by Robert Witmeyer
>On June 17, 2016, the Texas Supreme Court denied the parties’ motions for rehearing in U.S. Metals v. Liberty Mutual, No. 14-0753, 2015 WL 7792557 (Tex. Dec. 4, 2015). The Court’s opinion represents the current law in Texas for “property damage” and the “impaired property” exclusion under a CGL policy. But the Court’s opinion likely will be most cited for an issue that the Court did not fully analyze—insurance coverage for “rip and tear” costs.
The dispute arose from U.S. Metals’ sale of approximately 350 custom-made flanges to ExxonMobil for use in constructing non-road diesel units at ExxonMobil’s refineries. The flanges were supposed to meet industry standards and were designed to be welded to piping. The pipes and flanges were then covered with a special high temperature coating and insulation after they were welded together. In post-installation testing, several flanges leaked. Upon further investigation, it was determined that the flanges did not meet industry standards. ExxonMobil decided it was necessary to replace all of the flanges to avoid the risk of fire and explosion. For each flange, this process involved stripping the temperature coating and insulation (destroyed in the process), cutting the flange out of the pipe, removing the gaskets (also destroyed in the process), grinding the pipe surfaces smooth for re-welding, replacing the flange and gaskets, welding the new flange to the pipes, and replacing the temperature coating and insulation.
ExxonMobil sued U.S. Metals for $6,345,824 as the cost of replacing the flanges and $16,656,000 as damages for the loss of use of the diesel units while investigating, removing, and replacing the defective flanges. U.S. Metals settled with ExxonMobil for $2.2 million and then sought indemnification from its CGL carrier, Liberty Mutual Group, Inc. Liberty Mutual denied coverage.
The Texas Supreme Court described the issues before it as follows: “[I]s property physically injured simply by the incorporation of a faulty component with no tangible manifestation of injury? And second: is property restored to use by replacing a faulty component when the property must be altered, damaged, and repaired in the process?”
Beginning with the “property damage” issue, the court noted that different approaches exist but chose to follow the majority view. The Court stated, “We agree with most courts to have considered the matter that the best reading of the standard-form CGL policy text is that physical injury requires tangible, manifest harm and does not result merely upon the installation of a defective component in a product or system.” Thus, the Court concluded that the mere installation of the faulty flanges into the diesel units is not “property damage.”
Next, the Court addressed the “impaired property” exclusion. While the diesel units were not damaged by the installation of U.S. Metals faulty flanges, the units were physically injured in the process of replacing the flanges. The Court stated, “Because the flanges were welded to pipes rather than being screwed on, the faulty flanges had to be cut out, pipe edges resurfaced, and new flanges welded in. The original welds, coating, insulation, and gaskets were destroyed in the process and had to be replaced. The fix necessitated injury to tangible property, and the injury was unquestionably physical.” The Court therefore found, “[T]he repair costs and damages for the downtime were ‘property damages’ covered by the policy unless [the impaired property] exclusion applies.”
U.S. Metals argued that the “impaired property” exclusion did not apply for this reason: “[I]f the flanges had been screwed onto the pipes, removal and replacement would have been a simple matter, readily restoring the diesel units to use, and making them ‘impaired property’. But because the flanges were welded in, U.S. Metals argues, restoring the diesel units to use involved much more than simply removing and replacing the flanges alone, and therefore the diesel units were not ‘impaired property’ and Exclusion M does not apply.” The Texas Supreme Court disagreed by stating:
The policy definition of ‘impaired property’ does not restrict how the defective product is to be replaced. U.S. Metals argument requires limiting the definition to property ‘restored to use by the . . . replacement of [the flanges]’ without affecting or altering the property in the process. That limitation cannot be fairly inferred from the text itself, nor would it make sense to do so. In U.S. Metals’ view, the diesel units could not be restored to use by replacement of the flanges, not only because they had to be cut out and welded back in, but because of the wholly incidental replacement of insulation and gaskets. Coverage does not depend on such minor details of the replacement process but rather on its efficacy in restoring property to use. The diesel units were restored to use by replacing the flanges and were therefore impaired property to which Exclusion M applies. Thus, their loss of use is not covered by the policy.
However, in the last two sentences of the Court’s analysis, the Court held that the “impaired property” exclusion does not apply to the destroyed insulation and gaskets. The Court stated, “But the insulation and gaskets destroyed in the process were not restored to use; they were replaced. They were therefore not impaired property to which Exclusion M applied, and the cost of replacing them was therefore covered by the policy.” This conclusion suggests that a CGL policy may cover “rip and tear” costs under Texas law.
The Court’s analysis of the “impaired property” exclusion will undoubtedly lead to litigation over insurance coverage for “rip and tear” costs in Texas. However, the Court’s opinion was limited to the certified questions and did not address important coverage issues such as:
(1) whether a CGL insuring agreement provides coverage for consequential damages if there is no covered “property damage”;
(2) whether the intentional destroying of property can be an “occurrence”;
(3) whether exclusion a. (“expected or intended injury”) applies to “rip and tear”; and
(4) whether the insurance policy in effect at the time of the initial “property damage” or the policy in effect at the time of the repair is triggered.
Further, in light of the Court’s opinion, some insurers will almost certainly create “rip and tear” endorsements that limit their exposure for “rip and tear” costs. Policies with such endorsements may ultimately provide less coverage to policyholders than what many thought was covered under a standard form CGL policy prior to the Court’s opinion.
Therefore, the U.S. Metals decision is likely just the beginning for determining the scope of coverage available under CGL policies for “rip and tear” expenses in Texas.