Subrogation, Insurance Code Section 11580, and the Craziness We Call Insurance Law

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If you want to geek out on insurance law the next case is for you. The Insurance Company of the State of Pennsylvania v. American Safety Indemnity Company, 2nd District Court of Appeals, Case No. B283684 (March 1, 2019), is an interesting case involving Insurance Code Section 11580, which in essence provides that if a  judgment is entered against an insured (and there is coverage for that insured) the insured may sue the insurance company to pay for the judgment.

However, in this case, the party doing the suing was the insurer of a general contractor that had a judgment entered against it, and the party being sued was the insurer of subcontractor, on  subrogation basis.

Interesting stuff, if you’re into these kinds of things.

The Insurance Company of the State of Pennsylvania Case

Unlike Alexandre Dumas’ The Count of Monte Cristo with requires a flow chart to understand the relationships between its more than 38 characters, we thought it might be helpful to sort out the characters upfront so that you can understand the story that follows:

  • Amir and Brenda Moghadam: Homeowners who bought a home built by New Millennium Homes LLC (NMH) and later sued NMH for construction defects obtaining an award in arbitration against NMH of approximately $1.2 million.
  • New Millennium Homes: Builder of Amir and Brenda Moghadam’s home that sued its subcontractor Camarillo Engineering, Inc. (Camarillo) for the damages sought by the Moghadams in their arbitration and obtained a default judgment against Camarillo of approximately $1.5 million.
  • Camarillo Engineering: The mass grading, compacting and finish grading subcontractor hired by NMH that was supposed to have named NMH as an additional insured under its commercial general liability policy, but didn’t.
  • The Insurance Company of the State of Pennsylvania (ICSP): NMH’s excess liability insurer and the one who ultimately had to pay the Moghadams.
  • American Safety Indemnity Company (ASIC): Camarillo’s commercial general liability insurer who refused to indemnify Camarillo against NMH’s default judgment against Camarillo.

Prologue

The scene takes place in lovely Calabasas, California. Amir and Brenda Moghadam purchase the house of their dreams from NMH. It’s a sprawling estate of more than 15,000 square feet on over an acre of land. A rather largish man could live quite comfortably, and subsist quite nicely I’m sure, in one of the pantries.

They buy furniture. They decorate. They magically transform what was once just a house into a “home.” But happily ever after it wasn’t to be. They begin noticing “drywall and stucco cracks, separation and cracking of interior tiles, and lifting of exterior flagstones.” An ensuing geotechnical investigation reveals that there is “differential fill settlement, as well as expansive soil activity” and that “an inadequate design and construction of the post-tension slab foundation system are exacerbating the distress.” A construction engineer hired to conduct an investigation shakes his head, shrugs his shoulders and tells the Moghadams that their house would be better torn down and rebuilt. The Moghadams sue.

Chapter 1 – NMH Sues Camarillo

Upon being sued by the Moghadams, NMH, pursuant to its subcontract with Camarillo, tenders defense of the Moghadams’ claim to Camarillo’s commercial general liability insurer ASIC. After several unsuccessful attempts, ASIC informs NMH that Camarillo did not name NMH as an additional insured under its policy issued to Camarillo.

Desperate, NMH sues Camarillo for contractual and equitable indemnity, contribution and related causes of action. It is all for naught. Camarillo fails to respond to NMH’s complaint, and a default is entered against Camarillo.

Chapter 2 – The Insurance Company of the State of Pennsylvania (“ICSP”) Sues ASIC

Meanwhile, the Moghadams proceed to arbitration against NMH, winning a judgment of nearly $1.2 million against NMH. In turn, based on the judgment awarded to the Moghadams, NHM obtains a default judgment against Camarillo of more than $1.5 million. But without a defendant able to pay, it’s ICSP that is on the hook to pay the Moghadams.

ICSP later files suit against ASIC, alleging causes of action for declaratory relief, subrogation, breach of contract, and recovery under Insurance Code section 11580, on the ground that it is entitled to recover the amount of the default judgment entered against Camarillo from ASIC.

Both ICSP and ASIC file competing motions for summary judgment. After the dust settles, ICSP rises as the victor. But, as is the case with every story about litigation, the vanquished is always given a second chance to prevail, by way of an appeal.

Chapter 3- The Court of Appeal Decision

On appeal, ASIC made four arguments:

  1. ICSP is barred from recovering under Insurance Code Section 11580 because NMH’s default judgment against Camarillo is void since it didn’t include a specific claim for damages

ASIC’s first argument on appeal was that ICSP’s claim under Insurance Code Section 11580 was barred. Section 11580 provides in pertinent part that “whenever judgment is secured against the insured . . . in an action based upon bodily injury, death or property damage, then an action may be brought against the insurer on the policy and subject to its terms and limitations, by such judgment creditor to recover on the judgment.”

However, Civil Code Section 580 provides that relief granted to a plaintiff in a default judgment “cannot exceed that demanded in the complaint” and any such judgment is void.

