United States Court of Appeals

Fifth Circuit

FILED

August 8, 2007

Charles R. Fulbruge III

Clerk

REVISED SEPTEMBER 7, 2007

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 06-10727

ONEBEACON INSURANCE COMPANY, as Assignee of Potomac Insurance

Company of Illinois

Plaintiff - Appellee

v.

DON’S BUILDING SUPPLY INC

Defendant - Appellant

Appeal from the United States District Court

for the Northern District of Texas, Dallas

Before KING, DEMOSS, and OWEN, Circuit Judges.

PER CURIAM:

This diversity case involves important and determinative questions of

Texas law as to which there is no controlling Texas Supreme Court precedent.

Accordingly, we certify those unresolved questions to the Supreme Court of

Texas.

CERTIFICATION FROM THE UNITED STATES COURT OF

APPEALS FOR THE FIFTH CIRCUIT TO THE SUPREME COURT

OF TEXAS, PURSUANT TO TEXAS CONSTITUTION ARTICLE

5, § 3-C AND RULE 58 OF THE TEXAS RULES OF APPELLATE

PROCEDURE
No. 06-10727

1 OneBeacon initially sought such a declaration with regard to four additional lawsuits,

but DBS has since withdrawn its request for a defense in those suits because they involved

homes that were not constructed until after the end of the policies’ coverage period.

2

TO THE SUPREME COURT OF TEXAS AND THE HONORABLE JUSTICES

THEREOF:

I. STYLE OF THE CASE

The style of the case in which this certification is made is OneBeacon

Insurance Company v. Don’s Building Supply, Inc., Case No. 06-10727 in the

United States Court of Appeals for the Fifth Circuit, on appeal from the United

States District Court for the Northern District of Texas, Dallas Division.

Federal jurisdiction is based on diversity of citizenship.

II. STATEMENT OF THE CASE

Plaintiff-appellee OneBeacon Insurance Company (“OneBeacon”) seeks a

declaration that it has no duty to defend or indemnify its insured, defendantappellant Don’s Building Supply, Inc. (“DBS”), in twenty-two lawsuits1

that

various homeowners (the “homeowners”) have filed against DBS and other

defendants. DBS sought a defense from OneBeacon under three occurrencebased commercial general liability insurance policies (“CGL policies”) issued to

DBS by Potomac Insurance Company of Illinois (“Potomac”) and assigned by

Potomac to OneBeacon. After initially providing a defense to DBS, OneBeacon

has since withdrawn the defense, denied any further obligation to DBS under

the policies, and filed this declaratory judgment action. DBS asserted a

counterclaim in response, and each party filed a motion for summary judgment.

The district court granted summary judgment to OneBeacon, and DBS now

appeals.

The homeowners filed the underlying lawsuits in state courts throughout

northernTexas from 2003 to 2005, asserting claims arising from water intrusion

into the wall cavities oftheir homes due to an allegedly defective synthetic siding

system known as Exterior Insulation and Finish Systems (“EIFS”). The EIFS
No. 06-10727

2 One of the suits uses different language but makes similar allegations.

3

at issue was distributed and sold by DBS and designed, manufactured, and

marketed by other defendants. Specifically, the suits allege that the defendants

knew that EIFS was defectively designed and would fail to serve as a weathertight exterior cladding; that defendants knew that any wooden structures

adjacent to EIFS would be at risk of wood rot and other damage because of the

defective design; and that the defective EIFS allowed water to get inside the

walls each time that it rained, causing extensive damage to the homes, a

reduction in property values, and the need to retrofit or replace the EIFS. Each

of the homeowners’ petitions states that although the damage to the relevant

home remained undiscovered until some point within two years of the filing of

the suit,

[the] injury to the home actually began to occur on the

occasion of the first penetration of moisture behind the

[EIFS] which would have been at such time as the

improperly installed sealant joints and sealants began

to fail, allowing moisture within the system. Such

failure would have been within six months to one year

after the application of the EIFS . . . and such injury

was continuous thereafter. Continuous and repeated

exposure of the moisture sensitive substrates of the

home to the elements, specifically rain and wind-driven

rain, has resulted in an ongoing exposure to moisture

and accumulation of water behind the [EIFS]. Each

repeated moisture intrusion event has contributed to

and worsened the damage to Plaintiffs’ property.2

Faced with these lawsuits, DBS sought a defense from OneBeacon under

the CGL policies, which cover a combined policy period from December 1, 1993

to December 1, 1996 (the “policy period”). All of the houses involved in the

twenty-two underlying suits had EIFS installed at some point during the policy

period. In relevant part, the CGL policies obligate OneBeacon to defend DBS in,

and indemnify DBS against any liability arising from, any suit brought against
No. 06-10727

