Texas Court Construes Breach of Contract Exclusion Narrowly in Duty-to-Defend Case
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In a victory for policyholders, a recent decision from the Western District of Texas narrowly construed a common breach-of-contract exclusion and held that the insurer had a duty to defend its insured against an underlying lawsuit over construction defects. The allegations potentially supported a covered claim, as the conduct of the insured’s subcontractor could have been an independent, “but for” cause of the property damage at issue, thereby triggering the insurer’s duty to defend.

In Slay, the insured – a construction company – was hired by a city to design and construct a municipal sports complex, including Little League baseball fields, a softball field, parking lots, and a swimming pool.  The construction company hired a subcontractor to perform various services on the project, including paving parking lots and laying the cement for the pool.  After completing the project, one of the construction company’s employees noticed cracking in the parking lot and the pool.  The construction company notified the city and tried to work out a repair plan, but the city refused and eventually sued, alleging construction defects and asserting claims for breach of contract and negligence.

The construction company had Commercial General Liability (CGL) and excess policies with its insurer, Mt. Hawley Insurance Company. The construction company requested a defense against the city’s lawsuit, but its insurer denied coverage and sued the construction company, seeking a judgment that its policies did not require it to provide a defense against the city’s lawsuit.  The construction company’s policies contained a common exclusion barring coverage for breach of contract claims which removed coverage for property damage “arising directly or indirectly out of a breach of express or implied contract, breach of express or implied warranty, or fraud or misrepresentation regarding the formation, terms, or performance of a contract.”  The insurer argued that this exclusion barred coverage for the city’s lawsuit.

The court disagreed and held that the insurer had a duty to defend the construction company. In construing the “arising directly or indirectly out of” language in the breach of contract exclusion, the court held that the exclusion required a “but-for,” causal relationship between the insured’s conduct and the harms alleged in the underlying claim.  In other words, the court considered whether the alleged property damage could have happened if the construction company had not engaged in any negligent conduct or a breach of contract.  The city’s petition in the underlying lawsuit specifically alleged that the “work performed by [the construction company], its subcontractors and suppliers, was […] defective.”  The court therefore held that the city’s allegations left open the possibility that the property damage in question could have occurred even if the construction company had not breached its contract or engaged in negligent conduct.  As a result, the breach of contract exclusion did not apply, because the subcontractor’s mistakes could have been an independent, “but for” cause of the cracking.

Slay stands as a win for insureds.  Many CGL policies have similar or identical breach-of-contract exclusions.  Longstanding principles of law regarding the duty-to-defend analysis hold that exclusions should be narrowly construed against the insurer and in the insured’s favor, and that when making a duty-to-defend analysis, any doubts or ambiguities should be resolved in the insured’s favor.  The Slay court’s decision upholds both of those favorable canons for policyholders.

  • Partner

    A nationally recognized insurance coverage litigator, Lorie handles all aspects of complex, commercial litigation and arbitration for policyholders. Chambers-ranked and recognized as a “top 10 Super Lawyer,” Lorie has ...


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