A federal district court in Houston, interpreting Texas law, found that an insurance company had a duty to defend its insured, a manufactured home builder, against claims brought by a lender which funded 676 loans used to purchase homes. The case is Nautilus Insurance Co. v. ABN-AMRO Mortgage Group, Inc. Slip Op. 2006 WL 3545034 (S.D.Tex. 2006). Emerson Manufactured Homes, Ltd. and a related group of entities were defendants in two lawsuits. One suit was brought in state court by 928 individuals against Emerson for negligence and defective construction, among other claims. The other suit was brought by ABN-AMRO Mortgage Group, the lender for 676 of the homes in the state court matter, which alleged that Emerson negligently sold defective homes at inflated prices. Emerson’s insurance company, Nautilus, denied all coverage, claiming that neither of the two underlying suits alleged facts that are potentially covered by the applicable policies, therefore Nautilus had no duty to defend or indemnify Emerson in those matters. Nautilus filed the instant action in federal court seeking a court determination that there was no coverage under its policies, and therefore no duty to defend or indemnify. Id. at *1.

Generally speaking, an insurance company must defend its insured (hire a lawyer) if, looking at the “four corners” of the complaint, there are any claims that are potentially covered by the policy. If the pleadings against the insured allege anything that could possibly be covered, the insured is owed a defense. The duty to indemnify is separate, and not as broadly construed. The duty to indemnify arises once facts are established that the insured is liable for damages that are covered by the policy. Id. at *2-3. The Nautilus policy in question is a fairly standard General Liability policy, which obligates the insurance company to “pay those sums that the insured becomes legally obligated to pay as damages because of property damage.” The policy only applies to “property damage caused by an occurrence.” “Occurrence” means “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Id. at *3. Nautilus argued that ABN-AMRO had not alleged anything accidental about Emerson’s conduct. The Court disagreed, finding the allegations of “negligent construction” to be sufficient to count as allegations of non-intentional or accidental conduct. Id. at *4-5
Next, the Court analyzed whether or not the damages amounted to covered “property damage” under the policy. ABN-AMRO did allege that the homes were negligently constructed, and negligently attached to their foundations. It also claimed that the defects caused water damage to the homes and other types of damage to the structures. Id. at *5. However, the actual damages to the structures were not suffered by ABN-AMRO, who was only a lender, rather those damages were suffered by the homeowners themselves. ABN-AMRO argued that it was damaged because the homes were worth far less than they should have been due to the defects, and that since this diminution in value was caused by the property damage, for which Nautilus’s insured was responsible, then the language of the policy which extends coverage for damages that the insured is obligated to pay “because of property damage”, then it covers all those damages that flow from the property damage caused by Emerson. The Court agreed. Id. *5-6
Unfortunately for ABN-AMRO, its run of good luck stopped there. The Court found that the damage was excluded under the “your work” and “your product” exclusions. These exclusions disclaim coverage for damage to the insured’s work or his product. The “your work” exclusion has an exception for work done by a subcontractor. Tragically, there was no evidence that Emerson used any subcontractors to either build or place the homes. Id. at *7. The Court found that it was possible to interpret ABN-AMRO’s complaint such that it alleged damage to property that would not be considered Emerson’s “work” or “product”, but that was limited to the ground itself. There would be no coverage for defects to the homes, the cost to repair those defects, and the damage that they caused to the buyers or to the lender. Id. at *8.

Finally, the court analyzed Nautilus’ duty to defend under the complaint in the Homeowner lawsuit. For the same reasons, the Court found that the damages were excluded from coverage by the “your work” and “your product” exclusions in the policy. However, the Court found that the diminution in value of the property, excluding the homes themselves, may be covered. Id. at *9-10.

This is yet another example of how coverage restrictions and exclusions can gut a construction defect claim. In this case, these manufactured homes were poorly built, then poorly erected on site, obviously causing massive damage to themselves and the contents of the homes. Many of the homes were so bad that the buyers abandoned them, leaving them for the bank. But because of the wording of the policy, and because the home builder did not use subcontractors, the bank and the buyers are literally left out in the cold. The good news is that this analysis can assist other homeowners in later cases. If the diminution in value of the property is covered under a standard CGL policy, and the standard measure of damages for diminution is cost to repair, then a builder may be liable for the overall cost to repair on a project, without the need to find “consequential” or “resultant” damage.