California Court Broadly Interprets Insurance Policy’s “Liability Arising Out of” Language

In McMillin Mgmt. Servs. v. Financial Pacific Ins. Co., Cal.Ct.App. (4th Dist.), Docket No. D069814 (filed 11/14/17), the California Court of Appeal held that the term “liability arising out of,” as used in an ongoing operations endorsement, does not require that the named insured’s liability arise while it is performing work on a construction project.

In the McMillin case, the general contractor and developer (McMillin) contracted with various subcontractors, including a concrete subcontractor and stucco subcontractor insured by Lexington Insurance Company.  Both subcontractors performed their work at the project prior to the sale of the units.

The Lexington policies contained substantively identical additional insured endorsements that provided coverage to McMillin “for liability arising out of your [the named insured subcontractor’s] ongoing operations performed for [McMillin].” Several homeowners filed suit against McMillin, alleging that they had discovered various defective conditions arising out of the construction of their homes, including defects arising out of the work performed by Lexington’s insureds.  Lexington argued that there was no potential for coverage in McMillin’s favor under the endorsements because there were no homeowners during the time that the subcontractors’ operations were performing work at the project (the homes closed escrow after the subcontractors had completed their work); thus, McMillin did not have any liability for property damage that took place while the subcontractors’ operations were ongoing.

The court rejected Lexington’s argument, noting that the endorsements stated that Lexington would provide coverage to McMillin for liability “arising out of” ongoing operations, and that the term “arising out of” is not synonymous with “during.” The court opined that “arising out of” required only a “minimal causal connection or incidental relationship” between McMillin’s liability and the subcontractors’ ongoing operations, and that the lack of homeowners during the subcontractors’ ongoing operations did not rule out the possibility that McMillin could suffer liability arising out of the subcontractors’ ongoing operations. The court also held that Lexington failed to establish that all of the damage occurred after the ongoing operations were completed; and that under the plain language of the endorsements, if property damage occurred before the ongoing operations were completed, the additional insured was entitled to coverage.

McMillin is another example of the recent trend by the California Court of Appeal in expanding the scope of coverage under ongoing operations endorsements in favor of developers and general contractors, as evidenced by the court’s August 2017 ruling in Pulte Home Corp. v. American Safety Indemnity Co., 14 Cal.App.5th 1086 (2017).  Nevertheless, developers and general contractors would be well-advised to carefully review additional insured endorsements to confirm that the language of the endorsements is consistent with their expectations of coverage and contain no language that requires the named insured’s liability to arise during the course of the named insured’s ongoing operations as a prerequisite to coverage.