Slide 1

Report
Insurance Law Update
Construction Defect Coverage
Lee H. Shidlofsky
Shidlofsky Law Firm PLLC
512.685.1400
[email protected]
We’ve Got You Covered
1
INSURANCE COMPANY RHETORIC . . .
(A Bit of History)
• CGL policies are not
Performance Bonds
• Faulty workmanship is a
“business risk” to be assumed
by the insured
• Damages flowing from faulty
workmanship are economic
losses and do not constitute
“property damage”
• Damages flowing from faulty
workmanship are not an
“occurrence” because they are
not accidental
Lamar Homes v. Mid-Continent
242 S.W.3d 1 (Tex. 2007)
• Performance bond theory rejected
• Business Risk Rationale subsumed by exclusions
• Damage to the work itself can constitute “property
damage” (i.e., no requirement for third-party property
damage)
• Damage to the work itself can constitute an
“occurrence” (i.e., it is no less accidental)
– Foreseeability is not the test for determining
“occurrence”
– The insuring agreement does not have a tort vs.
contract distinction (i.e., breach of contract is okay)
– The economic loss rule is not a useful tool for
determining insurance coverage
FAVORITE INSURANCE LINE
Suffice to say, that if a [CGL] policy taken out by
a contractor is not generally intended to cover
“construction,” it might surprise the Texas
Supreme Court; it seems to treat this conclusion
as axiom.
Essex v. Hines, 385 F. App’x 596 (5th Cir. 2010)
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ARE WE RETREATING FROM
Lamar Homes?
2007-2009
2010-2012
2013
?
“PROPERTY DAMAGE”
“Property damage” means:
a.
Physical injury to tangible property,
including the loss of use of that property. All
such loss of use shall be deemed to occur at the
time of the physical injury that caused it; or
b.
Loss of use of tangible property that is
not physically injured. All such loss of use shall
be deemed to occur at the time of the
“occurrence” that caused it.
KEY ISSUES UNDER PRONG I
• Defect vs. Physical Damage
– Incorporation theory
• Damage to the insured’s own work vs.
third-party property
– emerging middle ground
• Pure economic loss vs. consequential
damages
– damages “because of” . . .
• Rip and Tear coverage
THE CRUX OF THE DEBATE
• A difference exists
between a claim for
the costs of repairing
or removing defective
work and a claim for
the costs of repairing
damage caused by the
defective work.
THE PERCEIVED PROBLEM
• When the property damaged is the insured’s
work, and the nature of the problem is
characterized as “faulty” or “defective”
workmanship, some courts have tendency to
inquire whether “property damage” covers
the repair or replacement of poor
workmanship.
• Conflation of business risk exclusions /
rationale with the insuring agreement.
DEFECT VS. PHYSICAL DAMAGE
• The “physical damage” prong distinguishes
between physical injury to tangible property and
a mere defect.
• Physical Injury
– Plain meaning connotes an alteration in
appearance, shape, color, or in other material
dimension (e.g., cracking, breaking, blistering,
deflecting, corroding, rusting, rotting, peeling,
dissolving, and so on).
– Odor? / Noise? / Aesthetic disappointment?
DEFECT VS. PHYSICAL DAMAGE
• A mere defect is not “property damage”
(e.g., painting a room the wrong color)
• Tangible Property
– Can you touch or see it?
– Property interests (i.e., easements)
• What about costs incurred to prevent
“property damage”?
– Most jurisdictions say no . . . but some split for
environmental and life-safety
DEFECT VS. PHYSICAL DAMAGE
• Incorporation Theory
– Many courts have adopted the position that
the presence of a defective product within a
larger whole, without some attendant physical
injury to the larger structure, does not
constitute “property damage.”
– Some courts have focused on the amount of
destruction that will occur to the larger whole
in order to repair the defective component.
WHAT HAS TO BE DAMAGED?
• Insured’s Own Work vs. Third-Party Property
– Claimant need not have an ownership interest in
the property
– Definition of “property damage” does not support
a distinction between damage to work itself vs.
third-party property (i.e., look to exclusions)
WHAT HAS TO BE DAMAGED?
• Emerging Middle Ground…
– Defective work itself, even if physically damaged,
is not “property damage”
– Damage to otherwise non-defective parts of the
“project”―even to the insured’s own work―can
constitute “property damage”
– No real support in the “property damage”
definition but viewed as a compromise position
WHAT HAS TO BE DAMAGED?
• Florida
– Amerisure Mutual Ins. Co. v. Auchter Company,
673 F.3d 1294 (11th Cir. 2012)
• Colorado
– Greystone Construction, Inc. v. National Fire &
Marine Ins. Co., 661 F.3d 1272 (10th Cir. 2011)
WHAT HAS TO BE DAMAGED?
