As a non-attorney insurance practitioner
who has been closely studying the commercial general liability (CGL) policy
for some time now—including its history and evolution to its current form—I
occasionally come across a coverage decision that seems so anomalous that it
commands my attention. The recent decision by the Fifth Circuit Court of
Appeals in Ewing Constr. Co., Inc. v. Amerisure Ins.
Co., 2012 U.S. App. LEXIS 12154 (5th Cir. Tex. June 15, 2012), is one
of those cases.
Craig F. Stanovich
Austin & Stanovich
Risk Managers, LLC
Applying Texas law, the Fifth Circuit expanded a previous holding by the
Texas Supreme Court in Gilbert Tex. Constr. LP v. Underwriters at Lloyd's
of London, 327 S.W.3d 118 (Tex. 2010), as to the scope and
meaning of the contractual liability exclusion in the CGL policy.
Ewing contracted with a school district to build tennis courts.
Shortly after the courts were finished, they were cracking and flaking and
unfit for playing tennis. Because the Texas Supreme Court had decided
earlier in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242
S.W.3d.1 (Tex. 2007), that faulty work could be an
occurrence and cause property damage (but coverage may be eliminated by
subsequent exclusions), the usual arguments of "no occurrence" and "no
property damage" were apparently not advanced by the insurer. In fact, there
was agreement that the physical defects in the tennis courts constituted
property damage caused by an occurrence.
Nonetheless, the insurer denied
coverage in what can only be described as a novel argument in the
construction defect wars. The insurer contended that the CGL's
liability exclusion eliminated coverage for defective
construction, so there was no duty to defend Ewing for the suit brought by
the school district for damages alleging defective construction to the
tennis courts. Specifically, the Fifth Circuit ruled:
that constitutes a mere breach of contract is not covered by the GL policy
because liability for deficient performance is contractual liability
excluded under the contractual liability exclusion.
In the Gilbert case, the
Texas Supreme Court found that the contractual liability exclusion applied
to what all observers seem to agree was a rather unique set of
circumstances. Gilbert was contracted to work with the Dallas Area Rapid
Transit (DART) agency to construct a rail system. Gilbert agreed in its
contract with DART to protect from damage and repair damage to third-party
properties that resulted from the construction.
Heavy rains during the
construction caused flooding in a building near the work site, and the
building owner sued Gilbert. Here is the unique part—Gilbert was protected
by DART's tort immunity, so Gilbert could not be held
liable under tort law for the damage to the third party's flooded property.
The only obligation that the building owner was able to enforce (as a
third-party beneficiary) was the contract to repair the damage to the
building caused by the construction. Gilbert's excess insurer, Lloyd's of
London (referred to as Underwriters) denied coverage to Gilbert, asserting
that the contractual liability exclusion eliminated coverage. In short, as
Gilbert was not liable under "general law," Gilbert had "assumed the
liability" to protect and repair the third party's property, and thus this
"assumed liability" was excluded.
a lengthy review of the holdings of other jurisdictions on the
interpretation and construction of the CGL policy's contractual liability
exclusion, the Gilbert court focused on the portion of the
contractual liability exclusion as respects Gilbert's obligation to pay
damages "by reason of the assumption of liability in a contract or
The Gilbert court concluded that the "plain meaning"
of the phrase "assumption of liability" should be determined by using
dictionary definitions, that "assume" means to "undertake" (Webster's Third
New International Dictionary 133, 2002), and that
"liability" is "the state or quality of being legally obligated or
accountable" (Black's Law Dictionary 997, 9th ed. 2009).
Thus, the Texas Supreme Court agreed with Lloyd's, the excess insurer, and
ruled that Gilbert had undertaken legal accountability for property damage
to the third party's property. The result was that Gilbert's undertaking
constituted an "assumption of liability" that "extended beyond Gilbert's
obligations under general law and incorporates contractual standards to
which Gilbert obligated itself." Thus, the damages claimed by the
third-party property owner were excluded by the contractual liability
exclusion of Gilbert's liability policy.
Circuit in Ewing took a leap, concluding that simply because
Ewing had contracted to build a tennis court, Ewing had also "assumed
liability for a construction defect." The result was that the insurer was
able to apply the CGL policy's contractual liability exclusion to avoid
coverage for the construction defect claim.
Unlike Gilbert, which did not involve damage to the policyholder's work, the Fifth Circuit
concluded that the CGL policy should not apply to
defect claims. The majority conceded as much in its
Applying this plain meaning approach preserves the longstanding
principle that a CGL policy is not protection for the insured's poor
performance of a contract. Although other jurisdictions adopt this principle
by holding that poor contractual performance is not, under a CGL policy, an
occurrence causing property damage, Texas chooses to arrive at this holding
through its interpretation of exclusions. Our holding today respects this
Consider a builder that contracts with an owner to build a new garage for
the owner. The contract will spell out the scope of work, the costs, etc.
But it is very hard to imagine that either the builder or the owner would
describe the contract as one that assumes liability.
course, the builder is accountable to build the garage. If the garage that
is built is defective and collapses, certainly the owner will seek a remedy.
