A homeowner insurance policy was required to defend the homeowner/seller of a house against a personal liability lawsuit by a purchaser that alleged damages resulting from a rock slide allegedly caused by the seller’s breach of contract and negligence. The carrier refused to provide a defense because it argued the “contractual liability” exclusion of the policy barred coverage. On final appeal, the Supreme Court of Arizona held that tort duties can arise independently of contractual duties and in this case the stand-alone negligence claim was independent of the purchase contract. The negligence claim that rests on a builder’s common law duty to construct a home as a reasonable builder did not seek contract damages for defects in the excavation said the court, but instead sought compensation for property damage caused by negligent excavation. Therefore, any personal liability imposed on the seller would not necessarily originate from the contract, and the contractual liability exclusion would therefore not apply for the carrier to avoid its duty to defend against the negligence claim. Teufel v. Amercian Family Mutual Insurance Company, 244 Ariz. 383 (2018).

The buyer alleged that “[a]s a builder-vendor,” [Seller] “negligently performed or negligently supervised the hillside grading and slope cut” for the Longlook Property. [Buyer] alleges resulting property damage, including “damage to the outside HVAC units, broken bay windows, broken interior marble flooring, damage to the exterior stucco, [and] costs to remove rock.”

The insurance company, American Family Mutual Insurance Company, contends that [Buyer’s] negligence claim is not a stand-alone claim because the duty underlying that claim was created solely by the real estate purchase contract. Specifically, American Family argues that because [Buyer] sued [Seller] as a builder–vendor, any duty he owed [Buyer] arose at the time the parties executed the contract. And despite the negligence label used in the complaint, [Buyer’s] claim is based on [Seller’s] failure to fulfill its contractual duty to deliver the Longlook Property free of defects and in a habitable condition.”

The court began its analysis by citing case law explaining that the insurer’s duty to defend is separate from and broader than its duty to indemnify. The duty exists when a third-party suit “alleges facts that, if true, would give rise to coverage, even though there would ultimately be no obligation to indemnify if the facts giving rise to coverage were not established.”   The court further explained that “if any claims fall within policy coverage, the insurer must defend against all claims, including ‘claims potentially not covered and those that are groundless, false, or fraudulent’.”

The contractual liability exclusion to personal liability coverage under the contract provided: “Contractual Liability. We will not cover personal liability under any contract or agreement.”

According to the court, “The dispute here concerns the meaning of ‘under any contract or agreement’ and whether it includes personal liability based on [Buyer’s] negligence claim. The policy does not define ‘under.’ And because fifteen other policy exclusions for personal liability use the term ‘arising out of,’ it is unclear whether “under” carries a different meaning.”

According to the insurance carrier, “’under’ should be broadly interpreted to mean that the exclusion applies to liability that could not exist ‘but for’ a contract, ‘irrespective of whether the liability is related to or independent of the contract.’” The carrier then argues “that [Buyer’s] negligence claim falls within the exclusion because “without entering into the real estate contract with [Seller], [Buyer] would not have been exposed to the effects of the alleged defective excavation.” In contrast the insured seller argued that the exclusion eliminated coverage only for pure contractual liability and did not apply to tort liability.

The court found applying the language of the policy, “the contractual liability exclusion applies to personal liability required by or originating from a contract; it is not triggered simply because a contract brought the injured party and the insured together.” Here, the court found that the insured’s reasonable expectations suggest that the contractual liability exclusion does not apply to liability based on a stand-alone tort claim that is viable apart from any contract between the injured party and the insured. In conclusion, said the court,

“[Buyer’s] negligence claim rests on a builder’s common law duty to construct a home as a reasonable builder would. That claim does not seek contract damages for defects in the excavation but instead seeks compensation for property damage caused by the negligent excavation. Any personal liability imposed on [Seller] would not be required by or originate from the contract with [Buyer].”


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. 21, No. 1 (Jan 2019).

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