Allocation of Coverage Between Direct and Additional Insured Coverage

Transcription

1 Recent Developments in Insurance Coverage Disputes Allocation of Coverage Between Direct and Additional Insured Coverage John H. Podesta Murchison & Cumming, LLP San Francisco, CA New insurance law cases and their impact on construction risks: Allocation between direct and additional insured coverage. I. INTRODUCTION The program as a whole addresses the recent developments in insurance law generally, and how those impact construction risks specifically. One area in which there is significant litigation in construction risks is the allocation of defense and indemnity exposure between a contractor s direct coverage, and the coverage provided primarily by subcontractors that additionally insure the contractor. The combinations of possible conflicts is a virtual laboratory for other applications of insurance law, for example:

2 1. In a construction defect action, the General has direct liability insurance subject to an SIR, and half of the subcontractors name the General Contractor as an additional insured: How will the defense and indemnity for the General Contractor be allocated? 2. In a serious personal injury matter, there is a strong indemnity agreement between the General and two responsible subcontractors, but only one of them has applicable additional insured coverage because of an SIR: What are the rights of the carrier that has triggered coverage vis a vis the General Contractor and the subcontractor with the SIR? These same allocation issues present in non-construction cases as well. Approaching the problem head-on requires attention to insurance fundamentals, whether your goal is to force players to the table to fund the defense and indemnity or to defend against unwarranted tenders. The law of allocation is an outgrowth of many individual fact scenarios and legal principles that work together, or sometimes against each other. The challenge is to identify which principles in particular contribution or subrogation apply to your set of facts. Once the lawyer can separate the characteristics of each type of coverage, the insured parties, and different claims that belong to the carriers and the insured, he or she can figure out the best approach to minimize liability to the client, or maximize the offsets & recovery from other sources. Unraveling problems of allocation between direct and additional insured coverage begins with subrogation and contribution. As one California court has opined, it is hard to imagine another set of legal terms with more soporific effect than indemnity, subrogation, contribution, coobligation, and joint tortfeasorship. (Herrick Corp. v. Canadian Ins. Co. 29 Cal App 4th 753, 756 (1994)). It is also difficult to think of two legal concepts that have caused more confusion and headache for both courts and litigants than have contribution and subrogation. (Id.) Succinctly, the following characteristics differentiate subrogation and contribution and help to define which thread of authority applies: Contribution. If two insurers share the same level of coverage (e.g., primary, umbrella, excess) for the same insured and they both apply to the same loss, then principles of contribution will likely apply. If contribution applies, then: 1. The trend is to prorate the loss between carriers this sometimes provides more recovery than a straight contractual claim; 2. The courts are skeptical of "other insurance" clauses that try to convert the primary to an excess policy it is less likely to be enforced; and 3. The damages recoverable are the amount that the paying carrier overpaid. Subrogation. If there is any non-alignment in the level of risk or the insured, then the paying carrier may stand in the shoes of its insured for whom it paid the loss and pursue others by way of subrogation. If subrogation applies, 1) The

3 paying carrier stands in the shoes of its insured on whose behalf it paid the loss; and 2) The defending carrier may assert all claims against the carrier that it could against the insured. Policyholder counsel also must navigate through contribution and subrogation. How an allocation between the policyholder s direct coverage and additional insured coverage may impact their loss runs, payment of retentions (if the direct coverage is implicated) impairment of their own coverage for other losses. The common scenarios in construction risks are not unique, however. Issues can arise in many different circumstances, including: 1. A retailer that has vendors coverage from its distributors or manufacturers; 2. A real estate property owner that has coverage from its tenants, or contractors that are performing maintenance or repair operations at the premises; 3. An automobile insurance company figuring the ranking between owners, drivers, lessors, hirers, etc. II. SPECIFIC CONTRIBUTION PROBLEMS AND APPLICATIONS 1. Construction defect litigation In construction defect litigation, there are typically several subcontractors and a general contractor involved. Friction over the allocation of defense and indemnity between the general contractor and the subcontractors inevitably arises. In larger cases there can be two dozen or more subcontractors and additional insured endorsements approaching that number in favor of the general contractor. How is the contractor, or the direct carrier, to approach allocation of the total costs? a The first question: contribution or subrogation? Assuming the general contractor/developer has direct primary insurance, whether or not there is self-insured retention, contribution will apply, and the court s job is to equitably distribute costs of defense and indemnity between the triggered policies. (Maryland Cas. v. Nationwide Mut. Ins. Co. (2000) 81 Cal App 4th 1082.) But what about allocation? The court has wide discretion to do equity to allocate, and the policy terms are guideposts, but not dispositive. For example, in Crowley Maritime Corp. v. Boston Old Colony Ins. Co., 158 Cal. App. 4th 1061, 1073 (Cal. App. 1st Dist. 2008) the court refused to force the carrier seeking contribution to comply with the arbitration clause in the defendant s indemnity policy. It stated, that the parties in the present case are not parties to an agreement containing an arbitration provision by estoppel or by incorporation by reference. The court ordered contribution and considered the arbitration clause as only one relevant factor. In Axis Surplus Ins. Co. v. Glencoe Ins. Ltd., 204 Cal. App. 4th 1214, 1231 (Cal. App. 4th Dist. 2012), the California Court of Appeals stated the general rule as follows: The trial court exercises its discretion and weighs the equities seeking to attain distributive justice and equity among the mutually liable insurers. The court may consider numerous factors in making its

