Who Provides the Defense in Construction Defect Suits?
October 2001
Subcontractors' insurers must provide a complete
defense to the developer/general contractor, but can they force others to pitch
in? Joe Postel examines recent case law.
by Joseph
P. Postel
Liberty Mutual Insurance Group
A recent California decision has subcontractors and their commercial general
liability (CGL) insurers crying foul and heading back to the drawing board.
In Presley Homes, Inc. v American States Ins. Co.,
90 Cal App 4th 571, 108 Cal Rptr 2d 686 (Cal App June 11, 2001), the California
Court of Appeal held that a subcontractor's CGL insurer was obligated to pay
all of its additional insured developer's defense costs in a construction defect
suit. This was despite the fact that the additional insured coverage was expressly
limited to liability arising out of the named insured subcontractors' work,
but the construction defect suit alleged both liability arising out of those subcontractors' work and liability not arising out of their work.
Although the subcontractors' insurer did not have to pay any settlement or
judgment on behalf of the additional insured developer, subcontractors having
read this decision correctly recognize that the defense costs for a large, complicated
construction defect suit can be enormous. Some raise the specter of the doorknob
subcontractor's insurer being forced to bear all of the developer or general
contractor's defense costs for a large, complicated construction defect suit
seeking damages that are 99 percent unrelated to doorknobs.
The Presley Case
Presley was the developer for a residential construction project in southern
California called Andora. American States insured two of Presley's subcontractors:
Darrell Link Construction and Sunrise Framers. Link was hired to do concrete
work, such as foundations, driveways, walkways, and stoops. Sunrise did the
framing.
Presley's subcontracts with Link and Sunrise required each of them to add
Presley as an additional insured to its CGL policy. Both policies were endorsed
to make Presley an additional insured, and each endorsement provided that its
coverage was primary and not diminished by the availability of other insurance.
Link's policy contained a CG 20 09 endorsement, and Sunrise's contained a
CG 20 10. The difference was immaterial to the case, however, as American States
did not deny that it owed a duty to defend Presley in the ensuing construction
defect suit brought by a homeowner in Andora.
Each endorsement, of course, limited the coverage for Presley to its liability
arising out of the named insured's work (Link or Sunrise). Although American
States admitted that the homeowner's complaint alleged liability arising out
of Link and Sunrise's work, i.e., it alleged defects in the concrete and framing,
American States contended that the complaint also alleged liability not arising
out of Link and Sunrise's work, i.e., not related to the concrete or framing,
and therefore not covered by American States. Therefore, American States refused
to provide a full funding of Presley's defense, instead attempting to secure
an agreement with Presley for a partial funding, reflecting only those portions
of the homeowner's complaint alleging defects in concrete or framing. When agreement
proved elusive, Presley demanded a full defense from American States, which
American States refused.
American States then settled the construction defect suit without any contribution
from Presley. But Presley had incurred significant costs defending the suit,
and filed a declaratory judgment action seeking reimbursement of those costs
from American States. The trial judge ruled that American States did not have
to fund the entire defense, but the California Court of Appeal reversed.
The court quoted the seminal decision in Buss v Superior
Court, 16 Cal 4th 35, 939 P2d 766 (Cal 1997):
[T]o defend meaningfully, the insurer must defend immediately. To defend
immediately, the insurer must defend entirely. It cannot parse the claims,
dividing those that are at least potentially covered from those that are
not.
Therefore, the court held, American States was not permitted to delay providing
a defense to Presley while it attempted to separate those allegations that potentially
arose out of its named insured subcontractors' work from those that did not.
American States was obligated, the court said, to provide a full and immediate
defense to Presley.
In response to American States' concern about bearing more than its fair
share of the defense costs, the court pointed out that subcontractors' insurers
are already protected by their right of equitable contribution from other insurers
also obligated to defend the developer. The hypothetical doorknob subcontractor's
insurer can seek equitable contribution with respect to defense costs from any
other subcontractor's insurer, if that insurer also had a duty to defend.
So, in the hypothetical, even if somehow the doorknob subcontractor's insurer
ended up footing the whole bill for the developer's and general contractor's
defense costs, the insurer could obtain reimbursement from the other subcontractors'
insurers for their pro-rata share of those costs.
Obstacles to Reimbursement
Subcontractors' insurers may not find it so easy to obtain adequate reimbursement
by means of an action for equitable contribution, in light of Maryland Casualty Co. v Nationwide Mut. Ins. Co.,
81 Cal App 4th 1082, 97 Cal Rptr 2d 374 (Cal App 2000), and Schal-Bovis v Casualty Ins. Co., 732 NE2d 1179
(Ill App 2000).
