Source: http://www.myconstructionexpert.com/blog/2017/11/
Timestamp: 2019-04-21 08:10:46+00:00

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November 2017 - Advise & Consult, Inc.Advise & Consult, Inc.
Since 2008 when the California legislature limited subcontractor indemnity obligations, the design professional community has been shouting “what about us?” Well, the legislature finally responded and a new law that limits design professional’s defense and indemnity obligations to their percentage of fault goes into effect on January 1, 2018.
SB 496 amends California Civil Code section 2782.8 and states that indemnity agreements must be limited to the negligence, recklessness or willful misconduct of the indemnitee (i.e. no more Type I indemnity with design professionals). The amendment also provides that “in no event shall the cost to defend charged to the design professional exceed the design professional’s proportionate percentage of fault”, with a limited opportunity for reallocation in the event another defendant is judgment proof.
However, the duty to defend still remains and still arises at the time of the tender of the defense (both issues that were unsuccessfully targeted by the design professional lobbyists).
Developers and Owners should strongly consider reviewing and revising the indemnity provisions in their consultant contracts to comply with the new legislation before the first of the year. This includes master agreements because project addenda entered into after January 1 are subject to the new law. The statute does not apply to current contracts, so these do not need to be amended.
Construction claims’ prosecution and defense present a serious challenge to the construction attorney. The intricate legal process begins with the ALERT of an onsite incident, accident, or fatality. Immediately following the initial client intake interview, through investigation, discovery, and trial, a construction lawyer is presented with the daunting task of continuing re-education. This includes the need to investigate, recognize, and evaluate complex, technical construction terms, processes, standards, material facts, and assemble evidence necessary to prepare and present the entire case in a clear, convincing manner to the court and jury.
Contractor claims may include requests for equitable adjustment to the contract, or for breach and subcontract terms and issues.
Effective preparation and prosecution of construction claims requires developing credible entitlement arguments, implemented with accepted methods to quantify damages sustained, all supported by construction project records and documentation. Construction lawyers frequently retain a consultant expert witness, with the experience and knowledge to advise and assist with construction claims’ prosecution or defenses.
The expert witness retained by construction attorneys, and often by clients directly, has the experienced “know- how” to investigate and evaluate potential claims. The expert may immediately inspect the construction project site to obtain and confirm facts, witnesses, and evidence necessary to support their positions in prosecution or defense of claims. The retained expert(s) can also provide litigation assistance to the construction lawyer, to obtain the optimum return on litigation investment. By using forensic investigation and developing and providing detailed expert reports, they encourage early settlements to resolve claims without costly litigation in time, emotion, and money.
The Supreme Court of Oregon issued a decision at the end of last year which perfectly illustrates the lengths to which a court may go to grant a contractor’s claim for defense from its insurer in a construction defect suit. In West Hills Development Co. v. Chartis Claims, Inc.,1 the Court held that a subcontractor’s insurer had a duty to defend a general contractor as an additional insured because the allegations of a homeowner’s association’s complaint could be interpreted to fall within the ambit of coverage provided under the policy—despite the fact that the policy only provided ongoing operations coverage, and despite the fact that the subcontractor was never mentioned in the complaint. The decision is favorable to policyholders but also provides an important lesson: that contractors may avoid additional insured disputes if those contractors have solid contractual insurance requirements for both ongoing and completed operations risks.
An insurer’s duty to defend is typically determined by the allegations of a complaint as compared with the language of the policy. This principle is often referred to as the “four-corners rule” in reference to the four corners of the paper the policy is written on. Some states have relaxed this rule and allow parties to introduce “extrinsic evidence”—that is, facts which are not set forth in the complaint—to establish the duty to defend.2 Oregon, however, has consistently followed the “four-corners rule,”3 with one notable exception: a party claiming additional insured status may introduce extrinsic evidence to prove that they are an insured on the policy.4 In West Hills, the Court reiterated Oregon’s stance on these issues.
West Hills Development Company (“West Hills”) was a general contractor for a townhouse development in Oregon. West Hills contracted with L&T Enterprises (“L&T”) as subcontractor and required that L&T obtain insurance coverage naming West Hills as an additional insured. L&T’s commercial general liability policy with Oregon Automobile Insurance Company (“Oregon Auto”) named West Hills as an additional insured on a standard additional insured endorsement, which insured West Hills “only with respect to liability arising out of [L&T’s] ongoing operations performed for [West Hills].” There was no contractual requirement that L&T provide completed operations additional insured coverage for West Hills, nor did the Oregon Auto policy include such coverage.
