Lamar Homes, Inc. v. Mid-Continent Casualty Co., #05-0832 (Tex. August 31, 2007)
In a watershed decision, the Texas Supreme Court has decided that a commercial general liability (CGL) insurer must defend insured contractors and builders against lawsuits alleging damage caused by the insured's construction defects. The critical insurance coverage issues are whether a contractor's defective work could constitute an "occurrence" (basically, an accident) and whether damage to the insured's construction work (as opposed to other property that the insured did not work on) could constitute "property damage" (physical injury to or loss of use of tangible property). This decision resolves one (or perhaps two) of the biggest insurance-coverage debates of the decade and will have lasting influence on how other coverage disputes will be analyzed under Texas law over the basic insuring language of the now ubiquitous CGL policy insuring agreement .
Facts. The homeowner plaintiffs sued the builder, Lamar Homes, after discovering cracks and leaks attributed to faulty construction of the foundation. The builder's CGL insurer refused to defend or indemnify the lawsuit asserting that: (1) the alleged faulty workmanship was not an occurrence because it was the result of deliberate conduct (i.e., breaching one's contract), not an accident; and (2) damage to an insured's own work or products could not be property damage under the "economic loss rule" (barring a plaintiff from recovering tort damages for economic losses resulting from a breach of contract).
Economic-Loss Rule. If I buy a defective toaster that explodes, my claim against the seller is limited to my economic loss, the remedy allowed under contract law (what I paid for the toaster), unless the explosion also damaged other property or caused bodily injury, in which case I can recover tort damages for the seller's negligence (or - the jackpot - punitive damages if I can prove gross negligence). The insurer in Lamar Homes asserted that CGL policies cover only torts, not breach of contract. Therefore, damage to the insured's work cannot be property damage under a CGL policy.
Occurrence. The court first found that faulty workmanship could be the result of accidental conduct because a deliberate act can be performed negligently. Much ink has been spilled on this issue, to which the Court has added the following formulation paraphrasing one of its earlier decisions:
[A] claim does not involve an accident or occurrence when either direct allegations purport that the insured intended the injury (which is presumed in cases of intentional tort) or circumstances confirm that the resulting damage was the natural and expected result of the insured's actions, that is, was highly probable whether the insured was negligent or not.
The Court was careful to say that "whether an insured's faulty workmanship was intended or accidental was dependent on the facts and circumstances of the particular case." Presumably, if the insured deliberately substituted an inferior ingredient or used substandard materials to cut costs, the defective workmanship would not be a covered occurrence. If, on the other hand, the defective work was the result of shoddy work by shirking employees, the builder could not be denied a defense.
But the thing to remember is that this is a duty-to-defend case. The Court restricts its analysis to the allegations in the pleadings, not to the actual facts of the particular case. From now on, a lawsuit alleging negligent workmanship, without much detail, will trigger the CGL insurer's duty to defend.
Property Damage. The second issue is perhaps even more important. If a court relies on the economic-loss rule to bar CGL coverage for a property-damage claim because it "sounds in contract," does that mean that conduct in the performance of a contract could never be covered? If even part of a plaintiff's claim was breach of contract, a court might be persuaded to dismiss it because it "sounds in contract". The Lamar Homes Court short-circuited the whole line of inquiry by putting the economic-loss rule out of insurance law. "It is a liability defense or remedies doctrine, not a test for insurance coverage." More importantly, the Court held that CGL policies are not restricted to covering torts.
Dissent. Three Justices filed a vigorous dissent, primarily attacking the majority's rejection of the economic-loss rule. "Selling damaged property is not the same thing as damaging property." The dissent also argues that the Court is following the minority view of courts across the country, but the majority dispute this assertion.
In the final analysis, as the Court observes, CGL policies will not necessarily cover defective workmanship because so-called "business-risk" exclusions target for elimination damage to the insured's work and replacement of the insured's defective products. Nevertheless, as the Dissenting Opinion points out, the practical effect in many cases will be that small subcontractors, who typically bear the responsibility for covering the general contractor and the owner in construction mishaps, will end up carrying a larger portion of the risk, and their premiums may rise. Also, insurers will almost surely be required to defend more construction-defect lawsuits.
The Lamar Homes Court also holds that a Texas statute allowing a penalty for delayed payment of "first-party claims" does applying to defense costs an insured incurs under a CGL policy. But that is an issue for another day.
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