THE ONGOING OPERATIONS ADDITIONAL INSURED ENDORSEMENT AS A NEW RISK TRANSFER ISSUE FOR COMPLETED OPERATIONS DAMAGE CLAIMS Mark C. Phillips Partner, Kramer, deboer & Keane, LLP This is really not an insurance coverage discussion, but a pragmatic economic discussion about construction defect litigation. In recent years, developers and general contractors have found increasing limitations placed upon their own direct insurance, as old policies exhaust and new policies are written with various exclusions and perhaps a self-insured retention provision. Developers and general contractors have been forced to look more to the Additional Insured Endorsement ( AIE ) in their trade contractors policies in order to fund their defense. The issue, as they see it, is whether they can rely upon the AIE as a risk-transfer opportunity, 1 one which might also lower the premium for their own liability insurance. 2 Additional Insured Coverage: An Overview Many prime contracts and subcontracts for construction projects include the requirement that owners, lenders, developers, general contractors, architects, and various key personnel be identified as additional insureds on a trade contractor s Commercial General Liability insurance policy for liability arising out of the trade contractor s work. 3 As one court explained: Since construction defect litigation is typically complex and expensive, a key motivation in procuring an additional insured endorsement is to offset the cost of defending lawsuits where the general contractor s liability is claimed to be derivative. 4 Typically such coverage is written by way of an AIE, but sometimes the coverage is endorsed through an amendatory endorsement which expands the definition of Who is an Insured. Provided that the purported additional insured individual or entity qualifies as such, they are entitled to benefits under the policy, subject to all the terms and conditions of the policy, without having to pay any premium for the coverage. 5 An AIE provision which is found frequently in construction defect litigation states that the additional insured is entitled to coverage only for vicarious liability arising out of acts performed by the named insured for the additional insured. For example: 1 See, e.g., North American Capacity Ins. Co. v. Claremont Liability Ins. Co., 177 Cal.App.4th 272, 276 (2009). 2 See, e.g., Scottsdale Ins. Co. v. Essex Ins. Co., 98 Cal.App.4th 86, 96-97 (2002). 3 See, e.g., Rossmoor Sanitation, Inc. v. Pylon, Inc., 13 Cal.3d 622, 626 (1975); see also, e.g., AIA Document A201, General Conditions of the Contract for Construction. 4 See Maryland Cas. Co. v. Nationwide Ins. Co., 65 Cal.App.4th 21, 33 (1998). 5 See, e.g., Transcontinental Ins. Co. v. Ins. Co. of State of Penn.,148 Cal.App.4th 1296, 1303 (2007); see also, e.g., Presley Homes, Inc. v. American States Ins. Co., 90 Cal.App.4th 571, 577 (2001). 1 P a g e
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 for that insured by or for you. [ISO Form CG 2010 11/85] 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 ongoing operations performed for that insured. [ISO Form CG 2010 10/93] Thus, not every AIE provides the same types of coverage to the purported additional insured. Each provision must be read carefully and in the context of the overall policy. Some AIEs do not afford coverage to the additional insured for liability arising out of its own acts or omissions. 6 Other AIEs might afford coverage without regard to whether the alleged injury or damage was caused by either the named insured or the additional insured. 7 Yet other AIEs might afford coverage for the additional insured s sole negligence. 8 And other AIEs may expressly exclude coverage for liability arising out of the additional insured s acts or omissions. 9 Unlike Crawford demands or other risk transfer opportunities which entail an allocation of liability, an insurer s defense obligation to the additional insured must extend to defense of the entire underlying action, even if the additional insured must defend against other claims which are unrelated to the named insured s scope of work. For example, if triggered, the much-maligned doorbell installer s policy is required to afford a defense to a general contractor for more than just claims alleging door bells, but also claims alleging electrical, drywall and framing damages too. 10 The general contractor might be an additional insured under multiple policies issued to various trade contractors, but if the doorbell installer s policy has the only operative AIE, the legal expense which its carrier must pay could well be in the six figures or more to defend issues far exceeding the doorbell installer s presumably modest indemnity exposure. Ongoing Operations Endorsements Many construction defect lawsuits are filed after the construction project is completed, viz. the lawsuit concerns a completed operations claim. When a trade contractor s CGL policy is issued after the named insured s work is completed, this is referred to as a completed operations policy. Some attorneys and claims professionals take the position that only an AIE within a completed operations policy which affords coverage for liability arising out of the named insured s completed operations will apply to such claims. The analysis often has turned on the wording of the AIE. 6 See, e.g., Acceptance Ins. Co. v. Syufy Enterprises, 69 Cal.App.4th 321, 330 (1999); see also, e.g., National Union Fire Ins. Co. v. Nationwide Ins. Co., 69 Cal.App.4th 709, 720 (1999). 