Texas Rip and Tear, Part Deux!

March 20, 2017
Dear Colleague,

Surprisingly, it’s been fifteen months since the last installment of The Shidlofsky Law Firm Blog. Even more surprising is that this post revisits U.S. Metals, Inc. v. Liberty Insurance Corp., which just so happens to have been the subject of our last blog post. Our goal in 2017 is to up the frequency of these blogs a bit more. In the meantime, to borrow from Demi Lovato—“Here we go go go go again!”

A. Factual and Procedural History Refresher

Exxon Mobil Corporation (“Exxon”) contracted U.S. Metals, Inc. (“U.S. Metals”) to manufacture standard, weld neck flanges meeting industry standards for installation in Exxon refineries. The flanges were irreversibly incorporated into the facilities by welding and bolting the flanges into insulated pipes of non-road diesel units at the refineries. Exxon discovered a leak in one of the installed flanges while conducting testing before putting the systems into operation. Exxon’s subsequent investigation revealed that U.S. Metals had subcontracted to a third-party the manufacturing of the flanges, and that the flanges had been improperly manufactured, not meeting the contractually required industry standards.

In order to mitigate its damages and avoid the risk of fire and explosion, Exxon ordered new flanges from a different manufacturer and replaced all the flanges supplied by U.S. Metals. Replacement of the flanges involved stripping the temperature coating and insulation (which were destroyed in the process), cutting the flange out of the pipe, removing the gaskets (which also were destroyed in the process), grinding the pipe surfaces smooth for re-welding, replacing the flange and gaskets, welding the new flange to the pipes, and replacing the temperature coating and insulation. The replacement process required portions of the refineries to be shut down for several weeks, resulting in the loss of use of the refineries.

In June 2011, Exxon sued U.S. Metals seeking damages for the costs associated with investigating the flange defect, acquiring replacement flanges, removing and replacing the defective flanges, and the resulting loss of use of Exxon’s property, and incidental and consequential damages. Exxon alleged the replacement damages were $6,345,824 and the loss of use damages were $16,656,000. In August 2011, Exxon and U.S. Metals reached a settlement for $2.2 million.

U.S. Metals then claimed indemnification from its CGL insurer, Liberty Insurance Company (“Liberty”), for the amount paid. U.S. Metals claimed coverage with Liberty based on a policy providing coverage for “bodily injury” and “property damage” (the “Policy”). Liberty denied U.S. Metals’ request based on the “your product” and “impaired property” exclusions. U.S. Metals then sued Liberty in the United States District Court for the Southern District of Texas. On cross-motions for summary judgment, the district court held that Liberty did not have a duty to defend because the “your product” exclusion negated coverage for the defective flanges as well as the costs to repair and replace them. Moreover, the district court held that the “impaired property” exclusion negated coverage for Exxon’s loss of use of its refineries. With regard to the duty to indemnify, the district court held that the “impaired property” exclusion negated coverage for both the entire replacement process and the loss of use claims.

U.S. Metals appealed to the Fifth Circuit, and the Fifth Circuit promptly certified four questions to the Supreme Court of Texas.

The Supreme Court of Texas issued its opinion in December of 2015 in which it (i) rejected the so-called “incorporation theory” and held that the mere installation of faulty materials into a larger whole does not cause “physical injury” to that larger whole and, therefore, does not cause “property damage”; but also (ii) held that otherwise unimpaired property destroyed during repair or replacement of the faulty materials may be covered “property damage” under a standard form commercial general liability (“CGL”) policy. The Fifth Circuit reversed the district court’s original determination of the case and remanded for further proceedings in light of the Supreme Court’s holdings. Cross-motions for summary judgment were filed as to the amount of covered damages.

B. The Case on Remand

1. Rip and Tear Coverage

The Supreme Court of Texas found that there was a duty to indemnify for property physically damaged during the removal of the faulty flanges; however, the holding of the Supreme Court of Texas was phrased more narrowly—”the insulation and gaskets destroyed in the process were not restored to use; they were replaced. They were therefore not impaired property to which Exclusion M applied, and the cost of replacing them was therefore covered by the policy.” Liberty, of course, argued that “indemnification should be limited to ‘insulation and gaskets,’ as specified” in the exact holding of the Supreme Court. U.S. Metals, on the other hand, took the position that the Supreme Court’s broader holding should be applied “to include the temperature coating and welds that were also destroyed when removing the faulty flanges.”

CliffsNotes® version: Liberty and U.S. Metals both read the Supreme Court’s opinion. Liberty agreed to pay for replacement insulation and gaskets. U.S. Metals wanted indemnification for insulation, gaskets, temperature coating, and welds.

