Texas Supreme Court Holds Exclusion Inapplicable to Construction Defect Claim

In its recent decision in Ewing Constr. Co. v. Amerisure Ins. Co., 2014 Tex. LEXIS 39 (Tex. Feb. 27, 2013), the Supreme Court of Texas addressed certified questions from the United States Court of Appeals for the Fifth Circuit regarding the scope of the Contractual Liability exclusion in the context of a construction defect claim.  The court was asked to determine whether a general contractor that enters into a contract agreeing to perform its work in a good and workmanlike manner “assumes liability” for damages arising out of the contractor’s defective work, thereby triggering the Contractual Liability exclusion.

Ewing Construction Company (“Ewing”) entered into a contract with Tuluso-Midway Independent School district (“TMISD”) to serve as the general contractor for a construction project at a school in Corpus Christi, Texas. Among other things, Ewing was to renovate and build additions to a tennis court, which Ewing did through its subcontractors.  The contract required Ewing to perform that work in a “good and workmanlike manner.”  Not long after construction was complete, cracking and flaking problems began and TMISD filed suit against Ewing asserting claims for breach of contract and negligence.

Amerisure Insurance Company issued a commercial general liability policy to Ewing for the time period at issue.  Ewing tendered its defense of the TMISD suit to Amerisure, which it denied based on the Contractual Liability exclusion. The Contractual Liability exclusion of the Policy stated in relevant part:

2. Exclusions

          This insurance does not apply to:

b. Contractual Liability

“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”

Ewing filed suit against Amerisure in the U.S. District Court for the Southern District of Texas, seeking a declaration that Amerisure breached its duties to defend and indemnify Ewing for any damages awarded to TMISD. Amerisure counterclaimed, seeking a declaration that it owed Ewing neither a duty to defend nor a duty to indemnify. Although Amerisure conceded that Ewing established coverage under the policy’s insuring agreements, it took the position that policy exclusions, in particular the Contractual Liability exclusion, precluded coverage and negated its duties to defend and indemnify.

The district court relied on Gilbert Texas Constr. Co. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010) in holding that no coverage was owed under the policy. The district court determined that Gilbert stood for the proposition that the Contractual Liability exclusion applies when an insured enters into a contract and assumes liability for its own performance under that contract. The district court concluded that TMISD’s pleadings established that pursuant to the contract between TMISD and Ewing, Ewing agreed to be liable for failing to perform under the contract if the work was deficient. The district court therefore concluded that the Contractual Liability exclusion applied to preclude coverage.

On appeal, the Fifth Circuit initially affirmed the district court’s judgment on the duty to defend, but later vacated and remanded the case with respect to the duty to indemnify to await the results of the underlying suit. Ewing petitioned for rehearing. The Fifth Circuit withdrew its opinion and certified two questions to the Supreme Court of Texas:

1. Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good an 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.

2. 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.”

The Texas Supreme Court carefully examined Gilbert and concluded that “assumption of liability” in the context of the exclusion meant that the insured had assumed a liability for damages that exceeded the liability it would have under general law. The Court defined “good and workmanlike” and “negligence” as having the same substantive meaning. The Court acknowledged that Ewing had a common law duty to perform its contract with skill and care.  Reasoning that the claims asserted by TMISD did not seek recovery for damages that exceeded the liability Ewing would have under general law, the Court concluded that the exclusion did not apply to preclude coverage.

The Court also rejected the notion that its holding would have the effect of transforming CGL policies into performance bonds. The Court observed that because the policy contained other exclusions that may apply to bar coverage in a case for breach of contract due to faulty workmanship, its ruling was consistent with the view that CGL policies are not performance bonds.