Following the completion of the project, the development’s homeowner’s association sued West Hills for construction defects. According to the complaint, West Hills’ subcontractors had negligently used improper means and methods in their construction work that resulted in defects. The association also alleged that West Hills was liable for negligence in hiring, supervising, and failing to oversee and inspect the subcontractors and their work. The Court noted that the “complaint contained very little information regarding the time when the damages allegedly occurred,” although the complaint did allege that the defects already existed and had started to cause damage when the owners purchased their townhomes. Moreover, as is often the case in suits brought by project owners, the complaint did not specifically identify the allegedly negligent subcontractors by name.
West Hills tendered a claim for additional insured coverage to Oregon Auto. Oregon Auto refused to defend West Hills, arguing that: (1) the homeowner’s association only alleged claims against West Hills as general contractor, not the named insured, L&T, and; (2) the claims did not arise from covered ongoing operations. Before the Oregon Supreme Court, Oregon Auto argued that the duty to defend could not be triggered merely because a complaint failed to “rule out” the possibility of coverage. Instead, it asserted that the duty to defend arises only when the complaint explicitly articulates a covered claim.
The Court rejected Oregon Auto’s argument and confirmed that the legal standard was whether the allegations in the complaint, reasonably interpreted, could result in liability for an incident or injury that was covered under the four corners of the policy, regardless of any ambiguity or lack of clarity in the complaint. Specifically, the Court found that the complaint alleged claims against West Hills from which West Hills may incur liability that could be reasonably interpreted to “aris[e] out of [L&T’s] ongoing operations performed for [West Hills],” as required under the additional insured endorsement. The complaint alleged that West Hills’ subcontractors had used “improper construction means and methods” and that West Hills was negligent in preventing them from doing so. Thus, although L&T was not specifically named in the complaint, the Court held that the complaint could reasonably be interpreted as alleging liability for conduct covered by the policy, i.e. L&T’s operations for West Hills. The Court further stated that the complaint alleged damages that occurred by the time the owners purchased their homes, making it possible that the damages occurred during L&T’s “ongoing operations.” In light of this analysis, the Court ruled that Oregon Auto had a duty to defend West Hills.
Thus, the West Hills decision confirmed Oregon’s broad duty to defend standard, a favorable outcome for policyholders. It is interesting to note, however, that the case might never have come about if West Hills had required that its subcontractors provide completed-operations additional insured coverage; if L&T had both ongoing and completed operations additional insured endorsements on its policy, then Oregon Auto’s duty to defend West Hills would have likely been more obvious. Upstream and downstream parties alike must consider case law such as this when developing effective risk management plans suitably tailored to their needs, and should remember to require appropriate additional insured coverage for both ongoing and completed operations from their subcontractors.
1. 360 Or. 650 (2016).
2. For a state-by-state breakdown on the use of extrinsic evidence in the determination of the duty to defend, see SDV Law, Extrinsic Evidence State by State Survey, http://www.sdvlaw.com/wp-content/uploads/2015/11/Extrinsic-Evidence-State-by-State-Survey. pdf.
3. Ledford v. Gutoski, 877 P.2d 80, 82 (Or. 1994); Insenhart v. Gen. Cas. Co., 377 P.2d 26, 28-29 (Or. 1962).
4. Fred Shearer & Sons, Inc. v. Gemini Ins. Co., 240 P.3d 67 (Or. 2010).
In Gillotti v. Stewart (April 26, 2017) 2017 WL 1488711, which was ordered to be published on May 18, 2017, the defendant grading subcontractor added soil over tree roots to level the driveway on the plaintiff homeowner’s sloped lot. The homeowner sued the grading subcontractor under the California Right to Repair Act (Civil Code §§ 895, et seq.) claiming that the subcontractor’s work damaged the trees.
After the jury found the subcontractor was not negligent, the trial court entered judgment in favor of the subcontractor. The homeowner appealed, arguing that the trial court improperly construed the Right to Repair Act as barring a common law negligence theory against the subcontractor and erred in failing to follow Liberty Mutual Insurance Co. v. Brookfield Crystal Cove LLC (2013) 219 Cal.App.4th 98. The Third District Court of Appeal disagreed and affirmed the trial court’s judgment in favor of the subcontractor.
This is the second time the Third District Court of Appeal has held that Liberty Mutual (discussed below) was wrongly decided and held that the Right to Repair Act is the exclusive remedy for construction defect claims. The decision follows its holding in Elliott Homes, Inc. v. Superior Court (Hicks) (2016) 6 Cal.App.5th 333, in which the Court of Appeal held that the Right to Repair Act’s pre-litigation procedures apply when homeowners plead construction defect claims based on common law causes of action, as opposed to violations of the building standards set forth in the Right to Repair Act. Elliott is currently on hold at the California Supreme Court, pending the decision in McMillin Albany, LLC v. Superior Court (2015) 239 Cal.App.4th 1132, wherein Liberty Mutual was rejected for the first time by the Fifth District. CGDRB continues to follow developments regarding the much anticipated McMillin decision closely, as well as all related matters.
