Privity and Additional Insured Coverage

Larry P. Schiffer and Suman Chakraborty | Squire Patton Boggs | October 5, 2017

When a worker is injured on a construction job and sues the relevant parties, a side battle often ensues over which carrier has the duty to defend and indemnify the owner, general contractor or subcontractor based on the language in the various construction contracts requiring some or all of those parties to be named as additional insureds. When there are multiple subcontracts cascading down

to the injured worker’s employer, determining whether the employer’s policy must defend and indemnify other parties as additional insureds can be confusing. In a recent Summary Order, which does not have precedential effect, the Second Circuit Court of Appeals weighed in on this issue under New York law.

In Cincinnati Ins. Co. v. Harleysville Ins. Co., an employee of a sub-subcontractor was injured and sued the building owner, general contractor and subcontractor. The sub-subcontractor’s construction contract with the subcontractor required the sub-subcontractor to add the subcontractor, general contractor and owner as additional insureds to the sub-subcontractor’s insurance policy. The subcontractor’s carrier sued the sub-subcontractor’s carrier arguing that the latter carrier had to defend and indemnify the additional insureds. The district court granted the subcontractor’s carrier’s summary judgment motion in part by finding that the sub-subcontractor had a duty to defend and indemnify the building owner as an additional insured, but not the general contractor. On appeal, the Second Circuit reversed in part and held that the sub-subcontractor’s carrier had no duty as neither the building owner nor the general contractor were additional insureds under the policy.

According to the court, the sub-subcontractor’s policy had 2 endorsements that addressed additional insureds. The first was the “Privity Endorsement,” which grants additional insured coverage “when you and such person or organization have agreed in writing in a contract or agreement that such person or organization be added as an additional insured on your policy.” The second was the “Declaration Endorsement,” which refers to the declarations section of the policy for a schedule of additional insureds.

In reversing, the court held that the Privity Endorsement did not confer additional insured status on the building owner or general contractor because there was no contractual privity between them and the sub-subcontractor. Simply put, the sub-subcontractor had no direct construction contract with the owner or the general contractor. The court noted that the law in New York was clear on this point and that New York courts had interpreted the identical provision to require contractual privity. The court stated that it did not matter if the sub-subcontractor’s construction contract required the owner and general contractor to be named as additional insureds (this was a matter for breach of contract), that contract could not modify the insurance policy because the Privity Endorsement was clear on its face that the construction contract had to be between the insured and the purported additional insureds. Because the insured had no construction contract with the owner or the general contractor there was no contractual privity and no coverage.

As to the Declaration Endorsement, the court noted that neither party were listed on the schedule as additional insureds. The court also found that a reference to a heading on the Declaration Endorsement that was the same as the Privity Endorsement did not expand the additional insured coverage grant automatically to every party when required in any construction agreement with the insured. Essentially, the court refused to write the Privity Endorsement out of the insurance policy. The court held that the Privity Endorsement modified the automatic status heading language in the declarations, not the other way around. In essence, the court held under New York law that in insurance contracts that require privity for additional insured coverage, the lack of a direct contract between the insured and the party seeking the additional insured coverage precludes extending additional insured coverage.

California Court of Appeal: Inserting The Phrase “Ongoing Operations” In An Additional Endorsement Is Not Enough to Preclude Coverage for Completed Operations

Gary Barrera | California Construction Law Blog | September 11, 2017

In a victory for additional insureds, a California appeals court held, in Pulte Home Corp. v. American Safety Indemnity Co., Cal.Ct.App. (4th Dist.), Docket No. D070478 (filed 8/30/17), that an insurer’s denial of coverage for completed operations based on the inclusion of the phrase “ongoing operations” in an additional insured endorsement, was improper. Additionally, an insurer wishing to limit coverage under an additional insured endorsement to ongoing operations must do so via clear and explicit language.

Pulte Home Corp. v. American Safety Indemnity Co.

In the Pulte case, Pulte Home Corp. was the general contractor and developer for two residential housing projects beginning in 2003 and sold in 2005 and 2006.  During construction, Pulte entered into subcontracts that obligated the subcontractors to name Pulte as an additional insured on their policies for completed operations.  One of the insurers, American Safety, issued three types of additional insured endorsements with substantially similar language.  The first endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’ which is ongoing and which is performed by the [named insured subcontractor] for [Pulte]” on or after the endorsement’s effective date.  The second endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’ and only as respects ongoing operations performed by the [named insured subcontractor] for [Pulte]” on or after the endorsement’s effective date.  The third endorsement provided coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’” performed at the project designated in the endorsement and only for “ongoing operations performed by the [named insured subcontractor]” on or after the endorsement’s effective date.