7 See, e.g., Fireman s Fund Insurance Company v. Atlantic Richfield Co., 94 Cal.App.4th 842, 849 (2001). 8 See, e.g., Chevron USA, Inc. v. Bragg Crane & Rigging Co., 180 Cal.App.3d 639, 646 (1986). 9 See, e.g., Presley Homes, 90 Cal.App.4th at 573. 10 See, e.g., Presley Homes, 90 Cal.App.4th at 576. 2 P a g e
The Fourth District California Court of Appeal dealt with this issue in Pardee Construction Company v. Insurance Company of the West. 11 The case involved a large residential tract housing project built in a San Diego suburb over multiple phases in the mid-to-late 1980s. The developer s subcontracts included the requirement that each trade contractor maintain completed operations CGL coverage, and that the developer be named as an additional insured on the policy. The homeowners association sued the developer for construction defects in 1995, and the developer tendered its defense to the trade contractors insurers. Some of the carriers provided the developer with a defense, but only as to claims arising out of their named insured s scope of work in this pre-presley era. Other carriers declined the developer s tender, which left the developer with an unfunded amount of defense costs which it was required to pay itself. The case eventually settled and the developer funded part of the settlement. Shortly thereafter, the developer sued the recalcitrant carriers for breach of contract, bad faith, fraud and declaratory relief. The trial court granted dispositive motions in favor of the carriers, and the developer appealed. The Court of Appeal reversed, finding in favor of the developer because the AIEs contained comparable language found in the CG 2010 11/85 form quoted above; the Court of Appeal held that they applied to completed operations claims such as these and were not limited to project-specific claims. The Pardee case is best known today for dictum concerning its interpretation of the CG 2010 10/93 endorsement quoted above. This dictum, which did not affect the holding of the case, has fueled subsequent discussion about whether that endorsement affords additional insured coverage for completed operations claims. The Court of Appeal, in reliance on insurance industry commentaries, stated: Moreover, in 1993, the Insurance Services Office (ISO) revised the language of the form 2010 endorsement utilized by the insurance industry to expressly restrict coverage for an additional insured to the ongoing operations of the named insured. This revised language effectively precludes application of the endorsement's coverage to completed operations losses. [Citation.] One insurance commentator stated regarding the 1993 revisions of the standard additional insured endorsement forms: The restriction of coverage in the two endorsements to only ongoing operations makes it clear that additional insureds will have no coverage under the named insured s policy for liability arising out of the products-completed operations exposure.... The effect of this change restricting the coverage to ongoing operations is, however, much more profound on [form 2010]. Previous editions of [that form] contained no completed operations exclusion and, thus, could be called on to cover an additional insured for liability arising out of the products-completed operations hazard. Similarly, construction industry and underwriting spokespersons have echoed this assessment: "Completed Operations Coverage. Prior to the 1993... revisions, the standard ISO additional insured endorsements provided the additional insured with coverage for liability arising out of your operations performed for the additional insured, which included completed operations. More recent editions of 11 See Pardee Construction Co. v. Ins. Co. of the West, 77 Cal.App.4th 1340 (2000). 3 P a g e