4 determination, including the nature of the underlying claim, the relationship of the insured to the various insurers, the particulars of each policy, and any other equitable considerations. Subrogation, on the other hand, is advanced because the named insured specifically negotiated subcontracts with each of the additional insurers named insurednamed Insuredf the indemnity agreement, then found that the indemnity agreement controlled over the other insurance clauses in the policies. Key to the court's decision in Rossmoor, however, was that the carriers and the named insureds remained parties to the litigation, and all of their respective rights were adjudicated simultaneously. The Rossmoor subrogation approach has not found favor in California, especially when the only parties are insurers (e.g., Reliance Nat. Indemnity Co. v. General Star Indemnity Co., 72 Cal. App. 4th 1063 (1999); JPI Westcoast Construction, L.P. v. RJS & Associates, Inc., 156 Cal. App. 4th 1448 (2007)). Thus, most courts will use other insurance principals to allocate a loss, without regard to the indemnity agreement between the Named Insureds. As one court stated, the indemnity agreement between Named Insureds is, after all, not a part of the insurance contract and therefore should not control issues of coverage. National Union Fire Ins. Co. v. NGM Ins. CO., 2011 US Dist. Lexis , Case No 11-CV 303-JD (December 21, 2011). The JPI Westcoast case is an extreme example of using other insurance principles without considering the indemnity agreement (i.e. a subrogation approach). In that case, a job site injury case, the general contractor tendered its defense under the additional insured endorsement and the indemnity agreement to the subcontractor. The subcontractor s carrier assumed the defense of the general contractor and settled the loss. The subcontractor s excess carrier, however, allocated a portion of its settlement to the general contractor as an additional insured under the policy, and then pursued the general contractor s direct primary coverage. The general contractor and the subcontractor had both been dismissed from the lawsuit by then. In JPI Westcoast, the California Court of Appeals held that principles of allocation between carriers, without regard to the indemnity agreement applied. Using the principal that all primary insurance was to be exhausted for a single insured before any excess coverage is triggered (see. e.g. Olympic Ins. Co. v. Employers Surplus Lines Ins. Co., 126 Cal. App. 3d 593 (Cal. App. 1st Dist. 1981)), the Court allowed recovery by the subcontractor s carrier from the general contractor s direct carrier. Stated simply, in that case, because an excess carrier was seeking recovery from a primary carrier, the court allowed recovery despite the fact that the contract between the two contractors would have provided for an opposite result. The general contractor s direct policy, therefore paid a full per occurrence limit. However, other cases have used the agreement between the parties (the subcontract or vendor s contract) to influence the allocation and intertwined contribution (equitable redistribution of loss between carriers on the same risk) and subrogation (allowing the carrier to pursue the rights of the insured against other carriers). For example, in Hartford Casualty Ins. Co. v. Mt. Hawley Ins.