In 2011 and 2013, two construction defect lawsuits were filed against Pulte by homeowners on each project. Pulte tendered its defense of the lawsuits to American Safety.  American Safety denied Pulte’s tenders, in part, on the grounds that coverage under the additional insured endorsements was limited to ongoing operations, and that the lawsuits alleged liability arising out of completed operations.  Pulte sued American Safety for bad faith.  The trial court ruled that American Safety’s denial of Pulte’s tenders was improper and that the additional insured endorsements were ambiguous because they did not effectively exclude coverage for completed operations.

The Appeal

On appeal, American Safety argued that the additional insured endorsements excluded coverage for completed operations because the inclusion of the phrase “ongoing operations” after the phrase “your work” was a limitation on “your work” and eliminated completed operations coverage. American Safety also argued that the endorsements limited coverage to the time frame of the subcontractors’ ongoing operations, and since the homes were sold as completed units, ongoing operations had already concluded.

The Court of Appeal rejected American Safety’s arguments. First, the court held that American Safety’s contention that there were no allegations of ongoing operations incorrectly focused on when the homeowners sustained financial damage through their purchase of the defective homes, and not when the homes became physically damaged.  The court opined that the property damage could have occurred while the subcontractor’s operations were ongoing but after the homes had been sold, and since the property damage became evident after the work was completed, American Safety was placed on sufficient notice that some of the subcontractors’ work could have been ongoing and/or completed during its policy periods, since the homes were built in phases.

Next, the Court of Appeal reaffirmed the trial court’s ruling that the additional insured endorsements were ambiguous because they combined coverage for ongoing and completed operations in a single clause, and failed to expressly limit coverage to the time of the subcontractors’ ongoing operations. The court held that the endorsements’ language allowing coverage for “liability arising out of ‘your [the named insured subcontractor’s] work’” could reasonably be read as a grant of coverage for liability arising out of the named insured’s completed operations.  The court ruled that the mere linking of the phrase “ongoing operations” to the “liability arising out of ‘your work’” clause did not explicitly restrict coverage to ongoing operations.  The court explained that if the “ongoing operations” language was intended by American Safety to preclude coverage for completed operations, the endorsements had to expressly state that coverage was limited to claims arising out of work performed during the policy period.

The Court of Appeal also noted the subcontracts’ requirement that Pulte be named as an additional insured for completed operations. The court observed that at the time American Safety issued the additional insured endorsements and at the time of Pulte’s tenders, it was aware that the subcontracts obligated the subcontractors to name Pulte as an additional insured for completed operations.  The court ruled that based on American Safety’s knowledge of this information, it should have taken into account Pulte’s reasonable expectations of coverage in interpreting its policy, but it did not do so, thereby failing to give equal consideration to its interests and its insureds’ interests.

Conclusion

The Pulte decision should provide developers and general contractors with powerful ammunition against insurers’ attempts to deny completed operations coverage merely because the endorsements contain the phrase “ongoing operations,” without taking into account whether the wording of the endorsement is ambiguous. Pulte makes it clear that insurers intending to limit coverage to ongoing operations must ensure that their endorsements contain clear and unambiguous language to that effect. Pulte is also noteworthy from the perspective of a developer and general contractor because if a subcontractor’s insurer has knowledge of the subcontractor’s contractual obligation to add the developer or general contractor to its policies of insurance as an additional insured for completed operations, it obligates the insurer to consider the developer or general contractor’s reasonable expectations of coverage when evaluating an additional insured tender.

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

Christopher Kendrick and Valerie A. Moore | Haight Brown & Bonesteel LLP | August 31, 2017

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 Pultecourt 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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Seventh Circuit Confirms Additional Insured’s Coverage for Alleged Construction Defects

Tred Eyerly | Insurance Law Hawaii | August 9, 2017

The Seventh Circuit held that the underlying complaint alleged an occurrence by asserting that the painting subcontractor was negligent in causing damage to the building. Westfield Ins. Co. v. Nat’l Decorating Serv., Inc., 2017 U.S. App. LEXIS 12516 (7th Cir. July 13, 2017).

McHugh Construction, the general contractor for construction of a 24 story condominium building in Chicago, retained National Decorating Service, Inc. as a subcontractor to perform all of the painting work. This meant National Decorating would paint the exterior of the building with a protective coating that was a waterproof sealant.

After completion, the building’s board of managers sued McHugh, National Decorating, and others for damages resulting from faulty workmanship. The third amended complaint alleged: (1)  significant cracking of the exterior concrete walls, interior walls, and ceilings; (2) significant leakage through the exterior concrete walls, balconies, and windows; (3) defects to the common elements of the building; and (4) damage to the interior ceilings, floors, interior painting, drywall, and furniture in the units.

