One issue that has tremendous implications for insureds in the construction
industry is the contractual liability exclusion. In the past 2 to 3 years,
cases have been decided that have cast doubt on prior decisions and have
created tremendous uncertainty as to the breadth of the exclusion.
The liability insurance policy contains certain exclusions that may apply in
whole or in part and affect available coverage.
- Exclusion b.—Contract Exclusion
The policy provides that the insurance does not apply to:
- "Bodily injury"
or "property damage" for which the insured is obligated to pay
damages by reason of the assumption of liability in a contract or agreement.
This exclusion does not apply to liability for damages:
(1) That the insured would have in the
absence of the contract or agreement; or
(2) Assumed in a contract or agreement that
is an "insured contract," provided the "bodily injury" or
"property damage" occurs subsequent to the execution of the contract
or agreement....
Generally speaking, the majority of courts interpreting this exclusion have
held that the exclusion applies to a limited category of cases in which the
insured assumes the tort liability of another, such as in an indemnity or hold
harmless agreement.1 But this is not always the
case.
Gilbert Texas Construction v. Underwriters at
Lloyd's, London
The Texas Supreme Court broadened this general position on the issue of
contractual liability exclusions, holding that exclusion 2.b. applies to any
liability assumed by the insured under a contract or agreement that does not
fit within the stated exceptions. In Gilbert Tex.
Constr. LP v. Underwriters at Lloyd's, London, 327 S.W.3d 118 (Tex.
2010), the Dallas Area Rapid Transit (DART) contracted with Gilbert to
construct part of the DART light rail system. During construction, a building
adjacent to the construction site owned by RT Realty (RTR) was flooded. The
contract between DART and Gilbert obligated Gilbert to "protect from
damage all existing improvement and utilities ... on adjacent property of a
third party" and to "repair any damage to those facilities, including
those that are the property of a third party, resulting from failure to comply
with the requirements of this contract or the failure to exercise reasonable
care in performing the work." RTR sued Gilbert and others for its damages.
RTR originally sued on tort and statutory theories of liability and then added
a breach of contract claim. Gilbert moved for summary judgment on governmental
immunity grounds, and the trial court granted partial summary judgment in favor
of Gilbert, dismissing all claims except for the breach of contract claim.
Gilbert was insured under a primary policy issued by Argonaut, which assumed
Gilbert's defense. Gilbert was also insured by Lloyd's of London under
a series of "follow form" excess policies. Lloyd's issued several
reservations of rights letters throughout the pendency of the suit. After the
trial court granted partial summary judgment in favor of Gilbert on the
immunity defense, Lloyd's issued another reservation of rights letter
taking the specific position that the contractual liability exclusion applied
to exclude the remaining breach of contract claim. Gilbert settled RTR's
claim for $6.175 million, and Lloyd's denied coverage for the settlement,
relying on this exclusion.
In the ensuing coverage dispute, Gilbert argued that the contractual
liability exclusion only applies when the insured assumes the liability of a
third party (such as in a contractual indemnification agreement) and does not
apply to a situation where, such as in this case, the insured assumes direct
liability to a third party by contract. Gilbert also argued that even if the
exclusion applies, an exception to the exclusion brings the breach of contract
claim back into coverage because Gilbert would not have been liable to RTR in
the absence of its contract with DART. The trial court held in favor of
Gilbert, but the case was reversed on appeal.
The Texas Supreme Court affirmed, holding that the contractual liability
exclusion applied to exclude coverage for Gilbert's liability to RTR.
Applying general rules of contract construction, the court held:
Considered as a whole, the contractual liability exclusion
and its two exceptions provide that the policy does not apply to bodily injury
or property damage for which the insured is obligated to pay damages by reason
of the assumption of liability in a contract or agreement, except for
enumerated, specific types of contracts called "insured contracts"
and except for instances in which the insured would have liability apart from
the contract.
Gilbert, 327 S.W.3d at 129.
