Texas Court Gives New Life to Contractual Liability Exclusion

Where contractors are involved, one of the most intractable problems for a carrier in negotiating and settling claims are the contract liability issues. How does a carrier identify if a contractual claim is covered? A recent case helps explain some of those thorny issues.

In Gilbert Texas Construction, L.P. v. Underwriters at Lloyd’s London, the Texas Supreme Court, on June 4, 2010, clarified one of the central problems in contractor cases: the application of the contractual liability exclusion — an exclusion found in most general liability policies.

In a surprise move, the Court undermined its prior Lamar Homes decision that had found coverage for breaches of contract, finding that the exclusion precludes coverage for breach of contract. In addition, the Court also determined that an excess carrier is not estopped from asserting the exclusion as a coverage defense when it does not control the defense of the underlying action.

The circumstances involved a contract between Dallas Area Rapid Transit Authority and Gilbert Texas Construction L.P., a general contractor, to construct a light rail system in Dallas, Texas. During construction, the city of Dallas suffered usually heavy rain so that a building adjacent to the construction area was flooded. The building owner sued Gilbert and several others for multiple causes of action, including a claim that Gilbert breached its contract with the property owner. Gilbert’s primary insurance carrier, Argonaut Insurance Co., assumed the defense. Underwriters at Lloyd’s London, the excess carrier, sent a series of reservation of rights letters regarding the property owner’s lawsuit.

Gilbert won summary judgment for all claims except for the property owner’s claim for breach of contract against Gilbert. After the trial court entered judgment, Underwriters sent another reservation of rights to Gilbert where it for the first time took the position that the property owner’s breach of contract claim was not covered due to the contractual liability exclusion. The breach of contract claim was ultimately settled, but the excess carrier denied coverage.

The Contractual Liability Exclusion

Underwriters did not take the position that Gilbert’s claim was not within the coverage provided under the policy’s insuring agreement. Rather, it asserted the claim was not covered under the contractual liability exclusion because the only remaining cause of action was for breach of contract. The Underwriters’ policy contained the contractual liability exclusion stating that it did not apply to property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract.

In its analysis of the contractual liability exclusion, the Texas Supreme Court first noted that Texas courts give a policy’s terms their ordinary meaning and seek to honor the parties’ agreement by not reading additional provisions into the contract. So, when considered as a whole, the contractual liability exclusion and its exceptions provide that:

The policy does not apply to bodily injury or property damage for which the insured is obligated to pay as damages by reason of the assumption of liability in a contract or agreement, except for enumerated, specific types of contracts called “insured contracts” and except for instances in which the insured would have liability apart from the contract.

The contract between Gilbert and the property owner provided that Gilbert would repair any damage to facilities, including third-party property, resulting from its failure to comply with the requirements of the contract.

In holding that the contractual liability exclusion excluded coverage for the property owner’s breach of contract claim, the Court rejected Gilbert’s argument that the word “assumption” as used in the exclusion meant the assumption of the liability of another. According to the Court, Gilbert urged it to read the exclusion to say “by reason of assumption of another’s liability in a contract or agreement.” While the Court noted that the exclusion did exclude coverage for liability of a third-party that is assumed, it has never been so narrow to only apply to third-party liability. If the policy was intended to do so, “it would have been simple to have said so.”

The Court also noted that the exclusion and its exceptions also supported its holding that the contractual liability exclusion precluded coverage for the property owner’s breach of contract action. The first exception applied to “insured contracts,” which are defined to include the assumption of another’s tort liability. This exception specifically stated that it applied to the tort liability of another. “The fact that the definition explicitly references assumption of the tort liability of another demonstrates that the parties are capable of using such narrow, specific language when that is their intent.”

The Court stated that while the exception to the exclusion brought back into coverage contracts in which the insured assumes the tort liability of another, the exclusion was not limited to such contracts. Rather, under the exclusion’s plain language, it excluded coverage for liability assumed by contract subject to the two exceptions: 1) insured contracts, as defined by the policy and 2) situations where the insured’s liability for damages does not depend on the obligations of the contract at issue.

The Court briefly discussed its previous holding in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007) and noted that this exclusion was not at issue in Lamar Homes. Rather, that case involved whether property damage resulting from construction defects could come within the general terms of a general liability policy for the purposes of the duty to defend. The exclusion was not raised. So, in this case, the facts show that the remaining theory of liability, after the judgment by the trial court, do come within the contractual liability exclusion for the purpose of determining the indemnity obligation.

No Estoppel

In addition to reinvigorating the contractual liability exclusion, the Court also addressed the scope and application of the estoppel doctrine. The Court addressed Gilbert’s argument that it was entitled to recover under a theory of estoppel because the carrier assumed control of its defense and harmed Gilbert.

In support of this argument, Gilbert claimed that the insurer failed to reserve its rights on the contractual liability exclusion and urged Gilbert’s counsel to move for summary judgment on the basis of governmental immunity. Gilbert contended it was prejudiced because the carrier informed defense counsel that if he did not move for judgment on the governmental immunity issues, it would deny coverage on the cooperation clause.

The Court held that the carrier had not assumed the defense of the property owner’s lawsuit and, even if it had, Gilbert was not prejudiced by its actions. The Court found that the mere threat of invoking the cooperation clause did not equal assuming control of the defense. The carrier had no duty to defend Gilbert under its policy, but it did have the right to “associate” with the defense.

Further, Underwriters had the right to “stand on the cooperation clause of its policy.” The Court held that “Underwriters’ disclosure of its intent to assert the contractual rights in its policy does not equate with asserting control over Gilbert’s defense.”

Even if Underwriters had assumed control of the defense of the claim, the Court found that Gilbert was not prejudiced. The Court found that the carrier did not have a duty to defend and did not appoint or retain Gilbert’s defense counsel.

In addition, other contractors who were parties to the suit also raised the immunity issue and testimony indicated that it likely did not matter that Gilbert raised the issue because the trial counsel ruled that the immunity extended to all contractors in the case. Therefore, Gilbert suffered no harm from the carrier’s reservation of rights.

Following Lamar Homes, the utility of the contractors liability exclusion was very much in doubt. With Gilbert, the Texas Supreme Court has given new life to a seemingly moribund exclusion.

Martin is a partner and Patrick is an associate in the Insurance Litigation and Coverage Practice of the law firm of Thompson Coe Cousins & Irons LLP.