But the builder did not agree to build a defective garage and further did
not agree to pay damages for that defective garage. All of that results from
something the builder did not agree to—defective construction. Yet, this is
how the majority in the Fifth Circuit characterizes all construction
contracts, as an assumption of liability.
The dissent in Ewing correctly
points this out: "no one interpreted this case as the majority does here, to
hold an 'assumption of liability' is inherent in every agreement to perform
a construction contract." [Emphasis added]
It is well settled that the standard
Insurance Services Office, Inc. (ISO), CGL policy includes coverage for
"products and completed operations" subject, of course, to all policy
exclusions, limitations, conditions, and definitions. Coverage provided
within products and completed operations has to be considered in
interpreting the CGL policy, particularly when deciding whether
warranties amount to an assumption of liability and are
thus excluded by the CGL.1
coverage is defined in policy form CG 00 01 12 07 under the
"product-completed operations hazard" as including "all 'bodily injury' and
'property damage' occurring away from premises you own or rent and arising
out of 'your product' or 'your work....'" "Your work" is also defined to
mean "(1) Work or operations performed by you or on your behalf; and (2)
Materials, parts or equipment furnished in connection with such work or
operations." This includes "(1) Warranties or representations made at any
time with respect to the fitness, quality, durability, performance or use of
'your work' and (2) The providing of or failing to provide
warning or instructions...." [Emphasis added.]
What is abundantly clear from
even a cursory review of the entire CGL policy is that
coverage is granted for bodily injury or property damage arising out of
"your work" and that "your work" includes any warranties or representations
made about the work—its quality, performance, or use. Stated differently,
the CGL policy expressly provides coverage for bodily injury or property
damage that may result from a breach of a warranty made with respect to work
The Fifth Circuit's holding that the contractual liability
exclusion is intended to eliminate all coverage for
warranties is contrary to the plain meaning of products and
completed operations coverage and further renders the definition of "your
The Fifth Circuit's opinion appears to be based in part on
the assumption that ISO intended to change the scope of coverage for
warranties for work performed because of changes to the wording in the
contractual liability exclusion made with the 1986 ISO CGL (and later
The contractual liability exclusion in the ISO comprehensive
general liability insurance policy, 1973 edition, included this exception:
"… but this exclusion does not apply to a warranty of fitness or quality of
the named insured's products or a warranty that work performed by or on
behalf of the named insured will be done in a workmanlike manner.…" As this
exception does not appear in today's CGL contractual liability exclusion,
some have speculated that ISO intended to remove coverage
for damages because of bodily injury or property damage if the bodily injury
or property damage results from the policyholder's work, specifically if the
liability is alleged to be a breach of warranty.
Such speculation is
unsupported by actual policy wording found in the 1986 CGL
edition (and later editions). It is quite clear that coverage is still
included within today's CGL policy; the reference to warranties has simply
been moved from the contractual liability exclusion to the definition of
"your work," a term not defined in the 1973 CGL policy.2
Today's CGL policy excludes property damage to "your work" (which
includes work done on behalf of the policyholder by a subcontractor) arising
out of it (the work) or any part of it. For the exclusion to apply, the work
must fall within the "product-completed operations hazard" when it suffers
property damage. This exclusion is commonly understood, both within and
outside of the insurance industry, to eliminate coverage when the
policyholder's work is defective and damages itself.
With the earlier
illustration, if the garage is completely built and then collapses due to
defective construction, it is clear that the builder's CGL will not pay for
the damages for which the builder may be liable as property damage. The
nature of the allegations do not matter—negligence, breach of warranty,
failure to complete the garage in a workmanlike manner—the property damage
to the builder's finished work is excluded by the "your work" exclusion.
Fifth Circuit recognizes that its interpretation of the contractual
liability exclusion "overlaps" with the "your work" exclusion and suggests
they would rather avoid the "confusion of overlapping exclusions," but
nonetheless maintains that the contractual liability exclusion eliminates
coverage for defective construction.
very important exception to the "your work" exclusion establishes that the
exclusion for property damage to the policyholder's finished work
apply if the work out of which the damage arises (or the
damaged work itself) is work performed on behalf of the policyholder by a
In our garage example, if the builder had used a
subcontractor to prepare the site, and the cause of the garage collapse was
the subcontractor's failure to adequately prepare the footings and
foundation, the builder that contracted with the owner would have coverage
for property damage claimed by the owner against the builder for the
collapsed garage. Stated differently, the builder will have coverage for
defective construction if the defect that caused the
collapse was the faulty work of a subcontractor.
What may be easily overlooked and too often
summarily dismissed is the critical importance of the "subcontractor
exception" and the insurance industry's time-honored recognition of its role
in the CGL policy. The "subcontractor exception" has been an integral part
of the CGL policy for decades and has been coverage offered by the insurance
industry and purchased by policyholders (for an additional premium) for
almost 40 years.
In the 1973 ISO comprehensive general liability policy, a
policyholder could readily purchase for an additional premium broad form property damage liability coverage (including completed
operations), which limited the application of the exclusion to work
performed by the named insured.
