Dear Colleague,
On June 27, 2014, a panel of the United States Fifth Circuit Court of Appeals may have singlehandedly returned Texas’s insurance coverage jurisprudence back to the pre- Ewing days a mere six months after Ewing was decided. In Crownover (the opinion can be found here), which had been abated pending the outcome in Ewing, the court held that a homebuilder contractually assumed liability beyond its common law obligation to the owner, triggering the “contractual liability” exclusion and negating coverage where the insured would not have been liable in the absence of the contract. Six months previously, the Supreme Court of Texas held on certified questions that a commercial builder had not assumed such liability when it had entered into a standard-form AIA contract with a school district to build tennis courts that ultimately cracked and fell apart. (Our analysis of Ewing can be found here.)
At issue in Crownover, was whether Mid-Continent had an obligation to pay for damage caused by its insured, Arrow Development, Inc., for Arrow’s failure to promptly correct work in the home it had constructed for the Crownovers. In an earlier arbitration, the arbitrator awarded the Crownovers damages for Arrow’s liability for breaching the express warranty to repair found in the parties’ contract. The contract contained a “warranty-to-repair” clause in paragraph 23.1 that provided that Arrow would “promptly correct work . . . failing to conform to the requirements of the contract documents.” After the home had been built, cracks appeared in the walls and foundation of the home, and additional problems arose with the HVAC system, causing it to leak and to run continuously to heat or cool the home. The Crownovers spent several hundred thousand dollars to fix the problems with the home.
After the Crownovers’ demands to repair were not fulfilled, the Crownovers filed their arbitration proceeding. The arbitrator determined that the claim under paragraph 23.1 was not barred by the statute of limitations and awarded damages. The arbitrator did not address statute of limitations defenses that pertained to other claims under the contract. Eventually, Arrow filed for bankruptcy, so the Crownovers’ only recourse was to recover under the Mid-Continent policy. Mid-Continent denied any obligation to pay the award, citing several coverage defenses and policy exclusions. The Crownovers filed suit and the district court granted a summary judgment filed by Mid-Continent and denied a cross-motion filed by the Crownovers, finding that the “contractual liability” exclusion negated coverage. The exclusion provides that “[t]his insurance does not apply to[] ‘property damage’ for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.” An exception to the exclusion reinstates coverage for “liability . . . [t]hat the insured would have in the absence of the contract or agreement.” The district court reasoned that the arbitrator, in finding that Arrow breached the express warranty, explicitly declined to decide liability on any other ground and, therefore, concluded that its sole obligation to the Crownovers was based on the “contractually assumed liability” and, therefore, the exclusion applied. The district court rejected the Crownovers’ contention that the “implied warranty of good workmanship” continued to apply to the contractor because no express disclaimer of the warranty existed, finding that an express warranty supersedes an implied warranty of the same kind. The Crownovers timely appealed.
On appeal, the U.S. Fifth Circuit discussed the Supreme Court of Texas’s two most recent rulings on the “contractual liability” exclusion— Gilbert Texas Construction, L.P. v. Underwriters at Lloyds London, 327 S.W.3d 118 (Tex. 2010), and Ewing Construction Co. v. Amerisure Insurance Co., 420 S.W.3d 30 (Tex. 2014). Having reviewed that case law, the court held that Mid-Continent established that the exclusion applied. In doing so, the court found that paragraph 23.1 of the contract with Arrow was “virtually indistinguishable from the contract provision in Gilbert that the Texas Supreme Court determined ‘extend[ed] beyond Gilbert’s obligations under general law and incorporate[d] contractual standards to which Gilbert obligated itself.’” Crownover, slip op. at 10 (quoting Gilbert, 327 S.W.3d at 122, 127 (noting Gilbert’s agreement to repair or pay for damage to third-party property “resulting from a failure to comply with the requirements of this contract”)). The court concluded as follows:
Whereas contractually agreeing to repair damage resulting from a failure to exercise reasonable care in performing the work or agreeing to perform work in a good and workmanlike manner would mirror a contractor’s duty under general law, see Ewing, 420 S.W.3d at 37-38; Gilbert, 327 S.W.3d at 127, contractually agreeing to repair damage resulting from a failure to comply with the requirements of the contract would not, see Gilbert, 327 S.W.3d at 127.