• Texas
– Bldg. Specialties, Inc. v. Liberty Mut. Fire Ins.
Co., 712 F. Supp. 2d 628, 640 (S.D. 2010)
– “The Lamar Homes court did not discuss
whether the defective foundation design or
construction could be ‘property damage’
without allegations that the defective
foundation caused damage to other parts of
the home.”
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential
– Damages “because of” “property damage”
– Transformation of otherwise “economic loss” into
covered damages
• Diminution in Value
• Profit / Overhead
• Increased Costs of Construction / Extended General
Conditions
• Attorneys’ Fees
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential
– Lennar v. Great Am. Ins. Co., 200 S.W.3d 651
(Tex. App.—Houston [14th Dist.] 2006, no pet.)
(distinguishing between: (i) the costs to repair
water damage to the homes; (ii) the costs to
remove and replace EIFS as a preventative
measure; and (iii) overhead costs, inspection
costs, personnel costs, and attorneys’ fees)
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential (Lennar)
– Depending on the home, the water damage
included wood rot, damage to substrate,
sheathing, framing, insulation, sheetrock,
wallpaper, paint, carpet, carpet padding,
wooden trim, and baseboards, mold damage,
and termite infestation.
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential (Lennar)
– Costs to repair water damage to the homes
and costs to remove EIFS solely to repair
underlying water damage are covered
“property damage,” while costs to remove and
replace EIFS as a preventative measure are not
covered “property damage”
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential (Lennar)
– “While Lennar may have been legally obligated
to pay the third-party EIFS claims by replacing
EIFS, making repairs, and/or making cash
payments, it was not legally obligated to incur
its own overhead costs, inspection costs,
personnel costs, and attorneys' fees in
connection with settling the claims”
PURE ECONOMIC LOSS VS.
CONSEQUENTIAL DAMAGE
• Economic vs. Consequential
– D.R. Horton, Inc. v. Am. Guarantee & Liab. Ins. Co., 4:11CV-039-A, 2012 WL 1893977 (N.D. Tex. May 22, 2012)
– “In order to prevail on an insured property damage
claim, the insured must distinguish, and apportion, the
insured property damage costs from the non-insured
costs, such as repairs or replacements necessary to
remedy the construction defects themselves, incidental
costs, and the cost of repairs or replacements to prevent
future property damage.”
RIP AND TEAR
• Rip & Tear
– Most jurisdictions hold that the repair cannot
create the “property damage”
– But “rip and tear” expenses covered if the
requisite “property damage” exists in the first
place
– Texas seemingly follows this approach (e.g.,
Lennar Corp. and Building Specialties).
LOSS OF USE OF TANGIBLE
PROPERTY (PRONG II)
• A claim by a property owner who alleges that
his business sustained economic losses during
a construction delay.
– Gibson & Associates, Inc. v. Home Ins. Co., 966 F.
Supp. 468 (N.D. Tex 1997)
LOSS OF USE OF TANGIBLE
PROPERTY (PRONG II)
• The key is that there must be an actual loss of use
of property. Merely pleading (or proving) a loss of
revenue is not sufficient. Such losses may be
covered under a policy, but only when caused by
physical injury or loss of use of tangible property.
– Nat’l Fire Ins. of Hartford v. C. Hodges &
Associates, PLLC, 825 F. Supp. 2d 792, 799 (W.D.
Tex. 2011)
PLEADING “PROPERTY DAMAGE”
• Should be relatively simple . . . but:
– “In its petition, Royal states that it has suffered
‘property damage’ as a result of PPI’s conduct, and
then defines ‘property damage’ in a way that
precisely mirrors the terms of the Policy.”
– “As mere legal assertions, these statements do not
qualify as ‘allegations’ for purpose of the eightcorners rule. Thus, the Court will not consider
them in evaluating Defendant Liberty’s duty to
defend.”
PPI Tech. Services, LP v. Liberty Mut. Ins. Co., 2012
WL 130389 (S.D. Tex. Jan. 17, 2012)
PLEADING “PROPERTY DAMAGE”
• Should be relatively simple . . . but:
– “Alvarez cannot trigger Evanston’s duty to
defend by simply alleging the tissues were her
property even if they were not. Whether the
tissues are property is a legal conclusion, and
we defer only to factual allegations in a
complaint when examining the duty to
defend.”
Evanston Ins. Co. v. Legacy of Life, Inc., 370
S.W.3d 377, 385 (Tex. 2012)
“PROPERTY DAMAGE” QUIZ
“PROPERTY DAMAGE” QUIZ
“PROPERTY DAMAGE” QUIZ
Contractual Liability Exclusion
The Debate Heads to the
Supreme Court of Texas
2013
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CONTRACTUAL LIABILITY
EXCLUSION
• Gilbert Tex. Construction, L.P. v. Underwriters at
Lloyd’s London, 327 S.W.3d 118 (Tex. 2010)
• Ewing Construction Co. v. Amerisure Ins. Co., 814 F.
