The rule courts generally employ to interpret undefined words in insurance policies — essentially, to look to the words’ plain or ordinary meaning — sounds simple. However, many times, there is more than one meaning of such words, lending to more than one reasonable interpretation of the particular provision at issue. In this situation, courts usually characterize the words as ambiguous and construe them in favor of the policyholder, as long as it has put forth a reasonable interpretation. But federal courts, when examining such undefined words in an insurance policy, have an additional option beyond consulting a dictionary: ask the highest relevant state court, if it has not already ruled on the issue. That is precisely what the Fifth Circuit did in U.S. Metals, Inc. v. Liberty Mutual Group, Inc. In the case, the appellate court examined two CGL policy exclusions, the “your products” and “impaired property” exclusions, and decided to certify questions to the Supreme Court of Texas regarding the meaning of the terms “physical injury” and “replacement” in those exclusions.
The case involved policyholder U.S. Metals, Inc., which sought coverage under its CGL policy with Liberty Mutual Group, Inc. for a settlement of a lawsuit brought by Exxon Mobil Corporation over defective flanges, which were irreversibly incorporated into Exxon’s refining facilities. The insurer had denied coverage based on the “your products” and “impaired property” policy exclusions.
The “your products” exclusion barred coverage for “property damage” to “your product” that arises out of your product or any part of it. The policy defined “property damage” to include “physical injury to tangible property, including all resulting loss of use of that property” or “loss of use of tangible property that is not physically injured.” However, the policy did not define the term “physical injury” and, thus, the Fifth Circuit was left to decide whether “physical injury” only arises when the third party’s product changed color, shape, or appearance due to the insured’s defective product or whether it arises at the moment of incorporation of the defective product.
The “impaired property exclusion” barred coverage for “‘[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’ or ‘your work.’” The policy defined “impaired property” as property belonging to a third party that cannot be used, or is less useful, because it incorporates the policyholder’s defective product if “such [impaired] property can be restored to use by the. . . replacement. . . of ‘your product’ . . . .” Because the policy did not define the term “replacement,” the Fifth Circuit was tasked with determining whether “replacement” included the destruction or removal of the third party’s property when the insured’s defective product was removed and replaced.
Noting the lack of controlling authority on the interpretation of these terms, the Fifth Circuit asked the Supreme Court of Texas whether “physical injury” and “replacement” in the context of the “your product” and “impaired property” exclusions are ambiguous, and, if so, whether the meanings presented by the policyholder were reasonable. Alternatively, if the terms are not ambiguous, the Fifth Circuit asked the Texas high court to decide which interpretation should be adopted.
CGL policyholders, most notably contractors and subcontractors, will undoubtedly pay close attention to the upcoming Supreme Court of Texas decision on these coverage issues. As the Fifth Circuit itself noted, such a decision will “have far-reaching implications due to the commonality of these exclusions within CGL policies” and “will affect a large number of litigants.” We’ll be following further developments.