5 Co., 123 Cal. App. 4th 278, (Cal. App. 2d Dist. 2004), the court used what I am referring to here as subrogation principles, in a dispute between a subcontractor s additional insurer and a direct insurer for the general contractor and held that the subcontractor s carrier was completely responsible for the loss. Arguably, this holding is limited to the facts of the case, because the Additional Insurer admitted that the indemnity agreement applied, and it therefore took contradictory (i.e. self serving and inequitable) positions: Hartford seeks to obtain equitable contribution from Mt. Hawley notwithstanding the indemnity provision in the subcontract between PCS and Valley Metal Hartford was undoubtedly aware of the indemnity provision throughout the underlying litigation as it repeatedly stated in writing that [p]er the contract, Hartford policy is primary and indemnification is owed for all except sole negligence or willful misconduct of [PCS], or words to that effect. Yet, Hartford now argues that the indemnity provision is irrelevant and that principles of equitable contribution are controlling. To require Mt. Hawley to pay Hartford $ 136,479.39, plus interest, when Mt. Hawley's insured, PCS, is not liable for anything due to the indemnity provision, is inconsistent with equitable principles designed to accomplish ultimate justice, The Hartford case is useful when the application of the indemnity agreement to the subcontractor carrier s obligations is straightforward, or the subcontractor s carrier has actually admitted that the agreement applies. 1. Application of these principals to Non-Construction Insurance problems These same basic principles have been applied by courts in non-construction defect cases. For example, in Wal-Mart Stores v. RLI Ins. Co., 292 F.3d 583, (8th Cir. Ark. 2002), the Eighth Circuit Court of Appeals addressed whether it would enforce an indemnity agreement between Wal-Mart and the distributor of a defective product. The principal combatants were Wal-Mart s primary carrier, National Union and the distributor s excess carrier, RLI. The court concludes: We think this potential circuity of action is significant, in that it reveals the true nature of the parties' obligations and relationships with each other. RLI will ultimately be liable for the $ 10 million because of Cheyenne's promise to indemnify Wal-Mart and RLI's contractual-liability coverage in its policy covering Cheyenne. To prevent such wasteful litigation and to give effect to the indemnification agreement between the parties, we hold that RLI cannot recover against National Union or Wal-Mart. We reverse the District Court's decision to the contrary. In its decision, the court notes that similar decisions have been rendered in Florida (J. Walters Constr. Inc. v. Gilman Paper Co., 620 So. 2d 219 (Fla. App. 1993)) and Mississippi (Chubb Insurance Co.of Canada v. Mid-Continent Cas. Co., 982 F. Supp. 435, 438 (S.D. Miss. 1997) and

6 Minnesota Continental Cas. Co. v. Auto-Owners Ins. Co., 238 F.3d 941 (8th Cir. 2000) (applying Minnesota law). The practitioner facing an allocation between direct coverage for the client and coverage from others that additionally insures the client must consider whether there is a valid indemnity agreement in place and whether the indemnity agreement can be enforced to require payment by the additional insured carrier. Depending on the jurisdiction, and whether the insureds are still in the lawsuit, the indemnity agreement may be applicable to shift responsibility to the additional insurer from the direct insurer. Regardless of the jurisdiction, however, both the indemnity agreement (or lack thereof) must be factored and considered. 2. Allocation between direct coverage with a specific excess provision relating to additional insured coverage The situation that can arise more in the construction injury setting than the construction defect setting is an endorsement that renders the direct coverage of the general contractor excess over any policy that names it as an additional insured. Curiously, such endorsements have met with mixed success. In California, in the context of an owner and tenant, the parties carriers each had modified other insurance clauses by endorsement. Hartford, the carrier for the tenant, had an automatic or blanket additional insured endorsement in favor of the owner. Travelers, the carrier for the owner, had an other insurance endorsement making it excess if there was Additional Insured coverage in favor of the owner. Hartford Casualty Ins. Co. v. Travelers Indemnity Co., 110 Cal. App. 4th 710, 727 (Cal. App. 1st Dist. 2003). The court upheld the trial court decision finding that Hartford had primary coverage for the entire loss. Similarly, in National Union Fire Ins. Co. v. NGM Ins. Co., 2011 US DIst. Lexis Caes No. 11-CV 303-JD (December 21, 2011), the New Hampshire District Court upheld an excess clause in an additional insurer s (landscape contractor s) policy which rendered its coverage excess over the direct coverage for the property owner. The Court felt the other insurance clauses could be reconciled and, therefore, the coverage for the property owner prioritized based on that fact alone. could be However, the Nevada Federal District Court refused to apply a specific excess other insurance condition in Everest Nat'l Ins. Co. v. Evanston Ins. Co., 2011 U.S. Dist. LEXIS 16876, 6-11 (D. Nev. Feb. 8, 2011), that provided as follows: "This insurance is excess over:... (2) Any other primary insurance available to you covering liability for damages arising out of the premises or operations for which you have been added as an additional insured by attachment of an endorsement." After finding a duty to defend the owner, the court reasoned: Accordingly, La Villa Apartments is an additional insured of Everest. Therefore, Evanston does not have the sole liability coverage for La Villa Apartments. Rather, it shares that coverage with Everest, and the Other Insurance provisions

