U.S. Metals, Inc. v. Liberty Mut. Grp., Inc.

• Decision Date: 04 December 2015
• Docket Number: NO. 14–0753,14–0753
• Citation: 490 S.W.3d 20
• Parties: U.S. Metals, Incorporated, Appellant v. Liberty Mutual Group, Incorporated, doing business as Liberty Insurance Corporation, Appellee
• Court: Texas Supreme Court

490 S.W.3d 20

U.S. Metals, Incorporated, Appellant

v.Liberty Mutual Group, Incorporated, doing business as Liberty Insurance Corporation, Appellee

NO. 14–0753

Supreme Court of Texas.

Argued September 2, 2015

Opinion delivered: December 4, 2015

Rehearing Denied June 17, 2016

Graig J. Alvarez Lance R. Bremer Ryan Matthew Perdue Fernelius Alvarez, P.L.L.C., Houston TX, for Appellant.

Bruce E. Ramage, Christopher W. Martin, Levon G. Hovnatanian, Martin Disiere Jefferson & Wisdom, L.L.P., Houston TX, for Appellee.

Patrick J. Wielinski, Cokinos Bosien & Young, Irving TX, for Amicus Curiae ABC of Texas, American Subcontractors Association, Inc., ASA of Texas, Inc., Associated General Contractors of America, and Texas Building Branch–Associated General Contractors of America

Adam Pierson, Matthew Nickel, Richard D. Salgado, Dentons US LLP, Dallas TX, for Amicus Curiae American Insurance Association, and Property Casualty Insurers Association of America.

Jennifer Lynn Dotson, Reed Smith LLP, Houston TX, for Amicus Curiae United Policyholders.

CHIEF JUSTICE HECHT delivered the opinion of the Court.

The insured under a standard-form commercial general liability insurance policy supplied flanges for use in constructing refinery processing units. The flanges leaked and had to be replaced to avoid the risk of fire or explosion. The flanges were welded to the pipes they joined and therefore had to be cut out while the refineries were shut down. The insured claims that its liability for the refinery owner's replacement costs and downtime damages are covered by its CGL policy.

The policy covers “physical injury” to property and the lost use of property that could not be restored by replacing the flanges. Four questions certified to us by the United States Court of Appeals for the Fifth Circuit¹ raise two issues. One is whether property is physically injured merely by installing a defective product into it. This is an issue over which American jurisdictions have differed and one which we have not had occasion to consider. The other issue is whether replacing the flanges restored the refinery property to use when some of the property was destroyed in the process. We conclude that the policy does not cover most of the damages claimed and answer the Circuit's questions accordingly.

I

U.S. Metals, Inc. sold ExxonMobil Corp. some 350 custom-made, stainless steel, weld-neck flanges for use in constructing nonroad diesel units at its refineries in Baytown, Texas, and Baton Rouge, Louisiana. The units remove sulfur from diesel fuel and operate under extremely high temperatures and pressures. ExxonMobil contracted for flanges made to meet industry standards and designed to be welded to the piping. The pipes and flanges, after they were welded together, were covered with a special high temperature coating and insulation.

In post-installation testing, several flanges leaked. Further investigation revealed that the flanges did not meet industry standards, and ExxonMobil decided it was necessary to replace them to avoid the risk of fire and explosion. For each flange, this process involved stripping the temperature coating and insulation (which were destroyed in the process), cutting the flange out of the pipe, removing the gaskets (which were also destroyed in the process), grinding the pipe surfaces smooth for re-welding, replacing the flange and gaskets, welding the new flange to the pipes, and replacing the temperature coating and insulation. The replacement process delayed operation of the diesel units at both refineries for several weeks.

ExxonMobil sued U.S. Metals for $6,345,824 as the cost of replacing the flanges and $16,656,000 as damages for the lost use of the diesel units during the process. U.S. Metals settled with ExxonMobil for $2.2 million and then claimed indemnification from its commercial general liability insurer, Liberty Mutual Group, Inc., for the amount paid.

