The Texas Supreme Court recently answered certified questions from the U.S. Fifth Circuit Court of Appeals arising from an insured’s claims that its liability for a refinery owner’s replacement costs and downtime damages are covered by its CGL policy. U.S. Metals, Inc. v. Liberty Mut. Grp., Inc., 2015 WL 7792557 (Tex. Dec. 4, 2015).

The insured supplied flanges for use in constructing refinery processing units. The flanges were welded to piping and then covered with a coating and insulation. However, the flanges leaked and had to be replaced, resulting in delayed operation of the units for several weeks. The refinery sued the insured for the cost of replacing the flanges and for damages for the loss of use of the units. The insured settled with the refinery and then sought indemnification for its CGL insurer.  

The insurer denied coverage, and the insured sued it to determine its rights under the policy. The federal district court granted summary judgment in favor of the insurer. On appeal, the Fifth Circuit certified to the Texas Supreme Court four questions about the meaning of “physical injury” and “replacement” in the CGL policy:

  1. In the “your product” and “impaired property” exclusions, are the terms “physical injury” and/or “replacement” ambiguous?
  2. If yes as to either, are the aforementioned interpretations offered by the insured reasonable and thus, must be applied pursuant to Texas law?
  3. If the above question 1 is answered in the negative as to “physical injury,” does “physical injury” occur to the third party’s product that is irreversibly attached to the insured’s product at the moment of incorporation of the insured’s defective product or does “physical injury” only occur to the third party’s product when there is an alteration in the color, shape, or appearance of the third party’s product due to the insured’s defective product that is irreversibly attached?
  4. If the above question 1 is answered in the negative as to “replacement,” does “replacement” of the insured’s defective product irreversibly attached to a third party’s product include the removal or destruction of the third party’s product?

The Texas Supreme Court explained that all damages for which the insured claimed coverage arose out of the defective flanges, and thus exclusions for damages to “your product” and “impaired property” of the policy apply. The policy excluded damage to property, or the loss of its use, if the property was not physically injured or if it was restored to use by replacement of the flanges. Thus, the Texas Supreme Court noted, the existence and extent of coverage thus depended on whether the refinery’s property was 1) physically injured or 2) restored to use by replacing the flanges. The insured argued the refinery’s property was physically injured by the installation of the flanges and also during the replacement process. 

In response to the Fifth Circuit’s certified questions, the Texas Supreme Court held that the terms “physical injury” or “replacement” were not ambiguous as incorporated into the “your product,” or “impaired property” exclusions. It found that the installation of the faulty flanges alone did not physically injure the units. However, the Supreme Court found that the refinery processing units were physically injured in the process of replacing the flanges and that repair costs and damages for the downtime were “property damage” covered unless exclusion m. applied.

The Supreme Court concluded that the units were restored to use by replacing the flanges and were therefore impaired property to which exclusion m. would apply, but that insulation and gaskets destroyed in the process were not restored to use — they were replaced — and therefore did not constitute impaired property to which exclusion m. applied.