A commercial general liability (CGL) policy often covers claims of damage for work that a construction firm has completed, but excludes damage “arising from the provision or failure to provide “professional services.” Where is the line between providing competent construction work and providing professional services?
On March 13, 2014, the California Court of Appeal issued a decision that does a terrific job of explaining how liability coverage applies when the question is whether the things that went wrong on a construction project resulted from actual construction work or from professional services.
Most construction contractors’ CGL policies (and some engineering firms’ policies) contain Products-Completed Operations Hazard (PCOH) coverage. The standard PCOH provision applies to bodily injury or property damage arising from the insured’s “work” or the insured’s “products” as long as:
- the injury or damage occurs away from premises owned or rented by the insured;
- the products are no longer in the insured’s physical possession; and
- the work has been completed.
Insurance companies often couple PCOH coverage with a broad “professional services” exclusion. The idea is that there is separate errors & omissions (E&O) coverage on the market to cover claims akin to professional “malpractice,” and that the CGL policy is designed to cover accidents arising from ordinary negligence. But there is a potential overlap between what might constitute the “ordinary” negligence of someone with a specialized area of expertise and the “professional” negligence of that same skilled person.
The standard-form professional services exclusion says that the policy does not cover bodily injury or property damage “due to or arising from the rendering or the failure to render professional services.” This includes “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.” It is easy to see how such an exclusion in a policy issued to an engineering firm might drive the policyholder to purchase an E&O policy, which will provide coverage for liabilities arising from professional services.
Problems can arise when a CGL policy contains both PCOH coverage and a professional services exclusion. However, in North Counties Engineering, Inc., et al. v. State Farm General Insurance Company, the California Court of Appeal explains how the two provisions can exist side by side without either thwarting the coverage to which the policyholder is entitled or writing the exclusion out of the policy.
Gary Akerstrom is the owner of North Counties Engineering (NCE). Lolonis Winery hired NCE in 1974 to design a dam on its property, but actual construction of the dam began more than 20 years later, in 1998. Lolonis retained both NCE and North Counties Development, Inc. (NCD) to build the dam. Lolonis also retained both firms to build an access road, a “spillway” and a sediment basin. NCE and NCD completed the project in November 1999.
In 2000, the state began investigating complaints that the dam was causing sediment to accumulate in downstream waterways and brought suit against Lolonis to fix the problems. Lolonis, in turn, sued NCE and NCD in 2004 for negligent construction of the dam, breach of contract and breach of warranty. The complaint alleged NCE had participated in the “construction” of the dam, access road, spillway and sediment basin. Among the claims were that NCE, itself, had built the sediment basin and that the failure of the basin to perform as intended had resulted in the downstream sediment damage alleged by the state.
NCE tendered the Lolonis complaint to its CGL carrier, State Farm, and demanded a defense. The initial claim handler at State Farm erroneously assigned 2004 as the “date of loss.” Thus, the claim was assigned to the NCE 2004-2005 policy period. This is important because State Farm began to include a PCOH exclusion in NCE’s policy in 2000. Before that period, all of NCE’s policies had included PCOH coverage.
In June 2004, State Farm wrote to NCE’s counsel and advised that it had decided to deny all coverage. The denial letter cited a litany of exclusions and listed both the PCOH exclusion and the professional services exclusion as applicable to the claims. The claim handler later admitted in testimony that it was a mistake to review the claim on the basis of coverage under the 2004 policy; the correct policy was the one for the 1999-2000 period (which provided PCOH coverage). Nonetheless, two years went by following the denial, during which NCE and Akerstrom were defending themselves in the underlying Lolonis action. During that period, NCE spent more than $500,000 of its own money on the defense.
In November 2006, NCE’s attorney again wrote to State Farm, providing an update and demanding a defense of the Lolonis action. In response, State Farm reiterated its complete denial. NCE’s counsel persisted in pursuing coverage. Finally, in September 2007, State Farm changed its position and began to defend NCE. However, it refused to reimburse NCE for any of the money that had been spent on the defense to date. That refusal led to coverage litigation between NCE and State Farm in 2008.
Following an 18-day trial, State Farm made a motion for a directed verdict, seeking a dismissal of the case. The trial judge granted the motion on the basis of the professional services exclusion. In a lengthy verbal opinion, the trial judge viewed all the work NCE had performed for Lolonis — including NCE’s hands-on construction work — through the prism of NCE’s engineering “expertise.” Accordingly, the court concluded the professional services exclusion applied. NCE appealed.
In analyzing how a professional services exclusion applies, the Court of Appeal distinguished a 1989 case that applied a professional services exclusion to a customer’s injury while she was having her ears pierced. The NCE Court noted that injury resulting from the faulty ear piercing “occurred while [the insured] was operating a retail cosmetics store.” In other words, the injury occurred during the act of piercing. In contrast, the damage in NCE “occurred after the appellants’ work was completed.” This is the key insight from the NCE decision.
PCOH coverage is defined as damage that occurs after the insured’s work is complete. NCE completed construction of the dam and turned it over to Lolonis. It was only then that damage arose from the allegedly faulty construction. If the injury or damage a party seeks against a contractor occurred on the job and during construction, it is then — and only then — that a professional services exclusion might apply. If the damage occurs after the job is complete, PCOH coverage applies but the professional services exclusion never should.