3

In relevant part, the policies provide:

1. Insuring Agreement

a. We will pay those sums that the insured becomes legally

obligated to pay as damages because of “bodily injury” or

“property damage” to which this insurance applies. We will have

the right and duty to defend any “suit” seeking those damages

. . . .

b. This insurance applies to “bodily injury” and “property

damage” only if:

(1) The “bodily injury” or “property damage” is caused by an

“occurrence” that takes place in the “coverage territory;” and

(2) The “bodily injury” or “property damage” occurs during the

policy period.

4

DBS to recover for “property damage” that (1) is caused by an “occurrence” and

(2) “occurs” during the policy period.3“Property damage” is defined as:

a. Physical injury to tangible property, including all

resulting loss of use of that property. All such loss of

use shall be deemed to occur at the time of the physical

injury that caused it; or

b. Loss of use of tangible property that is not physically

injured. All such loss shall be deemed to occur at the

time of the “occurrence” that caused it.

An “occurrence” is defined as “an accident, including continuous or repeated

exposure to substantially the same general harmful conditions.”

The central question before the district court was whether the property

damage described in the underlying suits is alleged to have occurred within the

policy period such that OneBeacon’s duty to defend DBS was triggered under the

CGL policies. To resolve this question, the court first had to identify the time at

which Texas law deems property damage to occur for purposes of a CGL policy,

and the court determined that it was bound by Fifth Circuit precedent holding

that “property damage ‘occurs’ within the meaning of a CGL policy [under Texas
No. 06-10727

4 The other homeowner’s petition similarly alleges that“no reasonable means existthat

would enable homeowners, such as Plaintiffs, to discover the damage occurring beneath the

exterior surfaces of EIFS; thus, making the defect inherently nondiscoverable.”

5 A two-year limitations period applies to the underlying suits’ claims for negligence,

gross negligence, and violations of the Texas DTPA. TEX. CIV.PRAC. & REM. CODE § 16.003(a)

(negligence and gross negligence); TEX. BUS. & COM. CODE § 17.565 (DTPA). A four-year

limitations period applies to the fraud-based claims asserted in the underlying suits, TEX.CIV.

PRAC. & REM. CODE § 16.004(a), but this difference did not affect the district court’s analysis.

5

law]. . . when the damage becomes manifest or identifiable.” Guar. Nat’l Ins. Co.

v. Azrock Indus. Inc., 211 F.3d 239, 246-47 (5th Cir. 2000); see also Am. Home

Assurance Co. v. Unitramp Ltd., 146 F.3d 311, 313 (5th Cir. 1998).

The district court then observed that each of the homeowners in the

underlying suits pleaded the discovery rule in order to avoid the application of

the statute of limitations for each of such homeowners’ claims. See

generally Burns v. Thomas, 786 S.W.2d 266, 267 (Tex. 1990) (discussing the

discovery rule). All but one of the homeowners pleaded the discovery rule as

follows:4

Discovery Rule Applies

The injury to Plaintiffs was inherently undiscoverable

in that the defects inherent in the EIFS are latent. The

defects cause damage within the wall cavity which is

not readily apparent to one examining the exterior of

the EIFS surface. As a result, the named Plaintiffs

would not, in the exercise of reasonable diligence,

immediately perceive, observe or discover EIFS’s

defects.

Each petition indicates that the damage was discovered shortly before the filing

of the relevant suit, and to avoid the statute of limitations for each claim but

one, the damage had to be discoverable no earlier than two years before the

filing of the suit.5 Because the first of the suits was filed on August 13, 2003,

none of the petitions alleges damage that could have been discovered before
No. 06-10727

6

August 13, 2001, which was well after DBS’s policy period expired in December

1996. Accordingly, the district court held that none of the pleadings alleges

property damage that manifested during the policy period.

