Tuesday, November 11, 2014

A Contractual-Liability Exclusion to Insurance Coverage Might Not Apply to Defective-Work Claims Against a Contractor.

The U.S. Court of Appeals for the Fifth Circuit recently held that, under Texas law, an insurer could not exclude coverage for property damage claims against a general contractor that were based on violations of express warranties of good workmanship and repair. Such claims did not fall within the typical contractual-liability exclusion used in the general contractor’s commercial general liability policy (“CGL policy”). The Fifth Circuit reversed the district court and rendered summary judgment in favor of the homeowners asserting the insured’s rights, remanding for a determination of attorneys’ fees.

Homeowners sought to collect an arbitration award for repairs to foundation- and HVAC-related property damage from the general contractor’s insurer.

In Crownover, homeowners obtained an arbitration award against the general contractor that built their home. The home had suffered extensive property damage caused by problems with the foundation and HVAC system. The arbitrator found in favor of the homeowners on their claims for violations of the general contractor’s express warranties, which promised that the contractor would “promptly correct work ... failing to conform to the requirements of the Contract Documents.” The contractor subsequently filed for bankruptcy, forcing the homeowners to turn to the contractor’s insurer to attempt to collect their award.

The insurer denied coverage, claiming various defenses and exclusions applied. The homeowners filed suit against the insurer. The district court granted summary judgment in favor of the insurer, finding that their claims fell within the policy’s exclusion for “’property damage’ for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.” This contractual-liability exclusion had an exception for “liability . . . [t]hat the insured would have in the absence of the contract or agreement.” The district court rejected the homeowners’ argument that the agreement had an implied warranty of good workmanship that would have supported the award, pointing out that such an implied warranty was superseded by the express warranty covering the same damage.

The court of appeals initially sided with the insurer, finding coverage was excluded.

In its first opinion, the court of appeals found that the contractual-liability exclusion applied and affirmed summary judgment in favor of the insurer. The court examined the Texas Supreme Court’s opinion in Gilbert Tex. Const., L.P. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010), as further explained in Ewing Const. Co., Inc. v. Amerisure Ins. Co., 420 S.W.3d 30 (Tex. 2014)

In Gilbert, the Texas Supreme Court found that the contractual-liability applied to certain claims against a general contractor, excluding coverage. The general contractor agreed to “protect the work site and surrounding property.” During construction, flooding occurred in a building on neighboring land adjacent to the construction site. The contractor settled with the neighboring owner, then brought suit under the contractor’s CGL policy. The Court affirmed summary judgment in the insurer’s favor. The contractor owed the neighboring owner a general duty in tort to refrain from causing property damage through a failure to use reasonable care when performing the contractor’s work. However, the contractor assumed an additional obligation to pay for the neighbor’s damages resulting from the contractor’s failure to perform work in compliance with the requirements of the contractor’s construction contract with the project’s owner. This obligation fell outside of the contractor’s otherwise-applicable duties to the neighbor under the law, and therefore fell within the contractual-liability exclusion. 

This analysis was further refined in the Ewing case, which has been discussed at length in an earlier post on The Dispute Resolver. In Ewing, the Texas Supreme Court answered a question certified by the Fifth Circuit concerning the applicability of the contractual-liability exclusion. The Court responded that the contractual-liability exclusion did not apply to property damage arising out of a contractor’s work if the contractor agreed to perform its work in a good and workmanlike manner, without more specific provisions enlarging the obligation. After receiving this answer, the Fifth Circuit reversed summary judgment in favor of the insurer on the contractual-liability exclusion and remanded the case to the district court for further proceedings. Ewing Constr. Co. v. Amerisure Ins. Co., 744 F.3d 917 (5th Cir. 2014).

