Every Texas construction defect case involving subcontractors now potentially covered
Insurers should expect more contract-based claims for defense as a result of a recent Texas Supreme Court ruling that may make every construction defect case involving subcontractors covered, even if limited to breach of contract or express warranty theories, so long as the damage was not expected or intended.
We believe this pro-insured conclusion will have a significant impact upon insurance coverage evaluations generally in Texas. As with many decisions, the concern is not so much the result in this case, but the broad language used by the Court which will be used by insureds in attempts to more broadly interpret the CGL policy.
An economic effect of the ruling in Lamar Homes, Inc. v. Mid-Continent Casualty Co., No. 05-0832 (August 31, 2007), which we expect to soon be made final, may be a significant increase in the cost of CGL insurance in Texas, especially for general contractors, home builders, and others who employ subcontractors.
Texas a liberal state?
At least as to these insurance issues, Texas may now be legitimately viewed as a “liberal” state, an observation clearly reflected in a strongly worded dissent in the case. The dissent accused the majority of turning the construction industry “on its head” adopting a minority rule applied in only five other states.
“Every ‘crack, stain, dent, leak, scratch, and short-circuit arising from a subcontractor’s work’ will now have to be repaired by the builder’s insurer,” the dissent said.
Considered one of the most important liability insurance coverage cases in Texas in many years, the case was a 6-3 decision authored by Justice David Medina. In it, the Court answered three certified questions from the Fifth Circuit Court of Appeals deciding that:
1. In a suit against a homebuilder for construction defects alleging only damage to and loss of use of the home itself, an “accident” or “occurrence” is present so long as the damages were unexpected and unintended;
2. In such a suit, damage to the home itself constitutes “property damage”; and
3. Former Article 21.55 of the Insurance Code (the “prompt pay” statute, now codified at sec. 542.051-.061 of the Code) applies to a claim for the denial of defense under a liability insurance policy – such claim constituting a “first
party claim” by the insured.
In the underlying damage suit, Lamar Homes was alleged to have negligently designed and constructed a new home’s foundation, resulting in cracking of the home’s sheetrock and stone veneer. It should be noted at the outset that the case was not simply one of faulty performance, but of faulty performance (by a subcontractor) which damaged another portion of the construction.
That distinction may be important in future cases.
As to the first issue, Mid-Continent urged that where a general contractor is sued only for damage to its construction, the loss sounds in contract, not tort, and thus there is no accident or “occurrence.” The court rejected the carrier’s argument that economic damages flowing from the insured’s contractual undertaking should be “conclusively presumed to have been foreseen.”
So long as there is a fortuitous and unintended event, the Court held that there is an accident. Also, for purposes of determining whether an “occurrence” is alleged, the Court refused to distinguish between a fortuitous and unintended event which damages the
insured’s own work, and one which damages the work of a third party. In concluding its “occurrence” analysis, the Court stated:
“Here, the complaint alleges an ‘occurrence’ because it asserts that Lamar’s defective construction was a product of its negligence. No one alleges that Lamar intended or expected its work or its subcontractors’ work to damage the
The Court next turned to the issue of whether damage to the home itself constitutes “property damage.” It held that allegations of cracking sheetrock and stone veneer are allegations of “physical injury” to “tangible property.” [Such a conclusion would not be remarkable at all, of course, if the sheetrock or veneer were someone else’s work]. But, the Court noted, Mid-Continent contended that no “property damage” was stated for what amounted to a public policy reason: the previously well-accepted idea that CGL coverage exists not to repair or replace the insured’s defective work, and permitting it to do so would transform a CGL policy into a performance bond.
The Court summarily rejected this argument, concluding that the CGL’s restrictions on coverage as to the insured’s own work are expressed not in the insuring agreement (and definitions), but in the policy’s “business risk” exclusions. It rejected the argument that the common law “economic loss” rule should in any way be adopted as an insurance coverage doctrine.
What’s really occurred here?
Despite its earlier holding that an “occurrence” was present because of the allegations of negligence against Lamar Homes, the Court made the following problematic comment:
“Contrary to the carrier’s contentions, the CGL policy makes no distinction between tort and contract damages. The insuring agreement does not mention torts, contracts or economic losses; nor do these terms appear in the definitions
of ‘property damage’ or ‘occurrence.” The CGL’s insuring agreement simply asks whether ‘property damage’ has been caused by an ‘occurrence.’ Therefore, any preconceived notion that a CGL policy is only for tort liability
must yield to the policy’s actual language.”
For this proposition (and throughout the opinion), the Court cited: JEFFREY W. STEMPEL, LAW OF INSURANCE CONTRACT DISPUTES (2d ed. 1999).
Last, the Court took up the issue of whether Texas’ prompt pay statute applies to duty to defend disputes. Adopting the position of the U.S. District Courts which have addressed the issue (and rejecting the position of almost all of the Texas Courts of Appeals), the Court held that an insured’s claim for attorney’s fees for defending a third-party claim is a “first party” claim. This means an insurer can be liable to an insured for interest on the attorney’s fee claim at the rate of 18% per annum, and for reasonable attorney’s fees.
The Court also rejected the argument that the procedures outlined in the statute are not workable as respects liability for defense costs.
For example, under the prompt pay statute, the insurer has 15 days after receiving notice of a claim to acknowledge receipt, commence an investigation, and request any additional information from the insured. The statutory deadlines for accepting and paying the claim do not begin to run until the insurer has received “all items, statements, and forms required by the insurer to secure final proof of loss.”
Trying to fit a square peg into a round hole, the Court ignored the fact that an initial demand for defense would implicate none of the items listed in the statute, and instead focused on the insured’s later submission of attorney’s fee bills to an insurer. Thus, the opinion holds that it is only when the insured receives and submits to the insurer a bill for legal services that the statutory penalties apply.
Writing in dissent, Justice Brister (joined by Justices Hecht and Willett) said the “economic loss” rule is well established, and although the policy does not expressly distinguish between tort and contract claims, it should be understood that the “property damage” limitation was intended to incorporate this common law doctrine.
Listed in Best Lawyers in America and selected to Texas Super Lawyers for Insurance Law, Sidney H. Davis, Jr. was the managing partner of the civil litigation law firm Touchstone, Bernays, Johnston, Beall, Smith & Stollenwerck, LLP in Dallas, Texas.
Sidney H. Davis, Jr. passed away on October 26, 2009. If you are seeking legal help, or have a question about this article or a pending legal matter, please contact Dawn Woelfel Hansen at (214) 741-1166.