In response to certified questions from the United States Court of Appeals for the Fifth Circuit, the Texas Supreme Court held that unintended construction defects are an occurrence and that allegations of loss of use or damage to a home may constitute property damage under a commercial general liability (CGL) contract. Lamar Homes, Inc. v. Mid-Continent Cas. Co., No. 05-0832 (Tex. Aug. 31, 2007). The Court also held that Texas’ prompt-payment of claims statute, which requires an insurer to pay interest and reasonable attorney fees if it does not respond to and/or pay a claim within a statutory deadline, applies to defense costs.
Factual and Procedural Background
The coverage dispute arose out of a lawsuit against an insured general contractor/ homebuilder, Lamar Homes, Inc. (Lamar), for construction defects. In April, 1997, Vincent and Janet DiMare entered into a contract to buy a house constructed by Lamar. In March, 2003, the DiMares sued Lamar in Texas state court for negligence and a “failure to design and/or construct the foundation of the DiMares’ residence in a good and workmanlike fashion in accordance with implied and express warranties” (the underlying litigation).
Lamar forwarded the suit to its insurer, Mid-Continent Casualty Company (Mid-Continent), seeking defense and indemnification under its CGL contract. Mid-Continent denied coverage, and Lamar sued Mid-Continent in a Texas state court, claiming that: 1) Mid-Continent owed Lamar a defense, and 2) that Mid- Continent’s failure to tender a defense violated former Texas Insurance Code Article 21.55 (recodified as sections 542.051-.061), the prompt-payment of claims statute. Mid-Continent removed the suit to federal court, where the parties filed cross-motions for summary judgment.
The federal district court held that Mid- Continent did not have a duty to defend. The district court explained that “[t]he purpose of comprehensive liability insurance coverage for a builder 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.” To do otherwise, noted the court, would create a performance bond.
The DiMares appealed the decision to the Fifth Circuit which, in turn, certified three questions to the Texas Supreme Court:
1. When a homebuyer sues his general contractor for construction defects and alleges only damage to or loss of use of the home itself, do such allegations allege an “accident” or “occurrence” sufficient to trigger the duty to defend or indemnify under a CGL policy?
2. When a homebuyer sues his general contractor for construction defects and alleges only damage to or loss of use of the home itself, do such allegations allege “property damage” sufficient to trigger the duty to defend or indemnify under a CGL policy?
3. If the answers to certified questions one and two are answered in the affirmative, does Article 21.55 of the Texas Insurance Code apply to a CGL insurer’s breach of the duty to defend?
In a six-to-three decision, the Texas Supreme Court answered “yes” to all three certified questions. The Court held that, with respect to the duty to defend, defective construction may constitute property damage caused by an occurrence. The Court also held that the prompt-payment of claims statute applied to an insured’s request for a defense under a CGL contract.
To answer the first certified question, the Court analyzed whether defective construction is an occurrence.
An “occurrence” was defined in the CGL contract as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Based on this definition, Mid-Continent argued that faulty workmanship was not an accident because injury to a contractor’s work is an expected and foreseeable consequence.
Although not defined in the CGL contract, the Court found an “accident” to mean a “fortuitous, unexpected, and unintended event.” (citations omitted). The Court stated that it had previously held that an intentional tort was not an accident and thus not an occurrence. The Court contrasted this with the situation where an insured engages in a deliberate act that causes an unexpected result. The Court reasoned that “a deliberate act, performed negligently, is an accident if the effect is not the intended or expected result; that is, the result would have been different had the deliberate act been performed correctly.”
The Court disagreed with the federal district court’s reasoning that damage to the insured’s work was not an occurrence but damage to a third-party’s property was an occurrence. The Court stated “[t]he CGL policy . . . does not define an ‘occurrence’ in terms of the ownership or character of the property damaged” and there is “no logical basis within the ‘occurrence’ definition [that] allows for distinguishing between damage to the insured’s work and damage to some third party’s property.”
The Court concluded that the underlying complaint alleged “an ‘occurrence’ because it asserts that Lamar’s defective construction was a product of its negligence. No one alleges that Lamar intended or expected its work or its subcontractors’ work to damage the DiMares’ home.”
The Court also addressed the second certified question -- whether defective construction is property damage.
Under the CGL contract, “property damage” was defined as “[p]hysical injury to tangible property, including all resulting loss of use of that property.” The Court stated that “this definition does not eliminate the general contractor’s work.” In the underlying litigation, 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 Court found that the allegations of cracking sheetrock and stone veneer are allegations of “physical injury” to “tangible property.”
