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Professional Services Exclusion May Not Be A Complete Bar On Coverage When Insured Also Performs Construction Work

On March 13, the California Court of Appeal, First Appellate District, ruled that a question of fact regarding whether an insured performed work outside of professional services precludes application of a professional services exclusion to eliminate the duty to defend.

In North Counties Engineering v. State Farm General Ins. Co., State Farm insured an engineering company under a business liability policy that included products-completed operations (PCO) coverage and a professional services exclusion.  North Counties Engineering (NCE) contracted with a winery to construct a dam.  The owner of NCE also had an ownership interest in his son’s construction company, North Counties Development (NCD), which also was working on the project.  Various oral and written contracts were entered into in relation to the work with at least one contract referring to NCE and NCD as the “contractor” and the owner guaranteeing full performance by both companies.

In 2004, after downstream neighbors began complaining about issues with the dam, the property owner sued NCE and NCD.  That litigation was ultimately resolved through settlement.  In 2008, NCE filed suit against State Farm.  During trial State Farm’s motion for nonsuit was granted with the trial judge observing that: 

[I]n fairness, if you look at the pleadings, the legal pleadings and the contracts, the NCE role is, as the engineering company, the support company, and that company was overseeing the [sic] NCD to make sure that whatever they did was done right. … NCE is the expert on the job, the professional providing professional services, design and construction, and also overseeing the work of NCD, the son’s business, which is doing more of the physical activity.  But in this sort of complicated project, I think that [the property owner] had a right to have the expert, the engineer, oversee and guarantee that the whole thing was done right.  That takes professional expertise and I think all of what [NCE] did was professional. …

Based on this reasoning, the trial court found that the professional services exclusion applied to bar coverage under the State Farm business liability policy.

Disagreeing, the appellate court first noted that the duty to defend in California is broad and that when “coverage depends on an unresolved dispute over a factual question, the very existence of that dispute would establish a possibility of coverage and thus a duty to defend.”  Based on this principle and citing testimony from State Farm’s adjuster admitting that the there was a potential for coverage, and a statement by State Farm’s counsel confirming that NCE did some installation work, the appellate court concluded that “there was evidence of something other than professional services.”

The appellate court then questioned whether the professional services exclusion applied to PCO coverage noting that the definition of “products-completed operations hazard” creates coverage for property damage from an insured’s failure to instruct or warn, and thus arguably provides coverage for NCE’s alleged failure to secure some permits.  In contrast, the appellate court observed that the professional services exclusion only applies to property damage resulting from the “rendering or failure to render any professional services or treatments [including] but is not limited to … engineering, drafting, surveying or architectural services, including preparing, approving, or failing to prepare or approve maps, drawings, opinions, reports, surveys, change orders, designs or specifications … supervisory or inspection services. …”

While the court did not actually rule that the interplay between PCO coverage and the professional services exclusion rendered the policy ambiguous, it did state that “it might be argued” that the professional services exclusion “cannot possibly apply” the policy’s PCO coverage. 

Ultimately, the court’s ruling was based on the conclusion that the trial court had erroneously granted a nonsuit before hearing all of the evidence, and that because there was a factual question as to whether the insured had performed only professional services, State Farm had a duty to defend.

Of note, the appellate court commented in footnote 5 that while it was aware of cases stating opinion evidence is irrelevant to the interpretation of  an insurance policy and that an insurer’s employees cannot create coverage by admission, this case was distinguishable because it dealt with employees charged with making the coverage decisions and it would in any event decline to follow those cases.

To read the opinion, click here.

The opinion in North Counties Engineering, Inc. v. State Farm General Ins. Co. (March 13, 2014) 224 Cal.App.4th 902; 14 C.D.O.S. 2780; 2014 Cal.App.LEXIS 235 is not final.  It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court.  These events would render the opinion unavailable for use as legal authority.

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