Thanks to Benjamin J. Morris from the San Diego office of Foley & Lardner LLP for his contribution to the Dispute Resolver: 

California Court of Appeal Affirms Finding that Additional Insured Endorsements in Subcontractors’ Policies did not Clearly Exclude Completed Operations Coverage for an Additional Insured (Developer/Contractor) and the Insurer Acted in Bad Faith in Denying Coverage and Defense

Pulte Home Corp. v. American Safety Indemnity Co., No. D070478, 2017 WL 3725045 (Cal. Ct. App. Aug. 30, 2017)

The California Court of Appeal recently issued a broad coverage decision in favor of a developer/contractor and affirmed punitive damages against the insurance carrier for its bad faith denial of a defense. The case arose from Pulte’s development of two residential projects in Southern California beginning in 2003. The homes were sold in 2005-2006. Pulte was named as an additional insured on certain subcontractors polices issued by American Safety in 2003-2006.

After residents of the developments filed construction defect suits against Pulte in 2011 and 2013, Pulte tendered the claims to American Safety, which denied Pulte’s request for a defense based on a position (among others) that the AI endorsements excluded the subcontractors’ completed operations. Pulte then filed suit against American Safety. The trial court found that the language of the AI endorsements on the relevant policies was ambiguous on the potential for coverage of the alleged claims; therefore, American Safety was required to provide a defense to Pulte. Pulte was awarded $455,238.45 for defense fees, costs, and prejudgment interest for the defense of the two underlying construction defect suits. The trial court also awarded $500,000 in punitive damages against American Safety finding that its decision to deny coverage was unreasonable and in bad faith. On appeal, the Pulte court affirmed the trial court’s award of contract damages and Pulte’s entitlement to punitive damages.[1]

The relevant subcontractors’ insurance policies all identified the aggregate limit for “products-completed operations” as $1 million; however, the policies contained multiple manuscript AI endorsements—that American Safety and Pulte agreed were substantially similar. The key AI endorsement cited in Pulte granted AI coverage, “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.”[2]

Relying on Pardee Construction Co. v. Insurance Co. of the West, 77 Cal. App. 4th 1340 (2000), 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.” After reviewing the relevant policy language and endorsements and the parties’ arguments, the Pulte court held that the AI endorsement did not clearly exclude “completed operations” coverage for the AI because liability for harm caused by the subcontractors “completed operations” could arise from the work performed after the policy was effective.  Moreover, the specific language of the AI endorsement did not clearly limit the coverage to liabilities which arose while the subcontractors were performing construction work. American Safety had “failed to expressly limit covered completed operations as to time or particular project in their policy and endorsement language.” 

Writing for the panel, Justice Huffman stated that “[b]oth sets of insureds could reasonably have expected that if the subcontractors had bought completed operations coverage for the work, it also applied to vicarious liability of the developer, if property damage problems appeared.” He further noted that“[t]hese AIEs do not clearly restrict coverage to only ongoing operations, simply by linking the ongoing operations phrase to the ‘liability arising out of the work’ clause.” Based on the facts surrounding the preparation of the manuscript AI endorsements and applicable legal precedent, doubts about whether a duty to defend existed should have been resolved in favor of Pulte.

After addressing whether American Safety had a duty to defend, the Pulte court went on to review the trial court’s finding that the insurer had acted unreasonably and in bad faith when it denied Pulte coverage for the alleged defects. The court affirmed the trial court’s decision finding there was substantial evidence that American Safety: (1) knew the policies were purchased to satisfy contractual requirements to provide completed operations coverage; (2) had a “pattern and practice of using every conceivable argument to deny coverage, whether the arguments are weak or strong, valid of invalid”; (3) routinely issued form letters denying AI coverage without reasonable case-by-case investigation; (4) denied coverage despite awareness of prior federal court decisions against its coverage interpretation; and (5) had continued these practices over a course of years. Justice Huffman concluded that “[s]uch conduct showed the company was primarily protecting its own interests in refusing to defend its additional insureds in construction defect cases.” Based on the above conduct, the Pulte court approved of Pulte’s entitlement to a punitive damages award, which would be recalculated on remand using an approximate one-to-one ratio after the trial court recalculated Pulte’s Brandt fees and costs.

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The author, Benjamin J. Morris, is a senior counsel in the San Diego office of Foley & Lardner LLP. His practice focuses on representing owners, developers, engineers, lenders, contractors, subcontractors, and consultants throughout all phases of construction projects and construction litigation.

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[1] The amount of punitive damages was remanded for adjustment following the trial court’s recalculation of Brandt fees, which were remanded only as to amount, not entitlement.

[2] Two other noted versions of the AI endorsements stated that the AI was insured: (1) “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; and (2) “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.