The insuring agreement in most commercial general liability policies states that the carrier “will pay those sums that the insured becomes legally obligated to pay as damages because of…’property damage’ to which this insurance applies.” In addition, most policies exclude coverage for the defective work of the named insured. Questions have arisen, however, as to whether and when there is coverage for damages commonly known as “rip-and-tear,” which are those damages caused to other property by the necessity of removing, replacing, and correcting defective work.
Prior to 2015, Texas law held that rip-and-tear damages were covered if there was underlying covered property damage in the first instance. See Lennar Corp. v. Markel Amer. Ins. Co., 413 S.W.3d 750 (Tex. 2013). That all changed with U.S. Metals v. Liberty Mutual Ins. Group, Inc., 490 S.W.3d 20, 22 (Tex. 2015). In U.S. Metals, the Court appears to hold that damages are covered even when they are not “because of” property damage, leading to vexing issues for the insurance carrier regarding when the duty to defend is triggered and whether rip-and-tear costs are covered when they are not “because of” property damage.
In U.S. Metals, U.S. Metals sold ExxonMobil 350 flanges for use in constructing diesel units. When ExxonMobil conducted post-installation testing, it discovered that several flanges leaked and did not meet industry standards such that it was necessary to replace them to avoid the risk of explosion. For each flange, this process involved stripping the temperature coating and insulation (which were destroyed in the process); cutting the flange out of the pipe; removing the gaskets (which were also destroyed in the process); grinding the pipe surfaces smooth for re-welding; replacing the flange and gaskets; welding the new flange to the pipes; and replacing the temperature coating and insulation.
After ExxonMobil sued U.S. Metals and the parties settled, U.S. Metals sought indemnification from its insurer. On appeal, the parties disputed whether the installation of the faulty flanges physically injured the diesel units. The Court noted that “the installation of the leaky flanges…can certainly be said to have injured – harmed or damaged – the diesel units by increasing the risk of danger from their operation and thus reducing their value.” However, no physical injury resulted because ExxonMobil replaced the flanges in order to avoid the risk of such injury.
The Court concluded that the diesel units were physically injured in the process of replacing the flanges because the flanges were welded to the pipes, and the removal process “necessitated injury to tangible property, and the injury was unquestionably physical.” That tangible property was the original welds, coating, insulation, and gaskets. Because the diesel units were restored by replacing the flanges, they were impaired property to which Exclusion M applied. Id. But it also concluded that the insulation and gaskets were destroyed in the process and replaced such that Exclusion M did not apply. Therefore, the Court held that these rip-and-tear costs, were covered because the items were physically injured and constituted “property damage.”
After U.S. Metals was decided, the Western District of Texas issued an opinion illustrating the problems the holding created. In Travelers Lloyds Ins. Co. v. Cruz Contracting of Texas, LLC, the Western District relied on the U.S. Metals holding to conclude that rip-and-tear damages were covered. 2017 WL 5202891 (W.D. Tex. Sept. 7, 2017). There, Cruz, the subcontractor, was hired by D & D to install utility systems, which were later discovered to be faulty. D & D alleged that, in order to replace the sewer system installed by Cruz, it had to tear out and redo roadways, curbs, and parkways.
Based on U.S. Metals, the court found that D & D suffered property damage in the form of rip-and-tear damages “to access faulty equipment installed by an insured…”. The problem with this conclusion is that no damages “because of” property damage existed prior to the rip-and-tear process being undertaken. Rather, as the court concedes, the adjoining utility work was “not physically disturbed by Cruz’s defective work” but was “rendered useless by the defective work.” Consequently, the court apparently relied upon the loss of use as the trigger for the insurer’s duty to defend.
This, in turn, raises the pivotal issue of when the alleged property damage actually occurs. In other words, since there was no “property damage” prior to the tear-out and replacement of Cruz’s work – there was merely faulty work (which is typically excluded from coverage) – when did the “covered” property damage occur? The court’s opinion states that the property damage “occurred when the utility systems installed by Cruz failed testing, rendering them inoperable and unusable.”. Although the court relies upon Don’s Building for this proposition, this is a rather questionable conclusion because there was no property damage prior to the damage caused in accessing the faulty work.
Take as an example pipe work that is performed before pouring a concrete floor. No damage exists at the time the pipes are installed; however, there is later discovered a leak in one of the connections that requires replacement. If suit is filed merely alleging that the pipe was faulty and that the concrete needed to be torn out, is this sufficient to trigger a duty to defend in Texas because the rip-and-tear is in itself property damage? And, if so, does the insurer for the connection supplier owe a duty to defend the entire lawsuit when the concrete flooring, pipes, and other building components are damaged in an effort to repair and replace the connection? If that is the case, almost every suit for construction defects may plead a covered claim because it will involve rip-and-tear costs.
Equally confounding it the issue of “when is the occurrence.” If the rip-and-tear is itself the “property damage,” then can an insured create its own trigger for defense by alleging that the installation was improperly performed and required the rip-and-tear damages to replace the faulty connection? These are the questions created by the holding in U.S. Metals that have yet to be answered, but the Cruz holding certainly got this issue wrong. That is because U.S. Metals clearly identifies when the occurrence is:
We have further held that, for purposes of a duty to defend under an occurrence-based policy period, damage due to faulty workmanship “occurs” not at the time the damage manifests (when it is discovered or discoverable) nor when the plaintiff is exposed to the agent that will eventually cause the damage (when it is installed, presumably). Rather, under a straightforward reading of the policy, we concluded that “[o]ccurred means when damage occurred, not when discovery occurred.” Since a defective product that causes damage is not an occurrence until the damage actually happens, it would be inconsistent to now find that a defective product that does not cause damage is nevertheless an occurrence at the time of incorporation.
Cruz, however, held that the “occurrence” happened when the utility systems failed testing without any related property damage. This is one example of the myriad of questions created by the U.S. Metals holding, relied upon by the Cruz court, and the lower courts’ application of the ruling, which may create the potential for a huge shift in coverage law as to when the duty to defend is triggered.