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Mar 16, 2013

Dallas Court of Appeals Finds No Coverage Where Insured Failed To Allocate Damages For Covered Claims From Non-Covered Claims

By: Julie Shehane 

On March 3, 2015, the Dallas Court of Appeals decided a coverage case involving the construction of townhomes.[1]  Dallas National Insurance Company (“DNIC”) was sued by Calitex Corp., Elshir Enterprises, L.P., and Thomas, L.P. (collectively referred to as “Calitex”) for a declaration that DNIC owed indemnity to Calitex respecting a judgment it obtained in a separate underlying lawsuit against a third party insured by DNIC (the “underlying lawsuit”).  DNIC issued a commercial general liability policy to Turnkey Residential Group, Inc. (“Turnkey”) from August 2, 2006 to August 2, 2007, which then renewed from August 2, 2007 to August 2, 2008. 

In October of 2006, Turnkey (as contractor) and Calitex (as owner) entered into a contract for Turnkey to construct a twelve-unit townhome complex in Dallas, Texas.  The Project was to be completed by October 26, 2007, but due to heavy rains in the winter of 2006-2007, the Project was delayed for three months.  Construction began in November of 2006.  Calitex filed the underlying lawsuit against Turnkey and Integrated Builders, Inc. (“Integrated”), a subcontractor of Turnkey’s.  On March 11, 2011, Calitex filed its Second Amended Petition, which alleged problems with Turnkey and Integrated’s performance and execution of the Project as early as February of 2007, which was when construction was still ongoing.  Specifically, Calitex alleged that (1) the stone exterior was not properly treated, leaked, or entire areas were left uncovered with stone; (2) the windows leaked after installation; (3) by February 20, 2008, over half the units had not reached substantial completion; and (4) as of March 11, 2011, the Project was substantially complete, but the quality of materials, labor and craftsmanship did not conform to the contract’s standards.  Calitex asserted damages of $600,000.00, which was calculated on a loss of valuation for each of the units. 

Turnkey tendered Calitex’s original petition to DNIC on February 14, 2008, and DNIC disclaimed coverage.  Following the jury trial, Calitex was awarded $500,000.00 in damages and $193,500 in attorney’s fees from Turnkey by a judgment in the underlying suit, dated March 15, 2011.  It also received a judgment against Integrated for $500,000.00 in damages.  Following the jury trial, Calitex filed suit against DNIC on November 7, 2011 for breach of contract as a third-party beneficiary of the Policy, and it requested a declaratory judgment respecting Calitex’s “rights, status, and other legal relations concerning coverage under [the policy],” in addition to attorney’s fees.  DNIC answered the lawsuit and asserted that there was no coverage pursuant to exclusion j(5) in the policy.  Specifically, DNIC alleged that there was no coverage “to the extent there was any ‘property damage’ to that particular part of real property on which the insured or any contractor or subcontractor working on the insured’s behalf were performing operations, if the ‘property damage’ arose out of those operations.”

The parties filed cross-motions for summary judgment.  DNIC asserted that (1) the damages awarded in the underlying suit were not covered; (2) the “business risk exclusions” were applicable to some of the damages in question; and (3) Calitex “failed to meet their burden to allocate covered damages (if any) from non-covered damages.”  In support of its contentions, DNIC relied upon exclusion j(5) in the policy, and that the facts adjudicated and judgment in the underlying lawsuit failed to allocate between covered and non-covered damages.  Specifically, DNIC argued that Calitex’s experts were hired while the construction was ongoing and determined that the stone façade on the exterior of the townhomes was not properly constructed.  Moreover, Calitex’s damages expert opined at the trial that the damages calculated were for the repair and replacement of faulty stonework.  Counsel for Calitex also argued at the trial of the underlying lawsuit that Calitex sought damages for the replacement of the faulty and defectively-installed stone. 

Calitex responded to DNIC’s arguments by asserting that the replacement cost for the units was a covered property damage, and that the “business risk exclusions” were inapplicable because the alleged “property damage” did not occur during ongoing operations, but after Turnkey had ceased operations.  Moreover, Calitex argued that the summary judgment evidence did not establish that any of the damages awarded in the underlying lawsuit were discovered during “ongoing operations” by Turnkey or its subcontractors.  In response to DNIC’s argument that Calitex failed to allocate damages between covered and non-covered claims, Calitex argued that the allocation rule did not apply because all damages awarded to Calitex were covered under the DNIC policy.  Calitex later argued that DNIC was collaterally estopped from attacking the underlying judgment.  DNIC responded that the underlying judgment was not determinative of coverage and that litigating coverage is not a “collateral attack” on the underlying judgment.  DNIC filed the appeal following the trial court’s orders against DNIC as to the cross-motions for summary judgment.

The Court of Appeals began its analysis by considering the doctrine of concurrent causes.  It specifically noted that the doctrine is not an affirmative defense or an avoidance issue, and that “it is a rule embodying the basic principle that insureds are not entitled to recover under their insurance policies unless they prove their damage is covered under the policy.”  The burden of segregating covered and non-covered damages falls on the insured.  The Court stated:

It is essential that the insured produce evidence which will afford a reasonable basis for estimating the amount of damage or the proportionate part of damage caused by a risk covered by the insurance policy.  . . .[F]ailure to segregate covered and noncovered perils is fatal to recovery.”

With regard to exclusion j(5), the Court rejected Calitex’s argument that the exclusion was inapplicable because the “property damage” was not discovered until after operations had ceased.  The Court reiterated the rule that “property damage” occurs under a commercial general liability policy when actual physical damage to the property occurs, not when it was or could have been discovered.  Due to the evidence submitted showing that leaks began to occur during operations, the Court found that at least some of the damage proved by Calitex was excluded by operation of the j(5) business risk exclusion. 

The Court then turned its attention to DNIC’s argument that, because at least some of the damages were excluded and Calitex failed to allocate between covered and non-covered claims, Calitex could not recover any damages awarded against Turnkey in the underlying lawsuit.  Calitex argued that all damages were covered under the policy, so it had no duty to allocate, and that DNIC was collaterally estopped from complaining about allocation because doing so was tantamount to a collateral attack on the judgment in the underlying lawsuit.  The Court rejected Calitex’s collateral attack argument, noting that while an insurer cannot challenge liability after judgment, it can certainly challenge coverage.  Calitex would have had to show how a coverage determination would have an impact on the liability of Turnkey in the underlying suit for its argument to have merit, which Calitex failed to do. 

The Court next considered DNIC’s allocation argument, and it concluded that Calitex’s evidence provided no “reasonable basis . . .for estimating the amount of damage or the proportionate part of damage caused by a risk covered by the insurance policy.”  The Court ruled that DNIC was entitled to summary judgment, finding that it was not liable to Calitex for the $500,000 in damages and $193,500 in attorney’s fees awarded to Calitex against Turnkey because Calitex failed to meet its burden to allocate. 

Oftentimes, insurers are sued in declaratory judgment actions after disclaiming coverage entirely, or after denying the duty to indemnify after judgment.  In these cases, insureds and their counsel frequently fail to allocate between the covered and potentially non-covered claims and damages in the underlying suit, and then cannot meet their burden of allocation.  For this reason, insurers should be prepared to assert the doctrine of concurrent causes and allocation rule in coverage actions. 

[1] Dallas Nat’l Ins. Co. v. Calitex Corp., et. al., No. 05-13-01505-CV, 2015 WL 968308 (Tex. App.—Dallas, Mar. 3, 2015, no pet.) (not yet reported).