The court found that Gilbert agreed in its contract with DART to repair any
damage to the property of a third party resulting from its failure to comply
with the terms of the contract or exercise reasonable care in its work. The
only theory of liability remaining at the time Gilbert settled with RTR arose
from this contractual obligation. Thus, the Texas Supreme Court held that the
exclusion unambiguously applied to preclude coverage for Gilbert's
settlement with RTR. In reaching this conclusion, the court rejected
Gilbert's argument that the contractual liability exclusion only applies
when the insured assumes the liability of another, such as in a contractual
indemnity agreement. The court held that if the exclusion was intended to apply
only to a contract in which the insured assumes liability of another party via
an indemnity or hold harmless agreement, it would have been simple to state
this, and the court declined to judicially rewrite the policy. The
"insured contract" exception to the contractual liability exclusion
reinforced the court's conclusion because it specifically reinstated the
very type of coverage Gilbert contended the entire exclusion was limited
to—contractual liability of a third party assumed by the insured. This
exception to the exclusion demonstrated that the parties were capable of using
specific, narrowing language when that was their intent.
Gilbert also argued that the second exception to the contractual liability
exclusion (damages the insured would have been responsible for in the absence
of the contract) brought the settlement back into coverage. Gilbert reasoned
that, if no contract existed in the first place, it would not have had immunity
and RTR's negligence claim against Gilbert would not have been subject to
an immunity defense. The Texas Supreme Court rejected this argument as well,
holding that "Gilbert had asserted no other basis for its settlement than
the breach of contract claim; thus, Gilbert's settlement payment for which
it seeks indemnity simply was not a liability for damages it had apart from its
contract with DART, as it must have been for the second exception to
apply." The court explained:
Gilbert would have us disregard the actual facts underlying
its settlement and hold that the exception applies even to potential liability
that Gilbert might have had if it had not entered into a contract with
DART. We decline to do so. Indemnity under a liability policy depends on actual
facts and adjudicated liability, not possible scenarios that did not occur.
Id. at 133, 134 (emphasis in original).
Ewing Construction v. Amerisure—District
Court
Following the Gilbert case, a federal
district court had the first opportunity to address the scope of the
Gilbert decision in the case of Ewing Constr.
Co. v. Amerisure Ins. Co., 814 F. Supp. 2d 739 (S.D. Tex. 2011). On
February 25, 2010, Ewing was sued in a lawsuit styled Tuloso-Midway Indep. Sch. Dist. v. Liberty Mut. Ins. Co.,
Cause No. 10–603421, in County Court at Law No. 1 of Nueces County, Texas (the
"Underlying Lawsuit"). The plaintiff in the underlying lawsuit,
Tuloso-Midway Independent School District ("Tuloso-Midway"), sought
damages from Ewing with regard to allegedly deficient construction of a tennis
facility in Corpus Christi, Texas, pursuant to a contract between Ewing and
Tuloso-Midway (the "Contract"). One issue was the application of the
contractual liability exclusion. The contractual liability exclusion to the
policy provided, in relevant part:
This insurance does not apply to:
b. Contractual Liability
"[B]odily injury" or "property damage"
for which the insured is obligated to pay damages by reasons of the assumption
of liability in a contract or agreement. This exclusion does not apply to
liability for damages:
(1) That the insured would have in the absence of the
contract or agreement; or
(2) Assumed in a contract or agreement that is an
"insured contract" ...
The district court was faced with the interpretation of Gilbert. It held that:
With respect to the "assumption of liability" part
of the exclusion, the Texas Supreme Court in Gilbert explained that the
exclusion is not limited to situations where "the insured assumes the
liability of another, such as in an indemnity or hold-harmless agreement,"
but rather "the exclusion's language applies without qualification to
liability assumed by contract [with two exceptions.]" Id. at 128-29. The
court concluded that the contractual liability exclusion "means what it
says," and "applies when the insured assumes liability for bodily
injuries or property damages by means of contract, unless an exception to the
exclusion brings a claim back into coverage or unless the insured would have
liability in the absence of the contract or agreement." Id. at 132....
Upon review, the Court concludes that the allegations in the
underlying petitions sufficiently demonstrate that Ewing assumed liability for
its own construction work pursuant to the parties' contract. In other
words, by entering into the contract with Tuloso-Midway, Ewing is liable if the
work it agreed to perform under that contract is defective. This finding is
consistent with Gilbert and the case law relied upon therein. See, e.g., TGA
Development, Inc., 62 F.3d at 1091-92 (stating that policy excluded coverage of
injuries "[f]or which the insured has assumed liability in a contract or
agreement," and finding that this "language plainly excludes coverage
for contractual claims made for [insured's] failure to provide [third
party] with a condominium unit free from defects.") (cited in Gilbert, 327
S.W.3d at 130 n. 9); Monticello Ins. Co., 1998 WL 1969611, at *2
("Liability under a contract does not arise only when a party assumes the
liability for another party. Any party to a contract assumes potential
liability under the agreement."). Applying Gilbert, the Court concludes
that Ewing assumed liability for its own defective work when it entered into
the contract with Tuloso-Midway for construction of the tennis courts at
issue....
