July 2008 Nevada Lawyer

INSURANCE INTERPRETATION

Nevada Supreme Court Adds its Voice to the Emerging Chorus of Giving Broad Construction to Commonly Used “Additional Insured” Endorsements. Federal Insurance Co. v. American Hardware Mutual Ins. Co., 124 Nev. Adv. Op. No. 31 (May 29, 2008).

BY PROFESSOR JEFFREY W. STEMPEL

The Problem and Its Background

Insurers and additional insureds have been locked in a contest for some time over the scope of additional insured coverage, with insurers often contending that additional insureds (insureds added onto a policy purchased from the insurer at the request of the named policyholder who bought the policy) are covered only if sued for vicarious liability flowing from the conduct of the named policyholder. Insurers argue that an additional insured does not enjoy coverage under the named insured’s policy in cases where the additional insured is sued because of its own active negligence or where the additional insured is the only allegedly negligent tortfeasor. Conversely, additional insureds argue that “an insured is an insured is an insured,” and that they enjoy the full range of coverage available to the named policyholder and are thus covered even where their conduct contributes to the injury, alone or in combination with that of the named policyholder. In general, additional insureds appear to be winning these coverage battles. (fn1)

The epicenter of the battleground is construction project activity. Typically, a general contractor, as part of its regular business operations, insists that the subcontractors it retains name the general contractor as an additional insured on the subcontractor policies. In this manner, the general contractor can obtain additional risk protection from the policies held by the subcontractors. The net effect is to expand the amount of liability insurance covering a particular construction project should there be construction defect litigation.

The Federal v. American Hardware Case

In Federal Insurance Co. v. American Hardware Mutual Ins. Co., 124 Nev. Adv. Op. No. 31 (May 29, 2008), the Nevada Supreme Court unanimously aligned itself with the apparent emerging majority approach and held that the additional insured endorsement in question covered active negligence by the additional insured and provided coverage even if the additional insured was the only insured accused of fault. The case began in state court but was removed to federal court, only to have the federal trial court certify the following legal question to the Nevada Supreme Court: “[w]hether, under Nevada law, an additional insured endorsement provides coverage for an injury caused by the sole independent negligence of an additional insured?” The court “[a]nswer[ed] the question in the affirmative and conclude[d] that, unless the contrary intent is demonstrated by specific language excluding or limiting coverage for injuries caused by the additional insured’s independent negligent acts, there is coverage.”  See 124 Nev. Adv. Op. No. 31 at *1-*2.

The liability insurance policy in question was issued by American Hardware Mutual to Clark Lift West, Inc. Clark Lift provided maintenance and repair services at a facility for Southern Wine and Spirits of America, Inc. American Hardware willingly issued an endorsement naming Southern Wine as an additional insured under the Clark Lift policy. The endorsement stated that Southern Wine was an additional insured covered for liability “but only with respect to liability arising out of [the named policyholder’s] ongoing operations performed for that [additional insured].” See id. at *2.

Soon after, a Clark Lift employee was injured while providing services at Southern Wine’s facility. He sued Southern Wine seeking damages, alleging that as he was repairing a conveyor belt drive, the belt unexpectedly began moving and that he slipped on loose cardboard that was negligently left on the floor, resulting in his hand being mangled in the conveyor belt mechanism. Upon receiving notice of the suit from the company, Southern Wine informed its CGL insurer, Federal Insurance. The two tendered the defense of the tort action to American Hardware, which refused the tender, arguing that the additional insured coverage applied only “when the alleged negligence could be imputed to the additional insured thorough the named insured’s operations, i.e., when the additional insured can be vicariously liable for the named insurance’s negligence.” See id. at *3.

