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North Counties Engineering, Inc. v. State Farm General Insurance Co.

California Court of Appeals, First District, Second Division

March 13, 2014

NORTH COUNTIES ENGINEERING, INC. et al., Plaintiffs and Appellants,

Sonoma County Superior Court, Trial Court No. SCV243762, Honorable Mark L. Tansil, Trial Judge

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[Copyrighted Material Omitted]

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Law Office of Duncan M. James, Duncan M. James and Donald J. McMullen for Plaintiffs and Appellants.

LHB Pacific Law Partners, Clarke Holland, Brendan J. Fogarty and Jenny J. Chu for Defendant and Respondent.

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Richman, J.

North Counties Engineering, Inc. (NCE), an engineering company, and Gary Akerstrom, its president (sometimes collectively, appellants), were sued in 2004 in two lawsuits that sought property damage arising out of the construction of a dam completed in 1999. Appellants tendered defense of the lawsuits to State Farm General Insurance Company (State Farm), under a business policy it had issued to NCE effective 1997. State Farm rejected the tender, a position it maintained for several years, until September 2007, when State Farm recognized that its position had been based on a policy declarations page first effective in 2001—and thus a policy not applicable to the claims in the lawsuits. State Farm agreed to provide a defense from September 2007 forward, leaving unreimbursed some $504, 000 in expenses incurred prior to that date.

Appellants sued State Farm seeking the unreimbursed expenses for its original refusal to defend, along with other damages. Following extensive discovery, the case proceeded to a jury trial, which jury heard testimony for twenty days, never to decide any issue in the case. Rather, the trial court granted State Farm’s motion for directed verdict, necessarily concluding that there was absolutely no evidence supporting that State Farm had a duty to defend. We conclude otherwise, and we reverse.


The Participants and the Project

NCE is a California corporation; Gary Akerstrom is its president and majority (90 percent) shareholder. Akerstrom has a bachelor’s degree in engineering and master’s degrees in business administration and structural engineering. Akerstrom also had an ownership interest in another corporation, North Counties Development, Inc. (NCD), which was co-owned and operated by his sons. Akerstrom, who was 71 years old at the time of trial, was also a licensed real estate broker, with many property interests in the Ukiah area.

Lolonis Winery (Lolonis) owns property in Redwood Valley, Mendocino County, on which there are vineyards and reservoirs. In 1974 Lolonis entered into a contract with NCE to design a “state-sized” earthen dam on the property (the Lolonis Dam), whose function would be to capture water from a stream referred to at trial as “Tributary A.” A state-sized dam requires government approval and oversight (Water Code § 6002 et seq.), and in June 1974 Lolonis submitted its plans and specifications to the Department of

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Water Resources, Division of Safety of Dams (DSOD). DSOD approved the plans at the time, but no work was done.

Twenty years later, in 1994, Lolonis had the plans approved again. Still, no work was begun, and in fact did not begin until 1997, with some preliminary work for the Lolonis Dam.

Meanwhile, Lolonis made improvements to two other dams on its property, the Quillen dam and the Winery dam. The work on these other dams was done pursuant to an oral agreement Lolonis had with NCE and NCD. Akerstrom himself was involved in the work on the Quillen and Winery dams, which included hands-on labor. The work on these dams was completed in 1997.

Lolonis began clearing the site for the Lolonis Dam reservoir in 1997, and actual construction of the dam itself began in 1998. NCE and Akerstrom were involved in the labor and construction work on the dam, and all work performed through 1998, including all three dams, was on a time and materials basis. That changed in 1999.

In 1999, Lolonis signed written agreements with NCE and NCD to complete construction of the Lolonis Dam in accordance with the plans drafted in 1974. In one contract, that of July 2, 1999, NCE and NCD were both defined as the “Contractor, ” responsible for furnishing “all work, labor, tools, equipment, materials... necessary to construct and complete in a good, expeditious, workmanlike and substantial manner the dam project under the terms of this agreement.” The Contractor guaranteed “all equipment, material, supplies and work furnished on the job against defective construction, components, or workmanship, ” and also agreed to “indemnify and hold [Lolonis] harmless from all claims, demands, or liability arising from or encountered in prosecution or work under this contract....” Further, Akerstrom guaranteed the full performance of the contracts by NCE and NCD.

In August 1999, as work progressed, NCE entered into two other agreements with Lolonis. One was to build an access road to the dam’s spillway, install large drainage culverts, and work on the “south-borrow area, ” from which soil was taken or “borrowed” to build the dam embankment. The other was to construct a sediment basin adjacent to the south-borrow area, into which sediment present in water runoff from the borrow area was collected.[1]

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Construction of the Lolonis Dam was completed in November 1999. The next month, DSOD conducted its final inspection, and in February 2000 issued a certificate of approval, permitting Lolonis to impound water and use the dam.

