United States: McMillin Management Services, L.P. V. Financial Pacific Insurance Company

In McMillin Management Services, L.P. v. Financial Pacific Insurance Company, 17 Cal.App.5th 187 (November 14, 2017), the California Fourth District Court of Appeal reversed the trial court’s entry of judgment in favor of Lexington Insurance Company (“Lexington”) and affirmed such judgment in favor of Financial Pacific Insurance Company (“Financial Pacific”) with respect to McMillin Management Services, L.P.’s and Imperial Valley Residential Builders, L.P.’s (collectively “McMillin”) tender of defense as additional insureds of a construction defect lawsuit under policies issued by Lexington and Financial Pacific to subcontractors. The parties’ dispute arose out of the development and construction of a single family home project in Brawley, California (“Project”). Lexington issued CGL policies to subcontractors Martinez Construction Concrete Contractor, Inc. (“Martinez”) and Rozema Corporation (“Rozema”). Financial Pacific issued policies to subcontractors A. M. Fernandez Drywall (“A.M. Fernandez”) and J.Q. Drywall (“Drywall”).

McMillin completed construction of the homes in June 2005. In June 2010, several homeowners within the Project filed a construction defect action against McMillin. In turn, McMillin tendered the defense of the underlying action to Lexington and Financial Pacific pursuant to additional insured endorsements included in both insurers’ policies issued to the subject subcontractors. Both Lexington and Financial Pacific refused to defend McMillin arguing that their policies only afforded coverage to McMillin for liability related to ongoing operations performed by their named insureds at the Project. Since the homeowners were alleging damages sustained by their homes after the Project had been completed, Lexington and Financial Pacific reasoned that potential coverage and a duty to defend was not owed under their policies to McMillin for the underlying construction defect lawsuit.

Thereafter, McMillin filed a complaint for breach of contract and bad faith against Lexington and Financial Pacific. In response, the carriers filed motions for summary judgment arguing that they did not owe McMillin a defense for the underlying construction defect action. The trial court granted both insurers’ motions and entered summary judgment in favor of Lexington and Financial Pacific. The Court of Appeal reversed the trial court’s entry of summary judgment and found that a duty to defend was owed to McMillin under the Lexington policy, but affirmed the trial court’s judgment in favor of Financial Pacific.

The Court of Appeal described the Lexington policies’ additional insured endorsements as follows:

The Lexington policies contain substantively identical additional insured endorsements that amend the policies to provide coverage to McMillin “‘but only with respect to liability arising out of your [i.e., Martinez's or Rozema's] ongoing operations performed for [McMillin].’” (Italics omitted.) The endorsements also each contain an exclusion that states:

“With respect to the insurance afforded to these additional insureds, the following exclusion is added:

“. . . Exclusions

“This insurance does not apply to ‘bodily injury’ or ‘property damage’ occurring after:

“(1) All work, including materials, parts or equipment furnished in connection with such work, on the project (other than service, maintenance or repairs) to be performed by or on behalf of the additional insured(s) at the site of the covered operations has been completed; or

“(2) That portion of ‘your work’ out of which the injury or damage arises has been put to its intended use by any person or organization other than another contractor or subcontractor engaged in performing operations for a principal as a part of the same project.”

In its motion for summary judgment, Lexington argued that the additional insured endorsements in its policies provided coverage only for liability arising out of Martinez’s or Rozema’s ongoing operations performed for McMillin. Lexington argued that there was no possible coverage under the endorsements because there were no homeowners who could have brought construction defect claims against McMillin during the time that Martinez’s or Rozema’s operations were ongoing. In addition, Lexington argued that the homeowners’ claims arose out of “completed operations,” as opposed to liability and damages relating to the named insured’s ongoing operations. In response, McMillin emphasized that the endorsements provided coverage for liability “arising out of” ongoing operations performed for McMillin. According to McMillin the language of the endorsements did not incorporate any coverage limitations related to when the liability must arise. Instead, McMillin argued that it need only establish the potential that its liability was connected to or related to the ongoing operations of Lexington’s named insureds.