The court had two primary bases for deciding in favor of coverage. First, it found the additional insured endorsement in the American Hardware policy to be ambiguous and hence construed it against American Hardware as the drafter. Second, the court applied what it viewed as the majority rule and the Nevada rule that grants of coverage in an insurance policy should be interpreted broadly unless there was a clear textual restriction on coverage in the policy or other strong evidence that the parties either intended the endorsement to be limited only to vicarious liability or that the policyholder’s reasonable expectation was that only vicarious liability was covered. See id. at *6-*13. (fn2)

The Significance of Federal v. American Hardware

The Federal v. American Hardware case is significant for a number of reasons. First, it puts another state supreme court unanimously in the camp of giving broad construction to the scope of additional insured coverage and requiring insurers to do more than just argue the purported public policy benefits of restricting coverage to only derivative liability or merely asserting a generalized industry intent that additional insured coverage be narrower than coverage for the named insured.

Second, in a move that perhaps will give both policyholder and insurer counsel concerns in future Nevada cases, the court stated that the construction of restrictive language in insurance policies will be assessed not only according to whether it is facially ambiguous and with reference to the general rule that restrictions on coverage must be clearly expressed, but also with reference to the reasonable expectations of the insured and extrinsic information as to the parties’ specific intent or the custom and practice regarding the understanding of the scope of coverage afforded by a common policy term. See id. at *11-14.

In particular, the court relied upon and arguably reinvigorated language to this effect in National Union Fire Ins. v. Caesar’s Palace, 106 Nev. 330, 792 P.2d 1129, 1130 (1990), a case in which the Supreme Court “explained that the district court should have allowed additional discovery in order to ascertain the parties’ intentions,” pointing out that, in the area of special events insurance, extrinsic evidence of custom and usage could be helpful in establishing what scope of coverage the parties intended by using the term “arising out of operation." (fn3)

Third, and perhaps most important, the Nevada Supreme Court’s decision in Federal v. American Hardware Mutual not only adds another case to the list of additional insured victories but also expressly embraces the view that a broad construction of the typical additional insured endorsement is the dominant majority view of the courts. The articulated norm is that the additional insured is covered under the named insured’s policy so long as the additional insured is being sued for something reasonably related to its operations involving the named insured.

An Available Escape Hatch for Insurers – But Reluctance to Use It

However, the decision also gives insurers a chance to avoid providing such broad coverage. “[A]n insurer may limit the coverage provided to an additional insured [but] in order to do so, it must include in the endorsement explicit language that would exclude particular causes of losses suffered. Absent an express exclusion, we are bound to construe the insurance term broadly, in favor of coverage.” See id. at *20-*21.  This means that insurers are perfectly free to write more restrictive additional insured endorsements or to introduce evidence of party intent, expectation, or industry custom and practice in arguing for a narrower construction of an additional insured endorsement.

Ironically, however, most insurers appear to continue to be using the “arising out of the named insured’s operations” endorsement, or only slight variations, even though the Insurance Services Office (ISO) made available to insurers a more favorable endorsement in 2004, albeit one that still is less than crystal clear (fn4). More ironically, ISO had, prior to issuance of the new form, considered using language stating that there was no coverage under the endorsement for claims involving “the sole negligence of the additional insured or by those acting on behalf of the additional insured.”  Now there’s language that is unambiguous. But because ISO was aware of how to write such straightforward endorsements but declined to put such clear language in the resulting 2004 form, insurers will have some explaining to do in contending that the much more vague 2004 form clearly accomplishes the same result. However, to the extent that courts permit insurers using the 2004 form to introduce extrinsic information such as drafting history, ISO’s accompanying materials make it quite clear that, under the new form, the intent of the insurance industry is to provide additional insured coverage only when the named policyholder’s acts or omissions result in suit against the additional insured.

Conclusion

For the moment, the key lessons of Federal Insurance v. American Hardware Mutual are these: First, insurers who continue to use the traditional pre-2004 “arising out of named insured operations” language for additional insured endorsements increasingly do so at their peril. Second, insurers who want to expressly write a narrower scope of additional insured coverage into their policies will probably be successful if their drafting is reasonably clear. Third, even where insurers have failed to do this, they may be able to win these coverage disputes in cases where they are able to produce sufficiently probative evidence that narrower scope was intended or that the additional insured had such an understanding or expectation.

