Insurance Law Client Alert: California Appeals Court Refuses to Apply Professional Services Exclusion to Products-Completed Operations Loss

In North Counties Engineering v. State Farm (No. A133713, filed 3/13/14), State Farm insured an engineering company under CGL insurance that had a professional services exclusion and included products-completed operations (PCO) coverage. The owner of the engineering company, NCE, contracted with a winery to construct a dam and associated works. Also on the project was the owner’s son, who had his own construction company, NCD. There were multiple contracts, both oral and written, variously naming one company or the other. The evidence later showed that the father performed hands-on work for the project.

After completion, the winery was sued over sediment and erosion caused by the dam. State Farm denied coverage on the ground that the professional services exclusion applied, as well as a mistaken belief that the policy had no PCO coverage. State Farm then changed its position and agreed to defend, but only going forward. The insured sued State Farm over past defense fees, alleging breach of contract and bad faith. The case went to trial and after testimony detailing State Farm’s claim handling, the trial judge granted a nonsuit, finding that the professional services exclusion barred all coverage:

“[I]f you look at the pleadings, the legal pleadings and the contracts, the NCE role is, as the engineering company, the support company, and that company was overseeing the [sic] NCD to make sure that whatever they did was done right…. NCE is the expert on the job, the professional providing professional services, design and construction, and also overseeing the work of NCD, the son’s business, which is doing more of the physical activity…. That takes professional expertise and I think all of what Mr. Akerstrom did was professional…. It was this professional work, and not ‘something incidental to their professional involvement’ that gave rise to the underlying actions. In this situation, it’s not a malpractice or E and O policy. It’s a business policy, which has good benefits, but is subject to the professional services exclusion.”

The appeals court reversed, finding, at a minimum, a factual dispute whether the insured had only provided professional services.

But the appeals court also engaged in a lengthy discussion whether the combination of PCO coverage and a professional services exclusion might render the policy ambiguous. The court criticized the complexity of products-completed operations coverage in general, stating: “In summary, the plaintiff gave the defendant coverage in a single, simple sentence easily understood by the common man in the market place. It attempted to take away a portion of this same coverage in paragraphs and language which even a lawyer, be he from Philadelphia or Bungy, would find it difficult to comprehend. The true meaning of the policy is difficult to determine. An examination of it involves a physical effort of no mean proportions.” (Quoting Insurance Co. of North America v. Electronic Purification Co. (1967) 67 Cal.2d 679, 689-690.)

The court then questioned whether the professional services exclusion would even apply to PCO coverage, since the definition of products-completed operations hazard effectively affords coverage for property damage from “your product” and “your work,” whereas the professional services exclusion applies to property damage resulting from:

“[R]endering or failure to render any professional services or treatments. This includes but is not limited to…. engineering, drafting, surveying or architectural services, including preparing, approving, or failing to prepare or approve maps, drawings, opinions, reports, surveys, change orders, designs or specifications…. supervisory or inspection services….”

The court explained that “Here, by contrast, the alleged damage occurred after appellants’ work was completed, and based on work outside the scope of that typically performed [by an engineering company].”

However, the North Counties court did not actually rule the policy ambiguous, only limiting itself to saying that “it might be argued that the ‘professional services’ exclusion cannot possibly apply,” and the court’s ruling ultimately rested on the conclusion that the trial court had erroneously granted a nonsuit before hearing all of the evidence. And because there had been a factual question from the outset whether the insured had only performed professional services, the court ruled that there had been a duty to defend.

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March 18, 2014