The Buck Stops Over There: Have Indemnitors Become the Insurers of First and Last Resort?

Pointing fingersInsurance and indemnity are the primary risk management strategies on construction projects. Insurance, such as commercial general liability insurance, insures against third party claims for bodily injury and property damage, and in the case of builder’s risk insurance, insures against first party claims during construction.

Indemnity, on the other hand, shifts liability from one party to another and can be broader than the types of claims covered by insurance although anti-indemnity statutes can limit the breadth of those claims.

Sometimes though insurance and indemnity work in ways you might never have expected, like in the next case, Valley Crest Landscape Development, Inc. v. Mission Pools of Escondido, Inc., Case No. G049060 (July 2, 2015), in which the California Court of Appeals for the Fourth District held a subcontractor liable in the face of both an indemnity claim brought by a general contractor as well as a subrogation claim brought by the general contractor’s insurance company.

Background

The facts of this case are both sad and ugly.

In 2000, Valley Crest Landscape Development, Inc. (“Valley Crest”) entered into a construction contract with CPH Monarch Hotel, LLC (“CPH”), the owner of the St. Regis resort located in Dana Point, California, for the construction of the resort’s exterior improvements including four pools. Valley Crest, in turn, subcontracted the pool work to Mission Pools of Escondido, Inc. (“Mission Pools”).

In 2007, Jeffrey Epp dove into the shallow end of one of the swimming pools and was severely injured rendering him a quadriplegic. He was also intoxicated at the time.

Mr. Epps filed a lawsuit against CPH, Valley Crest and Mission Pools alleging, among other things, that there was inadequate signage warning users of the depth of the pool, that depth markers were faded, and that the “grey” color used for the lining of the pool obscured its depth.

CPH filed a cross-complaint against Valley Crest pursuant to an indemnity provision contained in their construction contract. Valley Crest, in turn, filed a cross-complaint against Mission Pools pursuant to an indemnity provision contained in their subcontract.

In 2012, Epp settled with Valley Crest and Mission Pools on his personal injury claims, and Valley Crest settled with CPH on its indemnity claim, with Valley Crest and Mission Pools paying $250,000 to Epps and CPH of which Valley Crest paid $50,000 and Mission Pools paid $200,000. Epps had earlier settled with CPH for $4.5 million.

Later in 2012, Valley Crest’s insurer, National Union Fire Insurance Company (“National Union”), intervened and brought a subrogation claim against Mission Pools seeking recovery of its costs to defend Valley Crest and its settlement payment to Epps which totaled $421,161.54. Valley Crest also amended its complaint against Mission Pools seeking recovery of self-insured retention which it had to pay to defend itself which totaled $250,000. In total, Valley Crest and National Union sought $671,161.54 from Mission Pools.

At trial, Mission Pools lost to both Valley Crest and National Union and appealed.

The Court of Appeals Decision

Although Mission Pools appealed on several grounds, including that the  statute of limitations had run and that it was entitled to have a jury decide its case, the most interesting claim was based on Union National’s subrogation claim.

Subrogation is where an insurer, who has paid a loss on behalf of an insured, bring a claim against another person alleged to be responsible for that loss. Subrogation, or more specifically, equitable subrogation, may be brought against: (1) other parties who contributed to the harm suffered by a third party (Epps, in this case) under an equitable indemnity theory; or (2) other parties who are legally liable to the insured (Valley Crest, in this case) for the harmed suffered by a third party under a contractual indemnity theory. National Union brought its subrogation claim under the second theory on the ground that Mission Pools was legally liable to Valley Crest pursuant to the indemnity provision contained in their subcontract and, therefore, Mission Valley was similarly liable to National Union who paid for Valley Crest’s defense and settlement of Mr. Epp’s claim.

There are eight elements to prove equitable subrogation:

  1. The insured suffered a loss for which the defendant is liable, either as the wrongdoer whose act or omission caused the loss or because the defendant is legally responsible to the insured for the loss caused by the wrongdoer;
  2. The claimed loss was one for which the insurer was not primarily liable;
  3. The insurer has compensated the insured in whole or in part for the same loss for which the defendant is primarily liable;
  4. The insurer has paid the claim of its insured to protect its own interest and not as a volunteer;
  5. 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;
  6. The insurer has suffered damages caused by the act or omission upon which the liability of the defendant depends;
  7. Justice requires that the loss be entirely shifted from the insured to the defendant, whose equitable position is inferior to that of the insurer; and
  8. The insurer’s damages are in a liquidated sum, generally, the amount paid to the insured.

According to the Court of Appeal, the Valley Crest case only involved the seventh element of balancing the equities.

Relying heavily on Interstate Fire & Casualty Ins. Co. v. Cleveland Wrecking Co., 182 Cal.App.4th 23 (2010), the Court of Appeal explained that there are four factors considered by courts when balancing the equities (which, as you’ll read, will likely never favor the indemnitor):

  1. Who is alleged to have caused the loss – the insurer or the indemnitor;
  2. The nature of the insurance policy and the indemnity agreement;
  3. The nature of the insurer’s receipt of premiums; and
  4. the indemnitor’s compliance with the indemnity agreement.

Analyzing each of these factors, the Court of Appeals held that, as to the first factor, Mission Pools not National Union was alleged to have caused the loss. As to the second factor, the Court held that because National Union was not involved in the construction project, Mission Pools had “a liability of greater primacy” under the indemnity provision than National Union had under its insurance policy. As to the third factor, the Court held that National Union’s acceptance of insurance premiums in exchange for its obligation to insure Valley Crest was no different than Mission Pools agreement to perform the work in its subcontract and to indemnify Valley Crest for any claims arising out of that work. And, finally, the Court held that, as between National Union who complied with its insurance obligations, and Mission Pools who had not complied with its indemnity obligation, the balance of equities fell in favor of National Union.

The Court of Appeal’s decision can probably best be understood by its quote from Interstate Fire:

In our view, 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 an equitable position as the insurer that did fulfill its alleged indemnification obligation. We believe it is more prudent to permit subrogation, so that a party with an alleged contractual indemnification obligation will be encouraged to step up in the underlying case and either fulfill the obligation (and simplicity help settle the case) or resolve any dispute over the application of the indemnity obligation. If permitting subrogation to the insurer in any way results in a windfall (because the insurer that accepted premiums to insure against the loss may not shift the loss to the other indemnitor), it would be better for the windfall to go to the one that undisputedly fulfilled its contractual obligations, rather than the one that breached them.

Conclusion

Valley Crest marks the latest step down what seems to be the inevitable path of strict enforcement of indemnity provisions by the courts where indemnitors will become both the first party indemnitees will look to when there are claims as well as the last party indemnitees (and insurers) will look to when claims are paid.

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