In McMillin Homes Constr., Inc. v. Nat’l Fire & Marine Ins. Co., 35 Cal. App. 5th 1042 (2019), the appellate court reversed the trial court’s judgment, finding that a subcontractor’s insurer owed a duty to defend the additional insured general contractor in a construction defect suit even though the additional insured endorsement excluded coverage for “property in the care, custody or control of the additional insured.”

McMillin Homes Construction, Inc. (“McMillin”) was the developer and general contractor for a housing community project referred to as Auburn Lane. As part of its subcontract agreement, subcontractor Martin Roofing Company, Inc. (“Martin”) was required to obtain general liability insurance naming McMillan as an additional insured. Martin’s commercial general liability (“CGL”) policy with National Fire & Marine Insurance Company (“National Fire”) included McMillin as an additional insured on an endorsement which provided that National Fire would cover property damage or bodily injury arising out of Martin’s ongoing operations at the Auburn Lane, or out of McMillin’s general supervision of those operations. The National Fire policy excluded coverage for damage to property in McMillin’s “care, custody, or control.”

Homeowners in Auburn Lane and six other development projects sued McMillin for construction defects, including allegations of water intrusion and damage caused by roofing defects. McMillin tendered its defense to National Fire, who denied coverage. McMillin then filed a declaratory relief action against National Fire, additionally asserting causes of action for breach of contract and bad faith contending that National Fire breached its duty to defend McMillin.

National Fire argued that the text of the “care, custody, or control” exclusion (“CCC exclusion”) did not provide that it only applied where McMillin’s control over the damaged property was complete or exclusive and, therefore, it applied to preclude coverage in this instance. National Fire further argued that its CG 21 39 10 93 endorsement (“CG 21 39 endorsement”) was intended to “close the loop” and eliminate any indirect indemnity coverage to McMillan for construction defect litigation pursuant to an indemnification agreement in the subcontract. While the National Fire policy provided coverage for liability assumed in an “insured contract”, the CG 21 39 endorsement defined “insured contract” to exclude coverage for indemnification agreements like the one included in the McMillan-Martin subcontract. The trial court agreed with National Fire’s arguments, entering judgment in favor of National Fire after a bench trial, finding it owed no duty to defend McMillan.

On appeal, the parties did not dispute that National Fire’s duty to defend was triggered based on the coverage provision of the additional insured endorsement; instead, National Fire argued that the CCC exclusion precluded coverage. National Fire argued that because McMillan was the general contractor on the development project, any damage allegedly sustained while the homes were being built constituted damage to property in McMillan’s care, custody, or control. McMillan countered that the CCC exclusion only applied where the insured had exclusive or complete control over the damaged property.

The appellate court found that the CCC exclusion was not ambiguous and that it required the insured to have exclusive or complete control over the property in order to apply. The court referred to prior appellate decisions construing the CCC exclusion, relying largely on the Third Appellate District’s decision in Home Indem. Co. v. Leo L. Davis, Inc., 79 Cal. App. 3d 863 (1978) (“Davis”).

Seven years after Silva, Davis surveyed the landscape regarding the CCC exclusion. From Volf and Silva, the Davis court concluded, “in the California cases that have applied the exclusion to defeat coverage, contractual responsibility for the entire operation rested with the insured.” (Davis, supra, 79 Cal.App.3d at p. 870.) After examining a handful of out-of-state cases, Davis explained: “Almost invariably where coverage is denied, physical control by the insured has been exclusive, even if such exclusivity was only momentary, so long as the damage occurred in that moment. [Citation.] Our attention has been drawn to several cases in which the exclusion similarly defeated coverage despite the fact that the insured’s control was not exclusive because he was receiving directions from another. [Citations.] Such cases are to be contrasted, however, both with the present case and with those denying effect to the exclusion and thus affirming coverage, where physical control was shared by another with the insured.” (Id. at p. 871.)

Noting that the care, custody, or control exclusion had been deemed both ambiguous and unambiguous, the Davis court believed “[t]he only consistency in the[se] cases is the need for painstaking evaluation of the specific facts of each case, especially those that bear on the nature and extent of the insured’s control.” (Davis, supra, 79 Cal.App.3d at pp. 871–872.) It noted “the courts are not averse to holding [the exclusion] inapplicable where the control exercised by the insured—possessory or physical—is not exclusive and complete at the critical moment in question.” (Id. at p. 872.)

The McMillin court interpreted Davis as announcing the general rule that “[t]he CCC exclusion is inapplicable where the facts at best suggest shared control.” As such, the CCC exclusion unambiguously required exclusive or complete control in order to apply.

After determining the CCC exclusion was unambiguous, the appellate court found it did not apply to McMillin as National Fire’s interpretation of the CCC exclusion was based on assumptions regarding McMillin’s control over the development project, rather than facts. The record disclosed that while McMillin was responsible for the whole project and coordinating schedules to ensure the entire development project finished on time, Martin was responsible for controlling its jobsite and supervising the roofing work. As such, Martin and McMillin shared control over Martin’s roofing work.

The appellate court further reasoned that, even if the CCC exclusion was ambiguous, National Fire still owed no duty to defend as the reasonable expectations of McMillin were that “control” within the meaning of the exclusion required more than merely being the general contractor. The court noted that a key motivation for a general contractor to obtain an additional insured endorsement on a subcontractor’s liability policy is to offset the typically expensive costs of defending lawsuits where the general contractor’s liability is only derivative.

In construing policy language, we assess “the meaning a layperson would ordinarily attach to it.” (Waller, supra, 11 Cal.4th at p. 18.) National Fire’s construction bears little connection to the risk involved or the reason for a general contractor to seek coverage as an additional insured. Its stance might be “reasonable in the abstract,” but it is inconsistent with the basic rule that limitations on a promised defense duty must be conspicuous, plain, and clear. (Maryland, supra, 65 Cal.App.4th at p. 30.)

Finally, the appellate court rejected National Fire’s argument that the CG 21 39 endorsement – which allowed coverage for liability assumed by Martin in an “insured contract” – excluded coverage for construction defect litigation by excluding indemnification agreements from the definition of an “insured contract”.

In a nutshell, National Fire argues that by broadening the scope of an exclusion as to Martin, it closed the loop on its duty to cover McMillin for construction defect litigation. Construing the policy as a whole, National Fire believes the combined effect of these two exclusions showed its intent to eliminate its duty to pay for McMillin’s defense in Galvan “whether to McMillin directly as an additional insured or to McMillin indirectly as an indemnitee of Martin Roofing.” Accepting this theory, the trial court concluded “National Fire did not intend for this endorsement to reach construction defect litigation.”

The argument is unpersuasive for a simple reason. In resolving an ambiguity, we interpret provisions in the sense an insured reasonably understood them at the time of contract formation. (Marylandsupra, 65 Cal.App.4th at p. 29.) This rule does not protect the subjective beliefs of the insurer, but rather the objectively reasonable expectations of the insured. (Ibid.) Even if we accept the premise of National Fire’s argument, its intent as to coverage does not resolve which of two purportedly reasonable constructions of the CCC exclusion comports with the insured’s objectively reasonable expectations.

Accordingly, the Court of Appeal reversed the judgment, directing the trial court to enter judgment in McMillin’s favor.