusion cracks in the floors and driveways, and warped and buckled flooring.  HDI-Gerling initially undertook the defense of Taylor, but then sought a declaration in the U.S. District Court for the Northern District of Georgia that the CGL policy issued to Taylor did not cover the claims.  The district court granted judgment in favor of HDI-Gerling finding that the claims did not assert an “occurrence” as the only damage alleged was the work performed by Taylor.  That ruling was appealed to the Eleventh Circuit, which certified the issue of whether a claim for defective work qualifies an “occurrence” as used in the standard CGL policy.

The Georgia Supreme Court answered that question in the affirmative and rejected the district court’s ruling.  The CGL policy defines the term “occurrence” as an “accident,” and since an “accident” does not require a determination of the party who performed construction work or whose  interests were injured by that work, a claim for damages to the insured’s own work could qualify as an “occurrence.”  In the context of the term “occurrence,” the coverage determination depended upon whether the claimed damages were expected or intended from the standpoint of the insured.

The court went on to make clear that its decision was not contrary to the general rule that a CGL policy is not intended to insure liabilities for the repair or correction of the faulty workmanship of the insured.  The court recognized that the other clauses in the insuring agreement, including the requirement that the claim seek damages for “property damage,”  are better suited to preclude coverage for such claims.  The term property damage “must refer to property that is nondefective and to damage beyond faulty workmanship.”  The court was unwilling to define the line of demarcation between defective and nondefective property when both are a part of the same project.  The court also noted that policy exclusions are inserted into the policy to bar coverage for the repair or correction of defective work.  Finally, the court held that claims of fraud against an insured are generally not covered by a CGL policy, however a cause of action for breach of warranty may be covered where it includes a warranty given for nondefective property that was damaged by the insured’s defective work.

Illinois Court Holds No Duty to Defend Water Intrusion Claim

In its recent decision Lagestee-Mulder, Inc. v. Consol. Ins. Co., 2011 U.S. Dist. LEXIS 129308 (N.D. Ill. Nov. 8, 2011), the United States District Court for the Northern District of Illinois addressed what allegations must be made in a construction defect lawsuit in order to trigger coverage under a general liability policy.

Lagestee, the general contractor on a construction project, was named as a defendant in a construction defect suit.  It sought coverage as additional insured under a commercial general liability policy issued to one of its subcontractors by Consolidated Insurance Company.  Consolidated denied coverage to Lagestee on the basis that the underlying suit did not allege property damage, but instead was limited to seeking a remedy of the alleged construction defects.  Notably, the suit did not allege any particular third-party property damage, although it did allege that as a result of certain of the defects, water was allowed to infiltrate the building.  The suit did not, however, identify any particular damage resulting from the water instrusion.

The court began its analysis by noting that Illinois court have long recognized the rule that “[w]here the underlying suit alleges damage to the construction project itself due to a construction defect, there is no coverage; by contrast, where the underlying suit alleges that the construction defect damaged something other than the project itself, there is coverage.”  As such, explained the court, the absence of any allegation of specific third-party property damage resulting from the alleged would be fatal to Lagestee’s claim for coverage.  Lagestee acknowledged that the underlying suit did not allege third-party property damage per se, as the suit related primarily to use of defective construction materials and faulty workmanship.  Lagestee nevertheless argued that a duty to defend was triggered by the water intrusion allegations, since the presence of water at the building raised the potential for resulting property damage.

The court disagreed, concluding that while “[i]t is true that the underlying complaint does not disavow the proposition that the water infiltration damaged something other than the building itself … the mere possibility that such damage occurred does not trigger a duty to defend under Illinois law.”  In other words, a court is not permitted under Illinois law to speculate as to what damages might have result from alleged water infiltration.  Rather, the duty to defend is determined based solely on the damages actually alleged.  Because the underlying suit did not identify any particular damage resulting from the water infiltration, but instead alleged only that the defective construction allowed for water infiltration, it was not permissible for the court to speculate that such infiltration could result in covered property damage.  Thus, concluded the court, Consolidated did not have a duty to defend Lagestee in the underlying suit.