Appeals Court Finds Manuscript Additional Insured Endorsements Ambiguous Regarding Completed Operations Coverage for Additional Insured

In Pulte Home Corp. v. American Safety Indemnity Co. (No. D070478; filed 8/30/17), a California appeals court found that manuscript additional insured endorsements on construction subcontractors’ policies were ambiguous regarding additional insured coverage for the developer, and that substantial evidence supported a finding that the insurer’s refusal to defend the developer was in bad faith. The court also approved awarding punitive damages on a one-to-one basis with the general damages. But the appeals court remanded the case for a further determination on the amount of Brandt fees, based on the developer’s change from a contingency to an hourly agreement. 

The Pulte case arose from the development of two residential housing projects beginning in 2003 and sold in 2005-2006. Subcontractors were required to name Pulte as additional insured on their policies, some of them issued by American Safety. In 2013, homeowners sued Pulte based in part on the work of subcontractors insured by American Safety, which then denied coverage to Pulte because the construction had taken place years earlier. 

The policies in question had “products–completed operations” coverage of $1 million for the named insured subcontractors, but contained numerous versions of manuscripted additional insured endorsements (AIE) that American Safety contended limited coverage for Pulte. A key version of the coverage grant in certain of the AIEs stated:

“WHO IS AN INSURED (SECTION II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of ‘your work’ which is ongoing and which is performed by the Named Insured for the Additional Insured on or after the effective date of this Endorsement.” 

An alternative version of AIE amended the definition of “who is an insured” to include Pulte as an additional insured, “but only with respect to liability arising out of ‘your work’ and only as respects ongoing operations performed by the Named Insured for the Additional Insured on or after” the endorsement’s effective date. Yet other AIE versions provided coverage to the additional insured, “but only with respect to liability arising out of ‘your work’ which is performed at the project designated above. This Endorsement applies only to ongoing operations performed by the Named Insured on or after” the endorsement’s effective date. 

When coverage was denied, Pulte defended itself and then sued for bad faith. The Pulte court noted that it was dealing with the duty to defend and the mere potential for coverage, distinguishing products liability claims, and saying that: “[C]onstruction defect litigation is notoriously fluid. Claims omitted from one defect list pop up on a later defect list. While [American Safety] is not required to speculate on future claims, the [inspection] reports do not establish there was no potential for coverage after their preparation. The creation of reported defects in the concrete and electrical work performed, as an occurrence during the policy period, could have allowed continuous or repeated exposure to harmful conditions elsewhere…. American Safety incorrectly focuses on when the current property owners became financially damaged through purchases. This begs the question of when the subject property damage occurred from the work of the subcontractors. The coverage potential depends on when the property became physically damaged.” Thus, the Pulte court concluded that the lawsuits generally triggered a duty to defend. 

Citing Pardee Construction Co. v. Insurance Co. of the West (2000) 77 Cal.App.4th 1340, the Pulte court stated that, “the initial issue for policy interpretation is whether the additional insured endorsements explicitly exclude coverage for the subcontractors’ completed operations.” Pulte argued that the AIEs should be read as providing completed operations coverage for the additional insured along with the named insured, a reasonable expectation demonstrated by the insurance requirements of the subcontracts. Thus, there was a potential for completed operations coverage under the policies, and a grant of coverage “for liability arising out of ‘your work’“ was not inconsistent with the “ongoing operations” language. 

American Safety argued that its policies clearly distinguished between liability for ongoing versus “completed operations” coverage, and that the coverages were time sensitive and “complementary and not overlapping.” American Safety contended that its coverage exposure was limited to the time frame of the subcontractors’ ongoing operations at the project sites and that since the homes were sold as completed units, such ongoing operations had long been concluded by the time of the lawsuits. It also argued that the main policy’s faulty workmanship exclusions j.5; j.6; and l. applied to Pulte. 

The Pulte court said that property damage resulting from defective construction may occur over an extended period of time, spanning several policy periods and it is common for a general contractor or developer to be insured under several policies for the same liability. In such cases, several insurers on the risk may be required to share the costs of defense and indemnification and whether “completed operations” coverage extends to the vicarious liability of an additional insured developer depends on the wording of the additional insured endorsement. Moreover, “[w]here, as here, the insurer has drafted the policy language, it is usually held responsible for ambiguous policy language, through the rule of construction in favor of the insured’s reasonable expectations.” (Citing AIU Ins. Co. v. Superior Court (1990) 51 Cal.3d 807, 822–223.) 