The Insurance Policy

Robert Mirata, a State Farm insurance agent in Ukiah, had known Akerstrom since 1987. In 1990, Akerstrom met with Mirata to obtain insurance, in Akerstrom’s words to “cover my normal things, my business, which would cover, like fire insurance on the business, liability on the business, things that I would do outside, you know, any work like the P.C.O., products completed operations.” This was important, Akerstrom said, because he has “always been doing some construction work, normally for my own account.” And, he said, Mirata was aware of this: he “knew me and what I was doing.”

Mirata testified that his practice was to discuss information on the application with the potential insured, along with the scope of coverage. Mirata then filled out the application for insurance, and in the box for insured-business type, wrote “engineering and surveying.”

In 1991 State Farm issued policy No. 97-66-0110-2. It was entitled “Business Policy—Special Form 3, ” and the named insured was NCE. The declarations pages for the first many years of coverage—specifically, until the policy beginning June 11, 2000—provided as follows under the column labeled “Coverages and Limits”:

“Section I [¶]... [¶]

“Section II

“L Business Liability $1, 000, 000

“M Medical Payments 5, 000

“Products-Completed Operations 2, 000, 000

“(PCO) Aggregate...

“General Aggregate (Other than PCO) 2, 000, 000”

As described in detail below, the “Products Completed Operations” (sometimes PCO) coverage became a central factor in the case.

In April 2000 State Farm sent a notice to NCE advising of State Farm’s “intent to renew your policy with the Products Completed Operations Liability Exclusion Endorsement... as we do not offer [this coverage to] engineering companies.” The endorsement was FE 6312.

As relevant here, the policy provided as follows:

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“We will pay those sums that the insured becomes legally obligated to pay as damages because of... property damage, ... injury to which this insurance applies, ” going on to describe that the policy applies “to bodily injury or property damage caused by an occurrence which takes place in the coverage territory during the policy period....”

The policy also had numerous “Business Liability Exclusions, ” one of which, the “professional services” exclusion, would also be a central factor here. It provided as follows:

“Under Coverage L, this insurance does not apply: [¶]... [¶]

“10.... to property damage... due to rendering or failure to render any professional services or treatments. This includes but is not limited to: [¶]... [¶]

“b. 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;

“c. supervisory or inspection services;...”

And, of course, the policy specified that State Farm had the duty to defend any claim or suit seeking damages payable under the policy.

The Underlying Actions

In 2000, shortly after completion of the Lolonis Dam, the State began to investigate, apparently based on complaints from neighbors of excess sediment in the creek downstream, and concerns that the construction caused erosion in the surrounding waterways. Lolonis made attempts to remediate the problem, not to the State’s satisfaction, leading to the first lawsuit involved here, that filed by the state in early 2004: People ex rel. California Regional Water Quality Control Bd. v. Lolonis Vineyards, Inc. (Super. Ct. Mendocino County, 2009, No. SCUKCVG03-91551 (the State action). The State action named Lolonis (and the individuals connected with it) and sought injunctive relief, civil penalties, and damages under the Water Code, the Fish and Game Code, and the Civil Code.

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Lolonis filed a cross-complaint in the State action against NCE, NCD, and Akerstrom, asserting claims for breach of contract, negligence, indemnity, and declaratory relief. The complaint in the Lolonis action described for three pages the history of the planning and construction of the dam, beginning in 1974 and ending in 1999, and alleged, among other things, that in the winter of 1998-1999 the Department of Fish and Game “observed the earthen dam and determined that the unfinished construction had resulted in erosion and sediment escaping downstream.”

In April 2004 Lolonis filed the second action involved here, its own action against NCE, NCD, and Akerstrom: Lolonis Vineyards, Inc. v. North Counties Engineering Co. (Super. Ct. Mendocino County, No. SCUKCVG04-92182 (the Lolonis action). The Lolonis action alleged claims for breach of contract, express/implied warranty, and negligence. The complaint in the Lolonis action described for three pages the history of the planning and construction of the dam, beginning in 1974 and ending in 1999, and alleged, among other things, that in the winter of 1998-1999 the Department of Fish and Game “observed the earthen dam and determined that the unfinished construction had resulted in erosion and sediment escaping downstream.”

More specifically, the Lolonis complaint alleged as follows:

“1.... This action is to obtain damages for breach of contract, negligence and implied warranty from a contract for the construction of a dam on the Lolonis Vineyards, Inc. property. [¶]... [¶]

“30. [The State] seek[s] damages for negligence in the construction of the dam resulting in harm to tributaries A and B. To the extent such damages are recoverable, such damages are the direct result of negligent construction by [appellants and NCD]. [¶]... [¶][2]

“32. [Lolonis] contends that [appellants and NCD] breached their contracts with Lolonis... in failing to construct the dam in a good and professional manner. Specifically, [NCE] undertook to place fill for construction of the dam, construction of roadways and construction of the spillway... [S]uch fill resulted in damage to downstream tributaries... which has resulted in several hundred thousand dollars worth of damage to tributaries A and B.”