The Maryland Case
Nielsen Construction Company was hired to build a residential development
in southern California. Nielsen retained numerous subcontractors. Two of these
subcontractors were West Coast Sheet Metal and R.W. Strang Mechanical, Inc.
Both subcontracts required that Nielsen be added to the subcontractor's CGL
policy as an additional insured, and that the additional insured coverage be
sole primary and not contributing with Nielsen's own CGL coverage. In fulfillment
of these requirements, West Coast and Strang each purchased CGL coverage from
Nationwide. Each Nationwide policy contained a non-Insurance Services Office,
Inc. (ISO), endorsement making Nielsen an additional insured, but "only to the
extent that [Nielsen] is held liable for your acts or omissions arising out
of and in the course of operations performed for [Nielsen]."
The West Coast endorsement also provided, in typewritten language:
Coverage provided to the additional insured under this endorsement is
primary, but only with respect to acts or omissions of the named insured.
Any other insurance maintained by the additional insured is deemed to be
excess.
Nielsen had its own CGL policies with Maryland Casualty and AIG.
When Nielsen was sued for construction defects, it tendered its defense to
its own insurers, and to all of the subcontractors' insurers. Maryland and AIG
ultimately paid all of Nielsen's defense costs, however. But when they sued
the subcontractors' insurers, all but Nationwide admitted a duty to reimburse,
and Maryland and AIG reached settlements with all of those insurers.
Maryland and AIG's suit against Nationwide resulted in a judgment for Nationwide,
which was reversed on appeal. The court in the first appeal held that Nationwide
had a duty to defend. Maryland Casualty Co. v Nationwide
Ins. Co., 65 Cal App 4th 21 (Cal App 1998).
On remand, Maryland and AIG sought reimbursement from Nationwide of all of
their defense costs, on an equitable subrogation theory. The court entered judgment against Nationwide for all of the defense
costs, and Nationwide appealed. Nationwide contended that Maryland and AIG were
entitled only to a portion of their defense costs from Nationwide, under an equitable contribution theory.
On appeal, the court again reversed the trial court, holding that Maryland
and AIG were entitled only to a portion of their defense costs from Nationwide,
not all of them. The court discussed the difference between equitable subrogation
and equitable contribution. Equitable subrogation allows an insurer that has
paid coverage or defense costs to be placed in the insured's position to pursue
a full recovery from another insurer who was primarily liable for the loss.
Because the doctrine of equitable subrogation shifts the entire cost burden,
the insurer that is suing must show that the other insurer was primarily liable
for the loss. Typically, this doctrine would apply in an action by an excess
insurer that paid a loss against a primary insurer that didn't. Equitable contribution,
on the other hand, applies to apportion costs among insurers who share the same
level of liability on the same risk as to the same insured.
Maryland and AIG conceded that they both wrote primary policies to Nielsen,
but argued that the typewritten sole primary language in the additional endorsement
to West Coast's Nationwide policy rendered Maryland's and AIG's coverage excess
over Nationwide's. This excess status invoked the doctrine of equitable subrogation
and entitled them to recover all of their defense costs from Nationwide, they
argued. After all, despite the limitation in Nationwide's additional insured
endorsement (limiting coverage to vicarious liability for the acts or omissions
of Strand and West Coast), Nationwide had a duty to defend the entire construction
defect complaint.
This duty, together with the typewritten sole primary language in West Coast's
endorsement to its Nationwide policy, rendered Maryland and AIG excess, they
argued. Therefore, they could recover all of their defense costs from Nationwide.
The court disagreed. The court reasoned that because the typewritten sole,
primary language reiterated the vicarious liability limitation of Nielsen's
additional insured coverage, it would be illogical and inequitable to ignore
that limitation in apportioning defense costs. The court held that despite Nationwide's
duty to defend the entire complaint, Maryland and AIG had a "parallel duty"
to defend the entire complaint—despite the typewritten sole primary language
in the West Coast endorsement. Because their coverage was broader than Nationwide's;
it potentially encompassed allegations not covered by Nationwide's policy, such
as Nielsen's direct (as opposed to vicarious) liability, or its vicarious liability
for the acts or omissions of other subcontractors besides West Coast and Strang.
The court reversed the judgment in favor of Maryland and AIG, and remanded
the case for the purpose of determining how to equitably apportion the defense
costs between Maryland and AIG on the one hand, and Nationwide on the other.
Maryland seems inconsistent with Presley. Whereas the Presley court emphasized the insurer's duty to provide a complete defense,
without regard to any coverage limitations that might ultimately have an impact
on indemnity analysis, the Maryland court thought
it inappropriate to ignore coverage limitations in apportioning defense costs.