The district court agreed with U.S. Metals, noting the discrepancy in the Supreme Court’s opinion. In its decision, the Supreme Court initially stated that the “original welds, coating, insulation, and gaskets were destroyed in the process” of replacing the faulty flanges. Then in its holding, the Supreme Court left off “original welds” and “coating” and held that “the insulation and gaskets” were destroyed in the process of repairing the flanges, were replaced, were not restored to use, and were covered. The district court found no reason for the discrepancy and stated as follows:

The central thrust of the court’s holding was that any tangible property that was destroyed and not replaced during the flange removal process is covered by the Policy. When reading the court’s opinion as a whole, it is evident that this holding applies with equal force to the welds and coatings.

As such, the district court applied the Supreme Court’s holding and found, as a matter of law, that Liberty had a duty to indemnify U.S. Metals “for the costs of welds, coating, insulation, and gaskets that were destroyed and replaced in the flange removal process.”

2. Ancillary Rulings

After ruling on the coverage issue with regard to indemnification, the district court addressed Liberty’s duty to defend U.S. Metals and the amount of that claim. Liberty argued that it was not obligated to pay attorneys’ fees paid prior to the date it received the complaint in the underlying lawsuit and it should not be obligated to pay for fees associated with coverage advice given to U.S. Metals. The district court found the first claim baseless because Liberty had been notified of the claim and indeed denied coverage months before Exxon even filed its lawsuit. The district court rejected the second argument because Liberty failed to produce any evidence that “would enable the Court to determine how [U.S. Metals’] attorneys divide their time.” Thus, Liberty was obligated to pay all of U.S. Metals’ defense costs in the underlying lawsuit.

The district court also held that Liberty violated the Prompt Payment of Claims statute and owed 18% per annum on the attorneys’ fees U.S. Metals paid and that the interest began accruing from the moment U.S. Metals paid the fees; however, the statue did not apply to Liberty’s duty to indemnify because the statute does not apply to third-party claims.

U.S. Metals alleged various extra-contractual claims under the Texas Insurance Code, the Texas Deceptive Trade Practices Act, and the Stowers doctrine. In a thorough analysis, the district court rejected each of U.S. Metals’ extra-contractual claims. Finding that Liberty had a reasonable basis for its decision to deny coverage and that the ultimate resolution of a novel question of Texas law against it could not form the basis of a bad faith claim, the district court granted Liberty’s summary judgment regarding U.S. Metal’s bad faith claims under both the Texas Insurance Code and common law. U.S. Metals’ claim that Liberty engaged in unfair or deceptive practices in violation of the Texas Insurance Code or the Deceptive Trade Practices Act also were dismissed because there was no evidence of specific practices or statements in violation of the Insurance Code or the DTPA. Finally, the district court rejected U.S. Metals’ Stowers claim on the grounds that there was no “genuine issue of material fact that Defendant did not have a reasonable basis for denying the claim.”

C. Commentary

After the Supreme Court’s ruling in 2015, we predicted that the “rip and tear” ruling was “a potentially monumental sea-change in insurance coverage law in Texas.” We also predicted that “it will be heavily litigated in the coming years (and perhaps even on rehearing).” Lee is almost ready to officially retire his Carnac costume. The Supreme Court denied the motions for rehearing filed by Liberty and U.S. Metals, rejecting not only the parties’ arguments but also Mid-Continent’s arguments in its amicus brief in support of rehearing. (Considering Mid-Continent’s prominence in Texas insurance law jurisprudence, do not feign surprise at its involvement in this landmark case.)

As for that “heavy litigation,” as of today, only five courts have cited to the Supreme Court’s decision (including the Texas Criminal Court of Appeals?!) and only one of those citations is related to any of the Court’s central holdings. (Vinings Ins. Co. v. Byrdson Servs., LLC, 2016 WL 3584715 (E.D. Tex. June 17, 2016)). Other than that, reviewing those cases and the reason for citation to the Supreme Court’s U.S. Metals decision, one would be left thinking it was a seminal decision on the principle that no contract language is surplusage.

All that being said, the wheels of justice sometimes churn slowly and that “sea change” we foresaw may still be on the horizon. Perhaps Lee will need to hang onto his Carnac costume after all. Simply put, there remain a lot of unanswered questions. Stay tuned, and in the meantime, Make Coverage Great Again!

* * *

Shidlofsky Law Firm PLLC is pleased to announce that Rebecca DiMasi has joined the firm as a member. She has extensive experience handling coverage cases involving general liability, commercial property, commercial auto, and professional liability coverage, with a significant portion of her practice dedicated to construction defect claims. Rebecca is a member of the governing council of the Insurance Law Section of the State Bar of Texas, and a member of the Construction Law Section. She has been named a Super Lawyer by Texas Monthly Magazine, and is AV rated by Martindale-Hubbell. The firm's clients will greatly benefit from Rebecca's experience and knowledge. More importantly, the firm adds a Bear, to its current roster of a Mustang, a Longhorn, and a Hoosier, whatever that is.


Lee Shidlofsky
Member of Shidlofsky Law Firm

Douglas P. Skelley
Member of Shidlofsky Law Firm

Rebecca DiMasi
Member of Shidlofsky Law Firm

Henri E. Nicolas, Jr.
Senior Counsel of Shidlofsky Law Firm