Interstate Fire and Casualty Insurance Company ("Interstate") appeals from a judgment entered after the court sustained its demurrer to Interstate's amended complaint for subrogation against Cleveland Wrecking Company ("Cleveland") without leave to amend.
In the underlying litigation, Webcor Construction, Inc. ("Webcor") was the general contractor for a construction project. Cleveland and Delta Steel Erectors ("Delta") were subcontractors on the project. The subcontracts required both Cleveland and Delta to indemnify and defend Webcor for liability arising out of their work and to procure general liability insurance with Webcor as an additional insured. Delta complied with the insurance obligation, obtaining insurance through Interstate, but Cleveland failed to obtain the required insurance.
An employee of Delta, Frisby, was seriously injured while working on the site allegedly due to the negligence of a Cleveland employee. Frisby sued Cleveland and Webcor to recover for his personal injuries. Webcor tendered its defense and indemnification to Cleveland pursuant to the terms of the subcontract and to Interstate pursuant to terms of the Interstate-Delta policy. Cleveland rejected the tender. Interstate accepted it. The underlying personal injury action settled in good faith under Code of Civil Procedure section 877.6. Interstate funded Webcor's settlement and paid the costs incurred in defending Webcor.
Interstate sued Cleveland for subrogation, alleging that Cleveland breached its subcontract by failing to defend and indemnify Webcor. Cleveland demurred contending that Interstate was not entitled to subrogation because it was not in a superior equitable position to Cleveland and because Cleveland's alleged breach of contract had not caused any damage. The court sustained the demurrer with leave to amend. In its first amended complaint, Interstate added allegations that Cleveland's negligence was a proximate cause of Frisby's injuries and that Cleveland had violated its subcontract by failing to obtain insurance covering Webcor. Cleveland demurred again and the court sustained the demurrer without leave to amend, explaining that the good faith settlement cut off Webcor's ability to sue Cleveland for indemnity or contribution for its alleged negligent conduct. The court also found that Webcor had sustained no damages as a consequence of the breach, and therefore Interstate's equitable position was not superior to Cleveland's.
On appeal, Interstate contended the trial court erred on two grounds: (1) the good faith settlement between Cleveland and Frisby did not bar Interstate from proceeding against Cleveland on a claim for breach of an express contractual indemnification provision; and (2) the court erred in concluding that Webcor suffered no damages from Cleveland's alleged breach of the Agreement and that Interstate's equitable position was therefore not superior to Cleveland's.
As the appellate court explained, a general liability insurer that has paid a claim to a third party on behalf of its insured may have an equitable right of subrogation against (1) other parties who contributed to the harm suffered by the third party under an equitable indemnification theory, and (2) other parties who are legally liable to the insured for the harm suffered by the third party under a contractual indemnity theory. A good faith settlement precludes subrogation claims based on an equitable indemnity theory but not claims based on a contractual indemnity theory, yet subrogation may not be obtained even as to contractual indemnity claims unless the insurer is in an equitable position superior to that of the defendant. Because Interstate's first amended complaint sets forth a claim for express contractual indemnity, based on Cleveland's refusal to defend and indemnify Webcor under the terms of the subcontract, the Court held the claim is not barred by the good faith settlement determination.
The appellate court listed and addressed the eight elements for an insurer's subrogation cause of action, but the two main issues were whether Webcor suffered a loss for which Cleveland was liable and whether Interstate's equitable position was superior to Cleveland's. Cleveland argued that Webcor did not actually suffer any loss because Interstate paid the costs of defending against and settling Frisby's claims. Under Cleveland's view, no insurer could ever state a cause of action for subrogation in order to recover amounts it paid on behave of its insured, because of the very fact that it had paid amounts on behalf of its insured. The appellate court rejected this argument outright as illogical and contrary to decades of cases holding that an insurer may be equitably subrogated to its insured's indemnification claims.
On the second main issue, the appellate court held that the allegations in the first amended complaint supported the inference that Interstate's equitable position was superior to that of Cleveland. It alleged not only that Cleveland was contractually liable for the loss, but also that Cleveland caused the loss. Citing Pylon, Inc. v. Olympic Ins. Co. (1969) 271 Cal.App.2d 643, the appellate court stated an insurer is subrogated to its insured's express contractual indemnity claim against a party who contributed to the loss. Further, the appellate court found that the subcontract between the parties who were connected to the incident giving rise to the loss created the greater equitable responsibility for indemnification, as compared to that of the general liability insurer.
The appellate court also found that public policy favored subrogation in this case because "it is not a good idea to reward parties who refuse to fulfill their alleged indemnification obligations, particularly under the rubric that they are in as good or better equitable position as the insurer that did fulfill its alleged indemnification obligation. [] If permitting subrogation to the insurer in any way results in a windfall [], it would be better for the windfall to go to the one that undisputedly fulfilled its contractual obligations, than to the one that allegedly breached them."
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