What this means, as a practical matter, is that once again, no good deed goes
unpunished. Honest, upright subcontractors that add their customers as additional
insureds by means of a CG 20 10 endorsement, instead of using manuscript endorsements
that provide little coverage or only illusory coverage, will end up getting
less than full and fair reimbursement from subcontractors' insurers that do
employ drafting chicanery.
However, note: Maryland involved only the
issue of whether the excess clause in the
defending insurer's policy applied where the additional insured coverage in
the subcontractor's policy was narrower than the coverage of the policy that
defended. It is an open question whether this holding applies in an action between
two primary subcontractors' insurers. I
see no obvious reason that the reasoning of Maryland would not apply to such
a context, however.
The California Supreme Court may ultimately need to provide clarity on these
issues. It would be interesting to know how the trial judge in the Maryland case would have apportioned defense
costs on remand from the court of appeal, had the case not settled after remand.
Thanks to coverage lawyer Robert Closson of San Diego, who represented Maryland
Casualty in that case, for the information about the post-remand settlement.
The Schal-Bovis Case
Of course, the hypothetical doorknob subcontractor's insurer is really going
to be left out in the cold in any jurisdiction that would make the mistake of
following Schal-Bovis v Casualty Ins. Co., 732
NE2d 1179 (Ill App 2000), a decision I criticized in my last column. That decision held that one subcontractor's
insurer that paid a loss on behalf of its additional insured general contractor
could not obtain equitable contribution from a different subcontractor's insurer
that also provided additional insured coverage to the general contractor.
The rationale for this result was the erroneous proposition that since each
insurer's additional insured endorsement limits coverage to liability arising
out of its own named insured's work, the two insurers therefore insure different
risks, so they cannot obtain contribution from each other.
The Presley decision underscores just how
wrong the Schal-Bovis decision was. In a scenario
where a court would apply both Presley and Schal-Bovis, the hypothetical doorknob subcontractor's
insurer would have to pay all of the developer's and the general contractor's
defense costs, but would not be able to recover any of those costs from other
subcontractors' insurers. No one could justify such a result.
One possible distinction, however, is that Schal-Bovis involved insurers seeking equitable contribution as to settlement costs,
not defense costs. Arguably, the Schal-Bovis decision does not apply to defense costs, since the duty to defend is broader
than the duty to pay. But to apply the rationale of Schal-Bovis to either indemnity or defense costs produces an inequitable
result, as the Presley court implicitly recognized
in its discussion of American States' equitable contribution rights against
other subcontractors' insurers.
Subcontractors and their insurers outside Illinois, take heart! Courts in
other jurisdictions are unlikely to follow Schal-Bovis.
Equitable Contribution: A Valuable but Sometimes Imperfect Remedy
The right of the subcontractor's insurer to seek equitable contribution could
prove an imperfect remedy, at least to our hypothetical doorknob subcontractor.
Consider again the hypothetical situation where the doorknob subcontractor's
work represented only 1 percent of the defects on a project. Assume that there
are only a total of four other subcontractors providing additional insured coverage
to the developer/general contractor. Assume further that all five of the subcontractors
(including the doorknob subcontractor) have the standard ISO CG 00 01 other
insurance clause, that provides for sharing by equal shares.
We know from Presley that despite the existence
of the additional insured coverage for the developer/general contractor under
the other subcontractors' policies, the doorknob subcontractor's insurer must
provide a full defense. We also know from Presley that his remedy for being stuck footing the whole bill is to obtain equitable
contribution from the other subcontractors' insurers. But how much contribution
will he obtain?
This will be determined simply by the number of subcontractors' policies,
assuming that we are talking about defense costs, and thus, that limits issues
don't complicate matters. In the hypothetical, the doorknob subcontractor's
insurer will obtain reimbursement for 80 percent of the total defense costs,
leaving his net contribution at 20 percent. While that is a whole lot better
than paying 100 percent, it's a whole lot worse than the 1 percent of the total
damages that the doorknob subcontractor's work represented.
Yet, courts have not fashioned a method for basing defense cost apportionment
in this scenario on percentages of fault, or involvement, in the underlying
case. Frankly, it seems that any attempt to do so would be fraught with complications
and difficulty, and probably would create more problems than it solves. Arguably,
something like this would have awaited the trial judge on remand in the Maryland case.
At any rate, if subcontractors are heading back to the drawing board, it
ought to be to undo Schal-Bovis, not Presley. The problem subcontractors think they
see in Presley is one with a pretty good—though
not always perfect—solution in equitable contribution.
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