Supp. 2d 739 (S.D. Tex. 2011), aff’d, 684 F.3d 512 (5th
Cir. 2012), vacated and certified, 2012 WL 3205557
(5th Cir. Aug. 8, 2012);
• Crownover v. Mid-Continent Cas. Co., Civil Action No.
3:09-CV-2285-0 (N.D. Tex. Jan 13, 2011) (pending on
appeal to Fifth Circuit)
• Indian Harbor Ins. Co. v. KB Lone Star, Inc., 2012 WL
3866858 (S.D. Tex. Sept. 5, 2012)
THE EXCLUSION
b. Contractual Liability
“[B]odily 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” . . . .
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Gilbert Texas Construction
• Gilbert Tex. Construction, L.P. v. Underwriters at
Lloyd’s London, 327 S.W.3d 118 (Tex. 2010)
• The Court recognized that it was adopting the
“minority” view.
– “We disagree, by and large, with courts’ and
treatises’ conclusions that the language of the
contractual liability exclusion before us applies
only to indemnity or hold-harmless
agreements….”
• Holding: Underwriters had no duty to indemnify
and held exclusion applied (and exception did not)
because Gilbert could not have been liable to RTR
but for its specific assumption to “protect and
repair.”
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Gilbert Texas Construction
• It is not at all clear exactly what the Court
was saying in the opinion:
–Is the contractual liability exclusion a
pure breach of contract exclusion?
–What does it mean to “assume” liability?
–Has Lamar Homes been overruled?
–Is the case limited to its unusual facts
(e.g., contractual assumption mixed with
governmental immunity)?
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Gilbert Texas Construction
Did the Court provide a hint?
• Hypothetical based on Lamar Homes:
– What if the claimant waited three years after
discovery of the damage to bring the lawsuit?
– What if the insured in Lamar Homes moved for
summary judgment on the economic loss rule and
won?
• “We understand Gilbert’s concerns, but speculation
about coverage of insurance policies based on surmised
factual scenarios is a risky business because small
alterations in the facts can warrant completely
different conclusions as to coverage. It is proper that
we await a fully developed, actual case to decide an
issue not presented here.”
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Ewing Opinion
• Basic garden-variety commercial construction
defect claim involving cracking and flaking of
tennis courts.
• Contractor (Ewing) entered into contract with
school district for construction of tennis courts.
• State court lawsuit against GC and design team
with claims of negligence, breach of contract,
and breach of warranty.
• Amerisure denied a duty to defend based on
the contractual liability exclusion.
• Coverage lawsuit commenced during pendency
of underlying construction defect lawsuit.
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Ewing Opinion
• Duty to Defend Denied: Amerisure contended
that the economic loss rule defeats the pending
tort claims because the only real basis for
Ewing’s liability is in contract or warranty and
that is excluded by the contractual liability
exclusion.
• Say it isn’t So: Ewing contended that the
construction contract contains no express
assumption of liability for damages comparable
to Gilbert and, in any case, the coverage court
cannot issue an advisory opinion on the
economic loss rule when the negligence claims
remain pending in the underlying lawsuit.
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Ewing Opinion
• Addressing the issue of “assumption of
liability,” Judge Jack concluded that “Ewing
assumed liability for its own construction work
pursuant to the parties’ contract” because
“Ewing is liable if the work it agreed to perform
under the contract is defective.”
• Turning to the exception for liability that would
exist in the absence of contract or agreement,
Judge Jack concluded that the coverage court
could look to the merits of the pending state
court claims and utilize the economic loss rule
in doing so.
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Ewing Opinion – The Disconnect
• “The Texas Supreme Court • “Gilbert, therefore,
in Gilbert was careful to
stands for the
state, however ‘[w]e do not
proposition that the
hold that the [contractual
contractual liability
liability] exclusion . . .
exclusion applies when
precludes liability for all
an insured has entered
breach of contract claims,’
into a contract and, by
but rather it ‘excludes
doing so, has assumed
claims when the insured
liability for its own
assumes liability for
performance under that
damages in a contract . . . .’”
contract.”
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Comparing Gilbert to Ewing
Gilbert
• Duty to indemnify
• 3 party transaction
(Gilbert –> DART –> RTR)
• Express assumption of
liability for damages
that would not
otherwise exist
• All claims other than
breach of contract
dismissed by trial court
Ewing
• Duty to defend
• 2 party transaction
(Ewing –> Tuloso ISD)
• No express assumption
of liability for damages
(no real reference to
contract)
• All claims, including
negligence, remained
pending at trial court.