ASIC’s argument was that because NMH’s complaint against Camarillo did not specify a dollar amount it was seeking from Camarillo, NMH’s default judgment against Camarillo in the amount of $1.5 million was void. Of course, practically, it could not specify an amount, since NMH did not know if or in what amount a judgment would be entered against it in the arbitration filed by the Moghadams against NMH. Further, ASIC argued, since NMH’s default judgment was void, ICSP as NMH’s insurer did not have a judgment by which it could recover against ASIC under Insurance Code Section 11580.

The Court of Appeals, focusing on whether ASIC had notice of its potential liability, noted that while NMH did not specify a dollar amount it was seeking from Camarillo, NMH did attach a copy of the Moghadams arbitration claim, which sought to recover at least “$2,347,592” in damages. Thus, held the court, the allegations contained in the Moghadam’s arbitration claim “were more than adequate to put Camarillo on ‘formal notice’ of the ‘maximum judgment that may be asserted against [it],’ as required by due process.”

2. ICSP is barred from recovering under Insurance Code Section 11580 because the Moghadam’s judgment against NMH was not based upon property damage, and therefore, was not a covered claim under the insurance policy issued by ASIC

In the arbitration between the Moghadams and NMH the arbitrator awarded the Moghadams $1.2 million measured by the diminution in value of their home as a result of the soil conditions.

ASIC’s second argument was that because the Moghadams were awarded $1.2 million as measured by the diminution in value of their home, the judgment was not “based upon . . .  property damage.” Because Insurance Code Section 11580 limits recovery “subject to [the] terms and limitations” of the defending insurer’s policy, ICSP was not entitled to recovery against ASIC, since only property damage (as well as personal injury) were covered under its policy.

The Court of Appeals disagreed.

First, held the court, “NMH’s action against Camarillo for indemnity was plainly “based upon . . . property damage.”

Second, the court held that “the fact that the arbitrator measured the damages by diminution of value, rather than by the cost of repair, changes nothing. In statutory actions for construction defects, the homeowner’s ‘right to the reasonable value of repairing any nonconformity is limited to the repair costs, or the diminution in current value of the home caused by the nonconformist, whichever is less.”

Third, addressing the difference between the Moghadam’s judgment against NMH ($1.2 million) and NMH’s judgment  against Camarillo ($1.5 million), which reflected NMH’s attorney’s fees in its action against Camarillo, the court explained that “the statute on its face does not require every element of the damages in that judgment to be property damage; it requires the judgment to be ‘in an action based upon . . . property damage.'”

3. ICSP is barred from recovering under Insurance Code Section 11580 because the Moghadam’s failed to show when their property was damaged and ASIC’s policy only covers property damage occurring at the time the policy was in effect

ASIC’s third argument was that the Moghadam’s failed to show when their property was damaged, and because ASIC’s policy only covers property damage occurring at the time the policy was in effect, ICSP was barred from recovering under Insurance Code Section 11580.

ASIC issued several policies to Camarillo. However, the policy at issue contained language stating that, while ASIC was covering property damage “‘Property damage’ . . . which commenced prior to the effective date of this insurance will be deemed to have happened in its entirety prior to, and not during, the term of the insurance.” In other words, the policy would only be triggered if property damage “first occurred” during the policy period.

ASIC’s argument was that the Moghadams had not shown when the property damage first occurred, and therefore, unless the Moghadams showed that property damage first occurred during the policy term, there was no coverage.

The Court of Appeal disagreed, holding that it is a “settled rule” that “an insurer on the risk when continuous or progressively deteriorating damage or injury first manifests itself remains obligated to indemnify the insured for the entirety of the ensuing damage or injury.” In other words, while the Court didn’t expressly say it in so many words, ASIC’s policy was contrary to public policy.

4. ICSP is barred from recovering under Insurance Code Section 11580 because Camarillo didn’t satisfy its self-insured retention

ASIC’s fourth and final argument was that Camarillo didn’t satisfy it’s self-insured retention, which ranged from $15,000 to $50,000, depending on the type of claim, ASIC further stated that because the payment of self-insured retention was a condition precedent of coverage, no coverage existed and no claim could be made by ICSP under Insurance Code Section 11580. I’ve got to hand it to ASIC’s attorneys for creativity.

The Court of Appeals again disagreed, but this time, didn’t need to rely on a public policy argument. The policy language in question specifically stated that no coverage would be provided if ASIC requested that Camarillo pay its self-insured retention and Camillo failed to do so. There was no evidence, explained the Court, that ASIC ever requested that Camillo pay its self-insured retention. Thus, held the Court, ASIC’s reliance on the language as a defense to ICSP’s claim under Insurance Code Section 15580 was moot.

ASIC made other additional arguments as well, but because they weren’t raised during the underlying summary judgment motion,  the Court held that these arguments were “not before the court.”

Epilogue

The Insurance Company of State of Pennsylvania case is an interesting one, involving a statute I wasn’t intimately familiar with, and some creative defenses. When I asked my colleague Gary Barrera, an insurance attorney at the firm, he said, “Well, we could see the foreshadowing of that ending a mile away!” The moral of the story?  I’m glad I’m not an insurance claims attorney.

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