The exclusion to property damage to work
performed within the 1973 CGL without the broad form
property damage liability coverage was "(o) to property damage to work
performed by or on behalf of the named insured arising out
of the work or any portion thereof."
The broad form property damage
liability coverage endorsement made the following changes:
(k) and (o) are replaced by the following:
(3) with respect to the completed
operations hazard … to property damage to work performed by the named
insured arising out of such work….
Coverage for property
damage caused by a subcontractor's faulty work (i.e., the subcontractor
exception) was formerly provided by removing from exclusion (o) the phrase
"or on behalf of the named insured" and limiting the
exclusion for property damage to only the work performed directly by the
publications announcing the changes to the CGL policy (the commercial
general liability policy, 1986 edition), ISO unequivocally acknowledged that
the broad form property damage liability coverage was included within the
new CGL policy:
Broad Form Endorsement … also covers damages caused by
faulty workmanship … and damage to or caused by a subcontractor's work after
the insured's operations are completed. Broad Form coverage
has been incorporated in the new provisions … so that broad form coverage
for work and completed operations clearly applies.3
It is well understood by those in the insurance industry
that today's CGL policy includes the broad form coverage, the additional
charge now included in the policyholder's CGL premium. In
fact, not only does the insurance industry understand the import of the
subcontractor exception, but everyone also knows that an insurer may
eliminate the subcontract exception found in today's CGL—provided the
insurer and policyholder agree to this restriction in coverage.4
Relying on the contractual
exclusion instead of the "overlapping" exclusion for "your work" has the
effect of avoiding entirely the subcontractor exception to the "your work"
exclusion—protection the policyholder has purchased for years but will never
receive if the contractual exclusion is applied in the manner decided by the
Fifth Circuit. Failing to provide the policyholder the benefit of this
bargain—by negating the effect of the subcontractor's exception—is the basis
of the dissent by W. Eugene Davis, who was "troubled by this predicament":
In this case, the underlying petition alleges faulty workmanship by the
subcontractors and the contractor, and the policy does not include an
endorsement eliminating the subcontractor exception. Thus, the well known
endorsement discussed in the above cases was available in this case to
exclude coverage for defects caused by the subcontractor's work had the
parties bargained it in the policy. They did not do so. We should respect
Ewing Construction agreed to build tennis
courts. In its contract with the school district, Ewing did not agree to
assume liability for defective construction. The majority's position that
every construction contract is an "assumption of liability" is not only
contrary to an ordinary person's understanding of what is agreed upon in a
construction contract; such an interpretation robs policyholders of the
benefit of the bargain—the CGL insurance for which they have paid—the
subcontractor's exception to the "your work" exclusion.
In other words, it
is clear that the majority sought to eliminate coverage for construction
defects but could not do so through the "occurrence as property damage"
route. This typical argument was not available to Amerisure because of the
holding in Lamar Homes. Left with only the "your work"
exclusion and its subcontractor exception, the Fifth Circuit's majority
instead chose another avenue to eliminate coverage—by imposing an expansive
interpretation of what constitutes "assumption of liability" in a
contract—and thus avoided the "your work" exclusion and the well-established
Amerisure could have chosen to eliminate the
subcontractor exception but chose not to do so, and therefore Amerisure's
bargain with Ewing Construction was to include the
subcontractor exception. As correctly pointed out by the dissent, the
majority has read the subcontractor exception out of existence, rendering a
major portion of the CGL superfluous.5 As the dissent
suggests, the bargain made between the insurer and its policyholder must be
1"The principles Texas courts use in
interpreting an insurance policy are well established. We examine the entire
agreement and seek to harmonize and give effect to all provisions so none
will be meaningless." Gilbert Tex. Constr. LP v. Underwriters at Lloyd's of
London, 327 S.W.3d 118 (Tex. 2010), quoting MCI Telecomms. Corp.
v. Texas Utils. Elec. Co., 995 S.W.2d 647 (Tex. 1999).
2"We explained that the 'label attached to the
cause of action--whether it be tort, contract or warranty--does not
determine the duty to defend' and that 'any preconceived notion that a
policy is only for tort liability must yield to the policy's actual
language.'" Gilbert Tex. Constr. LP v. Underwriters at
Lloyd's of London, 327 S.W.3d 118 (Tex. 2010). [Emphasis added.]
3Important Notice to Policyholder—ISO General Liability Policy Revision—Highlights of Current and
Revised Contracts, pg. 6. Copyright, Insurance Services Office, Inc. 1984,
4CG 22 94 exclusion—"Damage to Your
Work Performed by a Subcontractor on Your Behalf."
majority acknowledges this issue but endorses the contractual liability
exclusion as merely another way to resolve these type cases. This position
would be acceptable if the application of the contractual liability
exclusion and the 'your work' exclusion led to the same result. However, the
'your work' exclusion contains the 'subcontractor exception,' for which the
contractual liability exclusion contains no equivalent. The majority thus
reads this exception out of existence." W. Eugene Davis, circuit judge,
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