Westfield was National Decorating’s insurer. McHugh was an additional insured. The policy defined “occurrence” as an “accident, including continuous or repeated exposure to substantially the same general harmful conditions.”

Both National Decorating and McHugh tendered to Westfield, who denied the tender. Westfield filed an action for declaratory judgment to determine its coverage obligations. The parties filed cross motions for summary judgment. The district court denied Westfield’s motion and granted the defendants’ motions. Therefore, it was determined Westfield had a duty to defend.

On appeal, Westfield argued National Decorating’s failure to apply a sufficiently thick coat of paint to the exterior of the building did not constitute an “accident” under the policy. Second, Westfield argued that because the damage was to the building itself, the damage was exempted from the policy’s coverage.

The Seventh Circuit disagreed that National Decorating’s actions could not constitute an “occurrence” as a matter of law. Under Illinois law, negligently performed work or defective work could give rise to an “occurrence” under a CGL policy. This was especially true where, as here, the policy defined an “occurrence” to include not only an accident, but also “continuous or repeated exposure to conditions.” Here, the underling complaint alleged that National Decorating was negligent. This was sufficient to satisfy the policy’s occurrence requirement when determining whether there was a duty to defend.

Further, damage to something other than the project itself did constitute an “occurrence.” Here, the parties disputed what constituted the scope of the project. Westfield contended that the project was the entire building and because the damage alleged was to that building, it was excluded from the policy’s scope. The defendants argued that the scope of the project was National Decorating, the Named Insured’s, work. The court agreed with the defendants.

National Decorating was responsible for painting the exterior of the building. The underlying complaint sought to recover for damages incurred to other portions of the building, not just the exterior, which was allegedly coated with an insufficient amount of paint. It would be illogical to conclude that the scope of the project for which National Decorating contracted was the entire building.

Westfield also argued that from a public policy perspective, finding that there was a duty to defend under a subcontractor’s CGL policy would obviate the need for a general contractor or developer to carry its own coverage. The court was not impressed with this argument, noting that coverage would only be available for damage caused to the building as a result of an “occurrence” caused by the Named Insured’s work. Therefore, the policy required a clear connection between the damage and the subcontractor’s work.

Consequently, the district court’s grant of summary judgment for the defendants was affirmed.

No Duty To Defend Additional Insured When Bodily Injury Not Caused by Insured

Tred Eyerly | Insurance Law Hawaii | July 19, 2017

The court found there was no duty to defend a suit for bodily injury against the additional insured where the injury was not caused by the insured. Consigli Constr. Co. v. Travelers Indem. Co., 2017 U.S. Dist. LEXIS 95339 (D. Mass. June 21, 2017).

Consigli was the general contractor for a renovation project at a high school. Among the subcontractors was American Environmental, Inc., who was responsible for demolishing concrete floors within the existing structures, and Costa Brothers, who did the masonry work. Wellington M. Ely was an employee of Costa Brothers and worked as a mason on the project.

Costa Brothers had a CGL policy with Travelers. As a subcontractor, Costa Brothers agreed to name Consigli as an additional insured on its policy.

Ely was injured when he tripped and fell over exposed wire where where the concrete floor had been broken up. American Environmental had demolished the concrete floor, allegedly without removing protruding wires or warning workers of the potential tripping hazard. Ely alleged that American Environmental and Consigli were both responsible for his injuries because American Environmental performed its demolition work negligently and Consigli failed to maintain a safe working environment.

Ely sued American Environmental and Consigli. Consigli tendered its defense to Travelers. The tender was denied because Travelers contended that Costa Brothers was not the cause of the loss.

Consigli settled with Ely and sued Travelers. Travelers moved for summary judgment. The court noted that Costa Brothers agreed to name Consigli as an additional insured, but only as to some injuries. Consigli qualified as an additional insured “[o]nly with respect to liability for ‘bodily injury’, ‘property damage’ or ‘personal injury'” and “[i]f and only to the extent that, the injury or damage is caused by acts or omissions of [Costa Brothers] . . .”

There was no possibility, based on the allegations of the underlying complaint, that Costa Brothers caused the injury to Ely. American Environmental caused the wire to be exposed by demolishing the floors negligently. Costa Brothers was not alleged to have undertaken work in the area where the accident occurred. Therefore, there was no act or omission by Costa Brothers identified in the complaint that would make Costa Brothers the proximate cause of Ely’s injury or would show that Costa Brothers brought about or provoked Ely’s injury.

Travelers had no duty to defend and was granted summary judgment.