Texas Supreme Court to Address Coverage for Faulty Workmanship and Scope of “Prompt Pay Statute”
Insurance Law Update
Lamar Homes, Inc v. Mid-Continent Casualty Company
Texas Supreme Court
The Texas Supreme Court will soon provide guidance to insurers regarding coverage for faulty workmanship claims under a commercial general liability (“CGL”) policy and whether Texas Insurance Code Article 21.55 (the “Prompt Pay Statute”) applies to the duty to defend. The Texas Supreme Court recently agreed to accept these questions certified by the Fifth Circuit in Lamar Homes, Inc v. Mid-Continent Casualty Company, 2005 U.S. App. Lexis 21441 (Texas Supreme Court Docket No. 05-0832) and has scheduled argument for February 14, 2006.
The underlying lawsuit in the Lamar Homes case involved claims against the insured contractor alleging negligence (shoddy workmanship) in designing and constructing a residential foundation, and breach of express and implied warranties. The insured tendered defense of the lawsuit to his insurer, Mid-Continent Casualty Company, which denied the claim on the ground that it was a claim for breach of warranty, not covered by the CGL policy. The insured filed suit seeking a declaration that Mid-Continent’s policy covered the claims asserted in the underlying action and seeking damages under Article 21.55 for Mid-Continent’s failure to defend. Judge Yeakel of the Western District of Texas, Austin Division, held that the underlying lawsuit essentially presented a claim for either breach of contract or breach of warranty, neither of which was covered under the CGL policy as a matter of law.
The district court’s decision was appealed to the Fifth Circuit and the Fifth Circuit immediately certified two questions for the Texas Supreme Court: (1) When a homebuyer sues his general contractor for construction defects and alleges only damage to or loss of use of the home itself, do such allegations allege an “accident” or “occurrence” sufficient to trigger the duty to defend or indemnify under a CGL policy; and (2) Whether an insured may seek the remedies available under Texas Insurance Code Article 21.55 for an insurer’s refusal to provide a defense.
The Mid-Continent policy contains standard definitions of “property damage” and “occurrence”. In certifying the questions, the Fifth Circuit noted the conflict among Texas appellate courts and the federal district courts regarding whether shoddy workmanship is an “occurrence” under a CGL policy. Some courts have held that damages resulting from shoddy work are foreseeable, and therefore not an accidental or unexpected loss. Other courts have held that where damages are the result of the contractor’s negligence, rather than intentional conduct, the loss is unexpected and therefore accidental.
The Fifth Circuit also noted the split among the Texas courts of appeal and federal district courts on whether defective workmanship constitutes “property damage” under a CGL policy. Some of the courts have held that there is no “property damage” where the only damage is the cost of repairing the faulty workmanship, as these are nothing more than the damages that would typically flow from a breach of the construction contract (i.e. “purely economic damages”). See Great American Lloyds Ins. Co. v. Mittlestadt, 109 S.W.3d 784 (Tex.App.--Fort Worth 2003, no pet.) Other courts have held that such damages are “property damage” because there is “physical injury to tangible property,” regardless of whether the damage is strictly to the object of the contract. See Gehan Homes, Ltd. v. Employers Mut. Cas. Co., 146 S.W.3d 833 (Tex.App.--Dallas 2004, pet. filed January 5, 2005).
Finally, the Texas Supreme Court will decide whether the remedies under Texas Insurance Code Article 21.55 are available to an insured when its insurer refuses to defend. Several federal district courts have recently held that Article 21.55 does apply to claims for a defense. See Rx.com, Inc. v. Hartford Fire Ins. Co., 364 F. Supp. 2d 609 (S.D. Tex. 2005); Housing Authority of City of Dallas v. Northland Ins. Co., 333 F. Supp. 2d 595 (N.D. Tex. 2004). However, several Texas courts of appeal have held that the “Prompt Pay Statute” only applies to first-party claims. See TIG Ins. Co. v. Dallas Basketball, Ltd., 129 S.W.3d 232 (Tex.App.--Dallas 2004, pet. denied). A finding that Article 21.55 applies to a request for defense will mean that any insurer that breaches its duty to defend will incur an 18% interest penalty on the amount of the claim (i.e. the insured’s defense costs) plus attorneys’ fees.