California Court of Appeal Finds Use of Term “Ongoing Operations” Ambiguous in Additional Insured Endorsement Favoring Developer
California’s Fourth District Court of Appeal in San Diego recently published a decision which benefits insureds and additional insureds, specifically developers and general contractors, at the expense of insurance companies. The Court held that an insurer wrongfully declined to defend an additional insured developer of residential housing projects based upon the inclusion of the term “Ongoing Operations” as a limit to the scope of coverage and defense afforded under similar additional insured endorsements favoring the developer. The Court found that the limiting language was ambiguous and sufficiently open to interpretation that the insurer was obligated to defend the developer in construction defect lawsuits filed following completion of the involved projects.
In Pulte Home Corporation v. American Safety Indemnity Company, 14 Cal.App.5th 1086 (August 30, 2017), the Fourth District Court of Appeal in California affirmed a San Diego trial court's ruling that a duty to defend Pulte Home Corp. ("Pulte") was triggered under three American Safety policies issued to subcontractors which included similar, although not identical, additional insured endorsements ("AIEs") affording coverage to Pulte for liability arising out of the named insured's work. Pulte was sued in separate cases in 2011 and 2013 by groups of homeowners who alleged that their Pulte homes were defective. American Safety insured some of the subcontractors who contracted with Pulte to work on the involved developments, and Pulte tendered its defense to American Safety in the lawsuits based upon its additional insured status under the subcontractors’ policies.
As noted, the AIE differed slightly in the language used. One provided coverage to the developer for “liability arising out of ‘your [subcontractor’s] work’ which is ongoing and which is performed by the [subcontractor] for [the developer];” another provided coverage for “liability arising out of ‘your [subcontractor’s] work’ and only as respects ongoing operations performed by the [subcontractor]for [the developer];” and the third provided coverage for “liability arising out of ‘your [subcontractor’s] work’” performed at the specified project but only for “ongoing operations performed by the [subcontractor]” on or after the date of issuance of the AIE.
American Safety denied Pulte’s tenders of defense, asserting that the coverage provided under the AIEs was for ongoing construction operations only and that the lawsuits alleged damages arising out of completed operations. Pulte sued American Safety for bad faith, seeking reimbursement of attorneys' fees and costs in the underlying construction defect actions, attorneys' fees incurred in the bad faith suit pursuant to the Brandt decision,  and punitive damages based upon the bad faith denial of coverage.
The trial court, ruling on companion summary judgment and adjudication motions, found that the “ongoing operations” language inserted in the AIEs was ambiguous and that at least one of the involved policies provided coverage to Pulte, as a matter of law. The trial court also awarded Brandt fees and imposed punitive damages of $500,000.00 based upon the compensatory damage award, including the Brandt fee recovery. American Safety appealed.
Review On Appeal
The Fourth District Court of Appeal affirmed the trial court as to the substance of the issues, finding that the “ongoing operations” language was indeed ambiguous and that American Safety wrongfully denied its obligation to defend Pulte in the underlying construction defect lawsuits. The Court of Appeal reversed the trial court’s damage award, however, and remanded the matter for further proceedings based upon the award of Brandt fees and punitive damages. The Appellate Court determined that the trial court improperly applied the formula for awarding fees as articulated in Brandt and then failed to properly calculate the punitive damage award, which was based directly upon the total amount of compensatory damages.
In affirming the trial court’s ruling interpreting language purportedly limiting coverage under the AIEs, the Court of Appeal rejected American Safety’s argument that the insertion of the term “ongoing operations” after the term “your work” acted to limit the scope of “your work” and to remove coverage for completed operations without expressly stating that such was the case. The Court of Appeal also rejected American Safety’s argument that the AIEs limited coverage to the period during which the subcontractors were working on the project because sale of each home as a completed unit provided a clearly defined cut-off between the subcontractors’ ongoing operations at the project and the conclusion of such operations. The Appellate Court opined that analysis of the scope of coverage should focus on when the homes were physically damaged (when the defective construction took place) and not on when the homeowners purchased the homes and thereby sustained financial damage. The Court stated that damage could have occurred after the homes were purchased but while the subcontractors’ work was ongoing.
The Appellate Court also affirmed the trial court’s finding that the AIE language was ambiguous because coverage for ongoing operations and completed operations was included in the same clauses and because the endorsements failed to expressly limit coverage to the period during which the subcontractors’ work was ongoing. The Court held that AIE language allowing coverage for “liability arising out of ‘your [subcontractor’s] work’” could reasonably be interpreted to provide coverage for claims arising out of completed operations. The Court held that if American Safety intended to preclude coverage for completed operations, the AIEs needed to expressly state that coverage was limited to claims arising out of work performed during the policy period. The ruling was likely based in part upon the reasonable expectations of the subcontractors and Pulte because most subcontracts require that the party secure completed operations coverage and have the developer named as an additional insured, so as to ensure that both parties are protected from liability arising out of potential construction defect claims by future homeowners.
The Pulte decision effectively restricts the ability of insurers to deny coverage for construction defect claims by issuing coverage endorsements which include the term “ongoing operations,” but which fail to explicitly state that liability for completed operations is not covered. Such limitations on the scope of coverage must be stated clearly and unambiguously. The holding is beneficial to insured subcontractors and particularly to their additional insureds, including developers and general contractors. As to the latter groups the case tells us that, to the extent a subcontractor’s insurer is on notice of the subcontractor’s obligation to name the developer/general contractor as an additional insured, the insurer must consider an additional insured developer/general contractor’s reasonable expectations of coverage when evaluating an additional insured tender of defense.
 Brandt v. Superior Court 37 Cal.3d 813 (1985) [Attorney fees recoverable as compensatory damages, attributable to counsel’s efforts in obtaining rejected amounts due under insurance contract.]