these endorsements provide coverage only with respect to your ongoing operations, which effectively eliminates coverage for completed operations. [Citation.] Although these 1993 revisions postdated the insurers policies here with the exception of U.S. Fire, they evince as to Nationwide and ICW alternative express limiting language that could have been employed. 12 In a post-pardee world, many attorneys and claims professionals have concluded, at least in California, that a completed operations policy which includes an ongoing operations AIE does not afford additional insured coverage for a completed operations claim arising out of the named insured s work. 13 However, this position is being revisited in light of a trio of recent unpublished Federal Court opinions. They do not look to Pardee s reliance on insurance industry commentaries, but instead construe the ongoing operations language in the AIE. In Jaynes Corporation v. American Safety Indemnity Company, 14 an unpublished Federal Court ruling on a Motion for Summary Judgment, a general contractor hired a concrete trade contractor to help build a residential tract project in Henderson, Nevada. Pursuant to the subcontract, the trade contractor agreed to procure additional insured coverage for the general contractor. The AIE provided in pertinent part: 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 performed at the project designated above. This Endorsement applies only to ongoing operations performed by the Named Insured on or after the effective date of this Endorsement. The homeowner association sued the general contractor in state court for defective construction. The general contractor tendered its defense to the concrete contractor s insurer, who declined the tender. The general contractor sued the insurer in Federal Court while the construction defect action was being litigated in state court. Both sides filed Motions for Summary Judgment in Federal Court on whether the AIE triggered a defense obligation to the general contractor in the underlying state court action. A threshold issue was whether the general contractor had standing to sue, since its direct carrier was defending it already in the underlying action. The general contractor overcame that objection by establishing that it was responsible for a portion of its own defense costs. The insurer cited Pardee for the proposition that an ongoing operations AIE does not afford additional insured coverage for claims which inherently involve completed work, not works in progress. The general contractor argued that this AIE does not limit coverage to only the alleged damage which 12 See, e.g., Pardee Construction Co., supra 77 Cal.App.4th at 1358-1359. 13 Few subsequent published opinions have cited Pardee on this issue, probably because they are factually distinguishable from Pardee. For a published Colorado opinion which relied on Pardee, see, e.g., Weitz Co, LLC v. Mid-Century Ins. Co., 181 P.2d 309 (Colo. Ct. App. 2009). 14 See Jaynes Corp. v. American Safety Indemnity Co., No. 2:10-cv-00764-MMD-GWF (D. Nev 2012). 4 P a g e
occurs during the named insured s ongoing operations, but also covers alleged damage which occurs after the operation is completed but which was caused by ongoing operations. The Court agreed with the general contractor, citing two Federal Court opinions based on similarlyworded AIE language and analogous facts. One (Tri-Star Theme Builders, Inc. v. OneBeacon Ins. Company) is an unpublished decision by the Ninth U.S. Circuit Court of Appeals in Arizona. 15 The other (McMillin Construction Services, L.P. v. Arch Specialty Insurance Company) is from the U.S. District Court for the Southern District of California. 16 Both Courts had concluded that the phrase ongoing operations was ambiguous to a reasonable layperson, thereby rejecting the insurers arguments that a Pardee-type rule should apply automatically. The Jaynes Court agreed, stating: The key phrase arising out of the Named Insured s ongoing operations (which is not defined) addresses only the type of activity (ongoing operations) from which the... [additional insured s] liabilities must arise in order to be covered, not when the injury or damage must occur. In other words, this language does not state that injury must occur, or liability must occur, during the Named Insured s ongoing operations, but rather requires only that the liability arise out of the ongoing operations, which may require only a minimal causal connection between the liability and the ongoing operations... At the very least, there is an argument that the endorsement s undefined language is ambiguous and should be construed against the drafter. * * * [T]o construe the plain language of a contractual provision as [the insurer] desires that an AI s coverage for liability arising out of a subcontractor s ongoing operations is restricted to coverage for damages occurring during the subcontractor s operations would be so counterintuitive as to be absurd, and would render the arising out of clause needless surplusage. The sound principles of contract interpretation dictate