Examining the facts at issue in Crownover, the court of appeals initially found that the contractual-liability exclusion applied. The contractor had assumed liability for property damage resulting from its failure to comply with the contract documents. The court reasoned that this duty was in addition to the general duty to perform work in a good and workmanlike manner, triggering the contractual-liability exclusion because the duty would not have existed absent the contract. The court also found that the exception to the exclusion did not apply because the arbitration award was limited to liability for breach of the express warranty to construct the project in compliance with contract documents, not an express or implied warranty of good workmanship.

On rehearing, the court of appeals changed its mind, finding that the warranty claims fell outside the contractual liability exclusion.

The court’s opinion changed on rehearing, reversing the judgment and rendering summary judgment in favor of the homeowners. The critical issue was whether the contractor’s duty to repair its defective work under the agreement expanded its existing obligations to the homeowners under the law. On rehearing, the Fifth Circuit found that it did not. The court explained that the contractor owed a duty to repair property damage from defective work regardless of any obligations in the contract. 

More significantly, the court held that the requirement to perform work in compliance with contract documents “did not increase [the contractor’s] liability in any relevant manner.” Under Texas law, the insurer bears the burden to show that an exclusion to coverage applies. The insurer in Crownover failed to demonstrate that compliance with the plans, specifications, and other contract documents exceeded general standards of good workmanship. In fact, the arbitrator’s factual findings suggested the opposite--both the foundation and the HVAC units did not perform as required, causing the claimed property damages. The contractor would have had the same liability for failure to perform its work in a good and workmanlike manner, and therefore the contractual-liability exclusion did not apply.

Interestingly, Fifth Circuit pointed out that the Gilbert opinion was limited to a particularly unique set of facts. The Court in Gilbert did not decide whether coverage might have existed if the neighbor had settled a claim for negligence rather than contractual liability. Under the facts of the case, the contractor was immune from tort claims because it had performed the work under contract for a governmental agency.

General contractors may seek coverage for property-damage claims based on allegations of deficient or defective workmanship.

The Crownover case is an important victory for general contractors and owners seeking insurance coverage for property damage resulting from deficient or defective workmanship. Few, if any, commercial construction contracts do not include express language requiring the general contractor to perform its work in compliance with the contract documents and in a good and workmanlike manner. Such language is consistent with the implied warranty (under the laws of Texas and many other states) of good workmanship. If the contractual-liability exclusion applied to claims for breach of express warranties, then insurers arguably could exclude coverage for any defective-work claims by arguing that any liability for implied warranties was superseded by liability for the express warranties, which was excluded. The Crownover opinion rejects this theory, permitting property-damage claims to proceed even if they are based on defective or deficient work.

Despite this holding, however, there is still a risk that the contractual-liability exclusion could apply under certain circumstances. If the plans, specifications, or other contract documents contained requirements in addition to the obligation to perform in a good and workmanlike manner, and such requirements caused the property damage at issue, an insurer could argue that the contractual-liability exclusion excludes coverage. For example, consider a situation where the contract required installation of a certain type of windows in a greenhouse, but a different type was installed that was typically used in greenhouses. If the special plants died as a result of the use of the wrong windows, the contractor arguably would have complied with its duty of good and workmanlike performance, but would have breached its duty to perform in compliance with contract documents. Owners and other claimants wishing to avoid this argument should take care to frame their claims in a manner that shows that the property damage resulted from a failure to perform work in a good and workmanlike manner or with reasonable care, regardless of the contract documents.

Interestingly, owners in Texas might have been able to obtain coverage even without the revision of the opinion in Crownover. As recently reported on The Dispute Resolver, the Texas Supreme Court recently pointed out that a homeowner may have negligence claims against a contractor for property damage caused outside the original scope of work. Chapman Custom Homes, Inc. v. Dallas Plumbing Co., --- S.W. 3d ----, 57 Tex. Sup. J. 1264, 2014 Tex. LEXIS 690 (Tex. Aug. 22, 2014) (per curiam). Such negligence claims would not be superseded by the express warranties and do not necessarily fall within the economic-loss rule. Thus, owners could seek to recover for property damage under negligence claims as an alternative basis for coverage.

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