7 of both policies come into play, and, pursuant to Great American Ins. Co. of New York, the coverage is prorated based upon the total coverage of each policy. Evanston hangs its hat on its Excess Provision and the language of Federal Insurance [v. Am. Hardware Mut. Ins. Co., 124 Nev. 319 (Nev. 2008)] to proclaim that its Excess Provision permits it to escape its obligations as the primary carrier for La Villa Apartments. In this instance, the standard Other Insurance provision is both reasonable and according to law. The language on which Evanston relies is ambiguous and cannot be applied to permit Evanston to escape its responsibilities as a primary carrier. It is not reasonable, and this Court will not permit, Evanston to take away with one hand what it purports to give with the other. Both policies are primary and co-obligated. Thus, in Nevada, there is strong policy in favor of carriers jointly contributing to a loss, and more doubtful that other insurance clauses seeking to make the direct coverage excess will be applied. In the construction setting, there have been movements by many carriers to add endorsements rendering the coverage excess to any subcontractor s policy that names the general contractor as an additional insured. These endorsements go by different names, including "contractor special conditions," "contractor s warranty of limits endorsements," and other similar sounding names. Case law is beginning to develop, some of which is favorable to carriers, upholding a limitation on coverage where the named insured fails to obtain proper additional insured coverage. (See e.g. North American Capacity Ins. Co. v. Claremont Liability Ins. Co., 177 Cal. App. 4th 272 (Cal. App. 2d Dist. 2009) where the direct coverage had a requirement that subcontractors have indemnity agreements and additional insured coverage in favor of the Named Insured. Presumably, therefore, at least in California, such endorsements are valid and enforceable (Hartford Casualty Ins. Co. v. Travelers Indemnity Co., 110 Cal. App. 4th 710, 727 (Cal. App. 1st Dist. 2003)) It remains to be seen whether similar endorsements might find their way into the owner/tenant arrangement, retail liability (requiring vendor s endorsements), and other areas of risk management. III. Subrogation when there is no unity of risk and insured Where two carriers seeking to allocate a loss are not on the same level of coverage (e.g., primary versus primary, umbrella versus umbrella, etc.), then subrogation rather than contribution is the rule. Under subrogation principles, the carrier paying the loss steps into the shoes of the named insured in order to enforce whatever rights the named insured has against others, including other insurers. While principles of equity still apply, so do contractual defenses. An example of when subrogation, rather than contribution, applies in a construction setting is Transcontinental Ins. Co. v. Insurance Co. of the State of Pennsylvania, 148 Cal. App. 4th 1296

8 (Cal. App. 4th Dist. 2007). In that case, additional insurers assumed the complete defense of the real estate developer, and then sued the direct carrier, an excess insurer, to recover all or a portion of the defense costs. The excess carrier argued, unsuccessfully, that the duty to defend extended to the entire action and thus the additional insured carriers had an obligation to defend fully and completely and had no rights against an excess insurer. The Court of Appeals disagreed. The Court found there were claims against the additional insured that were not potentially covered by any of the additional insurers and, citing Buss v. Superior Court, 16 Cal.4 th 35 (Cal. 1997), determined that the additional insurers had a right of reimbursement against the named insured for fees and costs that were related to the non covered claims.. Thus, since the additional insurers had a legitimate claim against the named insured, they could present that claim directly against another insurer, even if it was an excess carrier. Another example is in Continental Cas. Co. v. North American Capacity, et al, 683 F.3d 79 (5 Cir. Texas 2012), where the court stated that an excess carrier has a right of subrogation against primary carriers that did not completely defend the common insured. There is an interesting twist, however, to the usual rule that the subrogated carrier stands in the shoes of the insured. In the context of this excess versus primary coverage dispute, the insured had released the primary carriers, and they argued that the excess carrier s rights were thereby meaningless because it stepped into empty shoes. The court found that the rule was applied too broadly and reversed, holding that the excess carrier could defend the insured and seek recovery from the primary carriers. The key, it would seem, is the timing of the release by the insured vis a vis the payment by the excess carrier. In California, for example, the insured must have an assignable cause of action at the time of the payment. The essential elements of an insurer's cause of action for equitable subrogation are as follows: (e) the insured has an existing, assignable cause of action against the defendant which the insured could have asserted for its own benefit had it not been compensated for its loss by the insurer. Fireman's Fund Ins. Co. v. Maryland Casualty Co., 65 Cal. App. 4th 1279, 1292 (Cal. App. 1st Dist. 1998) SUMMARY AND CONCLUSION Allocation between direct coverage and additional insured coverage continues to be hotly contested The main weapons in the parties arsenal are contribution and subrogation. While the insured has direct rights, a question of allocation occurs once the insured s defense and indemnity has been covered. The allocation of the loss, however, directly affects the loss history of the parties involved, and therefore policyholders remain very interested in the allocation question. In the construction arena, there is a developed body of law as to when contribution and when subrogation would apply. An entire industry has built up selling insurance policies that will directly affect how coverage for expected losses will be prorated and paid. Identifying and creating a plan to use (or minimize the impact of) the indemnity agreement depending on the relationship of the parties is crucial to the planning process.