Applying Hardscape here, Tuloso-Midway alleges in the
underlying suit that the tennis courts, the subject matter of the contract
between Tuloso-Midway and Ewing, began to crack and show other structural
defects soon after construction was completed. The damage alleged is damage to
the subject matter of the contract, nothing else. Tuloso-Midway's original
petition states that it wanted "quality tennis courts that should last at
least twenty-five years," that Ewing represented that it could perform the
work, and based upon these assurances the parties entered into the contract.
(D.E. 18-16 at 4-5.) It further states that "Ewing gave notice of
substantial completion on or about April 20, 2009 but serious tennis court
cracking and flaking problems have continued after that date to the present.
Chunks of the court surfaces are coming loose. Flaking, crumbling, and cracking
make the courts unusable for any competitive event." (D.E. 18-16 at 5.)
Tuloso-Midway states that the actions alleged "constitute breach of
contract," as "[t]he construction is not in accordance with the
contract plans and specifications." Notably, it pleads in the alternative
that Ewing "breached its implied duty of ordinary care to Plaintiff
through its negligence in the preparation and management of construction."
(D.E. 18-16 at 5 (emphasis added).) Tuloso-Midway's negligence claim is
also based solely upon Ewing's alleged failures in the tennis court
construction process, such as failure to properly prepare for and manage
construction, failure to properly retain and oversee subcontractors, and
failing to take corrective action. (D.E. 18-16 at 8.) The allegations in the
First Amended Original Petition do not differ materially in this regard. (D.E.
18-17 at 5.) Similar to the Original Petition, the amended petition states that
Ewing breached its contract in part by "[f]ailing to exercise ordinary
care in the preparation, management and execution of construction." (D.E.
18-17 at 7.) The negligence cause of action is based upon the same conduct that
forms the breach of contract claim. (D.E. 18-17 at 7, 8.) The Second Amended
Original Petition (presently the live pleading) also does not differ materially
on this topic. (D.E. 18-18 at 4).
Ewing Construction Co. v. Amerisure—Fifth
Circuit
Ewing appealed the case to the Fifth Circuit Court of Appeals (684 F.3d 512
(5th Cir. Tex. 2012)). The Fifth Circuit specifically addressed the allegations
that were lodged against Ewing Construction:
The petition goes on to allege the following failures:
Serious tennis court cracking and flaking problems began
shortly after completion of the work and have continued since. Chunks of the
court surfaces are coming loose. Flaking, crumbling, and cracking make the
courts unusable for their intended purpose, competitive tennis events....
It then alleges that Ewing breached its contract and
performed negligently:
Defendant Ewing Construction has breached its contractual
commitments, proximately causing damages to Plaintiff. On information and
belief, Plaintiff says that Defendant Ewing and/or its subcontractors breached
its contract in the following respects:
a) Failing to complete construction in accordance with the
contract plans and specifications;
b) Failing to exercise ordinary care in the preparation,
management and execution of construction;
c) Failing to perform in a good and workmanlike manner;
and
d Failing to properly retain and supervise
subcontractors.
Furthermore, Defendant Ewing Construction and/or its
subcontractors was/were guilty of negligence proximately causing damage to
Plaintiff in the following respects:
a) Failing to properly prepare for and manage the
construction;
b) Failing to properly retain and oversee
subcontractors;
c) Failing to perform in a good and workmanlike manner;
and
d) Failing to properly carry out the construction so that it
was in [sic] completed in accordance with the plans and specifications.
The petition also states that Ewing "breached [its]
duty to Plaintiff to use ordinary care in the performance of [its] contract[ ],
proximately causing damages to Plaintiff."
