By J. Kent Holland, Jr.
The Texas Supreme Court in the recent decision of Lamar Homes v. Mid-Continent Casualty Company, 2007 WL 2459193 (Tex.), concluded that allegations of unintended construction defects, whether caused by the insured prime contractor or its subcontractor, may constitute an “accident” or “occurrence” under a CGL policy. In addition, the court found that that allegations of damage to, or loss of use of, the home itself (or the contractor or subcontractor’s work) may also constitute “property damage” sufficient to trigger the duty of the insurance carrier to defend the insured under a CGL policy.
The facts giving rise to the litigation concern the purchase of a new home from Lamar Homes, Inc. Several years after their purchase, the purchasers (DiMares) encountered problems they attributed to defects in their foundation. The DiMares sued Lamar and its subcontractor in federal district court in Texas complaining about these defects. Lamar forwarded the lawsuit to Mid-Continent Casualty Company to defend and indemnify it under a commercial general liability (CGL) policy. Mid-Continent refused to defend, prompting Lamar to seek declaratory judgment of its rights under the CGL policy.
Summary judgment was granted by the federal court for the insurance carrier because the court found the carrier had no duty to defend Lamar for construction errors that harmed only Lamar’s own product. The court reasoned that the purpose of a CGL policy is “to protect the insured from liability resulting from property damage (or bodily injury) caused by the insured’s product, but not for the replacement or repair of that product.”
The federal district court concluded that an injury to the insured contractor’s own work (the home) should not be considered an “occurrence” of property damage because the cost to correct faulty workmanship is an economic loss that a CGL policy should not cover. The district court further reasoned that defective construction could only be an occurrence when the defect caused bodily injury or damaged the property of a third party. Because the plaintiffs here did not allege damage to a third party’s property, the court concluded the carrier’s duty to defend had not been triggered.
Due to conflicting decisions in Texas state courts concerning coverage intent, the federal court decided not to enforce the summary judgment decision but to instead first ask the Texas Supreme Court to resolve the conflict between the state court cases.
As an initial matter, the Texas Supreme court determined that defective construction or faulty workmanship that damages only the work of the insured may be an “occurrence” which is defined, in part, as an “accident.” The term “accident” itself is not defined in the policy. The insurance company argued that faulty workmanship is not an accident because injury to the general contractor’s work is an expected and foreseeable consequence. The court found this argument unpersuasive, saying that Texas courts have not adopted foreseeability as the boundary between accidental and intentional conduct. The carrier’s argument, said the court, includes a false assumption–that the failure to perform under a contract is always intentional (or stated differently “that an accident can never exist apart from a tort claim”).
The Texas court explained that by applying previous Texas decisions, the federal court reached the conclusion that the terms “accident” and “occurrence” include damage that is the “unexpected, unforeseen or undesigned happening or consequence” of an insured’s negligent behavior, including “claims for damage caused by an insured’s defective performance or faulty workmanship.” The federal district court here drew a distinction between faulty workmanship that damaged the insured’s work or product and faulty workmanship that damaged a third party’s property. The federal district court cited Federated Mutual Insurance which concerned only the latter circumstance, and thus the district court reasoned that faulty workmanship that damaged the property of a third party is a covered “occurrence,” whereas faulty workmanship that damaged the property of the insured contractor is not.
But the Texas Supreme Court took issue with the district court’s interpretation because the CGL policy does not define an “occurrence” in terms of the ownership or character of the property damaged by the act or event. Rather, the policy asks whether the injury was intended or fortuitous, that is, whether the injury was an accident. The Texas court decided there was no logical basis within the “occurrence” definition for distinguishing between damage to the insured’s work and damage to some third party’s property. With regard to the question of whether an insured’s faulty workmanship was intended or “accidental” the court stated that this is dependent on the facts and circumstances of the particular case.
The court next turned to the question of whether defective construction or faulty workmanship damaging only the general contractor’s work is “property damage” under the CGL policy. The definition of “property damage” does not on its face, says the court, eliminate the general contractor’s work. In this case, the DiMares alleged that Lamar was negligent in designing and constructing their home’s foundation and that Lamar’s defective workmanship caused the home’s sheetrock and stone veneer to crack. The federal district court stated that damage to the homebuilder’s own work, the home, cannot be “property damage” because CGL insurance exists not to repair or replace the insured’s defective work and that such an interpretation transforms CGL insurance into a performance bond.
The Texas Supreme Court rejected the federal district court’s analogy to performance bonds and proceeded instead to analyze the “Damage to Your Work” exclusion of the CGL policy – particularly with regard to the exception to the exclusion for work performed on the Insured’s behalf by a subcontractor. In doing so, the court concluded that it agreed with the position of the Insured contractor that this exception was added to protect the insured from the consequences of a subcontractor’s faulty workmanship causing “property damage.” “Thus, when a general contractor becomes liable for damage to work performed by a subcontractor–or for damage to the general contractor’s own work arising out of a subcontractor’s work–the subcontractor exception preserves coverage that the “your-work” exclusion would otherwise negate.”
Rather than argue around the subcontractor exception, the insurance carrier argued that coverage only was intended to cover tort damages and must be denied as contractual “economic damages” The court states: “Contrary to the carrier’s contentions, the CGL policy makes no distinction between tort and contract damages.” The proper inquiry, says the court, is “whether an “occurrence” has caused “property damage,” not whether the ultimate remedy for that claim lies in contract or in tort.” And, according to the court, “claims for damage caused by an insured’s defective performance or faulty workmanship may constitute an ‘occurrence’ when ‘property damage’ results from the unexpected, unforeseen or undesigned happening or consequence of the insured’s negligent behavior.”
About the author: Kent Holland is 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 – including assistance with contract drafting, review and negotiation; change order and claims analysis (preparation or defense); risk management advice concerning insurance coverage – including assistance with negotiating and drafting the terms and conditions of policies and endorsements, advice to insurance underwriters; guidance to those procuring insurance; change order and claim preparation, analysis and defense; contract preparation; contract review and contract negotiation. Mr. Holland 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. 9, No. 7.