December 07, 2015 Practice Points

Almost No Coverage for Replacing Defective Component That Has Not Failed

The Texas Supreme Court rejected the argument that incorporation of defective flanges into diesel units should be considered property damage

by William T. Barker

In U.S. Metals, Inc. v. Liberty Mutual Group, Inc., No. 14-0753, 2015 Tex. LEXIS 1081 (Tex. Dec. 4, 2015), the Texas Supreme Court rejected the argument that incorporation of defective flanges into diesel units should be considered “property damage.” The insured sought coverage for removal and replacement of those flanges and for the loss of use resulting from the need to replace them.

But “property damage” was defined as “[p]hysical injury to tangible property, including all resulting loss of use of that property” or “[l]oss of use of tangible property that is not physically injured.” The court reasoned that “[a] thing whose use or function is diminished by the incorporation of a faulty component can fairly be said to be injured, even if the injury is intangible, latent, or inchoate. Here, the installation of the leaky flanges—or at least potentially leaky, and in any event below-standard—can certainly be said to have injured—harmed or damaged—the diesel units by increasing the risk of danger from their operation and thus reducing their value. But if that increased risk amounted to physical injury within the meaning of the CGL policy, then it is difficult to imagine a non-physical injury. Any lessening of property by adding a component would be not only injury but physical injury. The policy’s limitation of coverage to damages from physical injury necessarily implies that there can be non-physical, non-covered injuries. Otherwise, the requirement that injury be “physical” would be superfluous. To give ‘physical’ its plain meaning, a covered injury must be one that is tangible.” Id. at *9-10.

Of course, a physical injury did occur when the defective flanges were cut out, destroying welds, insulation and gaskets. Id. at *19. But most coverage for that was barred by the impaired-property exclusion. The diesel units containing the defective flanges were tangible property that incorporated the insured’s defective product (the flanges) and could be “restored to use by the repair, replacement, adjustment, or removal” of the flanges. Id. at *20.

U.S. Metals argued that restoring the diesel units to use involved much more than replacing its product, because doing so required destruction and replacement of other things (e.g., welds, insulation and gaskets). The court disagreed. “The policy definition of ‘impaired property’ does not restrict how the defective product is to be replaced.” Id. at *20. Because the diesel units had been restored to use by the replacement, there was no coverage for their loss of use. “But the insulation and gaskets destroyed in the process were not restored to use; they were replaced. They were therefore not impaired property to which Exclusion M applied, and the cost of replacing them was therefore covered by the policy.” Id. at 20-21.

William T. Barker is with Dentons, U.S., LLP, Chicago.

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