With respect to the general operation of the exclusion, the Fifth Circuit
held that:
Gilbert, principally, 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...." Id. at 132. The
School District's complaint in the underlying lawsuit reflects that the
insured, Ewing, assumed liability for defective construction by agreeing in a
contract to complete a construction project, specifically to build tennis
courts. Whether the breached promise was implied or express, the promise was of
a contractual nature, all the same. We therefore hold that the CGL policy's
contractual liability exclusion excludes coverage in the instant case.
The court then went on to address whether the exception to the exclusion
applied. The court held that it did not, ruling that:
The School District's use of the term
"negligence," however, is not dispositive. See Century Sur. Co. v. Hardscape Constr. Specialties, Inc., 578
F.3d 262, 267-70 (5th Cir. 2009). We must assess the substance of the School
District's petition and determine whether it alleges an action in contract,
tort, or both. Id. at 267 (citing Jim Walter
Homes, Inc. v. Reed, 711 S.W.2d 617, 617-18 (Tex. 1986)). To do this, we
look to the "source of liability and the nature of the plaintiff's
loss.... When the only loss or damage is to the subject matter of the contract,
the plaintiff's action is ordinarily on the contract." Id.
(quoting Sw. Bell Tel. Co. v. DeLanney, 809
S.W.2d 493, 494-95 & n. 2 (Tex.1991)).
Ewing's contract with the School District is the source
of its potential liability because Ewing's duty to construct usable tennis
courts arose out of contractual undertakings. Further, the damage alleged in
the School District's complaint is damage to the subject matter of the
contract, the tennis courts, not to any other property. The school
district's claim therefore sounds in contract, regardless of the other
labels that may be attached to it. Id. at 269-70. Because the
liability Ewing faces is contractual, it is not liability that would arise in
the absence of a contract. The exception, therefore, does not apply and
coverage remains excluded. We hold that Amerisure owes no duty to defend Ewing
in the underlying lawsuit.
Ewing Construction Co. v. Amerisure—Texas
Supreme Court
In response to the Fifth Circuit's opinion, a motion for rehearing and
rehearing en banc was filed by Ewing. This was joined by numerous amici. In
response, the Fifth Circuit has certified the following questions to the Texas
Supreme Court:
-
Does a general contractor that enters into a contract in which it agrees
to perform its 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.
-
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." We
disclaim any intention or desire that the Supreme Court of Texas confine
its reply to the precise form or scope of the questions certified.
The case was argued before the Texas Supreme Court on February 27, 2013, and
the decision is pending. However, many insurers and insureds alike are looking
ahead as to what can be done if the Texas Supreme Court follows the Fifth
Circuit. The most popular solution seems to endorse the policy to amend
Exclusion (b) to read that the insurance does not apply to:
b. "Bodily injury" or
"property damage" for which the insured is obligated
to pay damages by reason of the assumption of liability of a third
party in a contract or agreement....
It remains to be seen whether this modification or some other modification
will be necessary in order for those in the construction industry to obtain the
coverage they desire.
1See, e.g., Ferrell v. West Bend Mut. Ins. Co., 393 F.3d 786 (8th Cir.
2005); Federated Mut. Ins. Co. v. Grapevine Excavation
Inc., 197 F.3d 720 (5th Cir. 2000); Olympic,
Inc. v. Providence Wash. Ins. Co., 648 P.2d 1008 (Alaska 1982);
ACUITY v. Burd & Smith Constr., Inc., 2006
N.D. 187, 721 N.W.2d 33 (2006); Gibbs M. Smith, Inc. v.
U.S. Fid. & Guar. Co., 949 P.2d 337 (Utah 1997). But see
Nationwide Mut. Ins. Co. v. CPB Int'l Inc.,
No. 3:06–CV–0363, 2007 U.S. Dist. LEXIS 86506 (M.D. Pa. Nov. 26, 2007);
CIM Ins. Corp. v. Mid-Pac Auto Ctr., Inc., 108
F. Supp. 2d 1092 (D. Haw. 2000); Monticello Ins. Co. v.
Dismas Charities, Inc., No. 3:96–CV–550–S (W.D. Ky. Apr. 3, 1998);
Silk v. Flat Top Constr., Inc., 453 S.E.2d 356
(W. Va. 1994) (exclusion removed coverage for breach of contract); TGA Dev., Inc. v. Northern Ins. Co. of N.Y., 62 F.3d 1089
(8th Cir. 1995).