With respect to the federal district court’s argument that providing coverage for faulty workmanship would convert CGL insurance into a performance bond, the Texas Supreme Court stated that “[n]o rule of construction operates to eliminate coverage simply because similar protection may be available through another insurance product.”
With respect to the federal district court’s argument that CGL insurance “is not for the repair or replacement of . . . defective work,” the Court acknowledged that this may be true in some instances. For example, faulty workmanship that is intentional from the viewpoint of the insured is not an “occurrence,” or that merely diminishes the value of the home without causing physical injury or loss of use does not involve “property damage.” The Court stated, however, that “more often . . . faulty workmanship will be excluded from coverage by specific exclusions because that is the CGL’s structure.”
The Court discussed exclusions (j)(5), which excludes coverage for an insured’s work while operations are being performed, and l (your work exclusion), which excludes coverage for damage to an insured’s completed work unless that work is performed by a subcontractor. The Court stated that exclusion l would have barred coverage if it had not contained the subcontractor exception.
The Court discussed the drafting history of the exclusions, and explained that when the Insurance Services Offices (ISO) issued the 1986 CGL form, which incorporated the subcontractor exception into the your work exclusion, “the insurance industry specifically contemplated coverage for property damage caused by a subcontractor’s defective performance.” The Court stated that ISO has since issued an endorsement to eliminate the subcontractor exception to the your work exclusion.
The Court rejected the argument that under the economic-loss rule damage to Lamar’s own work is not “property damage,” but rather a contractual, economic loss. The economic loss rule, in the eyes of the Court, was “not a useful tool for determining insurance coverage” because the CGL contract made no distinction between tort and economic damages.
In conclusion, the Court stated that “we agree with the Fifth Circuit that ‘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.”
Prompt-Payment of Claims Statute
The third certified question asked whether an insured may avail itself of the remedies available under sections 542.051-.061 of the Texas Insurance Code (formerly Article 21.55) where the insurer denies a defense for claims that trigger coverage under a CGL contract. The Court held that the prompt-payment statute applied to a claim for defense costs.
The prompt-payment statute sets deadlines for an insurer to respond to a claim. The statute provides that an insurer that does not promptly respond to, or pay, a claim is liable not only for the amount of the claim, but also for “interest on the amount of the claim at the rate of 18 percent a year as damages, together with reasonable attorney’s fees.” Tex. Ins. Code § 542.060(a). “Claim” is defined as “a first party claim . . . [that] must be paid by the insurer directly to the insured . . .” Id. § 542.051(2). The statute does not define “a first-party claim.”
The Court stated that a first party claim is when “an insured seeks recovery for the insured’s own loss,” whereas a third party claim is when “an insured seeks coverage for injuries to a third party.” (citation omitted). Based upon that distinction, the Court held that a claim for defense costs is a first party claim because the insured is the only party who will suffer the loss or benefit from the claim.
The Court then discussed how the prompt-payment statute would apply to a claim for defense costs. After receiving written notice of a claim, an insurer has 15 days to acknowledge receipt, commence its investigation, and “request from the claimant all items, statements and forms that the insurer reasonably believes, at that time, will be required from the claimant.” Id. §§ 542.051(4), 542.055. If additional information is needed from the claimant, the insurer may make additional requests. Id. § 542.055(b). The statutory deadlines for paying a claim do not begin to run until the insurer has “receive[d] all items, statements, and forms required by the insurer to secure final proof of loss.” Id. §§ 542.056(a), 542.058. Thus, the Court concluded that an insured must submit its legal bills to the insurer and any penalty would run from the date that the bills are submitted.
Texas has adopted the minority view and held that an insured general contractor’s faulty workmanship may constitute property damage caused by an occurrence, triggering a defense obligation. Texas still recognizes that, however, defective workmanship may not be an occurrence if only intentional conduct or no physical injury is alleged.
An insurer must therefore carefully review the pleadings to determine if allegations of faulty workmanship trigger the duty to defend. The Texas Supreme Court also recognized that the business risk exclusions may bar coverage for faulty workmanship, and also recognized that an endorsement may be added to a CGL contract issued to a general contractor that would bar coverage for all faulty workmanship. Accordingly, if an insurer wants to preclude coverage for all of a general contractor’s faulty workmanship, it should consider endorsing its contracts to do so.
Texas also has now clarified that an insurer handling a claim seeking a defense under a CGL contract must comply with the statutory claims-handling deadlines contained in sections 542.051-.061 of the Texas Insurance Code. Thus, an insurer should respond to a written notice of a claim within the statutory deadlines. With respect to the statute’s application to defense costs, an insurer may be liable for statutory penalties from the date that the insured submits invoices for defense costs to the insurer.