Jeffrey W. Stempel is the Doris S. & Theodore B. Lee Professor of Law at UNLV’s William S. Boyd School of Law.

FOOTNOTES

1 See Jeffrey W. Stempel, Stempel on Insurance Contracts § 25.06 at p. 25-87 (3d ed. 2006 & Supp. 2008)(“[M]ost courts have tended to give the “arising under” language of the various traditionally used additional insured endorsements a broad construction and have refused to limit additional insured coverage to only cases of vicarious liability.”); Douglas R. Richmond, The Additional Problems of Additional Insureds, 33 Tort & Ins. L.J. 945, 958 (1998) (noting that “liberal interpretation of the additional insured endorsement is fast becoming the majority rule”). See, e.g., National Union Fire Ins. Co. v. Lumbermens Mut. Cas. Co., 385 F.3d 47 (1st Cir. 2004)(applying Massachusetts law); Acceptance Ins. Co. v. Syufy, 69 Cal. App. 4th 321, 81 Cal. Rptr. 2d 557, 562-63 (1999). But see Granite Const. Co., Inc. v. Bituminous Ins. Cos., 832 S.W.2d 427 (Tex. Ct. Civ. App. 1992). See also BP Chemicals, Inc. v. First State Ins. Co., 226 F.3d 420, 425-26 (6th Cir. 2000) (applying Texas law) (restricting coverage to cases not involving additional insured’s own negligence because the particular endorsement at issue explicitly barred coverage for “any negligent acts committed by the additional insured.”); National Union Fire Ins. Co. v. Nationwide Ins., 69 Cal. App. 4th 709, 82 Cal. Rptr. 2d 16, 21-22 (1999) (same).

2 Under Nevada law, “an insurer wishing to restrict a policy’s coverage should use language that `clearly and distinctly communicates to the insured the nature of the limitation.’” See id. at * 6, citing National Union Fire Ins. v. Reno’s Exec. Air, 100 Nev. 360, 364, 682 P.2d 1380, 1382 (1984). “Here, American Hardware’s endorsement contains no such distinctly limiting language. . . . Specifically, under one reasonable interpretation, the endorsement limits coverage to circumstances in which the named insured’s negligent acts or operations directly caused the plaintiff’s injury, that is, circumstances in which the additional insured is held vicariously liable for the named insured’s negligence. Under another reasonable interpretation, however, the endorsement covers the additional insured’s direct negligence, so long as the plaintiff’s injury has some connection to the work or operations that the named insured performed for the additional insured. See 124 Nev. Adv. Op. No. 31 at *6-*8 (citations omitted).

3 But in Federal v. American Hardware, the Court found that “[t]he record before us bears no indication of what negotiations or discussions took place in issuing the endorsement, if any, industry customs and usages or any other maters that might reflect the parties’ mutual understanding concerning a limited scope of coverage.” See 124 Nev. Adv. Op. No. 31 at *12-*13 (footnotes omitted). See also Anuvi, LLC v. G.L. Dragon, LLC, Nev. 163 P.3d 405, 407 (2006) (party intent can be ascertained from text of contract documents and from the surrounding circumstances even where specific extrinsic evidence of intent is not introduced or received).

⁴ See Randy J. Maniloff, Additional Insured Endorsements, FC& S Casualty & Surety Bulletin M. 23-1 (May 2004) at 23-3.

State Bar of Nevada Adds Construction Law Section

The Board of Governors of the State Bar of Nevada has approved the formation of a Construction Law Section. The purpose of this section is to further enhance the knowledge of members of the section, the members of the State Bar of Nevada and the members of the judiciary in all aspects of construction law and to assist the Board of Governors in the implementation of programs, policies and guidelines relevant to this field of law.

For more information about the section or to become a member, please contact Paul Matteoni at (775) 823-2900 or James Berchtold at (702) 385-3373.