The district court also rejected DBS’s contention that OneBeacon’s duty

to defend and indemnify was triggered by the homeowners’ claims for loss of use

of their property. The CGL policies dictate that a loss of use of damaged

property is deemed to occur at the time of the injury that caused it and that a

loss of use of undamaged property is deemed to occur at the time of the

occurrence that caused it. With regard to both types of property, the district

court determined that the timing of the loss of use must be measured in the

same way as the overall property damage—by looking to the time at which the

damage causing the loss of use manifested. Because the court found that the

pleadings do not allege property damage that manifested during the policy

period, the court held that OneBeacon has no duty to defend or indemnify DBS

under any of the CGL policies’ provisions.

III. LEGAL ISSUES

The Supreme Court of Texas has not yet adopted a particular rule for

determining when property damage occurs for purposes of an occurrence-based

liability policy, see Am. Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 853

n.20 (Tex. 1994), and the Texas appellate courts are split on the appropriate

rule. The Courts of Appeals in Dallas, San Antonio, and Austin have held that

property damage occurs atthe time thatthe damage manifests, which the courts

have further defined as the time that the damage becomes apparent or

identifiable. See, e.g., Summit Custom Homes, Inc. v. Great Am. Lloyds Ins. Co.,

202 S.W.3d 823, 827 (Tex. App.--Dallas 2006, pet. filed); State Farm Fire & Cas.

Co. v. Rodriguez, 88 S.W.3d 313, 322 (Tex. App.--San Antonio 2002, pet. denied);

State Farm Mut. Auto. Ins. Co. v. Kelly, 945 S.W.2d 905, 910 (Tex. App.--Austin

1997, writ denied); Cullen/Frost Bank of Dallas v. Commonwealth Lloyd’s Ins.
No. 06-10727

7

Co., 852 S.W.2d 252, 258 (Tex. App.--Dallas 1993, writ denied); Dorchester Dev.

Corp. v. Safeco Ins. Co., 737 S.W.2d 380, 383 (Tex. App.--Dallas 1987, no writ).

The Courts of Appeals in Houston, however, have in two cases rejected this

“manifestation rule” and instead applied an “exposure rule” to harms caused by

continuous or repeated exposure to conditions during a policy period. In Pilgrim

Enterprises, Inc. v. Maryland Casualty Co., 24 S.W.3d 488, 490-91 (Tex. App.--

Houston [1st Dist.] 2000, no pet.), property owners alleged personal injury and

property damage from long-term exposure to chemicals that entered the soil and

groundwater from a neighboring dry cleaning facility. After surveying the Texas

cases that applied the manifestation rule, the court held that “for CGL policies

covering continuous or repeated exposure to conditions, [damage] can occur as

the exposure takes place.” Id. at 497-98. Similarly, in Pine Oak Builders, Inc.

v. Great American Lloyds Insurance Co., No. 14-05-00487-CV, 2006 WL 1892669,

*7-8 (Tex. App.--Houston [14th Dist.] July 6, 2006, no pet.),the court applied the

exposure rule to a case involving property damage from water intrusion due to

defective EIFS siding.

Before the Houston Courts of Appeals adopted the exposure rule,the Fifth

Circuit made its “Erie guess” on the matter and applied the manifestation rule,

relying principally on the Dallas Court of Appeals cases. See Azrock, 211 F.3d

at 246-47; Unitramp, 146 F.3d at 313; Snug Harbor, Ltd. v. Zurich Ins., 968 F.2d

538, 544 (5th Cir. 1992). Given the present split in the Texas Courts of Appeals,

we believe that the appropriate rule is better determined by the Supreme Court

of Texas. Authoritative determination of the appropriate rule is necessary to

resolve the remaining issue of whether the underlying pleadings allege that

property damage occurred within the policy period such that OneBeacon has a

duty to defend and indemnify DBS in the underlying suits.

Moreover, as the Supreme Court of Texas has not yet weighed in on the

proper rule to be applied, it has not yet had occasion to clarify its scope. This
No. 06-10727

6 The petition stated:

Each and every claim made by the Plaintiffs herein is subject to

the discovery rule because the defects ofwhich Plaintiffs complain

were latent and/or otherwise undiscoverable. The defects cause

damage within the wall cavity which is not readily apparent to

one examining the exterior of the EIFS surface. As a result, the

named Plaintiffs would not, in the exercise of reasonable

diligence, immediately perceive, or discover the defects

complained of herein.

