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Mid-Continent Casualty Company v. JHP Development, Inc.

Posted 2/19/09  

On January 28, 2009, the Fifth Circuit Court of Appeals issued an opinion addressing exclusions J(5) and J(6) of the standard CGL insurance policy. See Mid-Continent Cas. Co. v. JHP Development, Inc., No. 05-50796, ___ F.3d ___, 2009 WL 189886 (5th Cir. Jan. 28, 2009).

TRC and JHP entered into a construction contract wherein JHP agreed to build a four-story, five-unit condominium project. Only the model condominium was to be completed under the construction plans, leaving the remaining four units unfinished so that the new owner for each unit could choose how the unit was finished. Sometime later, water intrusion problems developed with the condominiums. In particular, it was determined that JHP failed to properly water-seal the exterior finishes and retaining walls, which allowed large quantities of water penetrated the units, damaging building materials and interior finishes. JHP refused to repair the damage and complete the work, so TRC terminated the company's contract. TRC retained a substitute contractor who repaired and completed the condominiums, who spent more than $400,000 investigating, demolishing, repairing and replacing the non-defective interior finishes and wiring damaged by the water intrusion.

JHP notified Mid-Continent of the problems on the TRC project and sought coverage under its CGL policy. Mid-Continent denied coverage, claiming there was no "occurrence" or "property damage" as defined in the insurance policy. In addition, Mid-Continent alleged that various exclusions applied to bar coverage. Thereafter, TRC filed suit against JHP, and JHP tendered defense of the claim to Mid-Continent. Again, Mid-Continent denied coverage for the claim and refused to provide a defense. Ultimately, a default judgment was entered against JHP in excess of $1.5 million.

Mid-Continent then filed a declaratory judgment action against JHP and TRC, seeking a declaration that (1) JHP was not entitled to coverage; (2) no defense or indemnity duties existed; (3) TRC was not entitled to recover any sums as a third-party beneficiary or judgment creditor; and (4) the default judgment was not binding on Mid-Continent. JHP never filed an answer in the declaratory judgment action. TRC, in contrast, filed a counterclaim against Mid-Continent. Mid-Continent and TRC ultimately filed cross-motions for summary judgment on the coverage issues in the district court. That court granted TRC's motion and denied Mid-Continent's. The Western District of Texas ruled that there was an "occurrence" and "property damage," none of the exclusions applied to bar coverage and the default judgment in the underlying suit was binding on Mid-Continent.

On appeal, Mid-Continent urged the appellate court to find that exclusions J(5) and J(6) barred coverage and that, in any event, the default judgment against its insured was not binding on Mid-Continent because there was not a fully adversarial trial. With respect to J(5), the parties were in agreement that "the use of the present tense 'are performing operations'" in the exclusion clarifies that the exclusion applies only to property damage that occurred during the performance of JHP's construction operations. The parties, however, disagreed as to whether JHP was "performing operations" when the water intrusion took place. TRC argued that JHP was not "performing operations" because construction had been suspended until the four unfinished units were purchased. Mid-Continent, on the other hand, claimed that the project involved ongoing construction because the units remained unfinished.

According to the Fifth Circuit, "[t]he prolonged, open-ended, and complete suspension of construction activities pending the purchase of the condominium units does not fall within the ordinary meaning of 'performing operations.'" Further, "[a]lthough JHP intended to eventually complete construction work once the units were sold, an actor is not actively performing a task simply because he has not yet completed it but plans to do so at some point in the future." And, the cases cited by Mid-Continent actually all support that position, as none of them suggests that the exclusion applies to damage occurring during a prolonged suspension of construction work. Because JHP was not actively engaged in construction work at the time of the water intrusion, the exclusion did not apply.

Turning to J(6), the Fifth Circuit's focus was on the phrase "that particular part." TRC urged the court to find that it meant the exclusion only barred coverage for that portion of the condominium project that was the subject of the defective work at issue (i.e., the inadequately waterproofed exterior portions of the condominium units), as opposed to the otherwise non-defective work that was damaged as a result of the defective work (i.e., sheetrock, studs, wiring and flooring). Mid-Continent, on the other hand, argued that the phrase applied to the entire condominium project, and thus it excluded all the damage resulting from JHP's work.

The Fifth Circuit held that "[t]he plain meaning of the exclusion . . . is that property damage only to parts of the property that were themselves the subjects of the defective work is excluded." Further, the court said, "[t]he narrowing 'that particular part' language is used to distinguish the damaged property that was itself the subject of the defective work from other damaged property that was either the subject of non-defective work by the insured or that was not worked on by the insured at all." The court found "that exclusion J(6) bars coverage only for property damage to parts of a property that were themselves the subject of defective work by the insured; the exclusion does not bar coverage for damage to parts of a property that were the subject of only non-defective work by the insured and were damaged as a result of defective work by the insured on other parts of the property."

As a result, because no allegations existed that JHP performed defective work on the interior portions of the condominiums, the damage to such property was not excluded from coverage under J(6). Rather, only the exterior finishes and retaining walls are "[t]hat particular part of any property that must be restored, repaired or replaced because [JHP's work] was incorrectly performed on it."

The Fifth Circuit's opinion in JHP is the latest in a growing line of cases in Texas where courts adhere to the plain language in the insurance policy while rejecting arguments about what the insurer meant to exclude. As a result, insureds continue to gain traction with respect to the proper interpretation of CGL policies for construction defect lawsuits. This decision is particularly significant in that it addresses the two main "course of construction" exclusions, which previously had been interpreted to broadly exclude property damage that occurred during construction. In addition, the court's adherence to the Block and ATOFINA line of cases also is significant. By binding Mid-Continent to the default judgment in this case, more insurers might now think twice before denying an insured a defense outright.

Lee Shidlofsky, Visser Shidlofsky LLP