Insurance Blog: Texas Federal Court Analyzes What Triggers the Breach of Contract Exclusion

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Posted In: Insurance Recovery

on February 5, 2019

In Mt. Hawley Ins. Co. v. Slay Engineering, et al., a federal district court in Texas concluded an insurer had a duty to defend a general contractor in a construction defect case alleging breach of contract and negligence. No. 5-18-CV-00252-OLG, 2018 WL 3946547, at *7 (W.D. Tex. Aug. 15, 2018), --- F.Supp. --- 3d (2018). In so doing, the court narrowly interpreted a breach of contract exclusion and declined to adopt an interpretation of the policies at issue that would have rendered a subcontractor exception to a “your work” exclusion meaningless. For the breach of contract exclusion to eliminate an insurer’s duty to defend, the alleged breach must be a “but for” cause of the property damage and no other independent, covered “but for” causes can exist.

Background

In the underlying lawsuit, general contractor, Slay Engineering/Texas Multi-Chem/ Huser Construction, and the City of Jourdanton entered into a contract to construct a municipal sports complex. Id. at *1. The City filed a lawsuit alleging the work performed by Huser, its subcontractors, and suppliers was defective and not in compliance with the contract because of substantial cracks in the swimming pool, parking lot, and other paved surfaces and deficient site drainage. Id. at *2.

The policies at issue obligated Huser’s insurer, Mt. Hawley Insurance Company, to defend any suit seeking damages for any covered “property damage” caused by an “occurrence” unless such “property damage” was excluded from coverage. Id. at *3. In denying coverage, Mt. Hawley relied on two exclusions: (1) a “Damage to Your Work” exclusion barring coverage for certain “property damage” arising directly from Huser’s own work; and (2) an endorsement specifying coverage did not extend to any suit for “property damage” arising directly or indirectly out of a breach of “express or implied contract, breach of express or implied warranty, fraud or misrepresentation regarding the formation, terms or performance of a contract.” Id.

The Court’s Analysis

The court noted that, under Texas law, the phrase “arising out of” required a causal connection, meaning there must be “but for” causation. Id. (quoting Utica Nat. Ins. Co. of Texas v. Am. Indem. Co., 141 S.W.3d 198, 203 (Tex. 2004)). Mt. Hawley latched on to this concept, claiming that, “but for the Contract, there would be no cause of action to bring against Huser.” Id. at *6. The court rejected this interpretation because it conflated Huser’s causation of “property damage” with Huser’s ultimate contractual liability for economic losses. On this point, the court agreed with the analysis of a California court rejecting the same argument because it “‘would essentially defeat coverage in all instances because virtually all property damage that [the insured] would seek coverage for could be characterized as arising directly or indirectly out of a breach of contract or implied warranty.’” Id. (quoting Mt. Hawley Ins. Co. v. Aguilar, No. SACV0700969CJCMLGX, 2008 WL 11342656, at *3 (C.D. Cal. Feb. 29, 2008)). As such, the “directly or indirectly and “arising out of” language required Mt. Hawley to demonstrate that Huser’s breach of contract was a “but for” cause of the alleged property damage. Id. The mere fact that the City’s claims had some relation to Huser’s contract with the City or that Huser was sued for breach of contract were not alone sufficient to trigger the exclusion.

While acknowledging Huser’s breach might have been one “but for” cause, the court explained that, under Texas law, there must be no other independent “but for” causes covered under the policies to erase Mt. Hawley’s duty to defend. Id. at *7. The City’s petition alleged that work performed by Huser, its subcontractors and suppliers was defective and therefore, on its face, alleged another “but for” cause, i.e., the subcontractors’ work. As such, Mt. Hawley had a duty to defend absent an exclusion for claims related to the subcontractors’ work.

The court also rejected Mt. Hawley’s argument that the endorsement containing the breach of contract exclusion overrode the subcontractor exception to the “your work” exclusion because the subcontractors’ work was incidentally related to Huser’s work and breach of contract. Id. at *8. According to the court, a natural reading of the breach of contract exclusion was that it pertained to the insured’s liability for its own deficient work or to a specific contractual obligation the insured assumed. Id. Mt. Hawley’s interpretation unnecessarily rendered the subcontractor exception without meaning. As such, the court found that the City’s allegations potentially supported a covered claim, requiring Mt. Hawley to defend. Id. at *9.

Conclusion

This opinion demonstrates the proper scope of the breach of contract exclusion under Texas law by interpreting the exclusion narrowly to give meaning to all policy provisions. Coverage is not defeated merely because the allegations in the underlying lawsuit were incidentally related to a contract or breach of contract.

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