In reversing the trial court’s entry of judgment in favor of Lexington, the Court of Appeal held as follows:

Even assuming that Lexington is correct that McMillin did not face any liability to homeowners during Martinez's or Rozema's ongoing operations, the endorsements do not state that Lexington would provide coverage solely for liability occurring during Martinez's or Rozema's ongoing operations performed for McMillin. Rather, the endorsements state that Lexington would provide coverage to McMillin for liability “‘arising out of’” such ongoing operations. (Italics added.) The term “arising out of” is, of course, not synonymous with “during.” (Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Hovey (8th Cir. 1984) 726 F.2d 1286, 1290 [rejecting interpretation of agreement that “would require reading the words ‘arising out of’ as synonymous with ‘during’”].)

Indeed, as discussed above, the phrase “arising out of,” has specifically been given a “broad interpretation,” in the context of additional insured endorsements. (See Syufy, supra, 69 Cal.App.4th at p. 328.) The term “arising out of” in the endorsements granting McMillin coverage for “‘liability arising out of your [i.e., Martinez's or Rozema's] ongoing operations,’” provides only that McMillin's liability must be “linked,” through a “minimal causal connection or incidental relationship” (ibid.), with Martinez's or Rozema's ongoing operations. Thus, the fact that there were no homeowners at the time of Martinez's and Rozema's ongoing operations does not establish that McMillin could suffer no liability arising out of such ongoing operations.

For example, consider the work of Lexington subcontractors such as those in this case, who performed concrete flatwork and stucco work. The improper pouring of concrete on a foundation or the improper installation of stucco could permit water damage to other portions of the home. Thus, consequential damage could begin long before the subcontractors' work ended. If homeowners did not discover and file suit to recover for such damages until after the subcontractors ceased ongoing operations, that would not establish that McMillin suffered no liability arising out of such ongoing operations.

Both Lexington and the trial court have focused on the terms “ongoing operations” and “completed operations” in tandem, suggesting that any claim by a homeowner is necessarily covered, if at all, only by “completed operations” coverage. Lexington appears to suggest that an “ongoing operations” additional insured endorsement does not afford the additional insured with coverage provided under a named insured subcontractor's “products-completed” coverage.

The policies in this case state that “‘property damage’” covered under the “‘products-completed operations hazard’” does not include the named insured subcontractors' “[w]ork that has not yet been completed or abandoned.” Thus, the policy language makes clear that property damage occurring before completion of the named insured subcontractors' work would not be covered by “products-completed operations hazard.”

As our example above demonstrates, the lack of homeowners does not establish that any property damage caused by the named insured subcontractors' work occurred after the completion of their work. Thus, even assuming that Lexington is correct that an “ongoing operations” additional insured endorsement does not provide the additional insured with the same coverage afforded under a named insured subcontractor's “products-completed” coverage, a homeowner's construction defect claim is not, as Lexington suggests in its brief, necessarily one that is brought to recover under the “products-completed” coverage of a named insured subcontractor's policy. On the contrary, if property damage occurs before the named insured finishes work at the jobsite, under the plain language of the policy, an additional insured may be entitled to coverage pursuant to an “ongoing operations” endorsement.

. . .

For the reasons stated above, the fact that there were no homeowners in the Project at the time Martinez and Rozema ceased ongoing operations does not logically establish that the complaint in the underlying action did not subject McMillin to potential “‘liability arising out of your [i.e., Martinez's or Rozema's] ongoing operations performed for [McMillin].’” (Italics added.) In short, neither Pardee, nor the text of the endorsements, provide any support for the trial court's order or Lexington's contention on appeal.

Lexington's argument that we may affirm the judgment on the ground that McMillin's interpretation of the endorsement would render the term “ongoing” surplusage also fails. Lexington contends that we may affirm the judgment on this ground because McMillin purportedly argues that it is entitled to coverage for claims arising out of the subcontractors' completed operations, “since even ‘completed operations’ (under McMillin's argument) arise out of operations which were, at some point, ongoing.” Even assuming that McMillin is making this argument, we reverse the judgment solely on the narrow ground that the fact that there were no homeowners at the time Martinez and Rozema ceased ongoing operations does not establish as a matter of law the lack of a potential for coverage for McMillin under the policies. As explained above, we do not decide whether an ongoing operations endorsement such as that used in this case provides coverage to the additional insured only for damages that occur prior to the completion of the named insured's subcontractors' ongoing operations

The Court of Appeal affirmed the trial court’s entry of summary judgment in favor of Financial Pacific because the underlying construction defect lawsuit did not allege any potential damages relating to drywall. The Court of Appeal relied on the reasoning set forth in Monticello Insurance Company v. Essex Insurance Company (2008) 162 Cal.App.4th 1376 in holding in favor of Financial Pacific.

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