5th Circuit Holds No Duty to Indemnify Based on Contractual Liability Exclusion

by Traub Lieberman Straus & Shrewsberry LLP
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In its recent decision in Crownover v. Mid-Continent Cas. Co., 2014 U.S. App. LEXIS 12158 (5th Cir. June 27, 2014), the United States Court of Appeals for the Fifth Circuit had occasion to consider whether the Contractual Liability Exclusion barred an insurer’s duty to indemnify its insured for an award resulting from the insured’s defective construction.

Doug and Karen Crownover (the “Crownovers”) entered into a construction contract with Arrow Development (“Arrow) to construct a home on their land in Sunnyvale, Texas. The contract contained a warrant-to-repair clause that provided that Arrow would “promptly correct work….failing to conform to the requirements of the Construction Documents” (“paragraph 23.1”). After the work was completed, cracks began to appear on the walls and the foundation of the Crownover’s home. There were also problems with the heating, ventilation, and air condition system that caused leaking in the exterior lines and air ducts of the home. The Crownovers spent several hundred thousand dollars to fix the problems. The Crownovers sent demand letters to Arrow, which in turn Arrow sent to its insurer, Mid-Continental Casualty Co. (“Mid-Continent”). After failing to obtain the relief they sought, the Crownovers initiated an arbitration proceeding against Arrow. At the conclusion of the arbitration proceeding, the arbitrator awarded damages to the Crownovers for Arrow’s breach of paragraph 23.1.

Sometime after their unfavorable arbitration, Arrow filed for bankruptcy. During that proceeding, the bankruptcy court ruled that Crownover’s recovery was limited to the amount that could be recovered from any applicable insurance. As a result, the Crownovers sent a letter to Mid-Continent demanding that it pay the arbitration award. Citing several insurance policy exclusions, Mid-Continent denied their demand. The Crownovers then sued Mid-Continent for breach of contract. Both parties moved for summary judgment, which was granted by the district court in favor of Mid-Continent and against the Crownovers. In evaluating the arguments, the district court cited the contractual liability exclusion in the Mid-Continent policy, which provided: “[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.” The exclusion also contained an exception for “liability…[t]hat the insured would have in the absence of the contract or agreement.” Mid-Continent took the position that the contractual liability exclusion applied because the arbitrator’s award to the Crownovers was based only on Arrow’s breach of paragraph 23.1 of the construction agreement.

The Crownover’s argued that the exception to the exclusion applied because Arrow would have been liable in the absence of the express warranty to repair. Specifically, the Crownovers argued that the implied warranty of good workmanship continued to apply to the contract they had with Arrow because the contract contained no express disclaimer of the implied warranty. The district court, however, reasoned that when a contract contains an express warranty of good workmanship, that warranty supersedes any implied warranty. Thus, the district court held that the contractual liability exclusion applied with no applicable exception because the arbitrator’s award to the Crownovers was based solely on Arrows breach of the express warranty to repair nonconforming work. The Crownovers appealed.

Relying on Gilbert Texas Const., L.P. v. and Ewing Const. Co. v. Amerisure Ins. Co, the United States Court of Appeals for the Fifth Circuit affirmed the district court’s ruling. The Court stated that under Gilbert, the contractual liability exclusion applied only if Arrow “assumed” a duty in its contract with the Crownovers that exceeded the liability it would have under general law. The Crownovers cited paragraph 14.4 of the construction contract, which stated that “[t]he Contractor warrants to the Owner…that the Work will be free from defects no inherent in the quality required or permitted, an that the Work will conform with the requirements of the Contract Documents” and took the position that this express warranty of workmanship was equivalent to the implied warranty of workmanship. Thus, the Crownovers reasoned, the exclusion did not apply. The Court was not persuaded because paragraph 14.4 was not the basis for liability under the arbitration award. Instead, the arbitration award was based on Arrow’s agreement to repair any damages under paragraph 23.1 of the contract. As that promise went beyond the general obligations owed by Arrow to the Crownovers, the contractual liability exclusion applied.

The Court stated that the exception to the contractual liability exclusion restored coverage if the insured’s liability was the result of an otherwise covered claim in addition to its contractually assumed liability. Thus, the Crownovers argued that, under Gilbert, the district court should have looked beyond the arbitration award. Had it done so, the Crownovers reasoned, it would have determined that Arrow was liable for breaching the express warranty of workmanship under paragraph 14.4, as well as paragraph 23.1 and the implied warranty of good workmanship. The Court was not persuaded. The Court stated that Gilbert prevented it from looking beyond the arbitration award, and because the arbitrator awarded damages based only on the breach of the express warranty found in paragraph 23.1, the exception did not apply. Finally, the Court held that the Crownovers argument failed also because the implied warranty was superseded by the express warranty found in the construction contract. Therefore, the Court affirmed the district court’s determination granting summary judgment in favor of Mid-Continent and against the Crownovers. The Crownovers have since filed a petition for rehearing with the Fifth Circuit.