The convoluted provisions of the standard-form CGL policy:

• obligate Liberty Mutual to “pay those sums that [U.S. Metals] becomes legally obligated to pay as damages because of ... ‘property damage’ to which this insurance applies”;

• define “property damage” to mean “[p]hysical injury to tangible property, including all resulting loss of use of that property”, and “[l]oss of use of tangible property that is not physically injured”;

• exclude, in subparagraph K, “ ‘property damage’ to ‘your product’ arising out of it or any part of it”;

• exclude, in subparagraph M, “ ‘[p]roperty damage’ to ‘impaired property’ or property that has not been physically injured, arising out of ... [a] defect, deficiency, inadequacy or dangerous condition in ‘your product’ ”;

• define “your product” to mean “[a]ny goods or products ... sold ... by [U.S. Metals]”; and

• define “impaired property” to mean:

tangible property, other than “your product” ..., that cannot be used or is less useful because:

a. It incorporates “your product” ... that is known or thought to be defective, deficient, inadequate or dangerous; or

b. You have failed to fulfill the terms of a contract or agreement;

if such property can be restored to use by the repair, replacement, adjustment or removal of “your product” ... or your fulfilling the terms of the contract or agreement.

All damages for which U.S. Metals claims coverage arose out of its defective flanges, and thus Exclusions K and M apply. Under Exclusion K, damages to the flanges themselves are not covered, and U.S. Metals does not claim them. Under Exclusion M, the policy does not cover damages to property, or for the loss of its use, if the property was not physically injured or if it was restored to use by replacement of the flanges. The existence and extent of coverage thus depends on whether ExxonMobil's property was (1) physically injured or (2) restored to use by replacing the flanges. U.S. Metals contends that ExxonMobil's property was physically injured both by the mere installation of the faulty flanges and also later, during the replacement process. U.S. Metals further contends that the diesel units could not be restored to use simply by replacing the flanges because welds, gaskets, insulation, and coating were destroyed in the process and had to be replaced as well.

Liberty Mutual denied coverage, and U.S. Metals sued in federal district court to determine its right to a defense and indemnity under the policy. The court granted summary judgment for Liberty Mutual. On appeal, the Fifth Circuit certified to this Court the following four questions inquiring about the meaning of “physical injury” and “replacement” in the CGL policy and their application in this situation:

1. In the “your product” and “impaired property” exclusions, are the terms “physical injury” and/or “replacement” ambiguous?

2. If yes as to either, are the aforementioned interpretations offered by the insured reasonable and thus, must be applied pursuant to Texas law?

3. If the above question 1 is answered in the negative as to “physical injury,” does “physical injury” occur to the third party's product that is irreversibly attached to the insured's product at the moment of incorporation of the insured's defective product or does “physical injury” only occur to the third party's product when there is an alteration in the color, shape, or appearance of the third party's product due to the insured's defective product that is irreversibly attached?

4. If the above question 1 is answered in the negative as to “replacement,” does “replacement” of the insured's defective product irreversibly attached to a third party's product include the removal or destruction of the third party's product?²

As we will explain, the parties' dispute and the certified questions distill to two essential inquiries. First: did the mere installation of the faulty flanges physically injure the diesel units when the only harm at that point was the risk of leaks? Or put more generally: is property physically injured simply by the incorporation of a faulty component with no tangible manifestation of injury? And second: is property restored to use by replacing a faulty component when the property must be altered, damaged, and repaired in the process? We will address these issues in turn and then answer the certified questions.

II

A few basic principles guide our analysis. The interpretation of an insurance policy, like other contracts, begins with the text³ , and requires that undefined words be given their plain, ordinary, and generally accepted meanings absent some indication of a different intent.⁴ An interpretation that gives each word meaning is preferable to one that renders one surplusage.⁵ And a policy provision is ambiguous only if it is subject to more than one reasonable interpretation⁶ and not merely because the parties⁷ or other courts⁸ differ over its interpretation. With these basic principles in mind, we turn to the policy provisions at issue.

A

The parties dispute whether the installation of the faulty flanges physically injured the diesel units within the meaning of the CGL policy. The policy covers “injury”, which means “[t]he violation of another's legal right”, or more generally, “[a]ny harm or damage.”⁹ But the policy does not cover every injury; it covers only “physical injury”. “Physical” means “[o]f, relating to, or involving material things; pertaining to real, tangible objects”.¹⁰

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...