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Fifth Circuit Limits Effect of Contractual Liability Exclusion

Case:Crownover v. Mid-Continent Casualty Co.,
           5th Circuit Court of Appeals
           2014 U.S. App. LEXIS 20737 (10/29/2014)

Revisiting its opinion upholding summary judgment in favor of the insurer, a Fifth Circuit panel, without any new facts, reversed course on rehearing, finding that a homeowner whose foundation exhibited cracks and whose HVAC system was improperly installed could recover under its builder’s CGL policy.

The Crownovers entered into a contract with Arrow Development for the construction of their home in Sunnyvale, Texas. The contract contained a warrant-to-repair clause which provided that Arrow would “promptly correct work…failing to conform to the requirements of the Construction Documents.” After completion of the home, cracks began to appear on the walls and the foundation. Problems also occurred 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 in repairs. They sent demand letters to Arrow, which Arrow in turn presented to its insurer, Mid-Continent. The Crownovers later initiated an arbitration proceeding against Arrow. The arbitrator ultimately awarded damages to the Crownovers, finding Arrow had breached its express warranty to repair non-conforming work. Arrow later filed for bankruptcy and the Crownovers’ recovery was thus limited to that recoverable under Arrow’s insurance. Arrow’s insurer, Mid-Continent, however, denied coverage, relying primarily on the contractual liability exclusion in its policy.

Originally, the Fifth Circuit panel sided with the Texas district court, noting that the case was controlled by Gilbert Texas Construction LP v. Underwriters at Lloyds of London, 327 S.W.3d 118 (Tex. 2010) and Ewing Construction Co. v. Amerisure Insurance Co., 420 S.W.3d 30 (Tex. 2014), the district court found that the insurer had shown the standard CGL contractual-liability exclusion, which provides as follows, applied: “This insurance does not apply to property damage which the insured is obligated to pay as damages by reason of the assumption of liability in a contract or agreement. . . .” The lower court had further recognized that the exception to the exclusion, for “liability. . . that the insured would have in the absence of the contract or agreement,” was not applicable since Arrow’s obligation to perform in a workmanlike manner arose under the construction contract, not at law.

On rehearing, however, the Fifth Circuit panel reconsidered the effect of Gilbert and Ewing. The panel determined that Gilbert simply held that the contractual liability exclusion applied where the only viable claim was one in contract. The panel noted the Texas Supreme Court was clear that the exclusion is to apply only when the insured has assumed liability by virtue of a contract which exceeds its liability under general law. The panel further reasoned that Ewing instructs the court to essentially look behind the contract to determine if the liability sought to be excluded is actually greater than the insured would have had absent the contract.

Concluding that Arrow’s duty to repair in this case existed independent of any contractual express warranty, as there is a general duty to exercise reasonable care in performance of work under a contract, the panel on rehearing determined the contract did not expand Arrow’s liability “in any relevant manner.” Further noting that the insurer has the duty to show that its exclusion applies, and that exceptions and limitations on liability are strictly construed against the insurer and in favor of the insured, the panel concluded Mid-Continent had not shown Arrow’s agreement to “promptly correct work…failing to conform to the requirements of the contract documents” constituted an expansion of the contractor’s obligations beyond those that it owed under general Texas law, and thus the court granted summary judgment in the homeowner’s favor.

This case suggests the Fifth Circuit intends to look beyond the contractual language and to the facts of a particular case to determine if a contractor’s assumed liability is materially greater than that required under applicable law before it will apply the CGL contractual liability exclusion. Perhaps more importantly, this panel found the exclusion did not apply, rather than that the insured had shown the exception to the exclusion applied. Consequently, the panel appears to have treated the exclusion as a whole, shifting the burden to the insurer to show not only that the obligation at issue was assumed in a contract, but that the liability assumed was greater than that required by law. This appears to differ from the Texas Supreme Court’s approach.

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