Insurance Coverage of Construction Defects: The Supreme Courts of Louisiana and Texas Weigh In

March 14, 2008

Louisiana

The Louisiana Supreme Court, Supreme Services and Specialty Co. v. Sonny Greer, Inc., 06-1827 (La. 5/22/07), 958 So. 2d 634, addressed the issue of whether the costs incurred by an owner as a result of the defective installation and construction of concrete slabs by the general contractor and its subcontractor were covered by the general contractor's Commercial General Liability ("CGL") policy. The "work product" exclusion in the CGL policy excluded coverage for "property damage to . . . that particular part of any property that must be restored, repaired, or replaced because [the insured's] work was incorrectly performed on it."

The Louisiana Supreme Court held that the "work product" exclusion was applicable to work performed by both the general contractor and its subcontractor, and thus, denied coverage for repair, restoration, and replacement of the defectively installed foundation. The Supreme Court explained that the "work product" exclusion reflects the intent of the insurer to avoid the possibility that coverage under a CGL policy will be used to repair and replace the insured's-which includes both the contractor and its subcontractor-defective products and faulty workmanship. In practice, these costs might be covered by a performance bond.

While the "work product" exclusion applies to the work while it is in progress (or incomplete), the Supreme Court found that the "products-completed operations hazard" ("PCOH") provision-which provides coverage for property damage that arises out of a completed project or work performed away from the insured's premises-applied only after the work is completed. Additionally and important to coverage issues under a CGL policy, the PCOH provision applied only to work performed by the contractor-not its subcontractors.

After Supreme Services, a Louisiana appellate court was presented with the question of whether coverage existed under a CGL policy for damage to sheetrock and flooring as a result of removing previously installed defective steel studs. In Stewart Interior Contractors, L.L.C. v. Metalpro Industries, L.L.C., 07-0251 (La. App. 4 Cir. 10/10/07), 969 So. 2d 653, the Court noted that while the replacement of the steel studs was not covered under the policy based on the "work product" exclusion, the damage to the sheetrock was potentially covered under the PCOH provision. The Court ordered the trial to make more specific findings as to the cause of the damage to the sheetrock. Such a determination would be critical in deciding whether the costs attributable to repairing that damage would excluded from coverage.

While the nuances of the Louisiana Supreme Court's decision in the Supreme Services case and its progeny will continue to develop, the landscape of what damages arising from construction defects might be covered by a CGL policy is a bit more clear and should be considered by parties analyzing construction defect claims. Parties entering into construction contracts and negotiating insurance requirements in those contracts also must consider what insurance coverage will be afforded.

Texas

In a controversial recent decision, the Texas Supreme Court held that a homebuilder's alleged defective construction, when caused by a subcontractor's work, may be covered under the homebuilder's general commercial liability insurance policy. Lamar Homes Inc. v. Mid Continent Casualty Co., 239 S.W.3d. 236, 2007 WL 2459193 (Tex. 2007). The Texas Supreme Court found that the liability insurer had a duty to defend a homebuilder against such claims, and further, that statutory penalties apply to an insurer's breach of the duty to defend.

In Lamar, the homeowners purchased a new home from Lamar Homes, Inc., and several years later encountered problems they attributed to defects in their foundation. They sued Lamar and its subcontractor for the defects. Lamar's liability insurer denied coverage. Lamar sued its insurer and sought a declaration of its rights. The Court held in favor of the insurer, concluding that the insurer had no duty to defend Lamar for construction errors that harmed only Lamar's own product. The case went to the Fifth Circuit Court of Appeals, which asked the Texas Supreme Court to provide interpretation of state law.

The Texas Supreme Court held that the insurance company had a duty to defend the homebuilder against the homeowners' claims because allegations of unintended construction defects may constitute an "accident" or "occurrence" under a commercial general liability policy, and allegations of damage to or loss of use of the home itself may constitute "property damage" under the policy.

The Court held that a deliberate act, performed negligently, is an "accident" if the effect is not the intended or expected result - that is, the result would have been different had the deliberate act been performed correctly. The Supreme Court also held that the homeowners' complaint alleged an "occurrence" under the insurance policy because it asserted that Lamar's defective construction was a product of its negligence. The Court rejected the insurer's argument that the economic-loss rule should control because the homeowners' damages were contract damages, not tort damages.

The Court also held that the Texas "Prompt Payment of Claims" statute applies to an insurer's breach of the duty to defend. That statute provides for an 18% penalty and attorney's fees to be paid by an insurer that fails to pay a claim within the statutory deadline.

In a vigorous dissent, three justices wrote that the Court's decision "turns the construction industry on its head" by shifting the duty to repair a subcontractor's defective work from the builder to the insurance company.

Not surprisingly, the case has created substantial controversy and the insurer filed a motion for rehearing. Numerous interested parties, including the Property Casualty Insurers Association of America and the Complex Insurance Claim Litigation Association filed "friend of the court" briefs in support of rehearing.

On December 14, 2007, the Texas Supreme Court denied rehearing, without issuing an opinion. Thus, the Court's judgment is now final. In a dissent to the denial of rehearing, Justice Brister (joined by Justices Hecht and Willet) focused on the legislative history behind the prompt payment of claims statute. Justice Brister argued that the majority's holding gives the statute a meaning "that would have been news to any legislators reading it when it passed." We will have to wait to see if the Texas Legislature decides to clarify the meaning of the statute.

For more information, please contact Kelsey Kornick Funes (Louisiana) or Kate Alsina (Texas).