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A general contractor under contract to the Dallas Area Rapid Transit Authority (DART) was sued by the owner of a building adjacent to the construction site, alleging that water damage was caused by the contractor’s negligent construction activities.  In addition to suing for negligence, the building owner also sued the contractor for breach of contract, alleging that the contractor assumed liability for the damage under its contract with DART.  The trial court granted summary judgment for the contractor on the negligence claim on the basis of governmental immunity that applied to the contractor as well as to the government.  The breach of contract claim, however, was not dismissed and the contractor eventually settled the claim with the building owner for $6.175 million and then sought indemnity form its commercial general liability (CGL) carrier.  In response to the contractor’s demand for indemnity, the CGL carrier responded that the breach of contract claim was not covered under the policy because the policy excluded coverage for contractual liability.    On the contractor’s suit against the carrier to enforce coverage, the trial court granted summary judgment for the contractor, which was reversed by an intermediate appellate court and then affirmed by the Supreme Court of Texas in the case of Gilbert Texas Construction v. Underwriters at Lloyd’s London, 327 S.W3d 118 (Tex. 2010).  The basis of the holding was that the breach of contract claim fell within the policy’s contractual liability exclusion.

In reaching its decision, the court stated that the exclusion was not limited to only liability assumed of another party, such as indemnity provisions of contracts whereby a contractor agrees to assume its client’s liability to a third party.  Instead, the court held that the exclusion does not apply just to those situations in which the insured has assumed the liability of another.  The contractual liability provision at issue in this case provided as follows:

Protection of Existing Site Conditions

a. The Contractor shall preserve and protect all structures … on or adjacent to the work site….

b. The Contractor shall protect from damage all existing improvements and utilities (1) at or near the work site and (2) on adjacent property of a third party … [and] repair any damage to those facilities, including those that are the property of a third party, resulting from failure to comply with the requirements of this contract or failure to exercise reasonable care in performing the work. If the Contractor fails or refuses to repair the damage promptly, [DART] may have the necessary work performed and charge the cost to the Contractor.

In this case, says the court, “the contractor settled its breach of contract count with the plaintiff after the trial court had granted judgment in the contractor’s favor on all other theories of liability besides the contractual one.  Since the trial court had granted summary judgment as to everything else, the only claim that remained, according the Texas Supreme Court “fell within the policy’s contractual exclusion for purposes of determining [the insurance carrier’s] duty to indemnify.”

An exception to the exclusion for liability the contractor would have had in the absence of the contractual liability obligation was held to be inapplicable to get out from under the exclusion.  There was simply no basis of the claim that was otherwise covered, said the court, in addition to the contractually assumed liability to be applicable.  Because the tort claims against the contractor had been dismissed on the basis of sovereign (government contractor) immunity, “the only viable claim underlying [Contractor’s] settlement was for breach of contract.  Gilbert asserts no other basis for its settlement than the breach of contract claim; thus, Gilbert’s settlement payment for which it seeks indemnity simply was not liability for damages it had apart from its contract with DART, as it must have been in order for the [  ] exception [to the exclusion] to apply.”  For these reasons, the court held that the contractor was not entitled to coverage for the breach of contract claim brought by the third party building owner.

Comment: This case shows that the contractual liability exclusion in a policy may apply to exclude coverage for more than merely the indemnification provisions of a contract whereby a party agrees to assume liability that its client may have to a third party.   This case is somewhat unique in that the breach of contract claim was not brought by the party that actually had a contract with the contractor (i.e., DART) but was instead brought by a third party with whom the contractor had no relationship whatsoever.  That third party, building owner, argued that it was essentially an intended beneficiary of the contractual commitment that the contractor made with DART to “preserve and protect all structures … on or adjacent to the work site….”  It is interesting to note that the court does not explain the legal theory on which the building owner argued that it was an intended beneficiary and directly entitled to enforce the contract obligations the contractor made to DART.  That seems to this author like a critical element that should have been decided by the court before getting to the issue of how the contractual liability exclusion should be applied.  But letting that question pass for the moment, I tend to agree with the court that the contractual liability exclusion can be read broader than just applying to indemnity obligations.  But that will depend largely on how the language of the insurance policy is written.  Some policies seem to contemplate that it only applies to indemnity obligations.  Other policies contain broader language that might permit the carrier to deny coverage for a number of other obligations as well.  So, be knowledgeable of the wording of the contractual liability exclusion in your policy.  Also, be careful when negotiating contracts with clients that you don’t inadvertently run afoul of the contractual liability exclusion as the contractor was held to have done in this case.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 13, No.6  (May 2011).

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