The insured brought an action against the insurer to recover for breach of the duty to defend and indemnify the insured against liability for its costs to replace weld-neck flanges and damages from loss of use. This case is U.S. Metals v. Liberty Mutual Group, 490 S.W.3d 20 (Tex. 2016).

U.S. Metals sold ExxonMobil some 350 custom-made stainless steel weld-neck flanges for use in constructing nonroad diesel units. The flanges were to be welded to pipes. After the flanges were installed, testing showed that they leaked. ExxonMobil decided it was necessary to replace the flanges to avoid the risk of fire and explosion. The replacement process delayed the operation of the diesel units for several weeks.

ExxonMobil sued U.S. Metals for the cost of replacing the flanges and for the loss of use of the diesel units. U.S. Metals settled with ExxonMobil and then sought indemnification from its insurer, Liberty Mutual. The insurer denied coverage and the insured sued. The U.S. District Court entered summary judgment in favor of the insurer and the insured appealed.

The United States Court of Appeals, Fifth Circuit, handling the appeal, certified questions to the Supreme Court of Texas. The two main questions were: did the mere installation of the faulty flanges physically injure the diesel units when the only harm at that point was the risks of leaks; and, is property restored to use by replacing a faulty component when the property must be altered, damaged, and repaired in the process?

The Supreme Court of Texas noted that the liability policy issued by Liberty Mutual covered physical injury. The court said that most other courts from around the country hold that physical injury requires tangible, manifest harm and does not result merely upon the installation of a defective component in a product or system. The court concluded that property damage occurs when the damage actually occurs. In this instance, ExxonMobil was careful and cautious by testing the flanges before they were put to use on a regular basis, a use that would cause actual physical damage. So, the court ruled that the diesel units were not physically injured merely by the installation of the faulty flanges. The court went on to say that the units were physically injured in the process of replacing the faulty flanges because the flanges were welded to pipes and the flanges had to be cut out, pipe edges resurfaced, and new flanges welded in. Thus, the repair costs and damages for the downtime were property damages covered by the policy, that is, unless the impaired property exclusion applied.

The court noted that the impaired property exclusion denied coverage to property that could be restored to use by the replacement of the faulty item. U.S. Metals argued that restoring the diesel units to use involved much more than simply removing and replacing the flanges alone and so the units were not impaired property and the exclusion does not apply. The court disagreed. The court said that the definition of impaired property does not restrict how the defective product is to be replaced and the insured's interpretation of the exclusion requires limiting the definition to property restored to use without affecting or altering the property in the process. That limitation the court would not accept. The court held that the diesel units were restored to use by replacing the flanges and were therefore impaired property to which the exclusion applied. Thus, their loss of use is not covered by the policy.

The Supreme Court of Texas answered the certified questions as follows: physical injury did not occur when the faulty flanges were installed; and, the diesel units could be restored to use by replacing the faulty flanges, so the impaired property exclusion applied.

Editor's Note: The Texas Supreme Court ruled that mere installation of faulty product does not cause property damage covered by the general liability policy, and that the impaired property exclusion applied in this instance since the tangible property (the diesel units) could be restored to use by replacing the faulty product.