With respect to the ongoing versus completed operations issue, American Safety argued that the AIE wording affording coverage for “liability arising out of ‘your work,’ ‘but only as respects ongoing operations’“ constituted “a limiting term, excluding completed-operations coverage.” For support, American Safety pointed to the small premium for the AIE, and testimony that completed operations coverage was far more expensive. 

But the court read the wording differently, saying that “[t]he AIEs’ language allowing coverage for ‘liability arising out of ‘your [the named insured subcontractor’s] work’’ can reasonably be read as a grant of coverage for the insured’s completed operations, if property damage ensued from them.” Thus, American Safety “has taken a middle-ground and left the language in that the endorsement applies to ‘your work’ but limited to ongoing operations and therefore creating an ambiguity.” “If the ‘ongoing operations’ language was meant by American Safety to preclude coverage for completed operations losses, it had to expressly state ‘that coverage was limited to claims arising from work performed during the policy period.’ [] We cannot say the underlying complaints pleaded zero facts bringing Pulte within potential policy coverage. Assuming there was doubt as to whether the duty to defend existed, it should have been resolved in favor of the additional insureds.” 

Dealing also with the effect of the policy’s faulty workmanship exclusions, j.5; j.6; and l., American Safety argued that the exclusion applied because “[i]n the case of a general contractor, all the work at the project is considered its work product.” (Quoting George F. Hillenbrand, Inc. v. Insurance Co. of North America (2002) 104 Cal.App.4th 784, 805.) But the Pulte court rejected the argument saying: “This approach disregards the pleaded facts in the underlying complaints, that some of the numerous subcontractors’ work was allegedly defective and therefore caused problems with other interrelated and adjacent construction work at the projects.” Further, the Pulte court expressed concern that finding the faulty workmanship exclusions applicable because the entirety of the project could be considered Pulte’s work and products posed the specter of illusory insurance coverage. And, in any case, the record was insufficient to conclude that the exclusions negated all potential for coverage or a duty to defend. 

The Pulte court went on to address the bad faith finding, noting that American Safety had continued to deny Pulte coverage even after the trial court had denied an initial summary adjudication motion on one of the policies. Further, that American Safety had not appealed the result based on an apparent strategy of continuing to apply its own policy interpretation. In addition, the court found American Safety’s continued denial unreasonable in light of numerous federal trial court decisions against its position on the interpretation of “ongoing operations,” including a case against American Safety itself. (Citing D.R. Horton Los Angeles Holding Co., Inc. v. American Safety Indem. Co. (S.D.Cal., Jan. 5, 2012, No. 10CV443WQH) 2012 U.S. Dist. LEXIS 1881.) 

As further evidence of bad faith, the Pulte court noted evidence drawn from testimony of its claims representatives and corporate claims counsel about how hundreds of additional insureds’ claims were routinely denied based on the restrictive policy interpretations offered and “[t]he three adjusters who testified did not recall ever accepting an additional insured tender.” The court was also moved by the fact that the denials appeared to be form letters, “rather than the product of any appropriate case-by-case analysis.” 

Addressing punitive damages, the court stated that American Safety had demonstrated a “pattern and practice of using every conceivable argument to deny coverage, whether the arguments are weak or strong, valid or invalid.” “Such conduct showed the company was primarily protecting its own interests in refusing to defend its additional insureds in construction defect cases.” The fact of using a third party administrator was no defense either, and an insurer “cannot avoid responsibility by creating a company to handle claims and allowing the company and its managing agent … to deny all AI claims…. The pattern of not accepting additional insured tenders has gone on for years and clearly was known to the officers and managing agents of ASIC. Effectively, American Safety had been issuing AIEs while ‘knowing that coverage would never be honored and knowing that the additional insureds intended that they would be receiving a defense if they were sued in construction defect cases’.” 

On the subject of attorney’s fees under Brandt v. Superior Court (1985) 37 Cal.3d 813, the Pulte court did take issue with Pulte’s mid-stream change from a contingency to an hourly fee agreement, as an apparent attempt to manipulate the result in its favor. While acknowledging that fee arrangements are generally subject to change, the Pulte court found Pulte’s change inconsistent with the principles of Brandt, “which are to ensure that such a fee award reflects only those fees attributable to the attorney’s efforts to obtain the rejected payment due on the insurance contract.” Thus, the Pulte court ordered the case remanded for recalculation of the fees based on the original contingency agreement. And in noting that the Brandt fee issue also affected the amount of the punitive damages, the Pulte court gave passing approval to application of a one-to-one general-to-punitive damages ratio. 

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