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An opinion by a federal magistrate in the Northern District of Texas continued the current confusion and uncertainty under Texas law concerning whether faulty construction constitutes an “occurrence.” See Acceptance Ins. Co. v. Newport Classic Homes, Inc., 2001 WL 1478791 (N.D. Tex. Nov. 19, 2001). While the opinion constitutes a victory for insurers, opinions addressing the issue at both the state and federal levels continue to come down on both sides.

In Newport, the court addressed whether Acceptance had an obligation under its policy to defend or indemnify Newport in connection with an underlying lawsuit brought against it allegedly arising from faulty workmanship. The Taylors filed a lawsuit against Newport and others asserting claims for negligence, gross negligence, breach of contract, breach of warranty, fraud and violation of the Texas Deceptive Trade Practices-Consumer Protection Act, alleging the faulty design and construction of their home. Newport submitted the claim to Acceptance for a defense and indemnity, and Acceptance provided a defense under a reservation of rights, but filed an action for declaratory judgment on the coverage issues. The declaratory judgment action was subsequently stayed at the request of the parties, pending the outcome of a binding arbitration in the underlying lawsuit.

The arbitrators awarded the Taylors $216,221.44 for reasonable costs of repair; $10,500 for reasonable expenses of temporary housing during repair; $70,000 for reduction in the market value of the house; and $100,000 for attorneys’ fees. The trial court entered judgment confirming the arbitrator’s award. The court lifted the stay in the declaratory judgment action, and the parties moved for summary judgment. Acceptance argued that no “occurrence” existed because Newport’s faulty construction of the Taylors’ home was the result of intentional, and not negligent, conduct. Newport, to the contrary, pointed to the negligence allegations in the underlying lawsuit.

The court reiterated the Texas Supreme Court’s holding in Mid-Century Ins. v. Lindsey, 997 S.W.2d 153 (Tex. 1999), which found that an injury is accidental if from the viewpoint of the insured, it is not the natural and probable consequence of the action or occurrence which produced the injury, in other words, if the injury could not be reasonably anticipated by the insured, or would not ordinarily flow from the action or occurrence which caused the injury. The court also reiterated the recent holding in Hartrick v. Great Am. Lloyds Ins. Co., 62 S.W.3d 270 (Tex. App.-Houston [1st Dist.] – 2001, no pet. h.), which held that the insured’s intent or lack of intent to cause injury is not dispositive of coverage, but rather, both the insured’s intent and the reasonably foreseeable effect must be considered.

The court then undertook an analysis of recent federal cases interpreting Texas law involving faulty construction. The court concluded where broad allegations of negligence are present in the underlying complaint, such as, the insured failed to construct the home in a “good and workmanlike manner,” courts find that an “occurrence” exists. Id., citing, First Texas Homes, Inc. v. Mid-Continent Cas. Co., 2001 WL 238112 (N.D. Tex. March 7, 2001), aff’d, __ F.3d __, (5th Cir. Feb. 19, 2002).

On the other hand, the court noted where the underlying complaint contains specific allegations that an insured failed to comply with particular plans or specifications, courts have found that the injury-producing conduct does not constitute an accidental “occurrence.” Id., citing, Malone v. Scottsdale Ins. Co., 147 F. Supp. 2d 623, 627-28 (S.D. Tex. 2001). The court reasoned:

The distinction between the cases is one of degree. In First Texas, the insured purported to construct the house according to plan but, due to faulty workmanship, caused damage to the property. In Malone, the insured intentionally deviated from the architect’s plan and specifications, thereby causing damage to the property. Thus, the degree of intent and foreseeability in Malone was clearly greater than it was in the First Texas (sic), warranting a finding that there was no accident and no occurrence.

Looking to the allegations against Newport, the court held that Newport’s failure to build the house in a good and workmanlike manner, and its failure to construct the home in compliance with local building codes, indicated that the damage to the Taylors’ home was not accidental. Rather, the court found such damages were the natural consequence of its non-compliance, and, thus, should have reasonably been anticipated by Newport.

Unfortunately, the court also went on to address exclusion j(5), which precludes coverage for “property damage” to that particular part of real property on which the insured is performing operations, if the “property damage” arises out of those operations.

The court incorrectly held that this exclusion applied to preclude coverage for Newport’s faulty workmanship. The holding is incorrect because this exclusion should not apply to completed operations, but only to damage that occurs during the construction. The facts as set forth imply that the construction of the Taylors’ home was complete. Hopefully, this particular part of the holding will not cloud the future application of exclusion j(5).

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