Texas Supreme Court Takes Up Contractual Liability Issue, Again

One of the most fascinating aspects of writing about insurance litigation is that often issues that we discuss seem to be “finally” decided, only to reappear again.

For instance, previously for Insurance Journal we discussed a landmark case involving the viability of the contractual liability exclusion in a column just a little over a year ago. At that time, the Texas Supreme Court in Gilbert Texas Construction, L.P. v. Underwriters at Lloyd’s London, upheld the application of the exclusion in a construction defect case. This decision was rightly considered a groundbreaking decision because it reinvigorated the use of the exclusion and also included a discussion of the estoppel doctrine.

While the Gilbert decision established the viability of the exclusion under relatively narrow facts, it was anticipated that the cases following it would apply Gilbert to generally bar coverage for faulty workmanship claims.

On June 15, 2012 the United States Court of Appeals for the Fifth Circuit, in a split 2-1 decision, adopted a very broad reading of Gilbert in Ewing Construction Company v. Amerisure Insurance Company, 2012 U.S. App. Lexis 12154 (5th Cir. 2012).

The Ewing decision held that the contractual liability exclusion unequivocally barred coverage for faulty workmanship. The case involved a contract for the construction of tennis courts for a school district. Soon after the tennis courts were completed, the school district complained that they were cracking and flaking. After Amerisure denied the contractor’s (Ewing) request for defense and indemnity for a lawsuit brought by the school district, the insured filed a declaratory judgment action seeking coverage.

In analyzing whether the contractual liability exclusion applies to the allegations of the underlying lawsuit, the Fifth Circuit stated that Gilbert “stands for the proposition that a CGL policy’s contractual liability exclusion excludes coverage for property damage when ‘the insured assumes liability for … property damage by means of contract…’.”

As a result, it found that the exclusion applied to the allegations of the underlying lawsuit because Ewing assumed liability for defective construction by agreeing to complete the construction of the tennis courts. In so holding, the Fifth Circuit rejected Ewing’s argument that Gilbert was distinguishable and did not apply to implied promises contained in every contract.

The opinion states that “[w]hether a breached promise was implied or express, the promise was of a contractual nature, all the same.” The Fifth Circuit also stated that its holding preserved the “longstanding principle” that a CGL policy was not meant to protect the insured from its poor performance of a contract, citing an earlier Texas Supreme Court construction coverage case, Lamar Homes, Inc. v. Mid-Continent Cas. Co., from 2007.

Further, while the school district asserted a claim for both breach of contract and for negligence, the Court held that the school district’s claim for negligence was really a contract claim. So, no exception to the contractual liability exclusion applied. As a result, the Fifth Circuit held that Amerisure had a duty to defend.

The dissenting opinion argued vigorously that the implied warranties assumed by Ewing were easily distinguishable from the contractual liability to repair property damage of third parties the insured assumed in Gilbert. It also criticized the majority opinions’ expansion of the exclusion from Gilbert’s narrower holding that turned on the specific language of a particular contract’s provisions.

The contract in Gilbert included an express provision that provided that Gilbert was responsible for any damage done to nearby third-party property. The contract in Ewing contained no such provision. Further, the dispute only involved damage to the tennis courts and did not also include damage to any other property.

Thus, the dissent complained that the contractual obligations in these two cases were critically different and that in Gilbert the Texas Supreme Court held that Gilbert’s additionally agreed upon liability was an expressly assumed liability that fell within the language of the exclusion. The dissent further noted that commentators analyzing Gilbert read it as (1) rejecting the insured’s argument that the exclusion was limited to the assumption of liability of a third party and (2) that Gilbert assumed liability because in addition to performing the work under the contact, it also agreed to be responsible for any damage to the nearby property.

Like the majority decision, the dissent agreed that CGL policies should not act like de facto performance bonds. However, the dissent noted that the majority holding essentially gutted the “business risk” exclusions, including those containing exceptions for work done by subcontractors. As a result of the majority’s holding, the dissent argued that general contractors would have no coverage for faulty workmanship of a subcontractor because all claims for construction defects or faulty workmanship would be precluded by the exclusion.

The Fifth Circuit Reconsiders

Following the Ewing decision in June, there was a flurry of articles both applauding and criticizing the Fifth Circuit’s expansion of Gilbert. A common complaint was that under the Ewing court’s reasoning, an insurer would now have its pick of either the “your work” exclusion or the contractual liability exclusion without the exception for subcontracted work.

On Aug. 8, 2012, however, the Fifth Circuit surprised many of us by withdrawing its decision and sending the following questions to the Texas Supreme Court for their consideration:

1. Does a general contractor that enters into a contract in which it agrees to perform is construction work in a good and workmanlike manner, without more specific provisions enlarging this obligation, “assume liability” for damages arising out of the contractor’s defective work so as to trigger the Contractual Liability Exclusion?
2. If the answer to question one is “Yes” and the contractual liability exclusion is triggered, do the allegations in the underlying lawsuit alleging that the contractor violated its common law duty to perform the contract in a careful, workmanlike, and non-negligent manner fall within the exception to the contractual liability exclusion for “liability that would exist in the absence of contract”?

Apparently, the Fifth Circuit belatedly recognized that its ruling in Ewing may have overly expanded the scope of Gilbert, and is seeking guidance from the Texas Supreme Court to apply the proper scope to the contractual liability exclusion. The Texas Supreme Court has already accepted the certified questions and has set a briefing schedule. Given the current schedule, it is likely that we will have a definitive answer as to the proper scope and application of Gilbert by Spring 2013.

In any event, given the continuing confusion and flux regarding CGL policies and contractual liability, it will be a relief to have clear guidance from the Texas Supreme Court as to the proper application of the Gilbert decision. And so, for at least some time to come, another “resolved” issues is unresolved again.

Martin is a partner and Patrick is an associate in the Insurance Litigation and Coverage Practice of the law firm of Thompson Coe Cousins & Irons LLP.