Id. at 10–11. Thus, the exclusion applied.
The court rejected the Crownovers’ reliance on paragraph 14.4 of the contract that stated that “[t]he Contractor warrants to the Owner . . . that the Work will be free from defects not inherent in the quality required or permitted, and that the Work will conform with the requirements of the Contract Documents.” The court explained that that was not the basis of the arbitrator’s award and, moreover, Arrow could have been liable under paragraph 23.1 without being liable under paragraph 14.4. Further, Arrow could have violated paragraph 14.4 by performing non-conforming work, but the failure to promptly correct that work under paragraph 23.1 would constitute a separate violation of the contract.
The court also rejected the argument raised in the Texas Association of Builders’ amicus curiae brief that application of the “contractual liability” exclusion in such a scenario would render the “your work” exclusion and its subcontractor exception entirely meaningless. The court explained that the liability at issue was for the failure to repair and not for the work done initially by the subcontractors.
Turning to the exception for “liability . . . [t]hat the insured would have in the absence of the contract or agreement,” the Crownovers urged the court to look beyond the arbitration award and acknowledge that Arrow would have been liable under paragraph 14.4, as well as liable under the implied warranty of good workmanship, which is identical to the express warranty. Following Gilbert, the court refused to look beyond the arbitration award, noting there was no otherwise covered basis for its liability outside the contractually-assumed liability. Additionally, the court found that the implied warranty was superseded by the express warranty under Texas law because it provided for the manner, performance or quality of the desired construction. Id. at 14 (citing Centex Homes v. Buecher, 95 S.W.3d 266, 274–75 (Tex. 2002)). The court also rejected the Crownovers’ argument that the summary judgment rulings were improperly based on the rejection of the implied warranty of good workmanship, noting that the issue was fully briefed to the district court and no authority existed for overturning the ruling based on the district court’s refusal to provide the Crownovers an opportunity to respond to Mid-Continent’s sur-reply brief on the issue.
Having found that the “contractual liability” exclusion can, in fact, negate coverage for a construction contractor that enters into a standard-form construction contract, the U.S. Fifth Circuit seemingly has taken at least some of the teeth out of the Supreme Court of Texas’s decision in Ewing. Simply put, contracts often include a warranty to repair clause like that relied on by the Fifth Circuit in rejecting coverage. However, it is the damages that resulted from the failure to perform the work in a good and workmanlike manner that led to the need for repairs in the first place. Had the arbitrator found that the insured breached its warranty to perform the work in a good and workmanlike manner, coverage would have existed for the costs of those repairs under the Supreme Court’s holding in Ewing. Here, though, because the insured failed to repair the same damages, coverage somehow no longer exists under the “contractual liability” exclusion.
For coverage to not exist in that scenario is non-sensical. In other words, the Fifth Circuit seems to have created a false dichotomy between contractually agreeing to repair damage resulting from a failure to exercise reasonable care in performing the work (covered) and contractually agreeing to repair damage resulting from a failure to comply with the requirements of the construction contract (not covered). Huh? Also, it ignores the factual premise in Gilbert that caused the Supreme Court to rule the way it did in the first place. In particular, Gilbert contractually assumed liability to a third party by agreeing—on a strict liability basis—to repair third-party property damage and no such liability would have existed without such an agreement because Gilbert had governmental immunity from such claims by third parties. Those are not at all the facts in Crownover and, accordingly, it appears the Fifth Circuit incorrectly applied Gilbert. In doing so, the court has added significant confusion over application of the contractual liability exclusion.
The Crownovers are expected to file a Motion for Rehearing. Stay tuned -- We've Got You Covered.
Sincerely,
Lee Shidlofsky
Founding Member of Shidlofsky Law Firm
Douglas P. Skelley
Member of Shidlofsky Law Firm
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