In an opinion filed on the last day of 2019, the California Court of Appeal, Third District, reversed a trial court’s holding that an additional insured was not bound by an arbitration agreement in an insurance policy. In Philadelphia Indemnity Insurance Company v. SMG Holdings, Inc., Case No. C082841 (certified for publication on January 28, 2020), the court held that an arbitration agreement in a commercial general liability policy (“CGL”) issued by Philadelphia Indemnity Insurance Company (“Philadelphia”) bound SMG Holdings, Inc. (“SMG”), a “third party beneficiary” under the policy that was also “equitably estopped” from avoiding the arbitration clause. The court reversed the trial court, vacated its order denying Philadelphia’s petition to compel arbitration, and directed the trial court to order arbitration of the coverage dispute.

The coverage dispute arose out of personal injuries suffered in the parking lot of the Fresno Convention Center during the 2013 Future Farmers of America annual convention. During the event, an attendee tripped over a large pothole in the parking lot of the convention center, hit his head on a car, and suffered serious injuries. The injured attendee sued the City of Fresno as well as SMG.

As part of its licensing agreement to use the Fresno Convention Center for its annual convention, Future Farmers of America (“FFA”) was required to (and did) obtain a CGL policy “in a form acceptable to SMG” that named SMG and the City of Fresno as additional insureds under the policy. While the policy ultimately issued by Philadelphia to FFA did not specifically name SMG or Fresno, it contained a “deluxe endorsement” that extended 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.

SMG tendered the personal injury lawsuit to Philadelphia, seeking coverage under the policy issued by Philadelphia to FFA. Because the accident occurred in the parking lot over which SMG had exclusive control and the policy required that the “bodily injury” at issue in the personal injury lawsuit “arise out of” FFA’s (the named insured) negligence, Philadelphia denied SMG’s request for coverage. After Philadelphia and SMG were unable to resolve their coverage dispute, Philadelphia demanded arbitration and, when SMG resisted, Philadelphia filed an action and petitioned the superior court to compel arbitration against SMG. The trial court denied Philadelphia’s petition; Philadelphia appealed.

At issue in the appeal was the policy’s binding arbitration clause. Philadelphia asserted (without opposition from SMG) that the Federal Arbitration Act applied and, under the FAA, the court’s inquiry was limited to “determining (1) whether a valid agreement to arbitrate exists and, if it does, (2) whether the agreement encompasses the dispute at issue.” (United States ex rel. Welch v. My Left Foot Children’s Therapy, LLC (9th Cir. 2017) 871 F.3d 791, 796.). True, explained the court, “[b]ut whether a contract may be enforced by or against a nonsignatory to the contract is determined by principles of state law.” (Citing Rajagopalan v. NoteWorld, LLC (9th Cir. 2013) 718 F.3d 844, 847, citing Arthur Andersen LLP v. Carlisle (2009) 566 U.S. 624, 631.)

Under California law, “there are six theories by which a nonsignatory may be bound to arbitrate[.]” The court was concerned with two: (1) the intended third party beneficiary theory, and (2) the equitable estoppel theory. Based upon the facts and circumstances of the case, the court held that SMG was bound to arbitrate its coverage dispute under both theories. Based upon the license agreement (entered into between SMG and FFA) and the policy, the court held that SMG is an intended beneficiary of the policy. And, “SMG’s tender [to Philadelphia] also constitutes a knowing claim of contract benefits, namely defense and indemnity. Accordingly, SMG is estopped from disclaiming applicable contract burdens such as the arbitration clause.”

SMG nonetheless asserted that Philadelphia’s coverage denial represented an “inconsistent position that SMG is not an insured” and, thus, the arbitration clause (which only binds “insureds”) did not bind SMG. The court rejected this contention, explaining, “The argument proceeds from the premise that if SMG is an ‘insured’ for purposes of the arbitration clause, it is also entitled to coverage for the injury. But, … ‘insured’ [for purposes of the arbitration agreement] is defined by the terms of the policy and is separate from the question of whether a particular injury is covered.”

Ultimately, the court held that the policy’s arbitration clause was valid, binding and applied to the coverage dispute between Philadelphia and “nonsignatory” seeking additional insured coverage under the policy, SMG. Whether the court’s third party beneficiary analysis is broadened, limited or relied upon in future opinions, remains to be seen. Nevertheless, this case may serve as guidance for entities requesting to be added as additional insureds to an insurance policy (including, in particular, the effect of arbitration clauses contained in the policy), and may also provide guidance for insurers in future claims involving alleged and actual intended third party beneficiaries of insurance policies.