Liability Policy’s Arbitration Endorsement Applies to Third Party Beneficiaries, Including Additional Insureds

Haight Brown & Bonesteel LLP

In Philadelphia Indemnity Ins. Co. v. SMG Holdings, Inc. (No. C082841; filed 12/31/19, ord. pub. 1/28/20), a California appeals court held that a binding arbitration clause in an insurance policy extends to a third party, such as an additional insured.

In Philadelphia v. SMG, Philadelphia issued a general liability policy to a youth organization, Future Farmers of America (FFA), that had contracted to use the Fresno Convention Center for its annual convention. The contract required FFA to obtain liability insurance and to name the property manager, SMG, and the City of Fresno, as additional insureds. Philadelphia issued FFA a commercial lines CGL policy with an endorsement affording coverage to “managers, landlords, or lessors of premises” for “liability arising out of the ownership, maintenance or use of that part of the premises leased or rented” to the named insured. It also covered “any person or organization where required by a written contract executed prior to the occurrence” but only for liability arising from the named insured’s negligence.

During the event, a man suffered serious injury from a fall in the convention center parking lot. The man only sued SMG and the City, as did the man’s employer, for reimbursement of worker’s compensation benefits. SMG and the City tendered their defense and indemnity for the claim to Philadelphia which denied coverage.

Philadelphia asserted that while the policy covered owners and landlords, it did so only for liability arising from the ownership, maintenance, or use of the leased premises. Similarly, the policy covered organizations where required by contract — but only for liability arising from the named insured’s negligence. Since FFA was not authorized to use the parking lot for its event, and SMG had sole responsibility for the parking lot, the injury did not arise out of use of the leased premises. And nothing indicated any negligence on FFA’s part in causing the man’s fall. Therefore, Philadelphia responded that neither Fresno nor SMG qualified as additional insureds under the policy with respect to the parking lot injury litigation.

The Philadelphia policy also included a binding arbitration endorsement that provided in part: “If we and the insured do not agree whether coverage is provided under this Coverage Part for a claim made against the insured, then either party may make a written demand for arbitration.” Faced with a dispute from SMG, Philadelphia demanded arbitration, and filed a petition to compel arbitration when that was refused.

Philadelphia argued that the Federal Arbitration Act limited the court’s power to deciding whether a valid arbitration agreement existed and that SMG could not simultaneously argue that it was entitled to benefits under the policy while avoiding its burdens. SMG made the opposite argument, asserting that by having taken the position that SMG was not an insured under the policy, Philadelphia could not claim that SMG was an insured subject to arbitration.

The trial court refused to compel arbitration, on the ground that SMG was not a party to the contract. The court held that Philadelphia had offered no evidence of the circumstances and negotiations of the parties, and no evidence showed an intent to benefit SMG in particular. Plus, Philadelphia was estopped from claiming SMG was an insured under the policy for purposes of compelling arbitration because Philadelphia had denied SMG’s tender claiming that SMG was not an insured under the policy.

The appeals court reversed. The court said that whether a contract may be enforced by or against a nonsignatory to the contract is determined by state law. And in California, there are six theories by which a nonsignatory may be bound to arbitrate: (a) incorporation by reference; (b) assumption; (c) agency; (d) veil-piercing or alter ego; (e) estoppel; and (f) third-party beneficiary. (Citing Suh v. Superior Court (2010) 181 Cal.App.4th 1504, 1513.) The Philadelphia court found that third-party beneficiary and estoppel theories applied.

The Philadelphia court pointed out that the convention center contract required FFA to both obtain insurance for the event and to name SMG as an additional insured. In addition, the policy covered managers, landlords, or lessors of the premises as well as any person or organization where required by a written contract executed prior to the occurrence. The court cited Hartford Casualty Ins. Co. v. Travelers Indemnity Co. (2003) 110 Cal.App.4th 710, for the proposition that intent to name a third party beneficiary could be shown through a lease contract requiring the third party beneficiary to be designated as an additional insured.

The Philadelphia court was persuaded by the argument that equitable estoppel favored Philadelphia and not SMG on the arbitration clause. The court cited Boucher v. Alliance Title Co., Inc. (2005) 127 Cal.App.4th 262 for the proposition that a party may be estopped from asserting that a contract’s arbitration clause does not apply while maintaining that other provisions of the contract apply. And Philadelphia was not itself estopped, because it was not disclaiming any duties to SMG under the contract — it was only taking a position that the liability in question was not within the scope of the coverage afforded. Plus, the Philadelphia court found that “it defies logic to require a named insured demanding coverage to submit coverage disputes to arbitration, while freeing from that obligation an unnamed insured demanding the same coverage.”

Thus, the trial court was directed to enter an order compelling arbitration of the coverage dispute.

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Haight Brown & Bonesteel LLP

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