that the Court must follow [the general contractor s] far more reasonable interpretation. [Citation.] * * * [T]he cases that have limited coverage of the additional insured endorsement to damage occurring during the named insured s ongoing operations have not relied on the plain language of the clause. Instead, they have drawn inferences regarding the scope of coverage by relying on the drafting history of the clause by the insurance company. [Citations.] In fact, these cases reach their conclusion that the ongoing operations clause limits AI coverage to damage taking place during a subcontractor s operations only after tracing the development of ongoing operations clauses in the insurance industry from the early 1990s onward. [Citations.] While this history lesson makes for an interesting read, it is not persuasive in the face of the plain language of the ongoing operations clause.... such evidence might be persuasive if the controversy... were between two 15 See Tri-Star Theme Builders, Inc. v. OneBeacon Ins. Co., 2011 WL 1361468 (9th Cir. 2011). The Jaynes Court acknowledged that Tri-Star has no precedential value because it is an unpublished opinion, but cited Tri-Star because it found the Ninth Circuit s reasoning persuasive on construing an AIE which was comparable to the one litigated in Jaynes. 16 See McMillin Construction Services, L.P. v. Arch Specialty Ins. Co., 2012 WL 243321 (S.D. Cal. 2012). 5 P a g e
insurers, or if it suggested that the language reflected the mutual intent of the parties. This evidence is wholly lacking here. Indeed,... the only court to construe the additional insured endorsement, without reference to the industry s drafting history, held that it provided coverage for damages occurring after the completion of operations. What these Federal Court cases teach is that at least some Courts may consider the terms arising out of and ongoing operations ambiguous. The result is that an ongoing operations AIE could be construed in favor of the purported additional insured, thereby affording coverage in some circumstances. The decision to afford coverage might be clearer if, for example, the named insured performed its work during the policy term, and not before the insurance policy incepted. There is also an issue of what type of work the named insured performed, which might infer what type of injury or damage might occur. The AIE language litigated in these three Federal Court cases address only the type of activity performed by the named insured, not when the alleged injury or damage must occur. While some courts might conclude that the alleged injury or damage must occur during the course of construction, viz. prior to the project s completion, another possible interpretation is that coverage could be afforded for a completed operations claim, so long as the alleged injury or damage arose from the named insured s ongoing operations. The arising out of language used here is arguably very broad, requiring only a minimal causal nexus between the ongoing operations and the resulting injury or damage. Not all Federal Courts have taken this approach. In another unreported U.S. District Court case from the Southern District of California (D.R. Horton L.A. Holding Company v. American Safety Indemnity Company), 17 the Court chose to follow Pardee and omitted any discussion of the Tri-Star case (McMillin and Jaynes had not been decided yet). To this Court, the timing of the alleged damage was an important factor because ongoing operations meant injury or damage which occurs during the course of construction. Thus, an ongoing operations AIE should not apply to a claim for injury or damage which occurs after the completion of construction. Conclusion These recent Federal Court opinions show that Pardee is not necessarily iron-clad law on AIE tenders, and that reasonable minds can differ on how to apply an ongoing operations AIE as a risk transfer vehicle in a completed operations construction defect claim. California courts may take a harder look at the ongoing operations AIE as other sources of defense funding become harder to secure. Judges state repeatedly that insurers have an opportunity to limit the scope of coverage by rewriting their policy language. The renewed debate over the application of an ongoing operations AIE in a completed operations claim is a good example of the never-ending search for the clearest possible contractual meaning. In the meantime, developers and general contractors are engaged in their own never-ending search for risk transfer opportunities. CAVEAT: THE FOREGOING DOES NOT CONSTITUTE LEGAL ADVICE. PLEASE CONSULT AN ATTORNEY FOR INDIVIDUAL ADVICE REGARDING INDIVIDUAL SITUATIONS. 17 See D.R. Horton L.A. Holding Co. v. American Safety Indemnity Co., 2012 WL 33070 (S.D. Cal. 2012). 6 P a g e