Summit Custom Homes, 202 S.W.3d at 828.

8

case thus presents the additional determinative issue of whether property

damage can be deemed to have occurred under the governing rule during a time

in which the pleadings state that the damage was undiscoverable for purposes

of the discovery rule. Although the petitions in the underlying suits allege that

property damage began shortly after the EIFS installation and continued and

progressed with each intrusion of water, which took place during the policy

period, they also allege that the damage was hidden from view by the

undamaged external EIFS surface and was not discoverable or readily apparent

to someone looking at that surface until after the policy period ended.

The Texas Court of Appeals in Dallas considered the impact of the

discovery rule in Summit Custom Homes, which involved a claimed duty to

defend based on liability insurance that covered the period from 1996 to 2000.

202 S.W.3d 823. The focus of the parties’ arguments centered on whether the

underlying pleadings alleged actual damage caused by EIFS siding that

manifested in 1996, and the court found thatthe pleadings did not, both because

they did not specifically mention damage occurring in that year and because one

of the petitions invoked the discovery rule, which was in a form similar to the

invocation in this case.6Id. at 828. But despite the discovery rule’s apparent

applicability in that case to at least the year 1996, the court ultimately found

that the insurer failed to establish as a matter of law that the damage did not

manifest during any of the policy years, including 1996. See id. at 828, 830.
No. 06-10727

9

Our court has interpreted another Dallas Court of Appeals case as

establishing that hidden damage is not apparent for purposes of the

manifestation rule. See Unitramp, 146 F.3d at 314. Cullen/Frost involved

allegations of warped floors and rotten woodwork, among other structural

problems, that were only discovered after a professional inspection, and the

court recognized “that [liability] coverage is not afforded unless an identifiable

damage or injury, other than merely causative negligence, takes place during the

policy period.” 852 S.W.2d at 258. In Unitramp, our court rejected the claim

that the use of the word “identifiable” as the relevant gauge in Cullen/Frost

means “capable of being known by testing.” Unitramp, 146 F.3d at 314. Instead,

we held that “identifiable” was synonymous with “manifest” and “apparent,”

which we further defined as “capable of easy perception.” Id. Our court then

concluded that “in Cullen/Frost, the structural deterioration in condominium

units was not apparent because it was hidden;the floor displacement and rotten

woodwork were not readily observable by the senses. Accordingly, the problems

did not become apparent until the owners conducted inspections.” Id.

As with the question of the proper rule for determining when property

damage is deemed to occur under Texas law, the impact of the discovery rule’s

invocation on that analysis is also better decided by the Supreme Court of Texas.

A ruling on this issue is determinative of whether the pleadings in the

underlying suits allege property damage that occurred during the policy period,

thereby determining whether OneBeacon has a duty to defend and indemnify

DBS. If the underlying pleadings’ allegations of hidden but progressing damage

are sufficient to allege covered damage notwithstanding the undiscoverability

language, then OneBeacon has a duty to defend and indemnify DBS. If instead

the allegations that the damage was undiscoverable and not readily apparent

until after the policy period are sufficientto allege thatthe damage did not occur
No. 06-10727

10

during the policy period, then OneBeacon has no duty to defend or indemnify

DBS.

IV. QUESTIONS CERTIFIED

We hereby certify the following two determinative questions of law to the

Supreme Court of Texas:

1. When not specified by the relevant policy, what is the proper rule under

Texas law for determining the time at which property damage occurs for

purposes of an occurrence-based commercial general liability insurance policy?

2. Under the rule identified in the answer to the first question, have the

pleadings in lawsuits against an insured alleged that property damage occurred

within the policy period of an occurrence-based commercial general liability

insurance policy, such that the insurer’s duty to defend and indemnify the

insured is triggered, when the pleadings allege that actual damage was

continuing and progressing during the policy period, but remained

undiscoverable and not readily apparent for purposes of the discovery rule until

after the policy period ended because the internal damage was hidden from view

by an undamaged exterior surface?

We disclaim any intention or desire that the Supreme Court of Texas

confine its reply to the precise form or scope of the questions certified.