The Right to Repair Act makes contractors and subcontractors not involved in home sales liable for construction defects only if the homeowner proves they negligently cause the violation in whole or part (Civil Code §§ 911(b), 936). As such, the trial court in Gillotti instructed the jury on negligence with respect to the grading subcontractor. The jury found that while the construction did violate some of the Right to Repair’s building standards alleged by the homeowner, the subcontractor was not negligent in anyway. After the jury verdict, the trial court found in favor of the grading subcontractor.
The homeowner moved for a judgment notwithstanding the verdict or a new trial on the grounds that the trial court improperly barred a common law negligence theory against the grading subcontractor. The trial court denied the motions on the grounds that “[t]he Right to Repair Act specifically provides that no other causes of action are allowed. See Civil Code § 943.” The trial court specifically noted that its decision conflicted with Liberty Mutual, in which the Fourth District Court of Appeal held that the Right to Repair Act does not eliminate common law rights and remedies where actual damage has occurred, stating that Liberty Mutual was wrongly decided and that the Liberty Mutual court was naïve in its assumptions regarding the legislative history of the Right to Repair Act.
Additionally, the Court of Appeal rejected the argument that Civil Code § 897 preserves a common law negligence claims for violation of standards not listed in Civil Code § 986. It explained that the section of Civil Code § 897, which provides, “The standards set forth in this chapter are intended to address every function or component of a structure,” expresses the legislative intent that the Right to Repair Act be all-encompassing. Anything inadvertently omitted is actionable under the Act if it causes damage. Any exceptions to the Act are made expressly through Civil Code §§ 931 and 934. The Court concluded in no uncertain terms that the Right to Repair Act precludes common law claims in cases for damages covered by the Act.
The homeowner further argued that she was not precluded from bringing a common law claim because a tree is not a “structure,” and therefore the alleged tree damage did not fall within the realm of the Right to Repair. The Court of Appeal also rejected this argument, holding that while the tree damage itself was not expressly covered, the act of adding soil to make the driveway level (which caused the damage) implicated the standards covered by the Right to Repair Act. The Court explained that since under the Act a “structure” includes “improvement located upon a lot or within a common area” (Civil Code § 895(a)), as the driveway was an improvement upon the lot, the claim was within the purview of the Right to Repair Act. As the soil, a component of the driveway, caused damage (to the trees), it was actionable under the Act.
That it took an appellate court to order AIG’s Lexington Insurance to honor its additional insured obligations is a measure of how frequently insurers attempt to dodge this important contractual obligation. The case of McMillin Management Services v. Financial Pacific Insurance, et al., in the Fourth District of the California Court of Appeal, was decided just a few days ago, on November 14, 2017. The Court reversed the trial court, finding that Lexington had to defend McMillin, a general contractor because of the construction defects potentially caused by the operations of the Lexington insureds, two subcontractors.
Lexington argued that since the homeowners’ claims arose after the subcontractors’ work was done, these claims could not have “arisen out of” the subcontractors’ on-going operations and fit into the exclusion for completed operations. However, the additional insured endorsements were not so limited, and provided coverage for liability arising out of such operations as damage may well have occurred during the construction operations.
McMillin had used a number of subcontractors to work on the subject development, two of whom, Martinez and Rozema, purchased insurance with Lexington and included additional insured endorsements. This may be the first published decision specifically construing such “arising out of” language, which commonly appears in such endorsements. Although there was a completed operations exclusion, it was not clear when the alleged damages occurred, therefore there was a potential for a defense.
The appellate court relied on the holding of another decision that held the term “arising out of” in this context is to be broadly construed: “… it broadly links a factual situation with the event creating liability, and connotes only a minimal causal connection or incidental relationship.” Acceptance Ins. Co. v. Syufy Enterprises (1999) 69 Cal.App.4th 321, 328.
Lexington argued that McMillin could not have faced liability for the homeowners claims during its insureds’ operations (as there were no damages then—the project was just being built), but the appellate court noted “arising out of” is simply broader than “during.” This court concluded that: “The term “arising out of” in the endorsements granting McMillin coverage for ” ‘liability arising out of [Martinez’s or Rozema’s] ongoing operations,’ ” provides only that McMillin’s liability must be “linked,” through a “minimal causal connection or incidental relationship”…, with Martinez’s or Rozema’s ongoing operations.” Since it was entirely possible that property damage occurred while the operations were on-going, there was a potential for coverage and a duty to defend. In effect, the duty to defend continues until Lexington can establish with undisputed and conclusive facts that there were no damages until after the subcontractors’ work was completed.
This opinion establishes for developers and their counsel the importance of carefully reviewing additional insured endorsements to ensure the broadest possible protections against claims arising from the work of the subcontractors.

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