The Lolonis complaint also alleged that the State contended that Lolonis failed to obtain proper permits for the work in Tributary B, and this was

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also appellants’ responsibility, as they never notified Lolonis that permits were required.

For consistency with the briefing, Lolonis’s cross-complaint in the State action and its complaint in its action will be referred to collectively as “the underlying actions.”

Tender of the Underlying Actions

NCE, Akerstrom, and NCD jointly hired the Law Offices of Duncan M. James to defend them in the underlying actions. Via a May 2004 letter, James’s associate tendered defense of the underlying actions to State Farm. The claim was numbered 05-M340-073 (the claim), and was assigned to State Farm claim representative Karla Woerner, under the supervision of team manager Jean Splinter. Woerner designated May 7, 2004, the date the tender was received, as the “date of loss, ” testifying she did so for “record purposes.” There was no supporting testimony that this was an acceptable claims handling practice, and in fact Woerner made the following entry in the claim activity log: “Put in date of loss as date received claim [May 7, 2004] for record purposes. Will update date of loss when get a copy of the complaint for review.” Despite that, State Farm never changed the date of loss. Moreover, Woerner gave no explanation why she did not use the actual date(s) set forth in the underlying actions, which included the period beginning in 1997 and continuing through at least 1999. As State Farm’s own brief puts it, “[t]he underlying complaints tendered by appellants patently allege that the sediment and erosion damage giving rise to the suit began in the winter of 1997....” Regardless, Woerner did what she did, causing the consequences that followed from what she would later testify was something she “should have updated.”

According to the State Farm testimony at trial and also its claim activity log, Woerner reviewed the pleadings in the underlying actions, the attached contracts and correspondence, and spoke with James’s office. In an eight-page letter dated June 9, 2004, signed by Splinter “by... Woerner, ” State Farm advised that it had “completed [its] investigation and do not believe there is a potential for coverage for the lawsuit. Therefore, we are unable to provide your client with a defense.” Citing a litany of definitions and exclusions, the letter went on to assert that the negligence allegations did not arise from an “occurrence” because the “allegations against the insured cannot be construed as accidental”; that NCE’s contract with Lolonis was not an “insured contract” under the policy; that Lolonis “claims their damages are a result of [NCE’s] and Akerstrom’s professional services, ” [and] thus the

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professional services exclusion applies; and, finally, that “Endorsement FE6312 is part of this policy” and thus PCO coverage was excluded from coverage. Interestingly, the last page of the letter advised that State Farm was “waiting for Underwriting to provide us with the Declarations page and specimen policy, which you requested. Once received, we will forward to you immediately.” As will be seen, nothing was forthcoming from “Underwriting, ” at least for several years.

We momentarily digress from the chronology to mention Woerner’s testimony at trial concerning her conduct at the time the tender was rejected, beginning with her admission that, “[w]hen [she did] the evaluation, [she] was looking at a policy for 2004.” Woerner further admitted she conducted no interviews, made no inquiries, and requested no written statements regarding the underlying actions or the scope of work performed by appellants.

Over two years went by, apparently with no communication between James and State Farm relevant to the tender of defense. Then, on November 20, 2006, James wrote State Farm, “reasserting our demand that you tender a defense forthwith.” As to what had transpired in the interim, his letter advised as follows: “Since the time of that tender, my clients have been defending against the above referenced actions. [The State action] has been dismissed. Plaintiff LOLONIS VINEYARDS has been actively pursing [sic] the complaint in Mendocino County Superior Court... and, in an apparent response to an extensive ‘Motion for Summary Judgment or in the Alternative Summary Adjudication’ that was filed by the defendants, filed a motion to amend the complaint. [¶] By stipulation, the parties agreed: the amended complaint could be filed;.... A copy of the amended complaint, stipulation and order is enclosed.”

This time State Farm team manager Patrick Yaklin became involved and assigned the matter to claims representative Rudy Barajas. Barajas first reviewed the matter on December 22, 2006, and as he would later testify—and the State Farm log would confirm—he fundamentally relied on Woerner’s 2004 coverage memo. He did not independently establish the date of loss or reassess the claim. Rather, Barajas simply compared the new pleadings to the old by placing them side-by-side. That was it.

The State Farm claim log recites that on December 24 Yaklin “reviewed and discussed... with... Barajas, ” and “agree[d] with... Barajas analysis that there is still no duty to defend the matter and we will reiterate our denial.” So, on December 28, Barajas dictated a “retender” of the ...

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