A storm may be a-brewing on the insurance coverage front. Recent case law from Texas indicates a shifting pattern in court decisions that could have disastrous consequences for insureds. Certain courts in Texas have interpreted the contractual liability exclusion in a general liability policy to preclude coverage when breach of contract is alleged in the underlying complaint.
This interpretation operates to preclude coverage for any insured that has agreed to perform work pursuant to a contract, when the litigation arises from the work described in the contract. Yes, you read that right — if a contract exists between two parties under which one of them will perform certain work, and a dispute later relates to that work — be it property damage, defective construction, etc. — an insurer may not have an obligation to defend or indemnify its insured due to the contractual liability exclusion. Fortunately, to date, Connecticut law has rejected this interpretation; however, if this trend continues, it could create many problems for insureds.
The contractual liability exclusion generally 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.
The exclusion commonly contains an exception for liability assumed in an “insured contract.” An “insured contract” is frequently defined to include leases of premises, sidetrack agreements, obligations to defend a municipality, or the assumption of tort liability pursuant to contract.
Ewing Construction Co. v. Amerisure Insurance Co.
In June 2012, the U.S. Court of Appeals for the Fifth Circuit rendered its decision in Ewing Construction Co. Inc. v. Amerisure Ins. Co., 684 F.3d 512, holding that an obligation implied in a contract is sufficient to qualify as “assumption of liability” that triggers the contractual liability exclusion in a general liability policy.
Ewing Construction Co. entered into a contract with a school district to construct tennis courts. Following construction, the courts began to flake and crack. The school district initiated suit against Ewing for breach of contract and negligence. Ewing tendered the claim to its insurer, Amerisure, which denied the claim, leading Ewing to file suit.
In its holding, the Fifth Circuit held that the contractual liability exclusion applies to any liability arising under contract (that is not otherwise exempted), and because Ewing contracted to build the tennis courts and assumed the liability associated with the construction of the courts, Amerisure had no duty to defend or indemnify Ewing. In rendering this decision, the Ewing court noted that the damage to “your work” exclusion (an exclusion for “property damage” to “your work” that arises out of “your work”) was rendered meaningless by its interpretation of the contractual liability exclusion.
On Aug. 8, 2012, on petition for rehearing, the Fifth Circuit withdrew its June 2012 opinion and certified two questions to the Texas Supreme Court regarding the scope of the contractual liability exclusion. The Texas Supreme Court accepted certification on Aug. 24, 2012.
Gilbert Texas Construction v. Underwriters at Lloyd’s of London
The court in Ewing based part of its analysis on an earlier Texas Supreme Court decision, Gilbert Texas Construction v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010). In that case, Gilbert Texas Construction contracted with the Dallas Area Rapid Transit Authority (DART) to construct a light rail system. During construction, a heavy rainstorm occurred and an adjacent building sustained damage — allegedly the result of Gilbert and DART’s storm water pollution prevention plan, which limited the amount of water that could flow into storm drains.
The building’s owner initiated suit against Gilbert and DART, and Gilbert tendered to its primary carrier, who assumed defense; however, Lloyd’s of London, Gilbert’s excess carrier, refused to indemnify Gilbert for the settlement with the building owner, pursuant to the policy’s contractual liability exclusion. The court determined that the contractual liability exclusion excluded coverage for property damage when the only basis for liability is that the insured contractually agreed to be responsible for the damage.
Gilbert argued that the contractual liability exclusion should only operate when the liability that was “assumed” via contract was the liability of a third party. The court held that in contracting with DART, Gilbert undertook an obligation to protect improvements and utilities to properties adjacent to the project and to repair or pay for any such damages. It was this contractual obligation that the court held precluded coverage to Gilbert via the contractual liability exclusion.
In contrast to Texas courts, one Connecticut court has interpreted the “contractual liability” exclusion in exactly the manner that Gilbert and Ewing argued — that the exclusion applies “to those situations where an insured agrees to indemnify a third — party pursuant to contract, not tortious conduct as it relates to duties pursuant to a contract under which an insured was established and from which it draws its legal existence.”
Nationwide Mutual Insurance Co. v. Lydall Woods Colonial Village Inc., No. X04CV020126640S, 2003 WL 21718376 (Conn. Super. Ct. July 14, 2003) opinion corrected on reargument, No. X04CV020126640S, 2003 WL 22598525 (Conn. Super. Ct. Oct. 29, 2003).
Lydall Woods is a planned urban development (PUD). Pursuant to the PUD bylaws, Lydall Woods was obligated to address water drainage issues affecting numerous homes in the PUD. Lydall Woods sought coverage pursuant to an all-risk policy procured from The Hartford. The Hartford denied coverage arguing, in part, that all of Lydall Woods’ liability is connected to the PUD declaration, a contract — and is excluded by the contractual liability exclusion.
The Hartford relied on the same argument pronounced by the courts in Ewing and Gilbert. Fortunately, the court in Lydall Woods held that the exclusion did not operate to bar coverage for Lydall Woods’ failure to properly address water drainage problems because Lydall Woods’ conduct was not the liability of a third party, despite the fact that the conduct was undertaken pursuant to a contract. Therefore, there was no “assumption of liability” triggering the contractual liability exclusion.
Potential Catastrophic Impact
The potential impact of the Ewing and Gilbert decisions could be calamitous for insureds. The Ewing court mistakenly categorized construction contracts as “assumptions of liability.” Rarely will a contractor agree to undertake work without a contract — and based on the logic of the Fifth Circuit — each contract is an assumption of liability, which operates as a bar to coverage unless one of the exemptions applies.
This analysis runs contrary to the terms of the policy as a whole. Additionally, the Ewing court’s acknowledgement that its interpretation renders other aspects of the insurance policy “meaningless” is further support for the erroneous decision, as it is contrary to basic insurance analyses. Connecticut is one of many states which support giving each clause in a policy a meaning that does not render other provisions meaningless, and, to date, has interpreted the contractual liability exclusion appropriately.
Hopefully the Texas Supreme Court will respond in the negative to the questions posited by the appellate court in Ewing, reversing the dangerous trend which, if expanded, could render millions of contractors and subcontractors as good as uninsured for property damage associated with their contract. •