Installation Of Faulty Parts Does Not Constitute “Physical Injury” To Refinery Diesel Unit

The Texas Supreme Court, in response to certified questions from the Fifth Circuit Court of Appeals, held that the installation of faulty flanges in a refinery diesel unit did not constitute “physical injury” to the unit and, therefore, the insurer was not required to cover the cost to replace of the flanges.

U.S. Metals, Inc. (“US Metals”) sold ExxonMobil Corporation (“Exxon”) flanges for use in constructing diesel units at its refineries.  The flanges were designed to be welded to piping.  After they were welded together, the pipes and flanges were covered with high temperature coating and insulation.

In post-installation testing, several flanges leaked, and Exxon determined that it needed to replace the flanges to avoid the risk of fire and explosion.  This involved stripping the coating and insulation (which were destroyed in the process), cutting the flange out of the pipe, removing the gaskets (which were destroyed in the process), replacing the flange and gaskets, welding new flanges to the pipes, and replacing the temperature coating and insulation.  The replacement process delayed operation of the diesel units for several weeks.  US Metals paid Exxon $2.2 million in damages.

US Metals sought indemnity from its CGL insurer, Liberty Mutual Group, Inc. (“Liberty Mutual”).  The Liberty Mutual policy covered loss due to “property damage,” which was defined as “physical injury to tangible properly, including all resulting loss of use of that property,” and “loss of use of tangible property that is not physically injured.”  The Liberty Mutual policy, however, excluded coverage for “‘property damage’ to ‘your product’ arising out of it or any part of it.”  It also excluded “‘property 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.’”  The “impaired property” exclusion barred coverage “if such property can be restored to use by the … replacement … of ‘your product.’”  Liberty Mutual denied coverage based on the aforementioned exclusions.

The Texas Supreme Court held that the existence and extent of coverage depended on whether Exxon’s property was (1) physically injury or (2) restored to use by replacing the flanges.  US Metals argued that Exxon’s property was physically injured both by the mere installation of the faulty flanges and also later during the replacement process.  US Metals also argued 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.

First, the court held that the mere installation of the faulty flanges did not “physically injure” the diesel units.  The court held that, while the diesel unit’s incorporation of a faulty component can fairly be said to be injured (even if the injury is intangible or latent), that does not constitute “physical injury.”  “Physical injury” must be one that is tangible, or the policy’s use of the word “physical” would be mere surplusage.

Second, the court held that the physical injury caused by the removal of the faulty flanges was for the most part barred by the “impaired property” exclusion.  “The diesel units were restored to use by replacing the flanges and were therefore impaired property to which [the exclusion] applies.  Thus, their loss of use is not covered by the policy.”  However, because the insulation and gaskets were not restored to use, they were not “impaired property” and the cost of replacing them was covered by the policy.  U.S. Metals, Inc. v. Liberty Mutual Ins. Group, Inc., No. 14-0753 (Tex. December 4, 2015).

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