- See more at: http://www.traublieberman.com/insurance-law/2014/0718/4828/#sthash.pNeFCDxD.dpuf

In its recent decision in Crownover v. Mid-Continent Cas. Co., 2014 U.S. App. LEXIS 12158 (5th Cir. June 27, 2014), the United States Court of Appeals for the Fifth Circuit had occasion to consider whether the Contractual Liability Exclusion barred an insurer’s duty to indemnify its insured for an award resulting from the insured’s defective construction.

Doug and Karen Crownover (the “Crownovers”) entered into a construction contract with Arrow Development (“Arrow) to construct a home on their land in Sunnyvale, Texas. The contract contained a warrant-to-repair clause that provided that Arrow would “promptly correct work….failing to conform to the requirements of the Construction Documents” (“paragraph 23.1”). After the work was completed, cracks began to appear on the walls and the foundation of the Crownover’s home. There were also problems with the heating, ventilation, and air condition system that caused leaking in the exterior lines and air ducts of the home. The Crownovers spent several hundred thousand dollars to fix the problems. The Crownovers sent demand letters to Arrow, which in turn Arrow sent to its insurer, Mid-Continental Casualty Co. (“Mid-Continent”). After failing to obtain the relief they sought, the Crownovers initiated an arbitration proceeding against Arrow. At the conclusion of the arbitration proceeding, the arbitrator awarded damages to the Crownovers for Arrow’s breach of paragraph 23.1.

Sometime after their unfavorable arbitration, Arrow filed for bankruptcy. During that proceeding, the bankruptcy court ruled that Crownover’s recovery was limited to the amount that could be recovered from any applicable insurance. As a result, the Crownovers sent a letter to Mid-Continent demanding that it pay the arbitration award. Citing several insurance policy exclusions, Mid-Continent denied their demand. The Crownovers then sued Mid-Continent for breach of contract. Both parties moved for summary judgment, which was granted by the district court in favor of Mid-Continent and against the Crownovers. In evaluating the arguments, the district court cited the contractual liability exclusion in the Mid-Continent policy, which provided: “[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.” The exclusion also contained an exception for “liability…[t]hat the insured would have in the absence of the contract or agreement.” Mid-Continent took the position that the contractual liability exclusion applied because the arbitrator’s award to the Crownovers was based only on Arrow’s breach of paragraph 23.1 of the construction agreement.

The Crownover’s argued that the exception to the exclusion applied because Arrow would have been liable in the absence of the express warranty to repair. Specifically, the Crownovers argued that the implied warranty of good workmanship continued to apply to the contract they had with Arrow because the contract contained no express disclaimer of the implied warranty. The district court, however, reasoned that when a contract contains an express warranty of good workmanship, that warranty supersedes any implied warranty. Thus, the district court held that the contractual liability exclusion applied with no applicable exception because the arbitrator’s award to the Crownovers was based solely on Arrows breach of the express warranty to repair nonconforming work. The Crownovers appealed.

Relying on Gilbert Texas Const., L.P. v. and Ewing Const. Co. v. Amerisure Ins. Co, the United States Court of Appeals for the Fifth Circuit affirmed the district court’s ruling. The Court stated that under Gilbert, the contractual liability exclusion applied only if Arrow “assumed” a duty in its contract with the Crownovers that exceeded the liability it would have under general law. The Crownovers cited paragraph 14.4 of the construction contract, which stated that “[t]he Contractor warrants to the Owner…that the Work will be free from defects no inherent in the quality required or permitted, an that the Work will conform with the requirements of the Contract Documents” and took the position that this express warranty of workmanship was equivalent to the implied warranty of workmanship. Thus, the Crownovers reasoned, the exclusion did not apply. The Court was not persuaded because paragraph 14.4 was not the basis for liability under the arbitration award. Instead, the arbitration award was based on Arrow’s agreement to repair any damages under paragraph 23.1 of the contract. As that promise went beyond the general obligations owed by Arrow to the Crownovers, the contractual liability exclusion applied.

The Court stated that the exception to the contractual liability exclusion restored coverage if the insured’s liability was the result of an otherwise covered claim in addition to its contractually assumed liability. Thus, the Crownovers argued that, under Gilbert, the district court should have looked beyond the arbitration award. Had it done so, the Crownovers reasoned, it would have determined that Arrow was liable for breaching the express warranty of workmanship under paragraph 14.4, as well as paragraph 23.1 and the implied warranty of good workmanship. The Court was not persuaded. The Court stated that Gilbert prevented it from looking beyond the arbitration award, and because the arbitrator awarded damages based only on the breach of the express warranty found in paragraph 23.1, the exception did not apply. Finally, the Court held that the Crownovers argument failed also because the implied warranty was superseded by the express warranty found in the construction contract. Therefore, the Court affirmed the district court’s determination granting summary judgment in favor of Mid-Continent and against the Crownovers. The Crownovers have since filed a petition for rehearing with the Fifth Circuit.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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