When the Texas Supreme Court decides to look at controversial insurance coverage issues, you can assume that their decisions will never be boring. Such was the case in its Aug. 23 decision in Lennar Corp. v. Markel American Insurance Co.
The high court dealt with several interesting points of construction defect law, focusing primarily on whether an insurance company should pay a policyholder’s pre-litigation costs to locate and repair its defective construction despite an insurer’s refusal to consent to the repairs. In a decision that greatly expands the policyholder’s rights under commercial liability policies, the Court significantly limited the scope of voluntary payment exclusions.
The Lennar Corp. built homes in Texas in the 1990s using an Exterior Insulation Finish System (EIFS) on the roofs of many of its homes. At the time, Lennar was unaware that the use of EIFS was causing significant damage to some of its homes, including water damage, rotting and termite damage.
When Lennar became aware of the problems that EIFS could cause, it decided to remediate all of the homes it had built with EIFS, regardless of whether the homes had actually suffered any damage. However, Lennar did not notify its insurers about these potential problems or make any claims until after it began the remediation of the homes.
When it finally put its insurers on notice that it would seek indemnity for the remediation costs, much of the work was already completed. The insurers denied coverage, in part due to the voluntary payments provisions in their policies, and in turn, Lennar sued. Over the course of many years, Lennar reached settlements with all the separate insurers, with the exception of Markel.
In the ensuing coverage litigation, Markel maintained that it did not owe Lennar indemnity based upon several policy provisions in its commercial umbrella policy, such as the voluntary payments language. The voluntary payments provision expressly prohibited Lennar from making voluntary payments or incurring expenses without Markel’s prior consent. However, Lennar did not seek Markel’s consent prior to the remediation of the EIFS clad homes. Because Markel had not consented to Lennar’s remediation project, Markel argued it should not be liable for the costs.
The Texas Supreme Court disagreed. Relying on its 1994 decision in Hernandez v. Gulf Group Lloyds, a case where the Court found that one party’s breach of an agreement does not excuse the other’s performance unless the breach is material and causes prejudice to the non-breaching party, the Court found Lennar’s remediation program was a reasonable approach to a serious problem.
That being the case, Markel was required to prove that any voluntary payments of Lennar had prejudiced Markel. Since the jury at the trial court level had specifically found that Markel had not been prejudiced by Lennar’s failure to notify Markel of its remediation project, and since prejudice is a question of fact, the Texas Supreme Court refused to reconsider the jury’s findings.
Markel also relied upon the “ultimate net loss” provision of its policy in order to argue that it need not show prejudice in order to be excused from a duty to indemnify. Specifically, the “ultimate net loss” provision provides that Markel is obligated to pay Lennar’s “ultimate net loss,” which is defined as “the total amount of [property] damage for which [Lennar] is legally liable,” and such loss “may be established by adjudication, arbitration, or a compromise settlement to which we have previously agreed in writing.” In other words, the “ultimate net loss” provision permits Lennar to recover for its losses established by adjudication, arbitration, or settlement “to which we have previously agreed in writing.”
The Court did not agree with this argument, holding that Lennar’s breach of this provision was not material. The “ultimate net loss” provision is not a policy requirement that should be considered essential to coverage, and its purpose is effectively the same as the voluntary payments provision. Accordingly, the Court held that a breach of the ultimate net loss provision must be accompanied by a finding of prejudice in order to excuse performance by the insurer.
Another issue was Markel’s position that the whole amount of damages found by the jury was not covered by the policy. The jury awarded damages to Lennar for the cost to remove and replace all of the EIFS on all of the homes, even though it was indisputable that some of the homes had little or no damage.
Lennar’s damage model did not distinguish between the amount it expended on repairing homes that actually had water damage and homes that had none. The trial court asked the jury to find for each home the amount “incurred in payment of property damage,” which the court defined as “the cost to remove and replace the EIFS in order to access and repair underlying water damage or in order to determine the areas of underlying water damage, the cost to repair any water damage to the home,” or the cost to repair property damage to the home that occurred in the course of repairing water damage to the home.
Markel reasoned that Lennar’s failure to distinguish between remediation costs to homes that actually had property damage and those that did not inherently lead to including costs that were not “because of” property damage that “occurred during the policy period,” as required by the policy. Specifically, Markel complained that the costs Lennar incurred to determine, not repair, the areas of the homes that had water damage was not covered by the policy.
The Court stated that the phrase “because of” is susceptible to a broad definition, and “[u]nder no reasonable construction of the phrase can the cost of finding EIFS property damage in order to repair it not be considered to be ‘because of’ the damage.” The Court determined that the cost to find the damage caused by EIFS fell under the policy. In other words, investigation costs morphed into damages.
Finally, Markel posited that it should only be held responsible for “property damage” which occurred during its policy period. The evidence at trial showed that Lennar stopped using EIFS in 1998, and that water damage from EIFS typically begins within six to 12 months after home construction is completed. But, in its sole instance of judicial restraint in this case, the Court refrained from revisiting allocation issues and simply reiterated its adherence to its past ruling in American Physicians Insurance Exchange v. Garcia, 876 S.W.2d 842 (Tex. 1994) which allows insurers to reallocate a loss among themselves according to their subrogation rights. However, even this one seemingly straightforward ruling raises serious questions in this context since the other carriers had already settled, leaving no apparent opportunity for Markel to reallocate.
A New Trend?
This opinion is essentially a frontal assault on several critical provisions of liability policies that will assuredly lead to further litigation, revisions to policy language, and hopefully a motion for rehearing in this case. However, as this was a unanimous decision with only one concurring opinion, this decision may indicate a shift in the Court’s approach in insurance cases to a more results-oriented jurisprudence.
Martin is a partner in the Insurance Litigation and Coverage Practice of the law firm of Thompson Coe Cousins & Irons LLP.