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NO EXPRESS ASSUMPTION OF
LIABILITY FOR DAMAGES
• Ewing breached its contract by:
– “[f]ailing to complete construction in accordance with
the contract plans and specifications”
– “[f]ailing to exercise ordinary care in the preparation,
management and execution of contract”
– “[f]ailing to perform in a good and workmanlike
manner”
– “failing to properly retain and supervise
subcontractors”
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Comparing Lamar Homes to Ewing
Lamar Homes
Ewing
• “The economic-loss rule • Court applied the
. . . is not a useful tool
economic loss rule to
for determining
determine viability of
insurance coverage.”
tort claims
• “Contrary to the
• Court held no duty to
carrier’s contentions,
defend or indemnify for
the CGL policy makes no
breach of contract
distinction between tort
claims.
and contract damages.”
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Comparing Lamar Homes to Ewing
Lamar Homes
• Cracks in sheetrock
determined to be
“property damage”
caused by an
“occurrence” that falls
squarely within
“subcontractor
exception” to “your
work” exclusion
Ewing
• Cracks in tennis court
determined to be
“property damage”
caused by an
“occurrence” that falls
within “subcontractor
exception” to “your
work” exclusion BUT
now excluded by the
contractual liability
exclusion.
CAN YOU SAY SURPLUSAGE?
“YOUR WORK” EXCLUSION
“Property damage” to “your work” arising out of it
or any part of it and included in the “productscompleted operations hazard.”
This exclusion does not apply if the damaged
work or the work out of which the damage arises
was performed on your behalf by a
subcontractor.
• Damage that falls within the “subcontractor exception” of
the “your work” exclusion is necessarily damage to the
subject matter of the contract.
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Remember Gilbert
We understand Gilbert’s concerns, but
speculation about coverage of insurance
policies based on surmised factual scenarios is
a risky business because small alterations in the
facts can warrant completely different
conclusions as to coverage. It is proper that we
await a fully developed, actual case to decide
an issue not presented here.
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The Ewing Quote
The Court recognizes Ewing’s concern that
Amerisure’s interpretation of the Contractual
Liability exclusion would essentially wipe out any
coverage for a general contractor for “property
damage” that occurs to the project. While the
Court may not read Gilbert as broadly as
Amerisure does, and indeed makes no general
findings about its application beyond this case, it
does agree with the conclusion that it operates to
exclude coverage in the present circumstance and
in that sense is quite broad in application.
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INTERPRETIVE DANCE
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INTERPRETIVE DANCE II
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THE FIFTH CIRCUIT
Original Opinion
• 2-1 Decision Affirming the District Court
– “Although other jurisdictions adopt this principle
by holding that poor contractual performance is
not, under a CGL policy, an occurrence causing
property damage, Texas chooses to arrive at this
holding through its interpretation of coverage
exclusions.”
THE FIFTH CIRCUIT
Original Opinion
• 2-1 Decision Affirming the District Court
– Ewing’s contract with the School District is the
source of its potential liability because Ewing’s
duty to construct usable tennis courts arose out of
contractual undertakings
– The physical damage alleged is to the subject
matter of the contract
THE FIFTH CIRCUIT
Original Opinion
• 2-1 Decision Affirming the District Court
– “… [W]e pause to acknowledge a somewhat
troubling concern. If the contractual liability
exclusion means what it says, then it will often
exclude coverage under the same circumstances
as . . . the ‘your work’ exclusion.”
THE FIFTH CIRCUIT
Original Opinion
• Dissent
– Merely entering into a contract is not an
“assumption of liability”
– Majority approach renders the “your work”
exclusion and its subcontractor exception
meaningless
– Majority approach contravenes the intent and
evolution of CGL policy
– Majority approach fails to give a contractor the
benefit of its bargain with its CGL carriers
THE FIFTH CIRCUIT
Reality Check
• Vacate & Certify
– Does a general contractor that enters into a
contract in which it agrees to perform its
construction work in a good and workmanlike
manner, without more specific provisions
enlarging this obligation, “assume liability” for
damages arising out of the contractor’s
defective work
THE FIFTH CIRCUIT
Reality Check
• Vacate & Certify
– If the answer to question 1 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.”
SO WILL THE SUPREME COURT OF
TEXAS GET IT RIGHT?
Lets all Pray that they Do!!!
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IS IT REALLY DOOMSDAY?
• Short answer: Probably not.
– Major carriers are not relying on the contractual
liability exclusion
– Cases still being settled
• What if Affirmed?
– Harder to ignore, but the policy language likely
will change
– Possible legislation?
• What do I do right now?
– Business as usual
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Lee H. Shidlofsky
Shidlofsky Law Firm PLLC
512.685.1400
[email protected]
www.shidlofskylaw.com
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