Texas Supreme Court Rules CGL Policy’s “Contractual Liability" Exclusion Does Not Bar Coverage for Claims Arising From Construction Defects

On January 17, 2014, the Supreme Court of Texas rejected a commercial general liability (“CGL”) insurer’s attempt to invoke the “contractual liability” exclusion to deny coverage under a standard CGL policy regarding a construction defect breach of contract claim.  The insurer denied coverage to the general contractor, arguing that the contractor had assumed liability in its contract to perform its work in a “good and workmanlike manner”, and that a breach of contract claim based on construction defects, arising out of the failure to perform the contract in a good and workmanlike manner, was not covered under the CGL policy due to the standard “contractual liability” exclusion.  The Supreme Court held that the general contractor did not contractually assume any liability beyond its common law duty to perform its contract with due skill and care, and thus the policy exclusion did not apply.  The case is Ewing Construction Company, Inc. v. Amerisure Insurance Company.1

Generally speaking, insurance coverage for construction defects works as follows:  the plaintiff alleges the existence of defective construction that is a breach of a construction contract and/or breach of a duty (i.e., negligence) causing “personal injury” or “property damage.” These allegations within the four corners of the complaint trigger the insurer’s duty to indemnify the insured pursuant to the four corners of the insurance policy if the allegations constitute an “occurrence.” In many states, such allegations can lead to a finding of an “occurrence” under the reasoning that contractors do not intend to perform defective work and the defects are thus “accidental” (this issue has been the subject of several recent high-profile court decisions and a majority of jurisdictions now follow this logic).2  This scenario further triggers the insurer’s duty to defend the insured in the lawsuit (this process is frequently referred to as the “eight corners” rule).3  The insurer, however, has multiple “business risk” exclusions in its standard insurance policy that may further erode its indemnity obligations, including the “your work” exclusion that limits coverage for a general contractor’s own work (but is usually subject to a notable exception for the work of subcontractors) and the “damage to impaired property” exclusion. Another important exclusion is the “contractual liability” exclusion, which is the subject of the Ewing case.

The typical contractual liability exclusion purports to remove coverage for damages for “‘[b]odily 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.” Ewing, 2014 WL 185035 at *3 (quoting standard policy language).  This exclusion has two critical exceptions:  “(1) where the insured’s liability for damages would exist absent the contract, and (2) where the contract is an insured contract.” Id. at *6.  Ewing Construction’s insurer, Amerisure, took the position that when Ewing Construction agreed in its construction contract to perform its work in a “good and workmanlike manner,” Ewing Construction assumed liability in the contract that obligated the insured to pay damages resulting from the contractor’s breach of that provision—triggering the contractual liability exclusion and leaving Amerisure with no duty to indemnify or defend. Id. The contractor countered that its agreement to perform its work in a “good and workmanlike manner” did not lead to Ewing Construction taking on any more liability than it already owed to its contractual privy, the project owner, because by law Ewing Construction had the obligation “to comply with the contract’s terms and to exercise ordinary care in doing so.” Id. 

The Supreme Court of Texas agreed with the contractor. “Assumption of liability” in the contractual liability exclusion “means that the insured has assumed a liability for damages that exceeds the liability it would have under general law.” Id. Agreeing to perform its work in a “good and workmanlike manner” does not create any more liability than the contractor already has under the common law. Id. The Court crucially noted that the allegations of breach of contract and negligence were substantively the same: the plaintiff alleged that the contractor “fail[ed] to use ordinary care, that is, fail[ed] to do that which a reasonable person or provider of the defendant’s type would have done under the same or similar circumstances” and these allegations of negligence were the same as allegations of failing to perform the work in a “good and workmanlike manner” in accordance with the construction contract. Without assuming any more liability than common law already required, the contractual liability exclusion did not apply, and Amerisure had the duty to defend, and indemnify, the claims against Ewing Construction for breach of contract. For the exclusion to apply without exception, the contractor must assume some liability that is beyond the standard liability required by law for a contractor performing a construction contract. See, e.g., Gilbert Texas Construction, L.P. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010) (applying the contractual liability exclusion where the contractor undertook a specific obligation to repair or pay for damage to third-party property resulting from failure to comply with the contract, which the Supreme Court of Texas held was liability assumed beyond the contractor’s obligations under general law—or pursuant to an ordinary care/negligence standard).4

The Supreme Court of Texas included a brief corollary that is worth mentioning. Amerisure argued that the Court’s interpretation of the contractual liability exclusion would turn the insurance policy into a performance bond—essentially requiring the insurance company to guarantee the contractor’s performance of its contract.  The Court rejected this argument, noting two critical differences between an insurance policy and a performance bond: (1) the insurance policy’s requirement for resulting personal injury or property damage and (2) the existence of other common “business risk” policy exclusions not before the Court: “Because the policy contains exclusions that may apply to exclude coverage in a case for breach of contract due to faulty workmanship, our answer to the first certified question is not inconsistent with the view that CGL policies are not performance bonds.”  Id. at *7.

1 --S.W.3d --, 2014 WL 185035, No. 12-0661 (Tex. Jan. 17, 2014) (on certified question from the United States Court of Appeals for the Fifth Circuit).
See, e.g., Cherrington v. Erie Insurance Property and Casualty Company, 231 W.Va. 470 (2013); Taylor Morrison Services, Inc. v. HDI-Gerling America Insurance Company, 293 Ga. 456 (2013); see also Lamar Homes, Inc. v. Mid-continent Casualty Co., 242 S.W.3d 1 (Tex. 2007).
Evanston Ins. Co. v. Legacy of Life, Inc., 370 S.W.3d 377, 380 (Tex. 2012).
In addition, it should be noted that the Ewing case does not address the other stated “exception” to the “exclusion” for “insured contracts.” “Insured contracts” are contracts where the insured assumes the tort liability of another—such as an indemnity agreement. Gilbert, 327 S.W.3d at 128. This exception typically would apply, for example, if Ewing Construction agreed to indemnify the owner for the owner’s tort liability to a third party.