In Dallas National Insurance Company v. Calitex, ___ S.W.3d ___, 2015 WL 968308 (Tex. App. 2015), the Texas Court of Appeals, applying Texas law, reversed the trial court’s summary judgment rulings against the insurer, and held that (1) the “business risk exclusion” of the policyholder’s commercial general liability policy applied to damage discovered after the insured’s operations were completed and (2) the failure to segregate covered and non-covered damage precluded coverage, even if the insurer breached the duty to defend. 

The policyholder contracted with a third party to build a condominium complex.  Id. at *1.  The owner of the condominium complex sued the policyholder for faulty workmanship.  Id. at *2.  The insurer denied coverage for the lawsuit, contending that it had no obligation to defend or indemnify the insured.  The owner ultimately obtained a judgment against the policyholder.  Id.  When the insurer did not pay the judgment, the owner sued, as a third party beneficiary, for breach of contract, a declaration of rights under the insurance policy and attorneys’ fees.  Id. at *3.

The policy included a “business risk exclusion” that precluded coverage for property damage to “that particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the property damage arises out of those operations.”  Id. at *10.  The court held that the use of present tense in the exclusion (i.e., “are performing”) “makes clear that the exclusion only applies to property damage that occurred during the performance of construction operations.”  Id.  However, coverage hinged on when damage “occurred” not when it was “discovered.”  Id.  Accordingly, the fact that the damage was not “discovered” until after the insured completed its operations was not “relevant to this Court’s analysis.”  Id.

The court held that at least some of the damage that gave rise to the judgment occurred before the insured completed its operations at the condominium project, and thus was subject to the business risk exclusion.  Id. at *11.  Moreover, the court held that the insured had the burden to segregate covered damage from damage that was not covered by the policy.  Id. at *9, 11.  The owner of the condominium project argued that the insurer had given up the right to “seek ‘allocation’ of damages as a way of avoiding its indemnity obligations” by breaching the duty to defend its policyholder.  Id. at *11.  The court rejected that argument, holding that even if the insurer had breached its duty to defend, it still had the right to challenge coverage for the underlying judgment – including challenging which portions of the judgment were covered.  Id. at *12.

Because the condominium owner did not present “evidence which will afford a reasonable basis for estimating the amount of damage or the proportionate part of damage caused by a risk covered by the insurance policy,” the court held that it could not establish any recoverable damages.  Id. at *13.  As the court explained “failure to segregate covered and non-covered perils is fatal to recovery.”  Id. (citation omitted).  Accordingly, the court held that the insurer was entitled to summary judgment on all counts.  Id. at *14.

This case is significant because it clarifies the scope of the “business risk exclusion” and makes clear that the key question is whether the damage occurred before completion of the policyholder’s operations irrespective of when the damage was discovered.  In addition, the court tackled the recurring question of the parties’ respective obligations when there are covered and non-covered losses associated with a policyholder’s claim.  Consistent with the policyholder’s burden to prove coverage, the court reinforced that the policyholder has the burden to segregate covered damage from damage caused by excluded perils even where the insurer has breached the duty to defend.